Turning Point Brands, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing is an annual report, not a standalone quarterly filing; it also provides unaudited fourth-quarter results. Amounts below are in U.S. dollars.
Business context
Turning Point Brands sells other tobacco products and alternative products through three segments: Smokeless, Smoking, and NewGen. Its brands include Stoker’s, Zig-Zag, VaporBeast, and VaporFi. The company reported that more than 95% of 2019 sales were generated in the U.S. and that more than 80% of production, measured by net sales, was outsourced.
Financial results
| Metric | FY2019 | FY2018 |
|---|---|---|
| Net sales | $362.0 million | $332.7 million |
| Gross profit / margin | $136.7 million / 37.8% | $142.6 million / 42.9% |
| Operating income | $26.9 million | $48.5 million |
| Net income | $13.8 million | $25.3 million |
| Diluted earnings per share | $0.69 | $1.28 |
| Operating cash flow | $37.8 million | $13.1 million |
| Capital expenditures | $4.8 million | $2.3 million |
| Adjusted EBITDA | $67.3 million | $64.6 million |
Sales grew 8.8%, while cost of sales rose 18.5%. Reported gross profit included $23.0 million of restructuring costs, primarily inventory reserves, versus $2.9 million in 2018. Adjusted EBITDA is a non-GAAP measure and includes substantial adjustments; reported GAAP EBITDA declined to $38.6 million from $51.9 million.
Fourth-quarter 2019 sales were $80.2 million, gross profit was $12.3 million, and net loss was $12.3 million, compared with fourth-quarter 2018 sales of $94.3 million, gross profit of $38.7 million, and net income of $5.0 million. The fourth-quarter loss included $12.7 million of corporate and vapor restructuring costs after tax and a $0.8 million non-cash interest adjustment related to convertible debt.
Segment performance
- Smokeless: Sales increased 11.0% to $99.9 million and gross profit rose 12.4% to $52.3 million. Stoker’s moist snuff growth was partly offset by chewing-tobacco declines.
- Smoking: Sales decreased 2.5% to $108.7 million, while gross profit increased 4.1% to $59.4 million. Lower volumes reflected delayed Canadian paper orders and the company’s decision to de-emphasize lower-margin products.
- NewGen: Sales increased 16.9% to $153.4 million, but gross profit fell 35.7% to $25.1 million and the segment recorded a $20.6 million operating loss. Results included $23.2 million of restructuring expenses and $9.3 million of tariff expense; sales were also affected by the fourth-quarter vape-market disruption.
Liquidity, debt, and capital
At December 31, 2019, unrestricted cash was $95.3 million, restricted MSA escrow assets were $32.1 million, and working capital was $133.4 million, up from $48.1 million a year earlier. Operating cash flow increased substantially, partly reflecting a $21.0 million inventory cash inflow following inventory purchases in 2018. Investing cash flow was positive $15.9 million, principally due to changes in MSA escrow holdings; financing cash flow was positive $68.0 million, driven mainly by convertible-note proceeds.
Gross debt principal was $322.7 million, including $146.0 million under the first-lien term loan, $172.5 million of convertible senior notes, and a $4.2 million IVG note. Net debt carrying value after financing costs, discount, and current maturities was $269.0 million. The revolving facility had $46.3 million available. The 2.50% senior unsecured convertible notes mature in July 2024, have a conversion price of approximately $53.86 per share, and could convert into approximately 3.2 million shares under specified conditions. The company reported compliance with credit-facility covenants at year-end; a first-quarter 2020 amendment permitted certain PMTA-related EBITDA add-backs.
Material changes and unusual items
- In July 2019, the company issued $172.5 million of convertible notes, used part of the proceeds to repay its second-lien debt, and paid $20.5 million for capped-call transactions.
- The company acquired Solace for approximately $9.4 million in total consideration and acquired a 30% stake in Canadian distributor ReCreation Marketing for $1.0 million, with potential additional investment and ownership options.
- Management announced a review of strategic alternatives for third-party vaping distribution and a pivot toward proprietary brands. Restructuring included workforce reductions, warehouse consolidation, platform eliminations, and store closures.
- A $5.5 million net gain from settlement of a vendor contract reduced SG&A expense. A $2.0 million fair-value gain on the company’s CASH investment was recorded as investment income. Termination and curtailment of benefit plans contributed approximately $5.0 million of net periodic benefit income.
- The inventory valuation allowance increased to $21.5 million from $2.5 million, primarily reflecting NewGen products and increased regulation. Management reported no goodwill or intangible impairment in 2019, but cautioned that NewGen goodwill could be impaired if future revenues or assumptions weaken.
- The auditor issued an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were ineffective at year-end because of a material weakness in review of third-party valuation work for convertible debt. Management reported remediation completed and deemed effective as of March 6, 2020; the auditor did not provide an internal-control attestation.
Outlook, risks, and contingencies
The filing provides no quantified financial guidance. Management described growth plans focused on existing brands, international distribution, adjacent products, Nu-X alternatives, and selective acquisitions. The board authorized a $50 million share-repurchase program on February 25, 2020, subject to its discretion. A proposed SDI reorganization was under discussion, with no definitive agreement or completed transaction reported.
Key risks include FDA regulation and premarket authorization requirements for vapor products, including the then-applicable May 12, 2020 application deadline; flavor restrictions and changing federal, state, and local rules; uncertainty in the NewGen market; and tobacco-related taxes and declining tobacco consumption. The company also depends on a small group of suppliers and licensed brands, faces product-liability claims involving vapor products, and has substantial debt with restrictive covenants. The filing identifies pending vapor-related personal-injury claims and regulatory inquiries; the New York City proceeding involving IVG and VaporFi was settled on terms described as immaterial. The company stated that no future MSA escrow deposits were expected under then-current legislation; approximately $32.1 million remained restricted, with releases scheduled to begin in 2024.
Important facts for investors to verify
- Whether the vapor-business review, PMTA filings, and regulatory developments alter NewGen sales, margins, or required investment.
- How much of FY2019’s restructuring and inventory charges are non-recurring, and whether NewGen profitability recovers.
- Convertible-note accounting, interest expense, potential dilution, capped-call protection, and upcoming debt maturities and covenant headroom.
- Cash-flow sustainability after the 2019 inventory reduction and the availability and restrictions attached to cash and escrow assets.
- Progress in remediating the material weakness and any subsequent control or reporting issues.
- Outcomes of vapor-related litigation, supplier and trademark agreements, the proposed SDI reorganization, and the discretionary share-repurchase authorization.