Turning Point Brands, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This annual filing also reports fourth-quarter results; it is not a standalone quarterly filing. Figures below are in U.S. dollars unless noted.
Business context
Turning Point Brands sells other tobacco products (OTP), excluding cigarettes, through three segments: Smokeless, Smoking, and NewGen. Its portfolio includes Stoker’s and Zig-Zag tobacco products and a growing vapor-products business. NewGen growth in 2018 reflected continued VaporBeast momentum and the acquisitions of Vapor Supply and International Vapor Group (IVG). The company reported approximately 210,000 North American retail points of distribution; more than 95% of 2018 net sales came from the U.S.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $332.7 million | $285.8 million |
| Gross profit / margin | $142.6 million / 42.9% | $125.0 million / 43.7% |
| Operating income | $48.5 million | $49.7 million |
| Net income attributable to TPB | $25.3 million | $20.2 million |
| Diluted EPS | $1.28 | $1.04 |
| Operating cash flow | $13.1 million | $29.7 million |
| Capital expenditures | $2.3 million | $2.0 million |
Fourth-quarter 2018 net sales were $94.3 million, gross profit $38.7 million, net income attributable to TPB $5.0 million, and diluted EPS $0.25. Fourth-quarter 2017 comparables were $73.6 million, $32.3 million, $3.5 million, and $0.18, respectively.
Annual sales increased 16.4%, led by NewGen, whose sales rose 43.7% to $131.1 million. Smokeless sales rose 6.5% to $90.0 million; Smoking sales rose 1.4% to $111.5 million. Gross profit increased 14.1%, but consolidated gross margin declined 0.8 percentage points, chiefly because a greater share of sales came from lower-margin NewGen distribution. Operating income fell 2.4% as SG&A rose 25.0% to $94.1 million, including acquisition-related costs and acquired businesses’ expenses.
Operating cash flow fell 56%, primarily due to a $20.7 million inventory cash use, including pre-tariff purchases. Working capital was $48.1 million versus $41.3 million; unrestricted cash was $3.3 million. At December 31, the company had $224.0 million of face-value debt, including $26.0 million drawn on its revolving facility, and $22.7 million of remaining revolver availability after letters of credit. Reported leverage ratio was 3.4x. The company reported compliance with credit-facility covenants. It paid a $0.045-per-share dividend in January 2019.
Management commentary, outlook, risks and contingencies
- Management’s stated strategy is to expand existing brands and distribution, launch products, build the NewGen platform (including planned CBD products through Nu-X and its CASH relationship), pursue acquisitions, and maintain an asset-light model. The filing provides no quantified financial guidance.
- In September 2018, TPB acquired IVG for adjusted consideration of approximately $23.8 million, including cash, shares, and a $4.0 million note; it also acquired Vapor Supply for $4.8 million. IVG earnouts could total up to $4.5 million; $1.5 million was recognized as 2018 expense.
- TPB’s VMR supplier was acquired by Juul. VMR stopped accepting orders in November 2018, although TPB could sell remaining V2 inventory; 2018 V2 sales were approximately $7.8 million. TPB was in discussions and mediation regarding potential contract-related payment, whose outcome and financial impact were uncertain.
- Key risks include extensive and evolving FDA, state and local regulation and taxation; nicotine and product-liability exposure; uncertainty in vapor and CBD markets; competition and changing consumer demand; reliance on a small number of key suppliers and licensed brands; tariffs and euro exchange movements; and substantial debt with restrictive covenants and variable interest rates. A 1% interest-rate change was estimated to affect annual pretax income by approximately $1.5 million.
- Several lawsuits alleged injuries from malfunctioning vaporizer devices and batteries; the company said it was evaluating the claims. It reported no pending smokeless tobacco product-liability cases. Its MSA escrow deposits totaled about $32.1 million at cost ($30.6 million fair value); management said no further deposits were expected under current legislation after its covered product line was discontinued.
- Unusual items included a $2.4 million loss on debt refinancing, $2.0 million in net SG&A reductions associated with repayment of a supplier loan and warrant compensation, and $1.1 million of tariffs included in NewGen cost of sales. The effective tax rate was 19.9%, helped by discrete tax benefits from stock-option exercises.
Most important facts for investors to verify
- Whether NewGen acquisition-driven growth can produce durable earnings and cash flow while consolidated gross margin remains under pressure.
- Inventory levels, cash conversion, and the cause and persistence of the sharp decline in operating cash flow.
- Debt balances, variable-rate exposure, covenant headroom, and the ability to meet scheduled debt service.
- Regulatory and market developments affecting vapor, CBD, tobacco products, and product authorizations, as well as the outcome of the VMR matter and vapor-device litigation.
- Integration and purchase-accounting updates for IVG and Vapor Supply; the filing said acquisition accounting was preliminary. Management excluded IVG from its internal-control assessment; the auditor issued an unqualified opinion on the financial statements but did not attest to internal-control effectiveness.