Business context and reporting period
Turning Point Brands, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company sells other tobacco products through three segments: Smokeless, Smoking, and NewGen (including vapor products). Comparisons below are with the same 2016 periods unless noted. Dollar amounts are in millions unless stated otherwise.
Growth in NewGen chiefly reflects the acquisitions of VaporBeast and Vapor Shark; VaporBeast was included for the full nine-month period, and Vapor Shark was consolidated from April 1 and became wholly owned June 30.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $73.3 | $51.0 | $212.2 | $152.4 |
| Gross profit | $32.9 | $24.6 | $92.6 | $74.1 |
| Gross margin | 44.9% | 48.3% | 43.6% | 48.6% |
| Operating income | $14.4 | $11.9 | $38.8 | $33.6 |
| Net income | $7.4 | $6.8 | $16.1 consolidated; $16.7 attributable to TPB | $9.8 |
| Diluted EPS | $0.38 | $0.34 | $0.86 | $0.58 |
| Cash from operating activities | — | $20.4 | $(0.5) |
Q3 sales rose 43.9%, while gross profit rose 33.8%. Nine-month sales increased 39.2%, gross profit 24.9%, and operating income 15.5%. Nine-month Adjusted EBITDA, a non-GAAP measure, was $45.3 versus $39.0. The company reported a $6.1 debt-extinguishment loss in the 2017 nine-month period.
Q3 basic EPS was $0.39 versus $0.38. Q3 income tax expense was $3.1, including a $0.9 discrete tax benefit from stock-option exercises; the filing attributes $4.5 of nine-month tax benefits to option exercises. Nine-month EPS comparisons are affected by the May 2016 IPO and the resulting change in weighted-average shares.
Material changes and liquidity
- Segments: Q3 NewGen sales were $25.2 versus $3.3, primarily due to VaporBeast and Vapor Shark. Smokeless sales rose 12.6% to $21.3, led by Stoker’s; Smoking sales declined 6.6% to $26.9. Management cited promotional timing, continued cigar weakness, California excise taxes, and fewer shipping days for the Smoking decline.
- Margins and costs: Lower consolidated gross margin mainly reflected VaporBeast’s lower-margin distribution mix. SG&A increased 45.8% in Q3, primarily with acquired operations, strategic acquisition expenses, and sales and marketing investment. Interest expense declined to $4.0 in Q3 from $5.6, mainly after refinancing.
- Cash and working capital: Cash was $4.2 at September 30, 2017, versus $2.9 at year-end 2016. Nine-month operating cash flow was $20.4; investing used $0.8 and financing used $18.2, resulting in a $1.4 cash increase. Working capital was $36.5, down from $37.3 at year-end. The $30.9 MSA escrow asset is not ordinary operating cash and is subject to withdrawal restrictions.
- Debt: In February 2017, the company refinanced into a $250 million secured facility. September 30 principal balances totaled $214.6, including $15.6 drawn on the $50 million revolving facility; the balance-sheet carrying amount of notes and long-term debt was $187.5 after deductions for financing costs, current maturities, and the revolving balance. Debt includes variable-rate first-lien borrowings and a $55 million second-lien loan at 11%. The company reported covenant compliance at September 30. A 1% rate change would affect annual pretax income by approximately $1.7.
Outlook, risks, and unusual items
- No formal earnings or revenue guidance is provided. Management said operating cash flow and borrowing availability were expected to meet operating cash requirements for the foreseeable future.
- On November 9, 2017, the board approved a quarterly cash dividend of $0.04 per share, with the initial payment scheduled for December 15, 2017 to shareholders of record November 27.
- The FDA postponed application deadlines for covered products already marketed as of August 8, 2016, to August 8, 2021 for combustible products and August 8, 2022 for non-combustible products. The filing cautions that future FDA requirements and compliance costs could be significant, particularly for NewGen, cigars, and pipe tobacco; there is no assurance products will receive marketing authorizations.
- State tobacco taxes affected reported volumes: California’s 65.1% OTP tax took effect July 1, 2017, and Pennsylvania’s smokeless-products excise tax took effect in October 2016. Management also cited industry volume declines in chewing tobacco and ongoing tobacco-industry regulation and competition risks.
- Other risks include substantial indebtedness and restrictive debt covenants, reliance on suppliers and large retail customers, product liability and uncertain long-term vapor-product health effects, and acquisition integration. Standard General and related entities held approximately 52.9% of common stock; the company identified its controlled-company status and potential controlling-stockholder conflicts as risks. Management said ordinary-course legal proceedings were not expected to materially adversely affect the company.
Important facts for investors to verify
- How much of reported sales and earnings growth is attributable to acquired businesses versus underlying organic performance.
- Whether NewGen margins improve and whether the business can absorb future FDA compliance and product-authorization costs.
- Debt balances, interest-rate exposure, required amortization, covenant headroom, and actual availability under the revolving facility.
- The effect of California and other tobacco taxes on volumes, pricing, and market share across segments.
- The terms and ongoing affordability of the newly initiated dividend, given debt obligations and liquidity needs.