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Turning Point Brands, Inc. - Quarter Report: 2023 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, 2023

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 November 1, 2023, there were 17,604,527 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, 2023 and 2022 7
       
   
8
       
    Consolidated Statements of Comprehensive Income for the nine months ended September 30, 2023 and 2022
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
51
       
 
ITEM 6
52
       
  53
 
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 come up 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 Creative Distribution Solutions 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 U.S. Food and Drug Administration, 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 agreement escrow account;

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;

an increase in state and local regulation of our Creative Distribution Solutions products has been proposed or enacted;

an increase in tax of our Creative Distribution Solutions 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;

uncertainty surrounding FDA compliance policy;

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;

our amount of indebtedness;

the terms of our indebtedness, which may restrict our current and future operations;
 
our ability to comply with required disclosure requirements;

identification of material weaknesses in our internal control over financial reporting, which, if not remediated appropriately or timely, could result in loss of investor confidence and adversely impact our stock price;

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;

adverse impact of climate change;

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
 
2023
   
2022
 
Current assets:
           
Cash
 
$
96,071
   
$
106,403
 
Accounts receivable, net of allowances of $59 in 2023 and $114 in 2022
   
10,493
     
8,377
 
Inventories, net
   
116,926
     
119,915
 
Other current assets
   
23,322
     
22,959
 
Total current assets
   
246,812
     
257,654
 
Property, plant, and equipment, net
   
24,613
     
22,788
 
Deferred income taxes
   
8,190
     
8,443
 
Right of use assets
   
12,060
     
12,465
 
Deferred financing costs, net
   
203
     
282
 
Goodwill
   
136,280
     
136,253
 
Other intangible assets, net
   
81,725
     
83,592
 
Master Settlement Agreement (MSA) escrow deposits
   
27,534
     
27,980
 
Other assets
   
16,526
     
22,649
 
Total assets
 
$
553,943
   
$
572,106
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
 
$
11,237
   
$
8,355
 
Accrued liabilities
   
27,227
     
33,001
 
Current portion of long-term debt
    48,248        
Other current liabilities
   
6
     
20
 
Total current liabilities
   
86,718
     
41,376
 
Notes payable and long-term debt
   
316,573
     
406,757
 
Lease liabilities
   
10,433
     
10,593
 
Total liabilities
   
413,724
     
458,726
 
                 
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; 19,912,882 issued shares and 17,596,422 outstanding shares at September 30, 2023, and 19,801,623 issued shares and 17,485,163 outstanding shares at December 31, 2022
   
199
     
198
 
Common stock, nonvoting, $0.01 par value; authorized shares, 10,000,000; issued and outstanding shares -0-
   
     
 
Additional paid-in capital
   
117,143
     
113,242
 
Cost of repurchased common stock (2,316,460 shares at September 30, 2023 and December 31, 2022)
   
(78,093
)
   
(78,093
)
Accumulated other comprehensive loss
   
(3,855
)
   
(2,393
)
Accumulated earnings
   
103,517
     
78,691
 
Non-controlling interest
   
1,308
     
1,735
 
Total stockholders’ equity
   
140,219
     
113,380
 
Total liabilities and stockholders’ equity
 
$
553,943
   
$
572,106
 

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,
 
   
2023
   
2022
 
Net sales
 
$
101,722
   
$
107,802
 
Cost of sales
   
50,100
     
55,090
 
Gross profit
   
51,622
     
52,712
 
Selling, general, and administrative expenses
   
31,385
     
32,891
 
Operating income
   
20,237
     
19,821
 
Interest expense, net
   
3,984
     
4,802
 
Investment loss (gain)
   
2,101
     
(75
)
Gain on extinguishment of debt
    (481 )      
Income before income taxes
   
14,633
     
15,094
 
Income tax expense
   
3,767
     
3,797
 
Consolidated net income
   
10,866
     
11,297
 
Net gain (loss) attributable to non-controlling interest
   
35
     
(239
)
Net income attributable to Turning Point Brands, Inc.
 
$
10,831
   
$
11,536
 
                 
Basic income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
0.62
   
$
0.65
 
Diluted income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
0.58
   
$
0.60
 
Weighted average common shares outstanding:
               
Basic
   
17,595,980
     
17,749,294
 
Diluted
   
20,098,450
     
21,102,006
 

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,
 
   
2023
   
2022
 
Net sales
 
$
308,273
   
$
311,621
 
Cost of sales
   
155,556
     
155,646
 
Gross profit
   
152,717
     
155,975
 
Selling, general, and administrative expenses
   
94,093
     
98,779
 
Operating income
   
58,624
     
57,196
 
Interest expense, net
   
12,013
     
15,142
 
Investment loss
   
10,980
     
6,074
 
Gain on extinguishment of debt
   
(1,858
)
   
 
Income before income taxes
   
37,489
     
35,980
 
Income tax expense
   
9,573
     
8,706
 
Consolidated net income
   
27,916
     
27,274
 
Net loss attributable to non-controlling interest
   
(437
)
   
(684
)
Net income attributable to Turning Point Brands, Inc.
 
$
28,353
   
$
27,958
 
                 
Basic income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
1.61
   
$
1.55
 
Diluted income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
1.51
   
$
1.45
 
Weighted average common shares outstanding:
               
Basic
   
17,569,493
     
18,021,554
 
Diluted
   
20,415,786
     
21,401,485
 

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,
 
   
2023
   
2022
 
Consolidated net income
 
$
10,866
   
$
11,297
 
                 
Other comprehensive income (loss), net of tax
               
Unrealized loss on MSA investments, net of tax of $168 in 2023 and $333 in 2022
   
(527
)
   
(1,046
)
Foreign currency translation, net of tax of $0 in 2023 and 2022
   
270
     
(160
)
Unrealized loss on derivative instruments, net of tax of $102 in 2023 and $67 in 2022
   
(320
)
   
(210
)
     
(577
)
   
(1,416
)
Consolidated comprehensive income
   
10,289
     
9,881
 
Comprehensive gain (loss) attributable to non-controlling interest
   
35
     
(295
)
Comprehensive income attributable to Turning Point Brands, Inc.
 
$
10,254
   
$
10,176
 


 
Nine Months Ended
September 30,
 
   
2023
   
2022
 
Consolidated net income
 
$
27,916
   
$
27,274
 
                 
Other comprehensive income (loss), net of tax
               
Unrealized loss on MSA investments, net of tax of $108 in 2023 and $934 in 2022
   
(339
)
   
(2,940
)
Foreign currency translation, net of tax of $0 in 2023 and 2022
   
23
     
(122
)
Unrealized loss on derivative instruments, net of tax of $361 in 2023 and $67 in 2022
   
(1,136
)
   
(210
)
     
(1,452
)
   
(3,272
)
Consolidated comprehensive income
   
26,464
     
24,002
 
Comprehensive loss attributable to non-controlling interest
   
(437
)
   
(727
)
Comprehensive income attributable to Turning Point Brands, Inc.
 
$
26,901
   
$
24,729
 

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,
 
   
2023
   
2022
 
Cash flows from operating activities:
           
Consolidated net income
 
$
27,916
   
$
27,274
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Gain on extinguishment of debt
   
(1,858
)
   
 
Loss (gain) on sale of property, plant, and equipment
   
34
     
(8
)
Depreciation and other amortization expense
   
2,388
     
2,611
 
Amortization of other intangible assets
   
2,315
     
1,373
 
Amortization of deferred financing costs
   
1,795
     
1,936
 
Deferred income tax expense (benefit)
   
694
     
(431
)
Stock compensation expense
   
4,660
     
4,103
 
Noncash lease income
   
(48
)
   
 
Loss on investments
   
11,162
     
6,244
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(2,112
)
   
(5,030
)
Inventories
   
3,036
     
(26,467
)
Other current assets
   
(1,384
)
   
1,891
 
Other assets
   
(5,110
)
   
1,211
 
Accounts payable
   
2,865
     
2,074
 
Accrued liabilities and other
   
(6,348
)
   
(392
)
Net cash provided by operating activities
 
$
40,005
   
$
16,389
 
                 
Cash flows from investing activities:
               
Capital expenditures
 
$
(4,206
)
 
$
(6,662
)
Payments for investments
    (200 )     (1,000
)
Restricted cash, MSA escrow deposits
 

   

(10,169
)
Proceeds on the sale of property, plant and equipment
   
3
     
63
 
Net cash used in investing activities
 
$
(4,403
)
 
$
(17,768
)
                 
Cash flows from financing activities:
               
 Convertible Senior Notes repurchased
  $ (41,794 )   $  
 Proceeds from call options
    114        
Payment of dividends
   
(3,354
)
   
(3,259
)
Exercise of options
   
419
     
504
 
Redemption of options
    (346 )     (155 )
Redemption of performance restricted stock units
    (995 )     (1,228 )
Common stock repurchased
   
     
(27,032
)
Net cash used in financing activities
 
$
(45,956
)
 
$
(31,170
)
                 
Net decrease in cash
 
$
(10,354
)
 
$
(32,549
)
Effect of foreign currency translation on cash
 
$
22
   
$
(324
)
                 
Cash, beginning of period:
               
Unrestricted
  $
106,403
    $
128,320
 
Restricted
   
4,929
     
15,155
 
Total cash at beginning of period
  $
111,332
    $
143,475
 
                 
Cash, end of period:
               
Unrestricted
  $
96,071
    $
105,672
 
Restricted
   
4,929
     
4,930
 
Total cash at end of period
 
$
101,000
   
$
110,602
 
                 
Supplemental schedule of noncash investing activities:
               
Accrued capital expenditures
 
$
66
   
$
57
 
Accrued consideration for acquisition of investments
  $
250     $
 
                 
Supplemental schedule of noncash financing activities:
               
Dividends declared not paid
 
$
1,187
   
$
1,089
 

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, 2023 and 2022
(dollars in thousands except share data)
(unaudited)

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

 
Shares
   
Voting
   
Capital
   
 Stock
   
Income (Loss)
   
Earnings
   
Interest
   
Total
 
Beginning balance July 1, 2023
   
17,595,579
   
$
199
   
$
115,272
   
$
(78,093
)
 
$
(3,181
)
 
$
93,873
   
$
1,176
   
$
129,246
 
                                                                 
Unrealized loss on MSA investments, net of tax of $168
   
     
     
     
     
(527
)
   
     
     
(527
)
Unrealized loss on derivative instruments, net of tax of $102                             (320 )                 (320 )
Foreign currency translation, net of tax of $0
   
     
     
     
     
173
     
     
97
     
270
 
Stock compensation expense
   
     
     
1,824
     
     
     
     
     
1,824
 
Exercise of options
   
843
     
     
13
     
     
     
     
     
13
 
Settlement of call options, net of tax of $11
                34                               34  
Dividends
   
     
     
     
     
     
(1,187
)
   
     
(1,187
)
Net income
   
     
     
     
     
     
10,831
     
35
     
10,866
 
Ending balance September 30, 2023
   
17,596,422
   
$
199
   
$
117,143
   
$
(78,093
)
 
$
(3,855
)
 
$
103,517
   
$
1,308
   
$
140,219
 
                                                                 
                                                                 
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
 
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
 

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, 2023 and 2022
(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, 2023
   
17,485,163
   
$
198
   
$
113,242
   
$
(78,093
)
 
$
(2,393
)
 
$
78,691
   
$
1,735
   
$
113,380
 
                                                                 
Unrealized gain on MSA investments, net of tax of $108
   
                       
(339
)
   
     
     
(339
)
Unrealized loss on derivative instruments, net of tax of $361
                            (1,136 )                 (1,136 )
Foreign currency translation, net of tax of $0
   
     
     
     
     
13
     
     
10
     
23
 
Stock compensation expense
   
     
     
4,660
     
     
     
     
     
4,660
 
Exercise of options
   
30,214
     
     
419
     
     
     
     
     
419
 
Redemption of options
    (15,985 )           (346 )                             (346 )
Performance restricted stock units issuance
   
140,324
      1       77                               78  
Performance restricted stock units redeemed
    (43,294 )           (995 )                             (995 )
Settlement of call options, net of tax of $28
                86                               86  
Dividends
   
     
     
     
     
     
(3,527
)
   
     
(3,527
)
Net income
   
     
     
     
     
     
28,353
     
(437
)
   
27,916
 
Ending balance September 30, 2023
   
17,596,422
   
$
199
   
$
117,143
   
$
(78,093
)
 
$
(3,855
)
 
$
103,517
   
$
1,308
   
$
140,219
 
                                                                 
                                                                 
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 )
Performance restricted stock units issuance
    75,345       1       (1 )                              
Performance restricted stock units redeemed
                (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
 

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. Its segments are led by its core, proprietary brands: Zig-Zag® and CLIPPER® in the Zig-Zag Products segment and Stoker’s® along with Beech-Nut® and Trophy® in the Stoker’s Products segment. The Company’s products are available in more than 217,000 retail outlets in North America. The Company operates in three segments: (i) Zig-Zag Products, (ii) Stoker’s Products, and (iii) Creative Distribution Solutions (formerly known as NewGen).

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, 2022. 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 presented. 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, 2022. 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 to be 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 16, “Segment Information”. An additional disaggregation of contract revenue by sales channel can be found within Note 16 as well.

Shipping Costs

The Company records shipping costs incurred as a component of selling, general, and administrative expenses. Shipping costs incurred were approximately $5.1 million and $5.8 million for the three months ending September 30, 2023 and 2022, respectively. Shipping costs incurred were approximately $17.0 million and $17.9 million for the nine months ending September 30, 2023 and 2022, 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

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 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 100% of its non-inventory purchases (e.g. production equipment) 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 reclassified 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.

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. The U.S. 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 Creative Distribution Solutions products due to malfunctioning devices. 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, 2023, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $27.5 million. At December 31, 2022, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $28.0 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. We expect to begin withdrawal of the funds deposited beginning in 2024 so long as these deposits do not become subject to litigation under the MSA-related statutes.

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, 2023     As of December 31, 2022  
         
Gross
   
Estimated
         
Gross
   
Estimated
 
         
Unrealized
   
Fair
         
Unrealized
   
Fair
 
   
Cost
   
Losses
   
Value
   
Cost
   
Losses
   
Value
 
Cash and cash equivalents
 
$
1,929
   
$
   
$
1,929
   
$
1,929
   
$
   
$
1,929
 
U.S. Governmental agency obligations (unrealized position < 12 months)
   
     
   
     
10,226
     
(1,251
)
   
8,975
 
U.S. Governmental agency obligations (unrealized position > 12 months)
   
30,144
     
(4,539
)
   
25,605
     
19,918
     
(2,842
)
   
17,076
 
   
$
32,073
   
$
(4,539
)
 
$
27,534
   
$
32,073
   
$
(4,093
)
 
$
27,980
 

   
As of
 
   
September 30, 2023
 
Less than one year
 
$
2,200
 
One to five years
   
10,238
 
Five to ten years
   
15,751
 
Greater than ten years
   
1,955
 
Total
 
$
30,144
 

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


 
Deposits as of
 
Sales
Year
 
September 30,
2023
   
December 31,
2022
 
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
 

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 currently 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 was extended to all tobacco products not previously covered, including: (i) certain Creative Distribution Solutions 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, the 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 Premarket Tobacco Application (“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 for certain of our regulated products in order to continue selling these products while they remain under review. We have continued to supplement these applications with additional information and have responded to information requests from the FDA; however, there can be no guarantee that the FDA will accept such amendments and responses or that the applications will meet the standard of “appropriate for the protection of public health” or “substantially equivalent,” as appropriate. 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 the 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 the FDA will not shift its enforcement priorities or that it will increase in ability to enforce against unauthorized products over time.

On October 5, 2021, the FDA finalized two rules related to the Substantial Equivalence process and the Premarket Tobacco Product Application 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. The 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, or 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 increases 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 vape 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. Additionally, FDA has limited resources, which may impact its ability to meaningfully enforce these provisions. This may adversely affect our ability to compete in the marketplace against those who continue to sell unauthorized products; however, regulatory uncertainty in the FDA’s enforcement policies may likewise affect operations or sales of our proprietary products if the FDA’s policies or priorities shift.

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. On June 21, 2022, the 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 where we have had the opportunity to provide comments with regard to the impact such standards would have on our products. These proposed rules remain pending. 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. Derivative Instruments

Foreign Currency

During the nine months ended September 30, 2023, the Company executed various foreign exchange contracts, which met hedge accounting requirements for the purchase of €20.1 million and the sale of 15.2 million.

At September 30, 2023, the Company had foreign currency contracts outstanding for the purchase of €17.1 million and sale of €15.2 million. The foreign currency contracts’ fair value at September 30, 2023, resulted in an asset of $0.1 million included in Other current assets and a liability of $0.5 million included in Accrued liabilities. At December 31, 2022, the Company had foreign currency contracts for the purchase of €18.5 million and sale of €18.5 million. The foreign currency contracts’ fair value at December 31, 2022, resulted in an asset of $1.2 million included in Other current assets and a liability of $0.0 million included in Accrued liabilities.

Note 4. 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 10) bear interest at a rate of 5.625% per year. As of September 30, 2023, the fair value approximated $226.7 million, with a carrying value of $250 million. As of December 31, 2022, the fair value of the Senior Secured Notes approximated $226.4 million, with a carrying value of $250 million.

The Convertible Senior Notes (as defined in Note 10) bear interest at a rate of 2.50% per year, and the fair value of the Convertible Senior Notes without the conversion feature approximated $112.4 million, with a carrying value of $118.5 million as of September 30, 2023. As of December 31, 2022, the fair value of the Convertible Senior Notes without the conversion feature approximated $139.2 million, with a carrying value of $162.5 million.

See Note 10, “Notes Payable and Long-Term Debt”, for further information regarding the Company’s long-term debt.

Note 5. Inventories

The components of inventories are as follows:

    September 30,     December 31,  

 
2023
   
2022
 
Raw materials and work in process
 
$
5,512
   
$
7,283
 
Leaf tobacco
   
53,018
     
43,468
 
Finished goods - Zig-Zag Products
   
40,988
     
42,279
 
Finished goods - Stoker’s Products
   
8,729
     
9,667
 
Finished goods - Creative Distribution Solutions
   
7,059
     
15,431
 
Other
   
1,620
     
1,787
 
Inventories
 
$
116,926
   
$
119,915
 

The inventory valuation allowance was $4.1 million and $4.5 million as of  September 30, 2023, and December 31, 2022, respectively.

Note 6. Other Current Assets

Other current assets consist of:

    September 30,     December 31,  

 
2023
   
2022
 
Inventory deposits
 
$
5,357
   
$
6,395
 
Insurance deposit
   
3,000
     
3,000
 
Prepaid taxes
    1,675
      448
 
Other
   
13,290
     
13,116
 
Total
 
$
23,322
   
$
22,959
 

Note 7. Property, Plant, and Equipment

Property, plant, and equipment consists of:

    September 30,     December 31,  

 
2023
   
2022
 
Land
 
$
22
   
$
22
 
Buildings and improvements
   
3,940
     
3,096
 
Leasehold improvements
   
5,252
     
5,404
 
Machinery and equipment
   
28,837
     
25,832
 
Furniture and fixtures
   
8,138
     
9,264
 
Gross property, plant and equipment
   
46,189
     
43,618
 
Accumulated depreciation
   
(21,576
)
   
(20,830
)
Net property, plant and equipment
 
$
24,613
   
$
22,788
 

Note 8. Other Assets

Other assets consist of:

    September 30,     December 31,  

 
2023
   
2022
 
Equity investments
 
$
2,421
   
$
13,376
 
Debt security investment  
7,765    
7,820
 
Other
   
6,340
     
1,453
 
Total
 
$
16,526
   
$
22,649
 

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 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 from July 2021 to July 2022 was rolled into the convertible 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 convertible note bears an interest rate of 3.0% per year and matures July 31, 2026.Interest and principal not paid to date are receivable 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 Old Pal reaching certain sales thresholds. The weighted average interest rate on the convertible note was 3.0% for the three and nine months ended September 30, 2023. Old Pal has the option to convert the note into shares once sales reach a certain threshold. The conditions required to allow Old Pal to convert the note were not met as of September 30, 2023. Additionally, the Company has the right to convert the note into shares at any time after January 1, 2022. The Company has classified the debt security with Old Pal as available for sale. The Company reports interest income on available for sale debt securities in interest income in our Consolidated Statements of Income. Quarterly, we perform a qualitative assessment to determine if the fair value of the investment could be less than the amortized cost basis.  The fourth quarter 2022 qualitative assessment determined that the fair value of the investment could be less than the amortized cost basis and therefore the Company performed a quantitative assessment of the fair value of the investment.  The fair value as of December 31, 2022 was determined to be $7.9 million based on a Monte Carlo simulation (Level 3).  The Company determined that the impairment was a result of credit related factors and, as such, recorded an allowance for credit losses of $1.4 million which is included in investment loss for the year ended December 31, 2022. In the second quarter of 2023, based on a subsequent quantitative assessment of the fair value using a Monte Carlo simulation, the Company determined the fair value to be $7.7 million and recorded an additional allowance for credit losses of $0.3 million which is included in investment loss for the nine months ended September 30, 2023. The Company has recorded accrued interest receivable of $0.1 million and $0.1 million at September 30, 2023 and December 31, 2022, 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 has obtained exclusive U.S. distribution rights for Docklight’s Marley™ CBD topical products. In the first quarter of 2023, based on Docklight’s financial results and other operating difficulties, and the decline in the revenue multiples for public companies comparable to Docklight, the Company deemed the investment in Docklight was impaired resulting in the fair value of the Company’s investment decreasing to $3.8 million resulting in a loss of $4.9 million which was recorded for the three months ended March 31, 2023. In the second quarter of 2023, based on a significant change in Docklight’s business model, the Company deemed its investment in Docklight fully impaired resulting in an additional loss of $3.8 million bringing the fair value of the Company’s investment in Docklight to zero. Impairment losses for the Company’s investment in Docklight are recorded in Investment loss on our Consolidated Statements of Income.  Fair value for both periods was determined using a valuation derived from relevant revenue multiples (Level 3).

In October 2020, the Company invested $2.5 million to acquire a 20% stake in Wild Hempettes, LLC, a manufacturer of natural CBD cigarettes designed as the first cigarette-styled CBD pre-roll in the world. The Company has options to increase its stake to a 100% ownership position based on certain milestones. As part of the transaction, the Wild Hempettes joint venture was spun off from Crown Distributing LLC and formed as a vehicle for the Company to be the exclusive distributor of Hempettes™ cigarettes to U.S. bricks and mortar retailers under a profit-sharing arrangement. Effective January 2023, the Company terminated its distribution agreement. The Company accounts for its 20% share of Wild Hempettes profit or loss using the equity method of accounting. In the third quarter of 2023, based on Wild Hempettes financial results, the Company deemed its investment in Wild Hempettes to be other-than-temporarily impaired resulting in a $2.2 million impairment charge included in investment loss for the three and nine months ended September 30, 2023. Fair value for its share of investment in Wild Hempettes was determined using a valuation derived from relevant revenue multiples (Level 3).  As a result of the analysis, the Company’s 20% stake represents a fair value of $0.3 million.

In October 2020, the Company invested $15.0 million in dosist (“Dosist”), a global cannabinoid company, with an option to invest an additional $15.0 million on pre-determined terms over the twelve month period ending October 2021. The Company received a warrant exercisable for preferred shares of Dosist that would automatically be exercised upon the changing of certain federal cannabis laws in the United States, rescheduling cannabis and/or permitting the general cultivation, distribution and possession of cannabis. In the fourth quarter 2021, based on the financial results of Dosist and the overall cannabinoid market, the Company deemed its investment was impaired resulting in the fair value decreasing to $7.9 million. In the second quarter of 2022, based on a contemplated sale of the assets of Dosist, the Company deemed its investment was impaired resulting in a further decrease in 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. Subsequent to the second quarter of 2022 impairment, the contemplated sale of assets did not occur and Dosist entered into a new agreement with a new buyer receiving the assets of Dosist for the assumption of its liabilities. As such, the Company considered its $1.6 million remaining investment to be fully impaired as of December 31, 2022.

Note 9. Accrued Liabilities

Accrued liabilities consist of:

    September 30,     December 31,  

 
2023
   
2022
 
Accrued payroll and related items
 
$
6,299
   
$
7,685
 
Customer returns and allowances
   
6,384
     
7,291
 
Taxes payable
   
1,259
     
1,867
 
Lease liabilities
   
2,809
     
3,102
 
Accrued interest
   
2,507
     
7,277
 
Other
   
7,969
     
5,779
 
Total
 
$
27,227
   
$
33,001
 

Note 10. Notes Payable and Long-Term Debt

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

    September 30,     December 31,  

 
2023
   
2022
 
Senior Secured Notes
 
$
250,000
   
$
250,000
 
Convertible Senior Notes
   
118,541
     
162,500
 
Gross notes payable and long-term debt
   
368,541
     
412,500
 
Less deferred finance charges
   
(3,720
)
   
(5,743
)
Less current maturities
    (48,248 )      
Notes payable and long-term debt
 
$
316,573
   
$
406,757
 

Senior Secured Notes

On February 11, 2021, the Company closed a private offering (the “Offering”) of $250.0 million aggregate principal amount of its 5.625% senior secured notes due 2026 (the “Senior Secured Notes” or the “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 on or after February 15, 2023, at the redemption prices (expressed as a percentage of the principal amount to be redeemed) set forth below, plus accrued and unpaid interest, if any, on the Senior Secured Notes to be redeemed to (but not including) the applicable redemption date if redeemed during the period indicated below:

On or after February 15, 2023
   
102.813
%
On or after February 15, 2024
   
101.406
%
On or after February 15, 2025 and thereafter
   
100.000
%

If 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 Senior Secured Notes Indenture contains covenants that, among other things, restrict the ability of the Company and its restricted subsidiaries to: (i) grant or incur liens; (ii) incur, assume or guarantee additional indebtedness; (iii) sell or otherwise dispose of assets, including capital stock of subsidiaries; (iv) make certain investments; (v) pay dividends, make distributions or redeem or repurchase capital stock; (vi) engage in certain transactions with affiliates; and (vii) consolidate or merge with or into, or sell substantially all of our assets to another entity. These covenants are subject to a number of limitations and exceptions set forth in the Senior Secured Notes Indenture. The Senior Secured Notes Indenture provides for customary events of default. The Company was in compliance with all covenants as of September 30, 2023.

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 $25.0 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). On May 10, 2023, the Company and certain of its subsidiaries, as guarantors, entered into an amendment (the “Amendment”) to the 2021 Revolving Credit Facility (as amended, the “Amended Revolving Credit Facility”).  The Amendment includes certain modifications to the 2021 Revolving Credit Facility relating to the replacement of the London Inter-Bank Offered Rate with a Secured Overnight Financing Rate (“SOFR”) as the interest rate benchmark under the 2021 Revolving Credit Facility and adjusts certain other provisions to reflect current documentation standards and other agreed modifications.

Letters of credit are limited to $10.0 million (and are a part of, and not in addition to, the revolving line of credit). The Company has not drawn any borrowings under the Amended Revolving Credit Facility but does have letters of credit of approximately $1.4 million outstanding under the facility as of September 30, 2023. The Amended 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 Amended Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate or the Term SOFR rate, as applicable, 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 Amended Revolving Credit Agreement are guaranteed on a joint and several basis by the Guarantors. The Company’s and Guarantors’ obligations under the Amended Revolving Credit Facility are secured on a pari passu basis with the Senior Secured Notes.

The Amended Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The Amended Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio (as defined in the Amended 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 Amended Revolving Credit Facility and certain drawn and undrawn letters of credit (excluding (a) letters of credit that have been cash collateralized and (b) letters of credit having an aggregate face amount less than $5.0 million) in the aggregate outstanding exceeds 35% of the total commitments under the Amended Revolving Credit Facility. The Amended Revolving Credit Agreement provides for customary events of default. The Company was in compliance with all covenants as of September 30, 2023.

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

On November 7, 2023, in connection with the entry by a subsidiary of the Company in a new asset-backed revolving credit facility, the Company terminated the Amended Revolving Credit Agreement.

2023 ABL Facility

On November 7, 2023, TPB Specialty Finance, LLC, a wholly-owned subsidiary of the Company (the “ABL Borrower”), entered into a new $75.0 million  asset-backed revolving credit facility (the “2023 ABL Facility”), with the several lenders thereunder, and Barclays Bank Plc, as administrative agent (the “Administrative Agent”) and as collateral agent (the “Collateral Agent”) and First-Citizens Bank & Trust Company as additional collateral agent (the “Additional Collateral Agent”). Under the 2023 ABL Facility, the ABL Borrower may draw up to $75.0 million under Revolving Credit Loans and LILO Loans. The 2023 ABL Facility includes a $40.0 million accordion feature.  In connection with the 2023 ABL Facility, Turning Point Brands contributed certain existing inventory to the ABL Borrower. The 2023 ABL Facility is secured on a first priority basis (subject to customary exceptions) by all assets of the ABL Borrower.

The 2023 ABL Facility contains customary borrowing conditions including a borrowing base equal to the sum of (a) the lesser of (1) 85% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) 85% of the cost of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (2) 85% of the net orderly liquidation value (“NOLV”) percentage of the lower of (1)(A) or (1)(B); plus (b) 85% of the face value of all eligible accounts of the ABL Borrower minus (c) the amount of all eligible reserves.  The 2023 ABL Facility also includes a “last in last out” (“LILO”) borrowing base equal to the sum of (a) the lesser of: (1) 10% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) the cost of the sum of eligible inventory, plus eligible in-transit inventory and (2) 10% of the NOLV percentage of the lower of  (1)(A) or (1)(B); plus (b) 10% of the face amount of eligible account; minus (c) the amount of all eligible reserves.

Amounts borrowed under the 2023 ABL Facility are subject to an interest rate margin per annum equal to (a) from and after the closing date until the last day of the first full fiscal quarter ended after the closing date, (i) 1.25% per annum, in the case base rate loans, and (ii) 2.25% per annum, in the case of revolving credit loans that are SOFR Loans, (b)(i) 2.25% per annum, in the case of LILO loans that are base rate loans, and (ii) 3.25% per annum, in the case of LILO loans that are SOFR loans, (c) on the first day of each fiscal quarter, the applicable interest rate margins will be determined from the pricing grid below based upon the historical excess availability for the most recent fiscal quarter ended immediately prior to the relevant date, as calculated by the Administrative Agent.

Level
Historical Excess Availability
Applicable Margin
for SOFR Loans
Applicable Margin
for Base Rate Loans
I
Greater than or equal to 66.66%
1.75%
0.75%
II
Less than 66.66%, but greater than or equal to 33.33%
2.00%
1.00%
III
Less than 33.33%
2.25%
1.25%

The 2023 ABL Facility also requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the end of any four consecutive fiscal quarters on or after the closing date if excess availability shall be less than the greater of (a) 12.5% of the line cap and (b) $9.4 million, at any time and continuing until excess availability is equal to or exceeds the greater of (i) 12.5% of the line and (ii) $9.4 million for thirty (30) consecutive calendar days; provided that such $9.4 million level shall automatically increase in proportion to the amount of any increase in the aggregate revolving credit commitments thereunder in connection with any incremental facility.

The 2023 ABL Facility shall mature on the earlier of (x) November 7, 2027 and (y) the date that is 91 days prior to the maturity date of any material debt of the ABL Borrower or the Company or any of its restricted subsidiaries (subject to customary extensions agreed by the lenders thereunder); provided that clause (y) shall not apply to the extent that on any applicable date of determination (on any date prior to the date set forth in clause (y)), (A) the sum of (x) cash that is held in escrow for the repayment of such material debt pursuant to arrangements satisfactory to the Administrative Agent, (y) cash that is held in accounts with the Administrative Agent and/or the Additional Collateral Agent, plus (z) excess availability, is sufficient to repay such material debt and (B) the ABL Borrower has excess availability of at least $15.0 million after giving effect to such repayment of material debt, including any borrowings under the commitments in connection therewith.

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 are senior unsecured obligations of the Company.

In the fourth quarter of 2022, a wholly owned subsidiary of the Company repurchased $10.0 million in aggregate principal amount of the Convertible Senior Notes on the open market resulting in a $0.9 million gain on extinguishment of debt. Subsequent principal repurchases occurred in the first, second and third quarters of 2023 for $13.9 million, $15.1 million and $15.0 million, respectively, in aggregate principal amounts resulting in gains on extinguishment of debt of $0.7 million, $0.6 million and $0.6 million, respectively. The repurchased notes continue to be held by our subsidiary and may be resold subject to compliance with applicable securities law. As of September 30, 2023, $118.5 million aggregate principal remains outstanding and held by third parties.

The Convertible Senior Notes held by third parties are convertible into approximately 2,216,029 shares of TPB Common Stock under certain circumstances prior to maturity at a conversion rate of 18.6942 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.49 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. The conversion price is adjusted periodically as a result of dividends paid by the Company in excess of pre-determined thresholds of $0.04 per share. Upon conversion, the Company may pay cash, shares of common stock or a combination of cash and stock, as determined by the Company at its discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of September 30, 2023.

The Convertible Senior Notes of $118.5 million as of September 30, 2023, became current in the third quarter of 2023. As discussed above, on November 7, 2023, a wholly-owned subsidiary of the Company entered into the new 2023 ABL Facility to refinance up to $75.0 million of the Convertible Senior notes at maturity. As a result, the Company reclassified $70.0 million related to the Convertible Senior Notes from Current portion of long-term debt to Notes payable and long-term debt on the Company’s September 30, 2023 Balance Sheet. Based on current liquidity, free cash flow generation and availability under the 2023 ABL Facility, the Company believes it will have sufficient liquidity to address the maturity of the remaining Convertible Senior Notes.

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 $53.49 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.

Note 11. Leases

The Company’s leases consist primarily of leased property for manufacturing, warehouse, corporate offices and retail space 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,
 

  2023
    2022
 
Operating lease cost
           
Cost of sales
 
$
125
   
$
240
 
Selling, general and administrative
    496
      348
 
Variable lease cost (1)
    301
      235
 
Short-term lease cost
    7
      6
 
Total
 
$
929
   
$
829
 

(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.

   
Three Months Ended
September 30,
 
   
2023
   
2022
 
Financing lease cost
           
Selling, general and administrative
 
$
397
   
$
332
 
Total
 
$
397
   
$
332
 


 
Nine Months Ended
September 30,
 
   
2023


2022
 
Operating lease cost
           
Cost of sales
 
$
382
   
$
700
 
Selling, general and administrative     1,520
      1,133
 
Variable lease cost (1)     933
      558
 
Short-term lease cost     20
      31
 
Total    $ 2,855
     $ 2,422
 

   
Nine Months Ended
September 30,
 
   
2023
   
2022
 
Financing lease cost
           
Selling, general and administrative
 
$
1,083
   
$
920
 
Total
 
$
1,083


$
920
 

    September 30,     December 31,  
   
2023
   
2022
 
Assets:
           
Right of use assets - Operating
 
$
10,332
   
$
10,967
 
Right of use assets - Financing
 
1,728    
1,498  
Total lease assets
 
$
12,060
   
$
12,465
 
                 
Liabilities:
               
Current lease liabilities - Operating (2)
 
$
1,717
   
$
2,007
 
Current lease liabilities - Financing (2)
 
1,092    
1,095  
Long-term lease liabilities - Operating
 
9,854    
10,243  
Long-term lease liabilities - Financing
    579       350  
Total lease liabilities
 
$
13,242
   
$
13,695
 

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

Note 12. Income Taxes

The Company’s effective income tax rate for the three and nine months ended September 30, 2023 was 25.7% and 25.5%, respectively. 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, 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 13. 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, 2023, net of forfeitures, there were 276,484 Restricted Stock Units (“RSUs”), 118,519 options and 29,172 Performance-Based Restricted Stock Units (“PRSUs”) granted under the 2021 Plan. There are 965,877 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, 2021
   
619,835
   
$
28.51
   
$
8.70
 
                         
Granted
   
114,827
     
30.58
     
10.34
 
Exercised
   
(40,331
)
   
12.49
     
4.08
 
Forfeited
   
(11,117
)
   
32.60
     
9.35
 
Outstanding, December 31, 2022
   
683,214
    $
29.74
    $
9.24
 
                         
Granted
    77,519       20.71       6.45  
Exercised
   
(30,214
)
   
13.87
     
4.37
 
Forfeited
   
(65,214
)
   
27.38
     
9.11
 
Outstanding, September 30, 2023
   
665,305
   
$
29.67
   
$
9.14
 

Under the 2006, 2015 and 2021 Plans, the total intrinsic value of options exercised during the nine months ended September 30, 2023 and 2022, was $0.2 million, and $0.7 million, respectively.

At September 30, 2023, under the 2006 Plan, the exercise price for the 46,824 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 .85 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, 2023, 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, 2023
   
20,000
     
39,983
     
51,567
     
125,834
     
25,000
     
80,975
     
90,253
     
12,000
 
Number exercisable at September 30, 2023
   
20,000
     
39,983
     
51,567
     
125,834
     
25,000
     
80,975
     
63,727
     
8,040
 
Exercise price
 
$
13.00
   
$
15.41
   
$
21.21
   
$
47.58
   
$
20.89
   
$
14.85
   
$
51.75
   
$
47.76
 
Remaining lives
   
3.37
     
3.63
     
4.44
     
5.47
     
6.07
     
6.47
     
7.39
     
7.59
 
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,
    May 12,  
 
 
2021
   
2022
   
2022
    2023  
Number of options granted
   
7,500
      100,000       14,827       77,519  
Options outstanding at September 30, 2023
   
7,500
      73,023       14,827       77,519  
Number exercisable at September 30, 2023
   
5,100
      24,995       5,042       58,139  
Exercise price
 
$
45.05
    $ 30.46     $ 31.39     $ 20.71  
Remaining lives
   
7.63
      8.46       8.59       9.62  
Risk free interest rate
   
0.84
%
    2.10 %     2.92 %     3.41 %
Expected volatility
   
31.50
%
    35.33 %     35.33 %     34.51 %
Expected life
   
6.000
      6.000       6.000       5.186  
Dividend yield
   
0.63
%
    1.01 %     0.98 %     1.61 %
Fair value at grant date
 
$
13.23
    $ 10.23     $ 11.07     $
6.45  

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 $0.2 million and $0.3 million for the three months ended September 30, 2023 and 2022, respectively. The Company recorded compensation expense related to the options of approximately $0.6 million and $0.8 million for the nine months ended September 30, 2023 and 2022, respectively. Total unrecognized compensation expense related to options at September 30, 2023, is $0.3 million, which will be expensed over 0.94 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, 2023, there are 456,922 PRSUs outstanding. The following table outlines the PRSUs granted and outstanding as of September 30, 2023.

   
March 20,
   
March 18,
   
December 28,
   
February 18,
   
March 14,
    May 4,
 
   
2019
   
2020
   
2020
   
2021
   
2022
    2023  
Number of PRSUs granted
   
92,500
     
94,000
     
88,169
     
100,000
      49,996       133,577  
PRSUs outstanding at September 30, 2023
   
77,080
     
84,360
     
31,040
     
87,340
      43,525       133,577  
Fair value as of grant date
 
$
47.58
   
$
14.85
   
$
46.42
   
$
51.75
    $ 30.46     $ 22.25  
Remaining lives
   
0.25
     
1.25
     
0.25
     
2.25
      3.25       2.50  

The Company recorded compensation expense related to the PRSUs of approximately $0.8 million and $0.8 million in the consolidated statements of income for the three months ended September 30, 2023 and 2022, respectively, based on the probability of achieving the performance condition. The Company recorded compensation expense related to the PRSUs of approximately $1.9 million and $2.4 million in the consolidated statements of income for the nine months ended September 30, 2023 and 2022, respectively, based on the probability of achieving the performance condition. Total unrecognized compensation expense related to these awards at September 30, 2023, is $4.4 million which will be expensed over the service periods based on the probability of achieving the performance condition.


The Company has granted 228,640 RSUs which are outstanding and vest over one to five years. The following table outlines the RSUs granted and outstanding as of September 30, 2023.


   
March 14,
   
March 14,
   
April 29,
   
May 5,
     May 5,      May 8,  
   
2022
   
2022
   
2022
   
2023
     2023      2023  
Number of RSUs granted
   
50,004
     
28,726
     
4,522
      130,873    
22,472    
20,101  
RSUs outstanding at September 30, 2023
   
42,947
     
18,961
     
4,522
      130,873       11,236       20,101  
Fair value as of grant date
 
$
30.46
   
$
30.46
   
$
31.39
    $ 22.25  
$
22.25     $
21.77  
Remaining lives
   
3.25
     
1.25
     
3.25
      2.50       0.25       0.60  



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 $0.8 million and $0.4 million for the three months ended September 30, 2023 and 2022. The Company recorded compensation expense related to the RSUs of approximately $2.2 million and $0.9 million for the nine months ended September 30, 2023 and 2022, respectively. Total unrecognized compensation expense related to RSUs at September 30, 2023, is $3.3 million, which will be expensed over 2.44 years.

Note 14. Contingencies

On October 9, 2020, a purported stockholder of Turning Point Brands, Inc. (“TPB” or the “Company”), Paul-Emile Berteau (the “Plaintiff”), filed a complaint in the Delaware Court of Chancery (the “Court”) relating to the merger of Standard Diversified, Inc. (“SDI”) with a TPB subsidiary (“Merger Sub”)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 “Action”). 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 (collectively, the “Defendants”). The third count also 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 Defendants and the Company deny any wrongdoing but following a mediation in November 2022, the Defendants agreed to settle with the Plaintiff to eliminate the distraction, burden, expense, risks and potential delay of further litigation involving the asserted claims. The parties entered into a Stipulation and Agreement of Compromise, Settlement and Release, dated and filed with the Court on June 27, 2023 (together with the exhibits thereto, the “Settlement Stipulation”).  The material terms of the proposed settlement of the Action include, among other things, that the Defendants’ insurers will pay or cause to be paid an aggregate of $5,000,000 into an escrow account (the “Settlement Payment”) in exchange for a release of all claims.  Plaintiff also intends to seek an award of attorneys’ fees and expenses to Plaintiff’s counsel of up to $1,000,000 that will be paid out of the Settlement Payment with the remaining funds paid to the Company, and an additional mootness fee to Plaintiff’s counsel of up to $400,000 in connection with the third count of the complaint. The proposed settlement is subject to, and conditioned on approval by the Court, and no assurances can be given that such Court approval will be obtained. The impact to the Company is not expected to be material. 

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 Creative Distribution Solutions products. The Company is still evaluating these claims and the potential defenses to them and may from time to time settle some such suits in order to eliminate distraction, burden, expense, risks and potential delay of further litigation involving the asserted claims. 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. While we have received some such investigative requests with regard to the marketing of our vapor products, no regulatory bodies have taken action against us with regard to our marketing practices. 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. 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 recently won a dispositive motion in an arbitration brought by a former franchisee. We have one remaining former franchisee arbitration relating to claims of breach of contract and negligence allegations, among others. We believe we have good and valid substantive defenses against these claims and intend on vigorously defending our interests in this matter.

Note 15. 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,
 
   
2023
   
2022
 
                Per                 Per  
   
Income
   
Shares
   
Share
   
Income
   
Shares
   
Share
 
Basic EPS:
                                   
Numerator
                                   
Net income attributable to Turning Point Brands, Inc.
 
$
10,831
               
$
11,536
             
                                         
Denominator
                                       
Weighted average
           
17,595,980
   
$
0.62
             
17,749,294
   
$
0.65
 
                                                 
Diluted EPS:
                                               
Numerator
                                               
Net income attributable to Turning Point Brands, Inc.
 
$
10,831
                   
$
11,536
                 
Interest expense related to Convertible Senior Notes, net of tax
   
743
                     
1,054
                 
Diluted net income attributable to Turning Point Brands. Inc.
 
$
11,574
                   
$
12,590
                 
                                                 
Denominator
                                               
Basic weighted average
           
17,595,980
                     
17,749,294
         
Convertible Senior Notes
           
2,311,086
                     
3,213,589
         
Stock options and restricted stock units
           
191,384
                     
139,123
         
             
20,098,450
   
$
0.58
             
21,102,006
   
$
0.60
 


 
Nine Months Ended September 30,
 
   
2023
   
2022
 
                Per
                Per  
   
Income
   
Shares
   
Share
   
Income
   
Shares
   
Share
 
Basic EPS:
                                   
Numerator
                                   
Net income attributable to Turning Point Brands, Inc.
 
$
28,353
               
$
27,958
             
                                         
Denominator
                                       
Weighted average
           
17,569,493
   
$
1.61
             
18,021,554
   
$
1.55
 
                                                 
Diluted EPS:
                                               
Numerator
                                               
Net income attributable to Turning Point Brands, Inc.
 
$
28,353
                   
$
27,958
                 
Interest expense related to Convertible Senior Notes
   
2,546
                     
3,162
                 
Diluted net income attributable to Turning Point Brands. Inc.
 
$
30,899
                   
$
31,120
                 
                                                 
Denominator
                                               
Basic weighted average
           
17,569,493
                     
18,021,554
         
Convertible Senior Notes
           
2,637,252
                     
3,213,589
         
Stock options and restricted stock units
           
209,041
                     
166,342
         
             
20,415,786
   
$
1.51
             
21,401,485
   
$
1.45
 

Note 16. 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) Creative Distribution Solutions. The Zig-Zag Products segment markets and distributes (a) rolling papers, tubes, and related products; and (b) finished cigars and MYO cigar wraps and (c) CLIPPER reusable lighters and other accessories. The Stoker’s Products segment (a) manufactures and markets moist snuff and (b) contracts for and markets loose leaf chewing tobacco products. The Creative Distribution Solutions 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 U.S. and Canada while products in the Creative Distribution Solutions segment are distributed primarily through e-commerce to non-traditional retail outlets and direct to consumers in the U.S. 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.

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,
 
   
2023
   
2022
 
             
Net sales
           
Zig-Zag products
 
$
46,754
   
$
52,061
 
Stoker’s products
   
36,916
     
33,525
 
Total Zig-Zag and Stoker’s products
  $ 83,670     $ 85,586  
Creative Distribution Solutions
   
18,052
     
22,216
 
Total
 
$
101,722
   
$
107,802
 
                 
Gross profit
               
Zig-Zag products
 
$
26,745
   
$
28,035
 
Stoker’s products
   
20,572
     
18,279
 
Total Zig-Zag and Stoker’s products
  $ 47,317     $ 46,314  
Creative Distribution Solutions
   
4,305
     
6,398
 
Total
 
$
51,622
   
$
52,712
 
                 
Operating income (loss)
               
Zig-Zag products
 
$
16,672
   
$
18,740
 
Stoker’s products
   
15,703
     
13,653
 
 Corporate unallocated (1)(2)
    (11,678 )     (12,714 )
Total Zig-Zag and Stoker’s products
 
$
20,697
   
$
19,679
 
Creative Distribution Solutions
    (460 )     142  
Total
 
$
20,237
   
$
19,821
 
                 
Interest expense, net
   
3,984
     
4,802
 
Investment loss
    2,101       (75 )
Gain on extinguishment of debt     (481 )      
                 
Income before income taxes
 
$
14,633
   
$
15,094
 
                 
Capital expenditures
               
Zig-Zag products
 
$
3
   
$
29
 
Stoker’s products
   
1,211
     
940
 
Total Zig-Zag and Stoker’s products
  $ 1,214     $ 969  
Creative Distribution Solutions
   
     
 
Total
 
$
1,214
   
$
969
 
                 
Depreciation and amortization
               
Zig-Zag products
 
$
269
   
$
124
 
Stoker’s products
   
795
     
738
 
Total Zig-Zag and Stoker’s products
  $ 1,064     $ 862  
Creative Distribution Solutions
   
562
     
453
 
Total
 
$
1,626
   
$
1,315
 



(1)
Includes corporate costs that are not allocated to any of the three reportable segments.
(2)
Includes costs related to PMTA of $0.3 million in 2023 and $1.2 million in 2022.


 
Nine Months Ended
September 30,
 
   
2023
   
2022
 
             
Net sales
           
Zig-Zag products
 
$
135,363
   
$
143,959
 
Stoker’s products
   
106,634
     
98,816
 
Total Zig-Zag and Stoker’s products
  $
241,997     $
242,775  
Creative Distribution Solutions
   
66,276
     
68,846
 
Total
 
$
308,273
   
$
311,621
 
                 
Gross profit
               
Zig-Zag products
 
$
75,557
   
$
80,808
 
Stoker’s products
   
60,005
     
54,044
 
Total Zig-Zag and Stoker’s products
  $
135,562     $
134,852  
Creative Distribution Solutions
   
17,155
     
21,123
 
Total
 
$
152,717
   
$
155,975
 
                 
Operating income (loss)
               
Zig-Zag products
 
$
47,313
   
$
55,980
 
Stoker’s products
   
45,375
     
40,536
 
Corporate unallocated (1)(2)
   
(34,325
)
   
(40,692
)
Total Zig-Zag and Stoker’s products
  $
58,363     $
55,824  
Creative Distribution Solutions
    261       1,372  
Total
 
$
58,624
   
$
57,196
 
                 
Interest expense, net
   
12,013
     
15,142
 
Investment loss
   
10,980
     
6,074
 
Gain on extinguishment of debt
   
(1,858
)
   
 
                 
Income before income taxes
 
$
37,489
   
$
35,980
 
                 
Capital expenditures
               
Zig-Zag products
 
$
1,088
   
$
4,588
 
Stoker’s products
   
3,118
     
2,074
 
Total Zig-Zag and Stoker’s products
  $
4,206
    $
6,662
 
Creative Distribution Solutions
           
Total
 
$
4,206
   
$
6,662
 
                 
Depreciation and amortization
               
Zig-Zag products
 
$
803
   
$
309
 
Stoker’s products
   
2,210
     
2,275
 
Total Zig-Zag and Stoker’s products
  $
3,013     $
2,584  
Creative Distribution Solutions
   
1,690
     
1,400
 
Total
 
$
4,703
   
$
3,984
 



(1)
Includes corporate costs that are not allocated to any of the three reportable segments.
(2)
Includes costs related to PMTA of $1.1 million in 2023 and $4.3 million in 2022.

    September 30,     December 31,  
   
2023
   
2022
 
Assets
           
Zig-Zag products
 
$
176,975
   
$
225,893
 
Stoker’s products
   
175,566
     
151,241
 
Corporate unallocated (1)
   
172,294
     
155,348
 
 Total Zig-Zag and Stoker’s products   $
524,835     $
532,482  
 Creative Distribution Solutions
    29,108       39,624  
Total
 
$
553,943
   
$
572,106
 



(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 Creative Distribution Solutions sales are made business to business and business to consumer, both online and through our corporate retail stores. Creative Distribution Solutions net sales are broken out by sales channel below.


 
Creative Distribution
Solutions Segment
 
    Three Months Ended  
   
September 30,
 
   
2023
   
2022
 
Business to Business
 
$
16,089
   
$
18,226
 
Business to Consumer - Online
   
1,912
     
3,884
 
Other
   
51
     
106
 
Total
 
$
18,052
   
$
22,216
 


 
Creative Distribution
Solutions Segment
 
    Nine Months Ended  
   
September 30,
 
   
2023
   
2022
 
Business to Business
 
$
58,620
   
$
55,024
 
Business to Consumer - Online
   
7,247
     
13,453
 
Other
   
409
     
369
 
Total
 
$
66,276
   
$
68,846
 

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,
 
   
2023
   
2022
 
Domestic
 
$
93,533
   
$
98,173
 
Foreign
   
8,189
     
9,629
 
Total
 
$
101,722
   
$
107,802
 

    Nine Months Ended  

 
September 30,
 
   
2023
   
2022
 
Domestic
 
$
285,514
   
$
287,381
 
Foreign
   
22,759
     
24,240
 
Total
 
$
308,273
   
$
311,621
 

Note 17. Additional Information with Respect to Unrestricted Subsidiary

Under the terms of the Senior Secured Notes Indenture and Senior Secured Notes, the Company has designated its subsidiaries, South Beach Brands LLC, TPB Beast LLC and Intrepid Brands, LLC as “Unrestricted Subsidiaries”. South Beach Brands LLC is a holding company under which our vape business TPB Beast LLC operating as Creative Distribution Solutions sits. The Company is required under the terms of the Senior Secured Notes Indenture and the Senior Secured Notes to present additional information that reflects the financial condition and results of operations of the Company and its Restricted Subsidiaries separate from the financial condition and results of operations of the Company’s Unrestricted Subsidiaries as of and for the periods presented. This additional information is below.

Income Statement for the Three Months Ended September 30, 2023 and 2022 (unaudited):

    Three Months Ended September 30  
    2023
    2022  
   
Company and
Restricted
Subsidiaries
   
Unrestricted
Subsidiaries
   
Consolidated
   
Company and
Restricted
Subsidiaries
   
Unrestricted
Subsidiaries
    Consolidated  
Net sales
 
$
83,670
   
$
18,052
   
$
101,722
    $ 85,586     $ 22,216     $ 107,802  
Cost of sales
   
36,353
     
13,747
     
50,100
      39,272       15,818       55,090  
Gross profit
   
47,317
     
4,305
     
51,622
      46,314       6,398       52,712  
Selling, general, and administrative expenses
   
26,620
     
4,765
     
31,385
      26,635       6,256       32,891  
Operating income
   
20,697
     
(460
)
   
20,237
      19,679       142       19,821  
Interest expense, net
   
3,984
     
     
3,984
      4,802             4,802  
Investment loss
   
2,101
     
     
2,101
      (75 )           (75 )
Gain on extinguishment of debt
   
(481
)
   
     
(481
)
                 
Income before income taxes
   
15,093
     
(460
)
   
14,633
      14,952       142       15,094  
Income tax expense
   
3,885
     
(118
)
   
3,767
      3,761       36       3,797  
Consolidated net income
   
11,208
     
(342
)
   
10,866
      11,191       106       11,297  
Net loss attributable to non-controlling interest
   
35
     
     
35
      (239 )           (239 )
Net income attributable to Turning Point Brands, Inc.
 
$
11,173
   
$
(342
)
 
$
10,831
    $ 11,430     $ 106     $ 11,536  

Income Statement for the Nine Months Ended September 30, 2023 and 2022 (unaudited):

   
Nine Months Ended September 30
 
    2023     2022  
   
Company and
Restricted
Subsidiaries
   
Unrestricted Subsidiaries
   
Consolidated
   
Company and
Restricted
Subsidiaries
   
Unrestricted Subsidiaries
   
Consolidated
 
Net sales
 
$
241,997
   
$
66,276
   
$
308,273
   
$
242,775
   
$
68,846
   
$
311,621
 
Cost of sales
   
106,435
     
49,121
     
155,556
     
107,923
     
47,723
     
155,646
 
Gross profit
   
135,562
     
17,155
     
152,717
     
134,852
     
21,123
     
155,975
 
Selling, general, and administrative expenses
   
77,199
     
16,894
     
94,093
     
79,028
     
19,751
     
98,779
 
Operating income
   
58,363
     
261
     
58,624
     
55,824
     
1,372
     
57,196
 
Interest expense, net
   
12,013
     
     
12,013
     
15,142
     
     
15,142
 
Investment loss
   
10,980
     
     
10,980
     
6,074
     
     
6,074
 
Gain on extinguishment of debt
   
(1,858
)
   
     
(1,858
)
   
     
     
 
Income before income taxes
   
37,228
     
261
     
37,489
     
34,608
     
1,372
     
35,980
 
Income tax expense
   
9,506
     
67
     
9,573
     
8,374
     
332
     
8,706
 
Consolidated net income
   
27,722
     
194
     
27,916
     
26,234
     
1,040
     
27,274
 
Net loss attributable to non-controlling interest
   
(437
)
   
     
(437
)
   
(684
)
   
     
(684
)
Net income attributable to Turning Point Brands, Inc.
 
$
28,159
   
$
194
   
$
28,353
   
$
26,918
   
$
1,040
   
$
27,958
 

Balance Sheet as of September 30, 2023 (unaudited):

ASSETS
 
Company and
Restricted
Subsidiaries
   
Unrestricted
Subsidiaries
   
Eliminations
   
Consolidated
 
Current assets:
                       
Cash
 
$
92,353
   
$
3,718
    $
   
$
96,071
 
Accounts receivable, net
   
10,363
     
130
           
10,493
 
Inventories
   
109,867
     
7,059
           
116,926
 
Other current assets
   
20,417
     
2,905
           
23,322
 
Total current assets
   
233,000
     
13,812
           
246,812
 
Property, plant, and equipment, net
   
24,382
     
231
           
24,613
 
Deferred income taxes
   
8,190
     
           
8,190
 
Right of use assets
   
11,922
     
138
           
12,060
 
Deferred financing costs, net
   
203
     
           
203
 
Goodwill
   
136,280
     
           
136,280
 
Other intangible assets, net
   
66,798
     
14,927
           
81,725
 
Master Settlement Agreement (MSA) escrow deposits
   
27,534
     
           
27,534
 
Other assets
   
16,526
     
           
16,526
 
Investment in unrestricted subsidiaries
    49,047
            (49,047 )      
Total assets
 
$
573,882
   
$
29,108
    $
(49,047 )  
$
553,943
 
                                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                               
Current liabilities:
                               
Accounts payable
  $ 10,305     $ 932     $
    $ 11,237  
Accrued liabilities
   
25,243
     
1,984
           
27,227
 
Current portion of long-term debt
    48,248                   48,248  
Other current liabilities
   
6
     
           
6
 
Total current liabilities
   
83,802
     
2,916
           
86,718
 
Notes payable and long-term debt
   
316,573
     
           
316,573
 
Lease liabilities
   
10,363
     
70
           
10,433
 
Total liabilities
   
410,738
     
2,986
           
413,724
 
                                 
Commitments and contingencies
                       
                                 
Stockholders’ equity:
                               
Total Turning Point Brands Inc. Stockholders’ Equity/Net parent investment in unrestricted subsidiaries
   
161,836
     
26,122
      (49,047 )    
138,911
 
Non-controlling interest
   
1,308
     
           
1,308
 
Total stockholders’ equity
   
163,144
     
26,122
      (49,047 )    
140,219
 
Total liabilities and stockholders’ equity
 
$
573,882
   
$
29,108
    $
(49,047 )  
$
553,943
 

Balance Sheet as of December 31, 2022:

ASSETS
 
Company and
Restricted
Subsidiaries
   
Unrestricted
Subsidiaries
   
Eliminations
   
Consolidated
 
Current assets:
                       
Cash
 
$
103,990
   
$
2,413
    $
   
$
106,403
 
Accounts receivable, net
   
7,374
     
1,003
           
8,377
 
Inventories
   
104,883
     
15,032
           
119,915
 
Other current assets
   
18,828
     
4,131
           
22,959
 
Total current assets
   
235,075
     
22,579
           
257,654
 
Property, plant, and equipment, net
   
22,261
     
527
           
22,788
 
Deferred income taxes
   
8,443
     
           
8,443
 
Right of use assets
   
12,328
     
137
           
12,465
 
Deferred financing costs, net
   
282
     
           
282
 
Goodwill
   
136,253
     
           
136,253
 
Other intangible assets, net
   
67,241
     
16,351
           
83,592
 
Master Settlement Agreement (MSA) escrow deposits
   
27,980
     
           
27,980
 
Other assets
   
22,619
     
30
           
22,649
 
Investment in unrestricted subsidiaries
    60,120             (60,120 )      
Total assets
 
$
592,602
   
$
39,624
  $
(60,120 )  
$
572,106
 
                                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                               
Current liabilities:
                               
Accounts payable
 
$
7,628
   
$
727
    $
   
$
8,355
 
Accrued liabilities
   
31,118
     
1,883
           
33,001
 
Other current liabilities
   
20
     
           
20
 
Total current liabilities
   
38,766
     
2,610
           
41,376
 
Notes payable and long-term debt
   
406,757
     
           
406,757
 
Lease liabilities
   
10,593
     
           
10,593
 
Total liabilities
   
456,116
     
2,610
           
458,726
 
                                 
Commitments and contingencies
                       
                                 
Stockholders’ equity:
                               
Total Turning Point Brands Inc. Stockholders’ Equity/Net parent investment in unrestricted subsidiaries
   
134,751
     
37,014
    (60,120 )    
111,645
 
Non-controlling interest
   
1,735
     
           
1,735
 
Total stockholders’ equity
   
136,486
     
37,014
    (60,120 )    
113,380
 
Total liabilities and stockholders’ equity
 
$
592,602
   
$
39,624
  $
(60,120 )  
$
572,106
 

Note 18. Dividends and Share Repurchases

A dividend of $0.065 per common share was paid on October 6, 2023, to shareholders of record at the close of business on September 15, 2023.

The Company currently pays a quarterly cash dividend. 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. The program is subject to the ongoing discretion of the Board of Directors. On October 25, 2021, the Board of Directors increased the approved share repurchase program by $30.7 million and by an additional $24.6 million on February 24, 2022, in each case bringing the aggregate approval back to $50.0 million. $27.2 million remains available for share repurchases under the program at September 30, 2023.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion of the historical financial conditions and results of operations in conjunction with our consolidated financial statements and accompanying notes, which are included elsewhere in this Quarterly Report on Form 10-Q. In addition, this discussion includes forward-looking statements which are subject to risks and uncertainties that may result in actual results differing from statements we make. See “Cautionary Note Regarding Forward-Looking Statements.” Factors that could cause actual results to differ include those risks and uncertainties discussed in “Risk Factors.”

The following Management’s Discussion and Analysis (“MD&A”) relates to the unaudited financial statements of Turning Point Brands, Inc., included elsewhere in this Quarterly Report on Form 10-Q. The MD&A is intended to enable the reader to understand the Company’s financial condition and results of operations, including any material changes in the Company’s financial condition and results of operations since December 31, 2022, and as compared with the three and nine months ended September 30, 2022.  The MD&A is provided as a supplement to and should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in this Quarterly report on Form 10-Q, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

In this MD&A, unless the context requires otherwise, references to “our Company” “we,” “our,” or “us” refer to Turning Point Brands, Inc., and its consolidated subsidiaries. References to “TPB” refer to Turning Point Brands, Inc., without any of its subsidiaries. We were incorporated in 2004 under the name North Atlantic Holding Company, Inc. On November 4, 2015, we changed our name to Turning Point Brands, Inc. Many of the amounts and percentages in this discussion have been rounded for convenience of presentation.

Overview

Turning Point Brands, Inc. is a leading manufacturer, marketer and distributor of branded consumer products. We sell a wide range of products to adult consumers consisting of staple products with our iconic brands Zig-Zag® and Stoker’s® and our next generation products to fulfill evolving consumer preferences. Among other markets, we compete in the alternative smoking accessories and Other Tobacco Products (“OTP”) industries. The alternative smoking accessories market is a dynamic market experiencing robust secular growth driven by cannabinoid legalization in the U.S. and Canada, and positively evolving consumer perception and acceptance in North America. The OTP industry, which consists of non-cigarette tobacco products, exhibited mid-single-digit consumer unit annualized growth over the three-year period ended 2022 as reported by Management Science Associates, Inc., a third-party analytics and information company. Our segments are led by our core, proprietary brands: Zig-Zag® and CLIPPER® in the Zig-Zag Products segment and Stoker’s® along with Beech-Nut® and Trophy® in the Stoker’s Products segment. Our businesses generate solid cash flows which we use to invest in our business, finance acquisitions, increase brand support, expand our distribution infrastructure, and strengthen our capital position. We currently ship to approximately 800 distributors with an additional 200 secondary, indirect wholesalers in the U.S. that carry and sell our products. Under the leadership of a senior management team with extensive experience in the consumer products, alternative smoking accessories and tobacco industries, we have grown and diversified our business through new product launches, category expansions, and acquisitions while concurrently improving operational efficiency.

We believe there are meaningful opportunities to grow through acquisitions and joint ventures across all product categories. Our products are currently available in approximately 197,000 U.S. retail locations which, with the addition of retail stores in Canada, brings our total North American retail presence to an estimated 217,000 points of distribution. Our sales team targets widespread distribution to all traditional retail channels, including convenience stores. We also have a growing e-commerce business.

In the fourth quarter of 2022, we contributed our NewGen Products business to South Beach Holdings LLC doing business as Creative Distribution Solutions (“CDS”), a newly-formed wholly-owned subsidiary. CDS is separately operated and reports to its own Board of Directors. During the first quarter of 2023, the business was designated an unrestricted subsidiary under the Senior Secured Notes (the “Notes”) and concurrently we renamed what we previously referred to as our NewGen Products segment as our Creative Distribution Solutions segment as we believe this name better aligns with the goals and strategies of the segment.

Products

We operate in three segments: Zig-Zag Products, Stoker’s Products and Creative Distribution Solutions. In our Zig-Zag Products segment, we principally market and distribute (i) rolling papers, tubes, and related products; and (ii) finished cigars and make-your-own (“MYO”) cigar wraps and (iii) lighters and other accessories.  In addition, we have a majority stake in Turning Point Brands Canada which markets and distributes cannabis accessories and tobacco products throughout Canada. In our Stoker’s Products segment, we (i) manufacture and market moist snuff tobacco (“MST”) and (ii) contract for and market loose leaf chewing tobacco products. In our Creative Distribution Solutions segment, we (i) market and distribute liquid vapor products and certain other products without tobacco and/or nicotine; (ii) distribute a wide assortment of products to non-traditional retail via VaporBeast; and (iii) market and distribute a wide assortment of products to individual consumers via the VaporFi B2C online platform.

Operations

Our core Zig-Zag Products and Stoker’s Products segments primarily generate revenues from the sale of our products to wholesale distributors who, in turn, resell the products to retail operations. Our net sales, which include federal excise taxes, consist of gross sales net of cash discounts, returns, and selling and marketing allowances.

We rely on long-standing relationships with high-quality, established manufacturers to provide the majority of our produced products. More than 75% of our production, as measured by net sales, is outsourced to suppliers. The remaining production consists primarily of our moist snuff tobacco operations located in Dresden, Tennessee, and Louisville, Kentucky. Our principal operating expenses include the cost of raw materials used to manufacture the limited number of our products which we produce in-house; the cost of finished products, which are generally purchased goods; federal excise taxes; legal expenses; and compensation expenses, including benefits and costs of salaried personnel. Our other principal expenses include interest expense and other expenses.

Key Factors Affecting Our Results of Operations

We consider the following to be the key factors affecting our results of operations:


Our ability to further penetrate markets with our existing products;

Our ability to introduce new products and product lines that complement our core business;

Decreasing interest in some tobacco products among consumers;

Price sensitivity in our end-markets;

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

Cost and increasing regulation of promotional and advertising activities;

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

Labor and production costs;

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

Increasing and unpredictable regulation and/or marketing order decisions impacting Creative Distribution Solutions products;

Counterfeit and other illegal products in our end-markets;

Currency fluctuations;

Our ability to identify attractive acquisition opportunities; and

Our ability to successfully integrate acquisitions.

Critical Accounting Policies and Uses of Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2022 Annual Report on Form 10-K.

Recent Accounting Pronouncements

There are no recent accounting pronouncements that impact the Company.

Recent Developments

On November 7, 2023, a wholly-owned subsidiary of the Company (the “ABL Borrower”) entered into a new $75.0 million asset-backed revolving credit facility (the “2023 ABL Facility”). The Company intends to use borrowings distributed to it by ABL Borrower  under the 2023 ABL Facility to refinance a portion of the Convertible Senior Notes at maturity.  In connection with entry into the 2023 ABL Facility, the Company terminated the Amended Revolving Credit Agreement originally entered into in 2021.  See Part II Other Information --Item 5. Other Information.

Results of Operations

Comparison of the Three Months Ended September 30, 2023, to the Three Months Ended September 30, 2022

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

   
Three Months Ended September 30,
 
   
2023
   
2022
   
% Change
 
Consolidated Results of Operations Data:
                 
Net sales
                 
Zig-Zag products
 
$
46,754
   
$
52,061
     
-10.2
%
Stoker’s products
   
36,916
     
33,525
     
10.1
%
Total Zig-Zag and Stoker’s products
   
83,670
     
85,586
     
-2.2
%
Creative Distribution Solutions
   
18,052
     
22,216
     
-18.7
%
Total net sales
   
101,722
     
107,802
     
-5.6
%
Cost of sales
   
50,100
     
55,090
     
-9.1
%
Gross profit
                       
Zig-Zag products
   
26,745
     
28,035
     
-4.6
%
Stoker’s products
   
20,572
     
18,279
     
12.5
%
Total Zig-Zag and Stoker’s products
   
47,317
     
46,314
     
2.2
%
Creative Distribution Solutions
   
4,305
     
6,398
     
-32.7
%
Total gross profit
   
51,622
     
52,712
     
-2.1
%
                         
Selling, general, and administrative expenses
   
31,385
     
32,891
     
-4.6
%
Operating income
   
20,237
     
19,821
     
2.1
%
Interest expense, net
   
3,984
     
4,802
     
-17.0
%
Investment loss (gain)
   
2,101
     
(75
)
   
-2,901.3
%
Gain on extinguishment of debt
   
(481
)
   
   
NM
 
Income before income taxes
   
14,633
     
15,094
     
-3.1
%
Income tax expense
   
3,767
     
3,797
     
-0.8
%
Consolidated net income
   
10,866
     
11,297
     
-3.8
%
Net gain (loss) attributable to non-controlling interest
   
35
     
(239
)
   
-114.6
%
Net income attributable to Turning Point Brands, Inc.
 
$
10,831
   
$
11,536
     
-6.1
%

Net Sales:  For the three months ended September 30, 2023, consolidated net sales decreased to $101.7 million from $107.8 million for the three months ended September 30, 2022, a decrease of $6.1 million or 5.6%.

For the three months ended September 30, 2023, net sales in the Zig-Zag Products segment decreased to $46.8 million from $52.1 million for the three months ended September 30, 2022, a decrease of $5.3 million or 10.2%. The decrease in net sales was driven by the benefits in the third quarter of 2022 from the initial load-in of CLIPPER lighters and approximately $5 million of sales that were pulled forward from the fourth quarter of last year due to the timing of promotional activities and Canadian deliveries. Additionally, a discontinuation of an unprofitable product line impacted Canadian sales by $1.8 million.

For the three months ended September 30, 2023, net sales in the Stoker’s Products segment increased to $36.9 million from $33.5 million for the three months ended September 30, 2022, an increase of $3.4 million or 10.1%. For the three months ended September 30, 2023, volume increased 2.2% and price/product mix increased 7.9%. The increase in net sales was driven by double-digit growth of Stoker’s® MST and single-digit growth in loose-leaf chewing tobacco.

For the three months ended September 30, 2023, net sales in the Creative Distribution Solutions segment decreased to $18.1 million from $22.2 million for the three months ended September 30, 2022, a decrease of $4.1 million or 18.7%. The decrease in net sales was primarily the result of lower volumes in the vape distribution businesses.

Gross Profit:  For the three months ended September 30, 2023, consolidated gross profit decreased to $51.6 million from $52.7 million for the three months ended September 30, 2022, a decrease of $1.1 million or 2.1%. Gross profit as a percentage of net sales increased to 50.7% for the three months ended September 30, 2023, compared to 48.9% for the three months ended September 30, 2022 driven by decreased margin in Creative Distribution Solutions partially offset by increased margins in the Stoker’s Products and Zig-Zag Products segments.

For the three months ended September 30, 2023, gross profit in the Zig-Zag Products segment decreased to $26.7 million from $28.0 million for the three months ended September 30, 2022, a decrease of $1.3 million or 4.6% . Gross profit as a percentage of net sales increased to 57.2% of net sales for the three months ended September 30, 2023, from 53.9% of net sales for the three months ended September 30, 2022, driven primarily by product mix.

For the three months ended September 30, 2023, gross profit in the Stoker’s Products segment increased to $20.6 million from $18.3 million for the three months ended September 30, 2022, an increase of $2.3 million or 12.5%. Gross profit as a percentage of net sales increased to 55.7% of net sales for the three months ended September 30, 2023, from 54.5% of net sales for the three months ended September 30, 2022, primarily as a result of strong market share gains in MST and loose-leaf chewing tobacco and pricing gains in MST.

For the three months ended September 30, 2023, gross profit in the Creative Distribution Solutions segment decreased to $4.3 million from $6.4 million for the three months ended September 30, 2022, a decrease of $2.1 million or 32.7%. Gross profit as a percentage of net sales decreased to 23.8% of net sales for the three months ended September 30, 2023, from 28.8% of net sales for the three months ended September 30, 2022, primarily as a result of channel mix.

Selling, General, and Administrative Expenses:  For the three months ended September 30, 2023, selling, general, and administrative expenses decreased to $31.4 million from $32.9 million for the three months ended September 30, 2022, a decrease of $1.5 million or 4.6%. Selling, general and administrative expenses in the three months ended September 30, 2023, included $1.8 million of stock options, restricted stock and incentives expense, $0.3 million of expense related to PMTA, $0.2 million of expense related to corporate restructuring, $0.1 million of transaction costs and $0.1 million of expense related to the new ERP and CRM systems. Selling, general and administrative expenses in the three months ended September 30, 2022, included $1.4 million of stock option, restricted stock and incentives expense, $1.2 million of expense related to PMTA and $0.4 million of consulting expense related to the scoping and mobilization of the new ERP and CRM systems.

Interest Expense, net:  For the three months ended September 30, 2023, interest expense, net decreased to $4.0 million from $4.8 million for the three months ended September 30, 2022 as a result of the repurchase of $54.0 million total of Convertible Senior Notes as of September 30, 2023, and increased interest income on cash as a result of rising interest rates.

Investment Loss (Gain):  For the three months ended September 30, 2023, investment loss increased to $2.1 million compared to a $0.1 million gain for the three months ended September 30, 2022. The change is a result of an impairment charge recognized on our investment in Wild Hemp for $2.2 million in the third quarter of 2023.

Gain on Extinguishment of Debt: There was a gain on extinguishment of debt of $0.5 million for the three months ended September 30, 2023 as a result of repurchasing $15.0 million of Convertible Senior Notes compared to no gain on extinguishment of debt for the three months ended September 30, 2022.

Income Tax Expense:  Our income tax expense of $3.8 million was 25.7% of income before income taxes for the three months ended September 30, 2023. Our effective income tax rate was 25.2% for the three months ended September 30, 2022.

Net Gain (Loss) Attributable to Non-Controlling Interest:  Net gain attributable to non-controlling interest was $0.0 million for the three months ended September 30, 2023 compared to $0.2 million net loss for the three months ended September 30, 2022.

Net Income Attributable to Turning Point Brands, Inc.:  Due to the factors described above, net income attributable to Turning Point Brands, Inc. for the three months ended September 30, 2023 and 2022, was $10.8 million and $11.5 million, respectively.

Comparison of the Nine Months Ended September 30, 2023, to the Six Months Ended September 30, 2022

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

   
Nine Months Ended September 30,
 
   
2023
   
2022
   
% Change
 
Consolidated Results of Operations Data:
                 
Net sales
                 
Zig-Zag products
 
$
135,363
   
$
143,959
     
-6.0
%
Stoker’s products
   
106,634
     
98,816
     
7.9
%
Total Zig-Zag and Stoker’s products
   
241,997
     
242,775
     
-0.3
%
Creative Distribution Solutions
   
66,276
     
68,846
     
-3.7
%
Total net sales
   
308,273
     
311,621
     
-1.1
%
Cost of sales
   
155,556
     
155,646
     
-0.1
%
Gross profit
                       
Zig-Zag products
   
75,557
     
80,808
     
-6.5
%
Stoker’s products
   
60,005
     
54,044
     
11.0
%
Total Zig-Zag and Stoker’s products
   
135,562
     
134,852
     
0.5
%
Creative Distribution Solutions
   
17,155
     
21,123
     
-18.8
%
Total gross profit
   
152,717
     
155,975
     
-2.1
%
                         
Selling, general, and administrative expenses
   
94,093
     
98,779
     
-4.7
%
Operating income
   
58,624
     
57,196
     
2.5
%
Interest expense, net
   
12,013
     
15,142
     
-20.7
%
Investment loss
   
10,980
     
6,074
     
80.8
%
Gain on extinguishment of debt
   
(1,858
)
   
   
NM
 
Income before income taxes
   
37,489
     
35,980
     
4.2
%
Income tax expense
   
9,573
     
8,706
     
10.0
%
Consolidated net income
   
27,916
     
27,274
     
2.4
%
Net loss attributable to non-controlling interest
   
(437
)
   
(684
)
   
-36.1
%
Net income attributable to Turning Point Brands, Inc.
 
$
28,353
   
$
27,958
     
1.4
%

Net Sales:  For the nine months ended September 30, 2023, consolidated net sales decreased to $308.3 million from $311.6 million for the nine months ended September 30, 2022, a decrease of $3.3 million or 1.1%.

For the nine months ended September 30, 2023, net sales in the Zig-Zag Products segment decreased to $135.4 million from $144.0 million for the nine months ended September 30, 2022, a decrease of $8.6 million or 6.0%. The decrease in net sales was driven by anticipated declines in the U.S. rolling papers and wraps businesses which were impacted by a reduction of trade inventory, offset by growth in our Clipper business. Additionally, a discontinuation of an unprofitable product line negatively impacted Canadian sales by $3.6 million against the previous year.

For the nine months ended September 30, 2023, net sales in the Stoker’s Products segment increased to $106.6 million from $98.8 million for the nine months ended September 30, 2022, an increase of $7.8 million or 7.9%. For the nine months ended September 30, 2023, volume increased 1.0% and price/product mix increased 6.9%. The increase in net sales was driven primarily by double-digit growth of Stoker’s® MST.

For the nine months ended September 30, 2023, net sales in the Creative Distribution Solutions segment decreased to $66.3 million from $68.8 million for the nine months ended September 30, 2022, a decrease of $2.5 million or 3.7%. The decrease in net sales was primarily the result of reduced volumes in the vape distribution business.

Gross Profit:  For the nine months ended September 30, 2023, consolidated gross profit decreased to $152.7 million from $156.0 million for the nine months ended September 30, 2022, a decrease of $3.3 million or 2.1%. Gross profit as a percentage of net sales decreased to 49.5% for the nine months ended September 30, 2023, compared to 50.1% for the nine months ended September 30, 2022 driven by decreased margin in the Zig-Zag Products and Creative Distribution Solutions segments partially offset by increased margin in the Stoker’s Products segment.

For the nine months ended September 30, 2023, gross profit in the Zig-Zag Products segment decreased to $75.6 million from $80.8 million for the nine months ended September 30, 2022, a decrease of $5.2 million or 6.5%. Gross profit as a percentage of net sales decreased to 55.8% of net sales for the nine months ended September 30, 2023, from 56.1% of net sales for the nine months ended September 30, 2022, as a result of product mix including the decline in net sales of higher margin U.S. rolling paper and wraps products and contribution of CLIPPER lighters, as a result of the exclusive distribution deal entered into in February 2022, which operates at lower gross profit margins.

For the nine months ended September 30, 2023, gross profit in the Stoker’s Products segment increased to $60.0 million from $54.0 million for the nine months ended September 30, 2022, an increase of $6.0 million or 11.0%. Gross profit as a percentage of net sales increased to 56.3% of net sales for the nine months ended September 30, 2023, from 54.7% of net sales for the nine months ended September 30, 2022, primarily as a result of the strong incremental margin contribution of MST.

For the nine months ended September 30, 2023, gross profit in the Creative Distribution Solutions segment decreased to $17.2 million from $21.1 million for the nine months ended September 30, 2022, a decrease of $3.9 million or 18.8%. Gross profit as a percentage of net sales decreased to 25.9% of net sales for the nine months ended September 30, 2023, from 30.7% of net sales for the nine months ended September 30, 2022, primarily as a result of channel mix.

Selling, General, and Administrative Expenses:  For the nine months ended September 30, 2023, selling, general, and administrative expenses decreased to $94.1 million from $98.8 million for the nine months ended September 30, 2022, a decrease of $4.7 million or 4.7%. Selling, general and administrative expenses in the nine months ended September 30, 2023, included $4.7 million of stock options, restricted stock and incentives expense, $1.1 million of expense related to PMTA, $0.2 million of expense related to corporate restructuring, $0.4 million of expense related to the new ERP and CRM systems and $0.2 million related to transaction costs. Selling, general and administrative expenses in the nine months ended September 30, 2022, included $4.1 million of stock option, restricted stock and incentives expense, $0.8 million of transaction costs, $4.3 million of expense related to PMTA, $1.6 million of expense related to corporate restructuring and $1.6 million of consulting expense related to the scoping of the new ERP and CRM systems.

Interest Expense, net:  For the nine months ended September 30, 2023, interest expense, net decreased to $12.0 million, from $15.1 million for the nine months ended September 30, 2022 as a result of the repurchases of $44.0 million of Convertible Senior Notes through the third quarter of 2023, and increased interest income on cash as a result of rising interest rates.

Investment Loss:  For the nine months ended September 30, 2023, investment loss increased to $10.9 million compared to $6.1 million for the nine months ended September 30, 2022.  The change is a result of the year-to-date impairment charges recognized on our investments in Docklight and Wild Hemp for $6.5 million and $2.2 million, respectively, compared to an impairment charge of $6.3 million in the second quarter of 2022 related to our investment in Dosist.

Gain on Extinguishment of Debt: There was a gain on extinguishment of debt of $1.9 million for the nine months ended September 30, 2023 as a result of repurchasing $44.0 million of Convertible Senior Notes through the third quarter of 2023 compared to no gain on extinguishment of debt for the nine months ended September 30, 2022.

Income Tax Expense:  Our income tax expense of $9.6 million was 25.5% of income before income taxes for the nine months ended September 30, 2023. Our effective income tax rate was 24.2% for the nine months ended September 30, 2022 and included a discrete tax benefit $0.7 million relating to stock option exercises.

Net Loss Attributable to Non-Controlling Interest:  Net loss attributable to non-controlling interest was $0.4 million for the nine months ended September 30, 2023 compared to $0.7 million for the nine months ended September 30, 2022.

Net Income Attributable to Turning Point Brands, Inc.:  Due to the factors described above, net income attributable to Turning Point Brands, Inc. for the nine months ended September 30, 2023 and 2022, was $28.4 million and $28.0 million, respectively.

EBITDA and Adjusted EBITDA

To supplement our financial information presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, we use non-U.S. GAAP financial measures including EBITDA and Adjusted EBITDA. We believe Adjusted EBITDA provides useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Adjusted EBITDA is used by management to compare our performance to that of prior periods for trend analyses and planning purposes and is presented to our Board of Directors. We believe that EBITDA and Adjusted EBITDA are appropriate measures of operating performance because they eliminate the impact of expenses that do not relate to operating performance. In addition, our debt instruments contain covenants which use Adjusted EBITDA calculations.

We define “EBITDA” as net income before interest expense, gain (loss) on extinguishment of debt, provision for income taxes, depreciation, and amortization. We define “Adjusted EBITDA” as net income before interest expense, gain (loss) on extinguishment of debt, provision for income taxes, depreciation, amortization, other non-cash items, and other items we do not consider the ordinary course in our evaluation of ongoing operating performance noted in the reconciliation below.

Non-U.S. GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with U.S. GAAP. Adjusted EBITDA excludes significant expenses required to be recorded in our financial statements by U.S. GAAP and is subject to inherent limitations. Other companies in our industry may calculate this non-U.S. GAAP measure differently than we do or may not calculate it at all, limiting its usefulness as a comparative measure. The tables below provide reconciliations between net income and Adjusted EBITDA.

(in thousands)
 
Three Months Ended
September 30,
 
   
2023
   
2022
 
Net income attributable to Turning Point Brands, Inc.
 
$
10,831
   
$
11,536
 
Add:
               
Interest expense, net
   
3,984
     
4,802
 
Gain on extinguishment of debt
   
(481
)
   
 
Income tax expense
   
3,767
     
3,797
 
Depreciation expense
   
782
     
861
 
Amortization expense
   
844
     
454
 
EBITDA
 
$
19,727
   
$
21,450
 
Components of Adjusted EBITDA
               
Corporate restructuring (a)
   
190
     
17
 
ERP/CRM (b)
   
138
     
435
 
Stock options, restricted stock, and incentives expense (c)
   
1,824
     
1,442
 
Transactional expenses (d)
   
76
     
 
FDA PMTA (e)
   
275
     
1,169
 
Non-cash asset impairment (f)
   
2,173
     
 
Adjusted EBITDA
 
$
24,403
   
$
24,513
 

(a)
Represents costs associated with corporate restructuring, including severance.
(b)
Represents cost associated with scoping and mobilization of new ERP and CRM systems and cost of duplicative ERP licenses.
(c)
Represents non-cash stock options, restricted stock, incentives expense and Solace performance stock units.
(d)
Represents the fees incurred for transaction expenses.
(e)
Represents costs associated with applications related to FDA premarket tobacco product application (“PMTA”).
(f)
Represents impairment of investment assets.

 
(in thousands)
 
Nine Months Ended
September 30,
 
   
2023
   
2022
 
Net income attributable to Turning Point Brands, Inc.
 
$
28,353
   
$
27,958
 
Add:
               
Interest expense, net
   
12,013
     
15,142
 
Gain on extinguishment of debt
   
(1,858
)
   
 
Income tax expense
   
9,573
     
8,706
 
Depreciation expense
   
2,317
     
2,611
 
Amortization expense
   
2,386
     
1,373
 
EBITDA
 
$
52,784
   
$
55,790
 
Components of Adjusted EBITDA
               
Corporate restructuring (a)
   
190
     
1,619
 
ERP/CRM (b)
   
414
     
1,626
 
Stock options, restricted stock, and incentives expense (c)
   
4,660
     
4,103
 
Transactional expenses (d)
   
162
     
789
 
FDA PMTA (e)
   
1,095
     
4,265
 
Non-cash asset impairment (f)
   
11,162
     
6,300
 
Adjusted EBITDA
 
$
70,467
   
$
74,492
 

(a)
Represents costs associated with corporate restructuring, including severance.
(b)
Represents cost associated with scoping and mobilization of new ERP and CRM systems and cost of duplicative ERP licenses.
(c)
Represents non-cash stock options, restricted stock, incentives expense and Solace performance stock units.
(d)
Represents the fees incurred for transaction expenses.
(e)
Represents costs associated with applications related to FDA premarket tobacco product application (“PMTA”).
(f)
Represents impairment of investment assets.

Liquidity and Capital Resources

As of September 30, 2023, we had $96.1 million of cash on hand and have $23.6 million of availability under the 2021 Amended Revolving Credit Facility. Our principal uses for cash are working capital, debt service, and capital expenditures.

Our Convertible Senior Notes, with an outstanding balance of $118.5 million as of September 30, 2023, mature in July of 2024. On November 7, 2023, one of our wholly-owned subsidiaries entered into a new 2023 ABL Facility to refinance up to $75.0 million of the Convertible Senior Notes at maturity. As a result, we reclassified $70.0 million related to the Convertible Senior Notes from short-term to long-term liabilities on our September 30, 2023 Balance Sheet. With our strong cash balance, free cash flow generation and borrowing availability under the 2023 ABL Facility, we expect to have ample liquidity to address the remaining balance of the Convertible Senior Notes maturing next year, and to satisfy our operating cash requirements for the foreseeable future.

Our working capital, which we define as current assets less cash and current liabilities, decreased to $64.0 million at September 30, 2023, compared with $109.9 million at December 31, 2022 as a result of a portion of the Convertible Senior Notes becoming current during the quarter.

   
As of
 
(in thousands)
 
September 30,
2023
   
December 31,
2022
 
             
Current assets
 
$
150,741
   
$
151,251
 
Current liabilities
   
86,718
     
41,376
 
Working capital
 
$
64,023
   
$
109,875
 

Cash Flows from Operating Activities

For the nine months ended September 30, 2023, net cash provided by operating activities was $40.0 million compared to net cash provided by operating activities of $16.4 million for the nine months ended September 30, 2022, an increase of $23.6 million, primarily due to the timing of changes of inventory and other working capital.

Cash Flows from Investing Activities

For the nine months ended September 30, 2023, net cash used in investing activities was $4.4 million compared to net cash used in investing activities of $17.8 million for the nine months ended September 30, 2022, a reduction in cash used in investing activities of $13.4 million, primarily due to a decrease in purchases of investments in our MSA escrow account.

Cash Flows from Financing Activities

For the nine months ended September 30, 2023, net cash used in financing activities was $46.0 million compared to net cash used in financing activities of $31.2 million for the nine months ended September 30, 2022, an increase of $14.8 million, primarily due to $41.8 million in repurchases of Convertible Senior Notes during the period, offset by a decrease in repurchases of common stock of $27.0 million during 2023.

Dividends and Share Repurchase

A dividend of $0.065 per common share was paid on October 6, 2023, to shareholders of record at the close of business on September 15, 2023.

On February 25, 2020, our Board of Directors approved a $50.0 million share repurchase program, which is intended for opportunistic execution based upon a variety of factors including market dynamics. The program is subject to the ongoing discretion of the Board of Directors. On October 25, 2021, the Board of Directors increased the approved share repurchase program by $30.7 million and by an additional $24.6 million on February 24, 2022. $27.2 million remains available for share repurchases under the program as of September 30, 2023.

Long-Term Debt

As of September 30, 2023, we were in compliance with the financial and restrictive covenants of the Senior Secured Notes and 2021 Revolving Credit Facility. The following table provides outstanding balances of our debt instruments.

   
September 30,
2023
   
December 31,
2022
 
Senior Secured Notes
 
$
250,000
   
$
250,000
 
Convertible Senior Notes
   
118,541
     
162,500
 
Gross notes payable and long-term debt
   
368,541
     
412,500
 
Less deferred finance charges
   
(3,720
)
   
(5,743
)
Less current maturities
   
(48,248
)
   
-
 
Notes payable and long-term debt
 
$
316,573
   
$
406,757
 

Senior Secured Notes

On February 11, 2021, we closed a private offering (the “Offering”) of $250 million aggregate principal amount of our 5.625% senior secured notes due 2026 (the “Senior Secured Notes”). The Senior Secured Notes bear interest at a rate of 5.625% and will mature on February 15, 2026. Interest on the Senior Secured Notes is payable semi-annually in arrears on February 15 and August 15 of each year, commencing on August 15, 2021.We used the proceeds from the Offering (i) to repay all obligations under and terminate the 2018 First Lien Credit Facility, (ii) to pay related fees, costs, and expenses and (iii) for general corporate purposes.

Obligations under the Senior Secured Notes are guaranteed by the Company’s existing and future wholly-owned domestic subsidiaries (the “Guarantors”) that guarantee any credit facility (as defined in the indenture governing the Senior Secured Notes or the “Senior Secured Notes Indenture”) or capital markets debt securities of the Company or Guarantors in excess of $15.0 million. The Senior Secured Notes and the related guarantees are secured by first-priority liens on substantially all of the assets of the Company and the Guarantors, subject to certain exceptions.

The Company may redeem the Senior Secured Notes, in whole or in part, at any time on or after February 15, 2023, at the redemption prices (expressed as a percentage of the principal amount to be redeemed) set forth below, plus accrued and unpaid interest, if any, on the Senior Secured Notes to be redeemed to (but not including) the applicable redemption date if redeemed during the period indicated below:

On or after February 15, 2023
   
102.813
%
On or after February 15, 2024
   
101.406
%
On or after February 15, 2025 and thereafter
   
100.000
%

If we experience a change of control (as defined in the Senior Secured Notes Indenture), we must offer to repurchase the Senior Secured Notes at a repurchase price equal to 101% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest.

The Senior Secured Notes Indenture contains covenants that, among other things, restrict the ability of the Company and its restricted subsidiaries to: (i) grant or incur liens; (ii) incur, assume or guarantee additional indebtedness; (iii) sell or otherwise dispose of assets, including capital stock of subsidiaries; (iv) make certain investments; (v) pay dividends, make distributions or redeem or repurchase capital stock; (vi) engage in certain transactions with affiliates; and (vii) consolidate or merge with or into, or sell substantially all of our assets to another entity. These covenants are subject to a number of limitations and exceptions set forth in the Senior Secured Notes Indenture. The Senior Secured Notes Indenture provides for customary events of default. We were in compliance with all covenants as of September 30, 2023.

We incurred debt issuance costs attributable to the issuance of the Senior Secured Notes of $6.4 million which are amortized to interest expense using the effective interest method over the expected life of the Senior Secured Notes.

2021 Revolving Credit Facility

In connection with the Offering, we also entered into a new $25.0 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). On May 10, 2023, the Company and certain of its subsidiaries, as guarantors, entered into an amendment (the “Amendment”) to the 2021 Revolving Credit Facility (as amended, the “Amended Revolving Credit Facility”). The Amendment includes certain modifications to the 2021 Revolving Credit Facility relating to the replacement of the London Inter-Bank Offered Rate with a Secured Overnight Financing Rate (“SOFR”) as the interest rate benchmark under the 2021 Revolving Credit Facility and adjusts certain other provisions to reflect current documentation standards and other agreed modifications.

Letters of credit are limited to $10.0 million (and are a part of, and not in addition to, the revolving line of credit). We have not drawn any borrowings under the Amended Revolving Credit Facility but do have letters of credit of approximately $1.4 million outstanding under the facility as of March 31, 2023. The Amended Revolving Credit Facility will mature on August 11, 2025 if none of our Convertible Senior Notes are outstanding, and if any Convertible Senior Notes are outstanding, the date which is 91 days prior to the maturity date of July 15, 2024, for such Convertible Senior Notes.

Interest is payable on the Amended 2021 Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate of Term SOFR rate, as applicable, plus an applicable margin of 3.50% (with step-downs upon de-leveraging). We also have the option to borrow at a rate determined by reference to the base rate.

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

The Amended Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The Amended Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio of 5.50 to 1.00 (with a step down to 5.25 to 1.00 beginning with the fiscal quarter ending March 31, 2023) at the end of each fiscal quarter when extensions of credit under the Amended Revolving Credit Facility and certain drawn and undrawn letters of credit (excluding (a) letters of credit that have been cash collateralized and (b) letters of credit having an aggregate face amount less than $5.0 million) in the aggregate outstanding exceeds 35% of the total commitments under the Amended Revolving Credit Facility. The Amended Revolving Credit Agreement provides for customary events of default. We were in compliance with all covenants as of September 30, 2023.

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

On November 7, 2023, the Company terminated the Amended Revolving Credit Agreement in connection with entry into the new 2023 ABL Facility by one of its subsidiaries.

2023 ABL Facility

On November 7, 2023, TPB Specialty Finance, LLC, a wholly-owned subsidiary of the Company (the “ABL Borrower”), entered into a $75.0 million asset-backed revolving credit facility (the “2023 ABL Facility”), with the several lenders thereunder, and Barclays Bank Plc, as administrative agent (the “Administrative Agent”) and as collateral agent (the “Collateral Agent”) and First-Citizens Bank & Trust Company as additional collateral agent (the “Additional Collateral Agent”). Under the 2023 ABL Facility, the ABL Borrower may draw up to $75.0 million under Revolving Credit Loans and LILO Loans. The 2023 ABL Facility includes a $40.0  million accordion feature.  In connection with the 2023 ABL Facility, Turning Point Brands contributed certain existing inventory to the ABL Borrower. The 2023 ABL Facility is secured on a first priority basis (subject to customary exceptions) by all assets of the ABL Borrower.

The 2023 ABL Facility contains customary borrowing conditions including a borrowing base equal to the sum of (a) the lesser of (1) 85% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) 85% of the cost of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (2) 85% of the net orderly liquidation value (“NOLV”) percentage of the lower of (1)(A) or (1)(B); plus (b) 85% of the face value of all eligible accounts of the ABL Borrower minus (c) the amount of all eligible reserves.  The 2023 ABL Facility also includes a “last in last out” (“LILO”) borrowing base equal to the sum of (a) the lesser of: (1) 10% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) the cost of the sum of eligible inventory, plus eligible in-transit inventory and (2) 10% of the NOLV percentage of the lower of  (1)(A) or (1)(B); plus (b) 10% of the face amount of eligible account; minus (c) the amount of all eligible reserves.
Amounts borrowed under the 2023 ABL Facility are subject to an interest rate margin per annum equal to (a) from and after the closing date until the last day of the first full fiscal quarter ended after the closing date, (i) 1.25% per annum, in the case base rate loans, and (ii) 2.25% per annum, in the case of revolving credit loans that are SOFR Loans, (b)(i) 2.25% per annum, in the case of LILO loans that are base rate loans, and (ii) 3.25% per annum, in the case of LILO loans that are SOFR loans, (c) on the first day of each fiscal quarter, the applicable interest rate margins will be determined from the pricing grid below based upon the historical excess availability for the most recent fiscal quarter ended immediately prior to the relevant date, as calculated by the Administrative Agent.
Level
Historical Excess Availability
Applicable Margin
for SOFR Loans
Applicable Margin
for Base Rate Loans
I
Greater than or equal to 66.66%
1.75%
0.75%
II
Less than 66.66%, but greater than or equal to 33.33%
2.00%
1.00%
III
Less than 33.33%
2.25%
1.25%

The 2023 ABL Facility also requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the end of any four consecutive fiscal quarters on or after the closing date if excess availability shall be less than the greater of (a) 12.5% of the line cap and (b) $9.4 million, at any time and continuing until excess availability is equal to or exceeds the greater of (i) 12.5% of the line and (ii) $9.4 million for thirty (30) consecutive calendar days; provided that such $9.4 million level shall automatically increase in proportion to the amount of any increase in the aggregate revolving credit commitments thereunder in connection with any incremental facility.

The 2023 ABL Facility shall mature on the earlier of (x) November 7, 2027 and (y) the date that is 91 days prior to the maturity date of any material debt of the ABL Borrower or the Company or any of its restricted subsidiaries (subject to customary extensions agreed by the lenders thereunder); provided that clause (y) shall not apply to the extent that on any applicable date of determination (on any date prior to the date set forth in clause (y)), (A) the sum of (x) cash that is held in escrow for the repayment of such material debt pursuant to arrangements satisfactory to the Administrative Agent, (y) cash that is held in accounts with the Administrative Agent and/or the Additional Collateral Agent, plus (z) excess availability, is sufficient to repay such material debt and (B) the ABL Borrower has excess availability of at least $15.0 million after giving effect to such repayment of material debt, including any borrowings under the commitments in connection therewith.

Convertible Senior Notes

In July 2019 we closed an offering of $172.5 million in aggregate principal amount of our 2.50% Convertible Senior Notes due July 15, 2024 (the “Convertible Senior Notes”). The Convertible Senior Notes bear interest at a rate of 2.50% per year, payable semiannually in arrears on January 15 and July 15 of each year, beginning on January 15, 2020. The Convertible Senior Notes will mature on July 15, 2024, unless earlier repurchased, redeemed or converted. The Convertible Senior Notes are senior unsecured obligations.

In the fourth quarter of 2022, a wholly owned subsidiary of the Company repurchased $10.0 million in aggregate principal amount of the Convertible Senior Notes on the open market resulting in a $0.9 million gain on extinguishment of debt. Subsequent principal repurchases occurred in the first, second and third quarters of 2023 for $13.9 million, $15.1 million and $15.0 million, respectively, in aggregate principal amounts resulting in gains on extinguishment of debt of $0.7 million, $0.6 million and $0.6 million, respectively. The repurchased notes continue to be held by our subsidiary and may be resold subject to compliance with applicable securities law. As of September 30, 2023, $118.5 million aggregate principal remains outstanding and held by third parties.

The Convertible Senior Notes held by third parties are convertible into approximately 2,216,029 shares of TPB Common Stock under certain circumstances prior to maturity at a conversion rate of 18.6942 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.49 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. The conversion price is adjusted periodically as a result of dividends paid by the Company in excess of pre-determined thresholds of $0.04 per share. Upon conversion, the Company may pay cash, shares of common stock or a combination of cash and stock, as determined by the Company at its discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of 2023.

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

In connection with the Convertible Senior Notes offering, we entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $53.49 per and a cap price of $82.86 per share, and are exercisable when, and if, the Convertible Senior Notes are converted. We paid $20.53 million for these capped calls at the time they were entered into and charged that amount to additional paid-in capital.

Off-balance Sheet Arrangements

During the nine months ended September 30, 2023, we executed various foreign exchange contracts for the purchase of €20.1 million and sale of €15.2 million with maturity dates ranging from October 2023 to September 2024. At September 30, 2023, we had foreign currency contracts outstanding for the purchase of €17.1 million and sale of €15.2 million. The fair value of the foreign currency contracts were based on quoted market prices and resulted in an asset of $0.1 million included in Other current assets and a liability of $0.5 million included in Accrued liabilities at September 30, 2023. During 2022, we executed various foreign currency contracts for the purchase of €28.9 million and sale of €28.9 million. At December 31, 2022, we had foreign currency contracts for the purchase of €18.5 million and sale of €18.5 million. The fair value of the foreign currency contracts resulted in an asset of $1.2 million included in Other current assets and a liability of $0.0 million included in Accrued liabilities at December 31, 2022.

Inflation

Inflation in general, and the recent rapid increases in gas prices have had a substantial negative effect on the purchasing power of consumers. While historically, we have been able to increase prices at a rate equal to or greater than that of inflation, doing so would be difficult in the current inflationary environment. However, we have implemented price increases in areas where doing so has been feasible. In addition, we have been able to maintain a relatively stable variable cost structure for our products due, in part, to our successful procurement regarding our tobacco products and, in part, to our existing contractual agreement for the purchase of our premium cigarette papers.

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 2022 Annual Report on Form 10-K, during the quarter ended September 30, 2023. Please refer to our ‘Quantitative and Qualitative Disclosures about Market Risk’ included in our 2022 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 2022 Annual Report on Form 10-K, during the nine months ended September 30, 2023. Please refer to our ‘Quantitative and Qualitative Disclosures about Market Risk’ included in our 2022 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. We carry the Senior Secured Notes and Convertible Senior Notes at face value. Since the Senior Secured Notes and Convertible Senior Notes bear interest at a fixed rate, we have no financial statement 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 instrument is a revolving credit facility, which has no borrowing outstanding.

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 as of September 30, 2023. 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 material weaknesses in internal controls over financial reporting that were disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

As previously described in Part II, Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, during our evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2022, we concluded that our internal control over financial reporting was not effective solely due to the existence of the following material weaknesses: we did not design and maintain effective internal controls related to our information technology general controls (“ITGCs”) in the areas of user access and program change-management over certain information technology systems that support the Company’s financial reporting processes. Our business process controls (automated and manual) that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted.  We also did not appropriately design and operate controls associated with the risk assessment component of the internal control framework, specifically as it relates to identifying risks around segregation of duties within the financial reporting function, and the identification of all risks relating to the financial statements and controls that would address such risks. This impacts business process controls (automated and manual) throughout financial reporting and the business transaction cycles.

The material weaknesses did not result in any identified misstatements to our financial statements, and there were no changes to previously released financial results. The material weaknesses 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.

During the nine months ended September 30, 2023, we have continued to make progress on our remediation plans to address the material weaknesses in the Company’s internal controls over financial reporting. These remediation efforts include hiring additional experienced accounting and internal control specialists and external consultants. In addition, the Company is in process of redesigning key controls for both business processes and information technology controls along with implementing a new enterprise resource planning system.

PART II—OTHER INFORMATION

Item 1.  Legal Proceedings

For a description of our material pending legal proceedings, please see Contingencies in Note 14 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 2022 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 2022 Annual Report on Form 10-K. There have been no material changes to the Risk Factors set forth in the 2022 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 of Directors increased the approved share repurchase program by $30.7 million bringing the authority at the time back to $50.0 million (including approximately $19.3 million available for repurchases under the Board of Directors’ previous authorization). On February 24, 2022, the Board of Directors increased the approved share repurchase program by $24.6 million bringing total authority at that time to $50.0 million. This share repurchase program has no expiration date and is subject to the ongoing discretion of the Board of Directors. 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.

For the quarter ended September 30, 2023, the Company made no purchases of its common stock in connection with the repurchase program described above.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Disclosure Pursuant to Item 1.01 of Current Report on Form 8-K - Entry into a Material Definitive Agreement.

On November 7, 2023, TPB Specialty Finance, LLC, a wholly-owned subsidiary of the Company (the “ABL Borrower”), entered into a new $75.0 million asset-backed revolving credit facility (the “2023 ABL Facility”), with the several lenders thereunder, and Barclays Bank Plc, as administrative agent (the “Administrative Agent”) and as collateral agent (the “Collateral Agent”) and First-Citizens Bank & Trust Company as additional collateral agent (the “Additional Collateral Agent”). Under the 2023 ABL Facility, the ABL Borrower may draw up to $75.0 million under Revolving Credit Loans and LILO Loans. The 2023 ABL Facility includes a $40.0 million accordion feature. In connection with the 2023 ABL Facility, Turning Point Brands contributed certain existing inventory to the ABL Borrower. The 2023 ABL Facility is secured on a first priority basis (subject to customary exceptions) by all assets of the ABL Borrower.

The 2023 ABL Facility contains customary borrowing conditions including a borrowing base equal to the sum of (a) the lesser of (1) 85% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) 85% of the cost of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (2) 85% of the net orderly liquidation value (“NOLV”) percentage of the lower of (1)(A) or (1)(B); plus (b) 85% of the face value of all eligible accounts of the ABL Borrower minus (c) the amount of all eligible reserves.  The 2023 ABL Facility also includes a “last in last out” (“LILO”) borrowing base equal to the sum of (a) the lesser of: (1) 10% of the lower of (A) the market value (on a first in first out basis) of the sum of eligible inventory, plus eligible in-transit inventory of the ABL Borrower and (B) the cost of the sum of eligible inventory, plus eligible in-transit inventory and (2) 10% of the NOLV percentage of the lower of  (1)(A) or (1)(B); plus (b) 10% of the face amount of eligible account; minus (c) the amount of all eligible reserves.

Amounts borrowed under the 2023 ABL Facility are subject to an interest rate margin per annum equal to (a) from and after the closing date until the last day of the first full fiscal quarter ended after the closing date, (i) 1.25% per annum, in the case base rate loans, and (ii) 2.25% per annum, in the case of revolving credit loans that are SOFR Loans, (b)(i) 2.25% per annum, in the case of LILO loans that are base rate loans, and (ii) 3.25% per annum, in the case of LILO loans that are SOFR loans, (c) on the first day of each fiscal quarter, the applicable interest rate margins will be determined from the pricing grid below based upon the historical excess availability for the most recent fiscal quarter ended immediately prior to the relevant date, as calculated by the Administrative Agent.

Level
Historical Excess Availability
Applicable Margin
for SOFR Loans
Applicable Margin
 for Base Rate Loans
I
Greater than or equal to 66.66%
1.75%
0.75%
II
Less than 66.66%, but greater than or equal to 33.33%
2.00%
1.00%
III
Less than 33.33%
2.25%
1.25%

The 2023 ABL Facility also requires the Company and its restricted subsidiaries to maintain a fixed charge coverage ratio of at least 1.00 to 1.00 as of the end of any four consecutive fiscal quarters on or after the closing date if excess availability shall be less than the greater of (a) 12.5% of the line cap and (b) $9.375 million, at any time and continuing until excess availability is equal to or exceeds the greater of (i) 12.5% of the line and (ii) $9.375 million for thirty (30) consecutive calendar days; provided that such $9.375 million level shall automatically increase in proportion to the amount of any increase in the aggregate revolving credit commitments thereunder in connection with any incremental facility.

The 2023 ABL Facility shall mature on the earlier of (x) November 7, 2027 and (y) the date that is 91 days prior to the maturity date of any material debt of the ABL Borrower or the Company or any of its restricted subsidiaries (subject to customary extensions agreed by the lenders thereunder); provided that clause (y) shall not apply to the extent that on any applicable date of determination (on any date prior to the date set forth in clause (y)), (A) the sum of (x) cash that is held in escrow for the repayment of such material debt pursuant to arrangements satisfactory to the Administrative Agent, (y) cash that is held in accounts with the Administrative Agent and/or the Additional Collateral Agent, plus (z) excess availability, is sufficient to repay such material debt and (B) the ABL Borrower has excess availability of at least $15.0 million after giving effect to such repayment of material debt, including any borrowings under the commitments in connection therewith.

Disclosure Pursuant to Item 1.02 of Current Report on Form 8-KTermination of a Material Definitive Agreement.

On November 7, 2023, the Company terminated the 2021 Amended Revolving Credit Agreement in connection with the entry by one of its subsidiaries into the new 2023 ABL Facility.

Item 6. Exhibits

Exhibit No.
Description
Amendment No 1. Dated as of May 10, 2023, to the Credit Agreement, dated as of February 11, 2021, by and among Turning Point Brands, Inc., the obligors party thereto, Barclays Bank PLC, as administrative agent, and the lenders party thereto (incorporated herein by reference to Exhibit 10.1 of Turning Point Brand, Inc’s Current Report on Form 8-K filed with the Commission on May 16, 2023 (File No. 001-37763).
   
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, 2023, filed on November 8, 2023, 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:  November 8, 2023
   

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