Turning Point Brands, Inc. quarterly report, Q1 FY2021

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Turning Point Brands, Inc. — Q1 2021 Form 10-Q

Reporting period: Three months ended March 31, 2021; comparisons are with Q1 2020 unless otherwise noted. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.

Business context and results

Turning Point Brands manufactures, markets and distributes branded consumer products for adult consumers across Zig-Zag Products, Stoker’s Products and NewGen Products. Its brands include Zig-Zag, Stoker’s, Beech-Nut, Trophy, Nu-X and Solace, alongside vapor distribution platforms. The company reports distribution across more than 210,000 North American retail outlets.

  • Revenue: $107.6 million, up 18.7%. Growth came from all three segments, led by Zig-Zag.
  • Profitability: Gross profit was $53.3 million, up 28.6%; gross margin increased to 49.5% from 45.7%. Operating income was $24.3 million versus $9.0 million. Consolidated net income was $11.5 million; net income attributable to Turning Point Brands was $11.8 million, or $0.62 basic and $0.57 diluted per share, compared with $4.5 million and $0.23 basic and $0.22 diluted per share.
  • Segment sales: Zig-Zag $41.0 million (+41.8%); Stoker’s $29.3 million (+10.4%); NewGen $37.4 million (+6.0%). Zig-Zag’s growth reflected higher rolling-paper and MYO cigar-wrap sales; NewGen growth came from vape distribution and Nu-X.
  • Cash flow: Operating activities provided $24.2 million, versus $14.7 million. Investing activities used $15.8 million, including $14.9 million for MSA escrow investments. Financing activities provided $102.1 million, primarily reflecting note proceeds and repayment of the prior term loan. Unrestricted cash was $167.4 million at quarter-end; including restricted cash, total cash was $187.5 million.
  • Liquidity: Working capital, defined by management as current assets excluding cash less current liabilities, was $68.6 million, up from $65.0 million at year-end. The company reported $21.4 million of availability on its revolving facility.
  • Debt: Gross debt was $440.0 million and debt net of deferred financing costs and current maturities was $424.8 million. Debt included $250 million of 5.625% senior secured notes due 2026 and $172.5 million of 2.50% convertible senior notes due 2024. A $25 million revolver was undrawn, apart from approximately $3.6 million of letters of credit. The company stated it was in covenant compliance.

Material changes versus the prior period

  • Revenue rose 18.7%, gross profit rose 28.6%, and operating income increased to $24.3 million from $9.0 million. Gross-margin improvement was led by Zig-Zag, including higher MYO cigar-wrap sales and margins associated with the Durfort transaction.
  • SG&A fell 10.7% to $28.9 million. Management attributed the decrease mainly to $5.9 million of PMTA-related expense in Q1 2020, which did not recur in Q1 2021.
  • Interest expense increased 35.6% to $4.5 million, and the company recorded a $5.7 million loss on extinguishment of debt, both in connection with the refinancing. Adjusted EBITDA, a non-GAAP measure, was $28.0 million versus $17.8 million; the comparison includes the prior-year PMTA expense add-back.
  • In February 2021, the company issued $250 million of senior secured notes, used proceeds in part to repay and terminate its $130 million 2018 first-lien term loan, and entered a new $25 million revolving facility.
  • The company early adopted ASU 2020-06 retrospectively, changing convertible-note accounting and increasing reported debt while reducing annual interest expense by an estimated $6.7 million; diluted weighted-average shares are expected to increase by approximately 3.2 million. It also changed inventory accounting from LIFO to FIFO retrospectively; the filing reports no effect on Q1 2020 income from that change.

Outlook, risks and unusual items

  • Outlook: No specific revenue, earnings or cash-flow guidance is provided. Management said cash on hand, operating cash flows and revolver availability should meet operating cash requirements for the foreseeable future.
  • Regulatory exposure: The company submitted PMTAs covering 250 vapor products before the FDA deadline. Authorization, review timing and ongoing marketing permission are uncertain; unsuccessful or delayed applications could affect product availability, revenue and liquidity. Proposed or enacted flavor restrictions and other tobacco and vapor regulation also pose risks.
  • Other risks and contingencies: The filing highlights supplier concentration, product-liability claims involving tobacco and vapor products, litigation related to the SDI merger and franchise disputes. Management says it believes it has defenses, but cannot assure a favorable outcome. The company also identifies COVID-19-related operating and supply-chain uncertainty.
  • Unusual and subsequent items: The Q1 debt refinancing generated the $5.7 million extinguishment loss, including costs associated with terminating interest-rate swaps. On April 19, 2021, the company invested $8.7 million in Docklight Brands and obtained exclusive U.S. distribution rights for its Marley CBD topical products.
  • The company repurchased 119,031 shares under its program for $5.7 million during the quarter and reported $34.1 million remaining under the authorization. The most recent dividend was $0.055 per share, paid April 9, 2021.

Important facts for investors to verify

  1. Confirm the sustainability and drivers of strong segment growth and margin expansion, especially Zig-Zag’s results and the Durfort contribution.
  2. Track FDA review and authorization of the 250 PMTAs, as well as potential flavor restrictions and other regulatory actions.
  3. Assess refinancing costs, total debt, interest burden, revolver availability and covenant restrictions, including limits on dividends and share repurchases.
  4. Distinguish GAAP earnings from Adjusted EBITDA and review the effects of the debt-extinguishment loss, prior-year PMTA costs and ASU 2020-06 on comparisons and diluted shares.
  5. Monitor cash-flow quality: Q1 operating cash flow included a $14.9 million increase in accounts payable and a $12.5 million inventory cash use.
  6. Review pending litigation and the Docklight investment’s performance and follow-on investment rights.