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(Registrant’s telephone number, including area code)
Former name, former address and former fiscal year, if changed since last report: not applicable
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon Stock, $0.01 par value
iTPB
iNew York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☐
iAccelerated filer
☑
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging growth company
i☑
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act i☑
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☑
At July 20, 2021, there were i18,924,110 shares outstanding of the registrant’s voting common stock, par value $0.01 per share.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements may generally be identified by the use of words such as “anticipate,”“believe,”“expect,”“intend,”“plan,” and “will” or, in each case, their negative, or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts. By their nature, forward-looking statements involve risks and uncertainties because they relate to events, and depend on circumstances, that may or may not occur in the future. As a result, actual events may differ materially from those expressed in, or suggested by, the forward-looking statements. Any forward-looking statement made by Turning Point Brands, Inc. (“TPB”), in this Quarterly Report on Form 10-Q speaks only as of the date hereof. New risks and uncertainties come up
from time to time, and it is impossible for TPB to predict these events or how they may affect it. TPB has no obligation, and does not intend, to update any forward-looking statements after the date hereof, except as required by federal securities laws. Factors that could cause these differences include, but are not limited to:
•
declining sales of tobacco products, and expected continuing decline of sales, in the tobacco industry overall;
•
our dependence on a small number of third-party suppliers and producers;
•
the possibility that we will be unable to identify or contract with new suppliers or producers in the event of a supply or product disruption;
•
the possibility that our licenses to use certain brands or trademarks will be terminated, challenged or restricted;
•
failure to maintain consumer brand recognition and loyalty of our customers;
•
our reliance on relationships with several large retailers and national chains for distribution of our products;
•
intense competition and our ability to compete effectively;
•
competition from illicit sources and the damage caused by illicit products to brand equity;
•
contamination of our tobacco supply or products;
•
substantial and increasing U.S. regulation;
•
regulation of our products by the FDA, which has broad regulatory powers;
•
many of our products contain nicotine, which is considered to be a highly addictive substance;
•
requirement to maintain compliance with master settlement agreement;
•
possible significant increases in federal, state and local municipal tobacco- and vapor-related taxes;
•
uncertainty and continued evolution of regulation of our NewGen and cigar products;
•
our products are subject to developing and unpredictable regulation, such as court actions that impact obligations;
•
increase in state and local regulation of our NewGen products has been proposed or enacted;
•
increase in tax of our NewGen products could adversely affect our business;
•
sensitivity of end-customers to increased sales taxes and economic conditions;
•
possible increasing international control and regulation;
•
failure to comply with environmental, health and safety regulations;
•
imposition of significant tariffs on imports into the U.S.;
•
the scientific community’s lack of information regarding the long-term health effects of certain substances contained in some of our products;
•
infringement on or misappropriation of our intellectual property;
•
third-party claims that we infringe on their intellectual property;
•
significant product liability litigation;
•
the effect of the COVID-19 pandemic on our business;
•
our amount of indebtedness;
•
the terms of our indebtedness, which may restrict our current and future operations;
•
our loss of emerging growth status on December 31, 2021 and ability to comply with the additional requirements applicable to non-emerging growth companies;
•
reduced disclosure requirements applicable to emerging growth companies may make our common stock less attractive to investors, potentially decreasing our stock price;
•
our certificate of incorporation and bylaws, as well as Delaware law and certain regulations, could discourage or prohibit acquisition bids or merger proposals, which may adversely affect the market price of our common stock;
•
our certificate of incorporation limits the ownership of our common stock by individuals and entities that are Restricted Investors. These restrictions may affect the liquidity of our common stock and may result in Restricted Investors (as defined in our Certificate of Incorporation) being required to sell or redeem their shares at a loss or relinquish their voting, dividend and distribution rights;
future sales of our common stock in the public market could reduce our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us;
•
we may issue preferred stock whose terms could adversely affect the voting power or value of our common stock;
•
our business may be damaged by events outside of our suppliers’ control, such as the impact of epidemics (e.g., coronavirus), political upheavals, or natural disasters;
•
our reliance on information technology;
•
cybersecurity and privacy breaches;
•
failure to manage our growth;
•
failure to successfully integrate our acquisitions or otherwise be unable to benefit from pursuing acquisitions;
•
fluctuations in our results;
•
exchange rate fluctuations;
•
adverse U.S. and global economic conditions;
•
departure of key management personnel or our inability to attract and retain talent; and
•
failure to meet expectations relating to environmental, social and governance factors.
Accounts receivable, net of allowances of $i143 in 2021 and $i150
in 2020
i5,814
i9,331
Inventories
i99,010
i85,856
Other current assets
i25,809
i26,451
Total current assets
i288,107
i163,403
Property, plant, and equipment, net
i16,291
i15,524
Deferred income taxes
i-
i610
Right of use assets
i16,607
i17,918
Deferred financing costs, net
i441
i641
Goodwill
i162,768
i159,621
Other intangible assets, net
i78,468
i79,422
Master Settlement Agreement (MSA) escrow deposits
i31,819
i32,074
Other assets
i34,898
i26,836
Total assets
$
i629,399
$
i496,049
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$
i11,159
$
i9,201
Accrued liabilities
i37,495
i35,225
Current portion of long-term debt
i12,485
i12,000
Other current liabilities
i104
i203
Total current liabilities
i61,243
i56,629
Notes payable and long-term debt
i417,935
i302,112
Deferred income taxes
i1,165
i-
Lease liabilities
i14,788
i16,117
Other long-term liabilities
i-
i3,704
Total liabilities
i495,131
i378,562
Commitments and contingencies
i
i
Stockholders’ equity:
Preferred stock; $ii0.01/
par value; authorized shares ii40,000,000/; issued and outstanding shares -iiii0///-
i-
i-
Common stock, voting, $ii0.01/
par value; authorized shares, ii190,000,000/;
i19,616,224 issued shares and i18,923,523 outstanding shares
at June 30,2021, and i19,532,464 issued shares and i19,133,794
outstanding shares at December 31,2020
i196
i195
Common stock, nonvoting, $ii0.01/
par value; authorized shares, ii10,000,000/;
issued and outstanding shares -iiii0///-
i-
i-
Additional paid-in capital
i105,460
i102,423
Cost of repurchased common stock (i692,701 shares at June 30, 2021 and i398,670
shares at December 31, 2020)
(i24,277
)
(i10,191
)
Accumulated other comprehensive income (loss)
i279
(i2,635
)
Accumulated earnings
i48,647
i23,645
Non-controlling interest
i3,963
i4,050
Total stockholders’ equity
i134,268
i117,487
Total liabilities and stockholders’ equity
$
i629,399
$
i496,049
The accompanying notes are an integral part of the consolidated financial statements.
(dollars in thousands, except where designated and per share data)
i
Note 1. Description of Business and Basis of Presentation
Description of Business
Turning Point Brands, Inc. and its subsidiaries (collectively referred to herein as the “Company,”“we,”“our,” or “us”) is a leading manufacturer, marketer and distributor of branded consumer products with active ingredients. The Company sells a wide range of products to adult consumers consisting of staple products with its iconic brands Zig-Zag® and Stoker’s® to its next generation products to fulfill evolving consumer preferences. The Company operates in ithree
segments: (i) Zig-Zag Products, (ii) Stoker’s Products, and (iii) NewGen Products. Its ithree focus segments are led by its core, proprietary brands – Zig-Zag® in the Zig-Zag Products segment; Stoker’s® along with Beech-Nut® and Trophy® in the Stoker’s Products segment; and Nu-XTM,
Solace® along with its distribution platforms (Vapor Beast®, VaporFi® and Direct Vapor®) in the NewGen Products segment. The Company’s products are available in more than i210,000 retail outlets in North America.
Basis of Presentation
i
The accompanying unaudited interim, consolidated financial statements have been prepared in accordance with the accounting practices described in the Company’s audited, consolidated financial statements as of and for the year ended December 31, 2020. In the opinion of management, the unaudited, interim, consolidated financial statements included herein contain all adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company for the periods indicated. Such adjustments, other than nonrecurring adjustments separately disclosed, are of a normal and recurring nature. The operating results for interim periods are not necessarily indicative of results to be expected for
a full year or future interim periods. The unaudited, interim, consolidated financial statements should be read in conjunction with the Company’s audited, consolidated financial statements and accompanying notes as of and for the year ended December 31, 2020. The accompanying interim, consolidated financial statements are presented in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, accordingly, do not include all the disclosures required by generally accepted accounting principles in the United States (“GAAP”) with respect to annual financial statements.
i
Note 2. Summary of Significant Accounting Policies
i
Consolidation
The consolidated financial statements include the accounts of the Company, its subsidiaries, all of which are wholly-owned, and variable interest entities (“VIEs”) for which the Company is considered the primary beneficiary. All significant intercompany transactions have been eliminated.
i
Revenue Recognition
The Company recognizes revenues in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (Topic 606), which includes excise taxes and shipping and handling charges billed to customers, net of cash discounts for prompt payment, sales returns and incentives, upon delivery of goods to the customer – at which time the Company’s performance obligation is satisfied - at an amount that the Company expects to be entitled to in exchange for those goods in accordance with the five-step analysis outlined in Topic 606: (i) identify the contract
with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations, and (v) recognize revenue when (or as) performance obligations are satisfied. The Company excludes from the transaction price, sales taxes and value-added taxes imposed at the time of sale (which do not include excise taxes on smokeless tobacco, cigars or vaping products billed to customers).
The Company records an allowance for sales returns, based principally on historical volume and return rates, which is included in accrued liabilities on the consolidated balance sheets. The Company records sales incentives, which consist of consumer incentives and trade promotion activities, as a reduction in revenues (a portion of which is based on amounts estimated as being due to wholesalers, retailers and consumers at the end of the period) based principally on historical volume and utilization rates. Expected payments for sales incentives are included in accrued liabilities on the consolidated balance sheets.
A further requirement of ASC 606 is for entities to disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. The Company’s management views business performance through segments that closely resemble the performance of major product lines. Thus, the primary and most useful disaggregation of the Company’s contract revenue for decision making purposes is the disaggregation by segment which can be found in Note 18 of Notes to Consolidated Financial Statements. An additional
disaggregation of contract revenue by sales channel can be found within Note 18 as well.
i
Shipping Costs
The Company records shipping costs incurred as a component of selling, general, and administrative expenses. Shipping costs incurred were approximately $i8.1 million and $i6.9
million for the three months ending June 30, 2021 and 2020, respectively. Shipping costs incurred were approximately $i14.1 million and $i12.1 million for the
six months ending June 30, 2021 and 2020, respectively. The implementation of the Prevent All Cigarette Trafficking Act (“PACT Act”) in the second quarter of 2021 made the delivery of vape products to customers and consumers more challenging and more costly. In addition, increased sales and higher freight rates are causing shipping costs to increase.
i
Inventories
Inventories are stated at the lower of cost or net realizable value. Effective January 1, 2021, the Company changed its method of accounting for inventory using the last-in, first-out (“LIFO”) method to the first-in, first-out (“FIFO”) method. The Company applied this change retrospectively to all prior periods presented, which is discussed further in Note 6. Leaf tobacco is presented in current assets in accordance with standard industry practice, notwithstanding the fact that such tobaccos are carried longer than one year for the purpose of curing.
i
Fair Value
GAAP establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to unobservable inputs (level 3).
The three levels of the fair value hierarchy under GAAP are described below:
●
Level 1 – Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets at the measurement date.
●
Level 2 – Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
●
Level 3 – Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
i
Derivative Instruments
Foreign Currency Forward Contracts:The Company enters into foreign currency forward contracts to hedge a portion of its exposure to changes in foreign currency exchange rates on inventory purchase commitments. The Company accounts for its forward contracts under the provisions of ASC 815, Derivatives and Hedging. Under the Company’s policy, the
Company may hedge up to i100% of its anticipated purchases of inventory in the denominated invoice currency over a forward period not to exceed itwelve months. The
Company may also, from time to time, hedge up to ininety percent of its non-inventory purchases in the denominated invoice currency. Forward contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date, except any hedge ineffectiveness which is recognized currently in income. Gains and losses on these forward contracts
are transferred from other comprehensive income into inventory as the related inventories are received and are transferred to net income as inventory is sold. Changes in fair value of any contracts that do not qualify for hedge accounting or are not designated as hedges are recognized currently in income.
Interest Rate Swap Agreements: The Company enters into interest rate swap contracts to manage interest rate risk and reduce the volatility of future cash flows. The Company accounts for its interest rate swap contracts under the provisions of ASC 815, Derivatives and Hedging. Swap contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date, except any hedge ineffectiveness which is recognized
currently in income. Gains and losses on these swap contracts are transferred from other comprehensive income into net income upon settlement of the derivative position or at maturity of the interest rate swap contract. Changes in fair value of any contracts that do not qualify for hedge accounting or are not designated as hedges are recognized currently in income.
Manufacturers and sellers of tobacco products are subject to regulation at the federal, state, and local levels. Such regulations include, among others, labeling requirements, limitations on advertising, and prohibition of sales to minors. The tobacco industry is likely to continue to be heavily regulated. There can be no assurance as to the ultimate content, timing, or effect of any regulation of tobacco products by any federal, state, or local legislative or regulatory body, nor can there be any assurance that any such legislation or regulation would not have a material adverse effect on the Company’s financial position, results of operations, or cash flows. In a number of states targeted flavor bans have been proposed or enacted legislatively or by the administrative process. Depending on the number and location of such bans, that legislation or regulation could have
a material adverse effect on the Company’s financial position, results of operations or cash flows. Food and Drug Administration (“FDA”) continues to consider various restrictive regulations around our products, including targeted flavor bans; however, the details, timing, and ultimate implementation of such measures remain unclear.
The tobacco industry has experienced, and is experiencing, significant product liability litigation. Most tobacco liability lawsuits have been brought against manufacturers and sellers of cigarettes for injuries allegedly caused by smoking or exposure to smoke. However, several lawsuits have been brought against manufacturers and sellers of smokeless products for injuries to health allegedly caused by use of smokeless products. Typically, such claims assert that use of smokeless products is addictive and causes oral cancer. Additionally, several lawsuits have been brought against manufacturers and distributors of NewGen products due to malfunctioning devices. There can be no assurance the Company will not sustain losses in connection with such lawsuits and that such losses will not have a material adverse effect on the
Company’s financial position, results of operations, or cash flows.
Master Settlement Agreement (MSA): Pursuant to the Master Settlement Agreement (the “MSA”) entered into in November 1998 by most states (represented by their attorneys general acting through the National Association of Attorneys General) and subsequent states’ statutes, a “cigarette manufacturer” (which is defined to include a manufacturer of make-your-own (“MYO”) cigarette tobacco) has the option of either becoming a signatory to the MSA or opening, funding, and maintaining an escrow account to have funds available for certain potential tobacco-related liabilities with sub-accounts on behalf of each settling state. Such companies are entitled to direct the investment of the escrowed funds and withdraw any appreciation, but cannot withdraw the principal for itwenty-five
years from the year of each annual deposit, except to withdraw funds deposited pursuant to an individual state’s escrow statute to pay a final judgement to that state’s plaintiffs in the event of such a final judgement against the Company. The Company chose to open and fund an escrow account as its method of compliance. It is the Company’s policy to record amounts on deposit in the escrow account for prior years as a non-current asset. As of June 30,2021,the Company had on deposit approximately $i32.1
million, the fair value of which was approximately $i31.8 million. At December 31,2020,the Company had on deposit approximately $i32.1
million, the fair value of which was approximately $i32.1 million. Effective in the third quarter of 2017,the Company no longer sells any product covered under the MSA. Thus, absent a change in legislation, the Company will no longer be required to make deposits to the MSA escrow account.
The Company has chosen to invest a portion of the MSA escrow, from time to time, in U.S. Government securities including TIPS, Treasury Notes, and Treasury Bonds. These investments are classified as available-for-sale and carried at fair value. Realized losses are prohibited under the MSA; any investment in an unrealized loss position will be held until the value is recovered, or until maturity.
Fair values for the U.S. Governmental agency obligations are Level 2. The following tables show cost and estimated fair value of the assets held in the MSA account, respectively, as well as the maturities of the U.S. Governmental agency obligations held in such account for the periods indicated.
Food and Drug Administration: On June 22, 2009, the Family Smoking Prevention and Tobacco Control Act (the “FSPTCA”) authorized the FDA to immediately regulate the manufacturing, sale, and marketing of ifour categories of tobacco products – cigarettes, cigarette tobacco, roll-your-own tobacco, and smokeless tobacco. On August 8, 2016, the FDA deeming regulation became effective. The deeming
regulation gave the FDA the authority to also regulate cigars, pipe tobacco, e-cigarettes, vaporizers, and e-liquids as “deemed” tobacco products under the FSPTCA.
The FDA assesses tobacco product user fees on isixclasses of regulated tobacco products and computes user fees using a methodology similar to the methodology used by the U.S Department of Agriculture to compute the Tobacco Transition Payment Program (“TTPP,” also known as the “Tobacco Buyout”) assessment. First, the total, annual, congressionally established user fee assessment is allocated among the various classes of tobacco products using
the federal excise tax weighted market share of tobacco products subject to regulation. Then, the assessment for each class of tobacco products is divided among individual manufacturers and importers.
In August 2016, the FDA’s regulatory authority under the Tobacco Control Act (the “TCA”) was extended to all tobacco products not previously covered, including: (i) certain NewGen products (such as electronic cigarettes, vaporizers and e-liquids) and their components or parts (such as tanks, coils and batteries); (ii) cigars and their components or parts (such as cigar tobacco); (iii) pipe tobacco; (iv) hookah products; and (v) any other tobacco product “newly deemed” by the FDA. These “deeming regulations” apply to all products made or derived from tobacco intended for human consumption, but excluding accessories of tobacco products (such as lighters). Accordingly, the FDA has since regulated our cigar and cigar wrap products as well as our vapor products containing tobacco-derived nicotine and products intended or reasonably expected to be used to consume such e-liquids.
Under the deeming regulations, the FDA has responsibility for conducting premarket review of “new tobacco products”—defined as those products not commercially marketed in the United States as of February 15, 2007. There are ithree pathways for obtaining premarket authorization, including submission of a premarket tobacco product application (“PMTA”).
We submitted premarket filings prior to the September 9, 2020 deadline for certain of our products and intend to supplement and complete the applications within FDA’s discretionary timeline. A successful PMTA must demonstrate that the subject product is “appropriate for the protection of public health,” taking into account the effect of the marketing of the product on all sub-populations while a Substantial Equivalence Report must demonstrate that a new product either has the same characteristics as its predicate product or different characteristics, but does not raise different questions of public health. The FDA is required under a court order to issue a decision related to the authorization of these products within twelve months; otherwise, these products cease to be subject to the FDA’s continued compliance policy, which allows products to be marketed pending premarket review. FDA may, in its
discretion and on a case-by-case basis, deviate from this policy.
FDA has issued a number of proposed rules related to premarket filings; however, those rules were not finalized prior to the September 9, 2020, deadline. As such, it is unclear whether and how FDA will apply any new or additional requirements to currently pending applications. We believe we have products that meet the requisite standards and have filed premarket filings supporting a showing of the respective required standard. However, there is no assurance that the FDA’s guidance or ultimate regulation will not change, or that the FDA will review and authorize the products in the requisite time period or that, in that circumstance, the FDA will use its discretion on a case-by-case basis to allow for the continued marketing of the products, or that unforeseen circumstances will not arise that prevent us from sufficiently supplementing or completing our applications or otherwise increase the amount of time
and money we are required to spend to receive all necessary marketing orders. Although we filed many premarket applications in a timely manner, no assurance can be given that the applications will ultimately be successful. This may result in the prioritization of supplementing or completing applications for high priority SKUs in our inventory position, which could adversely impact future revenues.
In addition, we currently distribute many third-party manufactured vapor products for which we will be completely dependent on the manufacturer complying with the premarket filing requirements. There can be no assurance that these third-party products will receive a marketing order. While we will take measures to pursue regulatory compliance for our own privately-branded or proprietary vape products that compete with these third-party products, there is no assurance that such proprietary products would be as successful in the marketplace or can fully displace third-party products that are currently being distributed by us, which could adversely affect our results of operations and liquidity. For a period of time after the filing deadline, we expect there to be a lack of enforcement, which may adversely affect our ability to compete in the marketplace against those who continue to sell unauthorized products.
In January 2020, FDA issued a Guidance document (the “January 2020 Guidance”) that stated it would be prioritizing enforcement of several categories of electronic nicotine delivery system (“ENDS”) products: (1) flavored, cartridge-based ENDS products (other than tobacco- or menthol-flavored ENDS products); (2) ENDS products for which the manufacturer has failed to take (or is failing to take) adequate measures to prevent minors’ access; (3) ENDS products targeted to minors or whose marketing is likely to promote the use of ENDS by minors; and (4) ENDS products offered for sale after May 12, 2020, premarket application deadline (later updated to reflect the September 9, 2020 filing deadline) for which the manufacturer has not submitted a premarket application. The policy outlined several factors the agency would consider in its enforcement of
flavored cigars going forward but did not restrict those products as it had considered in the March 2019 Guidance proposal.
On April 29, 2021, the FDA announced plans to propose itwo tobacco product standards related to combusted tobacco products: (1) a ban on menthol as a characterizing flavor in cigarettes; and (2) a ban on all characterizing flavors (including menthol) in cigars. These product standards are required to go through the formal rulemaking process where we would have the opportunity to comment on the proposed rule with regard to any impact on any
of our products. The FDA’s policy on these and other regulated products may change or expand over time in ways not yet known and may significantly impact our products or our premarket filings.
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Recent Accounting Pronouncements Adopted
In December 2019, the FASB issued Accounting Standards Update (“ASU”) 2019-12 to simplify the accounting in ASC 740, Income Taxes. This guidance removes certain exceptions related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. This guidance also clarifies and simplifies other areas of ASC 740. This ASU became effective beginning in the first quarter of the Company’s fiscal year 2021. Certain amendments in this update must be applied on a prospective basis, certain amendments must be applied on a retrospective basis, and certain amendments must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings/(deficit)
in the period of adoption. The ASU was effective for the Company beginning in the first quarter of 2021. The ASU did not have an impact to the Company’s financial statements and related disclosures.
In August 2020, the FASB issued ASU 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). This guidance simplifies the accounting for convertible debt instruments by reducing the number of accounting models and the number of embedded conversion features that could be recognized separately from the convertible instrument. This guidance also enhances transparency and improves disclosures for convertible instruments and earnings per share guidance. This ASU is effective for annual reporting periods beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning
after December 15, 2020. This update permits the use of either the modified retrospective or fully retrospective method of transition. The Company early adopted this ASU effective January 1, 2021 using the full retrospective method of transition. The adoption resulted in a $i7.1
million increase in Accumulated earnings, a $i24.2 million increase in Notes payable and long-term debt, a $i6.3
million decrease in deferred income taxes and a $i24.9 million decrease in Additional paid-in capital as of December 31, 2020, and a $i2.2
million decrease in Accumulated deficit and a $i24.9 million decrease in Additional paid-in capital as of December 31, 2019. Interest expense will decrease by $i6.7
million annually and weighted average diluted common shares outstanding will increase by approximately i3.2 million shares.
In April 2021, ReCreation Marketing (“ReCreation”), a VIE for which the Company is considered the primary beneficiary, purchased i100% of the equity interests of Westhem Ventures LTD d/b/a Direct Value Wholesale (“DVW”) for $i3.8
million, net of cash acquired, with $i3.5 million paid in cash at closing and $i0.4
in accrued consideration to be paid during 2021. DVW is a Canadian distribution entity that operates in markets not primarily served by ReCreation. The acquisition expands ReCreation’s markets in Canada. On April 13, 2021, in connection with the acquisition of DVW, the Company provided a $i3.7 million unsecured loan to ReCreation bearing interest at i8%
per annum and maturing April 13, 2023. The unsecured loan is eliminated in the consolidation of ReCreation. As of June 30, 2021, ReCreation had not completed the accounting for the acquisition. The following table summarizes the consideration transferred and calculation of goodwill based on excess of the acquisition price over the estimated fair value of the identifiable net assets acquired and are based on management’s preliminary estimates:
/
Total consideration transferred
$
i3,462
Adjustments to consideration transferred:
Cash acquired
(i42
)
Accrued consideration
i402
Adjusted consideration transferred
i3,822
Assets acquired:
Working capital (primarily AR and inventory)
i1,265
Fixed assets and Other long term assets
i27
Net assets acquired
$
i1,292
Goodwill
$
i2,530
The goodwill of $i2.5 million consists of the synergies expected from combining the operations and is deductible for tax purposes.
ReCreation Marketing
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In July 2019, the Company obtained a i30% stake in a Canadian distribution entity, ReCreation for $i1
million paid at closing. In November 2020, the Company invested an additional $i1 million related to our i30%
stake. In November 2020, the Company also invested an additional $i2 million increasing its ownership interest to i50%.
The Company received board seats aligned with its ownership position. The Company also provided a $i2.0 million unsecured loan to ReCreation bearing interest at i8%
per annum and maturing November 19, 2022. The Company has determined that ReCreation is a VIE due to its required subordinated financial support. The Company has determined it is the primary beneficiary due to its i50% equity interest, additional
subordinated financing and distribution agreement with ReCreation for the sale of the Company’s products. As a result, the Company began consolidating ReCreation effective November 2020. As of June 30, 2021, the Company had not completed the accounting for the acquisition. The following table summarizes the consideration transferred and calculation of goodwill based on excess of the acquisition price over the estimated fair value of the identifiable net assets acquired and are based on management’s preliminary estimates:
/
Total consideration transferred
$
i4,000
Adjustments to consideration transferred:
Cash acquired
(i3,711
)
Working capital
i418
Debt eliminated in consolidation
i2,000
Adjusted consideration transferred
i2,707
Assets acquired:
Working capital (primarily AR and inventory)
i1,551
Fixed assets and Other long term assets
i70
Other liabilities
(i203
)
Non-controlling interest
(i4,050
)
Net assets acquired
$
(i2,632
)
Goodwill
$
i5,339
The goodwill of $i5.3 million consists of the synergies expected from combining the operations and is currently not deductible for tax purposes.
On July 16, 2020, the Company completed its merger with SDI, whereby SDI was merged into a wholly-owned subsidiary of the Company in a tax-free downstream merger. Under the terms of the agreement, the holders of SDI’s Class A Common Stock and SDI’s Class B Common Stock (collectively, “SDI Common Stock”) received in the aggregate, in return for their SDI Common Stock, TPB Voting Common Stock (“TPB Common Stock”) at a ratio of i0.52095
shares of TPB Common Stock for each share of SDI Common Stock at the time of the merger. SDI divested its assets, other than SDI’s TPB Common Stock, prior to close such that the net liabilities at closing were minimal and the only assets that SDI retained were the remaining TPB Common Stock holdings. The transaction was accounted for as an asset purchase for $i236.0 million in consideration, comprised of i7,934,704
shares of TPB Common Stock valued at $i234.3 million plus transaction costs and assumed net liabilities. The $i236.0 million was assigned to the i8,178,918
shares of TPB Common Stock acquired. The i244,214 shares of TPB Common Stock acquired in excess of the shares issued were retired resulting in a charge of $i1.7 million recorded in Accumulated
earnings (deficit). The Company no longer has a controlling shareholder.
Durfort Holdings
In June 2020, the Company purchased certain tobacco assets and distribution rights from Durfort Holdings S.R.L. (“Durfort”) and Blunt Wrap USA for $i47.7 million in total consideration, comprised of $i37.7
million in cash, including $i1.7 million of capitalized transaction costs, and a $i10.0
million unsecured subordinated promissory note (“Promissory Note”). With this transaction, the Company acquired co-ownership in the intellectual property rights of all of Durfort’s and Blunt Wrap USA’s Homogenized Tobacco Leaf (“HTL”) cigar wraps and cones. The Company also entered into an exclusive Master Distribution Agreement to market and sell the original Blunt Wrap® cigar wraps within the USA which was effective October 9, 2020. Durfort is an industry leader in alternative cigar and cigar wrap manufacturing and distribution. Blunt Wrap USA has been an innovator of new products in the smoking alternative market since 1997 and has secured patents in the USA and internationally for novel smoking
wrappers and cones. The transaction was accounted for as an asset purchase with $i42.2 million assigned to intellectual property, which has an indefinite life, and $i5.5
million assigned to the Master Distribution Agreement, which has a i15 year life. Both assets are currently deductible for tax purposes.
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Note 4. Derivative Instruments
Foreign Currency
The Company’s policy is to manage the risks associated with foreign exchange rate movements. The policy allows hedging up to i100% of its anticipated purchases of inventory over a forward period that will not exceed i12
rolling and consecutive months. The Company may, from time to time, hedge currency for non-inventory purchases, e.g., production equipment, not to exceed i90% of the purchase price. During 2020, the Company executed various forward contracts,
which met hedge accounting requirements, for the purchase of €i19.7 million and sale of €i21.4
million with maturity dates ranging from December 2020 to November 2021. At June 30, 2021, the Company had forward contracts for the purchase of €i8.2 million and sale of €i8.9
million outstanding. The foreign currency contracts’ fair value at June 30, 2021, resulted in an asset of $i0.0 million included in Other current assets and a liability of $i0.0
million included in Accrued liabilities. At December 31, 2020, the Company had forward contracts for the purchase of €i18.0 million and sale of €i19.6
million outstanding. The foreign currency contracts’ fair value at December 31, 2020, resulted in an asset of $i0.4 million included in Other current assets and a liability of $i0.0
million included in Accrued liabilities.
Interest Rate Swaps
The Company’s policy is to manage interest rate risk by reducing the volatility of future cash flows associated with debt instruments bearing interest at variable rates. In March 2018, the Company executed various interest rate swap agreements for a notional amount of $i70 million with an expiration of December 2022. The swap agreements fixed LIBOR at i2.755%.
The swap agreements met the hedge accounting requirements; thus, any change in fair value was recorded to other comprehensive income. The Company used the Shortcut Method to account for the swap agreements. The Shortcut Method assumes the hedge to be perfectly effective; thus, there is no ineffectiveness to be recorded in earnings. The swap agreements’ fair values at December 31, 2020, resulted in a liability of $i3.7
million included in other long-term liabilities. Losses of $i0.6 million were reclassified into interest expense for the six months ended June 30, 2020. The Company terminated
the interest rate swap agreement in conjunction with the prepayment of all outstanding amounts under the 2018 First Lien Credit Facility (as defined below) in the first quarter of 2021 with the early termination payment made by the Company in the amount of $i3.6 million which was reclassified out of accumulated other
comprehensive loss into loss on extinguishment of debt.
The estimated fair value amounts have been determined by the Company using the methods and assumptions described below. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Cash and Cash Equivalents
Cash and cash equivalents are, by definition, short-term. Thus, the carrying amount is a reasonable estimate of fair value.
Accounts Receivable
The fair value of accounts receivable approximates their carrying value due to their short-term nature.
Long-Term Debt
The Company’s Senior Secured Notes (as defined below) bear interest at a rate of i5.625% per year and the fair value of the Senior Secured Notes approximate their carrying value of $i250
million due to the recency of the notes’ issuance, related to the quarter ended June 30, 2021.
The Company’s 2018 First Lien Credit Facility bore interest at variable rates that fluctuated with market rates, the carrying values of the 2018 First Lien Credit Facility approximated its fair value. As of December 31, 2020, the fair value of the 2018 First Lien Term Loan approximated $i130.0 million. The
Company prepaid all outstanding amounts under the 2018 First Lien Credit Facility in the first quarter of 2021.
The Convertible Senior Notes (as defined) bear interest at a rate of i2.50% per year, and the fair value of the Convertible Senior Notes without the conversion feature approximated $i157.5
million, with a carrying value of $i172.5 million as of June 30, 2021. As of December 31, 2020, the fair value of the Convertible Senior Notes approximated $i155.3
million, with a carrying value of $i172.5 million.
Note Payable – Promissory Note
The Company’s Promissory Note bears interest at a rate of i7.5% per year, and the fair value of the Promissory Note approximated $i10.2
million, with a carrying value of $i10.0 million as of June 30, 2021. The fair value of the Promissory Note approximated its carrying value of $i10.0
million at December 31, 2020, due to the recency of the note’s issuance, related to the year ended December 31, 2020.
Note Payable – Unsecured Loan
The Company’s Unsecured Note bears interest at a rate of i1.0% per year, and the fair value of the Unsecured Note approximated $i7.3
million, with a carrying value of $i7.5 million as of June 30, 2021. The fair value of the Unsecured Note approximated its carrying value of $i7.5
million at December 31, 2020, due to the recency of the note’s issuance, related to the quarter ended December 31, 2020.
See Note 11, “Notes Payable and Long-Term Debt”, for further information regarding the Company’s long-term debt.
Foreign Exchange
At June 30, 2021, the Company had forward contracts for the purchase of €i8.2 million and sale of €i8.9
million. The fair value of the foreign exchange contracts is based upon quoted market prices for similar instruments, thus leading to them being categorized as level 2 instruments within the fair value hierarchy, and resulted in an asset of $i0.0 million and a liability of $i0.0
million as of June 30, 2021. At December 31, 2020, the Company had forward contracts for the purchase of €i18.0 million and sale of €i19.6
million resulting in an asset of $i0.4 million and a liability of $i0.0
million as of December 31, 2020.
Interest Rate Swaps
The Company had swap contracts for a total notional amount of $i70 million at December 31, 2020. The fair values of the swap contracts were based upon quoted market prices for similar instruments, thus leading to them
being categorized as level 2 instruments within the fair value hierarchy, and resulted in a liability of $i3.7 million December 31, 2020. The Company terminated the swap contracts in conjunction
with the prepayment of all outstanding amounts under the 2018 First Lien Credit Facility in the first quarter of 2021.
Effective January 1, 2021, the Company changed its method of accounting for inventory from the LIFO method to the FIFO method. Costs determined using the LIFO method were utilized on approximately i45.1% of inventories at December 31, 2020, prior to this change in method, and consisted primarily of tobacco inventory. The Company
believes the FIFO method is preferable because it: (i) conforms the accounting for all inventory with the method utilized for the majority of its inventory; (ii) better represents how management assesses and reports on the performance of the tobacco and other LIFO product lines as LIFO is excluded from management’s economic decision making; (iii) better aligns the accounting with the physical flow of that inventory; and (iv) better reflects inventory at more current costs.
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The Company applied this change retrospectively to all prior periods presented. This change resulted in a $i4.5 million increase in Accumulated earnings as of December 31, 2020, from $i12.1
million to $i16.6 million and a $i4.3
million decrease in Accumulated deficit as of December 31, 2019, from $i15.3 million to $i11.0
million. In addition, the following financial statement line items in the Company’s Consolidated Balance Sheets as of December 31, 2020 and its Consolidated Statements of Income and Consolidated Statements of Cash Flows for the three and six months ended June 30, 2020 were adjusted as follows:
On April 19, 2021, the Companyinvested $i8.7 million in Docklight Brands, Inc., a pioneering consumer products company with celebrated brands including Marley Natural® cannabis and Marley™ CBD. The Company has additional follow-on
investment rights. As part of the investment, the Company has obtained exclusive U.S. distribution rights for Docklight’s Marley™ CBD topical products.
On February 11, 2021, the Company closed a private offering (the “Offering”) of $i250 million aggregate principal amount of its i5.625%
senior secured notes due 2026 (the “Senior Secured Notes”). The Senior Secured Notes bear interest at a rate of i5.625% and will mature on iFebruary
15, 2026. Interest on the Senior Secured Notes is payable semi-annually in arrears on February 15 and August 15 of each year, commencing on August 15, 2021.The Company used the proceeds from the Offering (i) to repay all obligations under and terminate the 2018 First Lien Credit Facility, (ii) to pay related fees, costs, and expenses and (iii) for general corporate purposes.
Obligations under the Senior Secured Notes are guaranteed by the Company’s existing and future wholly-owned domestic subsidiaries (the “Guarantors”) that guarantee any Credit Facility (as defined in the Indenture governing the Senior Secured Notes or the “Senior Secured Notes Indenture”) or capital markets debt securities of the Company or Guarantors in excess of $i15.0
million. The Senior Secured Notes and the related guarantees are secured by first-priority liens on substantially all of the assets of the Company and the Guarantors, subject to certain exceptions.
The Company may redeem the Senior Secured Notes, in whole or in part, at any time prior to February 15, 2023, at a price equal to i100% of the principal amount of the Notes redeemed plus accrued and unpaid interest, if any, to, but excluding the applicable redemption date, plus a “make-whole” premium. Thereafter, the
Company may redeem the Senior Secured Notes, in whole or in part, at established redemption prices set forth in the Senior Secured Notes Indenture, plus accrued and unpaid interest, if any. In addition, on or prior to February 15, 2023, the Company may redeem up to i40%
of the aggregate principal amount of the Senior Secured Notes with the net cash proceeds from certain equity offerings at a redemption price equal to i105.625%, plus accrued and unpaid interest, if any to the redemption date; provided, however, that at least i50%
of the original aggregate principal amount of the Senior Secured Notes (calculated after giving effect to the issuance of any additional notes) remains outstanding. In addition, at any time and from time to time prior to February 15, 2023, but not more than once in any itwelve-month period, the Company may redeem up to i10%
of the aggregate principal amount of the Senior Secured Notes at a redemption price of i103% of the aggregate principal amount of Senior Secured Notes redeemed plus accrued and unpaid interest, if any to but not including the redemption date, on the Senior Secured Notes to be redeemed.
If the Company experiences a change of control (as defined in the Senior Secured Notes Indenture), the Company must offer to repurchase the Senior Secured Notes at a repurchase price equal to i101% of the principal amount
of the Notes to be repurchased, plus accrued and unpaid interest.
The Indenture contains covenants that, among other things, restrict the ability of the Company and its restricted subsidiaries to: (i) grant or incur liens; (ii) incur, assume or guarantee additional indebtedness; (iii) sell or otherwise dispose of assets, including capital stock of subsidiaries; (iv) make certain investments; (v) pay dividends, make distributions or redeem or repurchase capital stock; (vi) engage in certain transactions with affiliates; and (vii) consolidate or merge with or into, or sell substantially all of our assets to another entity. These covenants are subject to a number of
limitations and exceptions set forth in the Indenture.
The Company incurred debt issuance costs attributable to the issuance of the Senior Secured Notes of $i6.4 million which are amortized to interest expense using the effective interest method over the expected life of the Senior Secured Notes.
The Indenture provides for customary events of default.
2021 Revolving Credit Facility
In connection with the Offering, the Company also entered into a new $i25 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto (the “Lenders”) and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). The 2021 Revolving Credit Facility provides for a revolving line
of credit of up to $i25.0 million. Letters of credit are limited to $i10
million (and are a part of, and not in addition to, the revolving line of credit). The Company has inot drawn any borrowings under the 2021 Revolving Credit Facility but does have letters of credit of approximately $i3.6
million outstanding under the facility. The 2021 Revolving Credit Facility will mature on iAugust 11, 2025 if none of the Company’s Convertible Senior Notes are outstanding, and if any Convertible Senior Notes are outstanding, the date which is i91
days prior to the maturity date of July 15, 2024 for such Convertible Senior Notes.
Interest is payable on the 2021 Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate plus an applicable margin of i3.50% (with step-downs upon de-leveraging). The Company also has the option to borrow at a rate determined by reference to the base rate.
The obligations under the 2021 Revolving Credit Agreement are guaranteed on a joint and several basis by the Guarantors. The Company’s and Guarantors’ obligations under the 2021 Revolving Credit Facility are secured on a pari passu basis with the Senior Secured Notes.
The 2021 Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The 2021 Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio (as defined in the 2021 Revolving Credit Agreement) of i5.50 to 1.00 (with a step down to i5.25
to 1.00 beginning with the fiscal quarter ending March 31, 2023) at the end of each fiscal quarter when extensions of credit under the 2021 Revolving Credit Facility and certain drawn and undrawn letters of credit (excluding (a) letters of credit that have been cash collateralized and (b) letters of credit having an aggregate face amount less than $i5,000,000) in the aggregate outstanding exceeds i35%
of the total commitments under the 2021 Revolving Credit Facility.
The Company incurred debt issuance costs attributable to the issuance of the 2021 Revolving Credit Facility of $i0.5 million which are amortized to interest expense using the effective interest method over the expected life of the 2021 Revolving Credit Facility.
The 2021 Revolving Credit Agreement provides for customary events of default.
On March 7, 2018, the Company entered into $i250 million of credit facilities consisting of a $i160
million 2018 First Lien Term Loan and a $i50 million 2018 Revolving Credit Facility (collectively, the “2018 First Lien Credit Facility”), in each case, with Fifth Third Bank, as administrative agent, and other lenders, in addition to a $i40
million 2018 Second Lien Term Loan (the “2018 Second Lien Credit Facility,” and, together with the 2018 First Lien Credit Facility, the “2018 Credit Facility”) with Prospect Capital Corporation, as administrative agent, and other lenders. The 2018 Credit Facility contained a $i40 million accordion feature.
The 2018 Credit Facility contained customary events of default including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain other material indebtedness in excess of specified amounts, certain events of bankruptcy and insolvency, certain ERISA events, judgments in excess of specified amounts, and change in control defaults. The 2018 Credit Facility also contained certain negative covenants customary for facilities of these types including covenants that, subject to exceptions described in the 2018 Credit Facility, restrict the ability of the Company and its subsidiary guarantors: (i) to pledge assets, (ii) to incur additional indebtedness, (iii) to pay dividends, (iv) to make distributions, (v) to sell assets, and (vi) to make investments. See Note 19, “Dividends and Share Repurchase”, for further information
regarding dividend restrictions.
2018 First Lien Credit Facility: The 2018 First Lien Term Loan and the 2018 Revolving Credit Facility bore interest at LIBOR plus a spread of ii2.75/%
to ii3.50/%
based on the Company’s senior leverage ratio. The 2018 First Lien Term Loan had iquarterly required payments of $i2.0
million beginning June 30, 2018, increasing to $i3.0 million on June 30, 2020, and increasing to $i4.0
million on June 30, 2022. The 2018 First Lien Credit Facility had a maturity date of iMarch 7, 2023. The 2018 First Lien Term Loan was secured by a first priority lien on substantially all of the assets of the borrowers and the guarantors thereunder, other than certain excluded assets (the “Collateral”). In connection with the Convertible Senior Notes offering, the Company entered into a First Amendment (“the Amendment”)
to the First Lien Credit Agreement, with Fifth Third Bank, as administrative agent, and other lenders and certain other lender parties thereto. The Amendment was entered into primarily to permit the Company to issue up to $i200 million of convertible senior notes, enter into certain capped call transactions in connection with the issuance of such notes and to use the proceeds from the issuance of the notes to repay amounts outstanding under the 2018 Second Lien
Credit Facility and use the remaining proceeds for acquisitions and investments. In connection with the Amendment, fees of $i0.7 million were incurred. The 2018 First Lien Credit Facility contained certain financial covenants, which were amended in connection with the Convertible Senior Notes offering in the third quarter 2019. The covenants included maximum senior leverage ratio of i3.00x
with step-downs to i2.50x, a maximum total leverage ratio of i5.50x
with step-downs to i5.00x, and a minimum fixed charge coverage ratio of i1.20x.
In the first quarter of 2020, the financial covenants were amended to permit certain add-backs related to PMTA in the definition of Consolidated EBITDA for the period of October 1, 2019 until September 30, 2020. In connection with the Amendment, fees of $i0.2 million were incurred. The Company used a portion of the proceeds from the issuance of the Senior Secured Notes
to prepay all outstanding amounts under and terminate the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $i130.0 million, and the transaction resulted in a $i5.7
million loss on extinguishment of debt.
Convertible Senior Notes
In July 2019, the Company closed an offering of $i172.5 million in aggregate principal amount of its i2.50%
Convertible Senior Notes due iJuly 15, 2024 (the “Convertible Senior Notes”). The Convertible Senior Notes bear interest at a rate of i2.50%
per year, payable semiannually in arrears on January 15 and July 15 of each year, beginning on January 15, 2020. The Convertible Senior Notes will mature on July 15, 2024, unless earlier repurchased, redeemed or converted. The Convertible Senior Notes are senior unsecured obligations of the Company.
The Convertible Senior Notes are convertible into approximately i3,206,637 shares of TPB Common Stock under certain circumstances prior to maturity at a conversion rate of i18.589
shares per $i1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $i53.79
per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. The conversion price is adjusted periodically as a result of dividends paid by the Company in excess of pre-determined thresholds of $i0.04 per share. Upon conversion, the
Company may pay cash, shares of common stock or a combination of cash and stock, as determined by the Company at its discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of June 30, 2021.
The Company early adopted ASU 2020-06 effective January 1, 2021 on a retrospective basis to all periods presented. Under ASU 2020-06, the Company will account for the Convertible Senior Notes entirely as a liability and will no longer separately account for the Convertible Senior Notes with liability and equity components. See note 2 for further discussion of the impact of the adoption of ASU 2020-06.
The Company incurred debt issuance costs attributable to the Convertible Senior Notes of $i5.9 million which are amortized to interest expense using the effective interest method over the expected life of the Convertible Senior Notes.
In connection with the Convertible Senior Notes offering, the Company entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $i53.79 per and a cap price of $i82.86
per share, and are exercisable when, and if, the Convertible Senior Notes are converted. The Company paid $i20.53 million for these capped calls at the time they were entered into and charged that amount to additional paid-in capital.
The indenture covering the Convertible Senior Notes contains customary events of default.
Promissory Note
On June 10, 2020, in connection with the acquisition of certain Durfort assets, the Company issued the Promissory Note in the principal amount of $i10.0 million (the “Principal Amount”), with an annual interest rate of i7.5%,
payable quarterly, with the first interest payment due September 10, 2020. The Principal Amount is payable in itwo $i5.0
million installments, with the first installment due i18 months after the closing date of the acquisition (June 10, 2020), and the second installment due i36
months after the closing date of the acquisition. The second installment is subject to reduction for certain amounts payable to the Company as a holdback.
Unsecured Loan
On April 6, 2020, the 2018 First Lien Credit Facility was amended to allow for an unsecured loan under the Coronavirus Aid, Relief, and Economic Security Act of 2020 (“CARES”). On April 17, 2020, National Tobacco Company, L.P., a subsidiary of the Company, entered into a loan agreement with Regions Bank guaranteed by the Small Business Administration for a $i7.5
million unsecured loan. The proceeds of the loan were received on April 27, 2020. The loan is scheduled to mature on iApril 17, 2022 and has a i1.00%
interest rate.
Note Payable – IVG
In September 2018, the Company issued a note payable to IVG’s former shareholders (“IVG Note”). The IVG Note had a principal amount of $i4.0 million with an interest rate of i6.0%
per year and matured on iMarch 5, 2020. All principal and accrued and unpaid interest under the IVG Note were subject to indemnification obligations of the sellers pursuant to the International Vapor Group Stock Purchase Agreement dated as of September 5, 2018. The carrying amount of the IVG Note, $i4.2
million, was deposited into an escrow account in the first quarter of 2020 pending agreement with the sellers of any indemnification obligations. The escrow funds were distributed in the first quarter of 2021.
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Note 12. Leases
The Company’s leases consist primarily of leased property for manufacturing warehouse, head offices and retail space as well as vehicle leases. At lease inception, the Company recognizes a lease right of use asset and lease liability calculated as the present value of future minimum lease payments. In general, the Company does not recognize any renewal periods within the lease terms as there are no significant barriers to ending the lease at the initial term. Lease and non-lease components are accounted for as a single lease component.
Leases with an initial term of 12 months or less are not recorded on the balance sheet. Lease expense for these leases is recognized on a straight-line basis over the lease term.
i
The components of lease expense consisted of the following:
Weighted-average remaining lease term - operating leases
i7.0 years
i7.6 years
Weighted-average discount rate - operating leases
i4.93
%
i5.65
%
/
Nearly all the lease contracts for the Company do not provide a readily determinable implicit interest rate. For these contracts, the Companyuses a discount rate that approximates its incremental borrowing rate at the time of the lease commencement.
i
As of June 30, 2021, maturities of lease liabilities consisted of the following:
The Company’s effective income tax rate for the three and six months ended June 30, 2021, was i22.7% and i21.0%,
respectively, which includes a discrete tax deduction of $i2.0 million and $i5.2
million for the three and six months ended June 30, 2021, respectively, relating to stock option exercises. The Company’s effective income tax rate for the three and six months ended June 30, 2020, was i26.6% and i25.8%,
respectively, which includes a discrete tax deduction of $i0.0 million and $i0.9
million for the three and six months ended June 30, 2020, respectively, relating to stock option exercises.
The Company follows the provisions of ASC 740-10-25, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company has determined that the Company did not have any uncertain tax positions requiring recognition under the provisions of ASC 740-10-25. The
Company’s policy is to recognize interest and penalties accrued on uncertain tax positions, if any, as part of interest expense. The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. In general, the Company is no longer subject to U.S. federal and state tax examinations for years prior to 2017.
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Note 14. Pension and Postretirement Benefit Plans
The Company had a defined benefit pension plan. Benefits for hourly employees were based on a stated benefit per year of service, reduced by amounts earned in a previous plan. Benefits for salaried employees were based on years of service and the employees’ final compensation. The Company’s policy was to make the minimum amount of contributions that can be deducted for federal income taxes. The Company made ino
contributions to the pension plan in 2020. In October 2019, the Company elected to terminate the defined benefit pension plan, effective December 31, 2019 with final distributions made in third quarter of 2020.
The Company sponsored a defined benefit postretirement plan that covered hourly employees. This plan provided medical and dental benefits. This plan was contributory with retiree contributions adjusted annually. The Company’s policy was to make contributions equal to benefits paid during the year. In October 2019, the Company amended the plan to cease benefits effective June 30, 2020.
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The following table provides the components of net periodic pension and postretirement benefit costs and total costs for the plans:
On March 22, 2021, the Company’s Board of Directors adopted the Turning Point Brands, Inc. 2021 Equity Incentive Plan (the “2021 Plan”), pursuant to which awards may be granted to employees, non-employee directors, and consultants. In addition, the 2021 Plan provides for the granting of nonqualified stock options to employees of the Company or any subsidiary of the Company. Pursuant to the 2021 Plan, i1,290,000
shares, plus i100,052 shares remaining available for issuance under the 2015 Equity Incentive Plan (the “2015 Plan”), of TPB Common Stock are reserved for issuance as awards to employees, non-employee directors, and consultants as compensation for past or future services or the attainment of certain performance goals. The 2021 Plan is scheduled to terminate on March 21,
2031. The 2021 Plan is administered by the compensation committee (the “Committee”) of the Company’s Board of Directors. The Committee determines the vesting criteria for the awards, with such criteria to be specified in the award agreement. As of June 30, 2021, net of forfeitures, there were i7,478
Restricted Stock Units (“RSUs”) and i7,500 options granted under the 2021 Plan. There are i1,378,368
shares, available for grant under the 2021 Plan.
On April 28, 2016, the Board of Directors of the Company adopted the 2015 Plan, pursuant to which awards may be granted to employees, non-employee directors, and consultants. In addition, the 2015 Plan provides for the granting of nonqualified stock options to employees of the Company or any subsidiary of the Company. Pursuant to the 2015 Plan, i1,400,000
shares of TPB Common Stock were reserved for issuance as awards to employees, non-employee directors, and consultants as compensation for past or future services or the attainment of certain performance goals. The 2015 Plan was scheduled to terminate on April 27, 2026. The 2015 Plan was administered by the Committee. Upon adoption of the 2021 Plan, the 2015 Plan was terminated, and the Company determined no additional grants would be made under the 2015 Plan. However, all awards issued under the 2015 Plan that have not been previously terminated or forfeited remain outstanding and continue unaffected. There are ino
shares available for grant under the 2015 Plan.
On February 8, 2006, the Board of Directors of the Company adopted the 2006 Equity Incentive Plan (the “2006 Plan”) of North Atlantic Holding Company, Inc., pursuant to which awards may be granted to employees. The 2006 Plan provides for the granting of nonqualified stock options and restricted stock awards to employees. Upon the adoption of the Company’s 2015 Equity Incentive Plan in connection with its IPO, the Company determined no additional grants would be made under the 2006 Plan. However, all awards issued under the 2006 Plan that have not been previously terminated or forfeited remain outstanding and continue unaffected. There are ino
shares available for grant under the 2006 Plan.
Stock option activity for the 2006, 2015 and 2021 Plans is summarized below:
Under the 2006, 2015 and 2021 Plans, the total intrinsic value of options exercised during the six months ended June 30, 2021 and 2020, was $i5.3
million, and $i0.9 million, respectively.
At June 30, 2021, under the 2006 Plan, the outstanding stock options’ exercise price for ii102,316/
options is $i3.83 per share, all of which are exercisable. The weighted average of the remaining lives of the outstanding stock options with an exercise price of $i3.83
is approximately i2.89 years. The Company estimates the expected life of these stock options is iten
years from the date of grant. For the $i3.83 per share options, the weighted average fair value of options at the date of grant was determined using the Black-Scholes model with the following assumptions: a iten-year
life from grant date, a current share price and exercise price of $i3.83, a risk-free interest rate of i3.57%,
volatility of i40%, and ino
assumed dividend yield. Based on these assumptions, the fair value of these options is approximately $i2.17 per share option granted.
At June 30, 2021, under the 2015 and 2021 Plans, the risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. The expected volatility is based on the average long-term historical volatilities of peer companies. We intend to continue to consistently use the same group of publicly traded peer companies to determine expected volatility until sufficient information regarding volatility of our share price becomes available or until the selected companies are no longer suitable for this purpose. Due to our limited trading history, we are using the simplified method presented by SEC Staff Accounting Bulletin No. 107 to calculate expected holding periods, which represent the periods of time for which options granted are expected to be outstanding. We will continue to use this method until we have sufficient historical exercise experience to give us confidence in the
reliability of our calculations. The fair values of these options were determined using the Black-Scholes option pricing model.
i
The following table outlines the assumptions based on the number of options granted under the 2015 Plan.
The Company has recorded compensation expense related to the options based on the provisions of ASC 718 under which the fixed portion of such expense is determined as the fair value of the options on the date of grant and amortized over the vesting period. The Company recorded compensation expense related to the options of approximately $i1.4 million and $i0.2
million for the three months ended June 30, 2021 and 2020, respectively. The Company recorded compensation expense related to the options of approximately $i1.7 million and $i0.6
million for the six months ended June 30, 2021 and 2020, respectively. Total unrecognized compensation expense related to options at June 30, 2021, is $i1.6 million, which will be expensed over i2.2
years.
Performance-Based Restricted Stock Units (“PRSUs”) are restricted stock units subject to both performance-based and service-based vesting conditions. The number of shares of TPB Common Stock a recipient will receive upon vesting of a PRSU will be calculated by reference to certain performance metrics related to the Company’s performance over a ifive-year
period. PRSUs will vest on the measurement date, which is no more than i65 days after the performance period provided the applicable service and performance conditions are satisfied. As of June 30, 2021, there are i561,361
PRSUs outstanding, all of which are unvested. The following table outlines the PRSUs granted and outstanding as of June 30, 2021.
The Company recorded compensation expense related to the PRSUs of approximately $i1.3 million and $i0.4
million in the consolidated statements of income for the three months ended June 30,2021 and 2020, respectively, based on the probability of achieving the performance condition. The Company recorded compensation expense related to the PRSUs of approximately $i2.5 million and $i0.7
million in the consolidated statements of income for the six months ended June 30, 2021 and 2020, respectively, based on the probability of achieving the performance condition. Total unrecognized compensation expense related to these awards at June 30, 2021, is $i11.2
million which will be expensed over the service periods based on the probability of achieving the performance condition.
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Note 16. Contingencies
On October 9, 2020, a purported stockholder of Turning Point Brands, Inc., Paul-Emile Berteau, filed a complaint in the Delaware Court of Chancery relating to the merger of SDI with a subsidiary of the Company pursuant to the Agreement and Plan of Merger and Reorganization, dated as of April 7, 2020, by and among TPB, SDI and Merger Sub (the “SDI Merger”). The complaint asserts itwo
derivative counts purportedly on behalf of TPB for breaches of fiduciary duty against the Board of Directors of Turning Point Brands, Inc. and other parties. The third count asserts a direct claim against the Company and its Board of Directors seeking a declaration that TPB’s Bylaws are inconsistent with TPB’s certificate of incorporation. While the Company believes it has good and valid defenses to the claims, there can be no assurance that the Company will prevail in this case, and it could have a material adverse effect on the
Company’s business and results of operations.
Other major tobacco companies are defendants in product liability claims. In a number of these cases, the amounts of punitive and compensatory damages sought are significant and, if such a claim were brought against the Company, could have a material adverse effect on our business and results of operations. The Company is subject to several lawsuits alleging personal injuries resulting from malfunctioning vaporizer devices or consumption of e-liquids and may be subject to claims in the future relating to other NewGen products. The Company is still evaluating these claims and the potential defenses to them. For example, the
Company did not design or manufacture the products at issue; rather, the Company was merely the distributor. Nonetheless, there can be no assurance that the Company will prevail in these cases, and they could have a material adverse effect on the financial position, results of operations, or cash flows of the Company.
We have several subsidiaries engaged in making, distributing, and selling vapor products. As a result of the overall publicity and controversy surrounding the vapor industry generally, many companies have received informational subpoenas from various regulatory bodies and in some jurisdictions regulatory lawsuits have been filed regarding marketing practices and possible underage sales. We expect that our subsidiaries will be subject to some such cases and investigative requests. In the acquisition of the vapor businesses, we negotiated financial “hold-backs”, which we expect to be able to use to defray expenses associated with the information production and the cost of defending any such lawsuits as well as the franchisee lawsuit. To the extent that litigation becomes
necessary, we believe that the subsidiaries have strong factual and legal defenses against claims that they unfairly marketed vapor products.
We have itwo franchisor subsidiaries. Like many franchise businesses, in the ordinary course of their business, these subsidiaries are from time to time responding parties to arbitration demands brought by franchisees. iOne
of our subsidiaries, which we acquired in 2018, is the franchisor of the VaporFi system. This subsidiary is a responding party in an arbitration brought by a franchisee claiming, among other things, violations of Federal Trade Commission Rules and Florida law. These allegations relate to the franchise disclosure document (FDD) utilized by the franchise system, a small vapor store chain, prior to our acquisition of the chain in 2018. We believe that we have good and valid substantive defenses against these claims and will vigorously defend ourselves in the arbitration.
We have also been named in a lawsuit brought by a different franchisee represented by the same firm that represents the plaintiff in the action described above. This case relates to the termination of the franchise agreement by the franchisor for failure to pay franchising fees and our subsequent demand that the franchisee cease using our marks and de-image locations formerly housing the franchises. The franchisee filed suit against us in the U.S. District Court for the Southern District of Florida isixteen months after our demand. The franchisee is claiming tortious interference and conversion. We believe
that the suit was improperly brought before the U.S. District Court for the South District of Florida because the related franchising agreements included a mandatory arbitration clause. We believe we have good and valid substantive defenses against the claims and intend on vigorously defending our interests in this matter.
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Note 17. Income Per Share
i
The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations of net income:
Net income attributable to Turning Point Brands, Inc.
$
i27,137
$
i14,794
Denominator
Weighted average
i19,034,415
$
i1.43
i19,598,660
$
i0.75
Diluted EPS:
Numerator
Net income attributable to Turning Point Brands, Inc.
$
i27,137
$
i14,794
Interest expense related to Convertible Senior Notes
i2,108
i2,094
Diluted net income attributable to Turning Point Brands. Inc.
$
i29,245
$
i16,888
Denominator
Basic weighted average
i19,034,415
i19,598,660
Convertible Senior Notes
i3,206,637
i3,202,808
Stock options
i318,035
i274,066
i22,559,087
$
i1.30
i23,075,534
$
i0.73
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Note 18. Segment Information
In accordance with ASC 280, Segment Reporting, the Company has ithree reportable segments: (1) Zig-Zag Products; (2) Stoker’s Products; and (3) NewGen Products. The Zig-Zag Products segment markets and distributes (a) rolling papers, tubes, and related products; and (b) finished cigars and MYO cigar wraps. The Stoker’s Products segment (a) manufactures and markets moist snuff and (b) contracts
for and markets loose leaf chewing tobacco products. The NewGen Products segment (a) markets and distributes CBD, liquid vapor products and certain other products without tobacco and/or nicotine; (b) distributes a wide assortment of products to non-traditional retail outlets via VaporBeast; and (c) markets and distributes a wide assortment of products to individual consumers via the VaporFi B2C online platform. Products in the Zig-Zag Products and Stoker’s Products segments are distributed primarily through wholesale distributors in the United States while products in the NewGen Products segment are distributed primarily through e-commerce to non-traditional retail outlets and direct to consumers in the United States. The Other segment includes the costs and assets of the Company not assigned to one of the ithree
reportable segments such as intercompany transfers, deferred taxes, deferred financing fees, and investments in subsidiaries.
The accounting policies of these segments are the same as those of the Company. Corporate costs are not directly charged to the three reportable segments in the ordinary course of operations. The Company evaluates the performance of its segments and allocates resources to them based on operating income.
Includes assets not assigned to the ithree reportable segments. All goodwill has been allocated to the reportable segments.
Revenue Disaggregation—Sales Channel
i
Revenues of the Zig-Zag Products and Stoker’s Products segments are primarily comprised of sales made to wholesalers while NewGen sales are made business to business and business to consumer, both online and through our corporate retail stores. NewGen net sales are broken out by sales channel below.
The most recent dividend of $i0.055 per common share was paid on iJuly
9, 2021, to shareholders of record at the close of business on iJune 18, 2021.
Dividends are considered restricted payments under the Senior Secured Notes Indenture and Revolving Credit Facility. The Company is generally permitted to make restricted payments provided that, at the time of payment, or as a result of payment, the Company is not in default on its debt covenants. Additional earnings and market capitalization restrictions limit the aggregate amount of restricted, quarterly dividends during a fiscal year.
On February 25, 2020, the Company’s Board of Directors approved a $i50.0 million share repurchase program, which is intended for opportunistic execution based upon a variety of factors including market dynamics. The program is subject to the ongoing discretion of the Board. The total number of shares repurchased for the three months ended June 30, 2021, was i175,000
shares for a total cost of $i8.4 million and an average price per share of $i47.73. The $i25.7
million remains available for share repurchases under the program at June 30, 2021.
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Note 20. Subsequent Events
On July 23, 2021, the Company acquired certain assets of Unitabac, a marketer of mass-market cigars, for $i9.6 million. The acquisition is comprised of a robust portfolio of cigarillo products and all related intellectual property, including Cigarillo Non-Tip (NT) Homogenized Tobacco Leaf (HTL) products and Rolled Leaf and Natural Leaf Cigarillo
Products.
On July 21, 2021, the Company invested $i8 million in Old Pal Holding Company LLC (“Old Pal”), a leading brand in the cannabis lifestyle space. The Company invested in the form of a convertible
note which includes additional follow-on investment rights. Old Pal is a leading brand in the cannabis space that operates a non-plant touching licensing model. The Company’s investment will enable Old Pal to expand product offerings in existing states, which include California, Nevada, Michigan, Oklahoma, Ohio, Washington and Massachusetts, and will help create the infrastructure necessary to support continued territory and product expansion.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of the historical financial condition and results of operations in conjunction with our historical consolidated financial statements and accompanying notes, which are included elsewhere in this Quarterly Report on Form 10-Q. In addition, this discussion includes forward-looking statements subject to risks and uncertainties that may result in actual results differing from statements we make. See “Cautionary Note Regarding Forward-Looking Statements.” Factors that could cause actual results to differ include those risks and uncertainties discussed in “Risk Factors.”
The following discussion relates to the unaudited financial statements of Turning Point Brands, Inc., included elsewhere in this Quarterly Report on Form 10-Q. In this discussion, unless the context requires otherwise, references to “our Company”“we,”“our,” or “us” refer to Turning Point Brands, Inc., and its consolidated subsidiaries. References to “TPB” refer to Turning Point Brands, Inc., without any of its subsidiaries. We were incorporated in 2004 under the name North Atlantic Holding Company, Inc. On November 4, 2015, we changed our name to Turning Point Brands, Inc. Many of the amounts and percentages
in this discussion have been rounded for convenience of presentation.
Overview
Turning Point Brands, Inc. (the “Company,”“we,”“our,” or “us”) is a leading manufacturer, marketer and distributor of branded consumer products. We sell a wide range of products to adult consumers consisting of staple products with our iconic brands Zig-Zag® and Stoker’s® to our next generation products to fulfill evolving consumer preferences. Among other markets, we compete in the alternative smoking accessories and Other Tobacco Products (“OTP”) industries. The alternative smoking accessories market is a dynamic market experiencing robust secular growth driven by cannabinoid legalization in the U.S. and Canada, and positively evolving consumer perception and acceptance in North America. The OTP industry, which consists of non-cigarette
tobacco products, exhibited low double-digit consumer unit growth in 2020 as reported by Management Science Associates, Inc. (“MSAi”), a third-party analytics and information company. Our three focus segments are led by our core, proprietary brands: Zig-Zag® in the Zig-Zag Products segment; Stoker’s® along with Beech-Nut® and Trophy® in the Stoker’s Products segment; and Nu-XTM, Solace® along with our distribution platforms (Vapor Beast®, VaporFi®
and Direct Vapor®) in the NewGen Products segment. Our businesses generate solid cash flow which we use to finance acquisitions, increase brand support, expand our distribution infrastructure, and strengthen our capital position. We currently ship to approximately 800 distributors with an additional 200 secondary, indirect wholesalers in the U.S. that carry and sell our products. Under the leadership of a senior management team with extensive experience in the consumer products, alternative smoking accessories and tobacco industries, we have grown and diversified our business through new product launches, category expansions, and acquisitions while concurrently improving operational efficiency.
We have identified additional growth opportunities in the emerging alternatives market. In January 2019, we established Nu-X Ventures LLC (“Nu-X”), a new wholly owned subsidiary dedicated to the development, production and sale of alternative products and acquisitions in related spaces. The creation of Nu-X allows us to leverage our expertise in traditional OTP management to alternative products. Our management team has extensive experience navigating federal, state and local regulations that are directly applicable to the growing alternatives market. In July 2019, we acquired the assets of Solace Technology (“Solace”). Solace is an innovative product development company which established one of the top e-liquid brands and has since grown into a leader in alternative products. Solace’s legacy and innovation enhanced Nu-X’s strong and nimble development engine.
We believe there are meaningful opportunities to grow through acquisitions and joint ventures across all product categories. As of December 31, 2020, our products are available in approximately 190,000 U.S. retail locations which, with the addition of retail stores in Canada, brings our total North American retail presence to an estimated 210,000 points of distribution. Our sales team targets widespread distribution to all traditional retail channels, including convenience stores, and we have a growing e-commerce business.
We operate in three segments: Zig-Zag Products, Stoker’s Products and NewGen Products. In our Zig-Zag Products segment, we principally market and distribute (i) rolling papers, tubes, and related products; and (ii) finished cigars and make-your-own (“MYO”) cigar wraps. In our Stoker’s Products segment, we (i) manufacture and market moist snuff tobacco (“MST”) and (ii) contract for and market loose leaf chewing tobacco products. In our NewGen Products segment, we (i) market and distribute CBD, liquid vapor products and certain other products without tobacco and/or nicotine; (ii) distribute a wide assortment of products to non-traditional retail via VaporBeast; and (iii) market and distribute a wide assortment of products to individual consumers via the VaporFi B2C online platform.
Operations
Our core Zig-Zag Products and Stoker’s Products segments primarily generate revenues from the sale of our products to wholesale distributors who, in turn, resell the products to retail operations. In our NewGen Products segment, our acquisition of VaporBeast in 2016 expanded our revenue streams as we began selling directly to non-traditional retail outlets. Our acquisition of IVG in 2018 enhanced our B2C revenue stream with the addition of the Vapor-Fi online platform. The acquisition of Solace provided us with a line of leading liquids and a powerful new product development platform. Our net sales, which include federal excise taxes, consist of gross sales net of cash discounts, returns, and selling and marketing allowances.
We rely on long-standing relationships with high-quality, established manufacturers to provide the majority of our produced products. More than 80% of our production, as measured by net sales, is outsourced to suppliers. The remaining production consists primarily of our moist snuff tobacco operations located in Dresden, Tennessee, and Louisville, Kentucky. Our principal operating expenses include the cost of raw materials used to manufacture the limited number of our products which we produce in-house; the cost of finished products, which are generally purchased goods; federal excise taxes; legal expenses; and compensation expenses, including benefits and costs of salaried personnel. Our other principal expenses include interest expense and other expenses.
Key Factors Affecting Our Results of Operations
We consider the following to be the key factors affecting our results of operations:
•
Our ability to further penetrate markets with our existing products;
•
Our ability to introduce new products and product lines that complement our core business;
•
Decreasing interest in some tobacco products among consumers;
•
Price sensitivity in our end-markets;
•
Marketing and promotional initiatives, which cause variability in our results;
•
General economic conditions, including consumer access to disposable income;
•
Cost and increasing regulation of promotional and advertising activities;
•
Cost of complying with regulation, including the “deeming regulations”;
•
Counterfeit and other illegal products in our end-markets;
•
Currency fluctuations;
•
Our ability to identify attractive acquisition opportunities; and
On July 23, 2021, we acquired certain assets of Unitabac, a marketer of mass-market cigars, for $9.6 million. The acquisition is comprised of a robust portfolio of cigarillo products and all related intellectual property, including Cigarillo Non-Tip (NT) Homogenized Tobacco Leaf (HTL) products and Rolled Leaf and Natural Leaf Cigarillo Products.
Old Pal
On July 21, 2021, we invested $8 million in Old Pal Holding Company LLC (“Old Pal”), a leading brand in the cannabis lifestyle space. We invested in the form of a convertible note which includes additional follow-on investment rights. Old Pal is a leading brand in the cannabis space that operates a non-plant touching licensing model. Our investment will enable Old Pal to expand product offerings in existing states, which include California, Nevada, Michigan, Oklahoma, Ohio, Washington and Massachusetts, and will help create the infrastructure necessary to support continued territory and product expansion.
Direct Value Wholesale
In April 2021, ReCreation Marketing (“ReCreation”), a VIE for which we are considered the primary beneficiary, purchased 100% of the equity interest of Westhem Ventures LTD d/b/a Direct Value Wholesale (“DVW”) for $3.9 million satisfied through $3.5 million paid in cash and $0.4 in accrued consideration to be paid during 2021. DVW is Canadian distribution entity that operates in markets not primarily served by ReCreation. The acquisition expands ReCreation’s markets in Canada.
Docklight Brands, Inc.
On April 19, 2021, we invested $8.7 million in Docklight Brands, Inc., a pioneering consumer products company with celebrated brands including Marley Natural® cannabis and Marley™ CBD. We have additional follow-on investment rights. As part of the investment, we have obtained exclusive U.S. distribution rights for Docklight’s Marley™ CBD topical products.
Senior Secured Notes and 2021 Revolving Credit Facility
On February 11, 2021, we closed a private offering (the “Offering”) of $250 million aggregate principal amount of our 5.625% senior secured notes due 2026 (the “Senior Secured Notes”). The Senior Secured Notes bear interest at a rate of 5.625% and will mature on February 15, 2026. In connection with the Offering, we also entered into a new $25 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto (the “Lenders”) and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). The 2021 Revolving Credit Facility provides for a revolving line of credit of up to $25.0 million. We used a portion of the proceeds from the issuance of the Senior Secured Notes to prepay all outstanding amounts under and terminate
the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $130.0 million, and the transaction resulted in a $5.7 million loss on extinguishment of debt. Refer to the “Long-Term Debt” section for a more complete description of our Senior Secured Notes and 2021 Revolving Credit Facility.
Premarket Tobacco Applications
We submitted Premarket Tobacco Applications (“PMTAs”) covering 250 products to the FDA prior to the September 9, 2020 filing deadline. The PMTAs cover a broad assortment of products in the vapor category including multiple proprietary e-liquid offerings in varying nicotine strengths, technologies and sizes; proprietary replacement parts and components of open system tank devices through partnerships with two leading manufacturers for exclusive distribution of products in the United States; and a closed system e-cigarette.
Critical Accounting Policies and Uses of Estimates
Inventories
Inventories are stated at the lower of cost or net realizable value. Effective January 1, 2021, the Company changed its method of accounting for inventory using the last-in, first-out (“LIFO”) method to the first-in, first-out (“FIFO”) method. The Company applied this change retrospectively to all prior periods presented, which is discussed further in Note 6, “Inventories” in the Notes to the Consolidated Financial Statements included in this Quarterly Report. Leaf tobacco is presented in current assets in accordance with standard industry practice, notwithstanding the fact that such tobaccos are carried longer than one year for the purpose of curing.
There have been no other material changes to our critical accounting policies and estimates from the information provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2020 Annual Report on Form 10-K.
Recent Accounting Pronouncements
Refer to Note 2, “Summary of Significant Accounting Policies,” of Notes to Consolidated Financial Statements included in this Quarterly Report for a description of recently issued accounting pronouncements, including those recently adopted.
Net income attributable to Turning Point Brands, Inc.
$
15,355
$
10,295
49.2
%
Net Sales: For the three months ended June 30, 2021, consolidated net sales increased to $122.6 million from $105.0 million for the three months ended June 30, 2020, an increase of $17.7 million or 16.8%. The increase in net sales was primarily driven by increased sales volume in the Zig-Zag Products segment.
For the three months ended June 30, 2021, net sales in the Zig-Zag Products segment increased to $47.2 million from $27.4 million for the three months ended June 30, 2020, an increase of $19.8 million or 72.3%. For the three months ended June 30, 2021, volume increased 64.6% and price/mix increased 7.7%. The increase in net sales was led by a doubling in sales of our MYO cigar wraps business, which experienced COVID-related manufacturing disruption in the prior year period and trade inventory build that pulled orders into the quarter. This growth was complemented by double-digit growth in U.S. rolling papers and our Canadian business which benefited from the consolidation of ReCreation in the current year period.
For the three months ended June 30, 2021, net sales in the Stoker’s Products segment increased to $33.4 million from $30.8 million for the three months ended June 30, 2020, an increase of $2.5 million or 8.3%. For the three months ended June 30, 2021, volume increased 2.4% and price/mix increased 5.9%. The increase in net sales was driven by the continuing double-digit volume growth of Stoker’s® MST offset by low single-digit decline in loose-leaf chewing tobacco.
For the three months ended June 30, 2021, net sales in the NewGen products segment decreased to $42.1 million from $46.7 million for the three months ended June 30, 2020, a decrease of $4.7 million or 10.0%. The decrease in net sales was primarily the result of declines in the vape distribution businesses as a result of strong B2C orders during stay-at-home provisions in the prior year; however, there was less of a decline due to advanced buying in the quarter ahead of stricter shipping regulations around vaping as a result of the implementation of the Prevent All Cigarette Trafficking Act (“PACT Act”).
Gross Profit: For the three months ended June 30, 2021, consolidated gross profit increased to $60.0 million from $47.9 million for the three months ended June 30, 2020, an increase of $12.0 million or 25.1%. Gross profit as a percentage of revenue increased to 48.9% for the three months ended June 30, 2021, compared to 45.7% for the three months ended June 30, 2020 driven by increased margin in the Zig-Zag Products segment as a result of the Durfort transaction in June 2020.
For the three months ended June 30, 2021, gross profit in the Zig-Zag Products segment increased to $27.7 million from $15.7 million for the three months ended June 30, 2020, an increase of $12.1 million or 77.0%. Gross profit as a percentage of net sales increased to 58.8% of net sales for the three months ended June 30, 2021, from 57.2% of net sales for the three months ended June 30, 2020, as a result of increased MYO cigar wraps sales combined with margin increases as a result of the Durfort transaction in June 2020.
For the three months ended June 30, 2021, gross profit in the Stoker’s Products segment increased to $18.1 million from $16.5 million for the three months ended June 30, 2020, an increase of $1.6 million or 9.9%. Gross profit as a percentage of net sales increased to 54.4% of net sales for the three months ended June 30, 2021, from 53.6% of net sales for the three months ended June 30, 2020, primarily as a result of strong incremental margin contribution of MST.
For the three months ended June 30, 2021, gross profit in the NewGen products segment decreased to $14.1 million from $15.8 million for the three months ended June 30, 2020, a decrease of $1.7 million or 10.6%. Gross profit as a percentage of net sales decreased to 33.5% of net sales for the three months ended June 30, 2021, from 33.7% of net sales for the three months ended June 30, 2020.
Selling, General, and Administrative Expenses: For the three months ended June 30, 2021, selling, general, and administrative expenses increased to $35.1 million from $30.8 million for the three months ended June 30, 2020, an increase of $4.3 million or 14.1%. Selling, general and administrative expenses in the three months ended June 30, 2021 included $2.8 million of stock options, restricted stock and incentives expense (including $1.1 million for accelerated vesting of options for a departing executive), $0.7 million of transaction expenses and $0.6 million of expense related to PMTA. Selling, general and administrative expenses in the three months ended June 30, 2020 included $0.8 million of stock option, restricted stock and incentives
expense, $0.3 million of transaction costs and $3.3 million of expense related to PMTA. The increase in selling, general, and administrative expenses is the result of variable costs on our online businesses which have experienced sales advances as well as increased shipping costs from PACT Act implementation for vape products and higher freight rates across all segments.
Interest Expense, net: For the three months ended June 30, 2021, interest expense, net increased to $5.5 million, from $3.3 million for the three months ended June 30, 2020 as a result of the completion of the offering of the Senior Secured Notes and related refinancing of the 2018 First Lien Credit Facility which increased the Company’s outstanding debt.
Investment Income: For the three months ended June 30, 2021, investment income increased to $0.1 million, from $0.0 million for the three months ended June 30, 2020.
Net Periodic Income: Net periodic income was $0.0 million for the three months ended June 30, 2021 compared to $0.1 million for the three months ended June 30, 2020.
Income Tax Expense: Our income tax expense of $4.4 million was 22.7% of income before income taxes for the three months ended June 30, 2021 and included a discrete tax benefit of $2.0 million relating to stock option exercises. Our effective income tax rate was 26.6% for the three months ended June 30, 2020 and included a discrete tax deduction $0.0 million relating to stock option exercises.
Net Loss Attributable to Non-Controlling Interest: Net loss attributable to non-controlling interest was $0.3 million for the three months ended June 30, 2021 compared to $0.0 million for the three months ended June 30, 2020.
Net Income Attributable to Turning Point Brands, Inc.: Due to the factors described above, net income attributable to Turning Point Brands, Inc. for the three months ended June 30, 2021 and 2020, was $15.3 million and $10.3 million, respectively.
Net income attributable to Turning Point Brands, Inc.
$
27,137
$
14,794
83.4
%
Net Sales: For the six months ended June 30, 2021, consolidated net sales increased to $230.3 million from $195.7 million for the six months ended June 30, 2020, an increase of $34.6 million or 17.7%. The increase in net sales was primarily driven by increased sales volume in the Zig-Zag Products segment.
For the six months ended June 30, 2021, net sales in the Zig-Zag Products segment increased to $88.2 million from $56.3 million for the six months ended June 30, 2020, an increase of $31.9 million or 56.6%. For the six months ended June 30, 2021, volume increased 50.3% and price/mix increased 6.3%. The increase in net sales was led by double-digit growth in sales of our MYO cigar wraps business, which experienced COVID-related manufacturing disruption in the prior year period and trade inventory build that pulled orders into the current year period. This growth was complemented by double-digit growth in U.S. rolling papers and our Canadian business which benefited from the consolidation of ReCreation in the current year period.
For the six months ended June 30, 2021, net sales in the Stoker’s Products segment increased to $62.6 million from $57.3 million for the six months ended June 30, 2020, an increase of $5.3 million or 9.3%. For the six months ended June 30, 2021, volume increased 3.6% and price/mix increased 5.7%. The increase in net sales was driven by the continuing double-digit volume growth of Stoker’s® MST offset by low single-digit decline in loose-leaf chewing tobacco.
For the six months ended June 30, 2021, net sales in the NewGen products segment decreased to $79.5 million from $82.0 million for the six months ended June 30, 2020, a decrease of $2.6 million or 3.1%. The decrease in net sales was the result of declines in both the vape distribution businesses and Nu-X.
Gross Profit: For the six months ended June 30, 2021, consolidated gross profit increased to $113.2 million from $89.4 million for the six months ended June 30, 2020, an increase of $23.9 million or 26.7%. Gross profit as a percentage of revenue increased to 49.2% for the six months ended June 30, 2021, compared to 45.7% for the six months ended June 30, 2020 driven by increased margin in the Zig-Zag Products segment as a result of the Durfort transaction in June 2020.
For the six months ended June 30, 2021, gross profit in the Zig-Zag Products segment increased to $52.6 million from $31.8 million for the six months ended June 30, 2020, an increase of $20.8 million or 65.5%. Gross profit as a percentage of net sales increased to 59.7% of net sales for the six months ended June 30, 2021, from 56.5% of net sales for the six months ended June 30, 2020, as a result of increased MYO cigar wraps sales combined with margin increases as a result of the Durfort transaction in June 2020.
For the six months ended June 30, 2021, gross profit in the Stoker’s Products segment increased to $34.0 million from $30.4 million for the six months ended June 30, 2020, an increase of $3.7 million or 12.0%. Gross profit as a percentage of net sales increased to 54.4% of net sales for the six months ended June 30, 2021, from 53.0% of net sales for the six months ended June 30, 2020, primarily as a result of strong incremental margin contribution of MST.
For the six months ended June 30, 2021, gross profit in the NewGen products segment decreased to $26.6 million from $27.2 million for the six months ended June 30, 2020, a decrease of $0.6 million or 2.3%. Gross profit as a percentage of net sales increased to 33.4% of net sales for the six months ended June 30, 2021, from 33.1% of net sales for the six months ended June 30, 2020.
Selling, General, and Administrative Expenses: For the six months ended June 30, 2021, selling, general, and administrative expenses increased to $64.0 million from $63.2 million for the six months ended June 30, 2020, an increase of $0.9 million or 1.4%. Selling, general and administrative expenses in the six months ended June 30, 2021 included $4.3 million of stock options, restricted stock and incentives expense (including $1.1 million for accelerated vesting of options for a departing executive), $1.3 million of transaction expenses and $0.9 million of expenses related to PMTA. Selling, general and administrative expenses in the six months ended June 30, 2020 included $1.2 million of stock option, restricted stock and incentives
expense, $1.3 million of transaction costs and $9.2 million of expense related to PMTA. The increase in selling, general, and administrative expenses is the result of variable costs on our online businesses which have experienced sales advances as well as increased shipping costs from PACT Act implementation for vape products and higher freight rates across all segments.
Interest Expense, net: For the six months ended June 30, 2021, interest expense, net increased to $10.0 million, from $6.6 million for the six months ended June 30, 2020 as a result of the completion of the offering of the Senior Secured Notes and related refinancing of the 2018 First Lien Credit Facility which increased the Company’s outstanding debt.
Investment Income: Investment income was $0.1 million for the six months ended June 30, 2021 and 2020.
Loss on Extinguishment of Debt: There was $5.7 million loss on extinguishment of debt for the six months ended June 30, 2021 related to the repayment of the 2018 First Lien Credit Facility, compared to $0.0 million for the six months ended June 30, 2020.
Net Periodic Income: Net periodic income was $0.0 million for the six months ended June 30, 2021 compared to $0.2 million for the six months ended June 30, 2020.
Income Tax Expense: Our income tax expense of $7.1 million was 21.0% of income before income taxes for the six months ended June 30, 2021 and included a discrete tax benefit of $5.2 million relating to stock option exercises. Our effective income tax rate was 25.8% for the six months ended June 30, 2020 and included a discrete tax deduction $3.7 million relating to stock option exercises.
Net Loss Attributable to Non-Controlling Interest: Net loss attributable to non-controlling interest was $0.6 million for the six months ended June 30, 2021 compared to $0.0 million for the six months ended June 30, 2020.
Net Income Attributable to Turning Point Brands, Inc.: Due to the factors described above, net income attributable to Turning Point Brands, Inc. for the six months ended June 30, 2021 and 2020, was $27.1 million and $14.8 million, respectively.
EBITDA and Adjusted EBITDA
To supplement our financial information presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, we use non-U.S. GAAP financial measures including EBITDA and Adjusted EBITDA. We believe Adjusted EBITDA provides useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Adjusted EBITDA is used by management to compare our performance to that of prior periods for trend analyses and planning purposes and is presented to our Board of Directors. We believe that EBITDA and Adjusted EBITDA are appropriate measures of operating performance because they eliminate the impact of expenses that do not relate to operating performance. In addition, our Revolving Credit Agreement contains financial covenants which use Adjusted EBITDA calculations, and many of the carve-outs from the negative covenants in the Senior Secured
Notes Indenture and Revolving Credit Facility are based off of EBITDA, Adjusted EBITDA and related metrics.
We define “EBITDA” as net income before interest expense, loss on extinguishment of debt, provision for income taxes, depreciation, and amortization. We define “Adjusted EBITDA” as net income before interest expense, loss on extinguishment of debt, provision for income taxes, depreciation, amortization, other non-cash items, and other items we do not consider ordinary course in our evaluation of ongoing operating performance noted in the reconciliation below.
Non-U.S. GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with U.S. GAAP. Adjusted EBITDA excludes significant expenses required to be recorded in our financial statements by U.S. GAAP and is subject to inherent limitations. Other companies in our industry may calculate this non-U.S. GAAP measure differently than we do or may not calculate it at all, limiting its usefulness as a comparative measure. The tables below provide reconciliations between net income and Adjusted EBITDA.
Represents the fees incurred for transaction expenses.
(d)
Represents the fees incurred for transaction expenses.
Liquidity and Capital Reserves
Our principal uses for cash are working capital, debt service, and capital expenditures. We believe our cash on hand, cash flows from operations and borrowing availability under our 2021 Revolving Credit Facility are adequate to satisfy our operating cash requirements for the foreseeable future. As of June 30, 2021, we had $157.5 million of cash on hand and have $21.4 million of availability under the 2021 Revolving Credit Facility.
Our working capital, which we define as current assets less cash and current liabilities, increased $4.4 million to $69.4 million at June 30, 2021, compared with $65.0 million at December 31, 2020. The increase was primarily due to the increase in inventories as a result of increased sales.
For the six months ended June 30, 2021, net cash provided by operating activities was $37.4 million compared to net cash provided by operating activities of $17.5 million for the six months ended June 30, 2020, an increase of $19.9 million, primarily due to higher net income resulting from increased sales.
Cash Flows from Investing Activities
For the six months ended June 30, 2021, net cash used in investing activities was $34.4 million compared to net cash used in investing activities of $39.7 million for the six months ended June 30, 2020, a decrease of $5.3 million, primarily due to the acquisition of certain assets from Durfort in 2020 partially offset by the purchase of investments in our MSA escrow account which reflects the change in restricted cash and the investment in Docklight Brands, Inc in 2021.
For the six months ended June 30, 2021, net cash provided by financing activities was $92.2 million compared to net cash used in financing activities of $8.9 million for the six months ended June 30, 2020, an increase in cash flow of $101.1 million, primarily due to the net proceeds from the Senior Secured Notes partially offset by the repayment in full of the 2018 First Lien Term Loan in the first quarter of 2021.
Dividends and Share Repurchase
The most recent dividend of $0.055 per common share was paid on July 9, 2021, to shareholders of record at the close of business on June 18, 2021.
On February 25, 2020, our Board of Directors approved a $50.0 million share repurchase program, which is intended for opportunistic execution based upon a variety of factors including market dynamics. The program is subject to the ongoing discretion of the Board. The total number of shares repurchased for the six months ended June 30, 2021, was 175,000 shares for a total cost of $8.4 million and an average price per share of $47.73. The $25.7 million remains available for share repurchases under the program at June 30, 2021.
Long-Term Debt
As of June 30, 2021, we were in compliance with the financial and restrictive covenants of the Senior Secured Notes and 2021 Revolving Credit Facility. The following table provides outstanding balances of our debt instruments.
On February 11, 2021, we closed a private offering (the “Offering”) of $250 million aggregate principal amount of our 5.625% senior secured notes due 2026 (the “Senior Secured Notes”). The Senior Secured Notes bear interest at a rate of 5.625% and will mature on February 15, 2026. Interest on the Senior Secured Notes is payable semi-annually in arrears on February 15 and August 15 of each year, commencing on August 15, 2021.We used the proceeds from the Offering (i) to repay all obligations under and terminate the 2018 First Lien Credit Facility, (ii) to pay related fees, costs, and expenses and (iii) for general corporate purposes.
Obligations under the Senior Secured Notes are guaranteed by the Company’s existing and future wholly-owned domestic subsidiaries (the “Guarantors”) that guarantee any Credit Facility (as defined in the Indenture governing the Senior Secured Notes or the “Senior Secured Notes Indenture”) or capital markets debt securities of the Company or Guarantors in excess of $15.0 million. The Senior Secured Notes and the related guarantees are secured by first-priority liens
on substantially all of the assets of the Company and the Guarantors, subject to certain exceptions.
We may redeem the Senior Secured Notes, in whole or in part, at any time prior to February 15, 2023, at a price equal to 100% of the principal amount of the Notes redeemed plus accrued and unpaid interest, if any, to, but excluding the applicable redemption date, plus a “make-whole” premium. Thereafter, we may redeem the Senior Secured Notes, in whole or in part, at established redemption prices set forth in the Senior Secured Notes Indenture, plus accrued and unpaid interest, if any. In addition, on or prior to February 15, 2023, we may redeem up to 40% of the aggregate principal amount of the Senior Secured Notes with the net cash proceeds from certain equity offerings at a redemption price equal to 105.625%, plus accrued and unpaid interest, if any to the
redemption date; provided, however, that at least 50% of the original aggregate principal amount of the Senior Secured Notes (calculated after giving effect to the issuance of any additional notes) remains outstanding. In addition, at any time and from time to time prior to February 15, 2023, but not more than once in any twelve-month period, we may redeem up to 10% of the aggregate principal amount of the Senior Secured Notes at a redemption price of 103% of the aggregate principal amount of Senior Secured Notes redeemed plus accrued and unpaid interest, if any to but not including the redemption date, on the Senior Secured Notes to be redeemed.
If we experience a change of control (as defined in the Senior Secured Notes Indenture), we must offer to repurchase the Senior Secured Notes at a repurchase price equal to 101% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest.
The Indenture contains covenants that, among other things, restrict the ability of the Company and its restricted subsidiaries to: (i) grant or incur liens; (ii) incur, assume or guarantee additional indebtedness; (iii) sell or otherwise dispose of assets, including capital stock of subsidiaries; (iv) make certain investments; (v) pay dividends, make distributions or redeem or repurchase capital stock; (vi) engage in certain transactions with affiliates; and (vii) consolidate or merge with or into, or sell substantially all of our assets to another entity. These covenants are subject to a number of
limitations and exceptions set forth in the Indenture.
We incurred debt issuance costs attributable to the issuance of the Senior Secured Notes of $6.4 million which are amortized to interest expense using the effective interest method over the expected life of the Senior Secured Notes.
The Indenture provides for customary events of default.
2021 Revolving Credit Facility
In connection with the Offering, we also entered into a new $25 million senior secured revolving credit facility (the “2021 Revolving Credit Facility”) with the lenders party thereto (the “Lenders”) and Barclays Bank PLC, as administrative agent and collateral agent (in such capacity, the “Agent”). The 2021 Revolving Credit Facility provides for a revolving line of credit of up to $25.0 million. Letters of credit are limited to $10 million (and are a part of, and not in addition to, the revolving line of credit). We have not drawn any borrowings under the 2021 Revolving Credit Facility but do have letters of credit of approximately $3.6 million outstanding under the facility. The 2021 Revolving Credit Facility will mature on August 11, 2025 if none of our Convertible Senior Notes are outstanding, and if any Convertible Senior Notes are outstanding, the date which is
91 days prior to the maturity date of July 15, 2024 for such Convertible Senior Notes.
Interest is payable on the 2021 Revolving Credit Facility at a fluctuating rate of interest determined by reference to the Eurodollar rate plus an applicable margin of 3.50% (with step-downs upon de-leveraging). We also have the option to borrow at a rate determined by reference to the base rate.
The obligations under the 2021 Revolving Credit Agreement are guaranteed on a joint and several basis by the Guarantors. The Company’s and Guarantors’ obligations under the 2021 Revolving Credit Facility are secured on a pari passu basis with the Senior Secured Notes.
The 2021 Revolving Credit Agreement contains covenants that are substantially the same as the covenants in the Senior Secured Notes Indenture. The 2021 Revolving Credit Facility also requires the maintenance of a Consolidated Leverage Ratio (as defined in the 2021 Revolving Credit Agreement) of 5.50 to 1.00 (with a step down to 5.25 to 1.00 beginning with the fiscal quarter ending March 31, 2023) at the end of each fiscal quarter when extensions of credit under the 2021 Revolving Credit Facility and certain drawn and undrawn letters of credit (excluding (a) letters of credit that have been cash collateralized and (b) letters of credit having an aggregate face amount less than $5,000,000) in the aggregate outstanding exceeds 35% of the total commitments under the 2021 Revolving Credit Facility.
We incurred debt issuance costs attributable to the issuance of the 2021 Revolving Credit Facility of $0.5 million which are amortized to interest expense using the effective interest method over the expected life of the 2021 Revolving Credit Facility.
The 2021 Revolving Credit Agreement provides for customary events of default.
2018 Credit Facility
In the first quarter of 2021, we used a portion of the proceeds from the issuance of the Senior Secured Notes to prepay all outstanding amounts under and terminate the 2018 First Lien Credit Facility in the amount of $130.0 million, and the transaction resulted in a $5.7 million loss on extinguishment of debt. See Note 11, “Notes Payable and Long-Term Debt,” in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion.
Convertible Senior Notes
In July 2019 we closed an offering of $172.5 million in aggregate principal amount of our 2.50% Convertible Senior Notes due July 15, 2024 (the “Convertible Senior Notes”). The Convertible Senior Notes bear interest at a rate of 2.50% per year, payable semiannually in arrears on January 15 and July 15 of each year, beginning on January 15, 2020. The Convertible Senior Notes will mature on July 15, 2024, unless earlier repurchased, redeemed or converted. The Convertible Senior Notes are senior unsecured obligations.
The Convertible Senior Notes are convertible into approximately 3,206,637 shares of our voting common stock under certain circumstances prior to maturity at a conversion rate of 18.589 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.79 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. The conversion price is adjusted periodically as a result of dividends paid by the us in excess of pre-determined thresholds of $0.04 per share. Upon conversion, we may pay cash, shares of our common stock or a combination of cash and stock, as determined by us at our discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of June 30, 2021.
We early adopted ASU 2020-06 effective January 1, 2021 on a retrospective basis to all periods presented. Under ASU 2020-06, the Company will account for the Convertible Senior Notes entirely as a liability and will no longer separately account for the Convertible Senior Notes with liability and equity components. See Note 2, “Summary of Significant Accounting Policies,” in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion of the impact of the adoption of ASU 2020-06.
We incurred debt issuance costs attributable to the Convertible Senior Notes of $5.9 million which are amortized to the interest expense using the effective interest method over the expected life of the Convertible Senior Notes.
In connection with the Convertible Senior Notes offering, we entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $53.79 per and a cap price of $82.86 per share, and are exercisable when, and if, the Convertible Senior Notes are converted. We paid $20.53 million for these capped calls at the time they were entered into and charged that amount to additional paid-in capital.
The indenture covering the Convertible Senior Notes contains customary events of default.
Promissory Note
On June 10, 2020, in connection with the acquisition of certain Durfort assets, we issued an unsecured subordinated promissory note (“Promissory Note”) in the principal amount of $10.0 million (the “Principal Amount”), with an annual interest rate of 7.5%, payable quarterly, with the first interest payment due September 10, 2020. The Principal Amount is payable in two $5.0 million installments, with the first installment due 18 months after the closing date of the acquisition (June 10, 2020), and the second installment due 36 months after the closing date of the acquisition. The second installment is subject to reduction for certain amounts payable to us as a holdback.
Unsecured Loan
On April 6, 2020, the 2018 First Lien Credit Facility was amended to allow for an unsecured loan under the Coronavirus Aid, Relief, and Economic Security Act of 2020 (“CARES”). On April 17, 2020, National Tobacco Company, L.P., a wholly-owned subsidiary of the Company, entered into a loan agreement with Regions Bank guaranteed by the Small Business Administration for a $7.5 million unsecured loan. The proceeds of the loan were received on April 27, 2020. The loan is scheduled to mature on April 17, 2022 and has a 1.00% interest rate.
During the six months ended June 30, 2021, the Company did not execute any forward contracts. At June 30, 2021, the Company had forward contracts for the purchase of €8.2 million and sale of €8.9 million outstanding. The fair value of the foreign currency contracts was based on quoted market prices and resulted in an asset of $0.0 million included in Other current assets and liability of
$0.0 million included in Accrued liabilities at June 30, 2021. During 2020, the Company executed various forward contracts for the purchase of €19.7 million and sale of €21.4 million with maturity dates ranging from December 2020 to November 2021. At December 31, 2020, the Company had forward contracts for the purchase of €18.0 million and sale of €19.6 million outstanding. The fair value of the foreign currency contracts
is based on quoted market prices and resulted in an asset of $0.4 million included in Other current assets and liability of $0.0 million included in Accrued liabilities at December 31, 2020.The Company had interest rate swap contracts for a notional amount of $70 million at December 31, 2020. The fair values of the interest rate swap contracts are based upon quoted market prices and resulted in a liability of $3.7 million as of December 31, 2020, included in other long-term liabilities. The
Company terminated the interest rate swap agreement in conjunction with the prepayment of all outstanding amounts under to the 2018 First Lien Credit Facility in the first quarter of 2021 in the amount of $3.6 million, and the transaction resulted in a $5.7 million loss recorded in the loss on extinguishment of debt. See Note 11, “Notes Payable and Long-Term Debt,” in the Notes to Consolidated Financial Statements included in this Quarterly Report for further discussion.
Inflation
We believe that any effect of inflation at current levels will be minimal. Historically, we have been able to increase prices at a rate equal to or greater than that of inflation and believe that we will continue to be able to do so for the foreseeable future. In addition, we have been able to maintain a relatively stable variable cost structure for our products due, in part, to our successful procurement with regard to our tobacco products and, in part, to our existing contractual agreement for the purchase of our premium cigarette papers.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Sensitivity
There have been no material changes in our exposure to exchange rate fluctuation risk, as reported within our 2020 Annual Report on Form 10-K, during the period. Please refer to our ‘Quantitative and Qualitative Disclosures about Market Risk’ included in our 2020 Annual Report on Form 10-K filed with the SEC.
Credit Risk
There have been no material changes in our exposure to credit risk, as reported within our 2020 Annual Report on Form 10-K, during the six months ended June 30, 2021. Please refer to our ‘Quantitative and Qualitative Disclosures about Market Risk’ included in our 2020 Annual Report on Form 10-K filed with the SEC.
Interest Rate Sensitivity
In February 2021, we issued the Senior Secured Notes in an aggregate principal amount of $250 million. In July 2019, we issued Convertible Senior Notes in an aggregate principal amount of $172.5 million. We carry the Senior Secured Notes and Convertible Senior Notes at face value. Since the Senior Secured Notes and Convertible Senior Notes bear interest at a fixed rate, we have no financial statement risk associated with changes in interest rates. However, the fair value of the Convertible Senior Notes changes when the market price of our stock fluctuates, or interest rates change. Our remaining debt instruments bear interest at fixed rates and are not subject to interest rate volatility.
We have carried out an evaluation under the supervision, and with the participation of, our management including our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”), and Chief Accounting Officer (“CAO”), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the “Act”)) as of June 30, 2021. Based upon the evaluation, our CEO, CFO, and CAO concluded our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Act is: (i) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to our
management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures.
There have been no changes in the Company’s internal control over financial reporting during the fiscal quarter ended June 30, 2021 which have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
For a description of our material pending legal proceedings, please see Contingencies in Note 16 to the Notes to the Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report.
See ‘Risk Factors—We may become subject to significant product liability litigation’ within our 2020 Annual Report on Form 10-K for additional details.
Item 1A. Risk Factors
In addition to the other information set forth in this report, carefully consider the factors discussed in the ‘Risk Factors’ section contained in our 2020 Annual Report on Form 10-K. There have been no material changes to the Risk Factors set forth in the 2020 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On February 25, 2020, the Company’s Board of Directors approved a $50.0 million share repurchase program, which is intended for opportunistic execution based upon a variety of factors including market dynamics. This share repurchase program has no expiration date and is subject to the ongoing discretion of the Board. All repurchases to date under our stock repurchase programs have been made through open market transactions, but in the future, we may also purchase shares through privately negotiated transactions or 10b5-1 repurchase plans.
The following table includes information regarding purchases of our common stock made by us during the quarter ended June 30, 2021 in connection with the repurchase program described above:
Period
Total Number
of Shares
Purchased (1)
Average
Price Paid
per Share
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
Maximum Number
(or Approximate
Dollar Value)
of Shares that
May Yet Be
Purchased Under the
Plans or Programs
April 1 to April 30
-
$
-
-
34,075,635
May 1 to May 31
184,090
$
47.71
170,000
25,937,735
June 1 to June 31
5,000
$
42.87
5,000
25,723,385
Total
189,090
175,000
(1)
The total number of shares purchased includes (a) shares purchased under the February 2020 share repurchase program (which totaled 170,000 shares in May and 5,000 shares in June) and (b) shares withheld by the Company in an amount equal to the statutory withholding taxes for holders who vested in stock-based awards (which totaled 14,090 shares in May). Shares withheld by the Company to cover statutory withholdings taxes are repurchased pursuant to the applicable plan and not the authorization under the share repurchase program.
Section 1350 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101
XBRL (eXtensible Business Reporting Language). The following materials from Turning Point Brands, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2021, filed on July 27, 2021, formatted in Inline XBRL (iXBRL): (i) consolidated balance sheets, (ii) consolidated statements of income, (iii) consolidated statements of comprehensive income, (iv) consolidated statements of cash flows, and (v) the notes to consolidated financial statements.*
104
Cover Page Interactive Data File (formatted in iXBRL and included in Exhibit 101).*
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
