Turning Point Brands Inc (TPB) 2017 Q3 法說會逐字稿

Good day, and welcome to the Turning Point Brands' Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mark Stegeman, CFO. Please go ahead.

Thank you, Andrew. Good morning, and thanks, everyone for joining our call. I'm Mark Stegeman, CFO of Turning Point Brands. Participating with me today are Turning Point Brands' President and CEO, Larry Wexler; and Jim Murray, Senior Vice President of Business Planning.

Earlier today, we issued a news release covering our dividend initiation, third quarter and year-to-date performance. This release can be located in the IR section of our website, www.turningpointbrands.com, where a replay of today's conference call will be available.

In today's call, we will plan to discuss our operating results, share our views on the evolving regulatory climate and update the progress of our long-term growth strategies. Following our formal remarks, we will open up the floor to Q&A.

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, 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 reason management believes that they provide investors with useful information regarding the company's financial conditions and results of operations are set forth in the press release.

I will now turn the call over to Larry Wexler, our CEO.

Good morning, and thank you for joining the call. I'm pleased to announce that given our solid execution against our strategic plan today the Board of Directors approved the initiation of a cash dividend to shareholders. The initial quarterly dividend of $0.04 per common share will be paid on December 15, 2017, to shareholders of record on the close of business November 27. Declaring a dividend underscores the board's confidence in the company's long-term growth opportunities and its financial strength and demonstrates our ongoing commitment to enhancing shareholder value while expanding the universe of potential shareholders. We believe a dividend at this level is consistent with our focus on accretive acquisitions, continued organic growth and the strengthening of our capital position.

With that exciting the news and a statement of confidence expressed, I'm thrilled to talk about the progress Turning Point Brands continues to make in the OTP marketplace. Record third quarter sales of $73.3 million are up 44% higher than last year. Additionally, the company recorded records for gross profit, operating income and adjusted EBITDA.

All 3 of our focus brands, Stoker’s, Zig-Zag and VaporBeast, are vibrant and compelling long-term growth engines. And their success produces the cash flow that fuels our internal investments, which are focused on generating organic growth and funding acquisitions to expand our product portfolio and operating capabilities.

The core tobacco portfolio, led by Stoker’s and Smokeless, and Zig-Zag in Smoking, was up low single digits in sales and delivered record gross profit in the quarter. Our strategy to reshaping the company for continued growth, by acquiring VaporBeast in late 2016 and Vapor Shark earlier this year, we have substantially expanded our NewGen reach and it's share of company revenues. Our NewGen segment, now 34% of company revenues, has produced advances for 5 sequential quarters not only in net sales but also gross profit.

We're actively evaluating OTP companies, not only in the tobacco space but also in the vapor arena, as acquisition candidates. We do not have any announcements to make now, but we remain eager to bring good, immediately accretive companies into the fold. We look for companies that provide plug-and-play opportunities, such as our acquisition of Wind River Brands, or bolt-on infrastructure opportunities like the VaporBeast sales distribution engine.

Let me start with some additional details on our segment performance in the quarter. The Smokeless segment performed well in the quarter, driven by sustained strength of the Stoker’s brand. Segment net sales rose 12.6% to $21.3 million. Gross profit grew 22.2% to $11.5 million, and gross margin expanded 420 basis points to 53.9%.

Smokeless net sales growth was delivered on market share advances and not only MST but also in chewing tobacco, establishing a new company record.

In spite a very competitive environment and the ongoing impact of the Pennsylvania tax increase, shipments of Stoker’s MST cases during the quarter were up more than 10%. We continue to expand Stoker’s MST retail distribution with new -- with net new store placements of just shy of 3,000 stores in the quarter. We're encouraged by the success of increasing the frequency of sales calls on higher-opportunity outlets. Our strategy to increase store penetration will take time, but it's a path we're committed to, as Stoker’s is a superior differentiated products that consumers love.

Regarding the 5 Smokeless tobacco brands we purchased from Wind River in November 2016, we're implementing our distribution expansion program in the fourth quarter. The Wind River brands, which commanded an 8% category share in store with distribution, have already begun to prosper under our brand and sales management. At the time of acquisition, the brands held a 2.2 share of the total chewing tobacco market. By third quarter 2017, the brands had collectively advanced to 2.4 share points without any focused effort on our part. Our target expansion of these brands began in late October, and we believe it will pick up additional momentum as we move into 2018.

Now turning to our Smoking product segment. As we have discussed several times, the Smoking segment is particularly volatile due to industry-wide promotional activities, and this quarter was certainly no exception. Segment sales were $26.9 million in the quarter, just under the $27 million of sales recorded in the second quarter but $6.6 million below the year ago quarter, which was the strongest quarter in the last 2 years.

The decrease in net sales is principally due to the continuing weakness in cigars and the comparison to the exceptionally strong year ago quarter, which was partially offset by year-over-year strength in both U.S. and Canadian's Zig-Zag cigarette paper sales. Gross profit increased $100,000 sequentially to $14.2 million and was about 1.5% less than the year ago quarter. Gross margin increased from 50.1% in the third quarter of 2016 to 52.9% of sales.

California's 65% excise tax on MYO cigar wraps continued to depress segment sales in that state, as our MSAi volumes were impacted 35% from the previous year. We are currently responding with new products and promotional strategies and will continue to monitor the situation in California closely.

The iconic Zig-Zag brand remains an industry leader in both MYO cigar wraps and premium cigar -- premium cigarette papers. As a result of competitive promotional volatility in the quarter, particularly in MSAi shipments to retail, Zig-Zag cigarette papers lost share in the quarter but remained strong versus year ago on a 6-month or 52-week moving basis, which we think better illustrates the brand strength.

While the Smoking segment's quarterly net sales comparison is soft to a year ago, we anticipated a decline given the robust sales achieved in the prior year. We believe the company is well positioned in the focused areas of Smoking, particularly given our expanded efforts in the Canadian market, a rich pipeline of U.S. products.

In NewGen, third quarter sales increased to a record $25.2 million, and gross profits were a record $7.3 million. VaporBeast has proven to be a highly effective distribution engine in the NewGen space. And since we acquired it at the end of last year, we have continued to sharpen its operating practices and strengthen its sales reach to nontraditional retailers. These results are beginning to show up in the numbers. Relative to a year ago, the average number of customer shipments per month are up by mid-single digits. Additionally, average revenues per invoice are up by double digits. These metrics illustrate both the substantial progress we are making in expanding our share requirements and industry growth.

With regard to our June 30 acquisition of Miami-based Vapor Shark, we have been realizing modest improved operating momentum. Sales to both franchise and corporate stores are each now trending favorably, and integration savings are beginning to be realized.

As of quarter end, the total Vapor Shark store count stood at 34. As we discussed last quarter, the former owner will operate the 7 company-owned stores as franchise stores effective January 2018. As a result, going forward, TPB will only realize the wholesale value of these sales. Post the transfer of these stores, we are projecting annualized net sales of $10 million and income before taxes of approximately $1 million.

One small note to mention. Hurricane Irma unfavorably impacted Vapor Shark sales by about $200,000 in the quarter. Obviously, this was a temporary blip, and we've seen sales return to more normal levels. Unfortunately, some of our employees were impacted by the storm, but our facility experienced only a loss of power.

We strongly believe that the e-nicotine market is an attractive space with long-term growth opportunities. Both VaporBeast and Vapor Shark provide strong and complementary infrastructure for our future growth plans.

As regulatory environment plays an important role within the industry, I want to spend a couple of minutes discussing the FDA. In July, the FDA outlined its approach for regulating nicotine. As we said in last quarter's call, we're encouraged by the effort to make the product review process more efficient, predictable and transparent.

Recently, the FDA announced a 6-month delay in ingredient disclosures, another positive sign. Our key focus in the regulatory environment is preserving our ability to market OTP products that adult consumers want to purchase. At the same time, we are actively reviewing our product portfolio and identifying which of our smaller, low-margin product lines do not warrant the increased investments to obtain future FDA compliance. In the quarter, we rationalized 2 product lines with annual revenues of less than $1.4 million, and expensed $300,000 during the quarter.

With regard to our efforts to improve sales force effectiveness, we remain focused on expanding its size with quality professionals. On a year-to-date basis, the sales force is up low single digits versus a year ago. But like many companies in the strengthening business climate, we are having our share of attrition. So while our sales force sizes up, I'm not satisfied. And we'll continue to apply focused efforts behind our hiring, training and on-boarding processes.

While the fourth quarter is traditionally a tough time to hire, I believe the new hiring process we put in place will pay dividends as we move into the new year.

Having said that, we are tracking favorably against our key performance objectives, including a greater number of sales calls and strengthen frequency. As you recall, that we identified a strong correlation between sales force call frequency and our brand shares, including Stoker’s MST, where our share in store selling is pushing 7%, demonstrating what I call "brand share capacity".

Additionally, while it remains very early, you're going to see -- continue to see meaningful progress in our social media campaigns for both Zig-Zag and Stoker’s, where key metrics are up sequentially and versus a year ago. Importantly, these brands, especially Stoker’s, can benefit from increased awareness. We are building our capabilities in this area.

To summarize my thoughts on the quarter. I'm pleased with the continuing progress we are making, and we're on the right track: record sales, gross profit and adjusted EBITDA in both the quarter and for the 9 months.

Our strategic and operational plans are proving effective, as we expand our retail penetration and provide quality products with consistency to our loyal consumers. We're building out our capabilities to expand our reach and adhere to regulations while delivering profitable growth. An as evidenced by the board's decision to initiate a dividend, we remain excited about the future.

With that, I'll it turn over to Mark to review a few of the quarter's financial highlights

Thanks, Larry. Larry mentioned some of the top line metrics at the beginning of the call, and I'll provide some additional color and measures. Segment net sales mix continued to shift on the growth of VaporBeast. For the quarter, NewGen represented 34%, Smokeless 29% and Smoking 37%. Net sales for the quarter increased 43.9% to a record $73.3 million. This was driven by volume gains of 39.5% and price mix gains of 4.4%. Gross profit for the quarter increased 33.8% to a record $32.9 million. Gross margin was 44.9%, down from 48.3% a year ago, primarily as the result of the mix impact of lower distribution margins from VaporBeast.

Consolidated SG&A expense in the second quarter was $18.6 million compared to $12.7 million in 2016, driven principally by the inclusion of VaporBeast and Vapor Shark's SG&A expenses and strategic expenses.

For the quarter, strategic expenses and SG&A were $200,000, up about that same amount from a year ago. New product launch costs in SG&A were $400,000, about half of last year's third quarter. And the quarter also included new product launch costs and cost of goods sold, which amounted to $100,000 compared to $200,000 a year ago.

This quarter's cost of goods sold also included $300,000 associated with the Smoking segment product line rationalization. On a year-over-year basis, Smoking products margin was also negatively impacted by roughly $200,000 from the euro.

Net income for the quarter was $7.4 million, up $600,000 against the year ago quarter. The weighted average fully diluted share count during the quarter was $19.6 million, and fully diluted earnings per share was $0.38 per share. For the quarter, adjusted EBITDA increased 16% to $15.9 million versus $13.7 million last year.

Now let me discuss some nonoperating drivers. For the quarter, interest expense was $4 million, 27.6% lower than the year ago period, resulting from our February refinancing.

Net debt at quarter end was $206.7 million, a $13.2 million decrease from last quarter end. We continue to improve our leverage profile and ended the quarter within our target range of 2.5x to 3.5x with a net debt to adjusted EBITDA ratio of 3.5x and net debt to pro forma acquisition adjusted EBITDA of 3.4x.

Our MSAi account during the quarter produced investment income of $100,000 compared to roughly $300,000 a year ago. Net operating losses, or NOLs, available to offset federal income taxes amounted to approximately $25 million at quarter end, and we expect to fully utilize these NOLs during 2018.

In the third quarter, we issued approximately 130,000 shares in connection with stock options that were expiring. In the fourth quarter of 2018, another 100,000 options will be expiring. Finally, reported income tax expense was $3.1 million for the quarter and $3.9 million year-to-date, which equates to effective tax rates of 30% and 19%, respectively.

While our statutory rate for federal and state income taxes is approximately 38% absent any discrete items, our effective tax increase -- rate increases to 41%, largely because of permanent differences, that's items which are deductible for book but not for tax. However this year, because of the tax benefit of discrete items relating to stock options exercised of $4.5 million, our effective income tax expense year-to-date is 19% and does not bear the normal relationship to the 41% rate I just mentioned. We do not expect significant discrete items in the fourth quarter and anticipate our effective GAAP tax rate will be approximately 41% in the fourth quarter and 27% for the year.

In the quarter, federal excise taxes included in cost of goods sold totaled $4.7 million. FDA fees accounted for in cost of goods sold amounted to $100,000. CapEx for the quarter was $500,000, and we expect full year CapEx of approximately $2 million.

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

Thanks, Mark. We had another good quarter which produced solid results on the strength of our organization and our focused brands. The Smokeless, Stoker’s MST cans, tubs and Stoker's chew are each up in share driven by increased retail distribution. In Smoking, Zig-Zag cigarette papers are up in revenue in both the U.S. and Canada.

In NewGen, key metrics from VaporBeast continue to improve, driving positive performance in the segment. Most importantly in the quarter, we produce record net sales, gross profit, operating income and adjusted EBITDA, and we just initiated our first dividend. Moving forward, we are continuing to explore acquisition candidates and have an active pipeline of opportunities at reasonable multiples. We have a firm foundation, a determination to achieve our strategic goals and a motivation to increase the long-term value of our company. Thank you for participating on the call today. And with that, I'd like to open it up for questions.

(Operator Instructions) The first question comes from Vivien Azer of Cowen.

So congrats on the dividend announcement. That's certainly encouraging to see. A host of questions. I think just starting off on Smokeless, please. Obviously, a very rational pricing environment that was reflected in your good price mix realization. But I would like to hear kind of your thoughts on price gap management, given that you didn't fully match the pricing announcements that we saw from your key competitors?

I think, Vivien, when we look at our pricing it's hard to look at headline pricing that you see on Copenhagen and Grizzly, where our price positioning is sort of aligned with tub pricing and the tub pricing and some of the pricing at the -- with Longhorn on the -- in the value segment. We believe over time that we have the opportunity to increase our prices and get a greater realization but will do so -- but we still believe that we had a long runway of share growth ahead of us and don't want to get out ahead of that.

Fair enough. That makes sense. On the gross margin, sticking with Smokeless, could you just expand -- are there any kind of key drivers to call out? Because we've kind of become accustomed to modest but steady margin degradation given negative mix shift to the 1.2-ounce can over the tub. So any drivers to call out in terms of the gross margin expansion in the quarter for Smokeless?

I think the biggest driver, and I'm looking at Jim to confirm this, that the difference would be in the types of promotions that we ran and the gross margin hit that the buy 1 get 1 free that we ran in 2016, depressed the gross margin. So I think it's more in that. We tried to give some insight into that with some of the numbers in the promotional -- the cost of promotions and new initiatives in the cost of goods sold.

I think the only thing I'd add to that, Vivien, is we also, as we reported, had a very good quarter on chewing tobacco, and we have some nice margins there as well.

Perfect. On the Smoking products, just the qualification of the comp has me scratching my head a little bit just in terms of cycling a tough compare in 3Q '16. If I'm looking at my numbers correctly from a gross sales perspective, you're actually cycling your easiest compare of the year, so if you could just expand on that?

I think one of the differences is that I get the sense that you look at quarter-over-quarter when talking about compares, where we're looking sequentially. And so it just so happened that these last 2 third quarters benefited from the volatility of the segment. So both those quarter were pretty high. The last year's third quarter was the strongest quarter we had in the past 8 quarters. So it was -- it really was an outliner in terms of that volatility. I think what you see when you look at it sequentially that our sales were sort of in line with the recent patterns. So I think it's just the difference that you're looking at -- you were looking at year ago, where we sort of look at this business sequentially.

That's exactly right. We were looking at a year-over-year growth rates. So that's helpful. Last one for me. Can you just help us think about the excise tax? Because I was really surprised to see it down as much as it was in light of fairly notable excise tax increases in California and Pennsylvania?

The excise tax -- remember the cigar wraps, and I don't know to what extent we highlighted that in the last call. I can't remember, but cigar wraps were not taxed at all in California. Now they're bearing a 65% of federal excise tax.

It's a really, Vivien, largely due to the weak -- continuing weakness we're having perhaps in the quarter at least, weaker performance in Cigars. That's what's driving the delta there.

Sorry, Vivien. I missed that question a little bit.

The next question comes from Susan Anderson of B. Riley FBR.

Nice to see the dividend. Congrats. I was wondering maybe if you could talk about how we should think about the growth of the NewGen category as we start to cycle the acquisitions. I guess, should we assume second quarter, third quarter is a good run rate? And then -- except for annualized and then growing off of that. And maybe too, if you could just give some color on the other 2 categories and when you expect the impact of the excise taxes to start to taper off, and maybe how we should think about the annual run rate there too, going forward?

Okay. Let me address the NewGen category first. It is -- we are working very diligently to improve the capabilities of that category. And while we will start lapping -- obviously, the fourth quarter of last year we -- I think we had 1 month of VaporBeast. So after the fourth quarter we'll start going against full quarter comparables. We continue to see improvements in the operating performance there. So we intend to continue to invest and to grow that category. In terms of the excise taxes, they'll start -- we'll start lapping the Pennsylvania tax in the fourth quarter, and then we'll go to a more normalized comparisons and growth in those categories. I think you can see from the numbers, particularly in Smokeless, we're performing fairly strongly. The moist -- our moist business is up. Our chew business is up. And we anticipate continuing that progress over the next couple of quarters.

Great. And then...

That was a big question you had. I was trying to jot down all of the questions you were asking.

No problem. That was helpful. And then, just one more question from me. You talked about in cigarette papers just the increase in competition on the discount papers driving sales. And I guess I was just wondering is that impacting your premium brand at all? Or is it impacting pricing? Like maybe if you could just give a little bit more color on that dynamic?

Okay. When you look at shares and performance, we look at it through the MSAi database, which actually tracks shipments from wholesalers to retail. And there was a very large promotion in the third quarter from one of our competitors in the low-price area. As you can see from our sales being up in both Canada and United States, obviously, Canada wasn't impacted by that, the paper business is solid and is on a good track. And if we look at it on a longer period of time, the 26 and 52 weeks, again, because of volatility in this category, internally that's what we look at, we're seeing continued growth in share from the Zig-Zag brand. So I think this is a blip from the promotional activity. Obviously, it will take a few months to see if that had any impact in the marketplace, but we thought Zig-Zag had a pretty good quarter.

Great. It looks good. Actually just one more question to you on the Vape category, obviously you have a very strong distribution foothold now. It does seem like a lot of the acquisition opportunities are within Vape and surrounding it. I guess, how do see kind of that category growing? Is there still significant acquisition opportunity there? Do you think that the growth in the category tapers off longer term? Or how should we think about the investment that you want to continue to add there?

Okay. That's a pretty broad question. Let me try to pick off all of them. If I miss any, come back and reask the question. The first thing I'd like to comment on is that we're looking at both -- at acquisitions in both the tobacco space as well as the NewGen space. It just so happened that the NewGen ones occurred earlier, but we are actively looking at companies. There are 300 companies in the OTP space that are in tobacco only. That's not counting any NewGen. And we think there's some ripe acquisition opportunities there. The second thing is, just to remind you of our strategies for NewGen going forward, is that with VaporBeast they now ship to -- I call it a little less than half of all of the identified vape shops that we have found. We believe that there's opportunities for increased penetration among the total vape shops as well as increasing share requirements. Importantly, the third aspect of that is that once we were happy that we have the infrastructure in place we do have a set of products that we'd like to put through that sales engine. So we do have, call it a 3-pronged strategy there for continued growth. As far as the Vape category, it was a burst of enthusiasm when it first came out, then it -- particularly in measured retail through MSAi, we saw sort of a leveling of it. But in the alternative nontraditional retailers, there was continued growth. We're seeing growth inside our VaporBeast. Some of the candidates that we looked at and some of the conversations with other companies in this space they're experiencing growth. So we do think -- although it's hard to measure, we do think that the overall e-nicotine market is growing and is -- just can't put a number on it because we don't have insight to that. And one last aspect of it, remember there's still just under 40 million combustible smokers in the United States. And FDA has announced a focus on the continuing risk. And implied in that is that they would like to see people shift from combustion to other forms of nicotine or leaving the market. But as they announce their programs and all, we believe there's going to be greater opportunity for new product development and for interesting developments in the NewGen category, and we expect to benefit from that over time.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Stegeman for any closing remarks.

Thank you very much for participating on the call today. And we look forward to next quarter's report. Have a great day.

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