Turning Point Brands, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited consolidated results; amounts below are in millions unless stated otherwise.
Business context and financial performance
TPB sells smokeless tobacco, smoking products and NewGen products, including vapor and alternative products. Its core tobacco segments primarily sell through wholesalers; NewGen uses business-to-business and direct-to-consumer channels.
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $105.0 | $93.3 | $195.7 | $185.0 |
| Gross profit | $48.1 | $41.2 | $89.5 | $81.6 |
| Gross margin | 45.8% | 44.1% | 45.8% | 44.1% |
| Operating income | $17.3 | $19.9 | $26.4 | $32.0 |
| Net income | $9.2 | $13.2 | $12.5 | $19.8 |
| Diluted EPS | $0.47 | $0.66 | $0.63 | $0.99 |
| Adjusted EBITDA | $22.8 | $18.3 | $40.6 | $34.3 |
Q2 revenue grew 12.5%, with sales increasing across all segments. Smokeless sales rose 17.7%, Smoking 8.0% and NewGen 11.8%. For the first half, revenue rose 5.8%: Smokeless increased 17.6% and Smoking 10.7%, while NewGen declined 3.9%, primarily following the discontinuance of V2 in 2019. Q2 and first-half gross margins improved, but operating income and net income declined as higher SG&A and interest costs outweighed gross-profit growth.
SG&A increased 44.8% in Q2 and 27.1% for the first half. It included PMTA-related costs of $3.3 million in Q2 and $9.2 million year to date. Q2 2019 included a $5.5 million VMR vendor settlement gain, making the prior-year comparison less favorable for 2020. Adjusted EBITDA is a non-GAAP measure; its reconciliation adds back items including PMTA expense.
Cash flow, liquidity and debt
- Six-month operating cash flow was $17.5 million, down from $21.7 million. Investing cash outflow was $39.7 million, mainly reflecting the Durfort acquisition; financing cash outflow was $8.9 million.
- Unrestricted cash was $64.2 million at June 30, 2020, versus $95.3 million at year-end 2019. Working capital was $109.6 million, down from $133.4 million, primarily due to cash used for the acquisition. A separate $32.1 million MSA escrow balance is restricted.
- Gross debt principal was approximately $331.0 million; balance-sheet debt carrying value was $284.6 million long-term plus $12.0 million current maturities. The company had no revolver borrowings and reported $46.4 million of revolver availability. Management said it was in compliance with credit-facility covenants.
- Debt includes $141.0 million on the first-lien term loan, $172.5 million of 2.50% convertible notes due 2024, a $10.0 million Durfort promissory note at 7.5%, and a $7.5 million SBA-guaranteed unsecured loan at 1.0%. The term loan matures in 2023. Interest expense increased, in part from amortization of the convertible-note discount.
Material developments, outlook and risks
- In June, TPB acquired Durfort and Blunt Wrap assets and distribution rights for $47.8 million total consideration: $37.8 million cash and a $10.0 million note. The transaction included co-ownership of intellectual property for HTL wraps and cones and an exclusive U.S. distribution agreement expected to take effect within 120 days. Acquisition accounting was not complete at quarter-end.
- COVID-19 increased operating and safety costs and temporarily disrupted a Dominican Republic cigar-wrap supplier. TPB reported elevated online consumer sales and market-share gains, while in-person selling and product launches were affected; some planned price increases were delayed.
- The FDA PMTA filing deadline was extended to September 9, 2020. TPB expected to file by applicable deadlines but cautioned that applications may not succeed, rules may change, and some third-party vapor products might not remain available. Failure to maintain products or replace third-party offerings could hurt revenue and liquidity. Flavor restrictions and broader tobacco regulation remain material risks.
- Other risks include product-liability claims involving vapor products, a franchisee lawsuit, regulatory information requests, supplier concentration, tariffs, competition and debt obligations. No material changes to the previously disclosed risk factors were reported. The $32.1 million MSA escrow is restricted; TPB said it no longer sells products covered by the MSA and, absent a legislative change, expects no further deposits.
- No quantified earnings or revenue guidance was provided. Management said operating cash flows and available revolver capacity were adequate for foreseeable operating needs. On July 16, 2020, after quarter-end, TPB completed its SDI merger; the filing says it eliminated the controlling-shareholder structure and retired 245,234 TPB shares.
Important facts for investors to verify
- Progress, cost and regulatory status of PMTA submissions ahead of the September 9, 2020 deadline, including exposure to third-party vapor products.
- Whether NewGen sales and margins can recover or sustain growth, given first-half sales decline, tariffs and regulatory uncertainty.
- Cash generation and leverage after the Durfort purchase; confirm debt carrying value, principal payment schedule, covenant headroom and revolver availability.
- Durfort asset valuation, distribution-agreement commencement and acquisition integration results.
- Developments and potential financial exposure in vapor product-liability and franchisee litigation.
- Whether Adjusted EBITDA improvement is sustainable after considering PMTA add-backs and the prior-year VMR settlement gain.