During the nine months ended September 30, 2019, the Company recorded impairment charges of $0.8 million and $2.0 million related to the full impairment of the goodwill and intangible asset balances, respectively, in its Insurance segment. This impairment was a result of changes in the future plans for the Insurance segment and certain other factors impacting recoverability. As a result, there were no goodwill or intangible asset balances remaining in the Company’s Insurance segment as of September 30, 2019.
Note 12. Accrued Liabilities
Accrued liabilities consist of the following as of:
| (In thousands) | | September 30, 2019 | | | December 31, 2018 | |
| Accrued payroll and related items | | $ | 5,623 | | | $ | 6,063 | |
| Customer returns and allowances | | | 2,980 | | | | 2,895 | |
| Taxes payable | | | 691 | | | | - | |
| Lease liabilities | | | 1,914 | | | | - | |
| Other | | | 10,363 | | | | 14,925 | |
| | | $ | 21,571 | | | $ | 23,883 | |
Note 13. Liability for Losses and Loss Adjustment Expenses
The liability for unpaid losses and LAE is determined from individual case estimates for reported claims and a factor for IBNR claims. The methods for making such estimates and establishing claim reserves are continually reviewed and adjustments are reflected in the current period. While management believes the liability for unpaid losses and LAE is adequate, the ultimate liability may vary from the amount recorded and the variance may be material to the Company’s financial position and results of operations.
Activity in the liability for losses and LAE is summarized as follows:
(In thousands) | | Nine Months Ended September 30, 2019 | | | Period from January 2, 2018 to September 30, 2018 | |
| Reserve for losses and LAE at beginning of period | | $ | 27,330 | | | $ | 30,216 | |
| Provision for claims, net of insurance: | | | | | | | | |
| Incurred related to: | | | | | | | | |
| Prior year | | | 3,531 | | | | - | |
| Current year | | | 12,334 | | | | 17,007 | |
| Total incurred | | | 15,865 | | | | 17,007 | |
| Deduct payment of claims, net of reinsurance: | | | | | | | | |
| Paid related to: | | | | | | | | |
| Prior year | | | 12,658 | | | | 11,815 | |
| Current year | | | 4,105 | | | | 10,667 | |
| Total paid | | | 16,763 | | | | 22,482 | |
| Reserve for losses and LAE at end of period | | $ | 26,432 | | | $ | 24,741 | |
The components of the net liability for losses and LAE are as follows as of:
| (In thousands) | | September 30, 2019 | | | December 31, 2018 | |
| Case basis reserves | | $ | 13,062 | | | $ | 15,863 | |
| Incurred but not reported reserves | | | 13,370 | | | | 11,467 | |
| Total | | $ | 26,432 | | | $ | 27,330 | |
Note 14. Notes Payable and Long-Term Debt
Notes payable and long-term debt consist of the following as of:
| (In thousands) | | September 30, 2019 | | | December 31, 2018 | |
| 2018 First Lien Term Loan | | $ | 148,000 | | | $ | 154,000 | |
| 2018 Second Lien Term Loan | | | - | | | | 40,000 | |
| SDI Crystal Term Loan | | | - | | | | 15,000 | |
| SDI GACP Term Loan | | | 25,000 | | | | - | |
| Standard Outdoor Promissory Notes | | | 8,584 | | | | 9,950 | |
| Convertible Senior Notes | | | 172,500 | | | | - | |
| Note payable - IVG | | | 4,240 | | | | 4,000 | |
| Total Notes Payable and Long-Term Debt | | | 358,324 | | | | 222,950 | |
| Less: deferred finance charges and debt discount | | | (12,216 | ) | | | (4,903 | ) |
| Less: current maturities | | | (15,958 | ) | | | (9,431 | ) |
| | | $ | 330,150 | | | $ | 208,616 | |
Turning Point
2018 Credit Facility
On March 7, 2018, Turning Point entered into a $250 million credit facility consisting of a $160 million 2018 First Lien Term Loan with Fifth Third Bank, as administrative agent, and other lenders, and a $50 million 2018 Revolving Credit Facility (collectively, the “2018 First Lien Credit Facility”) in addition to a $40 million 2018 Second Lien Term Loan (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 contains a $40 million accordion feature. Proceeds from the 2018 Credit Facility were used to repay, in full, the 2017 Credit Facility. Turning Point incurred a loss on extinguishment of debt of $2.4 million in the first quarter of 2018 as a result of the refinancing.
The 2018 Credit Facility contains 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 contains 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 Turning Point 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.
2018 First Lien Credit Facility
The 2018 First Lien Term Loan and the 2018 Revolving Credit Facility bear interest at LIBOR plus a spread of 2.75% to 3.50% based on Turning Point’s senior leverage ratio. The 2018 First Lien Term Loan has quarterly required payments of $2.0 million beginning June 30, 2018, increasing to $3.0 million on June 30, 2020, and increasing to $4.0 million on June 30, 2022. The 2018 First Lien Credit Facility has a maturity date of March 7, 2023. The 2018 First Lien Term Loan is secured by a first priority lien on substantially all of the assets of the borrowers and the guarantors thereunder, including a pledge of Turning Point’s capital stock, other than certain excluded assets (the “Collateral”). In connection with the Convertible Senior Notes offering, Turning Point 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 Turning Point to issue up to $200 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 Turning Point’s Second Lien Credit Agreement and use the remaining proceeds for acquisitions and investments. In connection with the Amendment, fees of $0.7 million were incurred. The 2018 First Lien Credit Facility contains certain financial covenants, which were amended in connection with the Convertible Senior Notes offering in the third quarter of 2019. The covenants include maximum senior leverage ratio of 3.00x with step-downs to 2.50x, a maximum total leverage ratio of 5.50x with step-downs to 5.00x, and a minimum fixed charge coverage ratio of 1.20x. Based on an excess cash covenant for the facility, a principal payment of $4.5 million was due in the second quarter of 2019. All parties agreed to waive the payment, resulting in consent fees of $0.1 million. The weighted average interest rate of the 2018 First Lien Term Loan was 5.04% at September 30, 2019. As of September 30, 2019, Turning Point had no borrowings outstanding under the 2018 Revolving Credit Facility. The $50.0 million unused portion of the 2018 Revolving Credit Facility is reduced by letters of credit from Fifth Third Bank totaling $2.7 million, resulting in $47.3 million of availability under the 2018 Revolving Credit Facility as of September 30, 2019.
2018 Second Lien Credit Facility
The 2018 Second Lien Credit Facility bore interest at a rate of LIBOR plus 7.00% and had a maturity date of March 7, 2024. The 2018 Second Lien Term Loan was secured by a second priority interest in the Collateral and was guaranteed by the same entities as the 2018 First Lien Term Loan. The 2018 Second Lien Credit Facility contained certain financial covenants including a maximum senior leverage ratio of 3.75x with step-downs to 3.50x, a maximum total leverage ratio of 4.75x with step-downs to 4.50x, and a minimum fixed charge coverage ratio of 1.10x. Based on an excess cash covenant for the facility, a $4.5 million principal payment was made in the second quarter of 2019, resulting in a $0.2 million loss on extinguishment of debt. Turning Point used a portion of the proceeds from the issuance of the its 2.50% Convertible Senior Notes due July 15, 2024 to prepay all outstanding amounts related to the 2018 Second Lien Credit Facility in the third quarter of 2019. The principal paid in the third quarter amounted to $35.5 million and the transaction resulted in a $1.2 million loss on extinguishment of debt.
Convertible Senior Notes
In July 2019 Turning Point closed an offering of $172.5 million in aggregate principal amount of its 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 of Turning Point.
The Convertible Senior Notes are convertible into approximately 3,202,808 shares of Turning Point’s voting common stock under certain circumstances prior to maturity at a conversion rate of 18.567 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.86 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. Upon conversion, Turning Point may pay cash, shares of common stock or a combination of cash and stock, as determined by Turning Point at its discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of September 30, 2019.
The excess of the principal amount of the liability over its carrying amount (“debt discount”) is amortized to interest expense over the term of the Convertible Senior Notes using the effective interest rate method.
Turning Point incurred debt issue costs and allocated the total amount to the liability and equity components of the Convertible Senior Notes based on their relative values. The debt issue costs attributable to the liability component are amortized to interest expense over the term of the Convertible Senior Notes using the effective interest method. Issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.
In connection with the Convertible Senior Notes offering, Turning Point entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $53.86 per and a cap price of $82.86 per and are exercisable when and if the Convertible Senior Notes are converted. Turning Point paid $20.53 million for these capped calls and charged that amount to additional paid-in capital.
The carrying value of the equity component related to the Convertible Senior Notes at September 30, 2019 was $3.1 million. The effective interest rate on the liability component for the three-month period ended September 30, 2019 was 6.15%. Total interest cost of $0.9 million was recognized during the three-month period ended September 30, 2019, including $0.1 million amortization of debt discount.
Note Payable – IVG
In September 2018, Turning Point issued a note payable to IVG’s former shareholders (the “IVG Note”). The IVG Note is $4.0 million principal with 6.0% interest compounding annually and matures on March 5, 2020. All principal and accrued and unpaid interest under the IVG Note is 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 was $4.2 million as of September 30, 2019.
SDI and Standard Outdoor
SDI
On September 18, 2019, the Company entered into a Term Loan Agreement (the “Term Loan Agreement”) with GACP II, L.P., a Delaware limited partnership (the “Agent”), as administrative agent and collateral agent for the financial institutions (the “Lenders”). The Term Loan Agreement provides for a term loan of $25.0 million (the “Term Loan”). The Term Loan will be used to (a) repay, in full, all outstanding indebtedness under the Crystal Term Loan (as defined below), (b) finance the purchase of common stock of Turning Point, (c) finance the repurchase of common stock of the Company, (d) fund certain fees and expenses, and (e) provide working capital for the Company.
The Term Loan bears interest at a rate equal to the three-month “Libor Rate” as published in The Wall Street Journal plus 9.00%. Interest under the Term Loan Agreement is payable monthly with the principal balance due on September 18, 2024. The Term Loan was subject to a closing fee of $0.5 million, which was paid upon execution of the Term Loan Agreement. Additionally, the Term Loan is subject to an agent monitoring fee of $25,000, payable quarterly. An early termination fee shall be due at any time if on or prior to the third anniversary of the closing of the Term Loan, the Company prepays or repays (whether voluntarily or mandatorily), or is required to prepay or repay, the Term Loan in whole or in part. The obligations of the Company under the Term Loan Agreement are secured by all of the shares of Turning Point stock owned by the Company.
The Term Loan Agreement contains certain affirmative and negative covenants that are binding on the Company, including, but not limited to, restrictions (subject to specified exceptions and qualifications) on the ability of the Company to incur indebtedness, to create liens, to merge or consolidate, to make dispositions, to pay dividends or make distributions, to make investments, to pay any subordinated indebtedness, to enter into certain transactions with affiliates or to make capital expenditures. The Term Loan Agreement contains customary events of default (which are in some cases subject to certain exceptions, thresholds, notice requirements and grace periods). The Term Loan Agreement also contains certain representations, warranties and conditions, in each case as set forth in the Term Loan Agreement.
With respect to the maintenance of at least $2.0 million in unrestricted cash and cash equivalents in accounts subject to control agreements in favor of the Agent, as of September 30, 2019, the Company had approximately $12.9 million in unrestricted cash and cash equivalents in those accounts.
On September 18, 2019, in connection with entering into the Term Loan Agreement, the Company repaid in full all amounts outstanding under the Crystal Term Loan (as defined below). The Company recognized a loss on extinguishment of debt of $1.0 million, comprised of $0.7 million unamortized deferred financing costs and a $0.3 million early termination fee, which is recognized in the condensed consolidated statements of operations for the three and nine months ended September 30, 2019. The Company capitalized $0.6 million of deferred financing costs associated with closing on the Term Loan.
On February 2, 2018, SDI and its Standard Outdoor advertising subsidiaries (the “Borrowers”) entered into a term loan agreement with Crystal Financial LLC (“Crystal Term Loan”). The Crystal Term Loan provided for an initial term loan of $10.0 million and a commitment to provide additional term loans of up to $15.0 million. As of September 30, 2019, the Company had repaid all amounts outstanding under the Crystal Term Loan.
Interest expense related to the Term Loan and the Crystal Term Loan of $0.4 million and $1.2 million, including amortization of the discount, was recorded for the three and nine months ended September 30, 2019, respectively. Interest expense related to the Crystal Term Loan of $0.4 million and $0.8 million, including amortization of the discount, was recorded for the three and nine months ended September 30, 2018.
Standard Outdoor
On January 18, 2018, as partial consideration for an asset purchase of 83 billboard structures located in Alabama, as well as the ground leases and advertising contracts relating to such billboard structures, the Company issued a promissory note with a face value of $6.5 million. The promissory note was recorded net of a discount of $0.9 million, representing the difference between the face value and fair value at issuance. This discount will be amortized into interest expense using the effective interest rate method over the term of the promissory note. A principal payment of $1.0 million on the promissory note is payable January 1 of each year, beginning January 1, 2020 and ending January 1, 2022, with a $3.5 million final principal payment on January 1, 2023. The promissory note has a 5% fixed coupon interest rate and interest is payable quarterly.
On February 20, 2018, as partial consideration for an asset purchase of 86 billboard structures located in Georgia and Florida, as well as the ground leases and advertising contracts relating to such billboard structures, the Company issued a promissory note with a face value of $3.5 million. The promissory note was recorded net of a discount of $0.3 million, representing the difference between the face value and fair value at issuance. This discount will be amortized into interest expense using the effective interest rate method over the term of the promissory note. Principal payments began on March 1, 2019, with the remaining principal paid down monthly through March 1, 2022. The promissory note has a 5% fixed coupon interest rate and interest is payable monthly.
Interest expense related to the Standard Outdoor loans of $0.2 million and $0.6 million, including amortization of the discount, was recorded for the three and nine months ended September 30, 2019 and 2018, respectively.
The following table summarizes the consolidated scheduled principal repayments subsequent to September 30, 2019:
| | | Future Minimum Principal Payments | |
| October 1, 2019 - December 31, 2019 | | $ | 2,136 | |
| 2020 | | | 17,079 | |
| 2021 | | | 13,882 | |
| 2022 | | | 16,227 | |
| 2023 | | | 111,500 | |
| thereafter | | | 197,500 | |
| Total | | $ | 358,324 | |
Note 15. Leases
As of January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). The main impact to the financial statements is the recognition of lease liabilities and right of use assets.
Turning Point
Turning Point’s leases consist primarily of leased property for its manufacturing warehouse, head offices and retail space as well as vehicle leases. In general, Turning Point does not recognize any renewal periods within the lease terms as there are not significant barriers to ending the lease at the initial term. Lease and non-lease components are accounted for as a single lease component.
Standard Outdoor
Standard Outdoor leases land and constructs a billboard that it owns, or leases an existing billboard owned by a third party. Standard Outdoor does recognize certain renewal periods to match the remaining useful life of its billboard structures. From a lessor perspective, Standard Outdoor has operating leases related to customers that use its billboards to advertise; however, these lessees are typically considered to be short-term (less than 12 months) and are not cyclical with the same lessee.
Leases with an initial term of 12 months or less are not recorded on the condensed consolidated balance sheet. Lease expense for these leases is recognized on a straight-line basis over the lease term.
The components of lease expense consist of the following:
| (In thousands) | | Three Months Ended September 30, 2019 | | | Nine Months Ended September 30, 2019 | |
| Operating lease cost: | | | | | | |
| Cost of sales | | $ | 225 | | | $ | 649 | |
| Selling, general and administrative | | | 658 | | | | 2,115 | |
Variable lease cost (1) | | | 320 | | | | 802 | |
| Short-term lease cost | | | 31 | | | | 120 | |
| Sublease income | | | (30 | ) | | | (80 | ) |
| Total operating lease cost | | $ | 1,204 | | | $ | 3,606 | |
| (1) | Variable lease cost primarily includes elements of a contract that do not represent a good or service, but for which the lessee is responsible for paying. |
Supplemental balance sheet information related to leases consist of the following as of:
| (In thousands) | | September 30, 2019 | |
| Assets: | | | |
| Right of use assets | | $ | 13,755 | |
| Total leased assets | | $ | 13,755 | |
| | | | | |
| Liabilities: | | | | |
Current lease liabilities (1) | | $ | 1,914 | |
| Long-term lease liabilities | | | 12,280 | |
| Total lease liabilities | | $ | 14,194 | |
| (1) | Reported within accrued liabilities on the condensed consolidated balance sheet. |
| | | September 30, 2019 | |
| Consolidated weighted average remaining lease term - operating leases | | 9.2 years | |
| Consolidated weighted average discount rate - operating leases | | | 7.09 | % |
Nearly all the lease contracts for the Company do not provide a readily determinable implicit rate. For these contracts, the Company estimated the incremental borrowing rate based on information available upon the adoption of ASU 2016-02. The Company applied a consistent method in periods after the adoption of ASU 2016-02 to estimate the incremental borrowing rate.
As of September 30, 2019, future maturities of lease liabilities consist of the following:
| Year | | Payments | |
| October 1, 2019 - December 31, 2019 | | $ | 590 | |
| 2020 | | | 3,338 | |
| 2021 | | | 2,813 | |
| 2022 | | | 1,986 | |
| 2023 | | | 1,563 | |
| Thereafter | | | 9,633 | |
| Total lease payments | | | 19,923 | |
| Less: Imputed interest | | | 5,729 | |
| Present value of lease liability | | $ | 14,194 | |
During the three months ended September 30, 2019, Turning Point had seven retail leases and one warehouse lease extended, renewed or adjusted. These changes resulted in additional lease liabilities of $0.7 million. Also, during the nine months ended September 30, 2019, Standard Outdoor entered into three new leases as a part of its May 2019 asset acquisition resulting in additional lease liabilities of $0.1 million as of September 30, 2019.
Note 16. Pension and Postretirement Benefit Plans
Turning Point has 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 defined benefit pension plan is frozen. Turning Point’s policy is to make the minimum amount of contributions that can be deducted for federal income taxes. Turning Point expects to make no contributions to the pension plan in 2019. In the second quarter of 2018, Turning Point made mutually agreed upon lump-sum payments to certain individuals covered by the defined benefit pension plan which resulted in a curtailment loss of approximately $0.3 million during the second quarter of 2018, which is reported within net periodic benefit (income) expense, excluding service cost within the condensed consolidated statements of income (loss). In October 2019, Turning Point elected to terminate the defined benefit pension plan, effective December 31, 2019, with final distributions to be made in 2020.
Turning Point sponsored a defined benefit postretirement plan that covered hourly employees. This plan provides medical and dental benefits. This plan is contributory with retiree contributions adjusted annually. Turning Point’s policy is to make contributions equal to benefits paid during the year. Turning Point expects to contribute approximately $0.2 million to its postretirement plan in 2019 for the payment of benefits. In October 2019, Turning Point amended the plan to cease benefits effective June 30, 2020.
The following table provides the components of net periodic pension and postretirement benefit costs and total costs for the plans:
| | | Three months ended September 30, | |
| | | Pension Benefits | | | Post-Retirement Benefits | |
| (In thousands) | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Service cost | | $ | 26 | | | $ | 26 | | | $ | - | | | $ | - | |
| Interest cost | | | 130 | | | | 135 | | | | 25 | | | | 30 | |
| Expected return on plan assets | | | (161 | ) | | | (221 | ) | | | - | | | | - | |
| Amortization of losses (gains) | | | 36 | | | | 33 | | | | (41 | ) | | | (21 | ) |
| Net periodic benefit expense (income) | | $ | 31 | | | $ | (27 | ) | | $ | (16 | ) | | $ | 9 | |
| | | Nine months ended September 30, | |
| | | Pension Benefits | | | Post-Retirement Benefits | |
| (In thousands) | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Service cost | | $ | 78 | | | $ | 78 | | | $ | - | | | $ | - | |
| Interest cost | | | 390 | | | | 419 | | | | 76 | | | | 88 | |
| Expected return on plan assets | | | (484 | ) | | | (728 | ) | | | - | | | | - | |
| Amortization of losses (gains) | | | 110 | | | | 153 | | | | (125 | ) | | | (61 | ) |
| Curtailment loss | | | - | | | | 306 | | | | - | | | | - | |
| Net periodic benefit expense (income) | | $ | 94 | | | $ | 228 | | | $ | (49 | ) | | $ | 27 | |
Note 17. Stockholders’ Equity
Common Stock
At the consummation of the Contribution and Exchange, the Company issued 7,335,018 shares of its Class A common stock to Turning Point shareholders, in exchange for 9,842,373 shares of Turning Point stock, and 857,714 shares of its Class A common stock, in exchange for the Company’s outstanding common stock. The Company also issued 13,700 shares of Class A common stock to holders of the Company’s restricted stock, which vested at the time of the Contribution and Exchange. Following the consummation of the Contribution and Exchange, the Company distributed a dividend of one share of Class B common stock for each outstanding share of Class A common stock, for a total issuance of 8,190,166 shares of Class B common stock. In addition, under the Fifth Amended and Restated Certificate of Incorporation, which became effective at the time of the Contribution and Exchange, the number of authorized shares of the Company’s common stock, $0.01 par value per share, was increased from 50,000,000 to 330,000,000, of which 300,000,000 are Class A common stock and 30,000,000 are Class B common stock.
The Ninth Amended and Restated Certificate of Incorporation was approved by the Company’s stockholders by partial written consent on July 14, 2017, and in accordance with the rules of the Securities and Exchange Commission and Delaware corporation law regarding approval by partial written consent, became effective when filed with the Secretary of State of the State of Delaware on August 18, 2017.
Common Stock Repurchase Program
On June 29, 2017, the Company’s Board of Directors (the “Board”) authorized a program, effective immediately, to repurchase shares of the Company’s Class A common stock or Class B common stock, par value $0.01 per share, constituting, in the aggregate, up to 5% of the outstanding shares of Common Stock. Shares of Common Stock may be repurchased in the open market or through negotiated transactions. The program may be terminated or suspended at any time at the discretion of the Company.
The time of purchases and the exact number of shares to be purchased, if any, will depend on market conditions. The repurchase program does not include specific price targets or timetables. The Company intends to finance the purchases using available working capital.
Pursuant to this program, repurchases of 91,552 shares of common stock were made during the three months ended September 30, 2019 for a cost of $1.2 million. During the nine months ended September 30, 2019, repurchases of 131,652 shares of common stock were made for a cost of $1.8 million. No shares of common stock were repurchased during the three or nine months ended September 30, 2018. As of December 31, 2018, $0.8 million was included in accrued liabilities on the condensed consolidated balance sheets for unsettled repurchases.
In January 2018, the Company issued 181,825 shares of its Class A common stock in a private placement for gross proceeds of $2.0 million.
In March 2018, the Company granted 18,834 shares of restricted stock with immediate vesting to individuals for services performed. These shares were granted outside of the Company’s 2017 Omnibus Equity Compensation Plan.
Dividends paid by Turning Point
On November 9, 2017, the Board of Directors of Turning Point approved the initiation of a cash dividend to its shareholders. During the nine months ended September 30, 2019, Turning Point paid or accrued dividends of $1.4 million to its shareholders other than SDI. The most recent dividend was paid on October 11, 2019 to shareholders of record at the close of business on September 20, 2019.
Dividends are classified as restricted payments within the 2018 Credit Facility. Turning Point is generally permitted to make restricted payments provided that, at the time of payment, or as a result of payment, Turning Point is not in default on its debt covenants. Additional restrictions limit the aggregate amount of restricted, quarterly dividends during a fiscal year to the aggregate amount of mandatory and voluntary principal payments made on the priority term loans during the fiscal year.
Note 18. Share-Based Compensation
On June 9, 2017, the Company’s Board adopted the 2017 Omnibus Equity Compensation Plan (the “2017 Plan”) in order to provide employees of the Company and its subsidiaries, certain consultants and advisors who perform services for the Company or its subsidiaries, and non-employee members of the Board of the Company with the opportunity to receive grants of incentive stock options, nonqualified stock options, stock appreciation rights, stock awards, stock units, and other stock-based awards. The Board authorized 1,000,000 shares of the Class A Common Stock of the Company to be issued under the Plan. The Plan was approved by the Company’s stockholders by partial written consent on July 14, 2017, and in accordance with the rules of the Securities and Exchange Commission and Delaware corporation law regarding approval by partial written consent, became effective on August 17, 2017. As of September 30, 2019, the Company had 982,183 shares available for grant under the 2017 Plan.
The Company also has an Employee Stock Purchase Plan (the “ESPP”). The ESPP allows eligible full-time employees to purchase shares of common stock at 90 percent of the lower of the fair market value of a share of common stock on the first or last day of the quarter. Eligible employees are provided the opportunity to acquire Company common stock during each quarter. No more than 26,447 shares of common stock may be issued under the ESPP. Such stock may be unissued shares or treasury shares of the Company or may be outstanding shares purchased in the open market or otherwise on behalf of the ESPP. The Company’s ESPP is compensatory and therefore, the Company is required to recognize compensation expense related to the discount from market value of shares sold under the ESPP. The Company issues new shares to satisfy shares purchased under the ESPP.
Including the share-based compensation expense of SDI’s subsidiaries, the Company recorded share-based compensation expense of $1.2 million and $0.5 million recorded for the three months ended September 30, 2019 and 2018, respectively. For the nine months ended September 30, 2019 and 2018, the Company recorded share-based compensation expense of $3.0 million and $1.7 million, respectively. This expense is a component of selling, general and administrative expense in the condensed consolidated statements of income (loss).
No options of SDI were exercised during the three and nine months ended September 30, 2019 and 2018.
Information with respect to the adjusted activity of outstanding stock options is summarized as follows:
| | Number of Shares | | | Price Range | | Weighted Average Remaining Contractual term |
| Balance, January 1, 2019 | | | 2,463 | | | $ | 31.00 | | | $ | 46.25 | | |
| Cancelled | | | - | | | | - | | | | - | | |
| Balance, September 30, 2019 | | | 2,463 | | | $ | 31.00 | | | $ | 46.25 | | 3.1 years |
| Vested and exercisable at September 30, 2019 | | | 2,463 | | | $ | 31.00 | | | $ | 46.25 | | 3.1 years |
The following table provides additional information about the Company’s stock options outstanding and exercisable as of September 30, 2019:
| | | | Options Outstanding and Exercisable | |
| | | | | | | Weighted Average | |
Range of Exercise Prices | | | Number of Shares | | | Remaining Contractual Life | | Exercise Price | |
| $ 31.00 - $ 31.25 | | | | 1,400 | | | | 4.6 | | years | | $ | 31.18 | |
| $ 45.25 - $46.25 | | | | 1,063 | | | | 1.2 | | years | | | 45.63 | |
| $ 31.00 - $46.25 | | | | 2,463 | | | | 3.1 | | years | | $ | 37.41 | |
The Company grants restricted stock awards (“RSA”) which is the right to receive shares. The fair value of RSAs is based on the market price for the stock at the date of grant.
The following table summarizes the changes in non-vested RSAs for the nine months ended September 30, 2019:
| | | Shares | | | Weighted Average Grant Date Fair Value | |
| Non-vested RSAs at January 1, 2019 | | | 127,005 | | | $ | 10.96 | |
| Granted | | | 6,747 | | | | 14.45 | |
| Vested | | | (44,107 | ) | | | 11.28 | |
| Cancelled/Forfeited | | | (4,779 | ) | | | 13.34 | |
| Non-vested RSAs at September 30, 2019 | | | 84,866 | | | $ | 10.94 | |
As of September 30, 2019, there was $0.6 million of total unrecognized stock-based compensation expense, related to restricted stock awards, which will be recognized over the weighted-average remaining vesting period of one year.
Note 19. Income Taxes
In December 2017, the U.S. Congress passed the Tax Cuts and Jobs Act (“TCJA”) which the President signed in the same month. The TCJA reduced the corporate income tax rate to 21%, effective January 1, 2018. Other significant changes accompanying the corporate income tax rate reduction include eliminating the corporate alternative minimum tax, limiting the interest expense deduction to 30% of adjusted taxable income, and limiting net operating losses to 80% of taxable income for losses arising in tax years beginning after 2017. The TCJA required the Company to remeasure its deferred tax assets and liabilities at the newly enacted tax rate in December 2017, the period of enactment.
SDI has recorded a full valuation allowance as of September 30, 2019, offsetting its U.S. federal and state net deferred tax assets which primarily represent net operating loss carry forwards (“NOLs”). As of September 30, 2019, the Company’s management concluded, based upon the evaluation of all available evidence, that it is more likely than not that the U.S. federal and state net deferred tax assets will not be realized. Due to the reverse acquisition transaction with Turning Point, the Company determined that SDI has experienced a “change in control” as defined in Internal Revenue Code Section 382, which will result in an annual limitation on SDI’s utilization of NOLs in future periods. The Company completed the evaluation of the effects of Section 382 on SDI’s future utilization of its NOLs, and determined that the Company will be limited to $10.6 million of its $33.0 million pre-2018 NOLs over the next 20 years. All NOLs generated after December 31, 2017 have an indefinite life.
The Company’s income tax expense for the three and nine months ended September 30, 2019 was $2.2 million and $6.6 million, respectively. The Company’s income tax expense for the three and nine months ended September 30, 2018 was $1.4 million and $4.2 million, respectively. Turning Point’s effective income tax rate for the three and nine months ended September 30, 2019 was 26% and 21%, respectively, which includes discrete tax deduction of $0.1 million and $4.6 million for the three and nine months ended September 30, 2019, respectively, relating to stock option exercises. Turning Point’s effective income tax rate for the three and nine months ended September 30, 2018, was 15% and 17%, respectively, which includes discrete tax deductions of $3.3 million and $5.2 million for the three and nine months ended September 30, 2018, 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 2015.
As a part of the Company’s impairment of other indefinite lived intangible assets as described more fully in Note 11, “Goodwill and Intangible Asset Impairments,” the Company reversed its deferred tax liability recorded as a part of the purchase of Maidstone during the nine months ended September 30, 2019. The reversal decreased deferred income taxes by $0.4 million on the condensed consolidated balance sheet as of September 30, 2019 and provided an income tax benefit of $0.4 million to the condensed consolidated statements of income (loss) for the nine months ended September 30, 2019.
Note 20. Contingencies
The Company is a party from time to time to various proceedings in the ordinary course of business. For a description of the Master Settlement Agreement, to which the Company is a party, see Note 2, “Summary of Significant Accounting Policies.” Other than the proceedings mentioned below, there is no material litigation, arbitration or governmental proceeding currently pending against the Company or any of its officers or directors in their capacity as such, and the Company and its officers and directors have not been subject to any such proceeding.
Turning Point
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 could have a material adverse effect on Turning Point’s business and results of operations. Turning Point is a defendant in certain cases which have been dormant for many years, which cases have now been dismissed with prejudice.
Turning Point is subject to several lawsuits alleging personal injuries resulting from malfunctioning vaporizer devices and may be subject to claims in the future relating to other NewGen products. Turning Point is still evaluating these claims and the potential defenses to them. For example, Turning Point did not design or manufacture the products at issue; rather, it was merely the distributor. Nonetheless, there can be no assurance that Turning Point will prevail in these cases, and they could have a material adverse effect on the financial position, results of operations, or cash flows of Turning Point.
Turning Point has several subsidiaries engaged in making, distributing and retailing (online and in bricks-and-mortar) 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. Turning Point expects that its subsidiaries will be subject to some such cases and information requests. In the acquisition of the vapor businesses, Turning Point negotiated financial “hold-backs”, which it expects to be able to use to defray expenses associated with the information production and the cost of defending any such lawsuits. To the extent that litigation becomes necessary, Turning Point believes that the subsidiaries have strong factual and legal defenses against claims that it unfairly marketed vapor products.
On October 8, 2019, the City of New York filed a complaint against twenty-three companies, including IVG and VaporFi, making various allegations including selling to consumers over the age of 18 but under 21. In response, those subsidiaries have ceased all sales into New York City, which was an immaterial market for those businesses. The complaint has not been served on Turning Point’s subsidiaries. If the complaint is served, Turning Point believes that there are strong defenses and expect that the subsidiaries will vigorously defend the claims. Nonetheless, there can be no assurance that the subsidiaries will prevail, and an adverse result could have a material adverse effect on Turning Point’s business and results of operations.
Maidstone
Maidstone is a party to lawsuits arising in the normal course of its business. These lawsuits generally seek to establish liability under insurance policies and occasionally seek punitive damages. In the opinion of the Company’s management, none of the cases, individually or collectively, are likely to result in judgments for amounts, after considering established loss reserves and reinsurance, which would have a material adverse effect on the Company’s financial condition or results of operations.
The Company has experienced continuing losses in its Insurance segment, primarily driven by increases in losses and loss adjustment expenses, along with the full impairment of its goodwill and other intangible asset balances. The Company has no plans to contribute additional capital to its Insurance segment and anticipates it will continue to incur losses for the foreseeable future. In August 2019, Maidstone consented to the entry of an order of liquidation pursuant to Article 74 of the New York Consolidated Insurance Law (“Order of Liquidation”) with the New York State Department of Financial Services (the “NYSDFS”) and began to negotiate the terms of the Order of Liquidation with the NYSDFS. As of September 30, 2019, the NYSDFS has not yet filed its petition for the entry of an Order of Liquidation. If the entry of the Order of Liquidation is approved, the Company expects to be relieved of all the assets and liabilities of Maidstone by the New York State Liquidation Bureau (“Liquidation Bureau”). These condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties and such adjustments could be material to the Company’s financial position and results of operations.
Concentrations
Maidstone primarily wrote personal automobile and homeowner’s insurance in New York. Maidstone’s financial position, results of operations and cash flows are susceptible to risks as a result of these concentrations. In addition, Maidstone wrote a significant amount of business through brokers and a credit risk exists should any of these brokers be unable to fulfill their obligations with respect to the payment of insurance balances. Since April 1 and July 1, 2019, Maidstone is no longer writing new personal automobile and homeowner’s insurance policies, respectively. As prescribed by section 3425 of the New York Insurance Law, Maidstone continues to write renewal policies for existing personal automobile and homeowner’s insurance policyholders.
The creditworthiness of the counterparty is evaluated by Maidstone, taking into account credit ratings assigned by independent agencies. The credit approval process involves an assessment of factors, including, among others, the counterparty, country and industry credit exposure limits. Collateral may be required, at the discretion of the Company, on certain transactions based on the creditworthiness of the counterparty.
Maidstone’s fixed income investment portfolio is managed in accordance with guidelines that have been tailored to meet specific investment strategies, including standard of diversification, which limit the allowable holdings to any single issue.
Note 21. Legal Settlement
Turning Point engaged in discussions and mediation with VMR Products LLC (“VMR”), which was acquired in 2018. Pursuant to a Distribution and Supply Agreement (“VMR Agreement”), VMR was providing Turning Point with V2 e-cigarettes for the exclusive distribution in bricks-and-mortar stores in the United States. Under the terms of the VMR Agreement, in the event of termination following a change in control, the acquirer was required to make a payment to Turning Point under a formula designed to provide Turning Point with a fair share of the value created by Turning Point’s performance under the VMR Agreement. The discussions have been completed and Turning Point received $6.7 million in the second quarter of 2019 to settle the issue. Net of legal costs and reserves for anticipated future returns associated with the discontinuance, Turning Point recorded a $5.5 million gain in the second quarter, which was recorded as a reduction to selling, general, and administrative expenses.
Note 22. Earnings Per Share
The Company has two classes of common stock, Class A and Class B; shares of Class B common stock are convertible into shares of Class A common stock at any time, on a one-for-one basis. Shares of Class A common stock and Class B common stock have the same rights and powers, rank equally, share ratably and are identical in all respects and as to all matters, except that (i) each share of Class B common stock shall have the right to 10 votes per share and (ii) the shares of Class B common stock shall be convertible into shares of Class A common stock automatically upon the transfer of such shares of Class B common stock, with certain exceptions, or upon the affirmative vote of holders of two-thirds of the then-outstanding shares of Class B common stock or voluntarily by the holder of such shares of Class B common stock.
Diluted earnings per share is calculated similarly to basic earnings per share, except that the calculation includes the dilutive effect of the assumed exercise of options issuable under the Company’s stock incentive plans and the Company’s unvested restricted stock awards.
Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of common shares and the weighted average effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of stock options and restricted stock awards and the dilutive effect of such awards is reflected in diluted earnings per share by application of the treasury stock method.
The following tables set forth the computation of basic and diluted net income (loss) per share of Class A and Class B common stock:
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| (In thousands, except share and per share amounts) | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Basic net income (loss) per common share calculation: | | | | | | | | | | | | |
| Net income (loss) attributable to SDI | | $ | 234 | | | $ | 1,367 | | | $ | (2,347 | ) | | $ | 5,417 | |
| | | | | | | | | | | | | | | | | |
| Weighted average Class A common shares outstanding – basic | | | 9,085,510 | | | | 8,778,850 | | | | 9,063,511 | | | | 8,647,978 | |
| Weighted average Class B common shares outstanding – basic | | | 7,744,622 | | | | 7,898,562 | | | | 7,752,647 | | | | 7,970,845 | |
| Weighted average common shares outstanding – basic | | | 16,830,132 | | | | 16,677,412 | | | | 16,816,158 | | | | 16,618,823 | |
| Net income (loss) attributable to SDI per share of common stock – basic | | $ | 0.01 | | | $ | 0.08 | | | $ | (0.14 | ) | | $ | 0.33 | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| (In thousands, except share and per share amounts) | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Diluted net income (loss) attributable to SDI per common share calculation: | | | | | | | | | | | | |
| Net income (loss) attributable to SDI | | $ | 234 | | | $ | 1,367 | | | $ | (2,347 | ) | | $ | 5,417 | |
Impact of subsidiary dilutive securities (1) | | | (90 | ) | | | (93 | ) | | | (74 | ) | | | (233 | ) |
| Net income (loss) attributable to SDI - diluted | | $ | 144 | | | $ | 1,274 | | | $ | (2,421 | ) | | $ | 5,184 | |
| | | | | | | | | | | | | | | | | |
| Weighted average Class A common shares outstanding – basic | | | 9,085,510 | | | | 8,778,850 | | | | 9,063,511 | | | | 8,647,978 | |
| Weighted average Class B common shares outstanding – basic | | | 7,744,622 | | | | 7,898,562 | | | | 7,752,647 | | | | 7,970,845 | |
| Dilutive impact of stock options and restricted stock awards | | | 47,558 | | | | 64,248 | | | | - | | | | 42,986 | |
| Weighted average common shares outstanding – diluted | | | 16,877,690 | | | | 16,741,660 | | | | 16,816,158 | | | | 16,661,809 | |
| Net income (loss) attributable to SDI per share of common stock – diluted | | $ | 0.01 | | | $ | 0.08 | | | $ | (0.14 | ) | | $ | 0.31 | |
| (1) | The Company records an adjustment to net income (loss) in the relevant period for the dilutive impact of subsidiary stock-based awards on the Company’s reported net income (loss) for purposes of calculating net income (loss) per share. |
For the three and nine months ended September 30, 2019 and 2018, 2,463 stock options have been excluded from the computation of diluted weighted average shares outstanding, as they are anti-dilutive.
Note 23. Segment Information
In accordance with ASC 280, Segment Reporting, the Company has five reportable segments. Three of the Company’s segments are also those of Turning Point: (1) Smokeless products; (2) Smoking products; and (3) NewGen products. The Smokeless products segment (i) manufactures and markets moist snuff and (ii) contracts for and markets chewing tobacco products. The Smoking products segment (i) markets and distributes cigarette papers, tubes, and related products; (ii) markets and distributes finished cigars and MYO cigar wraps; and (iii) processes, packages, markets, and distributes traditional pipe tobaccos. The NewGen products segment (i) markets and distributes e-cigarettes, e-liquids, vaporizers, and certain other products without tobacco and/or nicotine; (ii) markets and distributes a wide assortment of vaping and Cannabidiol (“CBD”) related products to non-traditional retail outlets via VaporBeast, Vapor Shark, Vapor Supply, and IVG and Solace, and (iii) markets and distributes a wide assortment of vaping and CBD related products to individual consumers via Vapor Shark and VaporFi branded retail outlets in addition to online platforms. Smokeless and Smoking products are distributed primarily through wholesale distributors in the United States while NewGen products 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 Turning Point not assigned to one of the three reportable segments such as intercompany transfers, deferred taxes, deferred financing fees, and investments in subsidiaries.
Beginning in the first quarter of 2018, as a result of the acquisition of an insurance company, the Company has an additional segment, Insurance. The Insurance segment represents the Company’s property and casualty insurance business, operated through Maidstone, a New York domiciled seller of auto and personal lines.
The Company has experienced continuing losses in its Insurance segment, primarily driven by increases in losses and loss adjustment expenses, along with the full impairment of its goodwill and other intangible asset balances. The Company has no plans to contribute additional capital to its Insurance segment and anticipates it will continue to incur losses for the foreseeable future. In August 2019, Maidstone consented to the entry of an order of liquidation pursuant to Article 74 of the New York Consolidated Insurance Law (“Order of Liquidation”) with the New York State Department of Financial Services (the “NYSDFS”) and began to negotiate the terms of the Order of Liquidation with the NYSDFS. See Note 20, “Contingencies” for additional information.
The Company also reports an Other segment, which includes the results of operations of SDI and Standard Outdoor and assets of the consolidated Company not assigned to the five reportable segments, including Turning Point deferred taxes and deferred financing fees for the Revolving Credit Facility. Elimination includes the elimination of intercompany accounts between segments.
Accounting policies of these segments are the same as those of the Company. Corporate costs of Turning Point 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. In 2018, Turning Point corporate costs were allocated to the segments based on net sales. Turning Point believes this allocation does not reflect the operations of the business. Prior periods have been adjusted to conform to the current year presentation.
The tables below present financial information about reported segments:
| | | Three Months Ended September 30, | |
| (In thousands) | | 2019 | | | 2018 | |
| Revenues | | | | | | |
| Smokeless Products | | $ | 26,187 | | | $ | 21,743 | |
| Smoking Products | | | 30,222 | | | | 28,079 | |
| NewGen Products | | | 40,391 | | | | 33,527 | |
| Insurance | | | 6,544 | | | | 7,560 | |
Other(1) | | | 720 | | | | 686 | |
| | | | 104,064 | | | | 91,595 | |
| | | | | | | | | |
| Operating Income | | | | | | | | |
| Smokeless Products | | | 9,392 | | | | 5,861 | |
| Smoking Products | | | 12,931 | | | | 10,861 | |
| NewGen Products | | | (1,233 | ) | | | 2,539 | |
| Insurance | | | (249 | ) | | | (909 | ) |
Other(1) | | | (9,230 | ) | | | (7,463 | ) |
| | | | 11,611 | | | | 10,889 | |
| | | | | | | | | |
| Interest expense | | | 4,680 | | | | 4,450 | |
| Interest and investment income | | | (777 | ) | | | (243 | ) |
| Loss on extinguishment of debt | | | 2,117 | | | | - | |
| Net periodic benefit (income) expense, excluding service cost | | | (12 | ) | | | (45 | ) |
| Income before income taxes | | $ | 5,603 | | | $ | 6,727 | |
| | | | | | | | | |
| Capital Expenditures | | | | | | | | |
| Smokeless products | | $ | 1,208 | | | $ | 251 | |
| Smoking products | | | - | | | | - | |
| NewGen products | | | 888 | | | | 274 | |
| Insurance | | | 6 | | | | 20 | |
Other(1) | | | - | | | | - | |
| | | $ | 2,102 | | | $ | 545 | |
| Depreciation and amortization | | | | | | | | |
| Smokeless products | | $ | 415 | | | $ | 342 | |
| Smoking products | | | - | | | | - | |
| NewGen Products | | | 633 | | | | 343 | |
| Insurance | | | 33 | | | | 51 | |
Other(1) | | | 391 | | | | 375 | |
| | | $ | 1,472 | | | $ | 1,111 | |
| | | Nine Months Ended September 30, | |
| | | 2019 | | | 2018 | |
| (In thousands) | | | | | | |
| Revenues | | | | | | |
| Smokeless Products | | $ | 74,907 | | | $ | 66,900 | |
| Smoking Products | | | 81,104 | | | | 84,403 | |
| NewGen Products | | | 125,756 | | | | 87,089 | |
| Insurance | | | 21,958 | | | | 22,775 | |
Other(1) | | | 2,115 | | | | 1,764 | |
| | | | 305,840 | | | | 262,931 | |
| | | | | | | | | |
| Operating Income | | | | | | | | |
| Smokeless Products | | | 26,610 | | | | 21,049 | |
| Smoking Products | | | 33,251 | | | | 31,855 | |
| NewGen Products | | | 9,056 | | | | 5,511 | |
| Insurance | | | (8,622 | ) | | | 259 | |
Other(1) | | | (28,453 | ) | | | (24,646 | ) |
| | | | 31,842 | | | | 34,028 | |
| | | | | | | | | |
| Interest expense | | | 13,529 | | | | 12,556 | |
| Interest and investment income | | | (1,115 | ) | | | (620 | ) |
| Loss on extinguishment of debt | | | 2,267 | | | | 2,384 | |
| Net periodic benefit (income) expense, excluding service cost | | | (34 | ) | | | 176 | |
| Income before income taxes | | $ | 17,195 | | | $ | 19,532 | |
| | | | | | | | | |
| Capital Expenditures | | | | | | | | |
| Smokeless products | | $ | 2,310 | | | $ | 1,140 | |
| Smoking products | | | - | | | | - | |
| NewGen products | | | 1,750 | | | | 388 | |
| Insurance | | | 42 | | | | 63 | |
Other(1) | | | 15 | | | | - | |
| | | $ | 4,117 | | | $ | 1,591 | |
| Depreciation and amortization | | | | | | | | |
| Smokeless products | | $ | 1,137 | | | $ | 1,014 | |
| Smoking products | | | - | | | | - | |
| NewGen Products | | | 1,797 | | | | 1,139 | |
| Insurance | | | 118 | | | | 163 | |
Other(1) | | | 1,145 | | | | 936 | |
| | | $ | 4,197 | | | $ | 3,252 | |
| (In thousands) | | September 30, 2019 | | | December 31, 2018 | |
| Assets | | | | | | |
| Smokeless Products | | $ | 111,541 | | | $ | 99,441 | |
| Smoking Products | | | 140,940 | | | | 142,520 | |
| NewGen Products | | | 116,484 | | | | 95,397 | |
| Insurance | | | 38,132 | | | | 52,169 | |
Other (1) | | | 118,701 | | | | 32,416 | |
| | | $ | 525,798 | | | $ | 421,943 | |
| (1) | “Other” includes sales, operating income or assets that are not assigned to the other four reportable segments, such as sales, operating income or assets of SDI and Standard Outdoor, and Turning Point deferred taxes. All goodwill has been allocated to reportable segments. |
Revenue Disaggregation- Sales Channel
Revenues of the Smokeless and Smoking segments are primarily comprised of sales made to wholesalers while NewGen sales are made to business to business and business to consumer, both online and through Turning Point’s corporate retail stores. NewGen net sales are broken out by sales channel below.
| | | NewGen Segment | |
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| 2019 | | | 2018 | | | 2019 | | | 2018 | |
| (In thousands) | | | | | | | | | | | | |
| Business to Business | | $ | 29,981 | | | $ | 26,603 | | | $ | 93,182 | | | $ | 72,948 | |
| Business to Consumer - Online | | | 8,367 | | | | 4,361 | | | | 25,052 | | | | 8,095 | |
| Business to Consumer - Corporate store | | | 2,017 | | | | 2,550 | | | | 7,381 | | | | 5,943 | |
| Other | | | 26 | | | | 13 | | | | 141 | | | | 103 | |
| | | $ | 40,391 | | | $ | 33,527 | | | $ | 125,756 | | | $ | 87,089 | |
Net Sales – Domestic and Foreign
The following table shows a breakdown of consolidated net sales between domestic and foreign.
| | | Three Months Ended September 30, | | | Nine Months Ended September 30, | |
| (In thousands) | | 2019 | | | 2018 | | | 2019 | | | 2018 | |
| Domestic | | $ | 91,956 | | | $ | 79,215 | | | $ | 273,636 | | | $ | 228,590 | |
| Foreign | | | 5,564 | | | | 4,820 | | | | 10,246 | | | | 11,566 | |
| Net Sales | | $ | 97,520 | | | $ | 84,035 | | | $ | 283,882 | | | $ | 240,156 | |
Note 24. Related Party Transactions
SDI has engaged the services of CFGI, formerly Pine Hill Group, and Edward J. Sweeney to serve as interim Chief Financial Officer effective May 31, 2017. Mr. Sweeney carries out his role as interim Chief Financial Officer of the Company pursuant to an agreement between the Company and CFGI. Mr. Sweeney is a partner at CFGI. The agreement outlines the scope of responsibilities of CFGI, as well as Mr. Sweeney’s role. These include, but are not limited to, services provided to the Company as interim Chief Financial Officer, controllership services, technical accounting and financial reporting services, and risk, valuation and transaction advisory services. CFGI is compensated at an hourly rate for performing services pursuant to the agreement. CFGI is responsible for all payments to Mr. Sweeney. As a result, Mr. Sweeney has received no direct compensation from the Company and the amount of aggregate payments made to CFGI is based on the amount of work performed on the Company’s behalf by all CFGI resources. During the three and nine months ended September 30, 2019, the Company incurred expenses of $0.2 million and $0.7 million, respectively, related to services provided by CFGI.
Note 25. Statutory Information
The Company’s insurance subsidiary, Maidstone, is subject to insurance laws and regulations in the jurisdictions in which it operates. These regulations include certain restrictions on the amount of dividends or other distributions available to unitholders.
Under the insurance laws of New York State, Maidstone is restricted (on a basis of the lower of 10% of Maidstone’s statutory surplus at the end of the preceding twelve-month period or 100% of Maidstone’s adjusted net investment income for the preceding twelve-month period) as to the amount of dividends that Maidstone may declare or pay in any twelve-month period without prior approval of the NYSDFS. As of September 30, 2019, the maximum amount of dividends that may be paid by Maidstone without approval of the NYSDFS was $-0-. Further, under New York State law, companies may pay cash dividends only from earned surplus on a statutory basis. No dividends were declared or paid by Maidstone during the three or nine months ended September 30, 2019.
Maidstone is subject to certain risk-based capital (“RBC”) requirements as specified by the National Association of Insurance Commissioners (“NAIC”). Under such requirements, the amount of capital and surplus maintained by a property and casualty insurance company is to be determined on various risk factors including risk-based capital ratios. In August 2019, Maidstone reported a negative statutory capital and surplus to the NYSDFS for the second quarter of 2019. Due to the negative statutory surplus, the NYSDFS requested that Maidstone consent to an Order of Liquidation and in August 2019 Maidstone consented to the filing of a petition for the entry of an Order of Liquidation. As of September 30, 2019, the NYSDFS has not yet filed the petition for the entry of an Order of Liquidation. If approved, an Order of Liquidation would relieve the Company of the assets and liabilities of Maidstone, which would be transferred to the New York Liquidation Bureau.
Statutory combined capital and (deficit) surplus and net loss of Maidstone were as follows as of:
| (In thousands) | | September 30, 2019 | | | December 31, 2018 | |
| Statutory capital and (deficit) surplus | | $ | (559 | ) | | $ | 4,769 | |
| Statutory net loss | | $ | (5,522 | ) | | $ | (9,559 | ) |
Maidstone files financial statements prepared in accordance with statutory accounting practices prescribed or permitted by insurance regulators. Statutory net income (loss) and statutory (deficit) surplus, as reported to the insurance regulatory authorities, differ in certain respects from the amounts prepared in accordance with GAAP. The main differences between statutory net income (loss) and GAAP net income (loss) relate to deferred acquisition costs, deferred income taxes, unrealized appreciation or decline in value of investments and non-admitted assets.
Note 26. Subsequent Events
In October 2019, the Board of Directors of Turning Point initiated a review of strategic alternatives for the third-party vaping distribution business included within the NewGen segment. There can be no assurances that this process will result in the approval or completion of any particular strategic alternative or transaction in the future. Based on this review and other factors, Turning Point determined an interim impairment analysis of the goodwill and other intangible assets recorded in the NewGen segment was required. Turning Point has not yet completed the interim impairment analysis and impairment, if any, will be recorded in the fourth quarter.
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 SDI 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 SDI to predict these events or how they may affect it. SDI 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; |
| • | Turning Point’s dependence on a small number of third-party suppliers and producers; |
| • | the possibility that Turning Point will be unable to identify or contract with new suppliers or producers in the event of a supply or product disruption; |
| • | the possibility that Turning Point’s licenses to use certain brands or trademarks will be terminated, challenged or restricted; |
| • | failure to maintain consumer brand recognition and loyalty of Turning Point’s customers; |
| • | substantial and increasing U.S. regulation; |
| • | regulation of Turning Point’s products by the FDA, which has broad regulatory powers; |
| • | Turning Point’s products are subject to developing and unpredictable regulation, for example, current court action moving forward certain substantial Pre Market Tobacco Application obligations; |
| • | Turning Point’s products contain nicotine which is considered to be a highly addictive substance; |
| • | uncertainty related to the regulation and taxation of Turning Point’s NewGen products; |
| • | possible significant increases in federal, state and local municipal tobacco and vapor-related taxes; |
| • | possible increasing international control and regulation; |
| • | Turning Point’s reliance on relationships with several large retailers and national chains for distribution of its products; |
| • | our amount of indebtedness; |
| • | the terms of our credit facilities, which may restrict our current and future operations; |
| • | intense competition and our ability to compete effectively; |
| • | uncertainty and continued evolution of markets containing Turning Point’s NewGen products; |
| • | significant product liability litigation; |
| • | the scientific community’s lack of information regarding the long-term health effects of electronic cigarette, vaporizer and e-liquid use; |
| • | requirement to maintain compliance with master settlement agreement escrow account; |
| • | competition from illicit sources; |
| • | our reliance on information technology; |
| • | security and privacy breaches; |
| • | contamination of Turning Point’s tobacco supply or products; |
| • | infringement on our intellectual property; |
| • | third-party claims that we infringe on their intellectual property; |
| • | 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; |
| • | sensitivity of end-customers to increased sales taxes and economic conditions; |
| • | failure to comply with certain regulations; |
| • | departure of key management personnel or our inability to attract and retain talent; |
| • | imposition of significant tariffs on imports into the U.S.; |
| • | reduced disclosure requirements applicable to emerging growth companies may make Turning Point’s common stock less attractive to investors, potentially decreasing its stock price; |
| • | failure to maintain Turning Point’s status as an emerging growth company before the five-year maximum time period a company may retain such status; |
| • | our principal stockholders will be able to exert significant influence over matters submitted to our stockholders and may take certain actions to prevent takeovers; |
| • | 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; |
| • | Turning Point’s certificate of incorporation limits the ownership of Turning Point’s common stock by individuals and entities that are Restricted Investors. These restrictions may affect the liquidity of Turning Point’s common stock and may result in Restricted Investors 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; and |
| • | our status as a “controlled company” could make our common stock less attractive to some investors or otherwise harm our stock price. |
| • | the highly competitive nature of the out-of-home advertising industry; |
| • | regulations relating to the out-of-home advertising industry; |
| • | business risks relating to the out-of-home advertising industry, such as seasonality, competitiveness, risks from natural disasters and sensitivity to a decline in advertising expenditures, general economic conditions and other external events; |
| • | regulations relating to the insurance industry; |
| • | risks relating to the fact that Maidstone’s capital has fallen below the RBC minimum requirement and thus Maidstone faces restrictions with respect to operating its business and may be placed under rehabilitation or liquidation; and |
| • | business risks relating to the insurance industry, such as competitiveness, industry fragmentation and underwriting risks; and risks relating to reinsurance. |
| 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 interim condensed 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 which 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” in the Company’s Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission (“SEC”) on March 11, 2019 and in the Company’s Form 10-Q for the quarter ended March 31, 2019, filed with the SEC on May 8, 2019, and the quarter ended June 30, 2019, filed with the SEC on August 7, 2019.
The following discussion relates to the interim unaudited financial statements of the Company 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 Standard Diversified Inc. and our consolidated subsidiaries. References to “SDI” refer to Standard Diversified Inc. without any of its subsidiaries. Dollars are in thousands, except where designated and in per share data. Many of the amounts and percentages in this discussion have been rounded for convenience of presentation.
Overview
We are a holding company. Our subsidiaries are engaged in the following lines of business:
| • | Other tobacco products (Turning Point Brands, Inc. (“Turning Point”), a 50.1% owned subsidiary); |
| • | Outdoor advertising (Standard Outdoor LLC (“Standard Outdoor”), a wholly owned subsidiary), beginning in July 2017; and |
| • | Insurance (Pillar General Inc. (“Pillar General”), a wholly owned subsidiary), beginning in January 2018. |
We are a diversified holding company with interests in a variety of industries and market sectors. We are continually evaluating our portfolio of subsidiaries and lines of business and may make investment and divestiture decisions that could materially impact us and any of our existing or future lines of business. This may include investment and divestiture decisions to maintain our ownership percentage in Turning Point.
Recent Developments
Maidstone Insurance
In August 2019, we reported a negative statutory capital and surplus of Maidstone to the New York State Department of Financial Services (“NYSDFS”). The NYSDFS requested that Maidstone consent to an order of liquidation under Article 74 of New York State Insurance law (“Order of Liquidation”) to effect a liquidation of Maidstone by the NYSDFS. On August 7, 2019, Maidstone consented to the filing of a petition for the entry of an Order of Liquidation. Once the petition for the entry of an Order of Liquidation is filed and subsequently approved by New York State, we expect to be relieved of the assets and liabilities of Maidstone, which would be turned over to the New York State Liquidation Bureau (“Liquidation Bureau”).
Turning Point Brands
The Turning Point Board of Directors is reviewing strategic alternatives for Turning Point’s third-party vaping distribution business. Turning Point is committed to capitalizing on our core competencies in branding, distribution, product development, and regulatory affairs to create market-leading adult actives products. This includes investing in the FDA PMTA process for our proprietary brands. However, Turning Point believes the expected future returns from third-party vaping distribution may not justify the required investment of human and financial resources going forward. There can be no assurance that this process will result in the approval or completion of any particular strategic alternative or transaction in the future.
Solace Technologies Acquisition
In July 2019, Turning Point acquired the assets of E-Vape 12, Inc and Solace Technologies LLC (“Solace”) for $8.0 million in total consideration, comprised of $7.7 million in cash and $0.5 million holdback for 18 months. As additional consideration, Turning Point will issue, to the former owners, stock equal to $2.31 million upon the achievement of certain annual milestones. In addition, 88,582 performance based restricted stock with a fair value of $4.62 million were issued to former owners who became employees. Solace is an innovative product development company that has grown from the creator of one of the leading vape juice brands in the industry into a leader of alternative ingredients product development. Turning Point intends to incorporate Solace’s innovative products as well as the legacy vapor products into its Nu-X Ventures development engine.
ReCreation Marketing Investment
In July 2019, Turning Point obtained a 30% stake in Canadian distribution entity, ReCreation Marketing (“ReCreation”). Turning Point may invest $3 million through its newly-created subsidiary, Turning Point Brands (Canada) Inc., into ReCreation, with options to acquire up to a 50% ownership position. Turning Point will receive board seats aligned with its ownership position.
ReCreation is a specialty marketing and distribution firm focused on building brands in the Canadian smoking, vaping and alternative products categories. ReCreation’s management has significant expertise in marketing and distributing tobacco and cannabis products throughout Canada. ReCreation’s management and advisory team has over 50 years combined experience building and managing a portfolio of premium brands, all supported by an expert team of sales associates working across Canada to provide service to over 30,000 traditional retail outlets and newly-constructed cannabis dispensaries.
Convertible Notes Offering
See Note 14, “Notes Payable and Long-term Debt,” for discussion regarding Turning Point’s Convertible Senior Notes.
Standard Outdoor
On May 7, 2019, we, through Standard Outdoor, completed an asset acquisition consisting of nine billboard structures located in Georgia, as well as the ground leases and advertising contracts relating to such billboard structures for total consideration of $0.6 million.
SDI
On September 18, 2019, we entered into a Term Loan Agreement (the “Term Loan Agreement”) with GACP II, L.P., a Delaware limited partnership (the “Agent”), as administrative agent and collateral agent for the financial institutions (the “Lenders”). The Term Loan Agreement provides for a term loan of $25.0 million (the “Term Loan”). The Term Loan will be used to (a) repay, in full, all outstanding indebtedness under the Crystal Term Loan (as defined herein), (b) finance the purchase of common stock of Turning Point, (c) finance the repurchase of our common stock, (d) fund certain fees and expenses, and (e) provide working capital. At closing of the Term Loan, we received net proceeds from the Term Loan of $9.1 million.
On March 29, 2019, the duties of Ian Estus, formerly the Chief Executive Officer of SDI, were reassigned by the Board of Directors of the Company (the “Board”), such that Mr. Estus no longer serves as the Chief Executive Officer of the Company, or as an officer in any other position of the Company, or as an officer, director, manager or in any similar position for any of the Company’s subsidiaries. Mr. Estus remains a member of the Board. Also on March 29, 2019, Gregory H.A. Baxter, currently the Executive Chairman of the Board, was appointed by the Board to serve, on an interim basis, as the Chief Executive Officer of the Company, and to replace Mr. Estus on an interim basis in any other position held by Mr. Estus as an officer in any other position of the Company, or as an officer, director, manager or in any similar position for any of the Company’s subsidiaries, to serve in each case until his successor has been duly appointed or until his resignation or removal from any such position by further action of the Board.
Overview of Turning Point
Turning Point is a holding company which owns North Atlantic Trading Company, Inc. (“NATC”), and its subsidiaries, Turning Point Brands, LLC (“TPLLC”), and its subsidiaries, and Turning Point Brands (Canada) Inc. (“TPBC”). NATC includes subsidiaries National Tobacco Company, L.P. (“NTC”), National Tobacco Finance, LLC (“NTFLLC”), North Atlantic Operating Company, Inc. (“NAOC”), North Atlantic Cigarette Company, Inc. (“NACC”), and RBJ Sales, Inc. (“RBJ”). TPLLC includes subsidiaries Intrepid Brands, LLC (“Intrepid”), Vapor Beast, LLC (“VaporBeast”, f/k/a Smoke Free Technologies, Inc.), Vapor Shark, LLC, and its subsidiaries (collectively, “Vapor Shark”, f/k/a The Hand Media), Vapor Acquisitions Company, LLC (“Vapor Supply”), Vapor Finance, LLC (“VFIN”), International Vapor Group, LLC and its subsidiaries (collectively, “IVG”), and Nu-X Ventures, LLC (“Nu-X”).
Turning Point is a leading, independent provider of Other Tobacco Products (“OTP”) and adult consumer alternatives. Turning Point estimates the OTP industry generated approximately $11 billion of manufacturer revenue in 2018. In contrast to manufactured cigarettes, which have been experiencing declining volumes for decades based on data published by the Alcohol and Tobacco Tax and Trade Bureau (“TTB”), the OTP industry is demonstrating increased consumer appeal with low to mid-single digit consumer unit growth as reported by Management Science Associates, Inc. (“MSAi”), a third-party analytics and information company. Turning Point was the 6th largest competitor in terms of total OTP consumer units sold during 2018. Turning Point sells a wide range of products across the OTP spectrum; however, it does not sell cigarettes. Turning Point’s portfolio of brands includes some of the most widely recognized names in the OTP industry, such as Zig-Zag®, Beech-Nut®, Stoker’s®, Trophy®, VaporBeast® and VaporFi®. Turning Point currently ships to approximately 800 distributors with an additional 100 secondary, indirect wholesalers in the U.S. that carry and sell its products. Turning Point operates in three segments: (i) Smokeless products, (ii) Smoking products, and (iii) NewGen products. Under the leadership of a senior management team with an average of 23 years of experience in the tobacco industry, Turning Point has grown and diversified its business through new product launches, category expansions, and acquisitions while concurrently improving operational efficiency.
Turning Point has identified additional growth opportunities in the emerging alternatives market. In January 2019, it established its subsidiary, Nu-X Ventures (“Nu-X”), a new company and wholly-owned subsidiary dedicated to the development, production and sale of alternative products and acquisitions in related spaces. The creation of Nu-X allows Turning Point to leverage its expertise in traditional OTP management to alternative products. The Turning Point management team has over 100 years of experience navigating federal, state and local regulations that are directly applicable to the growing alternatives market. In July 2019, Turning Point acquired a 30% stake in ReCreation Marketing (“ReCreation). ReCreation is a specialty marketing and distribution firm focused on building brands in the Canadian smoking, vaping and alternative products categories. The investment will leverage ReCreation’s significant expertise in marketing and distributing tobacco and cannabis products throughout Canada. In November 2018, Turning Point acquired a minority stake in Canadian American Standard Hemp Inc. (“CASH”). The investment in CASH positions Turning Point to meaningfully participate in the market for hemp-derived products. Through its investment in CASH, Turning Point has access to CASH’s proprietary extraction processes enabling the harvest of cannabinoids for use in the creation and distribution of high-quality hemp-derived products. Both investments are part of Nu-X and Turning Point plans to make additional investments, partnerships and acquisitions to drive the business of Nu-X. These endeavors will enable Turning Point to continue to identify unmet customer needs and provide quality products that Turning Point believes will result in genuine customer satisfaction and foster the growth of revenue.
Turning Point believes there are meaningful opportunities to grow through acquisitions and joint ventures across all product categories. As of December 31, 2018, Turning Point’s products are available in approximately 185,000 U.S. retail locations which, with the addition of retail stores in Canada, brings Turning Point’s total North American retail presence to an estimated 210,000 points of distribution. Turning Point’s sales team targets widespread distribution to all traditional retail channels, including convenience stores.
Products
Turning Point operates in three segments: Smokeless products, Smoking products and NewGen products. In Turning Point’s Smokeless products segment, Turning Point (i) manufactures and markets moist snuff and (ii) contracts for and market loose leaf chewing tobacco products. In Turning Point’s Smoking products segment, Turning Point (i) markets and distributes cigarette papers, tubes and related products; (ii) markets and distributes finished cigars and MYO cigar wraps; and (iii) processes, packages, markets, and distributes traditional pipe tobaccos. In Turning Point’s NewGen products segment, Turning Point (i) markets and distributes e-cigarettes, e-liquids, vaporizers and certain other products without tobacco and/or nicotine; (ii) markets and distributes a wide assortment of vaping and Cannabidiol (“CBD”) related products to non-traditional retail via VaporBeast, Vapor Shark, Vapor Supply and IVG and IVG; and (iii) markets and distributes a wide assortment of vaping and CBD related products to individual consumers via Vapor Shark and VaporFi branded retail outlets in addition to online platforms. Turning Points portfolio of brands includes some of the most widely recognized names in the OTP industry, such as Stoker’s® in the Smokeless segment, Zig-Zag® in the Smoking segment, and VaporBeast® and VaporFi® in the NewGen segment.
Operations
Turning Point’s core tobacco business (Smokeless and Smoking segments) primarily generates revenues from the sale of Turning Point products to wholesale distributors who, in turn, resell the products to retail operations. Turning Point’s acquisition of VaporBeast in the fourth quarter of 2016 expanded Turning Point’s revenue streams as Turning Point began selling directly to non-traditional retail outlets. Turning Point’s acquisitions of Vapor Shark in the second quarter of 2017 and Vapor Supply in the second quarter of 2018 further expanded its selling network by allowing it to directly reach ultimate consumers through Vapor Shark and Vapor World branded retail outlets. Turning Point’s acquisition of IVG in the third quarter of 2018 enhanced its business-to-consumer revenue stream with the addition of Vapor-Fi branded retail outlets accompanying a robust online platform headlined by VaporFi.com and DirectVapor.com. Turning Point’s net sales, which include federal excise taxes, consist of gross sales net of cash discounts, returns, and selling and marketing allowances.
Turning Point relies on long-standing relationships with high-quality, established manufacturers to provide the majority of its produced products. Approximately 85% of Turning Point’s production, as measured by net sales, is outsourced to suppliers. The remaining production consists of Turning Point’s moist snuff tobacco operations located in Dresden, Tennessee, and Louisville, Kentucky; the packaging of Turning Point’s pipe tobacco in Louisville, Kentucky; and the proprietary e-liquids operations located in Louisville, Kentucky, and Miami, Florida. Turning Point’s principal operating expenses include the cost of raw materials used to manufacture the limited number of its products which Turning Point produces 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. Turning Point’s other principal expenses include interest expense and other expenses.
Key Factors Affecting Turning Point’s Results of Operations
Turning Point considers the following to be the key factors affecting its results of operations:
| • | Turning Point’s ability to further penetrate markets with its existing products; |
| • | Turning Point’s ability to introduce new products and product lines that complement its core business; |
| • | Decreasing interest in some tobacco products among consumers; |
| • | Price sensitivity in its end-markets; |
| • | Marketing and promotional initiatives, which cause variability in Turning Point’s 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 Remedy Order; |
| • | Counterfeit and other illegal products in our end-markets; |
| • | Turning Point’s ability to identify attractive acquisition opportunities in OTP; and |
| • | Turning Point’s ability to integrate acquisitions. |
Overview of Standard Outdoor
Standard Outdoor is an out-of-home advertising business. Revenues include outdoor advertising revenues, while operating expenses primarily include compensation costs, depreciation and rent expense.
Overview of Pillar General
On January 2, 2018, Pillar General acquired all of the outstanding capital stock of Interboro Holdings, Inc. (“Interboro”) for a cash purchase price of $2.5 million. Under the name Maidstone Insurance Company (“Maidstone”), Maidstone offered personal automobile and homeowner’s insurance, primarily in the state of New York. The results of Maidstone are included in our condensed consolidated results as of January 2, 2018, the date of acquisition.
During the nine months ended September 30, 2019, we recorded impairment charges of $0.8 million and $2.0 million related to the full impairment of the goodwill and intangible asset balances, respectively, in our Insurance segment. This impairment was a result of changes in the future outlook for the Insurance segment and certain other factors impacting recoverability, identified in the first quarter of 2019. As a result, there are no goodwill or intangible assets balances remaining in our Insurance segment.
In addition, Maidstone is subject to certain risk-based capital (“RBC”) requirements as specified by the National Association of Insurance Commissioners (“NAIC”). Under such requirements, the amount of capital and surplus maintained by a property and casualty insurance company is to be determined on various risk factors including risk-based capital ratios. In August 2019, the Company reported a negative statutory capital and surplus to the NYSDFS. The NYSDFS requested that the Company consent to an Order of Liquidation to effect a liquidation of the Company by the NYSDFS. On August 7, 2019, Maidstone consented to the filing of a petition for the entry of an Order of Liquidation. As of September 30, 2019, the NYSDFS had not yet filed the petition for entry of the Order of Liquidation.
Segment Information
We operate in five reportable segments; (1) Smokeless products, (2) Smoking products, (3) NewGen products, (4) Insurance and (5) Other, which includes our out-of-home advertising business and SDI holding company, as well as certain unallocated Turning Point amounts. Turning Point’s Smokeless products segment, Smoking products segment and NewGen products segment are described above within Overview of Turning Point – Products. The Insurance segment products include auto and homeowners property and casualty insurance.
Critical Accounting Policies and Uses of Estimates
There have been no 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 the Company’s Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on March 11, 2019.
Recent Accounting Pronouncements
Refer to Note 2, “Summary of Significant Accounting Policies” to our condensed consolidated financial statements included in this Quarterly Report for a description of recently issued accounting pronouncements, including those recently adopted.
Consolidated Results of Operations
The table and discussion set forth below relate to our condensed consolidated results of operations:
Comparison of the Three Months Ended September 30, 2019 to the Three Months Ended September 30, 2018
| | | Three Months Ended September 30, | | | | |
| (in thousands) | | 2019 | | | 2018 | | | % Change | |
| Revenues | | | | | | | | | |
| Smokeless Products | | $ | 26,187 | | | $ | 21,743 | | | | 20.4 | % |
| Smoking Products | | | 30,222 | | | | 28,079 | | | | 7.6 | % |
| NewGen Products | | | 40,391 | | | | 33,527 | | | | 20.5 | % |
| Insurance | | | 6,544 | | | | 7,560 | | | | -13.4 | % |
| Other | | | 720 | | | | 686 | | | | 5.0 | % |
| Total revenues | | $ | 104,064 | | | $ | 91,595 | | | | 13.6 | % |
| | | | | | | | | | | | | |
| Operating Income | | | | | | | | | | | | |
| Smokeless Products | | $ | 9,392 | | | $ | 5,861 | | | | 60.2 | % |
| Smoking Products | | | 12,931 | | | | 10,861 | | | | 19.1 | % |
| NewGen Products | | | (1,233 | ) | | | 2,539 | | | | -148.6 | % |
| Insurance | | | (249 | ) | | | (909 | ) | | | -72.6 | % |
| Other | | | (9,230 | ) | | | (7,463 | ) | | | 23.7 | % |
| Total operating income | | | 11,611 | | | | 10,889 | | | | 6.6 | % |
| | | | | | | | | | | | | |
| Interest expense | | | 4,680 | | | | 4,450 | | | | 5.2 | % |
| Interest and investment income | | | (777 | ) | | | (243 | ) | | | 219.8 | % |
| Loss on extinguishment of debt | | | 2,117 | | | | - | | | | 100.0 | % |
| Net periodic benefit income, excluding service cost | | | (12 | ) | | | (45 | ) | | | -73.3 | % |
| Income before income taxes | | | 5,603 | | | | 6,727 | | | | -16.7 | % |
| Income tax expense | | | 2,236 | | | | 1,436 | | | | 55.7 | % |
| Net income | | | 3,367 | | | | 5,291 | | | | -36.4 | % |
| Amounts attributable to noncontrolling interests | | | (3,133 | ) | | | (3,924 | ) | | | -20.2 | % |
| Net income attributable to SDI | | $ | 234 | | | $ | 1,367 | | | | -82.9 | % |
Total revenues. For the three months ended September 30, 2019, total revenues were $104.1 million, an increase of $12.5 million, or 13.6%, from $91.6 million for the three months ended September 30, 2018. The increase in total revenue was primarily driven by volume growth across all Turning Point segments in 2019, partially offset by a $1.0 million reduction in insurance premiums earned as a result of the decision to cease writing new policies during 2019.
Total operating income. For the three months ended September 30, 2019, total operating income was $11.6 million, an increase of $0.7 million, or 6.6%, from $10.9 million for the three months ended September 30, 2018. This increase was primarily due to increases in Turning Point’s operating income in the Smokeless and Smoking Products segments. These increases were partially offset by the shift to an operating loss in Turning Point's NewGen Products segment driven primarily by $2.0 million of new product launch costs of Nu-X products.
Interest expense. For the three months ended September 30, 2019, interest expense was $4.7 million compared to $4.5 million for the three months ended September 30, 2018. This increase of $0.2 million was primarily due to a higher average outstanding debt balances as a result of the Convertible Senior Notes entered into during the three months ended September 30, 2019.
Interest and investment income. Interest and investment income relating to investment of the MSA escrow deposits as well as SDI’s cash and cash equivalents was $0.8 million for the three months ended September 30, 2019, compared to $0.2 million for the three months ended September 30, 2018.
Loss on extinguishment of debt. For the three months ended September 30, 2019, we had a loss on extinguishment of debt of $2.1 million due to Turning Point paying off the 2018 Second Lien Credit Facility and SDI paying off the Crystal Term Loan. For the three months ended September 30, 2018, there was no gain or loss on extinguishment of debt.
Net periodic benefit income, excluding service cost. For the three months ended September 30, 2019, net periodic benefit income, excluding service cost was approximately $12,000 of income compared to approximately $45,000 for the three months ended September 30, 2018.
Income before income taxes. For the three months ended September 30, 2019, income before income taxes was $5.6 million compared to $6.7 million for the three months ended September 30, 2018. This decrease of $1.1 million was primarily due to the factors noted above.
Income tax expense. Our income tax expense was $2.2 million for the three months ended September 30, 2019 and is attributable to Turning Point’s income. Income tax expense was $1.4 million for the three months ended September 30, 2018.
Net income. Due to the factors described above, net income for the three months ended September 30, 2019 and 2018 was $3.4 million and $5.3 million, respectively.
Amounts attributable to noncontrolling interests. Income attributable to noncontrolling interests of $3.1 million and $3.9 million for the three months ended September 30, 2019 and 2018, respectively, was related to the shareholders of Turning Point other than SDI. The decrease was directly attributable to the decrease in Turning Point’s net income.
Net income attributable to SDI. For the three months ended September 30, 2019, net income attributable to SDI was $0.2 million compared to net income of $1.4 million for the three months ended September 30, 2018, a decrease of $1.1 million or 82.9%. This decrease was a result of the items discussed above.
Comparison of the Nine Months Ended September 30, 2019 to the Nine Months Ended September 30, 2018
| | | Nine Months Ended September 30, | | | | |
| (in thousands) | | 2019 | | | 2018 | | | % Change | |
| Revenues | | | | | | | | | |
| Smokeless Products | | $ | 74,907 | | | $ | 66,900 | | | | 12.0 | % |
| Smoking Products | | | 81,104 | | | | 84,403 | | | | -3.9 | % |
| NewGen Products | | | 125,756 | | | | 87,089 | | | | 44.4 | % |
| Insurance | | | 21,958 | | | | 22,775 | | | | -3.6 | % |
| Other | | | 2,115 | | | | 1,764 | | | | 19.9 | % |
| Total revenues | | $ | 305,840 | | | $ | 262,931 | | | | 16.3 | % |
| | | | | | | | | | | | | |
| Operating Income | | | | | | | | | | | | |
| Smokeless Products | | $ | 26,610 | | | $ | 21,049 | | | | 26.4 | % |
| Smoking Products | | | 33,251 | | | | 31,855 | | | | 4.4 | % |
| NewGen Products | | | 9,056 | | | | 5,511 | | | | 64.3 | % |
| Insurance | | | (8,622 | ) | | | 259 | | | | -3429.0 | % |
| Other | | | (28,453 | ) | | | (24,646 | ) | | | 15.4 | % |
| Total operating income | | | 31,842 | | | | 34,028 | | | | -6.4 | % |
| | | | | | | | | | | | | |
| Interest expense | | | 13,529 | | | | 12,556 | | | | 7.7 | % |
| Interest and investment income | | | (1,115 | ) | | | (620 | ) | | | 79.8 | % |
| Loss on extinguishment of debt | | | 2,267 | | | | 2,384 | | | | -4.9 | % |
| Net periodic benefit (income) expense, excluding service cost | | | (34 | ) | | | 176 | | | | -119.3 | % |
| Income before income taxes | | | 17,195 | | | | 19,532 | | | | -12.0 | % |
| Income tax expense | | | 6,569 | | | | 4,153 | | | | 58.2 | % |
| Net income | | | 10,626 | | | | 15,379 | | | | -30.9 | % |
| Amounts attributable to noncontrolling interests | | | (12,973 | ) | | | (9,962 | ) | | | 30.2 | % |
| Net (loss) income attributable to SDI | | $ | (2,347 | ) | | $ | 5,417 | | | | -143.3 | % |
Total revenues. For the nine months ended September 30, 2019, total revenues were $305.8 million, an increase of $42.9 million, or 16.3%, from $262.9 million for the nine months ended September 30, 2018. The increase in total revenues was primarily driven by volume growth in Turning Point’s NewGen segment which includes an additional eight additional months of IVG results in 2019, and sales from Turning Point’s newly launched Nu-X alternative products.
Total operating income. For the nine months ended September 30, 2019, total operating income was $31.8 million, a decrease of $2.2 million, or 6.4%, from $34.0 million for the nine months ended September 30, 2018. This decrease was primarily due to impairment losses recorded on our goodwill and other intangible assets in our Insurance segment of $2.8 million. This impairment loss was coupled with a combined $6.1 million of higher other operating expenses and incurred losses and loss adjustment expenses in our Insurance segment. The increased expenses are partially offset by Turning Point’s net $5.5 million gain related to the settlement of the VMR Distribution and Supply agreement (VMR Agreement) during the second quarter of 2019, as well as $1.0 million less of transactional costs.
Interest expense. For the nine months ended September 30, 2019, interest expense was $13.5 million compared to $12.6 million for the nine months ended September 30, 2018. This increase of $0.9 million was primarily due to a higher average outstanding debt balances and higher interest rates during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018.
Interest and investment income. Interest and investment income relating to investment of the MSA escrow deposits as well as SDI’s cash and cash equivalents was approximately $1.1 million for the nine months ended September 30, 2019, compared to $0.6 million for the nine months ended September 30, 2018.
Loss on extinguishment of debt. For the nine months ended September 30, 2019, loss on extinguishment of debt was $2.3 million as the result of Turning Point’s payment on its 2018 Second Lien Credit Facility and SDI’s repayment of the Crystal Term Loan. For the nine months ended September 30, 2018, loss on extinguishment of debt was $2.4 million as a result of Turning Point refinancing its credit facility in the first quarter of 2018.
Net periodic benefit (income) expense, excluding service cost. For the nine months ended September 30, 2019, net periodic benefit (income) expense, excluding service cost was approximately $34,000 of income compared to $0.2 million for the nine months ended September 30, 2018.
Income before income taxes. For the nine months ended September 30, 2019, income before income taxes was $17.2 million compared to $19.5 million for the nine months ended September 30, 2018. This decrease of $2.3 million was primarily due to the factors noted above.
Income tax expense. Our income tax expense was $6.6 million for the nine months ended September 30, 2019 and attributable to Turning Point’s income offset by an increase in income tax benefit on Maidstone due to a reversal of deferred tax liability, which provided an income tax benefit during the nine months ended September 30, 2019. Income tax expense was $4.2 million for the nine months ended September 30, 2018.
Net income. Due to the factors described above, net income for the nine months ended September 30, 2019 and 2018 was $10.6 million and $15.4 million, respectively.
Amounts attributable to noncontrolling interests. Income attributable to noncontrolling interests of $13.0 million and $10.0 million for the nine months ended September 30, 2019 and 2018, respectively, was related to the shareholders of Turning Point other than SDI and was directly attributable to the increase in Turning Point’s net income.
Net (loss) income attributable to SDI. For the nine months ended September 30, 2019, net loss attributable to SDI was $(2.3) million compared to net income of $5.4 million for the nine months ended September 30, 2018, a decrease of $7.7 million or 143.3%. This decrease was a result of the items discussed above.
Segment Results of Operations
Turning Point and Other segment
The table and discussion set forth below relate to the results of operations of the three Turning Point segments, as well as our Other reportable segment, which includes non-allocated amounts of Turning Point, SDI and Standard Outdoor:
Comparison of the Three Months Ended September 30, 2019 to the Three Months Ended September 30, 2018
| | | Three Months Ended September 30, | | | | |
| (in thousands) | | 2019 | | | 2018 | | | % Change | |
| Net sales | | | | | | | | | |
| Smokeless products | | $ | 26,187 | | | $ | 21,743 | | | | 20.4 | % |
| Smoking products | | | 30,222 | | | | 28,079 | | | | 7.6 | % |
| NewGen products | | | 40,391 | | | | 33,527 | | | | 20.5 | % |
| Other | | | 720 | | | | 686 | | | | 5.0 | % |
| Total net sales | | | 97,520 | | | | 84,035 | | | | 16.0 | % |
| Cost of sales | | | 54,636 | | | | 47,742 | | | | 14.4 | % |
| Gross profit | | | | | | | | | | | | |
| Smokeless products | | | 13,587 | | | | 11,020 | | | | 23.3 | % |
| Smoking products | | | 16,619 | | | | 14,814 | | | | 12.2 | % |
| NewGen products | | | 12,610 | | | | 10,377 | | | | 21.5 | % |
| Other | | | 68 | | | | 82 | | | | -17.1 | % |
| Total gross profit | | | 42,884 | | | | 36,293 | | | | 18.2 | % |
| Selling, general and administrative expenses | | | 31,024 | | | | 24,495 | | | | 26.7 | % |
| Operating income | | $ | 11,860 | | | $ | 11,798 | | | | 0.5 | % |
Net sales. For the three months ended September 30, 2019, overall net sales increased to $97.5 million from $84.0 million for the three months ended September 30, 2018, an increase of $13.5 million or 16.0%. The increase in net sales was primarily driven by Turning Point volume growth across all segments in 2019.
For the three months ended September 30, 2019, net sales in the Smokeless products segment increased to $26.2 million from $21.7 million for the three months ended September 30, 2018, an increase of $4.4 million or 20.4%. For the three months ended September 30, 2019, volume increased 15.1% and price/mix increased 5.3%. The increase in net sales was primarily driven by the continuing double-digit volume growth of Stoker’s® MST partially offset by declining sales in chewing tobacco, largely attributable to long-term segment erosion, and a continuing shift to lower price products.
For the three months ended September 30, 2019, net sales in the Smoking products segment increased to $30.2 million from $28.1 million for the three months ended September 30, 2018, an increase of $2.1 million or 7.6%. For the three months ended September 30, 2019, volume increased 3.6% and price/mix increased 4.0%. The increase in net sales is primarily related to increased wrap sales.
For the three months ended September 30, 2019, net sales in the NewGen products segment increased to $40.4 million from $33.5 million for the three months ended September 30, 2018, an increase of $6.9 million or 20.5%. The increase in net sales was primarily driven by $6.3 million of Nu-X alternative products sales in the quarter (which includes our acquisition of Solace) and an additional two months of IVG net sales in 2019, offset by declines in the existing vapor businesses in September.
For the three months ended September 30, 2019 and 2018, net sales in the Other segment was $0.7 million, all of which relates to the Standard Outdoor business.
Gross profit. For the three months ended September 30, 2019, gross profit increased to $42.9 million from $36.3 million for the three months ended September 30, 2018, an increase of $6.6 million or 18.2%. Gross profit as a percentage of revenue was 44.0% for the three months ended September 30, 2019 and 43.2% for the three months ended September 30, 2018.
For the three months ended September 30, 2019, gross profit in the Smokeless products segment increased to $13.6 million from $11.0 million for the three months ended September 30, 2018, an increase of $2.6 million or 23.3%. Gross profit as a percentage of net sales increased to 51.9% of net sales for the three months ended September 30, 2019, from 50.7% of net sales for the three months ended September 30, 2018, primarily as a result of increased MST volume.
For the three months ended September 30, 2019, gross profit in the Smoking products segment increased to $16.6 million from $14.8 million for the three months ended September 30, 2018, an increase of $1.8 million or 12.2%. Gross profit as a percentage of net sales increased to 55.0% of net sales for the three months ended September 30, 2019, from 52.8% of net sales for the three months ended September 30, 2018, as a result of increased wrap sales and a continued decline in the low margin cigar business. For the three months ended September 30, 2019 cigar sales were $1.0 million compared to $1.3 million for the three months ended September 30, 2018.
For the three months ended September 30, 2019, gross profit in the NewGen products segment increased to $12.6 million from $10.4 million for the three months ended September 30, 2018, an increase of $2.2 million or 21.5%. Gross profit as a percentage of net sales increased to 31.2% of net sales for the three months ended September 30, 2019, from 31.0% of net sales for the three months ended September 30, 2018, primarily as a result of the addition of proprietary Nu-X CBD and IVG, a business-to-consumer operation which generally has higher margins. For the three months ended September 30, 2019, gross profit included $2.6 million of tariff expenses.
For the three months ended September 30, 2019 and 2018, gross profit for the Other segment was $0.1 million, respectively, all of which relates to the Standard Outdoor business.
Selling, general and administrative expenses. For the three months ended September 30, 2019, selling, general and administrative expenses increased to $31.0 million from $24.5 million for the three months ended September 30, 2018, an increase of $6.5 million or 26.7%. Selling, general and administrative expenses included $3.7 million of expense relating to the inclusion of an additional two months of IVG activity, $2.0 million of new product launch costs for Nu-X products and $1.0 million of stock options, restricted stock and incentives expense. The increased expenses were offset by $0.6 million less of transactional costs for the three months ended September 30, 2019 as compared to three months ended September 30, 2018.
Comparison of the Nine Months Ended September 30, 2019 to the Nine Months Ended September 30, 2018
| | | Nine Months Ended September 30, | | | | |
| (in thousands) | | 2019 | | | 2018 | | | % Change | |
| Net sales | | | | | | | | | |
| Smokeless products | | $ | 74,907 | | | $ | 66,900 | | | | 12.0 | % |
| Smoking products | | | 81,104 | | | | 84,403 | | | | -3.9 | % |
| NewGen products | | | 125,756 | | | | 87,089 | | | | 44.4 | % |
| Other | | | 2,115 | | | | 1,764 | | | | 19.9 | % |
| Total net sales | | | 283,882 | | | | 240,156 | | | | 18.2 | % |
| Cost of sales | | | 159,217 | | | | 136,147 | | | | 16.9 | % |
| Gross profit | | | | | | | | | | | | |
| Smokeless products | | | 39,723 | | | | 34,546 | | | | 15.0 | % |
| Smoking products | | | 43,841 | | | | 43,158 | | | | 1.6 | % |
| NewGen products | | | 40,899 | | | | 26,111 | | | | 56.6 | % |
| Other | | | 202 | | | | 194 | | | | 4.1 | % |
| Total gross profit | | | 124,665 | | | | 104,009 | | | | 19.9 | % |
| Selling, general and administrative expenses | | | 84,201 | | | | 70,240 | | | | 19.9 | % |
| Operating income | | $ | 40,464 | | | $ | 33,769 | | | | 19.8 | % |
Net sales. For the nine months ended September 30, 2019, overall net sales increased to $283.9 million from $240.2 million for the nine months ended September 30, 2018, an increase of $43.7 million or 18.2%. The increase in net sales was primarily driven by volume growth in the NewGen segment which includes an additional eight months of IVG results in 2019, and sales from the newly launched Nu-X alternative products.
For the nine months ended September 30, 2019, net sales in the Smokeless products segment increased to $74.9 million from $66.9 million for the nine months ended September 30, 2018, an increase of $8.0 million or 12.0% primarily due to the continuing volume growth of Stoker’s® MST.
For the nine months ended September 30, 2019, net sales in the Smoking products segment decreased to $81.1 million from $84.4 million for the nine months ended September 30, 2018, a decrease of $3.3 million or 3.9%. The net sales decline is primarily attributable to the delay of Canadian paper orders in the first half of the year as a result of new packaging regulations in Canada and declining sales in the low-margins cigar business.
For the nine months ended September 30, 2019, net sales in the NewGen products segment increased to $125.8 million from $87.1 million for the nine months ended September 30, 2018, an increase of $38.7 million or 44.4%. The increase in net sales was primarily driven by $11.4 million of Nu-X alternative products sales year to date (including the Solace acquisition) and an additional eight months of IVG net sales in 2019.
For the nine months ended September 30, 2019, net sales in the Other segment was $2.1 million, compared to $1.8 million for the nine months ended September 30, 2018. The increase in net sales of $0.3 million in Other related to Standard Outdoor’s out-of-home advertising business, driven by a full three quarters of results on two asset acquisitions, which were acquired during the nine months ended September 30, 2018.
Gross profit. For the nine months ended September 30, 2019, gross profit increased to $124.7 million from $104.0 million for the nine months ended September 30, 2018, an increase of $20.7 million or 19.9%. Gross profit as a percentage of revenue was 43.9% for the nine months ended September 30, 2019 and 43.3% for the nine months ended September 30, 2018. The increase in gross profit was primarily due to higher margins in the Smokeless segment from increased MST volume and higher margins in the NewGen segment resulting from the addition of proprietary Nu-X CBD and IVG, a business-to-consumer operation which generally has higher margins.
For the nine months ended September 30, 2019, gross profit in the Smokeless products segment increased to $39.7 million from $34.5 million for the nine months ended September 30, 2018, an increase of $5.2 million or 15.0%. Gross profit as a percentage of net sales increased to 53.0% of net sales for the nine months ended September 30, 2019, from 51.6% of net sales for the nine months ended September 30, 2018. The increase in gross profit as a percentage of revenue is primarily due to efficiencies realized in the growing Stoker’s® MST line.
For the nine months ended September 30, 2019, gross profit in the Smoking products segment increased to $43.8 million from $43.2 million for the nine months ended September 30, 2018, an increase of $0.7 million or 1.6%. Gross profit as a percentage of net sales increased to 54.1% of net sales for the nine months ended September 30, 2019, from 51.1% of net sales for the nine months ended September 30, 2018, as a result of a continued decline in the low margin cigar business.
For the nine months ended September 30, 2019, gross profit in the NewGen products segment increased to $40.9 million from $26.1 million for the nine months ended September 30, 2018, an increase of $14.8 million or 56.6%. Gross profit as a percentage of net sales increased to 32.5% of net sales for the nine months ended September 30, 2019, from 30.0% of net sales for the nine months ended September 30, 2018, primarily as a result of the addition of proprietary Nu-X CBD and IVG, a business-to-consumer operation which generally has higher margins. For the nine months ended September 30, 2019, gross profit included $6.6 million of tariff expenses.
For the nine months ended September 30, 2019 and 2018, gross profit for the Other segment was $0.2 million, all of which relates to the Standard Outdoor business.
Selling, general and administrative expenses. For the nine months ended September 30, 2019, selling, general and administrative expenses increased to $84.2 million from $70.2 million for the nine months ended September 30, 2018, an increase of $14.0 million or 19.9%. The increase was related to $13.9 million of an additional eight months of IVG expenses, $2.2 million additional compensation expense related to stock options, restricted stock and incentives expense and $3.7 million additional new product launch costs for Nu-X products. The increased expenses are partially offset by a net $5.5 million gain related to the settlement of the VMR Distribution and Supply agreement (VMR Agreement) during the second quarter of 2019, as well as $1.0 million less of transactional costs. Refer to Note 21, “Legal Settlement”, of Notes to Consolidated Financial Statements for additional information on the settlement.
Insurance Segment
The table and discussion set forth below relate to the results of operations of our Insurance segment:
Comparison of the Three Months Ended September 30, 2019 to the Three Months Ended September 30, 2018
| | | For the Three Months Ended | | | | |
| (in thousands) | | September 30, 2019 | | | September 30, 2018 | | | % Change | |
| Insurance premiums earned | | $ | 6,055 | | | $ | 7,088 | | | | -14.6 | % |
| Net investment income | | | 210 | | | | 309 | | | | -32.0 | % |
| Other income | | | 279 | | | | 163 | | | | 71.2 | % |
| Total revenues | | | 6,544 | | | | 7,560 | | | | -13.4 | % |
| | | | | | | | | | | | | |
| Incurred losses and loss adjustment expenses | | | 4,790 | | | | 5,790 | | | | -17.3 | % |
| Other operating expenses | | | 2,003 | | | | 2,679 | | | | -25.2 | % |
| Total operating costs and expenses | | | 6,793 | | | | 8,469 | | | | -19.8 | % |
| Loss before income taxes | | | (249 | ) | | | (909 | ) | | | -72.6 | % |
| Net loss | | $ | (249 | ) | | $ | (909 | ) | | | -72.6 | % |
Insurance premiums earned. For the three months ended September 30, 2019, insurance premiums earned decreased by approximately $1.0 million, or 14.6%, to $6.1 million, as compared to $7.1 million for the three months ended September 30, 2018. We are no longer writing new policies in the Insurance segment.
Net investment income. For the three months ended September 30, 2019 net investment income decreased by approximately $0.1 million to $0.2 million, as compared to $0.3 million for the three months ended September 30, 2018. This was primarily due to a decrease in our fixed maturity available for sale securities balance since the third quarter of 2018.
Other income. We recognized $0.3 million of other income for the three months ended September 30, 2019, compared to $0.2 million for the three months ended September 30, 2018. Other income includes service and takeout fees, installment and late fees collected by Maidstone, and broker fees collected from non-affiliated insurance companies when acting as an agent. Service and takeout fees are in the form of credits for writing business from the state assigned pool. These credits can be used to reduce the amount of business written in the future or sold to third-party insurance companies for them to reduce their exposure to the assigned risk pool.
Incurred losses and loss adjustment expenses. For the three months ended September 30, 2019, incurred losses and loss adjustment expenses were $4.8 million, a decrease of $1.0 million, or 17.3%, compared to $5.8 million for the three months ended September 30, 2018. These amounts are based on individual case estimates for reported claims and a factor for incurred but not reported (“IBNR”) claims.
Other operating expenses. We incurred other expenses of $2.0 million for the three months ended September 30, 2019 compared to $2.7 million for the three months ended September 30, 2018, a decrease of $0.7 million. The decrease was due to a decrease in other operating expenses of $0.8 million and an increase in policy acquisition costs of $0.1 million. Other operating expenses consists of acquisition and underwriting expenses, salaries and benefits, depreciation, amortization and other general and administrative expenses.
Net loss. Due to the decrease in incurred losses and loss adjustment expenses combined with the decrease in other operating expenses, which exceeded the decrease in revenues, net loss for the three months ended September 30, 2019 was $0.2 million, compared to net loss of $0.9 million for the three months ended September 30, 2018, for the insurance business.
Comparison of the Nine Months Ended September 30, 2019 to the Period January 2, 2018 to September 30, 2018
| (in thousands) | | For the Nine Months Ended September 30, 2019 | | | For the Period from January 2, 2018 to September 30, 2018 | | | % Change | |
| Insurance premiums earned | | $ | 20,362 | | | $ | 21,539 | | | | -5.5 | % |
| Net investment income | | | 767 | | | | 679 | | | | 13.0 | % |
| Other income | | | 829 | | | | 557 | | | | 48.8 | % |
| Total revenues | | | 21,958 | | | | 22,775 | | | | -3.6 | % |
| | | | | | | | | | | | | |
| Incurred losses and loss adjustment expenses | | | 20,506 | | | | 17,007 | | | | 20.6 | % |
| Impairment loss on goodwill and other intangible assets | | | 2,826 | | | | - | | | | 100.0 | % |
| Other operating expenses | | | 7,248 | | | | 5,509 | | | | 31.6 | % |
| Total operating costs and expenses | | | 30,580 | | | | 22,516 | | | | 35.8 | % |
| (Loss) income before income taxes | | | (8,622 | ) | | | 259 | | | | -3429.0 | % |
| Income tax benefit | | | (420 | ) | | | - | | | | 100.0 | % |
| Net (loss) income | | $ | (8,202 | ) | | $ | 259 | | | | -3266.8 | % |
Insurance premiums earned. For the nine months ended September 30, 2019, insurance premiums earned decreased by $1.1 million, or 5.5%, to $20.4 million, as compared to $21.5 million for the period from January 2, 2018 to September 30, 2018. We are no longer writing new policies in the Insurance segment.
Net investment income. For the nine months ended September 30, 2019 net investment income increased by $0.1 million to $0.8 million, as compared to $0.7 million for the period from January 2, 2018 to September 30, 2018.
Other income. We recognized $0.8 million of other income for the nine months ended September 30, 2019, an increase of $0.2 million compared to $0.6 million for the period from January 2, 2018 to September 30, 2018. Other income includes service and takeout fees, installment and late fees collected by Maidstone, and broker fees collected from non-affiliated insurance companies when acting as an agent. Service and takeout fees are in the form of credits for writing business from the state assigned pool. These credits can be used to reduce the amount of business written in the future or sold to third-party insurance companies for them to reduce their exposure to the assigned risk pool.
Incurred losses and loss adjustment expenses. For the nine months ended September 30, 2019, incurred losses and loss adjustment expenses were $20.5 million, an increase of $3.5 million compared to $17.0 million for the period from January 2, 2018 to September 30, 2018. These amounts are based on individual case estimates for reported claims and a factor for incurred but not reported (“IBNR”) claims.
Impairment loss on goodwill and other intangible assets. For the nine months ended September 30, 2019, we recorded an impairment loss of $2.8 million on our Insurance segment goodwill and other intangible assets. There was no impairment loss recorded for the period from January 2, 2018 to September 30, 2018.
Other operating expenses. We incurred other expenses of $7.2 million for the nine months ended September 30, 2019 compared to $5.5 million for the period from January 2, 2018 to September 30, 2018, an increase of $1.7 million. The increase was due to an increase in policy acquisition costs of $2.8 million, including purchase accounting adjustments included in 2018, offset by a decrease in other operating expenses of $1.1 million. Other operating expenses consists of acquisition and underwriting expenses, salaries and benefits, depreciation, amortization and other general and administrative expenses.
Income tax benefit. We recognized $0.4 million of income tax benefit during the nine months ended September 30, 2019 due to the reversal of deferred tax liabilities recorded as a part of the acquisition of Maidstone. No income tax benefit was recorded during the period from January 2, 2018 to September 30, 2018.
Net (loss) income. Due to the impairment loss, coupled with the increases in incurred losses and loss adjustment expenses and other operating expenses, which were not offset by revenues, net loss for the nine months ended September 30, 2019 was $(8.2) million, compared to net income of $0.3 million for the period from January 2, 2018 to September 30, 2018, for the insurance business.
Liquidity and Capital Resources
The following table summarizes our condensed consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018:
| | | Nine months ended September 30, | |
| (In thousands) | | 2019 | | | 2018 | |
| Net cash flow provided by (used in): | | | | | | |
| Operating activities | | $ | 6,669 | | | $ | (9,765 | ) |
| Investing activities | | | 22,163 | | | | (29,765 | ) |
| Financing activities | | | 77,027 | | | | 36,490 | |
| Net increase (decrease) in cash | | $ | 105,859 | | | $ | (3,040 | ) |
Operating activities. Net cash provided by operating activities represents the cash receipts and cash disbursements from all of our activities other than investing activities and financing activities. Changes in cash from operating activities reflect, among other things, the timing of cash collections from customers, payments to suppliers, timing of payments to customers to settle insurance claims and changes in payments related to insurance policy acquisition costs.
Net cash provided by operating activities was $6.7 million for the nine months ended September 30, 2019, compared to net cash used in operating activities of $9.8 million for the nine months ended September 30, 2018, an increase of $16.5 million. The increase in net cash provided by operating activities was primarily the result of an increase in net cash provided by operations of Turning Point, as Turning Point provided $20.0 million of operating activities cash flow for the nine months ended September 30, 2019, compared to $1.0 million for the nine months ended September 30, 2018, an increase of $19.0 million, primarily due to changes in working capital accounts and increased net income for the current period.
Investing activities. Net cash provided by investing activities was $22.2 million for the nine months ended September 30, 2019, compared to net cash used in investing activities of $29.8 million for the nine months ended September 30, 2018. The increase in cash provided by investing activities was primarily due to the change in MSA escrow deposits from investments to cash holdings as well as a result of proceeds from the sale and maturity of fixed maturity securities, available-for-sale and lower cash paid for acquisitions in the nine months ending September 30, 2019.
Financing activities. Net cash provided by financing activities was $77.0 million for the nine months ended September 30, 2019, compared to net cash provided by financing activities of $36.5 million for the nine months ended September 30, 2018, an increase of $40.5 million. The increase in cash was primarily attributable to Turning Point’s proceeds from the issuance of its Convertible Senior Notes offset by payments on its 2018 Revolving Credit Facility, 2018 Second Lien Credit Facility, and payment for the associated call options and the incremental $10.0 million in borrowings on the GACP Term Loan.
Long-Term Debt
As of September 30, 2019, the Company was in compliance with the financial and restrictive covenants in its existing debt instruments. The following table provides outstanding balances under our debt instruments as of:
| (In thousands) | | September 30, 2019 | | | December 31, 2018 | |
| 2018 First Lien Term Loan | | $ | 148,000 | | | $ | 154,000 | |
| 2018 Second Lien Term Loan | | | - | | | | 40,000 | |
| SDI Crystal Term Loan | | | - | | | | 15,000 | |
| SDI GACP Term Loan | | | 25,000 | | | | - | |
| Standard Outdoor Promissory Notes | | | 8,584 | | | | 9,950 | |
| Convertible Senior Notes | | | 172,500 | | | | - | |
| Note payable - IVG | | | 4,240 | | | | 4,000 | |
| Total Notes Payable and Long-Term Debt | | | 358,324 | | | | 222,950 | |
| Less: deferred finance charges and debt discount | | | (12,216 | ) | | | (4,903 | ) |
| Less: current maturities | | | (15,958 | ) | | | (9,431 | ) |
| | | $ | 330,150 | | | $ | 208,616 | |
2018 Credit Facility
The 2018 Credit Facility contains 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 contains 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 Turning Point 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.
2018 First Lien Credit Facility
The 2018 First Lien Term Loan and the 2018 Revolving Credit Facility bear interest at LIBOR plus a spread of 2.75% to 3.50% based on Turning Point’s senior leverage ratio. The 2018 First Lien Term Loan has quarterly required payments of $2.0 million beginning June 30, 2018, increasing to $3.0 million on June 30, 2020, and increasing to $4.0 million on June 30, 2022. The 2018 First Lien Credit Facility has a maturity date of March 7, 2023. The 2018 First Lien Term Loan is secured by a first priority lien on substantially all of the assets of the borrowers and the guarantors thereunder, including a pledge of Turning Point’s capital stock, other than certain excluded assets (the “Collateral”). In connection with the Senior Notes offering, we 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 lending other lending parties thereto. The Amendment was entered into primarily to permit us to issue up to $200 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 our Second Lien Credit Agreement and use the remaining proceeds for acquisitions and investments in connection with the Amendment, fees of $0.7 million were incurred. The 2018 First Lien Credit Facility contains certain financial covenants, which were amended in connection with the Convertible Senior Notes offering in the third quarter of 2019. The covenants include maximum senior leverage ratio of 3.00x with step-downs to 2.50x, a maximum total leverage ratio of 5.50x with step-downs to 5.00x, and a minimum fixed charge coverage ratio of 1.20x. Based on an excess cash covenant for the facility, a principal payment of $4.5 million was due in the second quarter of 2019. All parties agreed to waive the payment, resulting in consent fees of $0.1 million. The weighted average interest rate of the 2018 First Lien Term Loan was 5.04% as of September 30, 2019. As of September 30, 2019, Turning Point had no borrowings outstanding under the 2018 Revolving Credit Facility. The $50.0 million unused portion of the 2018 Revolving Credit Facility is reduced by letters of credit from Fifth Third Bank totaling $2.7 million, resulting in $47.3 million of availability under the 2018 Revolving Credit Facility at September 30, 2019.
2018 Second Lien Credit Facility
The 2018 Second Lien Credit Facility bore interest at a rate of LIBOR plus 7.00% and had a maturity date of March 7, 2024. The 2018 Second Lien Term Loan was secured by a second priority interest in the Collateral and was guaranteed by the same entities as the 2018 First Lien Term Loan. The 2018 Second Lien Credit Facility contained certain financial covenants including a maximum senior leverage ratio of 3.75x with step-downs to 3.50x, a maximum total leverage ratio of 4.75x with step-downs to 4.50x, and a minimum fixed charge coverage ratio of 1.10x. Based on an excess cash covenant for the facility, a $4.5 million principal payment was made in the second quarter of 2019, resulting in $0.2 million loss on extinguishment of debt. Turning Point used a portion of the proceeds from the issuance of the Convertible Senior Notes to prepay all outstanding amounts related to the 2018 Second Lien Credit Facility in the third quarter of 2019. The principal paid in the third quarter of 2019 amounted to $35.5 million, and the transaction resulted in a $1.2 million loss on extinguishment of debt.
Convertible Senior Notes
In July 2019, Turning Point closed an offering of $172.5 million in aggregate principal amount of 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 3,202,808 shares of Turning Point voting common stock under certain circumstances prior to maturity at a conversion rate of 18.567 shares per $1,000 principal amount of the Convertible Senior Notes, which represents a conversion price of approximately $53.86 per share, subject to adjustment under certain conditions, but will not be adjusted for any accrued and unpaid interest. Upon conversion, Turning Point may pay cash, shares of its common stock or a combination of cash and stock, as determined by Turning Point at its discretion. The conditions required to allow the holders to convert their Convertible Senior Notes were not met as of September 30, 2019.
The excess of the principal amount of the liability over its carrying amount (“debt discount”) is amortized to interest expense over the term of the Convertible Senior Notes using the effective interest rate method.
Turning Point incurred debt issue costs and allocated the total amount to the liability and equity components of the Convertible Senior Notes based on their relative values. The debt issue costs attributable to the liability component are amortized to interest expense over the term of the Convertible Senior Notes using the effective interest method. Issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.
In connection with the Convertible Senior Notes offering, Turning Point entered into privately negotiated capped call transactions with certain financial institutions. The capped call transactions have a strike price of $53.86 per and a cap price of $82.86 per and are exercisable when and if the Convertible Senior Notes are converted. Turning Point paid $20.53 million for these capped calls and charged that amount to additional paid-in capital.
Note Payable – IVG
In September 2018, Turning Point issued a note payable to IVG’s former shareholders (the “IVG Note”). The IVG Note is $4.0 million principal with 6.0% interest compounding annually and matures on March 5, 2020. All principal and accrued and unpaid interest under the IVG Note is 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 was $4.2 million as of September 30, 2019.
SDI Term Loan
On September 18, 2019, we entered into a Term Loan Agreement (the “Term Loan Agreement”) with GACP II, L.P., a Delaware limited partnership (the “Agent”), as administrative agent and collateral agent for the financial institutions (the “Lenders”). The Term Loan Agreement provides for a term loan of $25.0 million (the “Term Loan”). The Term Loan will be used to (a) repay, in full, all outstanding indebtedness under the Crystal Term Loan, (b) finance the purchase of common stock of Turning Point, (c) finance the repurchase of our common stock, (d) fund certain fees and expenses, and (e) provide working capital.
The Term Loan bears interest at a rate equal to the three-month “Libor Rate” as published in The Wall Street Journal plus 9.00%. Interest under the Term Loan Agreement is payable monthly with the principal balance due on September 18, 2024. The Term Loan was subject to a closing fee of $0.5 million, which was paid upon execution of the Term Loan Agreement. Additionally, the Term Loan is subject to an agent monitoring fee of $25,000, payable quarterly. An early termination fee shall be due at any time if on or prior to the third anniversary of the closing of the Term Loan, we prepay or repay (whether voluntarily or mandatorily), or is required to prepay or repay, the Term Loan in whole or in part. Our obligations under the Term Loan Agreement are secured by all the shares of Turning Point stock owned by the Company.
On February 2, 2018, we and our Outdoor advertising subsidiaries (the “Borrowers”) entered into a term loan agreement with Crystal Financial LLC (“Crystal Term Loan”). The Crystal Term Loan provided for an initial term loan of $10.0 million and a commitment to provide additional term loans of up to $15.0 million. The Crystal Term Loan bore interest at a rate equal to the three-month “Libor Rate” as published in The Wall Street Journal plus 7.25%. Interest under the Crystal Term Loan agreement was payable monthly and was also subject to an agency fee of $50,000, payable upon execution of the agreement, and annually thereafter. In addition, the Crystal Term Loan was subject to a one-time commitment fee of $350,000, which was paid upon execution of the agreement. The principal balance was payable at maturity, on February 2, 2023. In August 2018, we borrowed an additional $5.0 million under the Crystal Term Loan. This borrowing is subject to the same terms as the initial borrowing. On September 18, 2019, in connection with entering into the Term Loan, all amounts outstanding under the Crystal Term Loan were repaid. The repayment resulted in a $1.0 million loss on extinguishment of debt for the third quarter of 2019.
Standard Outdoor Promissory Notes
On January 18, 2018, as partial consideration for an asset purchase of 83 billboard structures located in Alabama, as well as the ground leases and advertising contracts relating to such billboard structures, we issued a promissory note with a face value of $6.5 million. The promissory note was recorded net of a discount of $0.9 million, representing the difference between the face value and fair value at issuance. This discount will be amortized into interest expense using the effective interest rate method over the term of the promissory note. A principal payment of $1.0 million on the promissory note is payable January 1 of each year, beginning January 1, 2020 and ending January 1, 2022, with a $3.5 million final principal payment on January 1, 2023. The promissory note has a 5% fixed coupon interest rate and interest is payable quarterly.
On February 20, 2018, as partial consideration for an asset purchase of 86 billboard structures located in Georgia and Florida, as well as the ground leases and advertising contracts relating to such billboard structures, we issued a promissory note with a face value of $3.5 million. The promissory note was recorded net of a discount of $0.3 million, representing the difference between the face value and fair value at issuance. This discount will be amortized into interest expense using the effective interest rate method over the term of the promissory note. Principal payments began on March 1, 2019, with the remaining principal paid down monthly through March 1, 2022. The promissory note has a 5% fixed coupon interest rate and interest is payable monthly after March 1, 2019.
Off-balance Sheet Arrangements
During the nine months ended September 30, 2019 Turning Point did not execute any forward contracts. During 2018 Turning Point executed various forward contracts, none of which met hedge accounting requirements, for the purchase of €14.5 million with maturity dates ranging from March 2018 to January 2019. At September 30, 2019, and December 31, 2018, Turning Point had forward contracts for the purchase of €0.0 million and €1.5 million, respectively.
Inflation
We believe any effect of inflation at current levels will be minimal. Historically, Turning Point has been able to increase prices at a rate equal to, or greater than, the rate of inflation and believes it will continue to be able to do so for the foreseeable future. In addition, Turning Point has been able to maintain a relatively stable, variable cost structure for our products due, in part, to its successful procurement activities regarding its tobacco products and, in part, to its existing contractual agreement for the purchase of its 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 2018 Annual Report on Form 10-K, during the three months ended September 30, 2019. Please refer to our “Quantitative and Qualitative Disclosures about Market Risk” included in our 2018 Annual Report on Form 10-K filed with the SEC on March 11, 2019.
Credit Risk
There have been no material changes in our exposure to market risk during the three months ended September 30, 2019. Please refer to our “Quantitative and Qualitative Disclosures about Market Risk” included in our 2018 Annual Report on Form 10-K, filed with the SEC on March 11, 2019.
Interest Rate Sensitivity
Turning Point’s March 2018 refinancing resulted in all of its long-term debt instruments having variable interest rates that fluctuate with market rates. To reduce the volatility of future cash flows, Turning Point entered into interest rate swap agreements with lenders under the 2018 Credit Facility in March 2018. As of September 30, 2019, $70 million of Turning Point’s outstanding long-term debt carrying variable rates is covered by the interest rate swap agreements and, thus, effectively bears interest at a fixed rate. Turning Point believes the effect, if any, of reasonably possible near-term changes in interest rates on its consolidated financial position, results of operations, or cash flows would not be significant. A 1% increase in the interest rate would change pre-tax income by approximately $0.8 million per year. Refer to Note 4, “Derivative Instruments” of the notes to condensed consolidated financial statements for additional information regarding the interest rate swaps.
SDI also has exposure to interest rate volatility as a result of the Term Loan. The Term Loan bears interest at variable rates based on a rate equal to the three-month Libor Rate plus 9.00%. A 1% increase in the interest rate would change pre-tax income by approximately $0.3 million per year. We believe the effect, if any, of reasonably possible near-term changes in interest rates on our condensed consolidated financial position, results of operations, or cash flows would not be significant.
Maidstone’s primary exposure to market risk is interest rate sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because its investments are primarily in marketable debt securities. Maidstone’s available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. Due to the short-term duration of our investment portfolio an immediate 10% change in interest rates would not have a material effect on the fair market value of Maidstone’s portfolio.
In July 2019, Turning Point issued Convertible Senior Notes with an aggregate principal amount of $172.5 million. Turning Point carries the Convertible Senior Notes at face value less amortized discount on the balance sheet. Since the Convertible Senior Notes bear interest at a fixed rate, Turning Point has 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.
| Item 4. | Controls and Procedures |
We have carried out an evaluation, under the supervision and with the participation of our management, including our Interim Chief Executive Officer and Interim Chief Financial Officer, 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 September 30, 2019. Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in the reports that 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.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal controls over financial reporting during the most recent fiscal quarter.
We are a party from time to time to various proceedings in the ordinary course of business. For a description of the Master Settlement Agreement, to which Turning Point is a party, see “Notes to Consolidated Financial Statements - Note 2 Summary of Significant Accounting Policies: Risk and Uncertainties.” Other than the proceedings mentioned below, there is no material litigation, arbitration or governmental proceeding currently pending against us or any of our officers or directors in their capacity as such, and we and our officers and directors have not been subject to any such proceeding.
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 could have a material adverse effect on our business and results of operations. Turning Point is a defendant in certain cases which have been dormant for many years, which cases have now been dismissed with prejudice. Turning Point is subject to several lawsuits alleging personal injuries resulting from malfunctioning vaporizer devices and may be subject to claims in the future relating to our other NewGen products. Turning Point is still evaluating these claims and the potential defenses to them. For example, Turning Point did not design or manufacture the products at issue; rather, Turning Point was merely the distributor. Nonetheless, there can be no assurance that Turning Point will prevail in these cases, and they could have a material adverse effect on Turning Point’s business and results of operations. Because of their relative novelty, electronic cigarette and vaporizer product manufacturers and sellers have only recently become subject to litigation.
Turning Point engaged in discussions and mediation with VMR, which was acquired in 2018. Pursuant to a Distribution and Supply agreement (“VMR Agreement”), VMR was providing Turning Point with V2 e-cigarettes for the exclusive distribution in bricks-and-mortar stores in the United States. Under the terms of the VMR Agreement, in the event of termination following a change in control, the acquirer was required to make a payment to Turning Point under a formula designed to provide Turning Point with a fair share of the value created by Turning Point’s performance under the VMR Agreement. The discussions have been completed and Turning Point received $6.7 million in the second quarter of 2019 to settle the issue. Net of legal costs and reserves for anticipated future returns associated with the discontinuance, Turning Point recorded a $5.5 million gain in the second quarter, which is recorded as a reduction to selling, general, and administrative expenses.
Turning Point has several subsidiaries engaged in making, distributing and retailing (online and in bricks-and-mortar) 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. Turning Point expects that its subsidiaries will be subject to some such cases and information requests. In the acquisition of the vapor businesses, Turning Point negotiated financial “hold-backs”, which Turning Point expects to be able to use to defray expenses associated with the information production and the cost of defending any such lawsuits. To the extent that litigation becomes necessary, Turning Point believes that the subsidiaries have strong factual and legal defenses against claims that it unfairly marketed vapor products.
On October 8, 2019, the City of New York filed a complaint against twenty-three companies, including IVG and VaporFi, making various allegations including selling to consumers over the age of 18 but under 21. In response, those subsidiaries have ceased all sales into New York City, which was an immaterial market for those businesses. The complaint has not been served on Turning Point’s subsidiaries. If the complaint is served, Turning Point believes that there are strong defenses and expect that the subsidiaries will vigorously defend the claims. Nonetheless, there can be no assurance that Turning Point will prevail, and an adverse result could have a material adverse effect on our business and results of operations.
See “Risk Factors—We may become subject to significant product liability litigation” within our 2018 Annual Report on Form 10-K for additional details.
In addition to the other information set forth in this Quarterly Report on Form 10-Q, carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 11, 2019, which could materially affect our business, financial condition or future results. Except as set forth below, our risk factors as of the date of this Quarterly Report on Form 10-Q have not changed materially from those described in our Annual Report on Form 10-K.
Some of Turning Point’s products are subject to developing and unpredictable regulation.
Some of Turning Points NewGen products marketed through its Nu-X subsidiary and similar third-party products sold through its NewGen distribution vehicles may be subject to uncertain federal, state and local regulations concerning hemp, CBD and other non-tobacco consumable products. Enforcement initiatives by those authorities are therefore unpredictable and impossible to anticipate. Turning Point anticipates that all levels of government are likely to seek in some way to regulate these products, but the type, timing, and impact of such regulations remains uncertain. Accordingly, Turning Point cannot give any assurance that such actions would not have a material adverse effect on this emerging business.
Turning Point is currently and plans in the future to commercialize in the United States a variety of products containing hemp-derived CBD. While the Agriculture Improvement Act of 2018, or the Farm Bill, exempted hemp and hemp-derived products from the Controlled Substances Act, or the CSA, any such product commercialization may become subject to various laws, including the Farm Bill, the Food, Drug and Cosmetic Act, or the FD&CA, the Dietary Supplement Health and Education Act, or DSHEA, applicable state and/or local laws, and FDA regulations. Turning Point intends to offer hemp-derived CBD products in full compliance with laws and regulations. Nevertheless, violations of any such law or regulation could result in warning letters, significant fines, penalties, administrative sanctions, injunctions, convictions or settlements arising from civil proceedings initiated.
The Company’s insurance subsidiary, Maidstone, is subject to insurance laws and regulations in the jurisdictions in which it operates. These regulations include certain restrictions on the amount of dividends or other distributions available to unitholders.
Under the insurance laws of New York State, Maidstone faces certain restrictions on the amount of dividends that it may declare or pay. As of September 30, 2019, the maximum amount of dividends that may be paid by Maidstone without regulatory approval of the NYSDFS is $-0-.
Maidstone is subject to certain risk-based capital (“RBC”) requirements as specified by the National Association of Insurance Commissioners (“NAIC”). Under such requirements, the amount of capital and surplus maintained by a property and casualty insurance company is to be determined on various risk factors including risk-based capital ratios. In August 2019, Maidstone reported a negative statutory capital and surplus to the NYSDFS for the second quarter of 2019. Due to the negative statutory surplus, the NYSDFS requested that Maidstone consent to an Order of Liquidation and in August 2019 Maidstone consented to the filing of a petition for the entry of an Order of Liquidation. As of September 30, 2019, the NYSDFS has not filed the petition for the entry of an Order of Liquidation. If approved, an Order of Liquidation would relieve the Company of the assets and liabilities of Maidstone, which would be transferred to the New York Liquidation Bureau. See Note 25, “Statutory Information” to the notes to consolidated financial statements for further information.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
During the third quarter of 2019, we purchased shares of our Class A common stock as follows:
Period | | Total Number of Shares Purchased | | | Average Price Paid per Share | | | Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program | | | Maximum Number (or Approximate Dollar Value) of Shares That May Yet Be Purchased Under the Plans or Programs | |
January 1 – March 31 | | | 40,100 | | | $ | 14.02 | | | | 143,592 | | | (1) |
|
March 1 – June 30 | | | - | | | | - | | | | - | | | (1) |
|
July 1 - September 30 | | | 91,552 | | | | 12.93 | | | | 91,552 | | | (1) |
|
| Total | | | 131,652 | | | $ | 13.26 | | | | 235,144 | | | | |
| (1) | All repurchases were repurchased as a part of a publicly announced plan or program. The maximum number of shares (or approximate dollar value) of shares that may yet be purchased under the plans or programs is in the aggregate, up to 5% of the outstanding shares of common stock of the Company. |
| Item 3. | Defaults Upon Senior Securities |
Not applicable.
Not applicable.
Not applicable.
See the Exhibit Index immediately following the signature page of this Quarterly Report on Form 10-Q.
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.
| STANDARD DIVERSIFIED INC. | |
| | | |
| | By: /s/ Gregory H.A. Baxter | |
| | Name: Gregory H.A. Baxter | |
| | Title: Executive Chairman of the Board and Interim Chief Executive Officer | |
| | | |
| | /s/ Edward J. Sweeney | |
| | Name: Edward J. Sweeney | |
| | Title: Interim Chief Financial Officer | |
| | | |
Dated: November 6, 2019 | | | |
EXHIBIT INDEX
| Indenture, dated as of July 30, 2019, between Turning Point Brands, Inc. and GLAS Trust Company LLC, as trustee (including the Form of Note as Exhibit A thereto) (Filed as Exhibit 4.1 to the Current Report on Form 8-K of Turning Point Brands, Inc. filed with the SEC on July 31, 2019 and incorporated by reference herein.) |
| | |
| First Amendment to Amended and Restated First Lien Credit Agreement, dated as of July 24, 2019, among Turning Point Brands, Inc., Guarantors party thereto, the Lenders party thereto and Fifth Third Bank, as administrative agent and L/C lender (Filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q of Turning Point Brands, Inc. filed with the SEC on August 1, 2019 and incorporated by reference herein.) |
| | |
| Form of Capped Call Agreement (Filed as Exhibit 10.1 to the Current Report on Form 8-K of Turning Point Brands, Inc. filed with the SEC on July 31, 2019 and incorporated by reference herein.) |
| | |
| Term Loan Agreement, dated as of September 18, 2019, by and among Standard Diversified Inc. and GACP II, L.P., a Delaware limited partnership, as administrative agent and collateral agent for the financial institutions from time to time party thereto and for itself (Filed as Exhibit 99.1 to the Current Report on Form 8-K of Standard Diversified Inc. filed with the SEC on September 20, 2019 and incorporated by reference herein.) |
| Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
| | |
| Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* |
| | |
| Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.** |
| | |
| Certifications of Principal Financial Officer 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 SDI’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, filed on November 6, 2019, formatted in XBRL: (i) consolidated balance sheets, (ii) consolidated statements of income (loss), (iii) consolidated statements of comprehensive income (loss), (iv) consolidated statements of cash flows, and (v) the notes to consolidated financial statements.* |
| * | Filed or furnished herewith. |
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