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Turning Point Brands, Inc. - Quarter Report: 2022 September (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________

Commission file number: 001-37763

TURNING POINT BRANDS, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
20-0709285
(State or other jurisdiction of Incorporation or organization)
 
(I.R.S. Employer Identification No.)

5201 Interchange Way, Louisville, KY
 
40229
(Address of principal executive offices)
 
(Zip Code)

(502) 778-4421
(Registrant’s telephone number, including area code)

Former name, former address and former fiscal year, if changed since last report: not applicable

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value
TPB
New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes      No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes      No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
Emerging growth company
     

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      No 

At October 21, 2022, there were 17,563,978 shares outstanding of the registrant’s voting common stock, par value $0.01 per share.



TURNING POINT BRANDS, INC.
TABLE OF CONTENTS

   
Page No.
PART I—FINANCIAL INFORMATION
 
   
 
ITEM 1
Financial Statements (Unaudited)
 
       
   
5
       
   
6
       
    Consolidated Statements of Income for the nine months ended September 30, 2022 and 2021 7
       
   
8
       
   
9
       
   
10
       
    11
       
   
12
       
 
ITEM 2
37
       
 
ITEM 3
49
       
 
ITEM 4
49
       
PART II—OTHER INFORMATION
 
   
 
ITEM 1
50
       
 
ITEM 1A
50
       
 
ITEM 2
50
       
 
ITEM 3
50
       
 
ITEM 4
50
       
 
ITEM 5
50
       
 
ITEM 6
51
       
  52

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements may generally be identified by the use of words such as “anticipate,” “believe,” “expect,” “intend,” “plan,” and “will” or, in each case, their negative, or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts. By their nature, forward-looking statements involve risks and uncertainties because they relate to events, and depend on circumstances, that may or may not occur in the future. As a result, actual events may differ materially from those expressed in, or suggested by, the forward-looking statements. Any forward-looking statement made by Turning Point Brands, Inc. (“TPB”), in this Quarterly Report on Form 10-Q speaks only as of the date hereof. New risks and uncertainties arise from time to time, and it is impossible for TPB to predict these events or how they may affect it. TPB has no obligation, and does not intend, to update any forward-looking statements after the date hereof, except as required by federal securities laws. Factors that could cause these differences include, but are not limited to:


declining sales of tobacco products, and expected continuing decline of sales, in the tobacco industry overall;

our dependence on a small number of third-party suppliers and producers;

the possibility that we will be unable to identify or contract with new suppliers or producers in the event of a supply or product disruption, as well as other supply chain concerns, including delays in product shipments and increases in freight cost;

the possibility that our licenses to use certain brands or trademarks will be terminated, challenged or restricted;

failure to maintain consumer brand recognition and loyalty of our customers;

our reliance on relationships with several large retailers and national chains for distribution of our products;

intense competition and our ability to compete effectively;

competition from illicit sources and the damage caused by illicit products to brand equity;

contamination of our tobacco supply or products;

uncertainty and continued evolution of the markets for our NewGen and cigar products;

complications with the design or implementation of our new enterprise resource planning system could adversely impact our business and operations;

substantial and increasing U.S. regulation;

regulation or marketing denials of our products by the FDA, which has broad regulatory powers;

many of our products contain nicotine, which is considered to be a highly addictive substance;

requirement to maintain compliance with master settlement escrow agreement;

possible significant increases in federal, state and local municipal tobacco- and vapor-related taxes;

our products are subject to developing and unpredictable regulation, such as court actions that impact obligations;

increase in state and local regulation of our NewGen products has been proposed or enacted;

increase in tax of our NewGen products could adversely affect our business;

sensitivity of end-customers to increased sales taxes and economic conditions including significant increases in the rate of inflation and other declines in purchasing power;

possible increasing international control and regulation;

failure to comply with environmental, health and safety regulations;

imposition of significant tariffs on imports into the U.S.; 

the scientific community’s lack of information regarding the long-term health effects of certain substances contained in some of our products;

significant product liability litigation;

the effect of the COVID-19 pandemic on our business;

our amount of indebtedness;

the terms of our indebtedness, which may restrict our current and future operations;

identification of a material weakness in our internal control related to ineffective information technology general controls which, if not remediated appropriately or timely, could result in loss of investor confidence and adversely impact our stock price;

Changes in the method for determining LIBOR or the replacement of LIBOR with an alternative reference rate, may adversely affect interest expense related to outstanding debt;

our certificate of incorporation and bylaws, as well as Delaware law and certain regulations, could discourage or prohibit acquisition bids or merger proposals, which may adversely affect the market price of our common stock;

our certificate of incorporation limits the ownership of our common stock by individuals and entities that are Restricted Investors. These restrictions may affect the liquidity of our common stock and may result in Restricted Investors (as defined in our Certificate of Incorporation) being required to sell or redeem their shares at a loss or relinquish their voting, dividend and distribution rights;


future sales of our common stock in the public market could reduce our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us;

we may issue preferred stock whose terms could adversely affect the voting power or value of our common stock;

our business may be damaged by events outside of our suppliers’ control, such as the impact of epidemics (e.g., coronavirus), political upheavals, or natural disasters;

our reliance on information technology;

cybersecurity and privacy breaches;

failure to manage our growth;

failure to successfully integrate our acquisitions or otherwise be unable to benefit from pursuing acquisitions;

fluctuations in our results;

exchange rate fluctuations;

adverse U.S. and global economic conditions;

departure of key management personnel or our inability to attract and retain talent;

infringement on or misappropriation of our intellectual property;

third-party claims that we infringe on their intellectual property; and

failure to meet expectations relating to environmental, social and governance factors.


PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Turning Point Brands, Inc.
Consolidated Balance Sheets
(dollars in thousands except share data)

   
(unaudited)
       
     September 30,      December 31,  
ASSETS
 
2022
   
2021
 
Current assets:
           
Cash
 
$
105,672
   
$
128,320
 
Accounts receivable, net of allowances of $107 in 2022 and $262 in 2021
   
11,453
     
6,496
 
Inventories
   
113,928
     
87,607
 
Other current assets
   
24,729
     
26,746
 
Total current assets
   
255,782
     
249,169
 
Property, plant, and equipment, net
   
22,512
     
18,650
 
Deferred income taxes
   
2,795
     
1,363
 
Right of use assets
   
13,185
     
15,053
 
Deferred financing costs, net
   
309
     
388
 
Goodwill
   
162,120
     
162,333
 
Other intangible assets, net
   
86,112
     
87,485
 
Master Settlement Agreement (MSA) escrow deposits
   
27,845
     
31,720
 
Other assets
   
29,129
     
35,399
 
Total assets
 
$
599,789
   
$
601,560
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
 
$
9,247
   
$
7,361
 
Accrued liabilities
   
32,613
     
32,937
 
Other current liabilities
   
21
     
38
 
Total current liabilities
   
41,881
     
40,336
 
Notes payable and long-term debt
   
416,029
     
414,172
 
Lease liabilities
   
11,299
     
13,336
 
Total liabilities
   
469,209
     
467,844
 
                 
Commitments and contingencies
           
                 
Stockholders’ equity:
               
Preferred stock; $0.01 par value; authorized shares 40,000,000; issued and outstanding shares -0-
   
-
     
-
 
Common stock, voting, $0.01 par value; authorized shares, 190,000,000; 19,801,623 issued shares and 17,587,122 outstanding shares at September 30, 2022, and 19,690,884 issued shares and 18,395,476 outstanding shares at December 31, 2021
   
198
     
197
 
Common stock, nonvoting, $0.01 par value; authorized shares, 10,000,000; issued and outstanding shares -0-
   
-
     
-
 
Additional paid-in capital
   
112,034
     
108,811
 
Cost of repurchased common stock (2,214,501 shares at September 30, 2022, and 1,295,408 shares at December 31, 2021)
   
(75,901
)
   
(48,869
)
Accumulated other comprehensive loss
   
(3,424
)
   
(195
)
Accumulated earnings
   
96,088
     
71,460
 
Non-controlling interest
   
1,585
     
2,312
 
Total stockholders’ equity
   
130,580
     
133,716
 
Total liabilities and stockholders’ equity
 
$
599,789
   
$
601,560
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Income
(dollars in thousands except share data)
(unaudited)


 
Three Months Ended
September 30,
 
   
2022
   
2021
 
             
Net sales
 
$
107,802
   
$
109,904
 
Cost of sales
   
55,090
     
55,635
 
Gross profit
   
52,712
     
54,269
 
Selling, general, and administrative expenses
   
32,891
     
31,894
 
Operating income
   
19,821
     
22,375
 
Interest expense, net
   
4,802
     
5,397
 
Investment income
   
(75
)
   
(157
)
Gain on extinguishment of debt
    -       (375 )
Income before income taxes
   
15,094
     
17,510
 
Income tax expense
   
3,797
     
4,073
 
Consolidated net income
   
11,297
     
13,437
 
Net loss attributable to non-controlling interest
   
(239
)
   
(31
)
Net income attributable to Turning Point Brands, Inc.
 
$
11,536
   
$
13,468
 
                 
Basic income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
0.65
   
$
0.71
 
Diluted income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
0.60
   
$
0.65
 
Weighted average common shares outstanding:
               
Basic
   
17,749,294
     
18,897,974
 
Diluted
   
21,102,006
     
22,364,807
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Income
(dollars in thousands except share data)
(unaudited)


 
Nine Months Ended
September 30,
 
   
2022
   
2021
 
             
Net sales
 
$
311,621
   
$
340,188
 
Cost of sales
   
155,646
     
172,685
 
Gross profit
   
155,975
     
167,503
 
Selling, general, and administrative expenses
   
98,779
     
95,900
 
Operating income
   
57,196
     
71,603
 
Interest expense, net
   
15,142
     
15,406
 
Investment loss (income)
   
6,074
     
(292
)
Loss on extinguishment of debt
   
-
     
5,331
 
Income before income taxes
   
35,980
     
51,158
 
Income tax expense
   
8,706
     
11,151
 
Consolidated net income
   
27,274
     
40,007
 
Net loss attributable to non-controlling interest
   
(684
)
   
(598
)
Net income attributable to Turning Point Brands, Inc.
 
$
27,958
   
$
40,605
 
                 
Basic income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
1.55
   
$
2.14
 
Diluted income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
1.45
   
$
1.95
 
Weighted average common shares outstanding:
               
Basic
   
18,021,554
     
18,988,435
 
Diluted
   
21,401,485
     
22,464,542
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Comprehensive Income
(dollars in thousands)
(unaudited)


 
Three Months Ended
September 30,
 
   
2022
   
2021
 
Consolidated net income
 
$
11,297
   
$
13,437
 
                 
Other comprehensive income (loss), net of tax
               
Unrealized loss on MSA investments, net of tax of $333 in 2022 and $14 in 2021
   
(1,046
)
   
(43
)
Foreign currency translation, net of tax of $0 in 2022 and 2021
   
(160
)
   
(637
)
Unrealized (loss) gain on derivative instruments, net of tax of $67 in 2022 and $1 in 2021
   
(210
)
   
3
 
     
(1,416
)
   
(677
)
Consolidated comprehensive income
   
9,881
     
12,760
 
Comprehensive loss attributable to non-controlling interest
   
(295
)
   
(306
)
Comprehensive income attributable to Turning Point Brands, Inc.
 
$
10,176
   
$
13,066
 


 
Nine Months Ended
September 30,
 
   
2022
   
2021
 
Consolidated net income
 
$
27,274
   
$
40,007
 
                 
Other comprehensive income (loss), net of tax
               
Unrealized loss on MSA investments, net of tax of $934 in 2022 and $75 in 2021
   
(2,940
)
   
(235
)
Foreign currency translation, net of tax of $0 in 2022 and 2021
   
(122
)
   
324
 
Unrealized (loss) gain on derivative instruments, net of tax of $67 in 2022 and $811 in 2021
   
(210
)
   
2,628
 
     
(3,272
)
   
2,717
 
Consolidated comprehensive income
   
24,002
     
42,724
 
Comprehensive loss attributable to non-controlling interest
   
(727
)
   
(393
)
Comprehensive income attributable to Turning Point Brands, Inc.
 
$
24,729
   
$
43,117
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Cash Flows
(dollars in thousands)
(unaudited)


 
Nine Months Ended
September 30,
 
   
2022
   
2021
 
Cash flows from operating activities:
           
Consolidated net income
 
$
27,274
   
$
40,007
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Loss on extinguishment of debt
   
-
     
5,331
 
Gain on sale of property, plant, and equipment
   
(8
)
   
(2
)
Depreciation expense
   
2,611
     
2,313
 
Amortization of other intangible assets
   
1,373
     
1,431
 
Amortization of deferred financing costs
   
1,936
     
1,895
 
Deferred income tax (benefit) expense
   
(431
)
   
1,528
 
Stock compensation expense
   
4,103
     
6,015
 
Noncash lease income
   
-
     
(49
)
Loss (gain) on investments
   
6,244
     
(144
)
Changes in operating assets and liabilities:
               
Accounts receivable
   
(5,030
)
   
1,324
 
Inventories
   
(26,467
)
   
(10,970
)
Other current assets
   
1,891
     
(491
)
Other assets
   
1,211
     
685
 
Accounts payable
   
2,074
     
3,488
 
Accrued liabilities and other
   
(392
)
   
(2,796
)
Net cash provided by operating activities
 
$
16,389
   
$
49,565
 
                 
Cash flows from investing activities:
               
Capital expenditures
 
$
(6,662
)
 
$
(4,391
)
Acquisitions, net of cash acquired
    -       (16,416 )
Payments for investments
    (1,000 )     (16,657 )
Restricted cash, MSA escrow deposits
   
(10,169
)
   
(14,783
)
Proceeds on the sale of property, plant and equipment
   
63
     
2
 
Net cash used in investing activities
 
$
(17,768
)
 
$
(52,245
)
                 
Cash flows from financing activities:
               
Proceeds from Senior Secured Notes
 
$
-
   
$
250,000
 
Payments of 2018 first lien term loan
   
-
     
(130,000
)
Settlement of interest rate swaps
   
-
     
(3,573
)
Payment of promissory note
    -       (9,625 )
Payment of dividends
   
(3,259
)
   
(3,056
)
Payments of financing costs
   
-
     
(6,921
)
Exercise of options
   
504
     
2,071
 
Redemption of options
   
(155
)
   
(2,111
)
Redemption of stock units
    (1,228 )     -  
Common stock repurchased
   
(27,032
)
   
(20,481
)
Net cash (used in) provided by financing activities
 
$
(31,170
)
 
$
76,304
 
                 
Net (decrease) increase in cash
 
$
(32,549
)
 
$
73,624
 
Effect of foreign currency translation on cash
 
$
(324
)
 
$
235
 
                 
Cash, beginning of period:
               
Unrestricted
   
128,320
     
41,765
 
Restricted
   
15,155
     
35,074
 
Total cash at beginning of period
   
143,475
     
76,839
 
                 
Cash, end of period:
               
Unrestricted
   
105,672
     
130,551
 
Restricted
   
4,930
     
20,147
 
Total cash at end of period
 
$
110,602
   
$
150,698
 
                 
Supplemental schedule of noncash investing activities:
               
Accrued capital expenditures
 
$
57
   
$
-
 
                 
Supplemental schedule of noncash financing activities:
               
Dividends declared not paid
 
$
1,089
   
$
1,255
 
Accrued consideration for acquisition
 
$
-
   
$
316
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the Three Months Ended September 30, 2022 and 2021
(dollars in thousands except share data)
(unaudited)

                            Accumulated                    
          Common     Additional     Cost of
    Other           Non-        
    Voting     Stock,     Paid-In     Repurchased
    Comprehensive     Accumulated     Controlling        

 
Shares
   
Voting
   
Capital
   
Common Stock
   
Income (Loss)
   
Earnings
   
Interest
   
Total
 
                                                 
Beginning balance July 1, 2022
   
17,890,441
   
$
198
   
$
110,563
   
$
(68,287
)
 
$
(2,064
)
 
$
85,641
   
$
1,880
   
$
127,931
 
                                                                 
Unrealized loss on MSA investments, net of tax of $333
   
-
     
-
     
-
     
-
     
(1,046
)
   
-
     
-
     
(1,046
)
Unrealized loss on derivative instruments, net of tax of $67     -       -       -       -       (210 )     -       -       (210 )
Foreign currency translation, net of tax of $0
   
-
     
-
     
-
     
-
     
(104
)
   
-
     
(56
)
   
(160
)
Stock compensation expense
   
-
     
-
     
1,442
     
-
     
-
     
-
     
-
     
1,442
 
Exercise of options
   
3,053
     
-
     
29
     
-
     
-
     
-
     
-
     
29
 
Redemption of options
    -       -       -       -      
-
     
-
      -       -  
Performance restricted stock units issuance
    835       -       -       -       -       -       -       -  
Cost of repurchased common stock
   
(307,207
)
   
-
     
-
     
(7,614
)
   
-
     
-
     
-
     
(7,614
)
Dividends
   
-
     
-
     
-
     
-
     
-
     
(1,089
)
   
-
     
(1,089
)
Net income
   
-
     
-
     
-
     
-
     
-
     
11,536
     
(239
)
   
11,297
 
Ending balance September 30, 2022
   
17,587,122
   
$
198
   
$
112,034
   
$
(75,901
)
 
$
(3,424
)
 
$
96,088
   
$
1,585
   
$
130,580
 
                                                                 
                                                                 
Beginning balance July 1, 2021
   
18,923,523
   
$
196
   
$
105,460
   
$
(24,277
)
 
$
279
   
$
48,647
   
$
3,963
   
$
134,268
 
                                                                 
Unrealized gain on MSA investments, net of tax of $14
    -       -       -       -       (43 )     -       -       (43 )
Unrealized gain on derivative instruments, net of tax of $1
   
-
     
-
     
-
     
-
     
3
     
-
     
-
     
3
 
Foreign currency translation, net of tax of $0
    -       -       -       -       (362 )     -       (275 )     (637 )
Stock compensation expense
   
-
     
-
     
1,752
     
-
     
-
     
-
     
-
     
1,752
 
Exercise of options
   
74,660
     
1
     
1,184
     
-
     
-
     
-
     
-
     
1,185
 
Cost of repurchased common stock
   
(125,000
)
   
-
     
-
     
(6,395
)
   
-
     
-
     
-
     
(6,395
)
Acquisition of Recreation Marketing interest
    -       -       (1,127 )     -       -       -       (1,123 )     (2,250 )
Dividends
   
-
     
-
     
-
     
-
     
-
     
(1,063
)
   
-
     
(1,063
)
Net income
   
-
     
-
     
-
     
-
     
-
     
13,468
     
(31
)
   
13,437
 
Ending balance September 30, 2021
   
18,873,183
   
$
197
   
$
107,269
   
$
(30,672
)
 
$
(123
)
 
$
61,052
   
$
2,534
   
$
140,257
 

 The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the Nine Months Ended September 30, 2022 and 2021
(dollars in thousands except share data)
(unaudited)

                            Accumulated                    
          Common     Additional
    Cost of
    Other           Non-        
    Voting     Stock,     Paid-In     Repurchased
    Comprehensive     Accumulated     Controlling        

 
Shares
   
Voting
   
Capital
   
Common Stock
   
Income (Loss)
   
Earnings
   
Interest
   
Total
 
                                                 
Beginning balance January 1, 2022
   
18,395,476
   
$
197
   
$
108,811
   
$
(48,869
)
 
$
(195
)
 
$
71,460
   
$
2,312
   
$
133,716
 
                                                                 
Unrealized loss on MSA investments, net of tax of $934
   
-
      -       -       -      
(2,940
)
   
-
     
-
     
(2,940
)
Unrealized loss on derivative instruments, net of tax of $67     -       -       -       -       (210 )     -       -       (210 )
Foreign currency translation, net of tax of $0
   
-
     
-
     
-
     
-
     
(79
)
   
-
     
(43
)
   
(122
)
Stock compensation expense
   
-
     
-
     
4,103
     
-
     
-
     
-
     
-
     
4,103
 
Exercise of options
   
35,394
     
-
     
504
     
-
     
-
     
-
     
-
     
504
 
Redemption of options
   
-
     
-
     
(155
)
   
-
     
-
     
-
     
-
     
(155
)
Issuance of performance restricted stock units
   
75,345
      1       (1 )     -       -       -       -       -  
Redemption of performance restricted stock units
    -       -       (1,141 )     -       -       -       -       (1,141 )
Redemption of restricted stock units
    -       -       (87 )     -       -       -       -       (87 )
Cost of repurchased common stock
   
(919,093
)
   
-
     
-
     
(27,032
)
   
-
     
-
     
-
     
(27,032
)
Dividends
   
-
     
-
     
-
     
-
     
-
     
(3,330
)
   
-
     
(3,330
)
Net income
   
-
     
-
     
-
     
-
     
-
     
27,958
     
(684
)
   
27,274
 
Ending balance September 30, 2022
   
17,587,122
   
$
198
   
$
112,034
   
$
(75,901
)
 
$
(3,424
)
 
$
96,088
   
$
1,585
   
$
130,580
 
                                                                 
                                                                 
Beginning balance January 1, 2021
   
19,133,794
   
$
195
   
$
102,423
   
$
(10,191
)
 
$
(2,635
)
 
$
23,645
   
$
4,050
   
$
117,487
 
                                                                 
Unrealized loss on MSA investments, net of tax of $75
    -       -       -       -       (235 )     -       -       (235 )
Unrealized gain on derivative instruments, net of tax of $811
   
-
     
-
     
-
     
-
     
2,628
     
-
     
-
     
2,628
 
Foreign currency translation, net of tax of $0
    -       -       -       -       119       -       205       324  
Stock compensation expense
   
-
     
-
     
6,015
     
-
     
-
     
-
     
-
     
6,015
 
Exercise of options
   
158,420
     
2
     
2,069
     
-
     
-
     
-
     
-
     
2,071
 
Redemption of options
    -       -       (2,111 )     -       -       -       -       (2,111 )
Cost of repurchased common stock
   
(419,031
)
   
-
     
-
     
(20,481
)
   
-
     
-
     
-
     
(20,481
)
Acquisition of Recreation Marketing interest     -       -       (1,127 )     -       -       -       (1,123 )     (2,250 )
Dividends
   
-
     
-
     
-
     
-
     
-
     
(3,198
)
   
-
     
(3,198
)
Net income
   
-
     
-
     
-
     
-
     
-
     
40,605
     
(598
)
   
40,007
 
Ending balance September 30, 2021
   
18,873,183
   
$
197
   
$
107,269
   
$
(30,672
)
 
$
(123
)
 
$
61,052
   
$
2,534
   
$
140,257
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Notes to Consolidated Financial Statements
(dollars in thousands, except where designated and per share data)

Note 1. Description of Business and Basis of Presentation

Description of Business

Turning Point Brands, Inc. and its subsidiaries (collectively referred to herein as the “Company,” “we,” “our,” or “us”) is a leading manufacturer, marketer and distributor of branded consumer products. The Company sells a wide range of products to adult consumers consisting of staple products with its iconic brands Zig-Zag® and Stoker’s® and its next generation products to fulfill evolving consumer preferences. The Company’s three focus segments are led by its core, proprietary brands: Zig-Zag® in the Zig-Zag Products segment; Stoker’s® along with Beech-Nut® and Trophy® in the Stoker’s Products segment; and its distribution platforms (Vapor Beast®, VaporFi® and Direct Vapor®)and Solace® in the NewGen Products segment. The Company’s products are available in more than 215,000 retail outlets in North America. The Company operates in three segments: (i) Zig-Zag Products, (ii) Stoker’s Products, and (iii) NewGen Products.

Basis of Presentation

The accompanying unaudited interim, consolidated financial statements have been prepared in accordance with the accounting practices described in the Company’s audited, consolidated financial statements as of and for the year ended December 31, 2021, included in its Annual Report on Form 10-K for the year then ended. In the opinion of management, the unaudited, interim, consolidated financial statements included herein contain all adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company for the periods indicated. Such adjustments, other than nonrecurring adjustments separately disclosed, are of a normal and recurring nature. The operating results for interim periods are not necessarily indicative of results to be expected for a full year or future interim periods. The unaudited, interim, consolidated financial statements should be read in conjunction with the Company’s audited, consolidated financial statements and accompanying notes as of and for the year ended December 31, 2021. The accompanying interim, consolidated financial statements are presented in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, accordingly, do not include all the disclosures required by generally accepted accounting principles in the United States (“GAAP”) with respect to annual financial statements.

Note 2. Summary of Significant Accounting Policies

Consolidation

The consolidated financial statements include the accounts of the Company, its subsidiaries, all of which are wholly-owned, and variable interest entities (“VIEs”) for which the Company is considered the primary beneficiary. All significant intercompany transactions have been eliminated.

Revenue Recognition

The Company recognizes revenues in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (Topic 606), which includes excise taxes and shipping and handling charges billed to customers, net of cash discounts for prompt payment, sales returns and incentives, upon delivery of goods to the customer – at which time the Company’s performance obligation is satisfied - at an amount that the Company expects to be entitled to in exchange for those goods in accordance with the five-step analysis outlined in Topic 606: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations, and (v) recognize revenue when (or as) performance obligations are satisfied. The Company excludes from the transaction price, sales taxes and value-added taxes imposed at the time of sale (which do not include excise taxes on smokeless tobacco, cigars or vaping products billed to customers).

The Company records an allowance for sales returns, based principally on historical volume and return rates, which is included in accrued liabilities on the consolidated balance sheets. The Company records sales incentives, which consist of consumer incentives and trade promotion activities, as a reduction in revenues (a portion of which is based on amounts estimated as being due to wholesalers, retailers and consumers at the end of the period) based principally on historical volume and utilization rates. Expected payments for sales incentives are included in accrued liabilities on the consolidated balance sheets.

A further requirement of ASC 606 is for entities to disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. The Company’s management views business performance through segments that closely resemble the performance of major product lines. Thus, the primary and most useful disaggregation of the Company’s contract revenue for decision making purposes is the disaggregation by segment which can be found in Note 17 “Segment Information”. An additional disaggregation of contract revenue by sales channel can be also found within Note 17 “Segment Information.”

Shipping Costs

The Company records shipping costs incurred as a component of selling, general, and administrative expenses. Shipping costs incurred were approximately $5.8 million and $7.1 million for the three months ending September 30, 2022 and 2021, respectively. Shipping costs incurred were approximately $17.9 million and $21.1 million for the nine months ending September 30, 2022 and 2021, respectively.

Inventories

Inventories are stated at the lower of cost or net realizable value using the first-in, first-out (“FIFO”) method. Leaf tobacco is presented in current assets in accordance with standard industry practice, notwithstanding the fact that such tobaccos are carried longer than one year for the purpose of curing.

Fair Value

GAAP establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to unobservable inputs (level 3).

The three levels of the fair value hierarchy under GAAP are described below:


Level 1 – Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets at the measurement date.

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 – Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

Derivative Instruments

Foreign Currency Forward Contracts: The Company enters into foreign currency forward contracts to hedge a portion of its exposure to changes in foreign currency exchange rates on inventory purchase commitments. The Company accounts for its forward contracts under the provisions of ASC 815, Derivatives and Hedging. Under the Company’s foreign currency hedging policy, the Company may hedge up to 100% of its anticipated purchases of inventory in the denominated invoice currency over a forward period not to exceed twelve months. The Company may also, from time to time, hedge up to ninety percent of its non-inventory purchases in the denominated invoice currency. Forward contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date, except any hedge ineffectiveness which is recognized currently in income. Gains and losses on these forward contracts are transferred from other comprehensive income into inventory as the related inventories are received and are transferred to net income as inventory is sold. Changes in fair value of any contracts that do not qualify for hedge accounting or are not designated as hedges are recognized currently in income.

Interest Rate Swap Agreements: The Company enters into interest rate swap contracts to manage interest rate risk and reduce the volatility of future cash flows. The Company accounts for its interest rate swap contracts under the provisions of ASC 815, Derivatives and Hedging. Swap contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date, except any hedge ineffectiveness which is recognized currently in income. Gains and losses on these swap contracts are transferred from other comprehensive income into net income upon settlement of the derivative position or at maturity of the interest rate swap contract. Changes in fair value of any contracts that do not qualify for hedge accounting or are not designated as hedges are recognized currently in income.

Risks and Uncertainties

Manufacturers and sellers of tobacco products are subject to regulation at the federal, state, and local levels. Such regulations include, among others, labeling requirements, limitations on advertising, and prohibition of sales to minors. The tobacco industry is likely to continue to be heavily regulated. There can be no assurance as to the ultimate content, timing, or effect of any regulation of tobacco products by any federal, state, or local legislative or regulatory body, nor can there be any assurance that any such legislation or regulation would not have a material adverse effect on the Company’s financial position, results of operations, or cash flows. In a number of states, targeted flavor bans have been proposed or enacted legislatively or by the administrative process. Depending on the number and location of such bans, that legislation or regulation could have a material adverse effect on the Company’s financial position, results of operations or cash flows. Food and Drug Administration (“FDA”) continues to consider various restrictive regulations around our products, including targeted flavor bans; however, the details, timing, and ultimate implementation of such measures remain unclear.

The tobacco industry has experienced, and is experiencing, significant product liability litigation. Most tobacco liability lawsuits have been brought against manufacturers and sellers of cigarettes for injuries allegedly caused by smoking or exposure to smoke. However, several lawsuits have been brought against manufacturers and sellers of smokeless products for injuries to health allegedly caused by use of smokeless products. Typically, such claims assert that use of smokeless products is addictive and causes oral cancer. Additionally, several lawsuits have been brought against manufacturers and distributors of NewGen products due to malfunctioning devices, batteries, or marketing practices. There can be no assurance the Company will not sustain losses in connection with such lawsuits and that such losses will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Master Settlement Agreement (MSA):  Pursuant to the Master Settlement Agreement (the “MSA”) entered into in November 1998 by most states (represented by their attorneys general acting through the National Association of Attorneys General) and subsequent states’ statutes, a “cigarette manufacturer” (which is defined to include a manufacturer of make-your-own (“MYO”) cigarette tobacco) has the option of either becoming a signatory to the MSA or opening, funding, and maintaining an escrow account to have funds available for certain potential tobacco-related liabilities with sub-accounts on behalf of each settling state. Such companies are entitled to direct the investment of the escrowed funds and withdraw any appreciation but cannot withdraw the principal for twenty-five years from the year of each annual deposit, except to withdraw funds deposited pursuant to an individual state’s escrow statute to pay a final judgement to that state’s plaintiffs in the event of such a final judgement against the Company. The Company chose to open and fund an escrow account as its method of compliance. It is the Company’s policy to record amounts on deposit in the escrow account for prior years as a non-current asset. As of September 30, 2022, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $27.8 million. At December 31, 2021, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $31.7 million. The Company discontinued its generic category of MYO in 2019 and its Zig-Zag branded MYO cigarette smoking tobacco in 2017. Thus, pending a change in MSA legislation, the Company has no remaining product lines covered by the MSA and will not be required to make future escrow deposits.

The Company has chosen to invest a portion of the MSA escrow, from time to time, in U.S. Government securities including TIPS, Treasury Notes, and Treasury Bonds. These investments are classified as available-for-sale and carried at fair value. Realized losses are prohibited under the MSA; any investment in an unrealized loss position will be held until the value is recovered, or until maturity.

Fair values for the U.S. Governmental agency obligations are Level 2 in the fair value hierarchy. The following tables show cost and estimated fair value of the assets held in the MSA account, respectively, as well as the maturities of the U.S. Governmental agency obligations held in such account for the periods indicated.

   
As of September 30, 2022
   
As of December 31, 2021
 
          Gross     Gross     Estimated           Gross     Gross     Estimated  

 
    Unrealized     Unrealized     Fair           Unrealized     Unrealized    
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
   
Cost
   
Gains
   
Losses
   
Value
 
Cash and cash equivalents
 
$
1,928
   
$
-
   
$
-
   
$
1,928
   
$
12,155
    $ -     $ -     $ 12,155  
U.S. Governmental agency obligations
(unrealized position < 12 months)
   
15,712
     
-
     
(1,898
)
   
13,814
     
19,918
      4       (357 )     19,565  
U.S. Governmental agency obligations
(unrealized position > 12 months)
    14,433       -       (2,330 )     12,103       -       -       -       -  
   
$
32,073
   
$
-
   
$
(4,228
)
 
$
27,845
   
$
32,073
    $
4     $
(357 )   $
31,720  

   
As of
 
   
 September 30, 2022
Less than one year
 
$
-
 
One to five years
   
7,443
 
Five to ten years
   
20,747
 
Greater than ten years
   
1,955
 
Total
 
$
30,145
 

The following table shows the amount of deposits by sales year for the MSA escrow account:


 
Deposits as of
 
Sales
Year
 
September 30,
2022
   
December 31,
2021
 
1999
 
$
211
   
$
211
 
2000
   
1,017
     
1,017
 
2001
   
1,673
     
1,673
 
2002
   
2,271
     
2,271
 
2003
   
4,249
     
4,249
 
2004
   
3,714
     
3,714
 
2005
   
4,553
     
4,553
 
2006
   
3,847
     
3,847
 
2007
   
4,167
     
4,167
 
2008
   
3,364
     
3,364
 
2009
   
1,619
     
1,619
 
2010
   
406
     
406
 
2011
   
193
     
193
 
2012
   
199
     
199
 
2013
   
173
     
173
 
2014
   
143
     
143
 
2015
   
101
     
101
 
2016
   
91
     
91
 
2017
   
82
     
82
 
                 
Total
 
$
32,073
   
$
32,073
 

Food and Drug Administration (FDA): On June 22, 2009, the Family Smoking Prevention and Tobacco Control Act (the “FSPTCA”) authorized the FDA to immediately regulate the manufacturing, sale, and marketing of four categories of tobacco products – cigarettes, cigarette tobacco, roll-your-own tobacco, and smokeless tobacco. On August 8, 2016, the FDA deeming regulation became effective. The deeming regulation gave the FDA the authority to also regulate cigars, pipe tobacco, e-cigarettes, vaporizers, and e-liquids as “deemed” tobacco products under the FSPTCA.

The FDA assesses tobacco product user fees on six classes of regulated tobacco products and computes user fees using a methodology similar to the methodology used by the U.S Department of Agriculture to compute the Tobacco Transition Payment Program (“TTPP,” also known as the “Tobacco Buyout”) assessment. First, the total, annual, congressionally established user fee assessment is allocated among the various classes of tobacco products using the federal excise tax weighted market share of tobacco products subject to regulation. Then, the assessment for each class of tobacco products is divided among individual manufacturers and importers.

In August 2016, the FDA’s regulatory authority under the Tobacco Control Act (the “TCA”) was extended to all tobacco products not previously covered, including: (i) certain NewGen products (such as electronic cigarettes, vaporizers and e-liquids) and their components or parts (such as tanks, coils and batteries); (ii) cigars and their components or parts (such as cigar tobacco and wraps); (iii) pipe tobacco; (iv) hookah products; and (v) any other tobacco product “newly deemed” by the FDA. These “deeming regulations” apply to all products made or derived from tobacco intended for human consumption, but excluding accessories of tobacco products (such as lighters). Accordingly, the FDA has since regulated our cigar and cigar wrap products as well as our vapor products containing tobacco-derived nicotine and products intended or reasonably expected to be used to consume such e-liquids.

Subsequently, on April 14, 2022, FDA Center for Tobacco Products also obtained jurisdiction over non-tobacco nicotine products (“NTN Products”), including synthetic nicotine. That law subjects NTN Products to the same requirements as tobacco-derived products, including not selling these products to persons under 21 years of age, not marketing these products as modified risk tobacco products without authorization, and not distributing free samples of these products. Additionally, NTN Products became subject to premarket filing requirements. Under the new law, manufacturers were required to file a PMTA by May 14, 2022, in order to continue selling products currently on the market. NTN Products subject of a timely-filed PMTA, and not in receipt of a negative action, were allowed to remain on the market until July 13, 2022, at which time these products became subject to enforcement, similar to tobacco-derived products remaining under review.

A successful PMTA must demonstrate that the subject product is “appropriate for the protection of public health,” taking into account the effect of the marketing of the product on all sub-populations while a Substantial Equivalence Report must demonstrate that a new product either has the same characteristics as its predicate product or different characteristics, but does not raise different questions of public health. We submitted premarket filings prior to the September 9, 2020 deadline for certain of our tobacco and tobacco-derived products, all of which remain under review. We likewise filed premarket submissions for certain of our NTN Products ahead of the May 14, 2022 deadline. We have continued to supplement these applications with additional information; however, there can be no guarantee that FDA will accept such amendments or that the applications will meet the standard of “appropriate for the protection of public health.” The FDA has indicated its enforcement priority is those applicants who have received negative action on their application, such as a Marketing Denial Order or Refuse to File notification and who continue to illegally sell those unauthorized products, as well as products for which manufacturers failed to submit a marketing application. Despite these stated enforcement priorities, given FDA’s limited resources we expect that for a period of time there may be a lack of enforcement, which may adversely impact our ability to compete in the marketplace against those who continue to sell unauthorized products. There can be no guarantee that FDA will not shift its enforcement priorities or that it will increase in ability to enforce against unauthorized products over time.

The FDA has issued a number of proposed rules related to premarket filings; however, those rules were not finalized prior to the September 9, 2020, filing deadline. On October 5, 2021, the FDA finalized two rules related to the Substantial Equivalence process and the PMTA process, respectively, which both became effective November 4, 2021. Both final rules (collectively, the “Rules”) indicate that any new or additional requirements will not retroactively apply to currently pending PMTAs for tobacco and tobacco-derived products; however, the information outlined in the rule remains important to the FDA’s substantive review of an application. FDA has yet to indicate how it might apply these Rules to NTN Product filings. We believe we have products that meet the Rules and have filed premarket filings supporting a showing of the respective required standards. However, there is no assurance that the FDA’s guidance or regulations will not change, that the FDA will not prioritize its enforcement in a manner that negatively affects our pending applications, or that unforeseen circumstances will not arise that prevent us from sufficiently supplementing or completing our applications or otherwise increase the amount of time and money we are required to spend to receive all necessary marketing orders. Although we filed many premarket applications in a timely manner, no assurance can be given that the applications will ultimately be successful. This may result in the prioritization of supplementing or completing applications for high priority SKUs in our inventory position, which could adversely impact future revenues generated by lower priority SKUs.

In addition, we currently distribute many third-party manufactured vapor products for which we are completely dependent on the manufacturer complying with the premarket filing requirements. There can be no assurance that these third-party products will receive a marketing order or otherwise remain in compliance with relevant legal requirements. While we will take measures to pursue regulatory compliance for our own privately-branded or proprietary products that compete with these third-party products, there is no assurance that such proprietary products would be as successful in the marketplace or can fully displace third-party products that are currently being distributed by us, which could adversely affect our results of operations and liquidity. For a period of time after the filing deadline, we expect there to be a lack of enforcement, which may adversely affect our ability to compete in the marketplace against those who continue to sell unauthorized products.

On May 4, 2022, the FDA proposed two tobacco product standards related to combusted tobacco products: (1) a ban on menthol as a characterizing flavor in cigarettes; and (2) a ban on all characterizing flavors (including menthol) in cigars. We carry certain products that may be subject of the characterizing flavor ban in cigars, should it be finalized in its proposed form. On June 21, 2022, FDA also issued a proposed product standard related to restricting the level of nicotine in traditional cigarettes. These product standards are required to go through the formal rulemaking process, during which we were able to provide comments with regard to the impact such standards would have on our products. The FDA’s policy on these and other regulated products may change or expand over time in ways not yet known and may significantly impact our products or our premarket filings.

Prevent All Cigarette Trafficking Act (“PACT Act”): On December 27, 2020, President Trump signed the Further Consolidated Appropriations Act, 2021, into law. This law included an amendment to the Jenkins Act expanding the definition of “cigarette” to include “electronic nicotine delivery systems,” or ENDS, and required that the United States Postal Service (USPS) promulgate regulations clarifying the applicability of the prohibition on delivery sales of cigarettes to ENDS. USPS issued its final rule on October 21, 2021. We have received appropriate shipping exemptions from carrier services we use to carry the affected freight. Failure to comply with the PACT Act could result in significant financial or criminal penalties. To the extent we are unable to respond to, or comply with, these new requirements, we could lose our shipping exemptions, be subject to civil or criminal penalties, or there could be a material adverse effect on our business, results of operations and financial condition. 

Note 3. Acquisitions

Unitabac

In July 2021, the Company acquired certain assets of Unitabac, a marketer of mass-market cigars, for $10.7 million in total consideration, comprised of $9.6 million in cash and $1.1 million of capitalized transaction costs. The acquisition is comprised of a portfolio of cigarillo products and all related intellectual property, including Cigarillo Non-Tip (“NT”) Homogenized Tobacco Leaf (“HTL”) products and Rolled Leaf and Natural Leaf Cigarillo Products. The transaction was accounted for as an asset purchase with $10.0 million assigned to intellectual property, which has an indefinite life, and $0.7 million assigned to inventory. The intellectual property asset is deductible for tax purposes.

Direct Value Wholesale

In April 2021, Turning Point Brands Canada, a VIE for which the Company is considered the primary beneficiary, purchased 100% of the equity interests of Westhem Ventures LTD d/b/a Direct Value Wholesale (“DVW”) for $3.9 million, net of cash acquired, with $3.5 million paid in cash at closing and $0.5 million in accrued consideration to be paid during 2021. DVW is a Canadian distribution entity that operates in markets not primarily served by Turning Point Brands Canada. The acquisition expands Turning Point Brands Canada’s markets in Canada. On April 13, 2021, in connection with the acquisition of DVW, the Company provided a $3.7 million unsecured loan to Turning Point Brands Canada bearing interest at 8% per annum and maturing April 13, 2023. The unsecured loan is eliminated in the consolidation of Turning Point Brands Canada. The following table summarizes the consideration transferred and calculation of goodwill based on excess of the acquisition price over the estimated fair value of the identifiable net assets acquired:

Total consideration transferred
 
$
3,462
 
Adjustments to consideration transferred:
       
Cash acquired
   
(43
)
Accrued consideration
   
472
 
Adjusted consideration transferred
   
3,891
 
Assets acquired:
       
Working capital (primarily AR and inventory)
   
1,334
 
Fixed assets and Other long term assets
   
27
 
Net assets acquired
 
$
1,361
 
         
Goodwill
 
$
2,530
 

The goodwill of $2.5 million consists of the synergies expected from combining the operations and is deductible for tax purposes.

Turning Point Brands Canada

In July 2021, the Company invested an additional $2.3 million in Turning Point Brands Canada increasing its ownership interest to 65%. The Company received board seats aligned with its ownership position. The Company has determined that Turning Point Brands Canada continues to be a VIE due to its required subordinated financial support. The Company has determined it remains the primary beneficiary due to its 65% equity interest, additional subordinated financing and distribution agreement with Turning Point Brands Canada for the sale of the Company’s products. As a result of the Company remaining the primary beneficiary, the increase in ownership interest resulted in a decrease in Non-controlling interest of $1.1 million and a decrease in Additional paid-in capital of $1.1 million

Note 4. Derivative Instruments

Foreign Currency

The Company’s foreign currency hedging policy is to manage the risks associated with foreign exchange rate movements. The policy allows hedging of up to 100% of anticipated purchases of inventory over a forward period that will not exceed 12 rolling and consecutive months. The Company may, from time to time, hedge currency for non-inventory purchases, e.g., production equipment, not to exceed 90% of the purchase price. During the third quarter of 2022, the Company executed various option contracts, which met hedge accounting requirements for the purchase of €18.5 million with maturity dates ranging from August 2022 to March 2023. At September 30, 2022, the Company had option contracts for the purchase of €15.2 million outstanding. The foreign currency contracts’ fair value at September 30, 2022, resulted in an asset of $0.2 million which is included in Other current assets and a liability of $0.5 million included in Accrued liabilities. At December 31, 2021, the Company had no foreign currency contracts outstanding.

Interest Rate Swaps

The Company’s interest rate hedging policy is to manage interest rate risk relating to the volatility of future cash flows associated with debt instruments bearing interest at variable rates. In March 2018, the Company executed various interest rate swap agreements for a notional amount of $70 million with an expiration of December 2022. The swap agreements fixed LIBOR at 2.755%. The swap agreements met the hedge accounting requirements; thus, any change in fair value was recorded to other comprehensive income. The Company used the Shortcut Method to account for the swap agreements. The Shortcut Method assumes the hedge to be perfectly effective; thus, there is no ineffectiveness to be recorded in earnings. The Company terminated the interest rate swap agreement in conjunction with the prepayment of all outstanding amounts under the 2018 First Lien Credit Facility (as defined below) in the first quarter of 2021 with the early termination payment made by the Company in the amount of $3.6 million which was reclassified out of accumulated other comprehensive loss into loss on extinguishment of debt.

Note 5. Fair Value of Financial Instruments

The estimated fair value amounts have been determined by the Company using the methods and assumptions described below. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

Cash and Cash Equivalents

Cash and cash equivalents are, by definition, short-term. Thus, the carrying amount is a reasonable estimate of fair value.

Accounts Receivable

The fair value of accounts receivable approximates their carrying value due to their short-term nature.

Long-Term Debt

The Company’s Senior Secured Notes (as defined in Note 11, “Notes Payable and Long-Term Debt) bear interest at a rate of 5.625% per year. As of September 30, 2022, the fair value of the Senior Secured Notes approximated $220.8 million, with a carrying value of $250 million. As of December 31, 2021, the fair value of the Senior Secured Notes approximated their carrying value of $250 million due to the recency of the notes’ issuance, related to December 31, 2021.

The Convertible Senior Notes (as defined in Note 11, “Notes Payable and Long-Term Debt) bear interest at a rate of 2.50% per year, and the fair value of the Convertible Senior Notes without the conversion feature approximated $144.2 million, with a carrying value of $172.5 million as of September 30, 2022. As of December 31, 2021, the fair value of the Convertible Senior Notes approximated $159.8 million, with a carrying value of $172.5 million.

See Note 11, “Notes Payable and Long-Term Debt”, for further information regarding the Company’s long-term debt.

Note 6. Inventories

The components of inventories are as follows:

    September 30,     December 31,  

 
2022
   
2021
 
Raw materials and work in process
 
$
7,041
   
$
6,936
 
Leaf tobacco
   
46,231
     
35,900
 
Finished goods - Zig-Zag Products
   
39,926
     
25,663
 
Finished goods - Stoker’s Products
   
10,818
     
8,959
 
Finished goods - NewGen products
   
8,447
     
8,591
 
Other
   
1,465
     
1,558
 
Inventories
 
$
113,928
   
$
87,607
 

The inventory valuation allowance was $3.7 million and $7.7 million as of September 30, 2022, and December 31, 2021, respectively.

Note 7. Other Current Assets

Other current assets consist of:

    September 30,     December 31,  

 
2022
   
2021
 
Inventory deposits
 
$
2,823
   
$
12,091
 
Insurance deposit
   
3,000
     
3,000
 
Prepaid taxes
    783
      -
 
Other
   
18,123
     
11,655
 
Total
 
$
24,729
   
$
26,746
 

Note 8. Property, Plant, and Equipment

Property, plant, and equipment consists of:

    September 30,     December 31,  

 
2022
   
2021
 
Land
 
$
22
   
$
22
 
Buildings and improvements
   
3,096
     
3,096
 
Leasehold improvements
   
5,394
     
5,374
 
Machinery and equipment
   
24,821
     
19,591
 
Furniture and fixtures
   
9,254
     
9,402
 
Gross property, plant and equipment
   
42,587
     
37,485
 
Accumulated depreciation
   
(20,075
)
   
(18,835
)
Net property, plant and equipment
 
$
22,512
   
$
18,650
 

Note 9. Other Assets

Other assets consist of:

    September 30,     December 31,  

 
2022
   
2021
 
Equity investments
 
$
19,282
   
$
25,649
 
Debt security investment  
9,240    
8,000
 
Other
   
607
     
1,750
 
Total
 
$
29,129
   
$
35,399
 

The Company records its equity investments without a readily determinable fair value, that are not accounted for under the equity method, at cost, with adjustments for impairment and observable price changes.

In the second quarter 2022, based on a contemplated sale of the assets of dosist, the Company deemed its investment was impaired resulting in decreasing of the fair value of the investment to $1.6 million. Fair value was determined using a valuation derived from the contemplated purchase price (Level 3). This resulted in a loss of $6.3 million which is recorded in investment loss for the nine months ended September 30, 2022.

In July, 2021, the Company invested $8.0 million in Old Pal Holding Company LLC (“Old Pal”). In July 2022, the Company invested an additional $1.0 million in Old Pal.  The Company invested in the form of a convertible note which includes additional follow-on investment rights. The accrued interest of $0.2 million was rolled into the note in July 2022 resulting in a total investment of $9.2 million. Old Pal is a leading brand in the cannabis lifestyle space that operates a non-plant touching licensing model. The Company’s investment will enable Old Pal to expand product offerings in existing states, which include California, Nevada, Michigan, Oklahoma, Ohio, Washington and Massachusetts, and will help create the infrastructure necessary to support continued territory and product expansion. The convertible note bears an interest rate of 3.0% per year with an original maturity of July 31, 2026, which was extended to July 21, 2027 when the Company made its additional investment in Old Pal in July 2022. Interest and principal are payable at maturity. Old Pal has the option to extend the maturity date in one-year increments. The interest rate is subject to change based on sales levels of Old Pal meeting certain thresholds. The weighted average interest rate was 3% for the nine months ended September 30, 2022. Old Pal has the option to convert the note into shares once sales reach a certain threshold. Additionally, the Company has the right to convert the note into shares of Old Pal at any time. The conditions required to allow Old Pal to convert the note were not met as of September 30, 2022. The Company has classified the debt security with Old Pal as available for sale. The Company records the debt security at fair value and includes unrealized gains and losses recorded in stockholders’ equity as a component of accumulated other comprehensive income on our Consolidated Balance Sheets. The Company reports interest income on available for sale debt securities, in interest expense, net in our Consolidated Statements of Income. The fair value of the debt security approximated its carrying value of $9.2 million at September 30, 2022 and $8.0 million at December 31, 2021, due to the recency of the debt security’s purchase and the additional funding in the current period, related to each such date. The Company has recorded accrued interest receivable of $0.1 million and $0.1 million at September 30, 2022 and December 31, 2021, respectively, in other current assets on our Consolidated Balance Sheets.

In April 2021, the Company invested $8.7 million in Docklight Brands, Inc., a pioneering consumer products company with celebrated brands including Marley Natural® cannabis and Marley™ CBD. The Company has additional follow-on investment rights. As part of the investment, the Company obtained exclusive U.S. distribution rights for Docklight’s Marley™ CBD topical products.

Note 10. Accrued Liabilities

Accrued liabilities consist of:

    September 30,     December 31,  

 
2022
   
2021
 
Accrued payroll and related items
 
$
7,771
   
$
6,974
 
Customer returns and allowances
   
7,108
     
6,497
 
Taxes payable
   
2,984
     
2,053
 
Lease liabilities
   
3,130
     
2,976
 
Accrued interest
   
2,682
     
7,318
 
Other
   
8,938
     
7,119
 
Total
 
$
32,613
   
$
32,937
 

Note 11. Notes Payable and Long-Term Debt

Notes payable and long-term debt consists of the following in order of preference:

    September 30,     December 31,  

 
2022
   
2021
 
Senior Secured Notes
 
$
250,000
   
$
250,000
 
Convertible Senior Notes
   
172,500
     
172,500
 
Gross notes payable and long-term debt
   
422,500
     
422,500
 
Less deferred finance charges
   
(6,471
)
   
(8,328
)
Notes payable and long-term debt
 
$
416,029
   
$
414,172
 

Senior Secured Notes

On February 11, 2021, the Company closed a private offering (the “Offering”) of $250 million aggregate principal amount of its 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.The Company 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.

The Company may redeem the Senior Secured Notes, in whole or in part, at any time prior to February 15, 2023, at a price equal to 100% of the principal amount of the Notes redeemed plus accrued and unpaid interest, if any, to, but excluding the applicable redemption date, plus a “make-whole” premium. Thereafter, the Company may redeem the Senior Secured Notes, in whole or in part, at established redemption prices set forth in the Senior Secured Notes Indenture, plus accrued and unpaid interest, if any. In addition, on or prior to February 15, 2023, the Company may redeem up to 40% of the aggregate principal amount of the Senior Secured Notes with the net cash proceeds from certain equity offerings at a redemption price equal to 105.625%, plus accrued and unpaid interest, if any to the redemption date; provided, however, that at least 50% of the original aggregate principal amount of the Senior Secured Notes (calculated after giving effect to the issuance of any additional notes) remains outstanding. In addition, at any time and from time to time prior to February 15, 2023, but not more than once in any twelve-month period, the Company may redeem up to 10% of the aggregate principal amount of the Senior Secured Notes at a redemption price of 103% of the aggregate principal amount of Senior Secured Notes redeemed plus accrued and unpaid interest, if any to but not including the redemption date, on the Senior Secured Notes to be redeemed.

If the Company experiences a change of control (as defined in the Senior Secured Notes Indenture), the Company 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 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 Indenture. The Indenture provides for customary events of default. The Company was in compliance with all covenants as of September 30, 2022.

The Company 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, the Company also entered into a new $25 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto (the “Lenders”) and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). The 2021 Revolving Credit Facility provides for a revolving line of credit of up to $25.0 million. Letters of credit are limited to $10 million (and are a part of, and not in addition to, the revolving line of credit). The Company has not drawn any borrowings under the 2021 Revolving Credit Facility but does have letters of credit of approximately $3.6 million outstanding under the facility as of September 30, 2022. The 2021 Revolving Credit Facility will mature on August 11, 2025, if none of the Company’s 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 2021 Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate plus an applicable margin of 3.50% (with step-downs upon de-leveraging). The Company also has the option to borrow at a rate determined by reference to the base rate.

The obligations under the 2021 Revolving Credit Agreement are guaranteed on a joint and several basis by the Guarantors. The Company’s and Guarantors’ obligations under the 2021 Revolving Credit Facility are secured on a pari passu basis with the Senior Secured Notes.

The 2021 Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The 2021 Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio (as defined in the 2021 Revolving Credit Agreement) 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 2021 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 2021 Revolving Credit Facility. The 2021 Revolving Credit Agreement provides for customary events of default. The Company was in compliance with all covenants as of September 30, 2022.

The Company incurred debt issuance costs attributable to the issuance of the 2021 Revolving Credit Facility of $0.5 million which are amortized to interest expense using the effective interest method over the expected life of the 2021 Revolving Credit Facility.

2018 First Lien Credit Facility

The 2018 First Lien Term Loan and the 2018 Revolving Credit Facility bore interest at LIBOR plus a spread of 2.75% to 3.50% based on the Company’s senior leverage ratio. The Company used a portion of the proceeds from the issuance of the Senior Secured Notes to prepay all outstanding amounts under and terminate the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $130.0 million, and the transaction resulted in a $5.7 million loss on extinguishment of debt.

Convertible Senior Notes

In July 2019, the Company closed an offering of $172.5 million in aggregate principal amount of its 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 of the Company.

The Convertible Senior Notes are convertible into approximately 3,213,589 shares of TPB Common Stock under certain circumstances prior to maturity at a conversion rate of 18.630 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.68 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 September 30, 2022.

The Company incurred debt issuance costs attributable to the Convertible Senior Notes of $5.9 million which are amortized to interest expense using the effective interest method over the expected life of the Convertible Senior Notes.

In connection with the Convertible Senior Notes offering, the Company entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $53.68 per and a cap price of $82.86 per share, and are exercisable when, and if, the Convertible Senior Notes are converted. The Company paid $20.53 million for these capped calls at the time they were entered into and charged that amount to additional paid-in capital.

Promissory Note

On June 10, 2020, in connection with the acquisition of certain Durfort assets, the Company issued the Promissory Note in the principal amount of $10.0 million, with an annual interest rate of 7.5%, payable quarterly, with the first interest payment due September 10, 2020The Company prepaid all outstanding amounts under and terminated the Promissory Note in the third quarter of 2021 in the amount of $9.6 million. The transaction resulted in a $0.4 million gain on extinguishment of debt.

Unsecured Loan

On April 6, 2020, the 2018 First Lien Credit Facility was amended to allow for an unsecured loan under the Coronavirus Aid, Relief, and Economic Security Act of 2020 (“CARES”). On April 17, 2020, National Tobacco Company, L.P., a subsidiary of the Company, entered into a loan agreement with Regions Bank guaranteed by the Small Business Administration for a $7.5 million unsecured loan. The proceeds of the loan were received on April 27, 2020. The loan was scheduled to mature on April 17, 2022 and had a 1.00% interest rate. During 2021, the Company applied for forgiveness for the loan. On October 15, 2021, the Company received notice that its application for forgiveness was fully approved. The extinguishment of the unsecured loan occurred in the fourth quarter of 2021, resulting in a $7.5 million gain on extinguishment of debt. The Company is subject to audit relating to the unsecured loan until 2027 which could result in repayment of some or all of the unsecured loan previously forgiven. However, the Company believes that repayment of any amount is not probable.

Note 12. Leases

The Company’s leases consist primarily of leased property for manufacturing, warehouse and head offices as well as vehicle leases. At lease inception, the Company recognizes a lease right of use asset and lease liability calculated as the present value of future minimum lease payments. In general, the Company does not recognize any renewal periods within the lease terms as there are no significant barriers to ending the lease at the initial term. Lease and non-lease components are accounted for as a single lease component.

Leases with an initial term of 12 months or less are not recorded on the balance sheet. Lease expense for these leases is recognized on a straight-line basis over the lease term.

The components of lease expense consisted of the following:


 
Three Months Ended
September 30,
 

  2022
    2021
 
Operating lease cost
           
Cost of sales
 
$
240
   
$
225
 
Selling, general and administrative
    680
      771
 
Variable lease cost (1)
    235
      214
 
Short-term lease cost
    6
      13
 
Total
 
$
1,161
   
$
1,223
 

(1)
Variable lease cost includes elements of a contract that do not represent a good or service but for which the lessee is responsible for paying.


 
Nine Months Ended
September 30,
 
   
2022


2021
 
Operating lease cost
           
Cost of sales
 
$
700
   
$
682
 
Selling, general and administrative     2,053
      2,285
 
Variable lease cost (1)     558
      954
 
Short-term lease cost     31
      35
 
Sublease income     -
    (60 )
Total    $ 3,342
     $ 3,896
 

(1)
Variable lease cost includes elements of a contract that do not represent a good or service but for which the lessee is responsible for paying.

     September 30,      December 31,  
   
2022
   
2021
 
Assets:
           
Right of use assets
 
$
13,185
   
$
15,053
 
Total lease assets
 
$
13,185
   
$
15,053
 
                 
Liabilities:
               
Current lease liabilities (2)
 
$
3,130
   
$
2,976
 
Long-term lease liabilities
 
11,299

 
13,336
 
Total lease liabilities
 
$
14,429
   
$
16,312
 

(2)
Reported within accrued liabilities on the balance sheet.


 
As of September 30,
 
   
2022
   
2021
 
Weighted-average remaining lease term - operating leases
 
6.2 years
   
6.8 years
 
Weighted-average discount rate - operating leases
   
4.86
%
   
4.93
%

Nearly all the lease contracts for the Company do not provide a readily determinable implicit interest rate. For these contracts, the Company uses a discount rate that approximates its incremental borrowing rate at the time of the lease commencement.

As of September 30, 2022, maturities of lease liabilities consisted of the following:

    September 30,  

 
2022
 
2022
 
$
941
 
2023
   
3,685
 
2024
   
2,551
 
2025
   
2,234
 
2026
   
2,133
 
Years thereafter
   
5,344
 
Total lease payments
 
$
16,888
 
Less: Imputed interest
   
2,459
 
Present value of lease liabilities
 
$
14,429
 

Note 13. Income Taxes

The Company’s effective income tax rate for the three and nine months ended September 30, 2022, was 25.2% and 24.2%, respectively, which includes a discrete tax deduction of $0.0 million and $0.7 million for the three and nine months ended September 30, 2022, respectively, relating to stock option exercises. The Company’s effective income tax rate for the three and nine months ended September 30, 2021, was 23.3% and 21.8%, respectively, which includes a discrete tax deduction of $1.0 million and $6.2 million for the three and nine months ended September 30, 2021, respectively, relating to stock option exercises.

The Company follows the provisions of ASC 740-10-25, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company has determined that the Company did not have any uncertain tax positions requiring recognition under the provisions of ASC 740-10-25. The Company’s policy is to recognize interest and penalties accrued on uncertain tax positions, if any, as part of interest expense. The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. In general, the Company is no longer subject to U.S. federal and state tax examinations for years prior to 2019.

Note 14. Share Incentive Plans

On March 22, 2021, the Company’s Board of Directors adopted the Turning Point Brands, Inc. 2021 Equity Incentive Plan (the “2021 Plan”), pursuant to which awards may be granted to employees, non-employee directors, and consultants. In addition, the 2021 Plan provides for the granting of nonqualified stock options to employees of the Company or any subsidiary of the Company. Pursuant to the 2021 Plan, 1,290,000 shares, plus 100,052 shares remaining available for issuance under the 2015 Equity Incentive Plan (the “2015 Plan”), of TPB Common Stock are reserved for issuance as awards to employees, non-employee directors, and consultants as compensation for past or future services or the attainment of certain performance goals. The 2021 Plan is scheduled to terminate on March 21, 2031. The 2021 Plan is administered by the compensation committee (the “Committee”) of the Company’s Board of Directors. The Committee determines the vesting criteria for the awards, with such criteria to be specified in the award agreement. As of September 30, 2022, net of forfeitures, there were 103,282 Restricted Stock Units (“RSUs”), 106,912 options and 11,936 Performance-Based Restricted Stock Units (“PRSUs”) granted under the 2021 Plan. There are 1,167,922 shares available for grant under the 2021 Plan.

On April 28, 2016, the Board of Directors of the Company adopted the 2015 Plan, pursuant to which awards could have been granted to employees, non-employee directors, and consultants. In addition, the 2015 Plan provided for the granting of nonqualified stock options to employees of the Company or any subsidiary of the Company. Pursuant to the 2015 Plan, 1,400,000 shares of TPB Common Stock were reserved for issuance as awards to employees, non-employee directors, and consultants as compensation for past or future services or the attainment of certain performance goals. The 2015 Plan was scheduled to terminate on April 27, 2026. Upon adoption of the 2021 Plan, the 2015 Plan was terminated, and the Company determined no additional grants would be made under the 2015 Plan. However, all awards issued under the 2015 Plan that have not been previously terminated or forfeited remain outstanding and continue unaffected. There are no shares available for grant under the 2015 Plan. The 2015 Plan was administrated by the Committee.

On February 8, 2006, the Board of Directors of the Company adopted the 2006 Equity Incentive Plan (the “2006 Plan”) of North Atlantic Holding Company, Inc., pursuant to which awards may be granted to employees. The 2006 Plan provides for the granting of nonqualified stock options and restricted stock awards to employees. Upon the adoption of the Company’s 2015 Equity Incentive Plan in connection with its IPO, the Company determined no additional grants would be made under the 2006 Plan. However, all awards issued under the 2006 Plan that have not been previously terminated or forfeited remain outstanding and continue unaffected. There are no shares available for grant under the 2006 Plan.

Stock option activity for the 2006, 2015 and 2021 Plans is summarized below:

   
    Weighted     Weighted  
    Stock     Average     Average  
    Option     Exercise    
Grant Date
 

 
Shares
   
Price
   
Fair Value
 
Outstanding, December 31, 2020
   
711,060
   
$
19.58
   
$
6.42
 
                         
Granted
   
119,500
     
50.93
     
13.58
 
Exercised
   
(202,768
)
   
10.22
     
6.35
 
Forfeited
   
(7,957
)
   
33.22
     
9.63
 
Outstanding, December 31, 2021
   
619,835
     
28.51
     
8.70
 
                         
Granted
   
114,827
     
30.58
     
10.34
 
Exercised
   
(40,331
)
   
12.49
     
4.08
 
Forfeited
   
(10,779
)
   
32.20
     
9.25
 
Outstanding, September 30, 2022
   
683,552
   
$
29.74
   
$
9.24
 

Under the 2006, 2015 and 2021 Plans, the total intrinsic value of options exercised during the nine months ended September 30, 2022 and 2021, was $0.7 million, and $7.9 million, respectively.

At September 30, 2022, under the 2006 Plan, the exercise price for the 74,379 outstanding options is $3.83 per share, all of which are exercisable. The weighted average of the remaining lives of the outstanding stock options with an exercise price of $3.83 is approximately 1.71 years. The Company estimates the expected life of these stock options is ten years from the date of grant. For the $3.83 per share options, the weighted average fair value of options at the date of grant was determined using the Black-Scholes model with the following assumptions a ten-year life from grant date, a current share price and exercise price of $3.83, a risk-free interest rate of 3.57%, volatility of 40%, and no assumed dividend yield. Based on these assumptions, the fair value of these options is approximately $2.17 per share option granted.

At September 30, 2022, under the 2015 and 2021 Plans, the risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. The expected volatility is based on the average long-term historical volatilities of peer companies. We intend to continue to consistently use the same group of publicly traded peer companies to determine expected volatility until sufficient information regarding volatility of our share price becomes available or until the selected companies are no longer suitable for this purpose. Due to our limited trading history, we are using the simplified method presented by SEC Staff Accounting Bulletin No. 107 to calculate expected holding periods, which represent the periods of time for which options granted are expected to be outstanding. We will continue to use this method until we have sufficient historical exercise experience to give us confidence in the reliability of our calculations. The fair values of these options were determined using the Black-Scholes option pricing model.

The following table outlines the assumptions based on the number of options granted under the 2015 Plan.

   
February 10,
   
May 17,
   
March 7,
   
March 20,
   
October 24,
   
March 18,
   
  February 18,
   
May 3,
 

 
2017
   
2017
   
2018
   
2019
   
2019
   
2020
   
2021
   
2021
 
Number of options granted
   
40,000
     
93,819
     
98,100
     
155,780
     
25,000
     
155,000
     
100,000
     
12,000
 
Options outstanding at September 30, 2022
   
20,000
     
44,983
     
58,067
     
141,784
     
25,000
     
93,248
     
93,516
     
12,000
 
Number exercisable at September 30, 2022
   
20,000
     
44,983
     
58,067
     
141,784
     
25,000
     
61,081
     
39,165
     
4,080
 
Exercise price
 
$
13.00
   
$
15.41
   
$
21.21
   
$
47.58
   
$
20.89
   
$
14.85
   
$
51.75
   
$
47.76
 
Remaining lives
   
4.37
     
4.63
     
5.44
     
6.47
     
7.07
     
7.47
     
8.39
     
8.59
 
Risk free interest rate
   
1.89
%
   
1.76
%
   
2.65
%
   
2.34
%
   
1.58
%
   
0.79
%
   
0.56
%
   
0.84
%
Expected volatility
   
27.44
%
   
26.92
%
   
28.76
%
   
30.95
%
   
31.93
%
   
35.72
%
   
28.69
%
   
29.03
%
Expected life
   
6.000
     
6.000
     
6.000
     
6.000
     
6.000
     
6.000
     
6.000
     
6.000
 
Dividend yield
   
-
     
-
     
0.83
%
   
0.42
%
   
0.95
%
   
1.49
%
   
0.55
%
   
0.59
%
Fair value at grant date
 
$
3.98
   
$
4.60
   
$
6.37
   
$
15.63
   
$
6.27
   
$
4.41
   
$
13.77
   
$
13.06
 

The following table outlines the assumptions based on the number of options granted under the 2021 Plan.

   
May 17,
   
March 14,
   
April 29,
 
 
 
2021
   
2022
   
2022
 
Number of options granted
   
7,500
      100,000       14,827  
Options outstanding at September 30, 2022
   
7,500
      98,248       14,827  
Number exercisable at September 30, 2022
   
2,550
      -       -  
Exercise price
 
$
45.05
    $ 30.46     $ 31.39  
Remaining lives
   
8.63
      9.46       9.59  
Risk free interest rate
   
0.84
%
    2.10 %     2.92 %
Expected volatility
   
31.50
%
    35.33 %     35.33 %
Expected life
   
6.000
      6.000       6.000  
Dividend yield
   
0.63
%
    1.01 %     0.98 %
Fair value at grant date
 
$
13.23
    $ 10.23     $
11.07  

The Company has recorded compensation expense related to the options based on the provisions of ASC 718 under which the fixed portion of such expense is determined as the fair value of the options on the date of grant and amortized over the vesting period. The Company recorded compensation expense related to the options of approximately $0.3 million and $0.3 million for the three months ended September 30, 2022 and 2021, respectively. The Company recorded compensation expense related to the options of approximately $0.8 million and $2.0 million for the nine months ended September 30, 2022 and 2021, respectively. Total unrecognized compensation expense related to options at September 30, 2022, is $1.0 million, which will be expensed over 1.98 years.

PRSUs are restricted stock units subject to both performance-based and service-based vesting conditions. The number of shares of TPB Common Stock a recipient will receive upon vesting of a PRSU will be calculated by reference to certain performance metrics related to the Company’s performance over a five-year period. PRSUs will vest on the measurement date, which is no more than 65 days after the performance period provided the applicable service and performance conditions are satisfied. As of September 30, 2022, there are 472,701 PRSUs outstanding, all of which are unvested. The following table outlines the PRSUs granted and outstanding as of September 30, 2022.

   
March 7,
   
March 20,
   
July 19,
   
March 18,
   
December 28,
   
February 18,
   
March 14,
 

 
2018
   
2019
   
2019
   
2020
   
2020
   
2021
   
2022
 
Number of PRSUs granted
   
96,000
     
92,500
     
88,582
     
94,000
     
88,169
     
100,000
      49,996  
PRSUs outstanding at September 30, 2022
   
89,600
     
77,380
     
21,342
     
85,810
     
58,779
     
91,190
      48,600  
Fair value as of grant date
 
$
21.21
   
$
47.58
   
$
52.15
   
$
14.85
   
$
46.42
   
$
51.75
    $ 30.46  
Remaining lives
   
0.25
     
1.25
     
0.25
     
2.24
     
1.25
     
3.25
      4.25  

The Company recorded compensation expense related to the PRSUs of approximately $0.8 million and $1.3 million in the consolidated statements of income for the three months ended September 30, 2022 and 2021, respectively, based on the probability of achieving the performance condition. The Company recorded compensation expense related to the PRSUs of approximately $2.4 million and $3.9 million in the consolidated statements of income for the nine months ended September 30, 2022 and 2021, respectively, based on the probability of achieving the performance condition. Total unrecognized compensation expense related to these awards at September 30, 2022, is $4.7 million which will be expensed over the service periods based on the probability of achieving the performance condition.


The Company has granted 93,249 RSUs which vest over one to five years. The following table outlines the RSUs granted and outstanding as of September 30, 2022.


   
March 14,
   
March 14,
   
April 29,
   
April 29,
 
   
2022
   
2022
   
2022
   
2022
 
Number of RSUs granted
   
50,004
     
28,726
     
11,393
   
4,522  
RSUs outstanding at September 30, 2022
   
48,608
     
28,726
     
11,393
      4,522  
Fair value as of grant date
 
$
30.46
   
$
30.46
   
$
31.39
    $ 31.39  
Remaining lives
   
4.25
     
2.25
     
0.57
      4.25  



The Company has recorded compensation expense related to the RSUs based on the provisions of ASC 718 under which the fixed portion of such expense is determined as the fair value of the RSUs on the date of grant and amortized over the vesting period. The Company recorded compensation expense related to the RSUs of approximately $0.4 million and $0.1 million for the three months ended September 30, 2022 and 2021, respectively. The Company recorded compensation expense related to the RSUs of approximately $0.9 million and $0.2 million for the nine months ended September 30, 2022 and 2021, respectively. Total unrecognized compensation expense related to RSUs at September 30, 2022, is $2.1 million, which will be expensed over 3.44 years.

Note 15. Contingencies

On October 9, 2020, a purported stockholder of Turning Point Brands, Inc., Paul-Emile Berteau, filed a complaint in the Delaware Court of Chancery relating to the merger of SDI with a TPB subsidiary pursuant to the Agreement and Plan of Merger and Reorganization, dated as of April 7, 2020, by and among TPB, SDI and Merger Sub. The complaint purports to assert two derivative counts for breach of fiduciary duty on TPB’s behalf and against the TPB Board of Directors and certain SDI affiliates. The third count purports to assert a direct claim against TPB and its Board of Directors based on allegations that TPB’s Amended and Restated Bylaws are inconsistent with TPB’s certificate of incorporation. On October 26, 2020, the TPB Board of Directors adopted Amendment No. 1 to TPB’s Amended and Restated Bylaws, which amended the challenged section of the bylaws. On June 30, 2021, the court granted in part and denied in part the defendants’ motions to dismiss. Among other things, the court dismissed TPB director H.C. Charles Diao as a defendant in the action and dismissed the third count of the plaintiff’s complaint as moot. The remaining defendants answered the complaint on August 23, 2021 and continue to litigate. The parties plan to mediate the case in late November 2022. While the Company believes it has good and valid defenses to the claims, there can be no assurance that the Company will prevail in this case, and it could have a material adverse effect on the Company’s business and results of operations.

Other major tobacco companies are defendants in product liability claims. In a number of these cases, the amounts of punitive and compensatory damages sought are significant and, if such a claim were brought against the Company, could have a material adverse effect on our business and results of operations. The Company is subject to several lawsuits alleging personal injuries resulting from malfunctioning vaporizer devices or batteries and may be subject to claims in the future relating to other NewGen products. The Company is still evaluating these claims and the potential defenses to them. For example, the Company did not design or manufacture the products at issue; rather, the Company was merely the distributor. Nonetheless, there can be no assurance that the Company will prevail in these cases, and they could have a material adverse effect on the financial position, results of operations, or cash flows of the Company.

We have several subsidiaries engaged in making, distributing, and selling vapor products. As a result of the overall publicity and controversy surrounding the vapor industry generally, many companies have received informational subpoenas from various regulatory bodies and in some jurisdictions regulatory lawsuits have been filed regarding marketing practices and possible underage sales. We expect that our subsidiaries will be subject to some such cases and investigative requests. In the acquisition of the vapor businesses, we negotiated financial “hold-backs”, which we have used to defray expenses associated with the information production and the cost of defending any such lawsuits as well as the franchisee matter. To the extent that litigation becomes necessary, we believe that the subsidiaries have strong factual and legal defenses against claims that they unfairly marketed vapor products.

We have two franchisor subsidiaries, one of which no longer has any franchisees. Like many franchise businesses, in the ordinary course of their business, these subsidiaries are from time to time responding parties to arbitration demands brought by franchisees.

We have reached an agreement to arbitrate a claim brought by a former franchisee. This matter relates to the termination of the franchise agreement by the franchisor for failure to pay franchising fees and our subsequent demand that the franchisee cease using our marks and de-image locations formerly housing the franchises. The franchisee is claiming tortious interference and conversion. We believe the franchisor’s ultimate termination of the franchise agreement for multiple uncured material defaults by the franchisee was proper. We believe we have good and valid substantive defenses against the claims and intend on vigorously defending our interests in this matter.

Note 16. Income Per Share

The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations of net income:


 
Three Months Ended September 30,
 
   
2022
   
2021
 
                Per                 Per  
   
Income
   
Shares
   
Share
   
Income
   
Shares
   
Share
 
Basic EPS:
                                   
Numerator
                                   
Net income attributable to Turning Point Brands, Inc.
 
$
11,536
               
$
13,468
             
                                         
Denominator
                                       
Weighted average
           
17,749,294
   
$
0.65
             
18,897,974
   
$
0.71
 
                                                 
Diluted EPS:
                                               
Numerator
                                               
Net income attributable to Turning Point Brands, Inc.
 
$
11,536
                   
$
13,468
                 
Interest expense related to Convertible Senior Notes, net of tax
   
1,054
                     
1,054
                 
Diluted net income attributable to Turning Point Brands. Inc.
 
$
12,590
                   
$
14,522
                 
                                                 
Denominator
                                               
Basic weighted average
           
17,749,294
                     
18,897,974
         
Convertible Senior Notes
           
3,213,589
                     
3,207,293
         
Stock options
           
139,123
                     
259,540
         
             
21,102,006
   
$
0.60
             
22,364,807
   
$
0.65
 


 
Nine Months Ended September 30,
 
   
2022
   
2021
 
   
   
    Per
                Per  
   
Income
   
Shares
   
Share
   
Income
   
Shares
   
Share
 
Basic EPS:
                                   
Numerator
                                   
Net income attributable to Turning Point Brands, Inc.
 
$
27,958
               
$
40,605
             
                                         
Denominator
                                       
Weighted average
           
18,021,554
   
$
1.55
             
18,988,435
   
$
2.14
 
                                                 
Diluted EPS:
                                               
Numerator
                                               
Net income attributable to Turning Point Brands, Inc.
 
$
27,958
                   
$
40,605
                 
Interest expense related to Convertible Senior Notes
   
3,162
                     
3,162
                 
Diluted net income attributable to Turning Point Brands. Inc.
 
$
31,120
                   
$
43,767
                 
                                                 
Denominator
                                               
Basic weighted average
           
18,021,554
                     
18,988,435
         
Convertible Senior Notes
           
3,213,589
                     
3,207,293
         
Stock options
           
166,342
                     
268,814
         
             
21,401,485
   
$
1.45
             
22,464,542
   
$
1.95
 

Note 17. Segment Information

In accordance with ASC 280, Segment Reporting, the Company has three reportable segments: (1) Zig-Zag Products; (2) Stoker’s Products; and (3) NewGen Products. The Zig-Zag Products segment markets and distributes (a) rolling papers, tubes, and related products; and (b) finished cigars and MYO cigar wraps. The Stoker’s Products segment (a) manufactures and markets moist snuff and (b) contracts for and markets loose leaf chewing tobacco products. The NewGen Products segment (a) markets and distributes liquid vapor products and certain other products without tobacco and/or nicotine; (b) distributes a wide assortment of products to non-traditional retail outlets via VaporBeast; and (c) markets and distributes a wide assortment of products to individual consumers via the VaporFi B2C online platform. Products in the Zig-Zag Products and Stoker’s Products segments are distributed primarily through wholesale distributors in the United States while products in the NewGen Products segment are distributed primarily through e-commerce to non-traditional retail outlets and direct to consumers in the United States. Corporate unallocated includes the costs and assets of the Company not assigned to one of the three reportable segments such as intercompany transfers, deferred taxes, deferred financing fees, and investments in subsidiaries. As a result of a change in the Company’s chief operating decision maker (“CODM”), resulting from the hiring of a new Chief Executive Officer in the first quarter of 2022, certain general and administrative costs previously included to the NewGen Products segment are now included in Corporate unallocated to align with new management and reporting structures in the Company and better reflect how performance is now evaluated and resources are allocated by the CODM. Amounts in the prior year period have not been adjusted. Had such prior period amounts been adjusted, approximately $1.0 million and $3.0 million of costs for the three and nine months ended September 30, 2021 previously reported in the NewGen Products segment would have been reported in Corporate unallocated.

The accounting policies of these segments are the same as those of the Company. Corporate costs are not directly charged to the three reportable segments in the ordinary course of operations. The Company evaluates the performance of its segments and allocates resources to them based on operating income.

The tables below present financial information about reported segments:


 
Three Months Ended
September 30,
 
   
2022
   
2021
 
Net sales
           
Zig-Zag products
 
$
52,061
   
$
42,234
 
Stoker’s products
   
33,525
     
30,472
 
NewGen products
   
22,216
     
37,198
 
Total
 
$
107,802
   
$
109,904
 
                 
Gross profit
               
Zig-Zag products
 
$
28,035
   
$
23,703
 
Stoker’s products
   
18,279
     
17,104
 
NewGen products
   
6,398
     
13,462
 
Total
 
$
52,712
   
$
54,269
 
                 
Operating income (loss)
               
Zig-Zag products
 
$
18,740
   
$
17,122
 
Stoker’s products
   
13,653
     
13,305
 
NewGen products
   
142
     
2,027
 
Corporate unallocated (1)(2)
   
(12,714
)
   
(10,079
)
Total
 
$
19,821
   
$
22,375
 
                 
Interest expense, net
   
4,802
     
5,397
 
Investment income
    (75 )     (157 )
Gain on extinguishment of debt     -       (375 )
                 
Income before income taxes
 
$
15,094
   
$
17,510
 
                 
Capital expenditures
               
Zig-Zag products
 
$
29
   
$
12
 
Stoker’s products
   
940
     
2,209
 
NewGen products
   
-
     
2
 
Total
 
$
969
   
$
2,223
 
                 
Depreciation and amortization
               
Zig-Zag products
 
$
124
   
$
90
 
Stoker’s products
   
738
     
638
 
NewGen products
   
453
     
516
 
Total
 
$
1,315
   
$
1,244
 


(1)
Includes corporate costs that are not allocated to any of the three reportable segments.
(2)
Includes costs related to PMTA of $1.2 million in 2022 and $1.0 million in 2021.


 
Nine Months Ended
September 30,
 
   
2022
   
2021
 
Net sales
           
Zig-Zag products
 
$
143,959
   
$
130,440
 
Stoker’s products
   
98,816
     
93,096
 
NewGen products
   
68,846
     
116,652
 
Total
 
$
311,621
   
$
340,188
 
                 
Gross profit
               
Zig-Zag products
 
$
80,808
   
$
76,342
 
Stoker’s products
   
54,044
     
51,142
 
NewGen products
   
21,123
     
40,019
 
Total
 
$
155,975
   
$
167,503
 
                 
Operating income (loss)
               
Zig-Zag products
 
$
55,980
   
$
57,897
 
Stoker’s products
   
40,536
     
39,386
 
NewGen products
   
1,372
     
5,690
 
Corporate unallocated (1)(2)
   
(40,692
)
   
(31,370
)
Total
 
$
57,196
   
$
71,603
 
                 
Interest expense, net
   
15,142
     
15,406
 
Investment loss (income)
   
6,074
     
(292
)
Loss on extinguishment of debt
   
-
     
5,331
 
                 
Income before income taxes
 
$
35,980
   
$
51,158
 
                 
Capital expenditures
               
Zig-Zag products
 
$
4,588
   
$
110
 
Stoker’s products
   
2,074
     
4,226
 
NewGen products
   
-
     
55
 
Total
 
$
6,662
   
$
4,391
 
                 
Depreciation and amortization
               
Zig-Zag products
 
$
309
   
$
297
 
Stoker’s products
   
2,275
     
1,901
 
NewGen products
   
1,400
     
1,546
 
Total
 
$
3,984
   
$
3,744
 


(1)
Includes corporate costs that are not allocated to any of the three reportable segments.
(2)
Includes costs related to PMTA of $4.3 million in 2022 and $1.9 million in 2021.

    September 30,      December 31,  

 
2022
   
2021
 
Assets
           
Zig-Zag products
 
$
232,677
   
$
227,554
 
Stoker’s products
   
181,333
     
142,334
 
NewGen products
   
54,818
     
72,746
 
Corporate unallocated (1)
   
130,961
     
158,926
 
Total
 
$
599,789
   
$
601,560
 


(1)
Includes assets not assigned to the three reportable segments. All goodwill has been allocated to the reportable segments.

Revenue Disaggregation—Sales Channel

Revenues of the Zig-Zag Products and Stoker’s Products segments are primarily comprised of sales made to wholesalers while NewGen sales are made business to business and business to consumer, both online and through our corporate retail stores. NewGen net sales are broken out by sales channel below.


 
NewGen Segment
 
    Three Months Ended  
   
September 30,
 
   
2022
   
2021
 
Business to Business
 
$
18,226
   
$
27,169
 
Business to Consumer - Online
   
3,884
     
9,959
 
Other
   
106
     
70
 
Total
 
$
22,216
   
$
37,198
 


 
NewGen Segment
 
    Nine Months Ended  
   
September 30,
 
   
2022
   
2021
 
Business to Business
 
$
55,024
   
$
85,141
 
Business to Consumer - Online
   
13,453
     
31,255
 
Other
   
369
     
256
 
Total
 
$
68,846
   
$
116,652
 

Net Sales—Domestic vs. Foreign

The following table shows a breakdown of consolidated net sales between domestic and foreign customers.

    Three Months Ended  

 
September 30,
 
   
2022
   
2021
 
Domestic
 
$
98,173
   
$
102,255
 
Foreign
   
9,629
     
7,649
 
Total
 
$
107,802
   
$
109,904
 

    Nine Months Ended  

 
September 30,
 
   
2022
   
2021
 
Domestic
 
$
287,381
   
$
318,166
 
Foreign
   
24,240
     
22,022
 
Total
 
$
311,621
   
$
340,188
 

Note 18. Dividends and Share Repurchase

The most recent dividend of $0.06 per common share was paid on October 7, 2022, to shareholders of record at the close of business on September 16, 2022.

Dividends are considered restricted payments under the Senior Secured Notes Indenture and 2021 Revolving Credit Facility. The Company is generally permitted to make restricted payments provided that, at the time of payment, or as a result of payment, the Company is not in default on its debt covenants. Additional earnings and market capitalization restrictions limit the aggregate amount of restricted, quarterly dividends during a fiscal year.

On February 25, 2020, the Company’s 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. On October 25, 2021, the Board increased the approved share repurchase program by $30.7 million. On February 24, 2022, the Board increased the approved share repurchase program by $24.6 million. The program is subject to the ongoing discretion of the Board. The total number of shares repurchased for the three months ended September 30, 2022, was 307,207 shares for a total cost of $7.6 million and an average price per share of $24.78. $29.4 million remains available for share repurchases under the program at September 30, 2022. In addition, from time to time, the Company’s Board of Directors may authorize the repurchase of the Company’s debt securities, including the Senior Secured Notes and Convertible Senior Notes.

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
You should read the following discussion of the historical financial condition and results of operations in conjunction with our historical 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 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 discussion relates to the unaudited financial statements of Turning Point Brands, Inc., included elsewhere in this Quarterly Report on Form 10-Q. In this discussion, 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. (the “Company,” “we,” “our,” or “us”) 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 growth over the year period ending 2021 as reported by Management Science Associates, Inc. (“MSAi”), a third-party analytics and information company. Our three focus segments are led by our core, proprietary brands: Zig-Zag® in the Zig-Zag Products segment; Stoker’s® along with Beech-Nut® and Trophy® in the Stoker’s Products segment; and our distribution platforms (Vapor Beast®, VaporFi® and Direct Vapor®) along with Solace® in the NewGen 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. As of December 31, 2021, our products are available in approximately 195,000 U.S. retail locations which, with the addition of retail stores in Canada, brings our total North American retail presence to an estimated 215,000 points of distribution. Our sales team targets widespread distribution to all traditional retail channels, including convenience stores, and we have a growing e-commerce business.

Products

We operate in three segments: Zig-Zag Products, Stoker’s Products and NewGen Products. 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. 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 NewGen Products 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.

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 acquisition of VaporBeast in 2016 expanded our revenue streams as we began selling directly to non-traditional retail outlets. Our acquisition of IVG in 2018 enhanced our B2C revenue stream with the addition of the Vapor-Fi online platform. The acquisition of Solace in 2019 provided us with a line of leading liquids and a powerful new product development platform. 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 80% 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;

Marketing and promotional initiatives, which cause variability in our results;

General economic conditions, including consumer access to disposable income and other conditions affecting purchasing power such as inflation;

Supply chain challenges and freight costs;

Price sensitivity in our end-markets;

Cost and increasing regulation of promotional and advertising activities;

Cost of complying with regulation, including the “deeming regulation”

Increasing and unpredictable regulation of NewGen 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.

Recent Developments

Leadership Transition

In October 2022, Graham A. Purdy, the Company’s former Chief Operating Officer, was appointed as President and Chief Executive Officer of the Company and as a member of the Board upon the resignation of Yavor Efremov as the Company’s president and CEO and a member of the Board of Directors. In connection with Mr. Efremov’s termination of employment he is eligible to receive severance benefits as set forth in his employment agreement. We expect to take a charge of approximately $2.2 million in the fourth quarter 2022 for the severance benefits.

In connection with Mr. Purdy’s appointment and Mr. Efremov’s departure, David Glazek, current non-executive Chair of the Board, will transition to the role of Executive Chair effective January 2023.  Mr. Purdy will be the Company’s principal executive officer.  The Company expects to appoint a lead independent director at the time Mr. Glazek becomes the Company’s Executive Chair.

Non-Tobacco Nicotine Included Under Jurisdiction of FDA’s Center for Tobacco Products

New legislation enacted on March 15, 2022, provides authority for the FDA to regulate tobacco products containing nicotine from any source (“NTN Products”). This law took effect April 14, 2022, and requires NTN Products to comply with applicable requirements under the Federal Food, Drug, and Cosmetic Act, such as not selling to persons under 21 years of age, not marketing these products as modified risk tobacco products without FDA’s authorization, and not distributing free samples. Additionally, companies with NTN Products in the market between March 15, 2022, and April 14, 2022, were required to file a premarket tobacco application by May 14, 2022. NTN Products subject of a timely-filed PMTA, and not in receipt of a negative action, were allowed to remain on the market until July 13, 2022, at which time these products became subject to enforcement, similar to tobacco-derived products remaining under review. We submitted premarket filings for certain of our NTN Products prior to the May 14, 2022, deadline. While these applications remain under review, we will continue to supplement these filings with additional information to support a finding that the marketing of these products is “appropriate for the protection of public health.”

CLIPPER® Lighters

In February 2022, we entered into an agreement with Flamagas, a renowned lighter manufacturer, for exclusive distribution of CLIPPER® lighters in the United States and Canada.

Final Rule Related to PACT Act Published

On October 21, 2021, the United States Postal Service (“USPS”) published a Final Rule entitled “Treatment of E-Cigarettes in the Mail,” which followed its earlier publication of the Proposed Rule on February 19, 2021. This Final Rule was required as a result of the inclusion of Division FF, Title VI (Preventing Online Sales of E-Cigarettes to Children or “POSECA”) in the Further Consolidated Appropriations Act, 2021. POSECA, among other things, expanded the definition of “cigarettes” in the Jenkins Act and Prevent All Cigarette Trafficking (“PACT”) Act to expressly capture “electronic nicotine delivery systems,” i.e., ENDS. Consistent with the Proposed Rule, the Final Rule extends the existing prohibition on and exceptions to the mailing of “cigarettes” via USPS to ENDS products, other than the Consumer Testing and Public Health exceptions. Specifically, the Final Rule extends the following exceptions to the prohibition on mailing of ENDS products: the Business/Regulatory Purposes Exception, the Certain Individuals Exception, and the exception for intra-Alaska and intra-Hawaii shipments. We have received certain shipping exemptions from carrier services to carry the affected freight and have created a supplemental logistical network for those shipments not covered by the exemptions.

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 2021 Annual Report on Form 10-K.

Recent Accounting Pronouncements

There are no recent accounting pronouncements that impact the Company.

Results of Operations

Comparison of the Three Months Ended September 30, 2022, to the Three Months Ended September 30, 2021

The table and discussion set forth below displays our consolidated results of operations (in thousands):

   
Three Months Ended September 30,
 
   
2022
   
2021
   
% Change
 
Consolidated Results of Operations Data:
                 
Net sales
                 
Zig-Zag products
 
$
52,061
   
$
42,234
     
23.3
%
Stoker's products
   
33,525
     
30,472
     
10.0
%
NewGen products
   
22,216
     
37,198
     
-40.3
%
Total net sales
   
107,802
     
109,904
     
-1.9
%
Cost of sales
   
55,090
     
55,635
     
-1.0
%
Gross profit
                       
Zig-Zag products
   
28,035
     
23,703
     
18.3
%
Stoker's products
   
18,279
     
17,104
     
6.9
%
NewGen products
   
6,398
     
13,462
     
-52.5
%
Total gross profit
   
52,712
     
54,269
     
-2.9
%
                         
Selling, general, and administrative expenses
   
32,891
     
31,894
     
3.1
%
Operating income
   
19,821
     
22,375
     
-11.4
%
Interest expense, net
   
4,802
     
5,397
     
-11.0
%
Investment income
   
(75
)
   
(157
)
   
-52.2
%
Gain on extinguishment of debt
   
-
     
(375
)
   
-100.0
%
Income before income taxes
   
15,094
     
17,510
     
-13.8
%
Income tax expense
   
3,797
     
4,073
     
-6.8
%
Consolidated net income
   
11,297
     
13,437
     
-15.9
%
Net loss attributable to non-controlling interest
   
(239
)
   
(31
)
   
671.0
%
Net income attributable to Turning Point Brands, Inc.
 
$
11,536
   
$
13,468
     
-14.3
%

Net Sales:  For the three months ended September 30, 2022, consolidated net sales decreased to $107.8 million from $109.9 million for the three months ended September 30, 2021, a decrease of $2.1 million or 1.9%. The decrease in net sales was primarily driven by decreased sales volume in the NewGen Products segment.

For the three months ended September 30, 2022, net sales in the Zig-Zag Products segment increased to $52.1 million from $42.2 million for the three months ended September 30, 2021, an increase of $9.8 million or 23.3%. For the three months ended September 30, 2022, volume increased 21.7% and price/mix increased 1.6%. Our U.S. rolling papers business grew double-digits, primarily through our e-commerce channels.  Continued strength in paper cones, strong receptivity to promotional programs, the launch of CLIPPER lighters, and timing shifts in Canadian deliveries contributed to strong performance during the quarter. In total, we believe approximately $5 million of sales were pulled forward from the fourth quarter across the Zig Zag Products segment.

For the three months ended September 30, 2022, net sales in the Stoker’s Products segment increased to $33.5 million from $30.5 million for the three months ended September 30, 2021, an increase of $3.1 million or 10%. For the three months ended September 30, 2022, volume increased 2.4% and price/mix increased 7.6%. The increase in net sales was driven by double-digit growth of Stoker’s® MST partially offset by a mid-single digit decline in loose-leaf chewing tobacco. FRE nicotine pouch products was a marginal contributor to segment sales.

For the three months ended September 30, 2022, net sales in the NewGen products segment decreased to $22.2 million from $37.2 million for the three months ended September 30, 2021, a decrease of $15.0 million or 40.3%. The decrease in net sales was primarily the result of declines in the vape distribution businesses which continues to be impacted by the regulatory environment.  Net sales have been relatively steady sequentially within the current year period.

Gross Profit:  For the three months ended September 30, 2022, consolidated gross profit decreased to $52.7 million from $54.3 million for the three months ended September 30, 2021, a decrease of $1.6 million or 2.9%. Gross profit as a percentage of revenue decreased to 48.9% for the three months ended September 30, 2022, compared to 49.4% for the three months ended September 30, 2021 driven by mix.

For the three months ended September 30, 2022, gross profit in the Zig-Zag Products segment increased to $28.0 million from $23.7 million for the three months ended September 30, 2021, an increase of $4.3 million or 18.3%. Gross profit as a percentage of net sales decreased to 53.9% of net sales for the three months ended September 30, 2022, from 56.1% of net sales for the three months ended September 30, 2021, as a result of strong growth in lower gross margin products including the launch of our lighters business.

For the three months ended September 30, 2022, gross profit in the Stoker’s Products segment increased to  $18.3 million from $17.1 million for the three months ended September 30, 2021, an increase of $1.2 million or 6.9%. Gross profit as a percentage of net sales decreased to 54.5% of net sales for the three months ended September 30, 2022, from 56.1% of net sales for the three months ended September 30, 2021, primarily as a result of the mix impact of FRE and stronger growth in discount looseleaf products.

For the three months ended September 30, 2022, gross profit in the NewGen products segment decreased to $6.4 million from $13.5 million for the three months ended September 30, 2021, a decrease of $7.1 million or 52.5%. Gross profit as a percentage of net sales decreased to 28.8% of net sales for the three months ended September 30, 2022, from 36.2% of net sales for the three months ended September 30, 2021, primarily as a result of product mix and the competitive environment.

Selling, General, and Administrative Expenses:  For the three months ended September 30, 2022, selling, general, and administrative expenses increased to $32.9 million from $31.9 million for the three months ended September 30, 2021, an increase of $1.0 million or 3.1%. Selling, general and administrative expenses in the three months ended September 30, 2022, included $1.4 million of stock options, 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. Selling, general and administrative expenses in the three months ended September 30, 2021, included $1.8 million of stock option, restricted stock and incentives expense, $0.2 million of transaction income and $1.0 million of expense related to PMTA.

Interest Expense, net:  For the three months ended September 30, 2022, interest expense, net decreased to $4.8 million, from $5.4 million for the three months ended September 30, 2021 as a result of the repayment of the Promissory Note and forgiveness of the Unsecured Loan each discussed in Note 11 Notes Payable and Long-Term Debt in the Consolidated Financial Statements.  In addition interest income earned on our cash balance offset interest expense.

Investment Income:  For the three months ended September 30, 2022, investment income decreased to $0.1 million, compared to $0.2 million of investment income for the three months ended September 30, 2021.

Gain on Extinguishment of Debt  There was no gain on extinguishment of debt for the three months ended September 30, 2022 compared to $0.4 million for the three months ended September 30, 2021 related to the repayment of the Promissory Note.

Income Tax Expense:  Our income tax expense of $3.8 million was 25.2% of income before income taxes for the three months ended September 30, 2022 and included a discrete tax benefit of $0.0 million relating to stock option exercises. Our effective income tax rate was 23.3% for the three months ended September 30, 2021 and included a discrete tax benefit $1.0 million relating to stock option exercises.

Net Loss Attributable to Non-Controlling Interest:  Net loss attributable to non-controlling interest was $0.2 million for the three months ended September 30, 2022 compared to $0.0 million for the three months ended September 30, 2021.

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, 2022 and 2021, was $11.5 million and $13.5 million, respectively.

Comparison of the Nine Months Ended September 30, 2022, to the Nine Months Ended September 30, 2021

The table and discussion set forth below displays our consolidated results of operations (in thousands):

   
Nine Months Ended September 30,
 
   
2022
   
2021
   
% Change
 
Consolidated Results of Operations Data:
                 
Net sales
                 
Zig-Zag products
 
$
143,959
   
$
130,440
     
10.4
%
Stoker's products
   
98,816
     
93,096
     
6.1
%
NewGen products
   
68,846
     
116,652
     
-41.0
%
Total net sales
   
311,621
     
340,188
     
-8.4
%
Cost of sales
   
155,646
     
172,685
     
-9.9
%
Gross profit
                       
Zig-Zag products
   
80,808
     
76,342
     
5.8
%
Stoker's products
   
54,044
     
51,142
     
5.7
%
NewGen products
   
21,123
     
40,019
     
-47.2
%
Total gross profit
   
155,975
     
167,503
     
-6.9
%
                         
Selling, general, and administrative expenses
   
98,779
     
95,900
     
3.0
%
Operating income
   
57,196
     
71,603
     
-20.1
%
Interest expense, net
   
15,142
     
15,406
     
-1.7
%
Investment loss (income)
   
6,074
     
(292
)
   
-2180.1
%
Loss on extinguishment of debt
   
-
     
5,331
     
-100.0
%
Income before income taxes
   
35,980
     
51,158
     
-29.7
%
Income tax expense
   
8,706
     
11,151
     
-21.9
%
Consolidated net income
   
27,274
     
40,007
     
-31.8
%
Net loss attributable to non-controlling interest
   
(684
)
   
(598
)
   
14.4
%
Net income attributable to Turning Point Brands, Inc.
 
$
27,958
   
$
40,605
     
-31.1
%

Net Sales:  For the nine months ended September 30, 2022, consolidated net sales decreased to $311.6 million from $340.2 million for the nine months ended September 30, 2021, a decrease of $28.6 million or 8.4%. The decrease in net sales was driven by decreased sales volume in the NewGen Products segment.

For the nine months ended September 30, 2022, net sales in the Zig-Zag Products segment increased to $144.0 million from $130.4 million for the nine months ended September 30, 2021, an increase of $13.5 million or 10.4%. For the nine months ended September 30, 2022, volume increased 8.4% and price/mix increased 2.0%. The increase in net sales was driven by double-digit growth in U.S. rolling papers primarily through our e-commerce channels.  Continued strength in paper cones, strong receptivity to promotional programs, the launch of CLIPPER lighters, and timing shifts in Canadian deliveries contributed to strong performance during the quarter. In total, we believe approximately $5 million of sales were pulled forward from the fourth quarter across the Zig Zag Products segment. However, these increases were offset by declines in the cigar wraps business driven partially by a trade inventory reduction in the current period compared with a trade inventory load in the prior year period.

For the nine months ended September 30, 2022, net sales in the Stoker’s Products segment increased to $98.8 million from $93.1 million for the nine months ended September 30, 2021, an increase of $5.7 million or 6.1%. For the nine months ended September 30, 2022, volume decreased 1.4% and price/mix increased 7.5%. The increase in net sales was driven by double digit growth of Stoker’s® MST partially offset by a mid-single digit decline in loose-leaf chewing tobacco. FRE nicotine pouch products was a marginal contributor to segment sales.

For the nine months ended September 30, 2022, net sales in the NewGen products segment decreased to $68.8 million from $116.7 million for the nine months ended September 30, 2021, a decrease of $47.8 million or 41.0%. The decrease in net sales was primarily the result of declines in the vape distribution businesses which continue to be impacted by the regulatory environment.

Gross Profit:  For the nine months ended September 30, 2022, consolidated gross profit decreased to $156.0 million from $167.5 million for the nine months ended September 30, 2021, a decrease of $11.5 million or 6.9%. Gross profit as a percentage of revenue increased to 50.1% for the nine months ended September 30, 2022, compared to 49.2% for the nine months ended September 30, 2021 driven by mix as the NewGen Products segment generates lower margins.

For the nine months ended September 30, 2022, gross profit in the Zig-Zag Products segment increased to $80.8 million from $76.3 million for the nine months ended September 30, 2021, an increase of $4.5 million or 5.8%. Gross profit as a percentage of net sales decreased to 56.1% of net sales for the nine months ended September 30, 2022, from 58.5% of net sales for the nine months ended September 30, 2021, as a result of strong growth in lower gross margin products including the launch of our lighters business.

For the nine months ended September 30, 2022, gross profit in the Stoker’s Products segment increased to $54.0 million from $51.1 million for the nine months ended September 30, 2022, an increase of $2.9 million or 5.7%. Gross profit as a percentage of net sales decreased to 54.7% of net sales for the nine months ended September 30, 2022, from 54.9% of net sales for the nine months ended September 30, 2021.

For the nine months ended September 30, 2022, gross profit in the NewGen products segment decreased to $21.1 million from $40.0 million for the nine months ended September 30, 2021, a decrease of $19.0 million or 47.2%. Gross profit as a percentage of net sales decreased to 30.7% of net sales for the nine months ended September 30, 2022, from 34.3% of net sales for the nine months ended September 30, 2021, as a result of product mix and the competitive environment.

Selling, General, and Administrative Expenses:  For the nine months ended September 30, 2022, selling, general, and administrative expenses increased to $98.8 million from $95.9 million for the nine months ended September 30, 2021, an increase of $2.9 million or 3.0%. Selling, general and administrative expenses for the nine months ended September 30, 2022, included $4.1 million of stock options, restricted stock and incentives expense, $0.8 million of transaction expense, $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 and mobilization of the new ERP and CRM systems. Selling, general and administrative expenses in the nine months ended September 30, 2021, included $6.0 million of stock option, restricted stock and incentives expense (including $1.1 million for accelerated vesting of options for a departing executive), $1.1 million of transaction costs and $1.9 million of expense related to PMTA.

Interest Expense, net:  For the nine months ended September 30, 2022, interest expense, net decreased to $15.1 million, from $15.4 million for the nine months ended September 30, 2021 as a result of the increase in the Company’s outstanding debt in February 2021 offset by interest earned on our cash balance.

Investment Loss (Income):  For the nine months ended September 30, 2022, investment loss increased to $6.1 million, compared to $0.3 million of investment income for the nine months ended September 30, 2021, primarily as a result of $6.3 million impairment of our investment in dosist.  See Note 9 Other Assets in the Consolidated Financial Statements for information on the dosist impairment.

Loss on Extinguishment of Debt: There was no loss on extinguishment of debt for the nine months ended September 30, 2022 compared to $5.3 million for the nine months ended September 30, 2021 related to the repayment of the 2018 First Lien Credit Facility.

Income Tax Expense:  Our income tax expense of $8.7 million was 24.2% of income before income taxes for the nine months ended September 30, 2022 and included a discrete tax benefit of $0.7 million relating to stock option exercises. Our effective income tax rate was 21.8% for the nine months ended September 30, 2021 and included a discrete tax benefit $6.2 million relating to stock option exercises.

Net Loss Attributable to Non-Controlling Interest:  Net loss attributable to non-controlling interest was $0.7 million for the nine months ended September 30, 2022 compared to $0.6 million for the nine months ended September 30, 2021.

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, 2022 and 2021, was $28.0 million and $40.6 million, respectively.

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, net, gain (loss) on extinguishment of debt, provision for income taxes, depreciation, and amortization. We define “Adjusted EBITDA” as net income before interest expense, net, gain (loss) on extinguishment of debt, provision for income taxes, depreciation, amortization, other non-cash items, and other items we do not consider 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.

   
Three Months Ended
 
(in thousands)
 
September 30,
 
   
2022
   
2021
 
Net income attributable to Turning Point Brands, Inc.
 
$
11,536
   
$
13,468
 
Add:
               
Interest expense, net
   
4,802
     
5,397
 
Gain on extinguishment of debt
   
-
     
(375
)
Income tax expense
   
3,797
     
4,073
 
Depreciation expense
   
861
     
767
 
Amortization expense
   
454
     
477
 
EBITDA
 
$
21,450
   
$
23,807
 
Components of Adjusted EBITDA
               
Corporate restructuring (a)
   
17
     
-
 
ERP/CRM (b)
   
435
     
-
 
Stock options, restricted stock, and incentives expense (c)
   
1,442
     
1,752
 
Transactional expenses (d)
   
-
     
(232
)
FDA PMTA (e)
   
1,169
     
960
 
Adjusted EBITDA
 
$
24,513
   
$
26,287
 


(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").

   
Nine Months Ended
 
(in thousands)
 
September 30,
 
   
2022
   
2021
 
Net income attributable to Turning Point Brands, Inc.
 
$
27,958
   
$
40,605
 
Add:
               
Interest expense, net
   
15,142
     
15,406
 
Loss on extinguishment of debt
   
-
     
5,331
 
Income tax expense
   
8,706
     
11,151
 
Depreciation expense
   
2,611
     
2,313
 
Amortization expense
   
1,373
     
1,431
 
EBITDA
 
$
55,790
   
$
76,237
 
Components of Adjusted EBITDA
               
Corporate restructuring (a)
   
1,619
     
-
 
ERP/CRM (b)
   
1,626
     
-
 
Stock options, restricted stock, and incentives expense (c)
   
4,103
     
6,015
 
Transactional expenses (d)
   
789
     
1,077
 
FDA PMTA (e)
   
4,265
     
960
 
Non-cash asset impairment (f)
   
6,300
     
-
 
Adjusted EBITDA
 
$
74,492
   
$
84,289
 


(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 in dosist.

Liquidity and Capital Reserves

Our principal uses for cash are working capital, debt service, and capital expenditures. We believe our cash on hand, cash flows from operations and borrowing availability under our 2021 Revolving Credit Facility are adequate to satisfy our operating cash requirements for the foreseeable future. As of September 30, 2022, we had $105.7 million of cash on hand and have $21.4 million of availability under the 2021 Revolving Credit Facility.

Our working capital, which we define as current assets less cash and current liabilities, increased $27.7 million to $108.2 million at September 30, 2022, compared with $80.5 million at December 31, 2021 primarily due to increase in inventory as a result of our annual tobacco purchase.

   
As of
 
(in thousands)
 
September 30,
   
December 31,
 
   
2022
   
2021
 
             
Current assets
 
$
150,110
   
$
120,849
 
Current liabilities
   
41,881
     
40,336
 
Working capital
 
$
108,229
   
$
80,513
 

Cash Flows from Operating Activities

For the nine months ended September 30, 2022, net cash provided by operating activities was $16.4 million compared to net cash provided by operating activities of $49.6 million for the nine months ended September 30, 2021, a decrease of $33.2 million, primarily due to lower net income due to decreased sales in the NewGen Segment combined with the timing of changes to working capital, primarily as a result of annual tobacco inventory purchase.

Cash Flows from Investing Activities

For the nine months ended September 30, 2022, net cash used in investing activities was $17.8 million compared to net cash used in investing activities of $52.2 million for the nine months ended September 30, 2021, a decrease of $34.5 million, primarily due to the lower purchases of investments in our MSA escrow account as well as no acquisitions and a small investments made in the current year period.

Cash Flows from Financing Activities

For the nine months ended September 30, 2022, net cash used in financing activities was $31.2 million compared to net cash provided by financing activities of $76.3 million for the nine months ended September 30, 2021, a decrease of $107.5 million. The decrease was primarily due to an increase in cash used to repurchase common stock during 2022 while in 2021 the Company received net proceeds received from the Senior Secured Notes partially offset by the repayment in full of the 2018 First Lien Term Loan in the first quarter of 2021.

Dividends and Share and Repurchases

The most recent dividend of $0.06 per common share was paid on October 7, 2022, to shareholders of record at the close of business on September 16, 2022.

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. On October 25, 2021, the Board increased the approved share repurchase program by $30.7 million. On February 24, 2022, the Board increased the approved share repurchase program by $24.6 million. The program is subject to the ongoing discretion of the Board. The total number of shares repurchased for the nine months ended September 30, 2022, was 307,207 shares for a total cost of $7.6 million and an average price per share of $24.78. $29.4 million remains available for share repurchases under the program at September 30, 2022.

Subject to market conditions, we will from time to time opportunistically repurchase our Senior Secured Notes and Convertible Senior Notes and any other securities we may have outstanding.

Repurchases of common stock, Senior Secured Notes and Convertible Senior Notes may be made through bilateral transactions, open market transactions, 10b5-1 trading plans or otherwise.

Long-Term Debt

As of September 30, 2022, we were in compliance with the financial and restrictive covenants of the Senior Secured Notes and 2021 Revolving Credit Facility. The following table provides the outstanding balances of our debt instruments.

   
September 30,
   
December 31,
 
   
2022
   
2021
 
Senior Secured Notes
 
$
250,000
   
$
250,000
 
Convertible Senior Notes
   
172,500
     
172,500
 
Gross notes payable and long-term debt
   
422,500
     
422,500
 
Less deferred finance charges
   
(6,471
)
   
(8,328
)
Notes payable and long-term debt
 
$
416,029
   
$
414,172
 

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.

We may redeem the Senior Secured Notes, in whole or in part, at any time prior to February 15, 2023, at a price equal to 100% of the principal amount of the Notes redeemed plus accrued and unpaid interest, if any, to, but excluding the applicable redemption date, plus a “make-whole” premium. Thereafter, we may redeem the Senior Secured Notes, in whole or in part, at established redemption prices set forth in the Senior Secured Notes Indenture, plus accrued and unpaid interest, if any. In addition, on or prior to February 15, 2023, we may redeem up to 40% of the aggregate principal amount of the Senior Secured Notes with the net cash proceeds from certain equity offerings at a redemption price equal to 105.625%, plus accrued and unpaid interest, if any to the redemption date; provided, however, that at least 50% of the original aggregate principal amount of the Senior Secured Notes (calculated after giving effect to the issuance of any additional notes) remains outstanding. In addition, at any time and from time to time prior to February 15, 2023, but not more than once in any twelve-month period, we may redeem up to 10% of the aggregate principal amount of the Senior Secured Notes at a redemption price of 103% of the aggregate principal amount of Senior Secured Notes redeemed plus accrued and unpaid interest, if any to but not including the redemption date, on the Senior Secured Notes to be redeemed.

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 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 Indenture. The Indenture provides for customary events of default. We were in compliance with all covenants as of September 30, 2022.

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 (the “Lenders”) and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). The 2021 Revolving Credit Facility provides for a revolving line of credit of up to $25.0 million. Letters of credit are limited to $10 million (and are a part of, and not in addition to, the revolving line of credit). We have not drawn any borrowings under the 2021 Revolving Credit Facility but do have letters of credit of approximately $3.6 million outstanding under the facility as of September 30, 2022. The 2021 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 2021 Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate 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 2021 Revolving Credit Agreement are guaranteed on a joint and several basis by the Guarantors. The Company’s and Guarantors’ obligations under the 2021 Revolving Credit Facility are secured on a pari passu basis with the Senior Secured Notes.

The 2021 Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The 2021 Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio (as defined in the 2021 Revolving Credit Agreement) 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 2021 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 2021 Revolving Credit Facility. The 2021 Revolving Credit Agreement provides for customary events of default. We were in compliance with all covenants as of September 30, 2022.

We incurred debt issuance costs attributable to the issuance of the 2021 Revolving Credit Facility of $0.5 million which are amortized to interest expense using the effective interest method over the expected life of the 2021 Revolving Credit Facility.

2018 Credit Facility

In the first quarter of 2021, we used a portion of the proceeds from the issuance of the Senior Secured Notes to prepay all outstanding amounts under and terminate the 2018 First Lien Credit Facility in the amount of $130.0 million, and the transaction resulted in a $5.7 million loss on extinguishment of debt. See Note 11, “Notes Payable and Long-Term Debt,” in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion.

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.

The Convertible Senior Notes are convertible into approximately 3,213,589 shares of our voting common stock under certain circumstances prior to maturity at a conversion rate of 18.630 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.68 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 us in excess of pre-determined thresholds of $0.04 per share. Upon conversion, we may pay cash, shares of our common stock or a combination of cash and stock, as determined by us at our discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of September 30, 2022.

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 $53.68 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.

Promissory Note

On June 10, 2020, in connection with the acquisition of certain Durfort assets, we issued an unsecured subordinated promissory note (“Promissory Note”) in the principal amount of $10.0 million (the “Principal Amount”), with an annual interest rate of 7.5%, payable quarterly, with the first interest payment due September 10, 2020. We prepaid all outstanding amounts under and terminated the Promissory Note in the third quarter of 2021 in the amount of $9.6 million. The transaction resulted in a $0.4 million gain on extinguishment of debt.

Unsecured Loan

On April 17, 2020, National Tobacco Company, L.P., a wholly-owned subsidiary of the Company, entered into a loan agreement with Regions Bank guaranteed by the Small Business Administration for a $7.5 million unsecured loan issued pursuant to the CARES Act. The proceeds of the loan were received on April 27, 2020. The loan was scheduled to mature on April 17, 2022 and had a 1.00% interest rate. Under the CARES Act we were permitted to apply for forgiveness of the loan if the proceeds were used as required for certain purposes. During 2021, we applied for forgiveness for the loan. On October 15, 2021, we received notice that our application for forgiveness was fully approved. The extinguishment of the unsecured loan occurred in the fourth quarter of 2021 resulting in a $7.5 million gain on extinguishment of debt. We are subject to audit relating to the unsecured loan until 2027 which could result in repayment of some or all of the unsecured loan previously forgiven. However, we believe that repayment of any amount is not probable.

Off-balance Sheet Arrangements

During the nine months ended September 30, 2022, we executed various option contracts, which met hedge accounting requirements for the purchase of €18.5 million with maturity dates ranging from August 2022 to March 2023. At September 30, 2022, we had option contracts for the purchase of €15.2 million outstanding.  The foreign currency contracts’ fair value at September 30, 2022, resulted in an asset of $0.2 million included in Other current assets and a liability of $0.5 million included in Accrued liabilities.  During 2021, we did not execute any foreign currency contracts. We had no foreign currency contracts at December 31, 2021.  The Company had no interest rate swap contracts at September 30, 2022. The Company terminated its interest rate swap agreement in conjunction with the prepayment of all outstanding amounts under to the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $3.6 million, and the transaction resulted in a $5.7 million loss recorded in the loss on extinguishment of debt. See Note 11, “Notes Payable and Long-Term Debt,” in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion.

Inflation

Inflation in general and the recent rapid increases in costs of goods and services, such as food and gas prices have had a substantial negative effect on the purchasing power of consumers. While historically, we have been able to pass on most cost increases to our customers, no assurance can be given that we will continue to be able to do so. In addition, we have been able to maintain a relatively stable variable cost structure for our products due, in part, to our successful procurement with regard to our tobacco products and, in part, to our existing contractual agreement for the purchase of our premium cigarette papers.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Sensitivity

There have been no material changes in our exposure to exchange rate fluctuation risk, as reported within our 2021 Annual Report on Form 10-K, during the period. Please refer to our ‘Quantitative and Qualitative Disclosures about Market Risk’ included in our 2021 Annual Report on Form 10-K filed with the SEC.

Credit Risk

There have been no material changes in our exposure to credit risk, as reported within our 2021 Annual Report on Form 10-K, during the nine months ended September 30, 2022. Please refer to our ‘Quantitative and Qualitative Disclosures about Market Risk’ included in our 2021 Annual Report on Form 10-K filed with the SEC.

Interest Rate Sensitivity

In February 2021, we issued the Senior Secured Notes in an aggregate principal amount of $250 million. In July 2019, we issued Convertible Senior Notes in an aggregate principal amount of $172.5 million. Since the Senior Secured Notes and Convertible Senior Notes bear interest at a fixed rate, we have no financial risk associated with changes in interest rates. However, the fair value of the Convertible Senior Notes changes when the market price of our stock fluctuates, or interest rates change. Our remaining debt instruments bear interest at fixed rates and are not subject to interest rate volatility.

Item 4. Controls and Procedures

We have carried out an evaluation under the supervision, and with the participation of, our management including our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”), and Chief Accounting Officer (“CAO”), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the “Act”)) as of September 30, 2022. Based upon the evaluation, our CEO, CFO, and CAO concluded our disclosure controls and procedures are not effective as of such date solely due to the material weakness in internal controls over financial reporting that was disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

As previously described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, we began implementing a remediation plan to address the material weakness mentioned above. The material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time, and management has concluded through testing that these controls are operating effectively. We expect that the remediation of this material weakness will be completed by the end of the fiscal year 2022.

Other than in connection with aspects of our remediation plan, there have been no changes in the Company’s internal control over financial reporting during the fiscal quarter ended September 30, 2022 which have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

For a description of our material pending legal proceedings, please see Contingencies in Note 15 to the Notes to the Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report.
 
See ‘Risk Factors—We may become subject to significant product liability litigation’ within our 2021 Annual Report on Form 10-K for additional details.

Item 1A. Risk Factors

In addition to the other information set forth in this report, carefully consider the factors discussed in the ‘Risk Factors’ section contained in our 2021 Annual Report on Form 10-K. There have been no material changes to the Risk Factors set forth in the 2021 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
On February 25, 2020, the Company’s 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. On October 25, 2021, the Board increased the approved share repurchase program by $30.7 million bringing the authority at the time back to $50 million (including approximately $19.3 million available for repurchases under the Board’s previous authorization). On February 24, 2022, the Board increased the approved share repurchase program by $24.6 million bringing total authority at that time to $50 million. This share repurchase program has no expiration date and is subject to the ongoing discretion of the Board. All repurchases to date under our stock repurchase programs have been made through open market transactions, but in the future, we may also purchase shares through privately negotiated transactions or 10b5-1 repurchase plans.
 
The following table includes information regarding purchases of our common stock made by us during the quarter ended September 30, 2022 in connection with the repurchase program described above:
 
                     
Maximum Number
 
                     
(or Approximate
 
               
Total Number of
   
Dollar Value)
 
               
Shares Purchased
   
of Shares that
 
   
Total Number
   
Average
   
as Part of Publicly
   
May Yet Be
 
   
of Shares
   
Price Paid
   
Announced Plans
   
Purchased Under the
 
Period
 
Purchased (1)
   
per Share
   
or Programs
   
Plans or Programs
 
July 1 to July 31
   
86,841
   
$
27.93
     
86,841
   
$
34,578,518
 
August 1 to August 31
   
113,576
   
$
24.53
     
113,241
   
$
31,800,716
 
September 1 to September 30
   
107,125
   
$
22.51
     
107,125
   
$
29,389,333
 
Total
   
307,542
             
307,207
         

(1) The total number of shares purchased includes (a) shares purchased under the February 2020 share repurchase program (which totaled 86,841 shares in July, 113,241 in August and 107,125 shares in September) and (b) shares withheld by the Company in an amount equal to the statutory withholding taxes for holders who vested in stock-based awards (which totaled 335 shares in August). Shares withheld by the Company to cover statutory withholdings taxes are repurchased pursuant to the applicable plan and not the authorization under the share repurchase program.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None

Item 6. Exhibits

Exhibit No.
Description
   
Rule 13a-14(a)/15d-14(a) Certification of Graham Purdy.*
   
Rule 13a-14(a)/15d-14(a) Certification of Luis Reformina.*
   
Rule 13a-14(a)/15d-14(a) Certification of Brian Wigginton.*
   
Section 1350 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
   
101
XBRL (eXtensible Business Reporting Language). The following materials from Turning Point Brands, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2022, filed on October 26, 2022, formatted in Inline XBRL (iXBRL): (i) consolidated balance sheets, (ii) consolidated statements of income, (iii) consolidated statements of comprehensive income, (iv) consolidated statements of cash flows, and (v) the notes to consolidated financial statements.*
   
104
Cover Page Interactive Data File (formatted in iXBRL and included in Exhibit 101).*

*
Filed or furnished herewith
 
Signatures
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
TURNING POINT BRANDS, INC.
       
   
By:
/s/ Graham Purdy
   
Name:
Graham Purdy
    Title:  President and Chief Executive Officer

   
By:
/s/ Luis Reformina
   
Name:
Luis Reformina
    Title:  Chief Financial Officer

   
By:
/s/ Brian Wigginton
   
Name:
Brian Wigginton
    Title:  Chief Accounting Officer
       
Date: October 26, 2022
     


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