Turning Point Brands, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of the historical financial conditions and results of operations in conjunction with our consolidated financial statements and accompanying notes, which are included elsewhere in this Quarterly Report on Form 10-Q. In addition, this discussion includes forward-looking statements which are subject to risks and uncertainties that may result in actual results differing from statements we make. See “Cautionary Note Regarding Forward-Looking Statements.” Factors that could cause actual results to differ include those risks and uncertainties discussed in “Risk Factors.” The following Management’s Discussion and Analysis (“MD&A”) relates to the unaudited financial statements of Turning Point Brands, Inc., included elsewhere in this Quarterly Report on Form 10-Q. The MD&A is intended to enable the reader to understand the Company’s financial condition and results of operations, including any material changes in the Company’s financial condition and results of operations since December 31, 2022, and as compared with the three and nine months ended September 30, 2022. The MD&A is provided as a supplement to and should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in this Quarterly report on Form 10-Q, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the Annual Report on Form 10-K for the fiscal year ended December 31, 2022. In this MD&A, unless the context requires otherwise, references to “our Company” “we,” “our,” or “us” refer to Turning Point Brands, Inc., and its consolidated subsidiaries. References to “TPB” refer to Turning Point Brands, Inc., without any of its subsidiaries. We were incorporated in 2004 under the name North Atlantic Holding Company, Inc. On November 4, 2015, we changed our name to Turning Point Brands, Inc. Many of the amounts and percentages in this discussion have been rounded for convenience of presentation. Overview Turning Point Brands, Inc. is a leading manufacturer, marketer and distributor of branded consumer products. We sell a wide range of products to adult consumers consisting of staple products with our iconic brands Zig-Zag ® and Stoker’s ® and our next generation products to fulfill evolving consumer preferences. Among other markets, we compete in the alternative smoking accessories and Other Tobacco Products (“OTP”) industries. The alternative smoking accessories market is a dynamic market experiencing robust secular growth driven by cannabinoid legalization in the U.S. and Canada, and positively evolving consumer perception and acceptance in North America. The OTP industry, which consists of non-cigarette tobacco products, exhibited mid-single-digit consumer unit annualized growth over the three-year period ended 2022 as reported by Management Science Associates, Inc., a third-party analytics and information company. Our segments are led by our core, proprietary brands: Zig-Zag ® and CLIPPER ® in the Zig-Zag Products segment and Stoker’s ® along with Beech-Nut ® and Trophy ® in the Stoker’s Products segment. Our businesses generate solid cash flows which we use to invest in our business, finance acquisitions, increase brand support, expand our distribution infrastructure, and strengthen our capital position. We currently ship to approximately 800 distributors with an additional 200 secondary, indirect wholesalers in the U.S. that carry and sell our products. Under the leadership of a senior management team with extensive experience in the consumer products, alternative smoking accessories and tobacco industries, we have grown and diversified our business through new product launches, category expansions, and acquisitions while concurrently improving operational efficiency. We believe there are meaningful opportunities to grow through acquisitions and joint ventures across all product categories. Our products are currently available in approximately 197,000 U.S. retail locations which, with the addition of retail stores in Canada, brings our total North American retail presence to an estimated 217,000 points of distribution. Our sales team targets widespread distribution to all traditional retail channels, including convenience stores. We also have a growing e-commerce business. In the fourth quarter of 2022, we contributed our NewGen Products business to South Beach Holdings LLC doing business as Creative Distribution Solutions (“CDS”), a newly-formed wholly-owned subsidiary. CDS is separately operated and reports to its own Board of Directors. During the first quarter of 2023, the business was designated an unrestricted subsidiary under the Senior Secured Notes (the “Notes”) and concurrently we renamed what we previously referred to as our NewGen Products segment as our Creative Distribution Solutions segment as we believe this name better aligns with the goals and strategies of the segment. Products We operate in three segments: Zig-Zag Products, Stoker’s Products and Creative Distribution Solutions. In our Zig-Zag Products segment, we principally market and distribute (i) rolling papers, tubes, and related products; and (ii) finished cigars and make-your-own (“MYO”) cigar wraps and (iii) lighters and other accessories. In addition, we have a majority stake in Turning Point Brands Canada which markets and distributes cannabis accessories and tobacco products throughout Canada. In our Stoker’s Products segment, we (i) manufacture and market moist snuff tobacco (“MST”) and (ii) contract for and market loose leaf chewing tobacco products. In our Creative Distribution Solutions segment, we (i) market and distribute liquid vapor products and certain other products without tobacco and/or nicotine; (ii) distribute a wide assortment of products to non-traditional retail via VaporBeast; and (iii) market and distribute a wide assortment of products to individual consumers via the VaporFi B2C online platform. 37 Table of Contents Operations Our core Zig-Zag Products and Stoker’s Products segments primarily generate revenues from the sale of our products to wholesale distributors who, in turn, resell the products to retail operations. Our net sales, which include federal excise taxes, consist of gross sales net of cash discounts, returns, and selling and marketing allowances. We rely on long-standing relationships with high-quality, established manufacturers to provide the majority of our produced products. More than 75% of our production, as measured by net sales, is outsourced to suppliers. The remaining production consists primarily of our moist snuff tobacco operations located in Dresden, Tennessee, and Louisville, Kentucky. Our principal operating expenses include the cost of raw materials used to manufacture the limited number of our products which we produce in-house; the cost of finished products, which are generally purchased goods; federal excise taxes; legal expenses; and compensation expenses, including benefits and costs of salaried personnel. Our other principal expenses include interest expense and other expenses. Key Factors Affecting Our Results of Operations We consider the following to be the key factors affecting our results of operations: ● Our ability to further penetrate markets with our existing products; ● Our ability to introduce new products and product lines that complement our core business; ● Decreasing interest in some tobacco products among consumers; ● Price sensitivity in our end-markets; ● Marketing and promotional initiatives, which cause variability in our results; ● Cost and increasing regulation of promotional and advertising activities; ● General economic conditions, including consumer access to disposable income and other conditions affecting purchasing power such as inflation; ● Labor and production costs; ● Cost of complying with regulation, including the “deeming regulation”; ● Increasing and unpredictable regulation and/or marketing order decisions impacting Creative Distribution Solutions products; ● Counterfeit and other illegal products in our end-markets; ● Currency fluctuations; ● Our ability to identify attractive acquisition opportunities; and ● Our ability to successfully integrate acquisitions. Critical Accounting Policies and Uses of Estimates There have been no material changes to our critical accounting policies and estimates from the information provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2022 Annual Report on Form 10-K. Recent Accounting Pronouncements There are no recent accounting pronouncements that impact the Company. Recent Developments On November 7, 2023, a wholly-owned subsidiary of the Company (the “ABL Borrower”) entered into a new $75.0 million asset-backed revolving credit facility (the “2023 ABL Facility”). The Company intends to use borrowings distributed to it by ABL Borrower under the 2023 ABL Facility to refinance a portion of the Convertible Senior Notes at maturity. In connection with entry into the 2023 ABL Facility, the Company terminated the Amended Revolving Credit Agreement originally entered into in 2021. See Part II Other Information --Item 5. Other Information. 38 Table of Contents Results of Operations Comparison of the Three Months Ended September 30, 2023, to the Three Months Ended September 30, 2022 The table and discussion set forth below displays our consolidated results of operations (in thousands): Three Months Ended September 30, 2023 2022 % Change Consolidated Results of Operations Data: Net sales Zig-Zag products $ 46,754 $ 52,061 -10.2 % Stoker’s products 36,916 33,525 10.1 % Total Zig-Zag and Stoker’s products 83,670 85,586 -2.2 % Creative Distribution Solutions 18,052 22,216 -18.7 % Total net sales 101,722 107,802 -5.6 % Cost of sales 50,100 55,090 -9.1 % Gross profit Zig-Zag products 26,745 28,035 -4.6 % Stoker’s products 20,572 18,279 12.5 % Total Zig-Zag and Stoker’s products 47,317 46,314 2.2 % Creative Distribution Solutions 4,305 6,398 -32.7 % Total gross profit 51,622 52,712 -2.1 % Selling, general, and administrative expenses 31,385 32,891 -4.6 % Operating income 20,237 19,821 2.1 % Interest expense, net 3,984 4,802 -17.0 % Investment loss (gain) 2,101 (75 ) -2,901.3 % Gain on extinguishment of debt (481 ) – NM Income before income taxes 14,633 15,094 -3.1 % Income tax expense 3,767 3,797 -0.8 % Consolidated net income 10,866 11,297 -3.8 % Net gain (loss) attributable to non-controlling interest 35 (239 ) -114.6 % Net income attributable to Turning Point Brands, Inc. $ 10,831 $ 11,536 -6.1 % Net Sales: For the three months ended September 30, 2023, consolidated net sales decreased to $101.7 million from $107.8 million for the three months ended September 30, 2022, a decrease of $6.1 million or 5.6%. For the three months ended September 30, 2023, net sales in the Zig-Zag Products segment decreased to $46.8 million from $52.1 million for the three months ended September 30, 2022, a decrease of $5.3 million or 10.2%. The decrease in net sales was driven by the benefits in the third quarter of 2022 from the initial load-in of CLIPPER lighters and approximately $5 million of sales that were pulled forward from the fourth quarter of last year due to the timing of promotional activities and Canadian deliveries. Additionally, a discontinuation of an unprofitable product line impacted Canadian sales by $1.8 million. For the three months ended September 30, 2023, net sales in the Stoker’s Products segment increased to $36.9 million from $33.5 million for the three months ended September 30, 2022, an increase of $3.4 million or 10.1%. For the three months ended September 30, 2023, volume increased 2.2% and price/product mix increased 7.9%. The increase in net sales was driven by double-digit growth of Stoker’s ® MST and single-digit growth in loose-leaf chewing tobacco. For the three months ended September 30, 2023, net sales in the Creative Distribution Solutions segment decreased to $18.1 million from $22.2 million for the three months ended September 30, 2022, a decrease of $4.1 million or 18.7%. The decrease in net sales was primarily the result of lower volumes in the vape distribution businesses. Gross Profit: For the three months ended September 30, 2023, consolidated gross profit decreased to $51.6 million from $52.7 million for the three months ended September 30, 2022, a decrease of $1.1 million or 2.1%. Gross profit as a percentage of net sales increased to 50.7% for the three months ended September 30, 2023, compared to 48.9% for the three months ended September 30, 2022 driven by decreased margin in Creative Distribution Solutions partially offset by increased margins in the Stoker’s Products and Zig-Zag Products segments. 39 Table of Contents For the three months ended September 30, 2023, gross profit in the Zig-Zag Products segment decreased to $26.7 million from $28.0 million for the three months ended September 30, 2022, a decrease of $1.3 million or 4.6% . Gross profit as a percentage of net sales increased to 57.2% of net sales for the three months ended September 30, 2023, from 53.9% of net sales for the three months ended September 30, 2022, driven primarily by product mix. For the three months ended September 30, 2023, gross profit in the Stoker’s Products segment increased to $20.6 million from $18.3 million for the three months ended September 30, 2022, an increase of $2.3 million or 12.5%. Gross profit as a percentage of net sales increased to 55.7% of net sales for the three months ended September 30, 2023, from 54.5% of net sales for the three months ended September 30, 2022, primarily as a result of strong market share gains in MST and loose-leaf chewing tobacco and pricing gains in MST. For the three months ended September 30, 2023, gross profit in the Creative Distribution Solutions segment decreased to $4.3 million from $6.4 million for the three months ended September 30, 2022, a decrease of $2.1 million or 32.7%. Gross profit as a percentage of net sales decreased to 23.8% of net sales for the three months ended September 30, 2023, from 28.8% of net sales for the three months ended September 30, 2022, primarily as a result of channel mix. Selling, General, and Administrative Expenses: For the three months ended September 30, 2023, selling, general, and administrative expenses decreased to $31.4 million from $32.9 million for the three months ended September 30, 2022, a decrease of $1.5 million or 4.6%. Selling, general and administrative expenses in the three months ended September 30, 2023, included $1.8 million of stock options, restricted stock and incentives expense, $0.3 million of expense related to PMTA, $0.2 million of expense related to corporate restructuring, $0.1 million of transaction costs and $0.1 million of expense related to the new ERP and CRM systems. Selling, general and administrative expenses in the three months ended September 30, 2022, included $1.4 million of stock option, restricted stock and incentives expense, $1.2 million of expense related to PMTA and $0.4 million of consulting expense related to the scoping and mobilization of the new ERP and CRM systems. Interest Expense, net: For the three months ended September 30, 2023, interest expense, net decreased to $4.0 million from $4.8 million for the three months ended September 30, 2022 as a result of the repurchase of $54.0 million total of Convertible Senior Notes as of September 30, 2023, and increased interest income on cash as a result of rising interest rates. Investment Loss (Gain): For the three months ended September 30, 2023, investment loss increased to $2.1 million compared to a $0.1 million gain for the three months ended September 30, 2022. The change is a result of an impairment charge recognized on our investment in Wild Hemp for $2.2 million in the third quarter of 2023. Gain on Extinguishment of Debt: There was a gain on extinguishment of debt of $0.5 million for the three months ended September 30, 2023 as a result of repurchasing $15.0 million of Convertible Senior Notes compared to no gain on extinguishment of debt for the three months ended September 30, 2022. Income Tax Expense: Our income tax expense of $3.8 million was 25.7% of income before income taxes for the three months ended September 30, 2023. Our effective income tax rate was 25.2% for the three months ended September 30, 2022. Net Gain (Loss) Attributable to Non-Controlling Interest: Net gain attributable to non-controlling interest was $0.0 million for the three months ended September 30, 2023 compared to $0.2 million net loss for the three months ended September 30, 2022. Net Income Attributable to Turning Point Brands, Inc.: Due to the factors described above, net income attributable to Turning Point Brands, Inc. for the three months ended September 30, 2023 and 2022, was $10.8 million and $11.5 million, respectively. 40 Table of Contents Comparison of the Nine Months Ended September 30, 2023, to the Six Months Ended September 30, 2022 The table and discussion set forth below displays our consolidated results of operations (in thousands): Nine Months Ended September 30, 2023 2022 % Change Consolidated Results of Operations Data: Net sales Zig-Zag products $ 135,363 $ 143,959 -6.0 % Stoker’s products 106,634 98,816 7.9 % Total Zig-Zag and Stoker’s products 241,997 242,775 -0.3 % Creative Distribution Solutions 66,276 68,846 -3.7 % Total net sales 308,273 311,621 -1.1 % Cost of sales 155,556 155,646 -0.1 % Gross profit Zig-Zag products 75,557 80,808 -6.5 % Stoker’s products 60,005 54,044 11.0 % Total Zig-Zag and Stoker’s products 135,562 134,852 0.5 % Creative Distribution Solutions 17,155 21,123 -18.8 % Total gross profit 152,717 155,975 -2.1 % Selling, general, and administrative expenses 94,093 98,779 -4.7 % Operating income 58,624 57,196 2.5 % Interest expense, net 12,013 15,142 -20.7 % Investment loss 10,980 6,074 80.8 % Gain on extinguishment of debt (1,858 ) – NM Income before income taxes 37,489 35,980 4.2 % Income tax expense 9,573 8,706 10.0 % Consolidated net income 27,916 27,274 2.4 % Net loss attributable to non-controlling interest (437 ) (684 ) -36.1 % Net income attributable to Turning Point Brands, Inc. $ 28,353 $ 27,958 1.4 % Net Sales: For the nine months ended September 30, 2023, consolidated net sales decreased to $308.3 million from $311.6 million for the nine months ended September 30, 2022, a decrease of $3.3 million or 1.1%. For the nine months ended September 30, 2023, net sales in the Zig-Zag Products segment decreased to $135.4 million from $144.0 million for the nine months ended September 30, 2022, a decrease of $8.6 million or 6.0%. The decrease in net sales was driven by anticipated declines in the U.S. rolling papers and wraps businesses which were impacted by a reduction of trade inventory, offset by growth in our Clipper business. Additionally, a discontinuation of an unprofitable product line negatively impacted Canadian sales by $3.6 million against the previous year. For the nine months ended September 30, 2023, net sales in the Stoker’s Products segment increased to $106.6 million from $98.8 million for the nine months ended September 30, 2022, an increase of $7.8 million or 7.9%. For the nine months ended September 30, 2023, volume increased 1.0% and price/product mix increased 6.9%. The increase in net sales was driven primarily by double-digit growth of Stoker’s ® MST. For the nine months ended September 30, 2023, net sales in the Creative Distribution Solutions segment decreased to $66.3 million from $68.8 million for the nine months ended September 30, 2022, a decrease of $2.5 million or 3.7%. The decrease in net sales was primarily the result of reduced volumes in the vape distribution business. 41 Table of Contents Gross Profit: For the nine months ended September 30, 2023, consolidated gross profit decreased to $152.7 million from $156.0 million for the nine months ended September 30, 2022, a decrease of $3.3 million or 2.1%. Gross profit as a percentage of net sales decreased to 49.5% for the nine months ended September 30, 2023, compared to 50.1% for the nine months ended September 30, 2022 driven by decreased margin in the Zig-Zag Products and Creative Distribution Solutions segments partially offset by increased margin in the Stoker’s Products segment. For the nine months ended September 30, 2023, gross profit in the Zig-Zag Products segment decreased to $75.6 million from $80.8 million for the nine months ended September 30, 2022, a decrease of $5.2 million or 6.5%. Gross profit as a percentage of net sales decreased to 55.8% of net sales for the nine months ended September 30, 2023, from 56.1% of net sales for the nine months ended September 30, 2022, as a result of product mix including the decline in net sales of higher margin U.S. rolling paper and wraps products and contribution of CLIPPER lighters, as a result of the exclusive distribution deal entered into in February 2022, which operates at lower gross profit margins. For the nine months ended September 30, 2023, gross profit in the Stoker’s Products segment increased to $60.0 million from $54.0 million for the nine months ended September 30, 2022, an increase of $6.0 million or 11.0%. Gross profit as a percentage of net sales increased to 56.3% of net sales for the nine months ended September 30, 2023, from 54.7% of net sales for the nine months ended September 30, 2022, primarily as a result of the strong incremental margin contribution of MST. For the nine months ended September 30, 2023, gross profit in the Creative Distribution Solutions segment decreased to $17.2 million from $21.1 million for the nine months ended September 30, 2022, a decrease of $3.9 million or 18.8%. Gross profit as a percentage of net sales decreased to 25.9% of net sales for the nine months ended September 30, 2023, from 30.7% of net sales for the nine months ended September 30, 2022, primarily as a result of channel mix. Selling, General, and Administrative Expenses: For the nine months ended September 30, 2023, selling, general, and administrative expenses decreased to $94.1 million from $98.8 million for the nine months ended September 30, 2022, a decrease of $4.7 million or 4.7%. Selling, general and administrative expenses in the nine months ended September 30, 2023, included $4.7 million of stock options, restricted stock and incentives expense, $1.1 million of expense related to PMTA, $0.2 million of expense related to corporate restructuring, $0.4 million of expense related to the new ERP and CRM systems and $0.2 million related to transaction costs. Selling, general and administrative expenses in the nine months ended September 30, 2022, included $4.1 million of stock option, restricted stock and incentives expense, $0.8 million of transaction costs, $4.3 million of expense related to PMTA, $1.6 million of expense related to corporate restructuring and $1.6 million of consulting expense related to the scoping of the new ERP and CRM systems. Interest Expense, net: For the nine months ended September 30, 2023, interest expense, net decreased to $12.0 million, from $15.1 million for the nine months ended September 30, 2022 as a result of the repurchases of $44.0 million of Convertible Senior Notes through the third quarter of 2023, and increased interest income on cash as a result of rising interest rates. Investment Loss: For the nine months ended September 30, 2023, investment loss increased to $10.9 million compared to $6.1 million for the nine months ended September 30, 2022. The change is a result of the year-to-date impairment charges recognized on our investments in Docklight and Wild Hemp for $6.5 million and $2.2 million, respectively, compared to an impairment charge of $6.3 million in the second quarter of 2022 related to our investment in Dosist. Gain on Extinguishment of Debt: There was a gain on extinguishment of debt of $1.9 million for the nine months ended September 30, 2023 as a result of repurchasing $44.0 million of Convertible Senior Notes through the third quarter of 2023 compared to no gain on extinguishment of debt for the nine months ended September 30, 2022. Income Tax Expense: Our income tax expense of $9.6 million was 25.5% of income before income taxes for the nine months ended September 30, 2023. Our effective income tax rate was 24.2% for the nine months ended September 30, 2022 and included a discrete tax benefit $0.7 million relating to stock option exercises. Net Loss Attributable to Non-Controlling Interest: Net loss attributable to non-controlling interest was $0.4 million for the nine months ended September 30, 2023 compared to $0.7 million for the nine months ended September 30, 2022. Net Income Attributable to Turning Point Brands, Inc.: Due to the factors described above, net income attributable to Turning Point Brands, Inc. for the nine months ended September 30, 2023 and 2022, was $28.4 million and $28.0 million, respectively. 42 Table of Contents EBITDA and Adjusted EBITDA To supplement our financial information presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, we use non-U.S. GAAP financial measures including EBITDA and Adjusted EBITDA. We believe Adjusted EBITDA provides useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Adjusted EBITDA is used by management to compare our performance to that of prior periods for trend analyses and planning purposes and is presented to our Board of Directors. We believe that EBITDA and Adjusted EBITDA are appropriate measures of operating performance because they eliminate the impact of expenses that do not relate to operating performance. In addition, our debt instruments contain covenants which use Adjusted EBITDA calculations. We define “EBITDA” as net income before interest expense, gain (loss) on extinguishment of debt, provision for income taxes, depreciation, and amortization. We define “Adjusted EBITDA” as net income before interest expense, gain (loss) on extinguishment of debt, provision for income taxes, depreciation, amortization, other non-cash items, and other items we do not consider the ordinary course in our evaluation of ongoing operating performance noted in the reconciliation below. Non-U.S. GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with U.S. GAAP. Adjusted EBITDA excludes significant expenses required to be recorded in our financial statements by U.S. GAAP and is subject to inherent limitations. Other companies in our industry may calculate this non-U.S. GAAP measure differently than we do or may not calculate it at all, limiting its usefulness as a comparative measure. The tables below provide reconciliations between net income and Adjusted EBITDA. (in thousands) Three Months Ended September 30, 2023 2022 Net income attributable to Turning Point Brands, Inc. $ 10,831 $ 11,536 Add: Interest expense, net 3,984 4,802 Gain on extinguishment of debt (481 ) – Income tax expense 3,767 3,797 Depreciation expense 782 861 Amortization expense 844 454 EBITDA $ 19,727 $ 21,450 Components of Adjusted EBITDA Corporate restructuring (a) 190 17 ERP/CRM (b) 138 435 Stock options, restricted stock, and incentives expense (c) 1,824 1,442 Transactional expenses (d) 76 – FDA PMTA (e) 275 1,169 Non-cash asset impairment (f) 2,173 – Adjusted EBITDA $ 24,403 $ 24,513 (a) Represents costs associated with corporate restructuring, including severance. (b) Represents cost associated with scoping and mobilization of new ERP and CRM systems and cost of duplicative ERP licenses. (c) Represents non-cash stock options, restricted stock, incentives expense and Solace performance stock units. (d) Represents the fees incurred for transaction expenses. (e) Represents costs associated with applications related to FDA premarket tobacco product application (“PMTA”). (f) Represents impairment of investment assets. 43 Table of Contents (in thousands) Nine Months Ended September 30, 2023 2022 Net income attributable to Turning Point Brands, Inc. $ 28,353 $ 27,958 Add: Interest expense, net 12,013 15,142 Gain on extinguishment of debt (1,858 ) – Income tax expense 9,573 8,706 Depreciation expense 2,317 2,611 Amortization expense 2,386 1,373 EBITDA $ 52,784 $ 55,790 Components of Adjusted EBITDA Corporate restructuring (a) 190 1,619 ERP/CRM (b) 414 1,626 Stock options, restricted stock, and incentives expense (c) 4,660 4,103 Transactional expenses (d) 162 789 FDA PMTA (e) 1,095 4,265 Non-cash asset impairment (f) 11,162 6,300 Adjusted EBITDA $ 70,467 $ 74,492 (a) Represents costs associated with corporate restructuring, including severance. (b) Represents cost associated with scoping and mobilization of new ERP and CRM systems and cost of duplicative ERP licenses. (c) Represents non-cash stock options, restricted stock, incentives expense and Solace performance stock units. (d) Represents the fees incurred for transaction expenses. (e) Represents costs associated with applications related to FDA premarket tobacco product application (“PMTA”). (f) Represents impairment of investment assets. Liquidity and Capital Resources As of September 30, 2023, we had $96.1 million of cash on hand and have $23.6 million of availability under the 2021 Amended Revolving Credit Facility. Our principal uses for cash are working capital, debt service, and capital expenditures. Our Convertible Senior Notes, with an outstanding balance of $118.5 million as of September 30, 2023, mature in July of 2024. On November 7, 2023, one of our wholly-owned subsidiaries entered into a new 2023 ABL Facility to refinance up to $75.0 million of the Convertible Senior Notes at maturity. As a result, we reclassified $70.0 million related to the Convertible Senior Notes from short-term to long-term liabilities on our September 30, 2023 Balance Sheet. With our strong cash balance, free cash flow generation and borrowing availability under the 2023 ABL Facility, we expect to have ample liquidity to address the remaining balance of the Convertible Senior Notes maturing next year, and to satisfy our operating cash requirements for the foreseeable future. Our working capital, which we define as current assets less cash and current liabilities, decreased to $64.0 million at September 30, 2023, compared with $109.9 million at December 31, 2022 as a result of a portion of the Convertible Senior Notes becoming current during the quarter. As of (in thousands) September 30, 2023 December 31, 2022 Current assets $ 150,741 $ 151,251 Current liabilities 86,718 41,376 Working capital $ 64,023 $ 109,875 Cash Flows from Operating Activities For the nine months ended September 30, 2023, net cash provided by operating activities was $40.0 million compared to net cash provided by operating activities of $16.4 million for the nine months ended September 30, 2022, an increase of $23.6 million, primarily due to the timing of changes of inventory and other working capital. 44 Table of Contents Cash Flows from Investing Activities For the nine months ended September 30, 2023, net cash used in investing activities was $4.4 million compared to net cash used in investing activities of $17.8 million for the nine months ended September 30, 2022, a reduction in cash used in investing activities of $13.4 million, primarily due to a decrease in purchases of investments in our MSA escrow account. Cash Flows from Financing Activities For the nine months ended September 30, 2023, net cash used in financing activities was $46.0 million compared to net cash used in financing activities of $31.2 million for the nine months ended September 30, 2022, an increase of $14.8 million, primarily due to $41.8 million in repurchases of Convertible Senior Notes during the period, offset by a decrease in repurchases of common stock of $27.0 million during 2023. Dividends and Share Repurchase A dividend of $0.065 per common share was paid on October 6, 2023, to shareholders of record at the close of business on September 15, 2023. On February 25, 2020, our Board of Directors approved a $50.0 million share repurchase program, which is intended for opportunistic execution based upon a variety of factors including market dynamics. The program is subject to the ongoing discretion of the Board of Directors. On October 25, 2021, the Board of Directors increased the approved share repurchase program by $30.7 million and by an additional $24.6 million on February 24, 2022. $27.2 million remains available for share repurchases under the program as of September 30, 2023. Long-Term Debt As of September 30, 2023, we were in compliance with the financial and restrictive covenants of the Senior Secured Notes and 2021 Revolving Credit Facility. The following table provides outstanding balances of our debt instruments. September 30, 2023 December 31, 2022 Senior Secured Notes $ 250,000 $ 250,000 Convertible Senior Notes 118,541 162,500 Gross notes payable and long-term debt 368,541 412,500 Less deferred finance charges (3,720 ) (5,743 ) Less current maturities (48,248 ) - Notes payable and long-term debt $ 316,573 $ 406,757 Senior Secured Notes On February 11, 2021, we closed a private offering (the “Offering”) of $250 million aggregate principal amount of our 5.625% senior secured notes due 2026 (the “Senior Secured Notes”). The Senior Secured Notes bear interest at a rate of 5.625% and will mature on February 15, 2026. Interest on the Senior Secured Notes is payable semi-annually in arrears on February 15 and August 15 of each year, commencing on August 15, 2021.We used the proceeds from the Offering (i) to repay all obligations under and terminate the 2018 First Lien Credit Facility, (ii) to pay related fees, costs, and expenses and (iii) for general corporate purposes. Obligations under the Senior Secured Notes are guaranteed by the Company’s existing and future wholly-owned domestic subsidiaries (the “Guarantors”) that guarantee any credit facility (as defined in the indenture governing the Senior Secured Notes or the “Senior Secured Notes Indenture”) or capital markets debt securities of the Company or Guarantors in excess of $15.0 million. The Senior Secured Notes and the related guarantees are secured by first-priority liens on substantially all of the assets of the Company and the Guarantors, subject to certain exceptions. 45 Table of Contents The Company may redeem the Senior Secured Notes, in whole or in part, at any time on or after February 15, 2023, at the redemption prices (expressed as a percentage of the principal amount to be redeemed) set forth below, plus accrued and unpaid interest, if any, on the Senior Secured Notes to be redeemed to (but not including) the applicable redemption date if redeemed during the period indicated below: On or after February 15, 2023 102.813 % On or after February 15, 2024 101.406 % On or after February 15, 2025 and thereafter 100.000 % If we experience a change of control (as defined in the Senior Secured Notes Indenture), we must offer to repurchase the Senior Secured Notes at a repurchase price equal to 101% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest. The Senior Secured Notes Indenture contains covenants that, among other things, restrict the ability of the Company and its restricted subsidiaries to: (i) grant or incur liens; (ii) incur, assume or guarantee additional indebtedness; (iii) sell or otherwise dispose of assets, including capital stock of subsidiaries; (iv) make certain investments; (v) pay dividends, make distributions or redeem or repurchase capital stock; (vi) engage in certain transactions with affiliates; and (vii) consolidate or merge with or into, or sell substantially all of our assets to another entity. These covenants are subject to a number of limitations and exceptions set forth in the Senior Secured Notes Indenture. The Senior Secured Notes Indenture provides for customary events of default. We were in compliance with all covenants as of September 30, 2023. We incurred debt issuance costs attributable to the issuance of the Senior Secured Notes of $6.4 million which are amortized to interest expense using the effective interest method over the expected life of the Senior Secured Notes. 2021 Revolving Credit Facility In connection with the Offering, we also entered into a new $25.0 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). On May 10, 2023, the Company and certain of its subsidiaries, as guarantors, entered into an amendment (the “Amendment”) to the 2021 Revolving Credit Facility (as amended, the “Amended Revolving Credit Facility”). The Amendment includes certain modifications to the 2021 Revolving Credit Facility relating to the replacement of the London Inter-Bank Offered Rate with a Secured Overnight Financing Rate (“SOFR”) as the interest rate benchmark under the 2021 Revolving Credit Facility and adjusts certain other provisions to reflect current documentation standards and other agreed modifications. Letters of credit are limited to $10.0 million (and are a part of, and not in addition to, the revolving line of credit). We have not drawn any borrowings under the Amended Revolving Credit Facility but do have letters of credit of approximately $1.4 million outstanding under the facility as of March 31, 2023. The Amended Revolving Credit Facility will mature on August 11, 2025 if none of our Convertible Senior Notes are outstanding, and if any Convertible Senior Notes are outstanding, the date which is 91 days prior to the maturity date of July 15, 2024, for such Convertible Senior Notes. Interest is payable on the Amended 2021 Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate of Term SOFR rate, as applicable, plus an applicable margin of 3.50% (with step-downs upon de-leveraging). We also have the option to borrow at a rate determined by reference to the base rate. The obligations under the Amended Revolving Credit Agreement are guaranteed on a joint and several basis by the Guarantors. The Company’s and Guarantors’ obligations under the Amended Revolving Credit Facility are secured on a pari passu basis with the Senior Secured Notes. The Amended Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The Amended Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio of 5.50 to 1.00 (with a step down to 5.25 to 1.00 beginning with the fiscal quarter ending March 31, 2023) at the end of each fiscal quarter when extensions of credit under the Amended Revolving Credit Facility and certain drawn and undrawn letters of credit (excluding (a) letters of credit that have been cash collateralized and (b) letters of credit having an aggregate face amount less than $5.0 million) in the aggregate outstanding exceeds 35% of the total commitments under the Amended Revolving Credit Facility. The Amended Revolving Credit Agreement provides for customary events of default. We were in compliance with all covenants as of September 30, 2023. 46 Table of Contents We incurred debt issuance costs attributable to the issuance of the Amended Revolving Credit Facility of $0.5 million which are amortized to interest expense using the effective interest method over the expected life of the Amended Revolving Credit Facility. On November 7, 2023, the Company terminated the Amended Revolving Credit Agreement in connection with entry into the new 2023 ABL Facility by one of its subsidiaries. 2023 ABL Facility On November 7, 2023, TPB Specialty Finance, LLC, a wholly-owned subsidiary of the Company (the “ABL Borrower”), entered into a $75.0 million asset-backed revolving credit facility (the “2023 ABL Facility”), with the several lenders thereunder, and Barclays Bank Plc, as administrative agent (the “Administrative Agent”) and as collateral agent (the “Collateral Agent”) and First-Citizens Bank & Trust Company as additional collateral agent (the “Additional Collateral Agent”). Under the 2023 ABL Facility, the ABL Borrower may draw up to $75.0 million under Revolving Credit Loans and LILO Loans. The 2023 ABL Facility includes a $40.0 million accordion feature. In connection with the 2023 ABL Facility, Turning Point Brands contributed certain existing inventory to the ABL Borrower. The 2023 ABL Facility is secured on a first priority basis (subject to customary exceptions) by all assets of the ABL Borrower. The 2023 ABL Facility contains customary borrowing conditions including a borrowing base equal to the sum of (a) the lesser of (1) 85% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) 85% of the cost of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (2) 85% of the net orderly liquidation value (“NOLV”) percentage of the lower of (1)(A) or (1)(B); plus (b) 85% of the face value of all eligible accounts of the ABL Borrower minus (c) the amount of all eligible reserves. The 2023 ABL Facility also includes a “last in last out” (“LILO”) borrowing base equal to the sum of (a) the lesser of: (1) 10% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) the cost of the sum of eligible inventory, plus eligible in-transit inventory and (2) 10% of the NOLV percentage of the lower of (1)(A) or (1)(B); plus (b) 10% of the face amount of eligible account; minus (c) the amount of all eligible reserves. Amounts borrowed under the 2023 ABL Facility are subject to an interest rate margin per annum equal to (a) from and after the closing date until the last day of the first full fiscal quarter ended after the closing date, (i) 1.25% per annum, in the case base rate loans, and (ii) 2.25% per annum, in the case of revolving credit loans that are SOFR Loans, (b)(i) 2.25% per annum, in the case of LILO loans that are base rate loans, and (ii) 3.25% per annum, in the case of LILO loans that are SOFR loans, (c) on the first day of each fiscal quarter, the applicable interest rate margins will be determined from the pricing grid below based upon the historical excess availability for the most recent fiscal quarter ended immediately prior to the relevant date, as calculated by the Administrative Agent. Level Historical Excess Availability Applicable Margin for SOFR Loans Applicable Margin for Base Rate Loans I Greater than or equal to 66.66% 1.75% 0.75% II Less than 66.66%, but greater than or equal to 33.33% 2.00% 1.00% III Less than 33.33% 2.25% 1.25% The 2023 ABL Facility also requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the end of any four consecutive fiscal quarters on or after the closing date if excess availability shall be less than the greater of (a) 12.5% of the line cap and (b) $9.4 million, at any time and continuing until excess availability is equal to or exceeds the greater of (i) 12.5% of the line and (ii) $9.4 million for thirty (30) consecutive calendar days; provided that such $9.4 million level shall automatically increase in proportion to the amount of any increase in the aggregate revolving credit commitments thereunder in connection with any incremental facility. The 2023 ABL Facility shall mature on the earlier of (x) November 7, 2027 and (y) the date that is 91 days prior to the maturity date of any material debt of the ABL Borrower or the Company or any of its restricted subsidiaries (subject to customary extensions agreed by the lenders thereunder); provided that clause (y) shall not apply to the extent that on any applicable date of determination (on any date prior to the date set forth in clause (y)), (A) the sum of (x) cash that is held in escrow for the repayment of such material debt pursuant to arrangements satisfactory to the Administrative Agent, (y) cash that is held in accounts with the Administrative Agent and/or the Additional Collateral Agent, plus (z) excess availability, is sufficient to repay such material debt and (B) the ABL Borrower has excess availability of at least $15.0 million after giving effect to such repayment of material debt, including any borrowings under the commitments in connection therewith. 47 Table of Contents Convertible Senior Notes In July 2019 we closed an offering of $172.5 million in aggregate principal amount of our 2.50% Convertible Senior Notes due July 15, 2024 (the “Convertible Senior Notes”). The Convertible Senior Notes bear interest at a rate of 2.50% per year, payable semiannually in arrears on January 15 and July 15 of each year, beginning on January 15, 2020. The Convertible Senior Notes will mature on July 15, 2024, unless earlier repurchased, redeemed or converted. The Convertible Senior Notes are senior unsecured obligations. In the fourth quarter of 2022, a wholly owned subsidiary of the Company repurchased $10.0 million in aggregate principal amount of the Convertible Senior Notes on the open market resulting in a $0.9 million gain on extinguishment of debt. Subsequent principal repurchases occurred in the first, second and third quarters of 2023 for $13.9 million, $15.1 million and $15.0 million, respectively, in aggregate principal amounts resulting in gains on extinguishment of debt of $0.7 million, $0.6 million and $0.6 million, respectively. The repurchased notes continue to be held by our subsidiary and may be resold subject to compliance with applicable securities law. As of September 30, 2023, $118.5 million aggregate principal remains outstanding and held by third parties. The Convertible Senior Notes held by third parties are convertible into approximately 2,216,029 shares of TPB Common Stock under certain circumstances prior to maturity at a conversion rate of 18.6942 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.49 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. The conversion price is adjusted periodically as a result of dividends paid by the Company in excess of pre-determined thresholds of $0.04 per share. Upon conversion, the Company may pay cash, shares of common stock or a combination of cash and stock, as determined by the Company at its discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of 2023. We incurred debt issuance costs attributable to the Convertible Senior Notes of $5.9 million which are amortized to the interest expense using the effective interest method over the expected life of the Convertible Senior Notes. In connection with the Convertible Senior Notes offering, we entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $53.49 per and a cap price of $82.86 per share, and are exercisable when, and if, the Convertible Senior Notes are converted. We paid $20.53 million for these capped calls at the time they were entered into and charged that amount to additional paid-in capital. Off-balance Sheet Arrangements During the nine months ended September 30, 2023, we executed various foreign exchange contracts for the purchase of €20.1 million and sale of €15.2 million with maturity dates ranging from October 2023 to September 2024. At September 30, 2023, we had foreign currency contracts outstanding for the purchase of €17.1 million and sale of €15.2 million. The fair value of the foreign currency contracts were based on quoted market prices and resulted in an asset of $0.1 million included in Other current assets and a liability of $0.5 million included in Accrued liabilities at September 30, 2023. During 2022, we executed various foreign currency contracts for the purchase of €28.9 million and sale of €28.9 million. At December 31, 2022, we had foreign currency contracts for the purchase of €18.5 million and sale of €18.5 million. The fair value of the foreign currency contracts resulted in an asset of $1.2 million included in Other current assets and a liability of $0.0 million included in Accrued liabilities at December 31, 2022. Inflation Inflation in general, and the recent rapid increases in gas prices have had a substantial negative effect on the purchasing power of consumers. While historically, we have been able to increase prices at a rate equal to or greater than that of inflation, doing so would be difficult in the current inflationary environment. However, we have implemented price increases in areas where doing so has been feasible. In addition, we have been able to maintain a relatively stable variable cost structure for our products due, in part, to our successful procurement regarding our tobacco products and, in part, to our existing contractual agreement for the purchase of our premium cigarette papers. 48 Table of Contents