Turning Point Brands, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Unaudited results for the three months ended March 31, 2018, compared with Q1 2017. Turning Point Brands sells other tobacco products across Smokeless, Smoking, and NewGen segments; it does not sell cigarettes. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 / prior date |
|---|---|---|
| Net sales | $73.9 | $66.8 |
| Gross profit / margin | $31.8 / 43.0% | $27.7 / 41.4% |
| Operating income / margin | $9.7 / 13.2% | $10.8 / 16.2% |
| Net income | $3.0 | $1.9 |
| Diluted EPS | $0.15 | $0.10 |
| Operating cash flow | $8.4 | $(2.3) |
| Capital expenditures | $0.4 | $0.4 |
| Unrestricted cash | $3.8 at March 31 | $2.6 at December 31, 2017 |
| Working capital | $46.3 at March 31 | $41.3 at December 31, 2017 |
| Gross debt | $202.0 at March 31 | $205.6 at December 31, 2017 |
Net sales rose 10.7%. Segment sales were Smokeless $20.7 million (+2.5%), Smoking $27.0 million (-0.7%), and NewGen $26.2 million (+35.3%). Adjusted EBITDA, a company-defined non-GAAP measure, was $13.7 million versus $13.6 million; the filing cautions it is not a substitute for GAAP results.
Gross margin improved, primarily due to a favorable LIFO impact. SG&A increased 31.2% to $22.1 million, contributing to lower operating income despite sales growth. Interest expense declined to $3.7 million from $4.9 million. Cash from operations improved mainly due to working-capital movements, including lower inventories and higher accounts payable; accrued liabilities were a cash use.
Debt at quarter-end comprised $160 million first-lien term debt, $40 million second-lien term debt, and a $2 million VaporBeast note. The $50 million revolving facility had no borrowings outstanding. The balance sheet reports $188.2 million of notes payable and long-term debt after deferred financing costs and current maturities. Restricted MSA escrow deposits of $30.3 million are not ordinary available cash.
Material changes versus prior period
- NewGen sales and gross profit grew substantially, reflecting Vapor Shark’s inclusion and growth in existing stores; NewGen remained loss-making at the operating level, with a $1.5 million operating loss versus $0.7 million.
- Smokeless operating income increased to $4.5 million from $3.6 million. Smoking operating income fell to $6.9 million from $8.0 million as gross profit declined.
- On March 7, 2018, the company refinanced its prior credit facilities with a new $250 million facility. The refinancing generated a $2.4 million extinguishment loss; the comparable 2017 quarter included a $6.1 million loss from that year’s refinancing.
- The company adopted Topic 606 revenue accounting; it reported no effect on revenue timing, revenue amount, or net income.
Outlook, commentary, risks, and unusual items
- No specific revenue, earnings, or cash-flow guidance was provided. Management said operating cash flows and borrowing availability were adequate for foreseeable operating requirements.
- The company entered $70 million of interest-rate swaps fixing LIBOR at 2.755% through December 2022. Management estimated that a 1% interest-rate increase would affect annual pretax income by approximately $0.6 million. The company reported compliance with credit covenants at March 31.
- Credit agreements impose leverage and fixed-charge covenants and restrict, subject to exceptions, dividends, additional debt, asset sales, and investments. Dividends are also subject to credit-facility restrictions; the most recent $0.04-per-share quarterly dividend was paid April 13, 2018.
- Key risks include tobacco and NewGen regulation, potential FDA compliance costs, product-liability litigation involving malfunctioning vaporizers, supplier and retailer concentration, competition, and indebtedness. Several vaporizer injury lawsuits are pending; the company says it distributed rather than designed or manufactured the products and is evaluating claims and defenses.
- The company held approximately $30.3 million in MSA escrow at fair value. It stated it no longer sells products covered by the MSA and, absent legislative change, expects no further required deposits. Escrow investments had $1.7 million in gross unrealized losses at quarter-end.
- After quarter-end, on April 30, the company acquired assets of Vapor Supply and affiliates for $4.8 million cash; purchase-price allocation was still in progress. The CFO resigned March 13 and a new CFO was appointed; management said the change did not materially affect internal financial-reporting controls.
Important facts for investors to verify
- Whether NewGen growth can translate into operating profitability, and how much reflects acquired versus organic performance.
- Debt repayment capacity, covenant headroom, refinancing terms, and the effect of variable rates despite the $70 million hedge.
- Cash conversion and working-capital sustainability, including the availability of cash held in MSA escrow.
- Potential costs or outcomes from FDA rules, vaporizer litigation, and other tobacco-related regulation.
- Vapor Supply acquisition valuation, integration results, and the permitted capacity and conditions of the revolving credit facility.