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OFFON

TURNING POINT BRANDS, INC.

(TPB)
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TURNING POINT BRANDS, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

10/26/2021 | 04:29pm EST

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

The following discussion relates to the unaudited financial statements of Turning Point Brands, Inc., included elsewhere in this Quarterly Report on Form 10-Q. In this discussion, unless the context requires otherwise, references to "our Company" "we," "our," or "us" refer to Turning Point Brands, Inc., and its consolidated subsidiaries. References to "TPB" refer to Turning Point Brands, Inc., without any of its subsidiaries. We were incorporated in 2004 under the name North Atlantic Holding Company, Inc. On November 4, 2015, we changed our name to Turning Point Brands, Inc. Many of the amounts and percentages in this discussion have been rounded for convenience of presentation.

Overview

Turning Point Brands, Inc. (the "Company," "we," "our," or "us") is a leading manufacturer, marketer and distributor of branded consumer products. We sell a wide range of products to adult consumers consisting of staple products with our iconic brands Zig-Zag® and Stoker's® to 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 low double-digit consumer unit growth in 2020 as reported by Management Science Associates, Inc. ("MSAi"), a third-party analytics and information company. Our three focus segments are led by our core, proprietary brands: Zig-Zag® in the Zig-Zag Products segment; Stoker's® along with Beech-Nut® and Trophy® in the Stoker's Products segment; and Nu-XTM, Solace® along with our distribution platforms (Vapor Beast®, VaporFi® and Direct Vapor®) in the NewGen Products segment. Our businesses generate solid cash flow which we use to 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 have identified additional growth opportunities in the emerging alternatives market. In January 2019, we established Nu-X Ventures LLC ("Nu-X"), a new wholly owned subsidiary dedicated to the development, production and sale of alternative products and acquisitions in related spaces. The creation of Nu-X allows us to leverage our expertise in traditional OTP management to alternative products. Our management team has extensive experience navigating federal, state and local regulations that are directly applicable to the growing alternatives market. In July 2019, we acquired the assets of Solace Technology ("Solace"). Solace is an innovative product development company which established one of the top e-liquid brands and has since grown into a leader in alternative products. Solace's legacy and innovation enhanced Nu-X's strong and nimble development engine.

We believe there are meaningful opportunities to grow through acquisitions and joint ventures across all product categories. As of December 31, 2020, our products are available in approximately 190,000 U.S. retail locations which, with the addition of retail stores in Canada, brings our total North American retail presence to an estimated 210,000 points of distribution. Our sales team targets widespread distribution to all traditional retail channels, including convenience stores, and we have a growing e-commerce business.


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Products

We operate in three segments: Zig-Zag Products, Stoker's Products and NewGen Products. In our Zig-Zag Products segment, we principally market and distribute (i) rolling papers, tubes, and related products; and (ii) finished cigars and make-your-own ("MYO") cigar wraps. In our Stoker's Products segment, we (i) manufacture and market moist snuff tobacco ("MST") and (ii) contract for and market loose leaf chewing tobacco products. In our NewGen Products segment, we (i) market and distribute CBD, 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. In our NewGen Products segment, our acquisition of VaporBeast in 2016 expanded our revenue streams as we began selling directly to non-traditional retail outlets. Our acquisition of IVG in 2018 enhanced our B2C revenue stream with the addition of the Vapor-Fi online platform. The acquisition of Solace provided us with a line of leading liquids and a powerful new product development platform. Our net sales, which include federal excise taxes, consist of gross sales net of cash discounts, returns, and selling and marketing allowances.

We rely on long-standing relationships with high-quality, established manufacturers to provide the majority of our produced products. More than 80% of our production, as measured by net sales, is outsourced to suppliers. The remaining production consists primarily of our moist snuff tobacco operations located in Dresden, Tennessee, and Louisville, Kentucky. Our principal operating expenses include the cost of raw materials used to manufacture the limited number of our products which we produce in-house; the cost of finished products, which are generally purchased goods; federal excise taxes; legal expenses; and compensation expenses, including benefits and costs of salaried personnel. Our other principal expenses include interest expense and other expenses.

Key Factors Affecting Our Results of Operations

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

• Our ability to further penetrate markets with our existing products;

• Our ability to introduce new products and product lines that complement our

core business;

• Decreasing interest in some tobacco products among consumers;

• Price sensitivity in our end-markets;

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

• General economic conditions, including consumer access to disposable income;

• Freight and shipping costs and the availability of adequate freight for our

shipments;

• Cost and increasing regulation of promotional and advertising activities;

• Cost of complying with regulation, including the "deeming regulations";

• Counterfeit and other illegal products in our end-markets;

• Currency fluctuations;

• Our ability to identify attractive acquisition opportunities; and

• Our ability to integrate acquisitions.




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Recent Developments

Share Repurchase Authorization Increase

On October 25, 2021, the Board of Directors of Turning Point Brands increased the Company's share repurchase authorization by $30.7 million to an aggregate amount of $50.0 million, including approximately $19.3 million available for repurchases under the Board's previous authorization approved on February 25, 2020.

The repurchase authorization permits shares to be repurchased in open market or private transactions, through block trades, and pursuant to any trading plan or other arrangements. The timing, manner, price and amount of any repurchases will be determined by the Company's management in its discretion and will be subject to economic and market conditions, stock price, applicable legal requirements and other factors. The repurchase authorization does not obligate the Company to purchase any specific number of shares and may be suspended or discontinued at any time.

Final Rule Related to PACT Act Published

On October 21, 2021, the United States Postal Service ("USPS") published a Final Rule entitled "Treatment of E-Cigarettes in the Mail," which followed its earlier publication of the Proposed Rule on February 19, 2021. This Final Rule was required as a result of the inclusion of Division FF, Title VI (Preventing Online Sales of E-Cigarettes to Children or "POSECA") in the Further Consolidated Appropriations Act, 2021. POSECA, among other things, expanded the definition of "cigarettes" in the Jenkins Act and Prevent All Cigarette Trafficking ("PACT") Act to expressly capture "electronic nicotine delivery systems," i.e., ENDS. Consistent with the Proposed Rule, the Final Rule extends the existing prohibition on and exceptions to the mailing of "cigarettes" via USPS to ENDS products, other than the Consumer Testing and Public Health exceptions. Specifically, the Final Rule extends the following exceptions to the prohibition on mailing of ENDS products: the Business/Regulatory Purposes Exception, the Certain Individuals Exception, and the exception for intra-Alaska and intra-Hawaii shipments. While the Final Rule is largely in line with our expectations, we expect a transition period as we adjust our logistics.

Unitabac

On July 23, 2021, we acquired certain assets of Unitabac, a marketer of mass-market cigars, for $10.7 million in total consideration, comprised of $9.6 million in cash and $1.1 million of capitalized transaction costs. The acquisition is comprised of a robust portfolio of cigarillo products and all related intellectual property, including Cigarillo Non-Tip (NT) Homogenized Tobacco Leaf (HTL) products and Rolled Leaf and Natural Leaf Cigarillo Products.

Old Pal

On July 21, 2021, we invested $8 million in Old Pal Holding Company LLC ("Old Pal"), a leading brand in the cannabis lifestyle space. We invested in the form of a convertible note which includes additional follow-on investment rights. Old Pal is a leading brand in the cannabis space that operates a non-plant touching licensing model. Our investment will enable Old Pal to expand product offerings in existing states, which include California, Nevada, Michigan, Oklahoma, Ohio, Washington and Massachusetts, and will help create the infrastructure necessary to support continued territory and product expansion.

Direct Value Wholesale

In April 2021, ReCreation Marketing ("ReCreation"), a VIE for which we are considered the primary beneficiary, purchased 100% of the equity interest of Westhem Ventures LTD d/b/a Direct Value Wholesale ("DVW") for $3.9 million satisfied through $3.5 million paid in cash and $0.5 million in accrued consideration to be paid during 2021. DVW is Canadian distribution entity that operates in markets not primarily served by ReCreation. The acquisition expands ReCreation's markets in Canada.

Docklight Brands, Inc.

On April 19, 2021, we invested $8.7 million in Docklight Brands, Inc., a pioneering consumer products company with celebrated brands including Marley Natural® cannabis and Marley™ CBD. We have additional follow-on investment rights. As part of the investment, we have obtained exclusive U.S. distribution rights for Docklight's Marley™ CBD topical products.

Senior Secured Notes and 2021 Revolving Credit Facility

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. In connection with the Offering, we also entered into a new $25 million senior secured revolving credit facility (the "2021 Revolving Credit Facility") with the lenders party thereto (the "Lenders") and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the "Agent"). The 2021 Revolving Credit Facility provides for a revolving line of credit of up to $25.0 million. We used a portion of the proceeds from the issuance of the Senior Secured Notes to prepay all outstanding amounts under and terminate the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $130.0 million, and the transaction resulted in a $5.7 million loss on extinguishment of debt. Refer to the "Long-Term Debt" section for a more complete description of our Senior Secured Notes and 2021 Revolving Credit Facility.


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Premarket Tobacco Applications

We submitted Premarket Tobacco Applications ("PMTAs") covering 250 products to the FDA prior to the September 9, 2020 filing deadline. The PMTAs cover a broad assortment of products in the vapor category including multiple proprietary e-liquid offerings in varying nicotine strengths, technologies and sizes; proprietary replacement parts and components of open system tank devices through partnerships with two leading manufacturers for exclusive distribution of products in the United States; and a closed system e-cigarette, covering $0.7 million of inventory that was quarantined as of September 30, 2021. On September 14, 2021, the FDA issued a Marketing Denial Order ("MDO") for certain of the Company's proprietary e-liquid products subject of these PMTAs. The Company filed a Petition for Review in the Sixth Circuit Court of Appeals on September 23, 2021, followed by an Emergency Motion for a Stay Pending Review on September 30, 2021. On October 7, 2021, we were informed that the FDA had rescinded its September 14 MDO. We therefore withdrew both the Petition and Emergency Stay on October 8, 2021. The Rescission Letter indicated that the FDA had found additional relevant information that was not adequately assessed. The Rescission Letter further clarified that the FDA presently has no intention of initiating any regulatory enforcement action against the products.

Critical Accounting Policies and Uses of Estimates

Inventories

Inventories are stated at the lower of cost or net realizable value. Effective January 1, 2021, the Company changed its method of accounting for inventory using the last-in, first-out ("LIFO") method to the first-in, first-out ("FIFO") method. The Company applied this change retrospectively to all prior periods presented, which is discussed further in Note 6, "Inventories" in the Notes to the Consolidated Financial Statements included in this Quarterly Report. 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.

There have been no other 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 2020 Annual Report on Form 10-K.

Recent Accounting Pronouncements

Refer to Note 2, "Summary of Significant Accounting Policies," of Notes to Consolidated Financial Statements included in this Quarterly Report for a description of recently issued accounting pronouncements, including those recently adopted.


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Results of Operations

Comparison of the Three Months Ended September 30, 2021, to the Three Months Ended September 30, 2020

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


                                                             Three Months Ended September 30,
                                                            2021             2020        % Change
Consolidated Results of Operations Data:
Net sales
Zig-Zag products                                        $     42,234       $  35,973          17.4 %
Stoker's products                                             30,472          29,764           2.4 %
NewGen products                                               37,198          38,437          -3.2 %
Total net sales                                              109,904         104,174           5.5 %
Cost of sales                                                 55,635          55,867          -0.4 %
Gross profit
Zig-Zag products                                              23,703          21,263          11.5 %
Stoker's products                                             17,104          16,042           6.6 %
NewGen products                                               13,462          11,002          22.4 %
Total gross profit                                            54,269          48,307          12.3 %

Selling, general, and administrative expenses                 31,894          32,286          -1.2 %
Operating income                                              22,375          16,021          39.7 %
Interest expense, net                                          5,397           3,539          52.5 %
Investment income                                               (157 )            (3 )      5133.3 %
Gain on extinguishment of debt                                  (375 )             -            NM
Net periodic income, excluding service cost                        -           1,188        -100.0 %
Income before income taxes                                    17,510          11,297          55.0 %
Income tax expense                                             4,073           2,277          78.9 %
Consolidated net income                                       13,437           9,020          49.0 %
Net loss attributable to non-controlling interest                (31 )             -            NM

Net income attributable to Turning Point Brands, Inc. $ 13,468 $ 9,020 49.3 %

Net Sales: For the three months ended September 30, 2021, consolidated net sales increased to $109.9 million from $104.2 million for the three months ended September 30, 2020, an increase of $5.7 million or 5.5%. The increase in net sales was primarily driven by increased sales volume in the Zig-Zag Products segment.

For the three months ended September 30, 2021, net sales in the Zig-Zag Products segment increased to $42.2 million from $36.0 million for the three months ended September 30, 2020, an increase of $6.3 million or 17.4%. For the three months ended September 30, 2021, volume increased 17.0% and price/mix increased 0.4%. The increase in net sales was led by our Canadian business which benefited from the consolidation of ReCreation in the current year period. This growth was complemented by double-digit growth in U.S. rolling papers and our E-Commerce business.

For the three months ended September 30, 2021, net sales in the Stoker's Products segment increased to $30.5 million from $29.8 million for the three months ended September 30, 2020, an increase of $0.7 million or 2.4%. For the three months ended September 30, 2021, volume decreased 4.1% and price/mix increased 6.5%. The increase in net sales was driven by the continuing double-digit growth of Stoker's® MST offset by single-digit decline in loose-leaf chewing tobacco.

For the three months ended September 30, 2021, net sales in the NewGen products segment decreased to $37.2 million from $38.4 million for the three months ended September 30, 2020, a decrease of $1.2 million or 3.2%. The decrease in net sales was primarily the result of declines in the vape distribution businesses as a result of strong B2C orders during stay-at-home provisions in the prior year.

Gross Profit: For the three months ended September 30, 2021, consolidated gross profit increased to $54.3 million from $48.3 million for the three months ended September 30, 2020, an increase of $6.0 million or 12.3%. Gross profit as a percentage of revenue increased to 49.4% for the three months ended September 30, 2021, compared to 46.4% for the three months ended September 30, 2020 driven by increased margin in the NewGen Products and Stoker's Products segments.


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Table of Contents For the three months ended September 30, 2021, gross profit in the Zig-Zag Products segment increased to $23.7 million from $21.3 million for the three months ended September 30, 2020, an increase of $2.4 million or 11.5%. Gross profit as a percentage of net sales decreased to 56.1% of net sales for the three months ended September 30, 2021, from 59.1% of net sales for the three months ended September 30, 2020, as a result of the consolidation of ReCreation in the current year period which operates at lower margins than our traditional business.

For the three months ended September 30, 2021, gross profit in the Stoker's Products segment increased to $17.1 million from $16.0 million for the three months ended September 30, 2020, an increase of $1.1 million or 6.6%. Gross profit as a percentage of net sales increased to 56.1% of net sales for the three months ended September 30, 2021, from 53.9% of net sales for the three months ended September 30, 2020, primarily as a result of strong incremental margin contribution of MST.

For the three months ended September 30, 2021, gross profit in the NewGen products segment increased to $13.5 million from $11.0 million for the three months ended September 30, 2020, an increase of $2.5 million or 22.4%. Gross profit as a percentage of net sales increased to 36.2% of net sales for the three months ended September 30, 2021, from 28.6% of net sales for the three months ended September 30, 2020, primarily as a result of increased margins in the vape distribution businesses.

Selling, General, and Administrative Expenses: For the three months ended September 30, 2021, selling, general, and administrative expenses decreased to $31.9 million from $32.3 million for the three months ended September 30, 2020, a decrease of $0.4 million or 1.2%. Selling, general and administrative expenses in the three months ended September 30, 2021 included $1.8 million of stock options, restricted stock and incentives expense, $0.2 million of transaction income and $1.0 million of expense related to PMTA. Selling, general and administrative expenses in the three months ended September 30, 2020 included $0.8 million of stock option, restricted stock and incentives expense, $0.6 million of transaction costs and $5.3 million of expense related to PMTA. The increase in selling, general, and administrative expenses is the result of variable costs in our online businesses as well as increased shipping costs from PACT Act implementation for vape products and higher freight rates across all segments combined with the impact of the consolidation of ReCreation in the current year period.

Interest Expense, net: For the three months ended September 30, 2021, interest expense, net increased to $5.4 million, from $3.5 million for the three months ended September 30, 2020 as a result of the completion of the offering of the Senior Secured Notes and related refinancing of the 2018 First Lien Credit Facility which increased the Company's outstanding debt.

Investment Income: For the three months ended September 30, 2021, investment income increased to $0.2 million, from $0.0 million for the three months ended September 30, 2020.

Gain on Extinguishment of Debt: Gain on extinguishment of debt was $0.4 million for the three months ended September 30, 2021 related to the entire repayment of the $10 million Promissory Note from the acquisition of certain Durfort assets for a total payment of $9.6 million, compared to $0.0 million for the three months ended September 30, 2020.

Net Periodic Income: Net periodic income was $0.0 million for the three months ended September 30, 2021 compared to $1.2 million for the three months ended September 30, 2020.

Income Tax Expense: Our income tax expense of $4.1 million was 23.3% of income before income taxes for the three months ended September 30, 2021 and included a discrete tax benefit of $1.0 million relating to stock option exercises. Our effective income tax rate was 20.2% for the three months ended September 30, 2020 and included a discrete tax benefit $0.6 million from the shutdown of the pension plan.

Net Loss Attributable to Non-Controlling Interest: Net loss attributable to non-controlling interest was $0.0 million for the three months ended September 30, 2021 compared to $0.0 million for the three months ended September 30, 2020.

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, 2021 and 2020, was $13.5 million and $9.0 million, respectively.


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Table of Contents Comparison of the Nine Months Ended September 30, 2021, to the Nine Months Ended September 30, 2020

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


                                                             Nine Months Ended September 30,
                                                            2021            2020        % Change
Consolidated Results of Operations Data:
Net sales
Zig-Zag products                                        $    130,440      $  92,290          41.3 %
Stoker's products                                             93,096         87,081           6.9 %
NewGen products                                              116,652        120,455          -3.2 %
Total net sales                                              340,188        299,826          13.5 %
Cost of sales                                                172,685        162,152           6.5 %
Gross profit
Zig-Zag products                                              76,342         53,066          43.9 %
Stoker's products                                             51,142         46,424          10.2 %
NewGen products                                               40,019         38,184           4.8 %
Total gross profit                                           167,503        137,674          21.7 %

Selling, general, and administrative expenses                 95,900         95,436           0.5 %
Operating income                                              71,603         42,238          69.5 %
Interest expense, net                                         15,406         10,143          51.9 %
Investment income                                               (292 )         (128 )       128.1 %
Loss on extinguishment of debt                                 5,331              -            NM
Net periodic income, excluding service cost                        -            997        -100.0 %
Income before income taxes                                    51,158         31,226          63.8 %
Income tax expense                                            11,151          7,412          50.4 %
Consolidated net income                                       40,007         23,814          68.0 %
Net loss attributable to non-controlling interest               (598 )            -            NM

Net income attributable to Turning Point Brands, Inc. $ 40,605 $ 23,814 70.5 %

Net Sales: For the nine months ended September 30, 2021, consolidated net sales increased to $340.2 million from $299.8 million for the nine months ended September 30, 2020, an increase of $40.4 million or 13.5%. The increase in net sales was primarily driven by increased sales volume in the Zig-Zag Products segment.

For the nine months ended September 30, 2021, net sales in the Zig-Zag Products segment increased to $130.4 million from $92.3 million for the nine months ended September 30, 2020, an increase of $38.2 million or 41.3%. For the nine months ended September 30, 2021, volume increased 37.3% and price/mix increased 4.0%. The increase in net sales was led by double-digit growth in sales of our MYO cigar wraps business, which experienced COVID-related manufacturing disruption in the prior year period. This growth was complemented by our Canadian business which benefited from the consolidation of ReCreation in the current year period and double-digit growth in U.S. rolling papers.

For the nine months ended September 30, 2021, net sales in the Stoker's Products segment increased to $93.1 million from $87.1 million for the nine months ended September 30, 2020, an increase of $6.0 million or 6.9%. For the nine months ended September 30, 2021, volume increased 1.0% and price/mix increased 5.9%. The increase in net sales was driven by the continuing double-digit growth of Stoker's® MST offset by low single-digit decline in loose-leaf chewing tobacco.

For the nine months ended September 30, 2021, net sales in the NewGen products segment decreased to $116.7 million from $120.5 million for the nine months ended September 30, 2020, a decrease of $3.8 million or 3.2%. The decrease in net sales was primarily the result of declines in the vape distribution businesses as a result of strong B2C orders during stay-at-home provisions in the prior year.

Gross Profit: For the nine months ended September 30, 2021, consolidated gross profit increased to $167.5 million from $137.7 million for the nine months ended September 30, 2020, an increase of $29.8 million or 21.7%. Gross profit as a percentage of revenue increased to 49.2% for the nine months ended September 30, 2021, compared to 45.9% for the nine months ended September 30, 2020 driven by increased margin in the Zig-Zag Products segment as a result of the Durfort transaction in June 2020.


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Table of Contents For the nine months ended September 30, 2021, gross profit in the Zig-Zag Products segment increased to $76.3 million from $53.1 million for the nine months ended September 30, 2020, an increase of $23.3 million or 43.9%. Gross profit as a percentage of net sales increased to 58.5% of net sales for the nine months ended September 30, 2021, from 57.5% of net sales for the nine months ended September 30, 2020, as a result of increased MYO cigar wraps sales combined with margin increases as a result of the Durfort transaction in September 2020.

For the nine months ended September 30, 2021, gross profit in the Stoker's Products segment increased to $51.1 million from $46.4 million for the nine months ended September 30, 2020, an increase of $4.7 million or 10.2%. Gross profit as a percentage of net sales increased to 54.9% of net sales for the nine months ended September 30, 2021, from 53.3% of net sales for the nine months ended September 30, 2020, primarily as a result of strong incremental margin contribution of MST.

For the nine months ended September 30, 2021, gross profit in the NewGen products segment increased to $40.0 million from $38.2 million for the nine months ended September 30, 2020, an increase of $1.8 million or 4.8%. Gross profit as a percentage of net sales increased to 34.3% of net sales for the nine months ended September 30, 2021, from 31.7% of net sales for the nine months ended September 30, 2020, primarily as a result of increased margins in the vape distribution businesses.

Selling, General, and Administrative Expenses: For the nine months ended September 30, 2021, selling, general, and administrative expenses increased to $95.9 million from $95.4 million for the nine months ended September 30, 2020, an increase of $0.5 million or 0.5%. Selling, general and administrative expenses in the nine months ended September 30, 2021 included $6.0 million of stock options, restricted stock and incentives expense (including $1.1 million for accelerated vesting of options for a departing executive), $1.1 million of transaction expenses and $1.9 million of expenses related to PMTA. Selling, general and administrative expenses in the nine months ended September 30, 2020 included $2.0 million of stock option, restricted stock and incentives expense, $1.9 million of transaction costs and $14.4 million of expense related to PMTA. The increase in selling, general, and administrative expenses is the result of variable costs in our online businesses as well as increased shipping costs from PACT Act implementation for vape products and higher freight rates across all segments combined with the impact of the consolidation of ReCreation in the current year period.

Interest Expense, net: For the nine months ended September 30, 2021, interest expense, net increased to $15.4 million, from $10.1 million for the nine months ended September 30, 2020 as a result of the completion of the offering of the Senior Secured Notes and related refinancing of the 2018 First Lien Credit Facility which increased the Company's outstanding debt.

Investment Income: For the nine months ended September 30, 2021, investment income increased to $0.3 million, from $0.1 million for the nine months ended September 30, 2020.

Loss on Extinguishment of Debt: Loss on extinguishment of debt was $5.3 million for the nine months ended September 30, 2021 related primarily to the repayment of the 2018 First Lien Credit Facility, compared to $0.0 million for the nine months ended September 30, 2020.

Net Periodic Income: Net periodic income was $0.0 million for the nine months ended September 30, 2021 compared to $1.0 million for the nine months ended September 30, 2020.

Income Tax Expense: Our income tax expense of $11.2 million was 21.8% of income before income taxes for the nine months ended September 30, 2021 and included a discrete tax benefit of $6.2 million relating to stock option exercises. Our effective income tax rate was 23.7% for the nine months ended September 30, 2020 and included a discrete tax deduction $0.9 million relating to stock option exercises and a discrete tax benefit of $0.6 million from the shutdown of the pension plan.

Net Loss Attributable to Non-Controlling Interest: Net loss attributable to non-controlling interest was $0.6 million for the nine months ended September 30, 2021 compared to $0.0 million for the nine months ended September 30, 2020.

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, 2021 and 2020, was $40.6 million and $23.8 million, respectively.


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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 Revolving Credit Agreement contains financial covenants which use Adjusted EBITDA calculations, and many of the carve-outs from the negative covenants in the Senior Secured Notes Indenture and Revolving Credit Facility are based off of EBITDA, Adjusted EBITDA and related metrics.

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

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


                                                                Three Months Ended
(in thousands)                                                     September 30,
                                                                 2021          2020

Net income attributable to Turning Point Brands, Inc. $ 13,468 $ 9,020 Add: Interest expense, net

                                              5,397        3,539
Gain on extinguishment of debt                                      (375 )          -
Income tax expense                                                 4,073        2,277
Depreciation expense                                                 767          809
Amortization expense                                                 477          477
EBITDA                                                        $   23,807     $ 16,122
Components of Adjusted EBITDA
Other (a)                                                              -        1,188
Stock options, restricted stock, and incentives expense (b)        1,752          772
Transactional expenses (c)                                          (232 )        570
FDA PMTA (d)                                                         960        5,271
Adjusted EBITDA                                               $   26,287     $ 23,923


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(a) Represents non-cash pension expense (income) and foreign exchange hedging.

(b) Represents non-cash stock options, restricted stock, incentives expense and

Solace performance stock units.

(c) Represents the fees incurred for transaction expenses.

(d) Represents costs associated with applications related to FDA premarket

    tobacco product application ("PMTA").



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                                                                Nine Months Ended
(in thousands)                                                    September 30,
                                                                2021          2020

Net income attributable to Turning Point Brands, Inc. $ 40,605 $ 23,814 Add: Interest expense, net

                                            15,406       10,143
Loss on extinguishment of debt                                    5,331            -
Income tax expense                                               11,151        7,412
Depreciation expense                                              2,313        2,482
Amortization expense                                              1,431        1,304
EBITDA                                                        $  76,237     $ 45,155
Components of Adjusted EBITDA
Other (a)                                                             -          841
Stock options, restricted stock, and incentives expense (b)       6,015        1,987
Transactional expenses (c)                                        1,077        1,909
FDA PMTA (d)                                                        960       14,435
Adjusted EBITDA                                               $  84,289     $ 64,327


--------------------------------------------------------------------------------

(a) Represents non-cash pension expense (income) and foreign exchange hedging.

(b) Represents non-cash stock options, restricted stock, incentives expense and

Solace performance stock units.

(c) Represents the fees incurred for transaction expenses.

(d) Represents costs associated with applications related to FDA premarket

tobacco product application ("PMTA").

Liquidity and Capital Reserves

Our principal uses for cash are working capital, debt service, and capital expenditures. We believe our cash on hand, cash flows from operations and borrowing availability under our 2021 Revolving Credit Facility are adequate to satisfy our operating cash requirements for the foreseeable future. As of September 30, 2021, we had $130.6 million of cash on hand and have $21.4 million of availability under the 2021 Revolving Credit Facility.

Our working capital, which we define as current assets less cash and current liabilities, increased $15.2 million to $80.2 million at September 30, 2021, compared with $65.0 million at December 31, 2020. The increase was primarily due to the increase in inventories as a result of increased sales.

                                    As of
                       September 30,       December 31,
(in thousands)             2021                2020

Current assets        $       134,225     $      121,638
Current liabilities            54,056             56,629
Working capital       $        80,169     $       65,009


Cash Flows from Operating Activities

For the nine months ended September 30, 2021, net cash provided by operating activities was $49.6 million compared to net cash provided by operating activities of $33.2 million for the nine months ended September 30, 2020, an increase of $16.4 million, primarily due to higher net income resulting from increased sales.

Cash Flows from Investing Activities

For the nine months ended September 30, 2021, net cash used in investing activities was $52.2 million compared to net cash used in investing activities of $41.2 million for the nine months ended September 30, 2020, an increase of $11.1 million, primarily due to the purchase of investments in our MSA escrow account which reflects the change in restricted cash.


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Cash Flows from Financing Activities

For the nine months ended September 30, 2021, net cash provided by financing activities was $76.3 million compared to net cash used in financing activities of $16.9 million for the nine months ended September 30, 2020, an increase in cash flow of $93.2 million, primarily due to the net proceeds from the Senior Secured Notes partially offset by the repayment in full of the 2018 First Lien Term Loan in the first quarter of 2021 and the repurchase of common stock during 2021.

Dividends and Share Repurchase

The most recent dividend of $0.055 per common share was paid on October 8, 2021, to shareholders of record at the close of business on September 17, 2021.

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. The total number of shares repurchased for the three months ended September 30, 2021, was 125,000 shares for a total cost of $6.4 million and an average price per share of $51.16. $19.3 million remains available for share repurchases under the program at September 30, 2021.

Long-Term Debt


As of September 30, 2021, 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,       December 31,
                                              2021                2020
Senior Secured Notes                     $       250,000     $            -
2018 First Lien Term Loan                              -            130,000
Convertible Senior Notes                         172,500            172,500
Note payable - Promissory Note                         -             10,000
Note payable - Unsecured Loan                      7,485              7,485
Gross notes payable and long-term debt           429,985            319,985
Less deferred finance charges                     (8,947 )           (5,873 )
Less current maturities                           (7,485 )          (12,000 )

Notes payable and long-term debt $ 413,553 $ 302,112

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.


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

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

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

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.

The Indenture provides for customary events of default.

2021 Revolving Credit Facility

In connection with the Offering, we also entered into a new $25 million senior secured revolving credit facility (the "2021 Revolving Credit Facility") with the lenders party thereto (the "Lenders") and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the "Agent"). The 2021 Revolving Credit Facility provides for a revolving line of credit of up to $25.0 million. Letters of credit are limited to $10 million (and are a part of, and not in addition to, the revolving line of credit). We have not drawn any borrowings under the 2021 Revolving Credit Facility but do have letters of credit of approximately $3.6 million outstanding under the facility. The 2021 Revolving Credit Facility will mature on August 11, 2025 if none of our Convertible Senior Notes are outstanding, and if any Convertible Senior Notes are outstanding, the date which is 91 days prior to the maturity date of July 15, 2024 for such Convertible Senior Notes.

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

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

The 2021 Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The 2021 Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio (as defined in the 2021 Revolving Credit Agreement) of 5.50 to 1.00 (with a step down to 5.25 to 1.00 beginning with the fiscal quarter ending March 31, 2023) at the end of each fiscal quarter when extensions of credit under the 2021 Revolving Credit Facility and certain drawn and undrawn letters of credit (excluding (a) letters of credit that have been cash collateralized and (b) letters of credit having an aggregate face amount less than $5,000,000) in the aggregate outstanding exceeds 35% of the total commitments under the 2021 Revolving Credit Facility.

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


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The 2021 Revolving Credit Agreement provides for customary events of default.

2018 Credit Facility

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

Convertible Senior Notes

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

The Convertible Senior Notes are convertible into approximately 3,207,293 shares of our voting common stock under certain circumstances prior to maturity at a conversion rate of 18.593 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.78 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. The conversion price is adjusted periodically as a result of dividends paid by the us in excess of pre-determined thresholds of $0.04 per share. Upon conversion, we may pay cash, shares of our common stock or a combination of cash and stock, as determined by us at our discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of September 30, 2021.

We early adopted ASU 2020-06 effective January 1, 2021 on a retrospective basis to all periods presented. Under ASU 2020-06, the Company will account for the Convertible Senior Notes entirely as a liability and will no longer separately account for the Convertible Senior Notes with liability and equity components. See Note 2, "Summary of Significant Accounting Policies," in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion of the impact of the adoption of ASU 2020-06.

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 $53.78 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.

The indenture covering the Convertible Senior Notes contains customary events of default.

Promissory Note

On June 10, 2020, in connection with the acquisition of certain Durfort assets, we issued an unsecured subordinated promissory note ("Promissory Note") in the principal amount of $10.0 million (the "Principal Amount"), with an annual interest rate of 7.5%, payable quarterly, with the first interest payment due September 10, 2020. The Principal Amount was payable in two $5.0 million installments, with the first installment due 18 months after the closing date of the acquisition (June 10, 2020), and the second installment due 36 months after the closing date of the acquisition. The second installment was subject to reduction for certain amounts payable to us as a holdback. We prepaid all outstanding amounts under and terminated the Promissory Note in the third quarter of 2021 in the amount of $9.6 million. The transaction resulted in a $0.4 million gain on extinguishment of debt.

Unsecured Loan

On April 6, 2020, the 2018 First Lien Credit Facility was amended to allow for an unsecured loan under the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES"). On April 17, 2020, National Tobacco Company, L.P., a wholly-owned subsidiary of the Company, entered into a loan agreement with Regions Bank guaranteed by the Small Business Administration for a $7.5 million unsecured loan. The proceeds of the loan were received on April 27, 2020. The loan is scheduled to mature on April 17, 2022 and has a 1.00% interest rate. During 2021, we applied for forgiveness for the loan. On October 15, 2021, we received notice that our application for forgiveness was fully approved. We anticipate that the extinguishment of the unsecured loan will occur in the fourth quarter of 2021.


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Off-balance Sheet Arrangements

During the nine months ended September 30, 2021, the Company did not execute any forward contracts. At September 30, 2021, the Company had forward contracts for the purchase of €3.3 million and sale of €3.6 million outstanding. The fair value of the foreign currency contracts was based on quoted market prices and resulted in an asset of $0.0 million included in Other current assets and liability of $0.0 million included in Accrued liabilities at September 30, 2021. During 2020, the Company executed various forward contracts for the purchase of €19.7 million and sale of €21.4 million with maturity dates ranging from December 2020 to November 2021. At December 31, 2020, the Company had forward contracts for the purchase of €18.0 million and sale of €19.6 million outstanding. The fair value of the foreign currency contracts is based on quoted market prices and resulted in an asset of $0.4 million included in Other current assets and liability of $0.0 million included in Accrued liabilities at December 31, 2020. The Company had interest rate swap contracts for a notional amount of $70 million at December 31, 2020. The fair values of the interest rate swap contracts are based upon quoted market prices and resulted in a liability of $3.7 million as of December 31, 2020, included in other long-term liabilities. The Company terminated the interest rate swap agreement in conjunction with the prepayment of all outstanding amounts under to the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $3.6 million, and the transaction resulted in a $5.7 million loss recorded in the loss on extinguishment of debt. See Note 11, "Notes Payable and Long-Term Debt," in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion.

Inflation

While the rate of inflation has increased recently, we believe that any effect of inflation at current levels will be minimal. Historically, we have been able to increase prices at a rate equal to or greater than that of inflation and believe that we will continue to be able to do so for the foreseeable future. In addition, we have been able to maintain a relatively stable variable cost structure for our products due, in part, to our successful procurement with regard to our tobacco products and, in part, to our existing contractual agreement for the purchase of our premium cigarette papers. However, if the rate of inflation were to increase materially, it could have an adverse effect on our results of operations.

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