Turning Point Brands, Inc. — Q1 2019 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2019, compared with Q1 2018. Turning Point Brands sells other tobacco products through Smokeless, Smoking, and NewGen segments; it does not sell cigarettes. Amounts below are in millions of dollars unless noted.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $91.6 | $73.9 | +23.9% |
| Gross profit / margin | $40.5 / 44.2% | $31.8 / 43.0% | +27.2%; +1.2 pts |
| Operating income | $12.0 | $9.7 | +23.5% |
| Net income | $6.6 | $3.0 | +116.4% |
| Diluted EPS | $0.33 | $0.15 | More than doubled |
| Operating cash flow | $14.0 | $8.4 | +$5.6 |
| Capital expenditures | $0.9 | $0.4 | — |
Net income growth also reflected the absence of the $2.4 million debt-extinguishment loss recorded in Q1 2018. Interest expense increased 5.5% to $3.9 million. Adjusted EBITDA, a non-GAAP measure, was $16.1 million versus $13.7 million.
Segments and drivers
- Smokeless: Sales rose 8.7% to $22.5 million, with reported volume growth of 4.8% and price/mix growth of 3.9%; Stoker’s moist snuff growth was partly offset by chewing-tobacco declines.
- Smoking: Sales fell 5.5% to $25.5 million. Lower volume, delayed Canadian paper orders related to packaging regulations, and declining low-margin cigar sales contributed; price/mix partly offset the decline.
- NewGen: Sales increased 66.3% to $43.6 million, primarily due to VaporBeast momentum and the inclusion of IVG and Vapor Supply. Gross margin rose to 34.2% from 29.2%, partly reflecting IVG’s higher-margin business-to-consumer operations. NewGen sales included $12.7 million to end-customers, up from $2.9 million.
Consolidated SG&A increased 28.8% to $28.4 million. The company cited $5.9 million of expense associated with Vapor Supply and IVG, $0.9 million of transaction costs including IVG earnout expense, $0.5 million of severance, $0.5 million of duplicative warehouse costs, and $0.4 million of Nu-X launch costs.
Liquidity, cash flow and debt
- Cash and cash equivalents were $1.7 million at quarter-end, excluding restricted cash. Cash flow statements report total cash, including restricted cash, of $5.8 million at quarter-end. MSA escrow deposits and investments had a fair value of $31.0 million.
- Working capital was $47.1 million, down from $48.1 million at year-end. Management attributed the decrease primarily to the IVG note becoming current.
- Operating cash flow was $14.0 million; investing activities provided $0.8 million, mainly reflecting a shift of MSA funds from investments to cash; financing activities used $14.7 million, including $12.0 million of revolver repayments and $0.9 million of dividends paid.
- Total debt obligations, including the revolver and IVG note, were $210.0 million, down from $224.0 million at December 31, 2018. The revolver balance was $14.0 million; reported remaining availability was $34.7 million after a letter of credit. The filing reports compliance with credit-facility covenants at March 31.
- Term loans carry variable rates; weighted average rates were 5.75% on the first-lien term loan and 9.48% on the second-lien term loan. A $70 million interest-rate swap fixed the rate on that notional amount. The filing estimates a 1% rate increase would affect annual pretax income by approximately $1.4 million.
Material changes, outlook and risks
- Acquisitions and accounting: IVG, acquired in 2018, contributed to NewGen growth; acquisition accounting remained preliminary. The company adopted lease accounting on January 1, 2019, recognizing $11.0 million of right-of-use assets and $11.2 million of lease liabilities, with no material effect on pretax income or cash flows.
- Subsequent VMR settlement: The company received $6.7 million in April 2019 in connection with a VMR distribution-agreement matter. After legal costs and reserves for anticipated returns, it expected to record a $5.5 million gain in Q2 2019.
- Outlook: The filing provides no numerical earnings or revenue guidance. Management said operating cash flow and revolver availability should be adequate for operating requirements for the foreseeable future. It also expected minimal inflation effects and no pension contributions in 2019, with approximately $0.2 million of postretirement-plan contributions.
- Principal risks: Tobacco and NewGen products face significant and evolving FDA, federal, state, and local regulation, taxes, and potential compliance costs. FDA premarket application deadlines described in the filing were postponed to August 2021 for combustible deemed products and August 2022 for non-combustible products, while the FDA was considering policy changes. Other risks include declining tobacco categories, supplier and retailer concentration, competition, NewGen market uncertainty, leverage and credit restrictions, and product-liability claims. The company disclosed several lawsuits alleging injuries from malfunctioning vaporizer devices; outcomes and potential exposure were not clear.
- The company said there were no material changes to the risk factors in its 2018 Form 10-K. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How much of NewGen’s growth reflects sustainable organic demand versus acquired businesses, and whether its margins continue to improve.
- Whether Smoking-segment declines, including Canadian order delays and lower cigar sales, persist.
- Debt reduction, interest costs, covenant headroom, and the effect of variable rates beyond the $70 million swap coverage.
- The status and potential financial consequences of vapor-product litigation and evolving FDA requirements.
- The final IVG purchase accounting and earnout costs, and whether the expected $5.5 million VMR gain was recognized in Q2 as anticipated.
- The composition and availability of liquidity, including restricted MSA funds, working-capital movements, and the sustainability of operating cash flow.