Good morning, ladies and gentlemen, and welcome to the Turning Point Brands Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Louie Reformina, Chief Financial Officer. Please go ahead..

Thank you, operator. Good morning, everyone. This is Louie Reformina, Chief Financial Officer. Joining me are Turning Point Brands’ President and CEO, Yavor Efremov; Graham Purdy, Chief Operating Officer; and Summer Frein, Chief Marketing Officer. This morning, we issued a news release covering our second quarter results.

This release is located in the IR section of our website, www.turningpointbrands.com. There is also a presentation which we will be referencing on the call available on the slide. Turning over to slides of the presentation.

During this call, we will discuss our consolidated and segment operating results and provide a perspective on our progress against our strategic plan. As is customary, I direct your attention to the discussion of forward-looking and cautionary statements in today's press release and the risk factors in our filings with the SEC.

On the call today, we will be referencing certain non-GAAP financial measures. These measures and reconciliations to GAAP can be found in today's earnings release, along with reasons why management believes that they provide useful information. I will now turn the call over to our CEO, Yavor Efremov..

Thank you, Louie. Good morning, everyone, and thank you for joining our call. I have now been with the company for 2 quarters and wanted to start by sharing some thoughts on what I have seen so far and areas where we see opportunities.

In terms of immediate steps in light of the turbulence we saw in the quarter, and continued uncertainty, we have taken a number of cost control measures on the OpEx side and have restructured our CapEx plan to protect our cash flow for the year.

We continue to review the company for areas where we can improve on cost or delayed spending without putting future performance at material risk. While all steps are necessary given the current environment, I'm happy to report that there are significant growth opportunities ahead of us.

We have done more work on the areas we've highlighted in prior calls, and I wanted to give you an update on what we are seeing so far. First, we have done quite a bit of analysis to understand the alternative channel, which we define as head shops and dispensaries.

We believe that the target addressable market for the Alt Channel relative to the current product types we engage with is roughly the same as the measured channel.

While there are fewer dispensers and head shops than there are C stores, the velocity of product sales in the old channel is multiples of that in the C-store channel, and the availability of shelf space also allows for more of our products and accessories to be sold.

Importantly, we see the channel and its TAM growing strongly as a result of deregulation. MSAi does not measure sales in the Alt Channel, but we have utilized our own sales data along with other available market information to triangulate the estimated size, which again, we believe is similar to the size of the measured channel today.

And we expect that it will grow faster in the future. For MSAi, our share of the measured market, broadly speaking, is 1/3 between papers and cons. Based on our estimates, we have a single-digit share in the total opportunity set within the Alt Channel, which extends beyond our traditional paper products.

That leaves a large opportunity of incremental revenue that is available for us all the time. Penetrating the Alt Channel and continuing to push on the measured channel requires us to approach marketing in a different way. We recently brought Sam on board to drive that effort and to lead our talented Miami and L.A.

based teams, which have been critical to Zig-Zag's growth in recent years. I'm very excited by the initiatives she has outlined so far. While we are in the early stages, we believe that we can highlight the superior quality of our products and drive greater market share while at the same time realizing attractive returns.

As we increase our profit and penetration, we will continue to keep an eye on marketing costs to ensure that we realize a decent ROI. Second, we have historically underinvested in technology. As many other companies have shown, leveraging the right technology can drive the top line and allow us to control cost.

Specifically, we are looking to expand our CRM functionality to allow us to better track both performance and opportunities in the market and allow us to pivot quickly to respond to market dynamics. Moving from a cell-based solution to the full power of a modern CRM should help us drive the top line in ways that are not available to us today.

As discussed on our prior calls, we are replacing our 4 existing ERP systems with a single fully integrated ERP.

Over time, we expect significant efficiencies on the cost side from the implementation of the new system both in terms of eliminating the excess costs associated with maintaining outdated systems and manual processes as well as significantly better visibility into our business functions and better control our processes that should lead to better performance.

Summing it up, I'm even more optimistic now than when I joined. I will continue to review the opportunity set both for ways to drive revenue and to find initiatives to reduce costs, so we can grow the company. Turning to the quarter. While we experienced uneven results during the second quarter, we are pleased with the resilience of our business.

Rising prices at the pump and heightened the inflationary environment had an impact on consumer traffic in convenience stores. Zig-Zag overall had a stable quarter against the tough comparable period in the previous year.

Continued proliferation of the cannabinoid market combined with our new initiatives and new products, e-commerce DTC and targeting the outpace is offsetting the impact of recent inflationary pressures on consumer demand and tail off of COVID-related consumption. Our U.S.

Papers and E-commerce business delivered another strong quarter of double-digit growth that was offset by a decline in our reps business, which faced a tough comparable with the pull forward of sales in the previous year. Stoker's MST and loose-leaf business saw strong share gains during the quarter.

With its value proposition, Stoker's was well positioned for the consumers looking to trade down during the quarter. The FDA has accepted our pre-PMTA filing, and we look forward to continuing to supply our white pouch products to our consumers.

Meanwhile, NewGen navigated another challenging quarter but remained profitable despite a 45% decline in sales.

On capital allocation, we continued to buy back shares during the quarter and maintain a strong balance sheet for further capital deployment along with our priorities, which continue to be investing in the company, buybacks and accretive M&A. Going forward, we maintain a favorable outlook as Stoker's and Zig-Zag continue to be well positioned.

We are, however, mindful of the uncertainty in the economic environment and consumer confidence driven by the continued inflationary environment. With the current economic backdrop, along with the volatility we experienced during the second quarter, we have adjusted our outlook for the remainder of the year, as stated in today's press release.

With that, let me turn the call back over to Louie to go through our results..

Thank you, Yavor. Starting with our consolidated results on Slide 4. Q1 sales were down 16.1% to $102.9 million with stable results from Zig-Zag and Stoker's offset by a double-digit decline in NewGen. Gross margin increased to 110 basis points driven by mix from a decline in lower-margin NewGen sales.

Adjusted EBITDA was down $5.3 million year-over-year, with most of that decrease coming from the decline in our vape distribution business. Going over into segment performance, Slide 5 on Zig-Zag. Zig-Zag sales declined 2.1% year-over-year to $46.2 million with a 2.3% volume decline offset by 0.2% from price mix.

Wraps revenue was down 22% year-over-year due to an industry decline in the HCL Wraps category partially offset by growth in natural leaf wraps. As a reminder, we did have a pull forward of sales of $2 million in the previous year second quarter which affected the comps.

In addition, the trade was building up inventory in the first half of last year but brought down inventory during the first half of this year, as a result, the category saw a double-digit decline this year per MSAi. Our U.S. Papers and E-commerce business was up 10% year-over-year driven by growth in E-commerce and Paper cone sales.

E-commerce was up 84% and now represents 23% of the subsegment with strong growth expected for the rest of the year. Sales of cones products was up 59% and now 25% of the subsegment. Zig-Zag remains the number 1 premium and overall paper in MSAi measured market with 32.4% share.

Zig-Zag was the number 2 brand in the paper cones category in the MSAi measured market with 32% share. Cones continues to remain a large opportunity with only 1/3 of stores receiving paper products also receiving cones during the quarter in the MSAi measured market. The paper category saw a decline in the market in MSAi measured market down 8.6%.

Canada was up 38% for us during the quarter due to a load-in of new products and a full quarter from the DVW acquisition. The cigars and other subcategory grew 48%, with growth in our Cigars business and the addition of $0.2 million sales from Wild Hemp that was previously recognized in NewGen.

Gross margins declined 160 basis points during the quarter driven by higher growth in lower-margin products like paper cones.

Operating margin declined for the quarter and that was due to a decline in the high contribution margin wrap sales, a gross margin decline, variable costs from increased B2C e-commerce sales and the impact from the DVW acquisition as part of TPB Canada. Our marketing team continues its pressure to strengthen its Zig-Zag brand.

Its partnership with luxury fashion line Emery for its Spring 2022 collection led to tens of millions of impressions from organic social media posts, including from musicians like French Montana and Mick Jagger, and athletes like NFL Star CeeDee Lamb and FIFA athlete Trent Alexander Arnold and the Liverpool Football Club.

The fundamental long-term drivers for the segment remain intact as legal recreational cannabis continues to drive growth in sales at the store count in the Alt Channel. Turning over to Slide 6. Stoker's products net sales increased 0.7% to $33.6 million in the quarter, with a 6.1% volume decline offset by 6.8% from price mix.

Net sales for the MST portfolio grew 6% and represented 65% of Stoker's revenue in the quarter. That was up from 62% in the year earlier. Category volume was down 5.7%, whilst Stoker's was up [2.3%] as its share grew 50 basis points year-over-year to 6.3% during the quarter.

And its share in store selling was up 50 basis points to 9.8%, with Stoker's now in stores representing 64% of industry volumes, still provides a long runway for growth. Chewing tobacco sales declined 10% from the previous year. The category was down 7.1% during the quarter.

Stoker's Chew was the number 1 chewing brand in the quarter, gaining 150 basis points of share to 27.5% share according to MSAi. Despite softening industry demand in general during the quarter, Stoker's performed well as its value proposition products resonated well with consumers especially in the current inflationary environment.

FRE contributed $0.2 million in sales during the quarter, with sales negatively impacted ahead of the PMTA submission during the quarter but is expected to ramp again in the second half.

Gross margin decreased 60 basis points due to FRE inventory write-down but increased 80 basis points excluding FRE with MST price growth and incremental volume offsetting loose-leaf decline. Operating margin decreased 160 basis points with higher gross margin partially offset by higher sales costs, marketing costs in FRE and increased shipping costs.

Moving to Slide 7. NewGen continued to manage through a disruptive environment with sales down 45.1% from the previous year to $23.1 million. Our vape distribution business continues to be disrupted by the regulatory environment, including the implementation of the PACT Act late last year.

Gross margins were down 340 basis points impacted by product and channel mix as well as in the competitive environment. Operating income was down $1.1 million due to lower sales and higher freight costs offset by lower variable SG&A and reallocation of shared costs into the corporate segment.

As a reminder, NewGen results here are now a cleaner representation of our vape business, which remain profitable despite this challenging environment. We are still leading progress from the FDA on our PMTA and continue to adapt our business based on the changing dynamics in the industry.

We are happy to report that our FRE application was accepted last week. Again, this is part of the Stoker's segment, but it was a positive development in our PMTA applications.

Ultimately, we still believe that all the short-term challenges presents an opportunity for us in the long term given our size and ability to navigate this regulatory environment. Turning now to Slide 8, our balance sheet and liquidity.

We ended the quarter with over $107 million of cash on the balance sheet and $129 million of available liquidity, providing flexibility in capital deployment. Q2 is generally our weakest free cash flow quarter. This is when we do our annual tobacco purchase for our MST business.

We also front-loaded purchases for Zig-Zag products this year given transportational -- transportation bottlenecks and expect that to bleed down through the second half of the year. We repurchased 8.8 million of shares during the quarter. Turning over to Slide 9.

Due to the uncertain macro environment, slower than expected improvement in our NewGen products segments, we now expect the following results for the year. Zig-Zag product sales of $193 million to $200 million compared to previous expectations of $193 million to $203 million primarily due to the Q2 weakness in our wraps sales.

Stoker's product sales of $127 million to $133 million and consolidated adjusted EBITDA of $97 million to $103 million. We now expect CapEx to be roughly $10 million this year. This excludes ERP and CRM projects, which we're in the process of selecting an implementation partner.

We are still in the process of choosing an implementation part of ERP and CRM and should be able to provide more color on that in the next call. In addition, we are also projecting approximately $6 million of P&A spend, which includes supplemental filings for new products including our FRE nicotine pouch. Thank you for participating in the call today.

And with that, I would like to open the call for questions..

[Operator Instructions] And we will take our first question from Vivien Azer with Cowen..

So maybe we can just start with the Stoker's segment. Generally in line with our expectations just given the transparency in the category, but I was wondering if you could provide perhaps a post-quarter update. Gas prices have been on the decline for nearly a month now.

Obviously, your core consumer is very sensitive to inflationary swings particularly at the pump.

Has there been any directional change since you closed the quarter?.

So this is Yavor. Look, kind of just from a foot traffic perspective, I would say that, obviously, we've seen a lot less foot traffic. We think the consumer got impacted quite severely. And we're seeing that the reduced foot traffic obviously translated. That being said, I think Stoker's performed extremely well.

So if you look at it on a share basis, we've gained share in a very strong way, and we continue to expect that to continue as the consumer trades down. So we are very happy with how Stoker's performed. Again, we have positioned as the value brand, and we deliver portfolio amount of money that we charge, we deliver great quality.

I think the consumer has recognized that and we're seeing the shift benefiting us..

And has there been any change in terms of retailer receptivity to increase shelf placement for Stoker's given the inflationary backdrop?.

Vivien, this is Graham. Look, we've continued to make store gains consistent with our historical patterns. At this point in time, receptivity, buyer estimation has not changed for our product. Both our tubs and our cans are growing store counts..

Okay. Understood. And perhaps just pivoting to Stoker’s, where you’ve tempered the high end of the guidance range, recognizing there are a lot of moving pieces to that business.

But maybe if we could just put a macro lens on the nature of that guidance revision and just remind us, how does a compare to competitors in terms of price point? Do you think that this is just a consumer response to inflationary pressures? Or is there anything beyond that to read into?.

Vivien, in the guidance reduction, a lot of that related to the weakness that we saw in wraps during the quarter. And as we mentioned in the remarks, some – a lot of that related to trade inventory reduction in response to slowing demand. So I do think we are seeing a little bit of caution from the consumer given the rising gas prices.

And we’re seeing that across different categories..

And just to add to that, Vivien, one thing that I would continue to stress is, even in the overall macro environment, the brand continues to perform very, very well. So we’re not – it’s not so much concern around our performance of the brand.

It’s more concern for the consumer overall and what we’re seeing as being a very harsh environment for our consumer. But we do expect to continue to gain share. We do expect the brand to continue to perform very well..

And we will take our next question from Susan Anderson with B. Riley..

Louie, Yavor, Graham, it's Alec Legg on for Susan. On Stoker's, the gross margins, when you exclude the write-down of FRE, they continue to trend up. And I think previously, you said that it's mainly been driven by taking price in that category.

But in this inflationary environment, I guess, how much pricing is left to take before you might start to see more pushback in that category?.

Okay. Yes, so we still feel pretty good about pricing in Stoker's. Obviously, as we've said in the past, we are price followers in that segment. And what we are seeing in the market is pretty encouraging in terms of activity on the pricing segment.

Obviously, we're not the only ones to feel inflationary pressure in this environment, and it seems to be holding up to be a rational category for us..

And just to expand a little bit on that one, what I would say is, look, we have to measure price increases again. We see the consumer under tremendous pressure. At the same time, we are gaining share.

And one thing that we have noticed in the past is that given the quality of our products, once we get a customer, we tend to keep that customer, so gaining shares is something that we take very seriously. It is not a onetime and then goes back, we get our customers and then we keep them. So we are balancing the ability to increase price.

Again, we are price follower, but there is room against the long-term benefit of keeping and increasing share..

Got it. And then switching over to NewGen. You said the PMTA application was accepted but still waiting a decision.

I guess do you guys have a time line of when you might hear any news? And then can you remind us again how many products you filed for?.

So let me start by highlighting that we filed on modern oral products. That's the kind of the heavy, heavy bulk of the application. We had very little vape inside modern oral specifically. We have 2 products. One is FRE, which is the one that got accepted.

We have another product which we have not discussed publicly and I'm not going to do today, but we're very, very optimistic about it. They're both modern oral. And in terms of timing, we don't have any more visibility than anybody else. Kind of as we get news, we obviously let you guys know. So we know FRE was accepted.

Exactly when they're going to get to is very difficult to tell. But FRE is doing very well. We have a backlog that we're now filling up, so we're excited about it. I'm even more excited about the other products that we should be bringing to market hopefully next year..

And we will take our next question from Eric Des Lauriers with Craig-Hallum Capital Group..

With Zig-Zag, as you look towards the second half, are there any other inventory trade dynamics to call out with regards to wraps or your other categories? And would you expect to see a rebound in wraps in Q3? Or should we take your commentary on sort of some of your customers getting a little more cautious for the consumer here as a sign that this Q2 trade reduction was more of a normalization and that won't necessarily see a rebound in Q3?.

Yes, we think it's more of the latter. You're certainly going into the year, there were concerns about supply chain, and they likely had more inventory than they normally carry. So we think this is more of a normalization for Zig-Zag.

And where we do expect the ramp in Zig-Zag in the second half is for launching CLIPPER, so that should benefit us as that product ramps up for us. So that's happening both in the U.S. and Canada..

Great. I appreciate that commentary. And then just switching gears to NewGen here, can you comment just on the current volatility in that vape distribution business? Just kind of any sort of transparency on what you're seeing there with regards to whether it's turnover in third-party brands or some inventory flushing.

Obviously, we saw a relatively stable results quarter-over-quarter.

Is that a sign of a broader trend? Or can you just kind of give us a bit more of a sense of what you're seeing in that business with regards to volatility?.

Sure. So let me kind of start at the macro level for vape, and then I'll double click on our own business. On a macro level, obviously, the federal government has taken some steps in that area. They have been primarily about looking to increase regulation. We have not seen increased enforcement as of yet.

That being said, there were quite a bit of news in vape brand throughout the quarter which made customers nervous to the extent so July 14 was a big, big date. And the FDA put out an announcement, which obviously publicly available.

In that kind of -- so the continued uncertainty about what the FDA is going to do and how far they are going to enforce obviously impacts the customer specifically on the B2B side, where they're continuing to be hesitant about how far and what they can order because you just don't know if it's going to become illegal and you have to dispose of it the next day, which necessarily impacts how much inventory you're going to keep, how you're going to order.

And that's just -- industry-wide is just kind of giving you the color. Against that, we executed, I think, quite well. I'm very proud of the fact that the management has done 2 things. One -- number one, they have kept profitability. They continue to generate dollars for us.

Number two, we have managed inventory on that product aggressively ourselves, and we're managing inventory for the same reason. We're just kind of -- obviously, we're going to be compliant with anything and everything the FDA requires us to do.

But to be in a position where we don't have massive write-downs, we have to keep inventory low, which necessarily impacts how hard we can push the top line on that business.

So as the uncertainty diminishes, hopefully, with more clarity from the FDA, and as we said on previous calls, we are very, very supportive with strong enforcement, that should hopefully settle down in the business should be doing much better.

That being said, we don't have either the clarity or the enforcement today for us to tell you that this is going to get better in the next quarter. The uncertainty continues. We continue to have the same approach, which is, to our mind, the vape business is a cash flow paying option. So they generate cash for us.

It's not a lot of cash, but so long as they are profitable, we can wait for the vape uncertainty to get resolved and hopefully the FDA enforcing whatever the regulations end up being..

Got it. Very helpful color and certainly impressive to be able to maintain profitability in this environment. Just last one for me here.

With regards to the ERP system, can you just remind us your rough expected time line of when that should be completed and maybe when you'll start to see some of the benefits of that?.

Our current time line continues to be the same as we discussed earlier in the year, which is we expect to be complete by the end of next year. Hopefully, we'll start seeing the benefits before that. But at this point, we have not yet selected an implementation partner. We expect to do that shortly.

And we expect to kick off the implementation part of the project be solved. We have stable with the same time line we discussed before. There's no change in store..

And we will take our next question from Gaurav Jain with Barclays..

So a few questions from me and all on FRE. So what you have told us is that you booked some revenue and you also had a write-down this quarter because of the PMTA sort of deadline around synthetic nicotine. And I'm not very clear why that would happen. I mean, normally, we don't see companies pull back because of PMTA deadline.

So what exactly happened at your end?.

Yes. So we have to make a decision on which products we wanted to file. There were certain flavors that we chose not to file, and so that was the reason for the write-down on FRE.

We're encouraged we actually have a strong backlog of backorders on FRE right now, but there was a pause during the quarter because of the uncertainty around the synthetic nicotine regulation from some of our customers.

And what we're seeing now, especially with the acceptance that we perceive with FRE and strong receptivity for the product going forward..

Right. And what you have told us is that you booked some revenues this quarter, but clearly, volumes could be very different because we have seen massive amount of promotions from other players in the market.

Would you be able to share any volume data?.

Yes, we're -- obviously, for competitive reasons, we're not going to disclose the volumes. So we did disclose the sales, so that gives you an indication of what we did during the quarter. We reported our sales last quarter.

What I would say was, outside of synthetic nicotine regulation, we would have expected that -- a ramp, and we do expect that to ramp for us in the second half of the year..

On the promotional side, to your comment that it's a heavily promotional category, our approach has never been to outspend our competitors in marketing, and that is not going to change. We're not looking to go to go toe to toe with BAT and Swedish Match to find out if we can outspend them on marketing.

Our approach is differentiated product and a fantastic sales force..

Right. And you clearly have reduced your EBITDA guidance a bit here. Is it because of additional investments related to FRE? Because in the initial year of expanding that product, you will lose money most likely.

Or is it that e-cigarettes are trending below expectations? Or is it that the core business is trending below expectations? Could you just disaggregate?.

Yes. So as Yavor mentioned, we're going to be careful about how we spend on FRE. We're not looking to lose money. The good thing about that end market is a large and growing end market, and we don't need significant share to have an impact on our bottom line for that. So we're going to be very cautious about how we promote on FRE.

The real reason for the guidance reduction was, one, to your point, our NewGen business, as we highlighted in the press release, is not ramping to the extent that we thought. We're being a little bit more cautious there. The wraps hit for us in Q2, that comes at a high contribution margin because of the flow-through on that product.

And so those are 2 of the main reasons for the reduction in guidance. So also a response to kind of what we're seeing from -- in the consumer environment in terms of the headline news that everyone else is seeing out there as well..

And last question from me around your M&A philosophy. Like you spoke on -- around that a few months ago now, almost 6 months ago. And we haven't seen anything from the company yet.

So how have your thoughts evolved around M&A?.

Look, I wouldn't say that they have changed. Kind of what I said is M&A for us is going to be a game of patience. And successful M&A, we're not going to do things that we don't like. What do we like? Things that are accretive, things that fit well within our business, things that we can acquire the price that makes sense.

And one thing that I've emphasized pretty much on every call, we're going to be patient. The best M&A we could pursue this quarter was buying back our own shares, and that's exactly what we've done. And we'll continue to be following the same priorities; invest in the company, buy back shares and be very opportunistic when it comes to M&A.

It needs to make sense. And if it does make sense, we'll buy back our own shares and wait for it to make sense..

And there are no further questions at this time. I will now turn the call back to Yavor for any additional or closing remarks..

I wanted to thank everyone who joined us on the call today. And to highlight again, we have very resilient brand, we are happy with where we are, and we look forward to continue to execute on the plan and deliver for you and for the company to achieve its results and goals all the time. Thank you..

And ladies and gentlemen, this concludes today's conference call. You may now disconnect..