Turning Point Brands, Inc. — Q2 2017 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2017, compared with the same 2016 periods. The company sells smokeless tobacco, smoking products, and NewGen vapor products. Results include VaporBeast, acquired in November 2016, and Vapor Shark, consolidated from April 1, 2017; Turning Point Brands exercised its warrant to acquire Vapor Shark on June 30.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $72.1m | $51.6m | $138.9m | $101.4m |
| Gross profit / margin | $32.0m / 44.4% | $24.9m / 48.2% | $59.7m / 43.0% | $49.5m / 48.8% |
| Operating income | $13.6m | $10.8m | $24.4m | $21.7m |
| Net income attributable to Turning Point Brands | $7.4m | $0.8m | $9.3m | $3.0m |
| Diluted EPS | $0.38 | $0.05 | $0.48 | $0.22 |
Growth and margins. Sales grew 39.8% in Q2 and 36.9% in the first half, principally reflecting acquired NewGen businesses. NewGen sales were $23.0m in Q2 and $42.4m for the half, versus $3.1m and $6.7m, respectively, a year earlier. Smokeless sales rose 1.5% in Q2 and 5.6% for the half; smoking sales rose 0.9% in Q2 but declined 0.9% for the half. Overall gross margin contracted, which management attributed mainly to the lower distribution margins of VaporBeast. Operating income increased 26.5% in Q2 and 12.5% for the half.
Cash flow and liquidity. First-half operating cash flow was $6.4m, versus cash use of $9.1m in 2016; investing cash use was $0.3m and financing cash use was $7.2m. Cash declined by $1.2m to $1.7m. At June 30, current assets were $83.5m and current liabilities $54.8m, giving working capital of $28.7m, down from $37.3m at year-end 2016. Inventory was $67.8m, up from $62.2m.
Debt. In February, the company refinanced its prior facilities with a new $250m secured credit facility. At quarter-end, outstanding borrowings were $225.5m gross, including $25m drawn on the $50m revolver; long-term debt and notes reported net of financing costs and current maturities were $188.7m. The new facilities mature in 2022, with rates ranging from variable-rate first-lien borrowing to a fixed 11% second-lien term loan. The company reported compliance with its debt covenants. Management said operating cash flow and borrowing availability should meet operating cash requirements for the foreseeable future.
Material changes, outlook and risks
- Refinancing and unusual items: First-half results include a $6.1m loss on extinguishment of debt related to the February refinancing; the comparable 2016 period included a $2.8m debt-extinguishment loss. Interest expense declined to $9.0m from $15.3m for the first half. Q2 tax expense benefited from $1.6m of discrete stock-option tax benefits; the first-half benefit was $3.6m.
- Regulation and markets: California began a 27.3% excise tax on OTP products April 1; the rate increased to 65.08% on July 1. Management cited adverse effects on California MYO cigar-wrap sales. On July 28, the FDA postponed certain premarket filing deadlines for deemed combustible products to August 2021 and non-combustible products to August 2022; other deadlines were unchanged.
- Guidance: The filing provides no quantified earnings or revenue guidance. Management described growth initiatives and said it had no current plan to use its June S-3 registration for a potential offering of up to $200m of securities, alongside a potential secondary sale of approximately 12.8m shares by selling holders.
- Risks and contingencies: Key risks include tobacco-market decline, extensive and changing regulation and taxation, supplier and customer concentration, product liability, competition, acquisition integration, and substantial indebtedness and restrictive covenants. Standard General and affiliated parties hold significant influence; the company identifies itself as a controlled company. Management stated ordinary-course legal matters are not expected to have a material adverse effect. Disclosure controls were assessed as effective.
Important facts for investors to verify
- How much of reported NewGen growth and future profitability depends on VaporBeast and Vapor Shark, given the lower distribution margins and the timing of consolidation?
- Whether the California tax increase and other regulatory changes affect product volumes, pricing, and margins beyond the quarter.
- Debt-service capacity, covenant headroom, variable-rate exposure, and actual revolver availability; the filing estimates a 1% interest-rate change would alter annual pretax income by about $1.7m.
- Working-capital needs, particularly the increase in inventory, and the sustainability of positive operating cash flow.
- Potential dilution or market effects from the registered offering capacity, share sales, and controlling-stockholder arrangements.