10-Q 1 brhc10036668_10q.htm 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2022

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________

Commission file number: 001-37763

TURNING POINT BRANDS, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
20-0709285
(State or other jurisdiction of Incorporation or organization)
 
(I.R.S. Employer Identification No.)

5201 Interchange Way, Louisville, KY
 
40229
(Address of principal executive offices)
 
(Zip Code)

(502) 778-4421
(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
Common Stock, $0.01 par value
TPB
New 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.  Yes      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).  Yes      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
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
Emerging growth company
     

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  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      No 

At April 19, 2022, there were 18,136,353 shares outstanding of the registrant’s voting common stock, par value $0.01 per share.





TURNING POINT BRANDS, INC.
TABLE OF CONTENTS

 
Page No.
PART I—FINANCIAL INFORMATION
 
   
 
ITEM 1
 
       
   
5
       
   
6
       
   
7
       
   
8
       
   
9
       
   
10
       
 
ITEM 2
31
       
 
ITEM 3
40
       
 
ITEM 4
41
       
PART II—OTHER INFORMATION
 
   
 
ITEM 1
42
       
 
ITEM 1A
42
       
 
ITEM 2
42
       
 
ITEM 3
42
       
 
ITEM 4
43
       
 
ITEM 5
43
       
 
ITEM 6
44
       
  45

Cautionary Note Regarding Forward-Looking Statements

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, as well as other supply chain concerns, including delays in product shipments and increases in freight cost;

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;

uncertainty and continued evolution of the markets for our NewGen and cigar products;

complications with the design or implementation of our new enterprise resource planning system could adversely impact our business and operations;

substantial and increasing U.S. regulation;

regulation or marketing denials 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 escrow agreement;

possible significant increases in federal, state and local municipal tobacco- and vapor-related taxes;

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 including significant increases in the rate of inflation and other declines in purchasing power;

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;

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;

identification a material weakness in our internal control related to ineffective information technology general controls which, if not remediated appropriately or timely, could result in loss of investor confidence and adversely impact our stock price;

Changes in the method for determining LIBOR or the replacement of LIBOR with an alternative reference rate, may adversely affect interest expense related to outstanding debt;


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;

infringement on or misappropriation of our intellectual property;

third-party claims that we infringe on their intellectual property; and

failure to meet expectations relating to environmental, social and governance factors.


PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Turning Point Brands, Inc.
Consolidated Balance Sheets
(dollars in thousands except share data)

ASSETS
 
(unaudited)
March 31,
2022
   
December 31,
2021
 
Current assets:
           
Cash
 
$
126,045
   
$
128,320
 
Accounts receivable, net of allowances of $177 in 2022 and $262 in 2021
   
9,450
     
6,496
 
Inventories
   
105,858
     
87,607
 
Other current assets
   
25,663
     
26,746
 
Total current assets
   
267,016
     
249,169
 
Property, plant, and equipment, net
   
20,567
     
18,650
 
Deferred income taxes
   
1,754
     
1,363
 
Right of use assets
   
14,405
     
15,053
 
Deferred financing costs, net
   
362
     
388
 
Goodwill
   
162,323
     
162,333
 
Other intangible assets, net
   
87,022
     
87,485
 
Master Settlement Agreement (MSA) escrow deposits
   
30,237
     
31,720
 
Other assets
   
35,017
     
35,399
 
Total assets
 
$
618,703
   
$
601,560
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
 
$
29,464
   
$
7,361
 
Accrued liabilities
   
29,921
     
32,937
 
Other current liabilities
   
38
     
38
 
Total current liabilities
   
59,423
     
40,336
 
Notes payable and long-term debt
   
414,791
     
414,172
 
Lease liabilities
   
12,625
     
13,336
 
Total liabilities
   
486,839
     
467,844
 
                 
Commitments and contingencies
           
                 
Stockholders’ equity:
               
Preferred stock; $0.01 par value; authorized shares 40,000,000; issued and outstanding shares -0-
   
-
     
-
 
Common stock, voting, $0.01 par value; authorized shares, 190,000,000; 19,785,806 issued shares and 18,180,174 outstanding shares at March 31, 2022, and 19,690,884 issued shares and 18,395,476 outstanding shares at December 31, 2021
   
198
     
197
 
Common stock, nonvoting, $0.01 par value; authorized shares, 10,000,000; issued and outstanding shares -0-
   
-
     
-
 
Additional paid-in capital
   
109,073
     
108,811
 
Cost of repurchased common stock (1,605,632 shares at March 31, 2022, and 1,295,408 shares at December 31, 2021)
   
(59,491
)
   
(48,869
)
Accumulated other comprehensive loss
   
(1,326
)
   
(195
)
Accumulated earnings
   
81,327
     
71,460
 
Non-controlling interest
   
2,083
     
2,312
 
Total stockholders’ equity
   
131,864
     
133,716
 
Total liabilities and stockholders’ equity
 
$
618,703
   
$
601,560
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Income
(dollars in thousands except share data)
(unaudited)

 
Three Months Ended
March 31,
 
   
2022
   
2021
 
Net sales
 
$
100,894
   
$
107,641
 
Cost of sales
   
49,100
     
54,380
 
Gross profit
   
51,794
     
53,261
 
Selling, general, and administrative expenses
   
32,565
     
28,912
 
Operating income
   
19,229
     
24,349
 
Interest expense, net
   
5,196
     
4,486
 
Investment income
   
(78
)
   
(25
)
Loss on extinguishment of debt
   
-
     
5,706
 
Income before income taxes
   
14,111
     
14,182
 
Income tax expense
   
3,340
     
2,654
 
Consolidated net income
   
10,771
     
11,528
 
Net loss attributable to non-controlling interest
   
(227
)
   
(255
)
Net income attributable to Turning Point Brands, Inc.
 
$
10,998
   
$
11,783
 
                 
Basic income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
0.60
   
$
0.62
 
Diluted income per common share:
               
Net income attributable to Turning Point Brands, Inc.
 
$
0.55
   
$
0.57
 
Weighted average common shares outstanding:
               
Basic
   
18,257,695
     
19,093,961
 
Diluted
   
21,749,510
     
22,665,067
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Comprehensive Income
(dollars in thousands)
(unaudited)

 
Three Months Ended
March 31,
 
   
2022
   
2021
 
Consolidated net income
 
$
10,771
   
$
11,528
 
                 
Other comprehensive income (loss), net of tax
               
Unrealized loss on MSA investments, net of tax of $357 in 2022 and $144 in 2021
   
(1,126
)
   
(452
)
Foreign currency translation, net of tax of $0 in 2022 and 2021
   
(7
)
   
318
 
Unrealized gain on derivative instruments, net of tax of $0 in 2022 and $937 in 2021
   
-
     
2,448
 
     
(1,133
)
   
2,314
 
Consolidated comprehensive income
   
9,638
     
13,842
 
Comprehensive loss attributable to non-controlling interest
   
(229
)
   
(96
)
Comprehensive income attributable to Turning Point Brands, Inc.
 
$
9,867
   
$
13,938
 

The accompanying notes are an integral part of the consolidated financial statements

Turning Point Brands, Inc.
Consolidated Statements of Cash Flows
(dollars in thousands)
(unaudited)


 
Three Months Ended
March 31,
 
   
2022
   
2021
 
Cash flows from operating activities:
           
Consolidated net income
 
$
10,771
   
$
11,528
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Loss on extinguishment of debt
   
-
     
5,706
 
Loss (gain) on sale of property, plant, and equipment
   
1
     
(2
)
Depreciation expense
   
871
     
788
 
Amortization of other intangible assets
   
463
     
477
 
Amortization of deferred financing costs
   
645
     
604
 
Deferred income tax (benefit) expense
   
(34
)
   
552
 
Stock compensation expense
   
1,159
     
1,498
 
Noncash lease (income) expense
   
(5
)
   
6
 
Gain on investments
   
(14
)
   
(13
)
Changes in operating assets and liabilities:
               
Accounts receivable
   
(2,958
)
   
2,735
 
Inventories
   
(18,258
)
   
(12,461
)
Other current assets
   
1,081
     
1,283
 
Other assets
   
382
     
464
 
Accounts payable
   
22,101
     
14,882
 
Accrued liabilities and other
   
(3,165
)
   
(3,806
)
Net cash provided by operating activities
 
$
13,040
   
$
24,241
 
                 
Cash flows from investing activities:
               
Capital expenditures
 
$
(2,787
)
 
$
(842
)
Restricted cash, MSA escrow deposits
   
(8,468
)
   
(14,920
)
Proceeds on the sale of property, plant and equipment
   
1
     
2
 
Net cash used in investing activities
 
$
(11,254
)
 
$
(15,760
)
                 
Cash flows from financing activities:
               
Proceeds from Senior Secured Notes
 
$
-
   
$
250,000
 
Payments of 2018 first lien term loan
   
-
     
(130,000
)
Settlement of interest rate swaps
   
-
     
(3,573
)
Payment of dividends
   
(1,022
)
   
(958
)
Payments of financing costs
   
-
     
(6,614
)
Exercise of options
   
245
     
425
 
Redemption of options
   
-
     
(1,466
)
Redemption of performance restricted stock units
    (1,141 )     -  
Common stock repurchased
   
(10,622
)
   
(5,733
)
Net cash provided by (used in) financing activities
 
$
(12,540
)
 
$
102,081
 
                 
Net (decrease) increase in cash
 
$
(10,754
)
 
$
110,562
 
Effect of foreign currency translation on cash
 
$
(3
)
 
$
101
 
                 
Cash, beginning of period:
               
Unrestricted
   
128,320
     
41,765
 
Restricted
   
15,155
     
35,074
 
Total cash at beginning of period
   
143,475
     
76,839
 
                 
Cash, end of period:
               
Unrestricted
   
126,045
     
167,361
 
Restricted
   
6,673
     
20,141
 
Total cash at end of period
 
$
132,718
   
$
187,502
 
                 
Supplemental schedule of noncash investing activities:
               
Accrued capital expenditures
  $
187
    $
177
 
                 
Supplemental schedule of noncash financing activities:
               
Dividends declared not paid
 
$
1,131
   
$
1,071
 
Accrued expenses for incurred financing costs
 
$
-
   
$
301
 

The accompanying notes are an integral part of the consolidated financial statements.

Turning Point Brands, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the Three Months Ended March 31, 2022 and 2021
(dollars in thousands except share data)
(unaudited)

 
Voting
Shares
   
Common
Stock,
Voting
   
Additional
Paid-In
Capital
   
Cost of
Repurchased
Common Stock
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Accumulated
Earnings
   
Non-
Controlling
Interest
   
Total
 
                                                 
Beginning balance January 1, 2022
   
18,395,476
   
$
197
   
$
108,811
   
$
(48,869
)
 
$
(195
)
 
$
71,460
   
$
2,312
   
$
133,716
 
                                                                 
Unrealized loss on MSA investments, net of tax of $357
   
-
     
-
     
-
     
-
     
(1,126
)
   
-
     
-
     
(1,126
)
Foreign currency translation, net of tax of $0
   
-
     
-
     
-
     
-
     
(5
)
   
-
     
(2
)
   
(7
)
Stock compensation expense
   
-
     
-
     
1,159
     
-
     
-
     
-
     
-
     
1,159
 
Exercise of options
   
25,166
     
-
     
245
     
-
     
-
     
-
     
-
     
245
 
Performance restricted stock units issuance
    103,843       1       (1 )     -       -       -       -       -  
Performance restricted stock units redeemed
    (34,087 )     -       (1,141 )     -       -       -       -       (1,141 )
Cost of repurchased common stock
   
(310,224
)
   
-
     
-
     
(10,622
)
   
-
     
-
     
-
     
(10,622
)
Dividends
   
-
     
-
     
-
     
-
     
-
     
(1,131
)
   
-
     
(1,131
)
Net income
   
-
     
-
     
-
     
-
     
-
     
10,998
     
(227
)
   
10,771
 
Ending balance March 31, 2022
   
18,180,174
   
$
198
   
$
109,073
   
$
(59,491
)
 
$
(1,326
)
 
$
81,327
   
$
2,083
   
$
131,864
 
                                                                 
                                                                 
Beginning balance Janauary 1, 2021
   
19,133,794
   
$
195
   
$
102,423
   
$
(10,191
)
 
$
(2,635
)
 
$
23,645
   
$
4,050
   
$
117,487
 
                                                                 
Unrealized loss on MSA investments, net of tax of $144
   
-
     
-
     
-
     
-
     
(452
)
   
-
      -      
(452
)
Unrealized gain on derivative instruments, net of tax of $937
   
-
     
-
     
-
     
-
     
2,448
     
-
      -      
2,448
 
Foreign currency translation, net of tax of $0
    -       -       -       -       159       -       159       318  
Stock compensation expense
   
-
     
-
     
1,498
     
-
     
-
     
-
      -      
1,498
 
Exercise of options
   
44,357
     
1
     
424
     
-
     
-
     
-
      -      
425
 
Redemption of options
    -       -       (1,466 )     -       -       -       -       (1,466 )
Cost of repurchased common stock
   
(119,031
)
   
-
     
-
     
(5,733
)
   
-
     
-
      -      
(5,733
)
Dividends
   
-
     
-
     
-
     
-
     
-
     
(1,071
)
    -      
(1,071
)
Net income
   
-
     
-
     
-
     
-
     
-
     
11,783
      (255 )    
11,528
 
Ending balance March 31, 2021
   
19,059,120
   
$
196
   
$
102,879
   
$
(15,924
)
 
$
(480
)
 
$
34,357
   
$
3,954
   
$
124,982
 

The accompanying notes are an integral part of the consolidated financial statements

Turning Point Brands, Inc.
Notes to Consolidated Financial Statements
(dollars in thousands, except where designated and per share data)

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. The Company sells a wide range of products to adult consumers consisting of staple products with its iconic brands Zig-Zag® and Stoker’s® and its next generation products to fulfill evolving consumer preferences. Its three 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; along with its distribution platforms (Vapor Beast®, VaporFi® and Direct Vapor®)and Solace® in the NewGen Products segment. The Company’s products are available in more than 215,000 retail outlets in North America. The Company operates in three segments: (i) Zig-Zag Products, (ii) Stoker’s Products, and (iii) NewGen Products.

Basis of Presentation

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, 2021. 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, 2021. 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.

Note 2. Summary of Significant Accounting Policies

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.

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 17. An additional disaggregation of contract revenue by sales channel can be found within Note 17 as well.

Shipping Costs

The Company records shipping costs incurred as a component of selling, general, and administrative expenses. Shipping costs incurred were approximately $5.7 million and $5.9 million for the three months ending March 31, 2022 and 2021, respectively.

Inventories

Inventories are stated at the lower of cost or net realizable value using the first-in, first-out (“FIFO”) method. 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.

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.

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 100% of its anticipated purchases of inventory in the denominated invoice currency over a forward period not to exceed twelve months. The Company may also, from time to time, hedge up to ninety 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.

Risks and Uncertainties

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 twenty-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 March 31, 2022, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $30.2 million. At December 31, 2021, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $31.7 million. The Company discontinued its generic category of MYO in 2019 and its Zig-Zag branded MYO cigarette smoking tobacco in 2017. Thus, pending a change in MSA legislation, the Company has no remaining product lines covered by the MSA and will not be required to make future escrow deposits.

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 in the fair value hierarchy. 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.

   
As of March 31, 2022
   
As of December 31, 2021
 
   
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Fair
Value
   
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Fair
Value
 
Cash and cash equivalents
 
$
3,673
   
$
-
   
$
-
   
$
3,673
   
$
12,155
    $ -     $ -     $ 12,155  
U.S. Governmental agency obligations
(unrealized position < 12 months)
   
21,452
     
5
     
(1,145
)
   
20,312
     
19,918
      4       (357 )     19,565  
U.S. Governmental agency obligations
(unrealized position > 12 months)
    6,948       -       (696 )     6,252       -       -       -       -  
   
$
32,073
   
$
5
   
$
(1,841
)
 
$
30,237
   
$
32,073
    $
4     $
(357 )   $
31,720  

   
As of
 
   
 March 31,
2022
Less than one year
 
$
-
 
One to five years
   
7,443
 
Five to ten years
   
20,001
 
Greater than ten years
   
956
 
Total
 
$
28,400
 

The following shows the amount of deposits by sales year for the MSA escrow account:


 
Deposits as of
 
Sales
Year
 
March 31,
2022
   
December 31,
2021
 
1999
 
$
211
   
$
211
 
2000
   
1,017
     
1,017
 
2001
   
1,673
     
1,673
 
2002
   
2,271
     
2,271
 
2003
   
4,249
     
4,249
 
2004
   
3,714
     
3,714
 
2005
   
4,553
     
4,553
 
2006
   
3,847
     
3,847
 
2007
   
4,167
     
4,167
 
2008
   
3,364
     
3,364
 
2009
   
1,619
     
1,619
 
2010
   
406
     
406
 
2011
   
193
     
193
 
2012
   
199
     
199
 
2013
   
173
     
173
 
2014
   
143
     
143
 
2015
   
101
     
101
 
2016
   
91
     
91
 
2017
   
82
     
82
 
                 
Total
 
$
32,073
   
$
32,073
 

Food and Drug Administration (FDA): 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 four 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 six classes 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 and wraps); (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 three 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 have continued to supplement these applications with additional information. 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 has indicated its enforcement priority is those applicants who have received negative action on their application, such as a Marketing Denial Order or Refuse to File notification and who continue to illegally sell those unauthorized products, as well as products for which manufacturers failed to submit a marketing application.

The 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. On October 5, 2021, the FDA finalized two rules related to the Substantial Equivalence process and the Premarket Tobacco Product Application process, respectively, which both become effective November 4, 2021. Both final rules (collectively, the “Rules”) indicate that any new or additional requirements will not retroactively apply to currently pending PMTAs; however, the information outlined in the rule remains important to the FDA’s substantive review of an application. We believe we have products that meet the Rules and have filed premarket filings supporting a showing of the respective required standards. However, there is no assurance that the FDA’s guidance or regulations will not change, that the FDA will not prioritize its enforcement in a manner that negatively affects our pending applications, 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 generated by lower priority SKUs.

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 or otherwise remain in compliance with relevant legal requirements. 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.

On April 29, 2021, the FDA announced plans to propose two 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.

On March 15, 2022, the Consolidated Appropriations Act of 2022 was signed into law. This law included a new provision bringing non-tobacco nicotine products (“NTN Products”), including synthetic nicotine, under the jurisdiction of the FDA Center for Tobacco Products. This law took effect April 14, 2022, and subjects NTN Products to the same requirements as tobacco-derived products, including not selling these products to persons under 21 years of age, not marketing these products as modified risk tobacco products, and not distributing free samples of these products. Additionally, NTN Products on the market between March 15, 2022, and April 14, 2022, must file a PMTA by May 14, 2022. NTN Products subject of a timely-filed PMTA, and not in receipt of a negative action, may remain on the market until July 13, 2022. After July 13, 2022, these products are subject to enforcement.

We have been compiling premarket filings for certain of our NTN Products and will submit these filings ahead of the May 14, 2022, deadline. After the deadline passes, we will continue to supplement these filings with additional information; however, there can be no guarantee that FDA will accept such amendments or, similar to other filings, that the applications will meet the standard of “appropriate for the protection of public health.”  We also expect that for a period of time after the filing deadline, there may be a lack of enforcement, which may adversely impact our ability to compete in the marketplace against those who continue to sell unauthorized products.

Prevent All Cigarette Trafficking Act (“PACT Act”): On December 27, 2020, President Trump signed the Further Consolidated Appropriations Act, 2021, into law. This law included an amendment to the Jenkins Act expanding the definition of “cigarette” to include “electronic nicotine delivery systems,” or ENDS, and required that the United States Postal Service (USPS) promulgate regulations clarifying the applicability of the prohibition on delivery sales of cigarettes to ENDS. USPS issued its final rule on October 21, 2021. We have received appropriate shipping exemptions from carrier services we use to carry the affected freight. Failure to comply with the PACT Act could result in significant financial or criminal penalties. To the extent we are unable to respond to, or comply with, these new requirements, we could lose our shipping exemptions, be subject to civil or criminal penalties, or there could be a material adverse effect on our business, results of operations and financial condition.

Note 3. Acquisitions

Unitabac

In July 2021, the Company acquired certain assets of Unitabac, a marketer of mass-market cigars, for $10.7 million in total consideration, comprised of $9.6 million in cash and $1.1 million of capitalized transaction costs. The acquisition is comprised of a 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. The transaction was accounted for as an asset purchase with $10.0 million assigned to intellectual property, which has an indefinite life, and $0.7 million assigned to inventory. The intellectual property asset is deductible for tax purposes.

Direct Value Wholesale

In April 2021, Turning Point Brands Canada, a VIE for which the Company is considered the primary beneficiary, purchased 100% of the equity interests of Westhem Ventures LTD d/b/a Direct Value Wholesale (“DVW”) for $3.9 million, net of cash acquired, with $3.5 million paid in cash at closing and $0.5 million in accrued consideration to be paid during 2021. DVW is a Canadian distribution entity that operates in markets not primarily served by Turning Point Brands Canada. The acquisition expands Turning Point Brands Canada’s markets in Canada. On April 13, 2021, in connection with the acquisition of DVW, the Company provided a $3.7 million unsecured loan to Turning Point Brands Canada bearing interest at 8% per annum and maturing April 13, 2023. The unsecured loan is eliminated in the consolidation of Turning Point Brands Canada. As of March 31, 2022, Turning Point Brands Canada 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
 
$
3,462
 
Adjustments to consideration transferred:
       
Cash acquired
   
(43
)
Accrued consideration
   
472
 
Adjusted consideration transferred
   
3,891
 
Assets acquired:
       
Working capital (primarily AR and inventory)
   
1,334
 
Fixed assets and Other long term assets
   
27
 
Net assets acquired
 
$
1,361
 
         
Goodwill
 
$
2,530
 

The goodwill of $2.5 million consists of the synergies expected from combining the operations and is deductible for tax purposes.

Turning Point Brands Canada

In July 2021, the Company invested an additional $2.3 million in Turning Point Brands Canada increasing its ownership interest to 65%. The Company received board seats aligned with its ownership position. The Company has determined that Turning Point Brands Canada continues to be a VIE due to its required subordinated financial support. The Company has determined it remains the primary beneficiary due to its 65% equity interest, additional subordinated financing and distribution agreement with Turning Point Brands Canada for the sale of the Company’s products. As a result of the Company remaining the primary beneficiary, the increase in ownership interest resulted in a decrease in Non-controlling interest of $1.1 million and a decrease in Additional paid-in capital of $1.1 million

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 of up to 100% of its anticipated purchases of inventory over a forward period that will not exceed 12 rolling and consecutive months. The Company may, from time to time, hedge currency for non-inventory purchases, e.g., production equipment, not to exceed 90% of the purchase price. At March 31, 2022 and December 31, 2021, the Company had no forward contracts outstanding.

Interest Rate Swaps

The Company’s policy is to manage interest rate risk relating to 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 $70 million with an expiration of December 2022. The swap agreements fixed LIBOR at 2.755%. 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 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 $3.6 million which was reclassified out of accumulated other comprehensive loss into loss on extinguishment of debt.

Note 5. Fair Value of Financial Instruments

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 5.625% per year. As of March 31, 2022, the fair value of the Senior Secured Notes approximated their carrying value of $250 million due to the recency of the notes’ issuance, related to March 31, 2022. As of December 31, 2021, the fair value of the Senior Secured Notes approximated their carrying value of $250 million due to the recency of the notes’ issuance, related to December 31, 2021.

The Convertible Senior Notes (as defined) bear interest at a rate of 2.50% per year, and the fair value of the Convertible Senior Notes without the conversion feature approximated $160.9 million, with a carrying value of $172.5 million as of March 31, 2022. As of December 31, 2021, the fair value of the Convertible Senior Notes approximated $159.8 million, with a carrying value of $172.5 million.

See Note 11, “Notes Payable and Long-Term Debt”, for further information regarding the Company’s long-term debt.

Note 6. Inventories

The components of inventories are as follows:


 
March 31,
2022
   
December 31,
2021
 
Raw materials and work in process
 
$
7,483
   
$
6,936
 
Leaf tobacco
   
47,733
     
35,900
 
Finished goods - Zig-Zag Products
   
28,928
     
25,663
 
Finished goods - Stoker’s Products
   
11,142
     
8,959
 
Finished goods - NewGen products
   
9,167
     
8,591
 
Other
   
1,405
     
1,558
 
Inventories
 
$
105,858
   
$
87,607
 

The inventory valuation allowance was $5.4 million and $7.7 million as of March 31, 2022, and December 31, 2021, respectively.

Note 7. Other Current Assets

Other current assets consist of:

 
March 31,
2022
   
December 31,
2021
 
Inventory deposits
 
$
9,245
   
$
12,091
 
Insurance deposit
   
3,000
     
3,000
 
Other
   
13,418
     
11,655
 
Total
 
$
25,663
   
$
26,746
 

Note 8. Property, Plant, and Equipment

Property, plant, and equipment consists of:


 
March 31,
2022
   
December 31,
2021
 
Land
 
$
22
   
$
22
 
Buildings and improvements
   
3,096
     
3,096
 
Leasehold improvements
   
5,389
     
5,374
 
Machinery and equipment
   
22,322
     
19,591
 
Furniture and fixtures