Turning Point Brands, Inc. — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021. Unaudited results are compared with the corresponding 2020 periods. Amounts below are in millions of dollars unless noted.
Business context
Turning Point Brands manufactures, markets and distributes consumer products across Zig-Zag Products, Stoker’s Products and NewGen Products. Its portfolio includes rolling papers and cigar products, smokeless tobacco, and vapor, CBD and other products. The company reported that its products reached more than 210,000 North American retail outlets.
Financial performance and liquidity
| Metric | Q2 2021 | Q2 2020 | First half 2021 | First half 2020 |
|---|---|---|---|---|
| Net sales | $122.6 | $105.0 | $230.3 | $195.7 |
| Gross profit | $60.0 | $47.9 | $113.2 | $89.4 |
| Gross margin | 48.9% | 45.7% | 49.2% | 45.7% |
| Operating income | $24.9 | $17.2 | $49.2 | $26.2 |
| Net income attributable to TPB | $15.4 | $10.3 | $27.1 | $14.8 |
| Diluted EPS | $0.73 | $0.49 | $1.30 | $0.73 |
| Operating cash flow | Not stated separately for Q2 | $37.4 | $17.5 |
For the first half, capital expenditures were $2.2 million, implying operating cash flow less capital expenditures of approximately $35.2 million. The company reported $157.5 million of unrestricted cash at June 30, 2021; cash-flow disclosures also identify $14.9 million of restricted cash. Working capital, defined by the company as current assets less cash and current liabilities, was $69.4 million, up from $65.0 million at year-end 2020.
Gross debt was $440.0 million, including $250.0 million of 5.625% senior secured notes due 2026, $172.5 million of 2.50% convertible notes due 2024, and other notes. Reported notes payable and long-term debt, net of financing costs and current maturities, was $417.9 million. The new $25 million revolving facility was undrawn, with approximately $3.6 million of letters of credit outstanding and $21.4 million of availability. Management said cash, operating cash flows and revolver availability should meet operating needs for the foreseeable future. The company was in compliance with debt covenants at quarter-end.
Material changes versus the prior comparable periods
- Q2 sales grew 16.8%; first-half sales grew 17.7%. Zig-Zag was the main growth driver, while Stoker’s also grew and NewGen sales declined.
- Q2 gross margin increased to 48.9% from 45.7%; first-half margin rose to 49.2% from 45.7%. Management attributed much of the improvement to Zig-Zag product mix and higher margins following the 2020 Durfort transaction.
- Q2 net income attributable to TPB rose 49.2%; first-half net income rose 83.4%. First-half results included a $5.7 million loss on extinguishment of debt, while interest expense increased to $10.0 million from $6.6 million.
- First-half operating cash flow more than doubled to $37.4 million, although inventory growth used $12.0 million of cash.
- Segment performance was uneven: Q2 Zig-Zag sales rose 72.3%, Stoker’s rose 8.3%, and NewGen fell 10.0%. NewGen’s Q2 business-to-consumer online sales were $11.3 million versus $15.1 million a year earlier; the company reported no corporate-store sales in the period.
- The company refinanced its $130 million 2018 first-lien term loan with proceeds from the $250 million senior secured notes offering, increasing gross debt compared with year-end 2020. It also terminated associated interest-rate swaps.
Outlook, commentary, risks and unusual items
- No quantified revenue, earnings or cash-flow guidance was provided. Management described liquidity as adequate for the foreseeable future.
- Management cited volume growth in Zig-Zag and Stoker’s moist snuff, but noted ongoing declines in loose-leaf chewing tobacco and NewGen vapor distribution. Prior-year COVID-related manufacturing disruption and stay-at-home-driven NewGen orders affected comparisons; trade inventory build also pulled some Zig-Zag orders into the current quarter.
- Implementation of the PACT Act made vape-product delivery more difficult and costly. Higher freight rates and increased online-business variable costs also pressured expenses.
- The company had submitted FDA premarket applications covering 250 products by the September 2020 deadline. Approval is uncertain; FDA action, proposed flavor restrictions, state and local regulation, and third-party manufacturers’ compliance could affect product availability, revenue and costs.
- Disclosed legal exposures include a stockholder lawsuit concerning the SDI merger, product-liability cases involving vapor devices or e-liquids, and franchise-related disputes. Outcomes and potential losses were not clearly quantified.
- Unusual or significant items included $5.7 million of debt-extinguishment loss, $2.8 million of Q2 stock-option/restricted-stock/incentive expense (including $1.1 million for accelerated vesting tied to a departing executive), and $0.6 million of Q2 PMTA expense. Q2 SG&A also included $0.7 million of transaction expenses.
- Effective January 1, 2021, the company changed inventory accounting from LIFO to FIFO and applied the change retrospectively. It also early adopted convertible-debt accounting guidance retrospectively; management said this reduces annual interest expense by $6.7 million and increases diluted weighted-average shares by approximately 3.2 million.
- Subsequent to quarter-end, TPB acquired Unitabac assets for $9.6 million and invested $8 million in Old Pal through a convertible note. In April, it invested $8.7 million in Docklight and obtained U.S. distribution rights for Marley CBD topical products.
Most important facts for investors to verify
- Whether Zig-Zag’s exceptional growth, including the effect of trade inventory build and prior-year manufacturing disruption, is sustainable.
- NewGen trends, PACT Act-related shipping costs, and the status and potential outcomes of the company’s FDA applications and proposed product restrictions.
- Debt-service capacity and covenant headroom following the refinancing, including the convertible notes’ potential dilution and maturity timing.
- Cash-flow conversion and inventory levels, including the effect of inventory build and restricted MSA escrow funds on usable liquidity.
- Potential financial exposure from disclosed litigation and the results of the Unitabac, Docklight and Old Pal transactions.