Business context and reporting period
Turning Point Brands, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2016. The company sells other tobacco products (OTP), including smokeless tobacco, smoking products and NewGen vapor products; it does not sell cigarettes. Results are compared with the three months ended March 31, 2015. Amounts below are in millions unless stated otherwise.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $49.9 | $51.1 |
| Gross profit / margin | $24.6 / 49.4% | $24.7 / 48.3% |
| Operating income / margin | $10.9 / 21.9% | $12.0 / 23.5% |
| Net income | $2.2 | $3.4 |
| Diluted EPS | $0.27 | $0.41 |
| Operating cash flow | $1.0 | $6.8 |
| Capital expenditures | $0.5 | $0.3 |
| Cash at period end | $2.9 | $14.7 |
Gross margin increased despite lower gross profit. Adjusted EBITDA, a non-GAAP measure, was $12.5 versus $13.9. The filing cautions that this measure excludes expenses required under GAAP and is not a substitute for GAAP results.
At March 31, 2016, current assets were $62.9 and current liabilities $18.2, yielding working capital of $44.8, versus $42.8 at December 31, 2015. Inventory was $48.0, up from $44.3 at year-end. Reported notes payable and long-term debt, net of deferred financing charges and current maturities, was $290.5; the revolving facility had $1.0 outstanding, with $22.9 of additional borrowing availability. Stockholders’ deficit was $79.2.
Material changes versus the prior comparable period
- Sales declined 2.4%. Smokeless sales rose 4.7% to $18.3; Smoking sales declined 0.7% to $27.9; NewGen sales fell 33.6% to $3.6.
- Operating income fell 9.0% and net income fell 34.8%. SG&A increased 8.4% to $13.7, including higher salesforce compensation, moist-snuff merchandising and promotion, and legal costs associated with strategic initiatives and the IPO.
- Operating cash flow decreased by $5.9, primarily reflecting higher inventory and lower accrued expenses. Inventory increased $3.6 during the quarter; accrued expenses and other decreased $4.8.
- Segment operating income was mixed: Smoking Products increased to $7.5 from $7.0; Smokeless Products declined to $3.6 from $4.5; NewGen declined to $0.1 from $0.8.
Outlook, commentary, risks and unusual items
Management said operating cash flows and available ABL borrowing capacity were adequate for operating requirements for the foreseeable future. The filing gives no quantified revenue, earnings or cash-flow guidance. Management noted continued consumer movement from traditional retail to vape and accessory shops, which affected NewGen sales. It also cited elevated promotional activity in the cigarillo market.
After quarter-end, the May 2016 IPO sold 6.21 million voting shares at $10 per share, generating $62.1 million gross proceeds and approximately $58.2 million net proceeds. Proceeds and cash on hand funded IPO expenses and debt and warrant repurchases. The company reported that it retired all PIK Toggle Notes and 7% Senior Notes, repaid $20 million of Second Lien Term Loan principal, and retired Intrepid warrants and unit options. Management presented total debt of $304.5 million before these transactions and $209.6 million after them, including $20 million of cash repayment and $40.9 million of debt exchanged for equity. The post-IPO share count increased materially; the filing reports 16,927,737 voting and 938,857 non-voting shares outstanding after the transactions.
Key risks include substantial indebtedness and restrictive covenants, tobacco-product regulation and taxation (including FDA regulation and uncertainty for NewGen products), declining tobacco-product interest, supplier and retailer concentration, competition and illicit products, product liability, and the MSA escrow obligation. The company had approximately $31.9 million in MSA escrow deposits at March 31, 2016. Management reported compliance with debt covenants at quarter-end. It said ordinary-course legal matters were not expected to have a material adverse effect. The filing also notes a valuation allowance against certain deferred tax assets and that the effective tax expense does not bear the normal relationship to pretax income.
Management evaluated disclosure controls as effective as of March 31, 2016 and reported no material change in internal control over financial reporting during the quarter. The filing states interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Reconcile the post-IPO debt and cash position, including the distinction between face amounts, balance-sheet carrying values, cash repayments and debt exchanged for shares.
- Assess whether NewGen sales and margins stabilize after the sharp year-over-year decline and reported retail-channel shift.
- Track inventory growth and working-capital conversion given the reduction in operating cash flow.
- Review covenant headroom, borrowing-base availability and the effect of the IPO-related transactions on interest expense and leverage.
- Monitor dilution and per-share results following the IPO and debt-for-equity exchanges; management expected weighted-average shares and EPS to change significantly for the remainder of 2016.
- Evaluate regulatory, tax, product-liability and MSA escrow exposures, along with the company’s reliance on key suppliers, retailers and brand relationships.