Good morning, ladies and gentlemen, and welcome to the Turning Point Brands Third Quarter 2016 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. Now I'd like to turn the conference over to Mark Stegeman. Please go ahead, sir. .

Thanks, ma'am. Good morning, and thank you for joining our call. I'm Mark Stegeman, Chief Financial Officer of Turning Point Brands. As is customary, today's call is being recorded and will be available on our website. Earlier today, we issued a press release outlining our 2016 third quarter results.

You can access that release from the IR section of our website, www.turningpointbrands.com. On today's call, we will review our third quarter results and a few other things that we'd like to highlight. And after that, we'll it open it up to Q&A..

Participating with me today on the call our Turning Point Brands President and CEO, Larry Wexler; and Jim Murray, Senior Vice President of Business planning. Today's remarks contain forward-looking statements and projections of future results.

I direct your attention to the forward-looking and cautionary statements disclosure in today's press release on our website and the Risk Factors in our filings with the Securities and Exchange Commission for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements.

These forward-looking statements and projections are not guarantees of future performance and should not place undue reliance upon them. Except as provided by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements. .

We may also discuss today certain non-GAAP financial measures. These measures and reconciliations to the GAAP information along with the reasons management believes they provide investors with useful information regarding the company's financial condition and results of operation are set forth in the press release. .

I will now turn the call over to Larry Wexler, our Chief Executive Officer. .

Thank you, Mark, and good morning to everyone on the call. I'm excited to discuss our third quarter results. We saw the company generating near-record net income and growth in retail market share in chew, MST, cigar wraps and cigarette papers.

This morning, I will discuss the factors affecting third quarter and year-to-date results and later Mark will break down the financials and review the positive changes taking place in our balance sheet. .

But first, I want to discuss an acquisition we announced last Friday that emerged from our strategy to pursue attractive consolidation opportunities in a fragmented OTP market. We signed an agreement to purchase 4 strong regional chewing tobacco brands and a twist tobacco brand from Wind River Tobacco Company of Springfield, Tennessee.

The acquisition of these brands will boost our chewing tobacco market share by approximately 2 points to around 27%. .

Most importantly, the transaction provides a plug-and-play opportunity to drive future growth. We can leverage our core competencies and sales force execution to further expand a retail footprint of these brands. Currently, the brands are only available in approximately 25% of the U.S.

chewing tobacco market, primarily concentrated in the Central and South Atlantic regions. .

For the quarter, Wind River had a 2.2 market share, up 0.3 points from the prior year. Importantly, the Wind River chew brands command a 1/8 share in stores in which they've achieved distribution, as measured by MSAi.

So when I talk about retail brands that have compelling consumer equity that could be expanded, this is a great plug-and-play illustration. There's lots of upside. The acquisition was attractively priced at approximately $2.5 million, and we expect future operating margins to reflect the strengths of the brand.

The transaction fits into our thesis of acquiring brands or companies which may not been willing or able to address the evolving regulatory landscape on their own. We expect the transaction to close in the next few weeks. .

Now let me address the third quarter, update you on factors that influence results and highlight the organic opportunities we see on the horizon. From an operating standpoint, we had a solid quarter. Net sales were $51 million and gross profit was $24.6 million, generally in line with second quarter results.

Third quarter net income was near record at $6.8 million. Our 4 largest product lines, chewing tobacco, Moist Snuff, cigarette papers and Make-Your-Own cigar wraps, all gained MSAi retail share.

The quarter was solid even though period comparisons were sorted by timing of a major trade show that we discussed last quarter, which pulled an estimated $1.3 million in sales into second quarter and also by 1 less shipping date compared to last year. .

For a perspective, the year-ago quarter in 2015 was an exceptionally strong quarter. I'm very pleased with the quarter and our first 9 months results. To provide some perspective, year-to-date, we achieved mid-single-digit sales increases and margin expansion in the core tobacco portfolio.

The smokeless segment had $18.9 million in quarterly sales, representing 37% of total company sales and grew 1.2% over 2015. Our smokeless growth for the quarter was restrained by the second quarter trade show impact I mentioned earlier, the anniversary pipeline volume of Stoker's MST can introduction and 1 less shipping day.

While the industry MST volumes grew in the low single digits, Stoker's MST shipments to retail grew in the high single digits according to MSAi. This resulted in yet another record share of 2.7%. The continuing rollout events, Stoker's MST cans boosted its overall retail presence to over 45,000 retailers, a 50% increases versus year-end 2015.

With over 200,000 stores selling MST products, growing distribution, particularly in change, continue to be priority for our sales force. .

In the chewing tobacco category, Turning Point increase market share, while industry volumes fell 5%. As you know, we operate primarily with an asset-light model and have very low CapEx. The exception has been Stoker's MST product that we manufacture with proprietary process.

To accommodate the continued growth of Stoker's MST, I'm pleased to announce that on October 28, we purchased our previously leased manufacturing facility in Dresden, Tennessee for $1.3 million.

The ownership of the facility provides additional flexibility for expansion, to continue to meet growing consumer demand and also to protect our proprietary manufacturing process that makes Stoker's the differentiated and superior product that consumers tell us it is. .

The smoking segment was solid with $28.8 million in net sales, representing 57% of the company's net revenues. Sequentially, sales were $2 million higher than the second quarter and 1.5% less than a year ago. The rollout of Zig-Zag Make-Your-Own cigarillo size wraps continues to go well, resulted an increase MYO cigar wrap market share.

Zig-Zag also increased share in cigarette papers. Industry cigarette paper volumes declined by low single digits, while the company's MYO cigar wraps -- industry's MYO cigar wraps increased by double digits according to MSAi. .

Comparing third quarters year-over-year, the increase in Zig-Zag MYO cigar wrap sales this quarter was offset by the timing of both Canadian cigarette paper and U.S. promotional paper orders as well as sales declines in cigars.

Again, to summarize, in our core tobacco portfolio, which includes smokeless and smoking, net sales grew in the mid-single digits, and while we also expanded margins to 50.5% for the 9 months ending September. .

The NewGen segment is our smallest segment, but one we believe presents future opportunity. Segment net sales were $3.3 million, up modestly relative to the prior quarter and up $300,000 against the third quarter of 2015.

The third quarter introduction of the Primal branded herbal-based non-tobacco non-nicotine cones and wraps contribute to the improving sales trend, but still too early to assess consumer adoption. .

Volume vapors continue to move away from traditional retail outlets, where Turning Point had traditionally focused its sales efforts. They're going to alternative shops where we're building our sales infrastructure. Internationally, our sales efforts are focused on the Primal, Stoker's and Zig-Zag brands.

While modest, they're producing gains in several geographies including Canada, South America and Europe. As a reminder, we have slowed the pace of some of our other planned introductions to continue to focus on Stoker's MST and the Zig-Zag rillos launch and support our acquisition activities. .

Before I turn the call over to Mark to discuss the results and our financials in more depth, I want to make sure I emphasize positive impact of our May IPO had in reducing our debt, with leverage now under 4x.

The reduction in interest expense has allowed us to use our strong stable cash flows to pursue acquisitions, invest in our infrastructure and focus on the factors that build long-term shareholder value.

While I'm exceedingly pleased with our transformation, including the ability to initiate our acquisition strategy and drive the expansion of our sales force, which is up around 9% versus a year ago, we are still a work in progress. We're on our way, but we're not there yet.

Growth of my ingoing expectations, I would characterize our progress as being on plan, but we are an insatiably hungry team. .

With that, I'll turn it over to Mark. .

Thanks, Larry. This was yet another milestone quarter for Turning Point Brands as we delivered near record net income, strong operating results and began successfully executing against our consolidation and acquisition strategy.

As we've consistently mentioned, our quarterly results can be a bit volatile and we remain focused on long-term trends, genuine consumer satisfaction and long-term value creation for our shareholders. Therefore, I will focus most of my attention on year-to-date results. .

Now overall for Turning Point Brands, our sales for the quarter were $51 million and net sales for the 9-month period increased 1.3% to $152.4 million. Gross profit for the quarter was $25.4 million, and for the 9 months was up 2.1% to $74.1 million.

Gross margin in the quarter was 48.3% and for the 9 months expanded 30 basis points from a year ago to 48.6%. SG&A expenses for the quarter were $12.7 million compared to $11.8 million in the 2015 quarter. Let me walk you through the third quarter SG&A expenses so that you have a full appreciation of the ins and outs for each quarter. .

Reported third quarter 2016 SG&A was $12.7 million, which included $900,000 in non-recurring which was $300,000 higher than a year ago. $200,000 in recurring public company costs, which we did not have a year earlier; and three, expenses for strategic initiatives were unfavorable in the quarter by $400,000.

SG&A expenses for the year-to-date period were $40.6 million versus $39.4 million.

For the 9 months, SG&A expenses included $1 million in nonrecurring launch costs, which were favorable to a year ago by $0.5 million; $500,000 in strategic initiatives, which were favorable versus 2015 by $1.7 million; nonrecurring expenses related to the year ago warehouse reconfiguration were favorable by $400,000; and lastly $400,000 in nonrecurring -- excuse me recurring public company costs, which we did not have a year earlier.

Interest expense for the quarter was $5.5 million compared to $8.7 million a year earlier. For the 9 months, interest expense was $20.9 million versus $25.7 million in the comparable period.

We estimate that with our lower debt profile, post-IPO that our current financing arrangements will result in annual interest expense of approximately $18 million. We continue to explore opportunities to further reduce interest expense. .

Net income in the quarter increased $2 million to $6.8 million, and increase $3.1 million to $9.8 million for the 9 months. Adjusted EBITDA was $13.7 million in the quarter versus $14.1 million in last year's strong comparable quarter. For the 9 months, adjusted EBITDA was $39 million versus $39.4 million a year ago.

Fully diluted weighted average shares outstanding for the quarter were $19.7 million and fully diluted earnings per share were $0.34 for the quarter. .

Now moving back to some highlights on the segments. First, focusing on just the core tobacco portfolio, which includes our smokeless and smoking segments. The combined net sales there grew 1.3% in the quarter and 4.1% for the 9-month period.

Gross profit for that combined tobacco portfolio declined by 1.1% for the quarter to $23.8 million and was up 5% for the 9 months to $71.9 billion. Gross margins for the combined tobacco portfolio for the quarter contracted 20 basis points from a year ago to 49.9% and expanded 40 basis points to 50.5% for the 9 months. .

Now a couple highlights on each of the segments. Starting with the smokeless segment. Net sales from the smokeless segment are up 7.4% for the 9 months to $58.9 million. Gross profit grew by 59 -- excuse me, 5.9% to $29.5 million on the year-to-date basis.

For the 9 months, gross margins decreased 70 basis points from a year ago to 50% as the mix in sales continues to shift from chew to moist. As Larry mentioned, Stoker's MST generated high single digit volume gains and MSAi shipments to retail in the quarter. And we've increased our MST cans retail penetration by another 5,000 stores in the quarter.

As a result of the Stoker's MST sustained momentum, we took the opportunity, as Larry mentioned, on October 28, to purchase our previously leased facility to provide operating flexibility.

You will recall that we have a proprietary manufacturing process that we believe makes a superior product and a $1.3 million investment protects our ability to deliver our high-quality Stoker's moist product. This is an unusual exception to our historical CapEx requirements. .

Our base smokeless business remains strong, as TPB grew third quarter share in both chewing tobacco and moist. The addition of the soon-to-be-acquired Wind River brands will add incremental margin and the opportunity to expand the retail distribution footprint of these brands. Now turning to smoking.

Smoking product net sales year-to-date were up 1.9% or $1.5 million to $83.4 million versus the preceding year. As a reminder, TPB grew share in the quarter for both cigarette papers and MYO cigar wraps. Year-to-date, smoking gross profit increased 4.3% to $42.4 million.

Gross margins on a 9-month basis expanded 120 basis points from a year ago to 50.8%. .

Onto NewGen. While we presently -- is a small piece of our company, we continue to believe that there are significant opportunities given the shifting category and channel dynamics. As you know, the traditional channel for the paper business has been a dynamic and turbulent place to be, to say the least.

NewGen net sales on a 9-month basis are down $3.7 million to $10 million. Importantly, we are seeing the NewGen declines moderate, as demonstrated by much more stable quarterly sales over the last 5 quarters, where they have ranged from a high of $3.6 million to a low of $3.1 million.

Year-to-date, NewGen gross profit eroded by $1.9 million to $2.3 million. Gross margin for the 9-month period decreased to 22.4% from a year ago due to the ongoing channel dynamics resulting in heightened returns as the trade adjusts inventory levels to the new lower traditional outlet demand. .

Moving to some other metrics for the quarter. Net debt at quarter end was $196.7 million, a decrease of $7.4 million from the preceding quarter due principally to strong operating cash flow, resulting in the paydown of the ABL revolver, which had a 0 balance at quarter end. Net debt decreased $91 million from December 31, 2015.

Our NOLs available to offset taxes amounted to $39.7 million at September 30. Our master settlement agreement accounts totaled $31.9 million at quarter end. Our CapEx for the quarter was $400,000 and $1.2 million for the 9 months ended September 30. But as a reminder, we purchased our Dresden manufacturing facility after quarter end for $1.3 million.

So for 2016, we're expecting a little more than $3 million in CapEx. Moving forward, we expect to return to our historic asset light CapEx levels of about $2 million per year. .

Federal excise taxes included in our sales and our cost of good sales for the quarter totaled $5.4 million, and for the 9 months, $15.9 million. FDA fees accounted for and cost of goods sold amounted to $100,000 in the quarter and $300,000 for the 9 months.

Importantly, as outlined in our release this morning, we began paying the FDA fees on the newly deemed products including cigars and pipe, effective October 1, 2016. For the fourth quarter, we would anticipate the fees for the newly deemed products to be approximately $300,000.

Additionally, for the fourth quarter, want to note we will have 1 less shipping day than we did in 2015. Also, after the quarter and effective October 1, Pennsylvania implemented a new excise tax of $0.55 per ounce on smokeless products. Pennsylvania represents about 3% of industry chewing tobacco volumes and 6% of industry MST volumes.

And finally, on Tuesday, November 8, California voted to approve state excise tax increases on a variety of tobacco products. In addition to the $2 increase on cigarettes effective April 1, 2017, they will be increasing state excise taxes on OTP as well, OTP being Other Tobacco Products.

While the Board of Equalization has not yet defined the OTP increase, the industry estimates that will result in an increase from roughly 27% of wholesale cost to 65%. Importantly, excise taxes will now be extended to vapor and cigar wrap products as well. .

So in summary, our year-to-date results are encouraging and our financial condition dramatically improved as a result of the May IPO.

We are now focused on using our improved financial flexibility to invest in our sales force, to continue new product development and to capture additional revenue and margin through acquisitions that are highly accretive, all to build long-term shareholder value. .

With that, I'll turn it back over to Larry for a few final comments before we turn to Q&A.

Larry?.

Thanks, Mark. As we wrap up, I would like to leave you with some key takeaways about company and opportunities ahead. Our core tobacco portfolio is performing exceptionally well as we drive not only Stoker's MST, but also Zig-Zag in the smoking space.

Our sales staff expansion and product investments are poised to generate long-term organic net sales growth. The brands acquired from Wind River provide immediate market share and the potential to expand beyond the 25% of markets where it's presently sold. .

We think there are great opportunities remaining for consolidation in the OTP industry. The products of smaller company facing FDA uncertainty can benefit from the strengths of our team of regulatory professionals, brand managers and our sales force.

We continue to focus on increasing our financial flexibility by reducing debt with a target net debt adjusted EBITDA of 2.5x to 3.5x. As mentioned earlier, we are presently under 4x. We believe we have the right strategy at the right time to grow our business.

We're an innovative and nimble company, pursuing targeted long-term growth, ultimately by delighting consumers with truly great products. We appreciate your participation in today's conference call. .

And with that, I'll open the floor up for questions. .

[Operator Instructions] Our first question comes from Vivien Azer of Cowen. .

Just wanted to start off on the transaction, please.

And if you could give us a little bit of color on how we should think about the impacts, both to the top line as well as to gross margin?.

Vivien, as we've talked in the past, we basically have a acquisition strategy that has 3 sort of targets. The first is plug-and-play products that we can easily take -- put on our price list and start distributing them, take away out some of the overhead and immediately increase the profitability of those products.

That fits in that particular -- this acquisition fits in that particular activity. Second one is the brands with -- that have a strong presence in regional parts of the country that have lacked the national distribution or widespread distribution. We think these brands do. They have 1/8 share in the stores in which they sell.

And we believe that there's upside in taking these brands into new stores and new geographies. The third one is that snap on infrastructure to get us into new channels and new markets. This one does not fit that criteria. So basically, it fits 2 out of the 3 criteria. This is a relatively small acquisition even for a company our size.

The point is not the size. The point is that these are brands that we believe have some growth potential and we think will provide some very nice returns considering the size of the investment. .

Okay, that's helpful.

But just to circle back on that, can like you quantify at all like what we should expect of each in terms of impact on the top line or to margin, please?.

Yes. We've got -- okay, just to give you just an order of magnitude. The sales that we're picking up over the last 12 months were a little less than $3 million. And as we don't disclose margins on any individual product groups, their margins run a little bit less than our current margins in that area. .

Perfect. That's exactly what I needed.

On the purchase of the MST manufacturing, how do we think about that in terms of the margin profile for the segment going forward?.

Okay. Well, obviously, we'll be staying in the current facility. So there's no impact on operations. The way to think about it is that lease cost will go down and we'll be picking up some noncash depreciation and some interest expense.

The interest on the facility is roughly in line with what our current lease payments are, so is the way to think about it.

Does that give you the answer to your question?.

Yes. Depreciation being right around 50,000 a year. .

Okay, got it. And then... .

Let me just add -- Vivien, I'm sorry, let me just add something to that. The important thing is it really gives us flexibility to lay the place out, lay the factory out the way we want to and to make some changes to it, which the former owner was not particularly cooperative with. So this does gives us some operational flexibility. .

Yes. And we've got great group of very productive employees down there that really do a super job [indiscernible]. .

Got it. That's great. And then, on NewGen, clearly the industry kind of adjustments or shift in consumer purchase behavior continue to impact your business. You called out Primal as having contributed in the third quarter.

So I was wondering if you could offer some color on how big of a benefit Primal was, just so we can have a better sense of what the underlying business is actually doing?.

The rollout started midway through the third quarter. You're really talking about pipeline level quantities. So it wasn't particularly material. For -- compared to the overall company sales. .

Okay.

But the NewGen segment did post higher net sales on a sequential basis, so I'm just curious what was that all Primal?.

Okay. I see where you're coming from. Think about it as roughly $0.5 million, maybe a little bit less. .

Okay. Got it. And just last one, a housekeeping item. Mark, you called out 1 fewer selling day in 4Q.

You also had one fewer selling day in 3Q, so as we kind of look back at our model, where were the extra selling days?.

Vivien, it's Jim. We didn't look back to find that because we found it peculiar also. But there obviously -- for the year, we're down 1 day, so there was 1 extra day. My guess is it was in the second quarter. And as we try and get better on this, we'll be -- as we discover these things, we disclose it here. My guess is we had in the second quarter.

I can certainly follow back up. Yes. So there is 1 less for the year versus '15. .

[Operator Instructions] Our next question comes from Susan Anderson of FBR. .

It was nice to see the Primal rollout too. I was wondering if you could talk about how many stores it's in now in the U.S., and I assume it's in Canada too.

Also, I've seen some pretty good reviews online, any early thoughts on how the consumers are responding to the product? And then also, maybe if you could give us some color around the margin differences versus your other products?.

Okay. So I can give you some qualitative answer and we consider this grandmother research, which we don't put very much weight into it. The feedback from the sales force is that the products were pretty well received by the trade and the little consumer feedback we've gotten has been positive. But the people who don't like it don't always talk to you.

So we're not putting a lot of weight on that at this point. In terms of number of stores, quite frankly, we didn't grab that number. We can follow up with you and get you that if you're interested. .

Yes. It's not going to be all that significant really. It's initial pipeline volume. We don't have any feedback on consumer adoption. We'll get a better flavor of that in Q4. .

Got it.

So I guess, it seems like there's still a lot of opportunity to roll it out to additional stores going forward?.

Yes. We're just in the beginning, Susan. This is -- it started in the mid-quarter. And as we talked about on past calls, it takes us 9 to 18 months to roll out a product, just given the size of our sales force. .

Got it. Okay. .

To answer the balance of the question, Susan, the margin, we don't disclose margins as the segment level or anything like that. But the margins are a little bit stronger than we have in our cigar wraps business. .

Perfect. And then, on the other NewGen products, so the e-cigs and stuff, it looks like then based on the Primal $500 million or so, it looks like -- or $0.5 million, it looks like maybe e-cigs have improved now in terms of the bleeding.

Do you think it's getting better from here now?.

I think if you look back over the last 4 or 5 quarters, it's sort of in a range, in a fairly stable range. .

Yes, that's right. .

There is continued shifts out of traditional retail to the alternative channels. And layered on top of that, there has been some -- a lot of competitive activity from some of the large tobacco companies. So all in all, it's -- within that context, it's pretty stable. .

Got it. Okay. .

Susan, I think it's right to characterize it as it does begin to show some stability there. I think the issue that we're facing in the numbers that we print is that we're still facing higher than historic return rates that we called out in the release. And we're hoping that those and expecting them to moderate further.

But that's what's the remaining issue right now. I don't think it's consumer demand at this point. .

Got it. Okay.

And then any additional color or new thoughts around kind of going into the accessories channel or any inroads, I guess, that you guys have made into there, any thoughts around that?.

Yes, we're currently portioning a share of our calls against those channels, which we're making some progress. It's not as fast as I would like at this point. But we're learning a lot and we're getting better at it as we go forward. .

Got it. And then last one just the acquisition pipeline. It sounds like there's a lot of opportunity out there.

How should we think about after, I guess, you've probably had some time to review what opportunities there is out there, just kind of the segments where you see the biggest opportunity going forward?.

OTP is a pretty diversified marketplace and we see opportunities across almost the entire spectrum. We're just now just trying to sort through which ones we think would have the biggest impact on the company and with the biggest long-term potential. So we're active, just don't want to talk any more about it at this point. .

This concludes our question-and-answer session. I'd now like to turn the conference back to Mark Stegeman for closing remarks. .

Thanks, everyone, for joining today's call. .

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..