Turning Point Brands, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. The interim financial statements are unaudited; amounts below are in millions unless noted.
Business context and results
Turning Point Brands sells smokeless tobacco, smoking products and NewGen products, including vaping products. It acquired VaporBeast in November 2016, materially expanding NewGen; Q1 2017 includes a full quarter of VaporBeast results. The company reported net sales including federal excise taxes and FDA fees.
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $66.8 | $49.9 | +33.9% |
| Gross profit | $27.7 | $24.6 | +12.2% |
| Gross margin | 41.4% | 49.4% | Down 8.0 percentage points |
| Operating income | $10.8 | $10.9 | −1.4% |
| Interest expense | $4.9 | $8.5 | −41.7% |
| Loss on debt extinguishment | $6.1 | — | Refinancing-related |
| Net income | $1.9 | $2.2 | −16.0% |
| Diluted EPS | $0.10 | $0.27 | Comparability affected by IPO/share count changes |
Sales growth reflected volume growth of 30.1% and price/mix growth of 3.8%. Segment sales were $20.2 million for smokeless products (+10.4%), $27.2 million for smoking products (−2.5%) and $19.4 million for NewGen (+431.7%). NewGen’s growth was primarily attributable to VaporBeast. NewGen gross margin was 24.3%, down from 31.0%, reflecting VaporBeast’s lower distribution margins. Overall gross margin also declined, while SG&A increased 23.1% to $16.9 million, partly due to VaporBeast, strategic acquisition expenses and sales and marketing investments.
Adjusted EBITDA, a non-GAAP measure, was $13.6 million versus $12.5 million. The company reported that the 2017 tax benefit primarily reflected tax benefits from stock-option exercises; net income therefore did not track pretax results in the usual way.
Cash flow, liquidity and debt
- Cash from operations was negative $2.3 million, versus positive $1.0 million a year earlier; management attributed the decline primarily to lower earnings and increased working-capital needs.
- Capital expenditures were $0.4 million. Cash declined to $2.2 million from $2.9 million at year-end.
- Working capital was $26.4 million, down from $37.3 million at December 31, 2016, primarily reflecting increased short-term borrowings following refinancing.
- At March 31, gross debt was $231.6 million: $29.6 million drawn on the revolving facility, $200.0 million of term loans and a $2.0 million VaporBeast note. Balance-sheet long-term debt, net of financing charges and current maturities, was $192.0 million. The company also reported $2.2 million cash.
- On February 17, the company refinanced its prior facilities with a new secured facility of up to $250 million. The $50 million revolver had $29.6 million drawn at quarter-end. First-lien term borrowings were $145 million and the second-lien term loan was $55 million. The second-lien loan bears fixed interest of 11%; stated weighted average rates on first-lien borrowings were 4.2%–7.0%.
- The facilities mature in 2022 and include leverage and fixed-charge coverage covenants, restrictions on matters including additional debt and dividends, and scheduled amortization beginning June 2017. The company said it was in compliance with its debt covenants at March 31.
- Management stated that operating cash flows and revolver availability should be adequate for operating cash needs for the foreseeable future. A 1% interest-rate change was estimated to affect annual pretax income by approximately $1.7 million.
Material developments, outlook and risks
The $6.1 million debt-extinguishment loss arose from the February refinancing. Interest expense fell year over year, but the refinancing charge and lower operating income contributed to lower net income. The refinancing replaced higher-cost prior debt and extended maturities, but the company remained highly leveraged and had limited on-balance-sheet cash. A $30.5 million MSA escrow asset was held for tobacco-related obligations and should not be treated as ordinary available liquidity.
No quantified earnings or sales guidance was provided. Management cited the overall tobacco market’s declining sales as a risk, alongside increasing U.S. regulation, FDA oversight and uncertainty around NewGen product regulation and taxation. California’s OTP tax changes took effect after quarter-end: the existing 27.3% rate applied from April 1, 2017, with a further increase to an industry-estimated 62%–68% equalized rate scheduled for July 1. The filing noted adverse category sales effects associated with the initial MYO cigar-wrap tax impact.
Other cited risks include supplier and customer concentration, competition and illicit products, product liability, uncertain long-term health effects of vaping, acquisition integration and execution, and debt restrictions. Management believed ordinary-course legal matters would not have a material adverse effect; it reported no material changes to the risk factors in the 2016 Form 10-K. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Debt-facility terms, scheduled amortization, covenant headroom and availability under the revolver; the filing states compliance but does not quantify headroom.
- Whether VaporBeast’s sales growth can translate into improved NewGen margins and operating profit.
- The effects of California tax increases and evolving FDA rules on product volumes, pricing and compliance costs.
- Whether operating cash flow and working capital improve after the Q1 cash use and lower working-capital balance.
- The treatment and liquidity limitations of MSA escrow assets, and the sustainability of tax benefits related to stock-option exercises.