Earnings Call Transcript - TPB Q4 2023

Operator, Operator

Ladies and gentlemen, good morning, and welcome to the Turning Point Brands' Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. All lines have been placed on mute to help prevent any background noise. After today's presentation, there will be an opportunity to ask questions. 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.

Louie Reformina, CFO

Thank you. Good morning, everyone. This is Louie Reformina, Chief Financial Officer. Joining me are Turning Point Brands, President and CEO, Graham Purdy; and Chief Revenue Officer, Summer Frein. This morning, we issued a news release covering our fourth quarter results. This release is located in the IR section of our website, www.turningpointbrands.com. During this call, we will discuss our consolidated and segment operating results and provide our perspective on the operating environment and our progress against our strategic plan. As discussed, may 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 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 our CEO, Graham Purdy.

Graham Purdy, CEO

Thanks Louie. Good morning, everyone, and thank you for joining our call. Our fourth quarter results were at the high end of our expectations and demonstrated continued progress against our plan. Adjusted EBITDA increased 7.5% to $24.8 million for the quarter, and we finished 2023 having generated $61.2 million of free cash flow. During Q4, Stoker's finished the year on a high note, posting extraordinary 18.6% revenue growth for the quarter. Zig-Zag was down 2.9% for the quarter due to the previously discussed discontinuation of an unprofitable product line in Canada. We are pleased with the market share increases for Stoker's, which continues to be a steady growth engine with a long runway for volume growth and favorable pricing dynamics. That said, to be clear, while Stoker's continues to gain momentum, we do not believe 19% organic revenue growth for our legacy Stoker's products is sustainable over the long term. However, we do believe these and greater levels of growth are achievable for FRE, our modern oral or white pouch nicotine product. This product will compete in the category that is trending towards $2 billion in manufacturer revenue and grew volume by over 50% last year per MSAi. Up until recently, we were focused on optimizing our supply chain to ensure consistent product quality, analyzing consumer feedback and testing online and in-store marketing and merchandising programs to best position us for a successful rollout of FRE. We are now focusing on prudently ramping up our sales and distribution efforts with the goal of achieving sustainable, consistent growth. Our strategy for this exciting category focuses on leveraging our sales and distribution expertise to profitably expand FRE's presence and store count over an extended timeframe similar to what we have achieved with Stoker's MST. FRE presents a significant opportunity for the company given its differentiated offering. Like Stoker's MST, we don't need outsized share in the market to have a significant impact on our overall bottom line. We look forward to providing updates on this exciting new product in quarters to come. Moving on to Zig-Zag. While we faced a headwind from previously discussed inventory destocking throughout much of the year, we believe the reduction in trade inventory is behind us, setting the backdrop for a return to growth in 2024. We were pleased that both our Zig-Zag papers in the traditional channel and alternative channel business posted double-digit growth. We are encouraged by our wholesale customers and consumers' response to our expanding and more complete portfolio, fueled by many new products launched over the past few years. In Q4, we launched combo books as well as our first seasonal vintage apparel line. As you may have noticed, we leaned into our direct relationships with our consumers using several social media tactics to engage our growing audience. As mentioned, we continue to see strong demand from consumers in the alternative channel as legalization and further normalization of cannabis is expanding the alternative store footprint, dispensaries, head shops, and smoke shops, which cater to a growing accessory market. Our alternative B2B business saw continued momentum with Zig-Zag sales growing by over 30% during the quarter driven by an acceleration in premium paper sales in the second half of 2023. Our strategy in the alternative channel is to be a valued partner to the growing distributor, retailer, and manufacturing networks serving this ecosystem. In addition to growing traffic, alternative stores are attractive because they offer the Zig-Zag portfolio more valuable shelf space and merchandising real estate than traditional convenience stores. We try to be a solution provider to various customers throughout the ecosystem. And in doing so, we're able to build brand awareness and consumer trial to ensure we satisfy this growing consumer base. As discussed in the past, our growth in the alternative market has been driven by two drivers: one, gaining new customers across the retail, distributor, and manufacturing landscape; and two, increasing order sizes to both existing and new customers as we expand our portfolio. Cross-selling CLIPPER lighters is an example of that; both drivers continue to be healthy. Lastly, in 2023, we were pleased to close on our ABL Facility, which, along with the cash we have on hand, gives us ample liquidity to address our convertible debt maturity later this year. With that, let me hand the call over to Summer to walk through progress and the results of several of our specific go-to-market initiatives.

Summer Frein, CRO

Thank you, Graham. Throughout Q4, we continued to make progress against our roadmap of furthering Zig-Zag's position as a lifestyle brand. Our focus on growing Zig-Zag's portfolio and the alternative channel while increasing the brand ubiquity remains a core tenet of that plan. In Q4, we continued building a product assortment that aligns with market demand. In early December, at MJBizCon, we launched our new Zig-Zag combo booklet, a convenient package combining both papers and tips available in several varieties of our paper assortment. Since its launch, our team is ahead of plan and gaining valuable shelf space. In 2024 and beyond, you should expect us to continue to launch new products that cater to this rapidly evolving consumer. We also launched Zig-Zag’s first seasonal apparel collection, the Vintage Collection, which garnered the attention of the fashion and streetwear community, with two of the largest culture publications covering the launch. The Vintage Collection paid homage to Zig-Zag’s century-long influence in the smoking world by blending style, heritage, and culture. 2024 marks the 145th anniversary of the brand, and launching the Vintage Collection is just the first of many moments we’ll bring to consumers and retail to celebrate this remarkable milestone. Furthermore, we continued to develop our event and partnership strategy to integrate Zig-Zag into music, entertainment, and other creative communities, including recent collaborations with major record labels. Leading into 2024, we hosted Grammy events within the Afrobeat community in partnership with Roc Nation, with the famous DJ collective Soulection, and five-time Grammy Award-winning producer D’Mile, who added another Grammy at the ceremony for Producer of the Year. Throughout Q4, we continued increasing store penetration for CLIPPER lighters and capitalizing on the synergies between CLIPPER and Zig-Zag. We look forward to continuing to provide updates that showcase the momentum and efforts that support Zig-Zag’s growth. Moving to Stoker’s, as Graham noted, the success we had for this segment was driven by another strong quarter of share gains for both Stoker’s MST and loose-leaf. With its product quality and value proposition continuing to resonate with consumers, we expect that trend to continue. While a small contributor during the quarter, we are excited about the broader rollout of our FRE white nicotine pouch product. We are in the midst of our initial push on FRE in both brick-and-mortar stores and digital marketplaces, both our own and other parties' websites. The receptivity and engagement from our trade partners and with consumers continue to reinforce that our product quality, moisture content, pouch size, and differentiated nicotine offerings are leading to positive consumer sentiment. In summary, we continue building our brands for the long-term, executing against the plan we’ve established, and growing our business in retail and with our consumers. Our efforts are focused on maximizing the value of our world-class brands and strengthening our extensive distribution capabilities. Let me now turn the call back over to Louie to go through our results.

Louie Reformina, CFO

Thank you, Summer. Starting with our consolidated quarterly results. Q4 sales were down 6.1% to $97.1 million. Gross margin was up 410 basis points to 52.0% due to segment and product mix. Adjusted EBITDA was up 7.5% to $24.8 million. Going into segment performance, Zig-Zag sales decreased 2.9% year-over-year to $45.1 million due to the discontinuation of an unprofitable product line in Canada that impacted sales by $1.4 million. Our U.S. papers and wraps business was stable, with double-digit growth in our B2B alternative sales business. Our Canadian and other smoking accessories categories saw declines during the quarter due to the discontinuation of the low-margin third-party product line. Gross margins increased 100 basis points to 56.5% during the quarter, driven primarily by product mix, including the discontinuation of a low-margin product line. Stoker’s products net sales increased 18.6% to $38.0 million in the quarter with a 14.2% volume increase and 4.4% price mix increase. MST, Chew, and FRE all delivered strong growth during the quarter. Net sales for the MST portfolio grew double digits. Stoker’s retail shipment pounds were up despite the category being down 5.6%, with share growing 50 basis points year-over-year to 7.1% during the second quarter, according to MSAi. MST share in-store selling was up 40 basis points year-over-year to 10.7% with Stoker’s now in stores representing 67% of industry volumes, which still provides a long runway for growth. We also had strong growth in our international export business. Chew sales were up high single digits from the previous year. Stoker’s Chew was the number one chewing brand in the quarter, gaining 220 basis points of share with 31.0% share according to MSAi. Overall, TPB loose-leaf retail shipment pounds were up despite the category being down 2.2%. Category performance was driven by a larger decline in premium loose-leaf, with TPB’s volumes benefiting from its valued positioning and continuing consumer trade down. Our FRE sales more than doubled off a low base as we start a broader expansion of the product in 2024. Gross margin increased 380 basis points to 57.6%, primarily due to MST pricing gains. CDS sales were $14.1 million with a gross margin of 22.4%. Moving to our balance sheet, after generating $61 million of free cash flow during the year, we ended the quarter with $117.9 million of cash on the balance sheet. And as of today, we have sufficient cash to address the maturity of our remaining $118.5 million convertible notes due July 2024. With our projected free cash flow generation this year, we will be able to stay within our net and gross leverage target range of 2.5x to 3.5x after retiring our convert this year, while having the flexibility for future capital deployment. Onto guidance. At this point we expect consolidated adjusted EBITDA of $95 million to $100 million. The guidance excludes contribution from our CDS business, which contributed a little over $2 million of EBITDA in fiscal year 2023. Other projections include effective income tax rate of 24% to 26%, we expect CapEx to be approximately $9 million to $11 million this year, compared to $5.7 million the previous year, including $6.5 million of payments related to an automation project that was pushed out from 2023 to 2024. We also expect to spend $6 million to $9 million in capitalized software implementation costs related to the ERP and CRM implementation after spending a little over $6 million last year. The first stage of the CRM is now live, and we expect the ERP to go live in the first half of 2024. We currently expect to spend approximately $4 million for the full year to supplement our PMTAs related to our modern oral products, which remain under review by the FDA. Now, let me turn it back to Graham.

Graham Purdy, CEO

Overall, we saw impressive momentum for Stoker’s MST along with the progress in the alternative channel in support of Zig-Zag. We’re also very excited about FRE. Thank you for participating in the call today. And with that, I’d like to open the call for questions.

Operator, Operator

And we will take our first question from Scott Fortune with Roth MKM. Your line is open.

Scott Fortune, Analyst

Yes. Good morning and thank you for the question. Congratulations on the continued penetration into that alternative smoke shop channel and the progress continues there. If we look at the channel, are you displacing competitors or looking at it as continued kind of gradual market penetration within that channel? And then is there any promotional activity you have to do to kind of initially enter that channel to gain that share? Just talk about kind of the promotional activity in that channel too, as you continue to build that out.

Summer Frein, CRO

Hey, sure, this is Summer. Thanks for the question. I heard you first ask about whether we are displacing competitors and then ask about our promotional strategy as we’re growing in the alternative channel? Look, our penetration into the alternative channel is something we continue to be encouraged by. Primarily we’re focused on expanding distribution and gaining shelf space. So naturally that comes at the expense of taking space from some competitors. But for us, we’re really focused on just gaining shelf space and continuing to grow in that channel given the total addressable market that we see and the opportunity ahead of us. Fortunately, because of the strong brand equity that Zig-Zag has, we are not overly promotionalizing in that space and are quite encouraged by our pricing strategy thus far.

Scott Fortune, Analyst

I appreciate the color. And then kind of following up on that on FRE, and obviously you have differentiated size, pouch, and nicotine kind of offerings that continue to expand as you put more sales and support there. But what are you seeing from the competitive side moving up into the FRE offering nicotine-wise? Or how do you see that playing out as we look out in 2024 and driving that growth going forward here?

Summer Frein, CRO

Yes, sure. So, as you noted, one of the things that makes FRE so fantastic is its differentiated nicotine positioning in the market. Because of the dynamic nature of the nicotine space, we aren’t seeing a lot of competitive activity, although I don’t think that’s necessarily a forever situation due to where consumers are gravitating. Certainly, competitors will see that, but we’re excited to get into the market and continue to expand and capitalize on our point of differentiation at this point.

Scott Fortune, Analyst

Perfect. And then last one for a follow-up there. Obviously, you’re ramping the FRE product and the strong trends there. It’s akin to a similar opportunity as you saw in Stoker’s over time as you ramped up that product. Just kind of step us through the steady incremental gains you’re seeing and the timing of the cadence. And when this becomes more meaningful throughout 2024, looking at 2025 and beyond for FRE? Just kind of step us through that cadence and the size opportunity as that grows here.

Summer Frein, CRO

Yes. As I think were noted in the opening remarks, we continue to see that category grow significantly over the past several years and as we anticipate over the years to come. We see it as a $2 billion industry now. So very similar to our Stoker’s strategy, even a high single-digit share in that growing market is really significant to our business. And so we’re focused on prudent, steady growth quarter-over-quarter, and as we’ve sort of rolled out this quarter, that’s what we’re on track to do is continue to see that steady growth. That was our success story for Stoker’s, and following that same playbook will likely work very well for us.

Scott Fortune, Analyst

Thanks. That’s helpful. I appreciate the detail. I’ll jump back in the queue.

Summer Frein, CRO

Thanks for the questions.

Operator, Operator

And we will take our next question from Michael Legg with Benchmark. Your line is open.

Michael Legg, Analyst

Thanks. Good morning. Great quarter. Wanted to dig down a little on the FRE. What's your pricing strategy there first?

Summer Frein, CRO

Sure. Our pricing strategy is pretty straightforward in the sense that we are focused on maintaining a profitable business and not over-promoting that space.

Michael Legg, Analyst

Okay. But is it similar to Stoker’s where there’s premium product and then you have the more cost-effective product? Or are you going to compete with Zyn at a premium price point?

Summer Frein, CRO

We will be and are competing at a premium price point. So it's a different approach than Stoker’s, given our brand positioning.

Michael Legg, Analyst

Okay. And then you mentioned high single-digit market share opportunity in a $2 billion market, so we're talking $100-plus million there. Can you talk about what your long-term market share goal is and what your store ramp-up expectations are to get this distributed?

Graham Purdy, CEO

Hey Mike, it's Graham. Thanks for the question. I appreciate it. Look, I think we're – number one, we're bullish on the category. Number two, we're incredibly bullish on our product, given the points of differentiation that Summer had articulated. I think we’re optimistic about our success rate following the methodical plan we've used for Stoker's, which has been a slow and steady grind over the last 10 years or so. I think our expectation would be that FRE will probably follow a similar path to that over time.

Michael Legg, Analyst

Okay. Great. And then you mentioned CLIPPER, can we talk about what you're seeing with CLIPPER and how that's going?

Graham Purdy, CEO

Yes. We're very encouraged by the results. We're on plan relative to the store gains that we're making in the market. Summer's team has done a nice job of expanding our social footprint and building some really nice marketing campaigns around CLIPPER lighters. We're seeing a lot of energy in the alternative channel with the carry of both Zig-Zag and CLIPPER in that space. So I'd say generally, we're excited about the results thus far. It's a consumer product that competes against a very large and well-organized and well-capitalized player in the market. But again, similar to the FRE story, we feel very positive about the long-term prospects of the product.

Michael Legg, Analyst

Okay. Great. And then just the $4 million legal settlement, what was that?

Louie Reformina, CFO

We had a shareholder settlement that was disclosed in the press release.

Michael Legg, Analyst

Okay. We'll take a look then. And then the automation project, what is that for?

Louie Reformina, CFO

Yes. So we disclosed the project before. We decided to do it in stages and we're taking the first line and optimizing. So we're able to defer some of the payments for the future lines for later this year.

Michael Legg, Analyst

Okay. Thanks. And then just one last question on the debt. Do you plan on paying that off? Or do you plan on refinancing the debt and continuing with the same leverage?

Louie Reformina, CFO

Yes. At this point, we've got enough cash to be able to pay back in July. So that is our current plan.

Michael Legg, Analyst

Okay, thanks. Great quarter. Congrats.

Graham Purdy, CEO

Thanks Mike.

Operator, Operator

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

Eric Des Lauriers, Analyst

Thank you for taking my questions. I offer my congrats on the quarter as well. So it's great to see momentum at both the alternative channel for Zig-Zag and with the new FRE products really kind of gaining momentum here. Within the Zig-Zag alternative channel, you mentioned you're sort of able to do a bit more brand building through that channel versus traditional C-store. Could you just expand on that? And maybe just give us some examples of some of the ways that you are able to drive brand recognition and brand equity? Is this more shelf space? Is this sort of also being able to sell apparel? Just kind of expand on that, that would be great. Thank you.

Summer Frein, CRO

Yes. Hey Eric, thanks for the question. In terms of the difference in brand building in the alternative space versus the traditional C-store channel, it really is much more open. If you think about walking into the variety of stores that are in the alternative channel, there's a lot more receptivity to the sorts of things that you can hang and position in-store. And certainly, you touched on apparel. These types of retailers are also open to selling different sorts of merchandise. And so it really opens up the ballpark and the types of product expansion that we can capitalize on in those stores in a very different way than what is more traditional C-store space that has a more limited shelf space and opportunities for those varieties of products.

Eric Des Lauriers, Analyst

Okay. That's helpful. And just in terms of the growth that you have been experiencing within the alternative channel, obviously, you guys have been going after this for some time here. Is there anything specific to call out to this sort of growth that's been building over the past couple of quarters? You mentioned new products; has it been a matter of finding products that this channel is looking for and that’s helped you increase your share within that channel? Or is it kind of all of the above, including apparel and these other things as well? Just wondering if there's anything to sort of call out as the driver to increase this penetration within this channel.

Louie Reformina, CFO

I mean, no special callouts. As you mentioned, we've had pretty strong success in this market for a while. And so we expect to continue with the same things. A lot of it is just increasing our penetration, as Summer mentioned, within that channel and our product offering, and the continued momentum we are seeing is leading to this hypergrowth we're experiencing. We still think there's a lot of further opportunity for us to attack that market.

Eric Des Lauriers, Analyst

Okay. Great. And then just a couple more quick ones from me. On CLIPPER, I know that we've sort of been working through some heightened inventory levels at retail. Can you kind of just give us an update on what you're seeing there?

Graham Purdy, CEO

Yes. Look, I think this sort of goes across our business. We feel like the inventory overhang from last year is largely behind us at this point in time, and that would include CLIPPER.

Eric Des Lauriers, Analyst

Okay. Great. And then last one for me. So I understood this automation project. Excuse me, you've been optimizing this first line here, so a bit of a push out in some of the CapEx dollar expectations here. Could you just help us with the cadence? I think it might be pushed to maybe Q2, maybe the second half? Just any kind of commentary on cadence would be helpful.

Louie Reformina, CFO

Yes, listen, we expect to be through the majority of it in the first half of the year and continuing to ramp up the production through the rest of the year on this project.

Eric Des Lauriers, Analyst

Okay, thank you so much, guys.

Louie Reformina, CFO

Thanks Eric.

Operator, Operator

There are no further questions at this time. I will now turn the call back to Mr. Graham Purdy for closing remarks.

Graham Purdy, CEO

Thanks, operator. I appreciate everybody's time today. We're excited about the quarter, and we're excited to communicate with you here in a few months on results today. So thank you so much.

Operator, Operator

Ladies and gentlemen, this concludes today's call. We thank you for your participation. You may now disconnect.