Turning Point Brands, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Unaudited results; comparisons are with the corresponding 2022 periods. Amounts below are in U.S. dollars unless noted.
Business context
TPB manufactures, markets and distributes branded consumer products through Zig-Zag Products, Stoker’s Products and Creative Distribution Solutions (CDS), formerly NewGen. In Q1 2023, CDS was designated an unrestricted subsidiary under the senior notes indenture. TPB reports products available through approximately 217,000 North American retail locations.
Financial performance
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Net sales | $105.6m (+2.6%) | $102.9m | $206.6m (+1.3%) | $203.8m |
| Gross profit / margin | $52.5m / 49.7% | $51.5m / 50.0% | $101.1m / 48.9% | $103.3m / 50.7% |
| Operating income | $20.5m | $18.1m | $38.4m | $37.4m |
| Net income attributable to TPB | $9.9m; diluted EPS $0.53 | $5.4m; diluted EPS $0.30 | $17.5m; diluted EPS $0.94 | $16.4m; diluted EPS $0.86 |
| Adjusted EBITDA | $25.3m | $24.7m | $46.1m | $50.0m |
| Operating cash flow | Not presented separately | Not presented separately | $27.5m | $7.1m |
Q2 operating margin was approximately 19.5%, versus 17.6% a year earlier; Q2 net margin attributable to TPB was approximately 9.4%, versus 5.3%. First-half Adjusted EBITDA fell about 7.8%, despite higher operating income and net income.
Segment trends and material changes
- Stoker’s Products: Q2 sales rose 7.3% to $36.1m; first-half sales rose 6.8% to $69.7m. Management cited growth, pricing and product mix in moist snuff tobacco (MST), lifting segment gross margin.
- Zig-Zag Products: Q2 sales increased 1.1% to $46.7m, but first-half sales declined 3.6% to $88.6m. Management cited U.S. rolling-paper and wrap weakness, including reduced trade inventory, partly offset by Canadian and other accessory growth. First-half segment gross profit declined 7.5%.
- CDS: Q2 sales decreased 1.3% to $22.8m and gross profit fell 12.5%; management cited lower vape distribution volumes and unfavorable product mix. First-half sales rose 3.4%, while gross profit fell 12.7%.
- Consolidated Q2 gross profit increased 2.0%, but gross margin declined 0.3 percentage points. For the first half, gross profit declined 2.1% and gross margin declined 1.8 percentage points, reflecting mix pressure in Zig-Zag and CDS.
Cash, debt and liquidity
- June 30 cash was $100.5m; working capital, defined by TPB as current assets excluding cash less current liabilities, was $109.5m, versus $109.9m at year-end 2022. Revolver availability was $23.6m; no revolver borrowings were outstanding, with approximately $1.4m of letters of credit.
- First-half operating cash flow was $27.5m, up from $7.1m, primarily due to timing of inventory and other working-capital changes. Investing cash outflow was $3.0m; financing cash outflow was $30.4m, including $27.4m for convertible-note repurchases. Cash declined $5.9m from year-end.
- Debt at June 30 comprised $250.0m of 5.625% secured notes due 2026 and $133.5m of 2.50% convertible notes due July 15, 2024; reported debt net of financing costs was $379.2m. TPB repurchased $29.0m principal of convertible notes in the first half, recording a $1.4m extinguishment gain.
- After quarter-end, the remaining convertible notes became current. Management stated it believes cash, free cash flow and financing alternatives will provide adequate liquidity to address the maturity. The company reported compliance with debt covenants at June 30.
- TPB paid a $0.065-per-share dividend on July 7, 2023. The repurchase program had $27.2m of authorization remaining at June 30.
Management commentary, risks and unusual items
- Q2 investment loss was $4.1m; first-half investment loss was $8.9m. The company recorded a $3.8m additional Q2 impairment of Docklight, bringing that investment to zero, and a $0.3m additional credit-loss allowance on its Old Pal note. First-half Docklight impairment was $6.5m.
- Management described inflation and reduced consumer purchasing power as pressures, while noting feasible price increases and relatively stable variable product costs. No formal financial guidance is provided in the supplied filing text.
- Regulatory uncertainty remains material, including FDA review and enforcement of product marketing applications, potential flavor restrictions, and state and local regulation. TPB also cites product-liability exposure, illicit competition, supplier concentration, retailer dependence and sensitivity to consumer spending.
- Disclosure controls were deemed ineffective at June 30, 2023, solely because of previously reported material weaknesses in IT access and change-management controls and financial-reporting risk assessment and segregation-of-duties controls. No resulting financial-statement misstatements were identified. Remediation work, including control redesign, specialist hiring and ERP implementation, was ongoing.
- A proposed stockholder-litigation settlement provides for insurers to fund $5.0m into escrow; plaintiff’s counsel may seek up to $1.5m in fees from that amount, with the balance payable to TPB. Court approval remained pending, and the company said the impact was not expected to be material. The filing also describes vapor-device injury suits and franchise arbitrations.
Important facts for investors to verify
- How TPB plans to repay, refinance or otherwise address the $133.5m convertible-note maturity in July 2024, and the resulting liquidity impact.
- Whether margin pressure and revenue trends in Zig-Zag and CDS persist, and whether Stoker’s growth can continue to offset them.
- Progress toward remediating the material weaknesses and the timing and risks of the new ERP implementation.
- FDA decisions, enforcement policies and state or local restrictions affecting TPB’s vapor and other regulated products.
- Final court approval and proceeds from the stockholder-litigation settlement, alongside outcomes and potential costs of other litigation.
- Further performance or impairment developments for investments, particularly the Old Pal convertible note and the now-fully-impaired Docklight investment.