Earnings Call Transcript - TPB Q1 2020

Operator, Operator

Good day and welcome to the Turning Point Brands' First Quarter 2020 Earnings Conference Call and Webcast. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would like to turn the conference over to Mr. Louie Reformina, Vice President of Business Development. Mr. Reformina, the floor is yours.

Louie Reformina, Vice President of Business Development

Thank you. Good morning everyone. This is Louie Reformina, Vice President of Business Development. Joining me today are Turning Point Brands' President and CEO, Larry Wexler; Graham Purdy, Chief Operating Officer, and Bobby Lavan, Chief Financial Officer. This morning we issued a news release covering our first quarter 2020 results. This release is located in the IR section of our website, www.turningpointbrands.com where a replay of today's conference call will also be available. In this call, we will discuss our consolidated and segment operating results and provide our perspective on our progress against our strategic plans. 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 Securities and Exchange Commission. The disclosure outlines various factors that could cause actual results to differ materially from projections or forward-looking statements that may be cited in today's discussion. These forward-looking statements and projections are not guarantees of future performance and you should not place undue reliance upon them except as provided by Federal Securities Laws, and we undertake no obligation to publicly update or revise any forward-looking statements. In the call today, we will reference 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 Larry Wexler, our CEO.

Larry Wexler, CEO

Thank you, Louie, and good morning, everyone. I want to thank you for joining the call during this trying time, and hope you and your family are staying safe. Our first quarter was strong, particularly considering the disruption of all businesses across the country at the end of the quarter. We outperformed our expectations across all our major business lines. Tobacco, both Smokeless and Smoking, exceeded expectations, even after discounting for our estimates of sales pulled forward due to the current environment. We're especially encouraged by the results of our reorganization of the vape business with sales growing more than 10% sequentially each month of the quarter. That aside, our focus is on the safety and well-being of our colleagues and in the communities and customers we serve. I would like to thank our employees for the job they have done to ensure a safe working environment for each other and our communities and express how truly proud and inspired I am of the resiliency they have shown in their commitment to serve our customers' needs. As an organization, we've implemented several changes to enhance safety and mitigate risk in our work environment. For our warehouse and manufacturing operations, these include split shifts where appropriate, temperature scans, contactless hand sanitizing stations, protective equipment, social distancing guidelines, and increased cleaning and sanitation. We canceled all unnecessary travel and implemented telecommuting where possible. Like many companies, we have changed the way we communicate through increased use of video conferencing, and have implemented tele-selling initiatives throughout the salesforce. Some of these changes are proving to be rewardingly efficient and are likely to remain in place even after this crisis and lead to ongoing cost savings. We have deferred annual compensation increases for corporate employees other than those contractually required. We've also put on hold new spending commitments as we cautiously manage in this environment. Meanwhile, consumer demand for our products and brands has remained consistently strong. Our products are an important part of our consumers' daily lives. The dedication of our workforce to serve this demand has been remarkable. We have hired additional employees at our Louisville facility and implemented wage increases for our hourly employees to take care of their families in these turbulent times. We have also added capacity to manufacture hand sanitizers in three of our four facilities and donated over 100,000 bottles to hospitals, nursing homes, and first responders in our local communities. We do expect COVID-19 to impact results in the second quarter. A third-party cigarette manufacturer in the Dominican Republic temporarily closed for three weeks and is slowly ramping back up. In-person selling has been dramatically dampened, which will slow new product launches. Select budget annual and price increases will be delayed. These temporary issues are expected to be somewhat offset by our growing B2C platforms. There were a few notable trends at the end of the quarter, which we believe resulted from the stay-at-home restrictions in response to the pandemic. We believe trade-in loading benefited our sales by approximately $2 million during the quarter, split evenly between Smokeless and the Smoking segments. During the last two weeks of the quarter, our case orders for Stoker's MST cans were up over 40% from the trends earlier in the quarter. Stoker's MST tubs saw almost a 60% lift during the same period as consumers shifted to larger volume quantities during the pandemic. Some of this is undoubtedly trade loading, but so far, we have seen less of a giveback on tubs than we expected, which is a sign that consumers are trading down and volume purchasing trends in the category may be accelerating through the economic environment. Another area that saw benefit was our B2C e-commerce businesses. We saw a meaningful increase at the end of March, not only in our vape platforms, but also in our branded products websites. These trends have continued through April as consumers shift to the ease of purchasing online. We're pleased to bring new customers to our sites and look forward to serving them going forward. Turning to the PMTA process, the district court judge for Maryland agreed to the FDA's request to extend the deadline for filing from May 12th to September 9th. As we said before, we believe the PMTA process will be a major shift in the industry. Our scientific and regulatory expertise will be a major competitive advantage to help get our higher margin proprietary vape products through the process. We continue to be excited about the longer-term potential for these products in a much less cluttered market. Overall, we are pleased with our performance in the quarter. More importantly, we came together as an organization to tackle the challenges presented to us by this current epidemic. We will continue to be vigilant about the safety and well-being of our employees and we intend to make the necessary adjustments to our businesses to adapt to the changing environment. To add some more color and perspective on our quarter and the path forward, let me turn the call over to Graham Purdy, Chief Operating Officer.

Graham Purdy, Chief Operating Officer

Thank you, Larry. Let me now give you a quick snapshot of the performance from our core tobacco business. Our results were strong in the quarter driven by robust customer demand. Smokeless saw double-digit growth in the quarter. Stoker's moist snuff delivered another record share, up one full share point compared to a year ago to 4.8 with our share in stores receiving the product now at 8.5%. Stoker's moist snuff is now in stores that represent 56.6% of industry volumes. Both cans and tubs delivered significant gains during the quarter, with most of the growth driven by same-store sales gains. As Larry mentioned, we saw particular strength in our Stoker's tubs shipments at the end of the quarter. Chewing tobacco sales held flat as ongoing category decline was offset by Stoker's chew continuing to expand its share. Stoker's chew registered 22 share in the quarter, remaining the second-largest brand in the category while closing the gap with the market leader. Smoking saw double-digit growth in the quarter, led by strong double-digit growth in U.S. rolling papers and high single-digit growth in cigar wraps. In the U.S., Zig-Zag Papers remained the leading premium paper brand, increasing its share year-over-year for the third consecutive quarter. Growth was driven by strengthening our core products along with contributions from our new products, where we continue to leverage Zig-Zag's iconic positioning. Zig-Zag organic hemp papers are now in approximately 39,000 retail outlets, while paper cones and unbleached papers are now in approximately 31,000 and 21,000 retail outlets, respectively. Zig-Zag's share of the paper cone category has climbed from 5% to 27% over the last year to position Zig-Zag as the number two cone brand, while Zig-Zag Paper is the number one hemp paper brand with a 28 share. We're especially excited about the first quarter launch of our hemp wrap line, where initial trade demand has exceeded our expectations. Going forward, our recent focus on the alternative and e-commerce channels should lead to positive contributions for the remainder of the year. In Canada, we will be driving the brand further this quarter with our new recreational marketing partnership, which will facilitate our entry into the large and growing universe of dispensaries. Overall, our core tobacco business was especially strong in the quarter, with Smokeless and Smoking seeing double-digit growth. Stoker's MST expansion and Zig-Zag advances remain the engines behind continued company gains, with total tobacco gross profits up 17% in the quarter. Moving to NewGen, we completed the consolidation streamlining of our vape business under one management team last quarter. Our vape businesses performed better than expected during the quarter, showing a strong bounce from the previous quarter as we benefited from better focus and coordination from a unified management team and superior in-stock positions at key products. Our China sourcing team played a key role positioning us at the front of the queue as factories came back online in China, which allowed both our B2B and B2C platforms to satisfy surging customer growth during the quarter. We're excited about the future prospects for this business as we welcome these new customers onto our platform. In our B2C business, we saw a particularly strong rebound at the end of the quarter as customers shifted to purchasing online. On a high level for our vape business, we have successfully navigated through the disruption in the market last year and believe the trough is now behind us with the segment returning to profitability. We are now looking forward to completing the PMTA process, after which there's significant potential for our proprietary brands. In our NewX business, our full lineup of new CBD on-the-go products, including gummies, tinctures, and shots continue to expand retail presence, now over 6,600 retail stores. Additionally, we added caffeine to the 12 pin along with solid nicotine chew in the first quarter. With a growing pipeline of products under development, NewX is primed to be a strong engine for future growth. We talked about winning on last quarter's call. We coupled a robust planning and communication process with a series of strategies and tactical initiatives to ensure we do just that in the marketplace. We believe we are just beginning to see the fruits of those efforts, and we remain driven to deliver results through these challenging circumstances. And with that, I'll turn it to Bobby for a review of our first quarter financial performance. Bobby?

Bobby Lavan, Chief Financial Officer

Thank you, Graham. Company results in the first quarter were stronger than we expected with every segment coming in ahead of plan, benefiting from accelerated demand, trade loading, and strong execution. Before I review the segment consolidated performance for the quarter, let me first summarize some recent developments. PMTA has been moved out for months to September 9th. This does not impact our full year plans, and we continue to expect to spend a total of $15 million to $18 million on the process. On April 8th, TPB and Standard Diversified, SDI announced a definitive agreement for a tax-free merger and transaction expected to be completed by the summer. SDI shareholders will receive 0.97 shares of TPB common shares for each common share of TPB held by SDI. At the close of the transaction, we are pleased to have come to an agreement on this, and the transaction will effectively retire 1.5% of our shares outstanding and eliminate the overhang of a holding company structure. Turning now to segment reviews. In Smokeless, the Stoker's continues to deliver sustained growth momentum. Smokeless net sales increased 17.5% year-over-year in the quarter. Net sales for the MST portfolio grew 33% and represented 59% of Smokeless revenues in the quarter, up from 52% a year earlier. Total Smokeless volumes increased 16.7% with price mix advancing 0.8%. We believe trade loading impacted our sales by approximately $ million in the quarter. Year-over-year industry volumes for MST increased by approximately 2% with chewing tobacco eroding by approximately 4%. Stoker's shipments to retail continue to outpace the Smokeless industry in the quarter, growing its MSAi share in both chewing tobacco and MST. Turning to smoking products, segment net sales in the quarter increased 13% with double-digit growth in the U.S. rolling papers, partially offset by a year-over-year decline of $500,000 in non-focus cigar and MLI pipe products. We disconnected our pipe products which generated $1 million of sales in 2019 at the end of the quarter. Cigar wrap net sales were up high single-digit, while Canadian rolling papers were up mid-single-digit. Total smoking volume increased 10.9%, while price mix increased 2.4%. We believe trade loading impacted our sales by approximately $1 million in the quarter. According to MSAi, first quarter industry volumes for U.S. papers increased mid-single-digits, while MYO Cigar Wrap shipment to retail contracted by low single-digits. Moving to our NewGen segment, we saw stronger than expected results during the quarter. Net sales decreased 19% year-over-year from the lingering impact of vape market disruption and the discontinuation of the V2 business, partially offset by positive contributions from CBD, solid, and other NewX products. The segment did see 28% sales growth sequentially. For the quarter, NewGen gross profit decreased $3.5 million to $11.4 million as the result of declining net sales. First quarter 2020 included $2.8 million of tariff expense compared to $2.0 million a year ago. Moving to the consolidated business, adjusted EBITDA for the quarter was $17.8 million as compared to $16.1 million in the prior year. Encouragingly, the NewGen segment returned to positive contribution for the quarter on sales advances and the new consolidated and streamlined structure. We are pleased that our first quarter results were above our expectations. We are also encouraged by government measures to support consumers in the economy. In light of the uncertainty around COVID-19, we feel it's prudent to maintain our revenue and EBITDA guidance previously guided until we get more clarity on the duration and impact of the response to the virus. Projected 2020 total net sales of $338 million to $353 million and adjusted EBITDA of $69 million to $75 million. We are also guiding the second quarter to $81 million to $87 million, a little bit wider due to the uncertainty. M&A discussions continue as we evaluate potential partners and targets. Although coronavirus has likely delayed the timing of completing such transactions, we have seen an increased pipeline of attractive opportunities. With that, I'll turn the call back to Larry for closing comments.

Larry Wexler, CEO

Thank you, Bobby. While we continue to deal with a challenging environment, the company executed well during the quarter and shows its resilience and its ability to meet consumers' needs. We remain committed to our goals of growing our tobacco business, creating operating leverage, and finding new market opportunities. The company has implemented a number of new initiatives; however, the timing and the impact of their implementation may be impacted by the current environment. But as you can see from our numbers, we remain optimistic based on what we saw before the economic disruption. Our company remains solid and resilient, and our people remain committed to the journey. Thank you for participating in the call today. With that, I'd like to open the call for questions.

Operator, Operator

Thank you. We will now start the question-and-answer session. The first question comes from Vivien Azer of Cowen. Please proceed.

Vivien Azer, Analyst

Thanks. Good morning. Appreciate the question. Hope everyone is safe and healthy. Just wanted to start with the supply chain disruption that you called out from one of your suppliers in the Dominican Republic. Seems like they're back online. Just remind us how big a piece of the business that impacts and how you're thinking about kind of bringing inventory and products back online if in fact you were short on supply. Thanks.

Bobby Lavan, Chief Financial Officer

Yes, so Wrap is about 15% of our sales. It is a lower margin product. We're assuming right now about a $5 million hit to the quarter from the wraps business now, it's been down for three weeks, so we think that that $5 million is probably conservative, but that's where we're at, at this point.

Vivien Azer, Analyst

And is that supplier back online or no?

Bobby Lavan, Chief Financial Officer

They are.

Vivien Azer, Analyst

Okay, got it. Perfect. Thanks. On the Smokeless side of the business, clearly very strong share momentum even pre-COVID. Larry, I was intrigued by your comment that you think that there might not be as much pantry destocking as we've seen for other CPG categories. Certainly, that was evident in some of the Nielsen data that we saw today. Just in terms of what you're hearing from your retail customers, any issues with foot traffic? Like certainly we're hearing it from the beverage guys, the gas, certainly your data wouldn't suggest it. But just curious any incremental insights you're hearing from your retail partners around foot traffic impacting consumer demand?

Larry Wexler, CEO

Okay, so what we've been hearing from the field and what I've seen in driving around is that you're seeing fewer people in the stores, but they're buying more. I was in a convenience store and saw someone walk out with a whole bag full of product where they usually would go in and just buy one can or one pack of cigarettes at a time. What we've seen in our shipments is that it's remained pretty consistent. We spoke about the lift that we had at the end of the quarter. We have not seen the payback that we thought we might, particularly on moist snuff. I think one of the aspects of our products, particularly the tub, is that it's very convenient. In these times where a consumer considers buying a handful of cans, they can go in and buy the tub that can last about a week. And as we've talked about in the past, the cans have been a good feeder into the tubs. I think that just has been accelerated by the current conditions where people can't get out of their houses as much.

Vivien Azer, Analyst

Yes, that makes good sense. Are you hearing anything about the health of the Stoker's brands specifically? To follow up on my original question, are you noticing any commentary regarding shifts in consumer demand related to the paycheck cycle or the stimulus checks that were issued around April 15th? Thanks.

Graham Purdy, Chief Operating Officer

We haven't really noticed that yet. This has only been happening for a little over a month. We are focused on selling to the stores and will sell out if needed. However, we haven't observed any significant changes in our consumers aside from bulk buying. I would also mention that our Smokeless segment is less influenced by city conditions, so we are active in areas where people aren't as restricted. On the Smoking side, our product is closely linked to recreational use. People are staying home and continuing to use our products, so we feel somewhat protected from those challenges.

Vivien Azer, Analyst

Yes, that seems reasonable. The comment on pricing in the press release and potential pricing delays. Can you just expand on that? I mean it seems appropriate given the commentary we've heard from Philip Morris International last week about their expectations for pricing in the back half and international markets. But in the U.S., you're obviously not the price leader. So, just wanted to get some more color on that comment. Thanks.

Larry Wexler, CEO

Yes. So, the big guy took an MST price increase at the beginning of the year. We did not follow. The expectation would be that like they took a price increase last year on April 30th, we expected that as well on MST. That seems like it's going to be delayed. That being said, we feel that we can't take price increases on cans, but we can take price increases on tubs. So, it will be a slight modification to our plan, but we don't think it's significant relative to the full year plan.

Vivien Azer, Analyst

Perfect, that's all really helpful. I'll turn it back into the queue. Thanks.

Operator, Operator

The next question will come from Susan Anderson of B. Riley FBR.

Susan Anderson, Analyst

Hi, good morning. Great job this quarter. I was wondering about the MST growth; how much do you think was due to customers trading down versus stocking up? Did you identify where the significant growth originated?

Bobby Lavan, Chief Financial Officer

Yes, I mean, the outsized growth came from tubs, which is a trade down. But I think at the end of the day, the business was growing significantly up until the last few weeks of March and then it just shut up. So, the business continues to be double-digit strength with or without sort of these trade downs.

Susan Anderson, Analyst

Got it. Okay. And then do you think any of that is stocking up that maybe will hit later quarters, or are you seeing that it was kind of straight growth?

Bobby Lavan, Chief Financial Officer

Yes, we're assuming a $2 million giveback in the second quarter.

Susan Anderson, Analyst

Okay.

Bobby Lavan, Chief Financial Officer

Now, the one thing I'd say is we haven't seen it in April, which we think goes to the strength of the Stoker's brand. So, we're pretty excited about that. But we have been assuming that $2 million giveback in the second quarter.

Susan Anderson, Analyst

Okay. And then, I guess, with the NewGen segment now being reset for the vape business, how should we think about the margins there as we kind of look out over the next couple of years? What are you guys expecting in terms of expansion at all or how should we think about that now with the reset?

Bobby Lavan, Chief Financial Officer

Yes, I mean, I don't think we're going to change our long-term guidance on NewGen anytime. I mean 30% gross profit has been something that that business has sat at for the past few years. But as we've discussed, we expect gross margin increases in NewGen. That's what we've been working towards with our proprietary brand. I'll tell you, we did put out a new investor presentation on our website that sort of quantifies this a little bit with the long-term target being 50%. But that's something that is going to take a while to get there.

Susan Anderson, Analyst

Yes, okay. Got it. And then can you talk about just what you're seeing on the acquisition front? It sounds like you're seeing an increase in potential opportunity out there. What categories are you seeing these opportunities, and are you seeing prices maybe become more attractive?

Bobby Lavan, Chief Financial Officer

Yes, we are recognizing a significant opportunity in the cannabis and smoking sectors. You can expect us to make progress in these areas. We raised capital last summer with the aim of increasing our involvement in the cannabis and smoking markets, and we are currently seeing that develop. However, the difficulties we anticipated in the cannabis sector have turned out to be even more challenging than we expected, which sometimes complicates deal-making. For instance, one of our competitors recently reported a substantial bad debt expense because customers are not fulfilling their payment obligations. Therefore, it becomes difficult to pursue deals when companies are struggling to pay their bills. The situation is complex, but we are prepared for it. While we did not foresee it unfolding in exactly this manner, we are ready to face these challenges.

Susan Anderson, Analyst

Got it. That's helpful. And then lastly, just modeling question, I guess. So, the actions you're taking for COVID, such as like the increased wages, more employees, should we think about that impacting SG&A materially, or how should we think about that and kind of outlook for the next quarter?

Bobby Lavan, Chief Financial Officer

Yes, I would say actually, it's going to go the other way. I would say the expenses that we're paying whether it's more overtime or hourly wage increases, those are more than offset by sort of decreases in business where we've cut back on non-essential spending; T&E has been pulled back significantly. So, we're not expecting any sort of SG&A creep at all. Great, that's helpful. Thanks so much. I'll jump back in. Good luck next quarter.

Operator, Operator

Next, we have a follow-up from Vivien Azer of Cowen. Hello, Ms. Azer, your phone might be muted.

Vivien Azer, Analyst

Thank you very much for the prompt. I wanted to follow up on the PMTA. Given the judge's accommodative ruling in Maryland due to the disruptions from COVID-19, are you planning to use the full length of that extension? Is there value in submitting your application now? We saw that the Imperial brand filed today. Is there a benefit to getting ahead in the queue? Thank you.

Larry Wexler, CEO

There's no benefit. I mean the only benefit is on flavored pods, which is not a significant part of our PMTA. Right, because remember, the PMTA we're filing on open systems, the open systems are still out on the market.

Vivien Azer, Analyst

Okay. But just in terms of getting like feedback earlier from the FDA, no value in that at all, because they're just going to work through everything all at once?

Larry Wexler, CEO

Yes, I mean, we're having dialogue with the FDA. So, we're getting feedback already. So that's it. So, submitting the PMTA early really doesn't get you much, particularly on the lower interest category, which is the open systems. And so we'll file a little bit early, but we're not in like some rush to do it.

Vivien Azer, Analyst

Got it. And then just from a cost perspective, obviously, you're just having your team work remotely, but I'm curious just in terms of utilizing third-party resources to the extent that you are, whether any delays are going to drive some inflation in the costs if the work is taking longer?

Larry Wexler, CEO

To be fair, it's a little bit of whack-a-mole. But I don't expect any significant creep. There are some consultants we have on retainer that they'll stay on an extra few months, and so that's an extra $25,000 here $25,000 there, but the bulk of the expense was going into lab capacity. And so that lab capacity did not increase because of extended time.

Vivien Azer, Analyst

Understood. Thanks for the follow-up. I appreciate it.

Operator, Operator

At this time, we're showing no further questions. We will go ahead and conclude the question-and-answer session. I would now like to turn the conference call back over to the management team for any closing remarks. Gentlemen?

Larry Wexler, CEO

Thank you everybody for joining the call. See you next quarter.

Operator, Operator

Thank you, sir and to the rest of the team for your time also today. The conference is now concluded. At this time, you may disconnect your lines everyone. Take care and have a wonderful day.