Turning Point Brands, Inc. quarterly report, Q2 FY2018

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Turning Point Brands, Inc. — Q2 2018 Form 10-Q

Reporting period: Three and six months ended June 30, 2018; unaudited. Amounts below are in millions of dollars except per-share data. The company sells products across Smokeless, Smoking, and NewGen segments; reported net sales include federal excise taxes.

Financial performance and liquidity

  • Q2 revenue: $81.1 million, up 12.5% year over year. Smokeless sales rose 10.8%, Smoking 8.5%, and NewGen 18.7%.
  • Q2 profit: Gross profit was $35.8 million, up 11.8%; gross margin was 44.1%, versus 44.4%. Operating income was $14.8 million, up 8.4%. Net income attributable to TPB was $9.3 million, up 25.3%; basic/diluted EPS was $0.48/$0.47, versus $0.39/$0.38.
  • First-half results: Revenue was $155.0 million, up 11.6%; gross profit was $67.6 million, up 13.2%, and gross margin improved to 43.6% from 43.0%. Operating income was essentially flat at $24.5 million. Net income attributable to TPB was $12.4 million versus $9.3 million; basic/diluted EPS was $0.64/$0.62 versus $0.49/$0.48.
  • Cash flow: First-half operating cash flow was $6.0 million, compared with $6.4 million. Investing activities used $14.0 million, including the $6.5 million supplier loan and $4.8 million Vapor Supply acquisition; capital expenditures were $1.0 million. Financing activities provided $6.1 million. June 30 unrestricted cash was $3.4 million; restricted cash was $1.9 million.
  • Liquidity: Working capital was $53.3 million, up from $41.3 million at year-end. The $50 million revolving facility had $16.0 million drawn and $33.3 million available, net of a letter of credit.
  • Debt: Gross borrowings were $214.0 million: $158.0 million first-lien term debt, $40.0 million second-lien term debt, and $16.0 million revolver borrowings. The reported carrying value of notes payable and long-term debt was $186.3 million after deferred financing costs and current maturities. June 30 weighted average rates were 5.34% on the first-lien term loan, 6.05% on the revolver, and 9.05% on the second-lien loan. The company reported compliance with credit covenants.

Material changes and notable items

  • NewGen was the fastest-growing segment. First-half NewGen sales grew 26.3%, driven by VaporBeast, a full additional quarter of Vapor Shark results, and the April acquisition of Vapor Supply for $4.8 million. NewGen remained loss-making at the operating level: a $1.8 million first-half loss, versus a $1.4 million loss.
  • Q2 sales growth also reflected Stoker’s moist snuff and Zig-Zag papers and cigar wraps. The company continued to de-emphasize lower-margin cigar products and rationalize its MYO tobacco line.
  • SG&A rose 14.4% in Q2 and 22.2% in the first half, reflecting acquisition-related costs, added NewGen operations, legal expenses tied to anti-counterfeiting efforts, and departmental reorganization costs. A $0.5 million supplier receivable reserve reversal partially offset Q2 expenses.
  • In March, TPB refinanced its prior facility with a new credit facility. First-half interest expense fell to $7.2 million from $9.0 million, but refinancing generated a $2.4 million extinguishment loss. The prior-year first half included a $6.1 million extinguishment loss.
  • Management reported first-half Adjusted EBITDA of $30.9 million versus $29.4 million, a non-GAAP measure that excludes specified items.
  • TPB issued a $6.5 million secured loan to a vapor-products supplier, due May 2019 and bearing 15% annual interest, with quarterly interest payments beginning August 2018.

Outlook, risks, and contingencies

  • Management said operating cash flows and revolver availability were adequate for foreseeable operating requirements. The filing provides no quantified earnings or revenue guidance.
  • Interest-rate exposure remains relevant: $70 million of variable-rate debt was covered by swaps fixing LIBOR at 2.755% through December 2022. Management estimated a 1% rate increase would change annual pretax income by approximately $1.4 million.
  • Key risks include tobacco and NewGen regulation, taxation and FDA requirements; changing consumer demand; supplier and retailer concentration; competition and illicit products; debt and covenant restrictions; and product-liability exposure.
  • The company disclosed several lawsuits alleging injuries from malfunctioning vaporizer devices. It said it was evaluating the claims and defenses, including that it distributed but did not design or manufacture the products; outcomes could materially affect results. It reported no material changes to the risk factors in its 2017 Form 10-K.
  • MSA escrow assets had a fair value of $30.2 million and are restricted; the company said it stopped selling MSA-covered products in Q3 2017 and, absent a legislative change, would no longer have to make deposits. The filing also reported a roughly $0.3 million pension curtailment loss in Q2.

Important facts for investors to verify

  • How much reported sales and NewGen growth reflects acquisitions versus underlying organic growth, and whether NewGen can reach operating profitability.
  • The supplier’s ability to repay the $6.5 million loan, including collateral value and collection risk.
  • Debt levels, covenant headroom, scheduled amortization, and sensitivity to variable interest rates despite the $70 million swap coverage.
  • Cash conversion and working-capital needs, particularly inventory growth and the reliance on revolver borrowings to help fund investing activity.
  • Developments in vaporizer product-liability lawsuits, FDA rulemaking and compliance costs, and the availability or release of restricted MSA escrow assets.
  • The sustainability of earnings growth after considering acquisition-related and other adjustments included in Adjusted EBITDA.