Turning Point Brands, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited consolidated results. TPB sells smokeless tobacco, smoking products, and NewGen products, including vapor products; the filing describes it as a U.S. provider of other tobacco products.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $83.3 million | $73.3 million | $238.4 million | $212.2 million |
| Gross profit / margin | $36.2 million / 43.4% | $33.0 million / 45.0% | $103.8 million / 43.5% | $92.7 million / 43.7% |
| Operating income | $13.0 million | $14.4 million | $37.5 million | $38.9 million |
| Net income | $8.0 million | $7.4 million | $20.3 million attributable to TPB | $16.7 million attributable to TPB |
| Diluted EPS | $0.40 | $0.38 | $1.03 | $0.86 |
| Adjusted EBITDA | $16.5 million | $15.9 million | $47.4 million | $45.3 million |
Figures are rounded; Adjusted EBITDA is a non-GAAP measure. Q3 sales grew 13.6%, but operating income declined 10.2% as SG&A rose 25.5%, including acquisition-related costs and expenses from the expanded NewGen business. Lower taxes helped net income increase 7.9%. For the first nine months, sales rose 12.3% and TPB-attributable net income rose 21.7%; operating income fell 3.7%. The 2018 period included a $2.4 million debt-extinguishment loss, versus $6.1 million in 2017.
Segments and material changes
- Q3 segment sales: Smokeless $21.7 million (+2.1%); Smoking $28.1 million (+4.5%); NewGen $33.5 million (+33.1%). NewGen growth reflected VaporBeast momentum and contributions from Vapor Supply and one month of IVG.
- Q3 segment operating income: Smokeless $4.1 million versus $6.0 million; Smoking $8.6 million versus $9.0 million; NewGen $0.4 million versus a $0.5 million loss. NewGen’s share of sales increased while its margins remained below the legacy segments, weighing on consolidated gross margin.
- In April, TPB acquired Vapor Supply assets for $4.8 million. In September, it acquired IVG for adjusted consideration of $23.7 million, including $14.4 million cash, $5.3 million in shares, and a $4.0 million seller note; up to $4.5 million of additional earnouts was contemplated. Purchase accounting remained preliminary.
- After quarter-end, VMR’s new owner, Juul Labs, informed TPB on November 6 that it would stop accepting orders for V2 products. TPB reported $5.5 million of V2 sales in the first nine months and said inventory could support sales through Q1 2019; replacement initiatives were not quantified.
Cash flow, liquidity, and debt
- Operating cash flow was $1.0 million for the first nine months, down from $20.4 million. Management attributed the decrease mainly to inventory growth, including pre-tariff purchases. Investing cash use was $21.9 million, primarily reflecting acquisitions; financing provided $16.7 million, including revolver borrowings.
- Cash at September 30 was $1.6 million unrestricted and $1.4 million restricted. Working capital was $48.1 million, compared with $41.3 million at year-end 2017. Inventory was $89.4 million, up from $63.3 million.
- Gross borrowings were $230 million: $156 million first-lien term loan, $40 million second-lien term loan, $30 million revolver, and $4 million IVG note. Net debt carrying value, after financing costs and current maturities, was $188.5 million; the balance sheet separately reports the $30 million revolver as current debt. Revolver availability was $19.5 million after a letter of credit.
- The March 2018 refinancing replaced the prior facility; TPB recorded a $2.4 million extinguishment loss. Facilities have variable rates and maturities in 2023–2024. Interest-rate swaps cover $70 million of debt and fix LIBOR at 2.755% through December 2022. TPB said it was in compliance with financial and restrictive covenants and considered cash flows and borrowing availability adequate for foreseeable operating requirements.
- The filing gives inconsistent September 30 weighted-average rates in different sections: the debt note reports 5.49%, 6.36%, and 9.15% for first-lien term, revolver, and second-lien term debt; MD&A reports 5.34%, 6.05%, and 9.05%, respectively.
Outlook, risks, and unusual items
- No quantified company-wide revenue or earnings guidance is provided. Management expects to replace V2 sales with new initiatives after available inventory is sold, but provides no forecast for replacement timing or volume.
- Key risks include tobacco and vapor-product regulation and taxation, FDA requirements and compliance costs, changing NewGen markets, supplier concentration, retailer relationships, competition, indebtedness and restrictive covenants, and product liability. TPB disclosed several lawsuits alleging injuries from malfunctioning vaporizer devices; outcomes could materially affect results or cash flows.
- TPB reported that it no longer sold products covered by the MSA from Q3 2017 and, absent legislative changes, expected no further MSA escrow deposits. Escrow investments had a $29.9 million fair value, including $2.1 million of gross unrealized losses.
- The quarterly dividend was $0.04 per share, paid October 12, 2018, subject to credit-facility restrictions. A supplier repaid a $6.5 million loan in September and paid a $1.0 million early-termination fee, recorded as a reduction to SG&A.
Investor verification priorities
- Reconcile the conflicting debt interest-rate disclosures and assess variable-rate exposure, hedging coverage, covenant headroom, and required debt service.
- Evaluate the sustainability and cash conversion of reported earnings given $1.0 million operating cash flow and the $26.1 million increase in inventory since year-end.
- Separate organic NewGen growth from acquisition contributions, and monitor IVG and Vapor Supply integration, preliminary purchase accounting, and earnout obligations.
- Assess the lost V2 supply relationship, replacement-product execution, and the possible financial effects of vaporizer litigation and regulatory changes.
- Review the limitations and exclusions in Adjusted EBITDA and the restrictions governing future dividends and other payments.