SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

☐	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2017

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From _________ to _________

Commission File Number 001-36696

STANDARD DIVERSIFIED OPPORTUNITIES INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (302) 824-7062

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   ☑     No   ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   ☑    No   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.:

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

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

At October 31, 2017, there were 8,306,450 shares outstanding of the registrant’s Class A common stock, par value $0.01 per share, and 8,080,948 shares outstanding of the registrant’s Class B common stock, par value $0.01 per share.

 

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STANDARD DIVERSIFIED OPPORTUNITIES INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 

Item1.

Financial Statements

Standard Diversified Opportunities Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(dollars in thousands except share data)

(unaudited)

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

 

Standard Diversified Opportunities Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(dollars in thousands except share data)

(unaudited)

 

 

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

 

Standard Diversified Opportunities Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(dollars in thousands)

(unaudited)

 

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

 

Standard Diversified Opportunities Inc. and Subsidiaries

Condensed Consolidated Statement of Equity

(dollars in thousands, except share data)

(unaudited)

		Standard Diversified Opportunities Inc. Shareholders
		Class A Common Shares								Class B Common Shares									Class A Treasury Shares								Additional Paid-In Capital				Accumulated Other Comprehensive Loss				Accumulated Deficit				Noncontrolling Interests				Total
		Shares				Amount				Shares				Amount					Shares				Amount
Balance January 1, 2017 (shares adjusted for reverse stock split and reclassification)			857,714			$	9				841,448			$	9		​			(16,266	)		$	(555	)		$	105,616			$	(4,049	)		$	(66,972	)		$	-			$	34,058
Vesting of SDOI restricted stock			13,700				-				13,700				-					-				-				-				-				-				-				-
Issuance of Class A and Class B Common shares to former holders of Turning Point Brands shares in reverse acquisition			7,335,018				73				7,335,018				73					-				-				16,771				-				-				-				16,917
Allocation of Turning Point Brands equity to noncontrolling interests as part of reverse acquisition			-				-				-				-					-				-				(50,234	)			1,788				29,613				18,833				-
Conversion of Class B common stock into Class A common stock			109,218				1				(109,218	)			(1	)				-				-				-				-				-				-				-
Issuance of Class A common stock in business combination			3,757				-				-				-					-				-				39				-				-				-				39
Issuance of Class A common stock for services performed			3,309				-				-				-					-				-				34				-				-				-				34
Retirement of Class A treasury shares			(16,266	)			-				-				-					16,266				555				(555	)			-				-				-				-
Unrecognized pension and postretirement cost adjustment			-				-				-				-					-				-				-				179				-				39				218
Unrealized gain on investments			-				-				-				-					-				-				-				208				-				33				241
SDOI stock-based compensation			-				-				-				-					-				-				132				-				-				-				132
Impact of Turning Point equity transactions on APIC and NCI			-				-				-				-					-				-				(653	)			-				-				(293	)			(946	)
Turning Point acquisition of noncontrolling interest			-				-				-				-					-				-				(560	)			-				-				560				-
Turning Point distribution to noncontrolling interest			-				-				-				-					-				-				-				-				-				(4	)			(4	)
Net income			-				-				-				-					-				-				-				-				9,530				5,046				14,576
Balance September 30, 2017			8,306,450			$	83				8,080,948			$	81					-			$	-			$	70,590			$	(1,874	)		$	(27,829	)		$	24,214			$	65,265

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

Standard Diversified Opportunities Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(dollars in thousands)

(unaudited)

 

Standard Diversified Opportunities Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Continued)

(dollars in thousands)

(unaudited)

 

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

 

Standard Diversified Opportunities Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except where designated and per share data)

(unaudited)

Note 1. Organization and Description of Business

The accompanying condensed consolidated financial statements include the results of operations of Standard Diversified Opportunities Inc. (“SDOI”), a holding company, and its subsidiaries (collectively, “the Company”).

SDOI (f/k/a Special Diversified Opportunities Inc. and Strategic Diagnostics Inc.) was incorporated in the State of Delaware in 1990, and, until 2013, engaged in bio-services and industrial bio-detection (collectively, the “Life Sciences Business”). On July 12, 2013, SDOI sold substantially all of its rights, title and interest in substantially all of its non-cash assets related to the Life Sciences Business and became a “shell company,” as such term is defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended.

On June 1, 2017, SDOI consummated a Contribution and Exchange Transaction (the “Contribution and Exchange”) to acquire a 52.1% controlling interest in Turning Point Brands, Inc. (“Turning Point”). The transaction was accounted for as a recapitalization or reverse acquisition. Turning Point was the accounting acquirer for financial reporting purposes, notwithstanding the legal form of the transaction.  The primary reason the transaction was treated as a purchase by Turning Point rather than a purchase by SDOI was because SDOI was a shell company with limited operations and Turning Point’s stockholders gained majority control of the outstanding voting power of the Company’s equity securities through their collective ownership of a majority of the outstanding shares of Company common stock. Consequently, reverse acquisition accounting has been applied to the transaction. Accordingly, the historical financial statements of Turning Point through May 31, 2017 became the Company’s historical financial statements, including the comparative prior periods. These condensed consolidated financial statements include the results of SDOI from June 1, 2017, the date the reverse acquisition was consummated. As of September 30, 2017, SDOI has a 51.3% ownership interest in Turning Point.

Prior to the consummation of the Contribution and Exchange, SDOI amended and restated its certificate of incorporation to provide for, among other things, (i) the reclassification of every 25 shares of its common stock, par value $0.01 per share, into one share of a new class of common stock, par value $0.01 per share, designated as Class A Common Stock (the “Class A Common Stock”) and (ii) the authorization for issuance of an additional class of common stock, par value $0.01 per share, of SDOI designated as Class B Common Stock (the “Class B Common Stock”). Prior to the closing of the Contribution and Exchange, SDOI declared a dividend of one share of Class B Common Stock for each outstanding share of Class A Common Stock, payable to holders of record of Class A Common Stock on June 2, 2017.

The capital structure, including the number and type of shares issued appearing in the consolidated balance sheets for the periods presented, reflects that of the legal parent or accounting acquiree, SDOI, including the shares issued to effect the reverse acquisition after the Contribution and Exchange and the capital structure modified by the 1-for-25 exchange ratio of the SDOI shares outstanding prior to the consummation of the Contribution and Exchange. As a result of the reverse acquisition, stockholders’ equity has been retrospectively adjusted as of the earliest period presented in these consolidated financial statements. These adjustments include an increase of $9 to the par value of Class A common stock issued, an increase of $9 to the par value of Class B common stock issued, a decrease of $184 in the par value of common stock, an increase of $(555) in treasury stock and an increase of $721 to additional paid-in capital as of January 1, 2017. There was no change to Turning Point’s historical total stockholders’ equity as a result of the reverse acquisition.

 

All references in the unaudited condensed consolidated financial statements presented herein to the number of shares and per share amounts of common stock have been retroactively restated to reflect the reclassification of common stock, the shares issued in the Contribution and Exchange and the dividend of Class B Common Stock. Refer to Note 3, Acquisitions, for further information. As a result of the consummation of the Contribution and Exchange, SDOI is no longer a shell company.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

SDOI is now a holding company and its consolidated financial statements include Turning Point and its subsidiaries. Turning Point is also a holding company which owns North Atlantic Trading Company, Inc. (“NATC”), and its subsidiaries and Turning Point Brands, LLC (“TPLLC”), and its subsidiaries.  Except where the context indicates otherwise, references to Turning Point include Turning Point; NATC and its subsidiaries National Tobacco Company, L.P. (“NTC”), National Tobacco Finance Corporation (“NTFC”), North Atlantic Operating Company, Inc. (“NAOC”), Smoke Free Technologies, Inc.—d/b/a VaporBeast (“VaporBeast”)—North Atlantic Cigarette Company, Inc. (“NACC”), and RBJ Sales, Inc. (“RBJ”); and TPLLC and its subsidiaries Intrepid Brands, LLC (“Intrepid”) and Vapor Shark, LLC—f/k/a The Hand Media—and its subsidiaries (collectively, “Vapor Shark”).  Effective September 1, 2017, Turning Point: (1) dissolved NATC Holding Company, formerly a direct subsidiary of Turning Point which owned NATC and its subsidiaries; (2) transferred direct ownership of Vapor Shark from Turning Point to TPLLC; and (3) merged Stoker, Inc., and Fred Stoker & Sons, Inc., with and into RBJ Sales, Inc.

 

 

The unaudited condensed consolidated financial statements include the accounts of the Company, its subsidiaries, all of which are wholly-owned, and the results of Vapor Shark from April 1, 2017, through June 30, 2017. All significant intercompany transactions have been eliminated.

Vapor Shark was a variable interest entity (“VIE”) for which Turning Point was considered the primary beneficiary due to an April 2017 management agreement in which Turning Point was granted the right to purchase equity of Vapor Shark. Turning Point did not own Vapor Shark during the second quarter of 2017. On June 30, 2017, Turning Point exercised a warrant to purchase all of the issued and outstanding equity of Vapor Shark. Beginning June 30, 2017, Vapor Shark became a wholly owned subsidiary of Turning Point. See ‘Note 3 – Acquisitions’ for details regarding the warrant exercise.

 

Noncontrolling Interests

These condensed consolidated financial statements reflect the application of Accounting Standards Codification Topic 810, Consolidations (“ASC 810”) which establishes accounting and reporting standards that require: (i) the ownership interest in subsidiaries held by parties other than the parent to be clearly identified and presented in the consolidated balance sheet within shareholder’s equity, but separate from the parent’s equity; (ii) the amount of consolidated net income attributable to the parent and the noncontrolling interest to be clearly identified and presented on the face of the consolidated statements of income; and (iii) changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary to be accounted for consistently.

SDOI acquired a 52.1% interest in Turning Point on June 1, 2017 through a reverse acquisition as described in Note 1. Amounts pertaining to the noncontrolling ownership interest held by third parties in the financial position and operating results of the Company are reported as noncontrolling interests in the accompanying condensed consolidated financial statements. As of September 30, 2017, SDOI has an ownership interest of 51.3% in Turning Point.

 

Prior to the acquisition of Vapor Shark by Turning Point on June 30, 2017, it was consolidated by Turning Point as a VIE from April 1, 2017 to June 30, 2017, with its results during this period reflected as noncontrolling interest.

Use of Estimates

The preparation of the condensed consolidated financial statements requires the management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of expenses during the period. The Company’s significant estimates include those affecting the valuation of goodwill and other intangible assets, assumptions used in determining pension and postretirement benefit obligations and deferred income tax valuation allowances. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments that have maturities of three months or less when acquired to be cash equivalents.

Revenue Recognition

 

Turning Point recognizes revenues, net of sales incentives and sales returns, including shipping and handling charges billed to customers, upon delivery to the customer. Delivery signifies a transfer of title and risk of loss to the customer in accordance with ASC 605-10-S99. Turning Point classifies customer rebates as sales deductions in accordance with the requirements of ASC 605-50-25.

 

The Company’s outdoor sign business recognizes outdoor advertising revenue on an accrual basis ratably over the term of the contracts.

Shipping Costs

Turning Point records shipping costs incurred as a component of selling, general and administrative expenses. Shipping costs incurred were approximately $2.9 million and $1.7 million for the three months ended September 30, 2017 and 2016, respectively. Shipping costs incurred were approximately $7.4 million and $4.8 million for the nine months ended September 30, 2017 and 2016, respectively.

 

Fair Value

GAAP establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

The three levels of the fair value hierarchy under GAAP are described below:

Level 1 – Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets at the measurement date.

Level 2 – Inputs to the valuation methodology include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; inputs other than quoted prices that are observable for the asset or liability; and inputs derived principally from or corroborated by observable market data by correlation or other means.

Level 3 – Unobservable inputs which reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

Master Settlement Agreement Escrow Account

Pursuant to the Master Settlement Agreement (the “MSA”) entered into in November 1998 by most states (represented by their attorneys general acting through the National Association of Attorneys General) and subsequent states’ statutes, a “cigarette manufacturer” (which is defined to include a manufacturer of make-your-own (“MYO”) cigarette tobacco) has the option of either becoming a signatory to the MSA or opening, funding, and maintaining an escrow account to have funds available for certain potential tobacco-related liabilities, with sub-accounts on behalf of each settling state. Such companies are entitled to direct the investment of the escrowed funds and withdraw any appreciation, but cannot withdraw the principal for twenty-five years from the year of each annual deposit, except to withdraw funds deposited pursuant to an individual state’s escrow statute to pay a final judgment to that state’s plaintiffs in the event of such a final judgment against the company. Turning Point has chosen to open, fund and maintain an escrow account as its method of compliance. It is Turning Point’s policy to record amounts on deposit in the escrow account for prior years as a non-current asset.  Each year’s annual obligation is required to be deposited in the escrow account by April 15 of the following year.  In addition to the annual deposit, many states have elected to require quarterly deposits for the previous quarter’s sales. As of September 30, 2017, Turning Point had on deposit approximately $32.0 million, the fair value of which was approximately $30.9 million. At December 31, 2016, Turning Point had on deposit approximately $31.9 million, the fair value of which was approximately $30.4 million.

Turning Point invests a portion of the MSA escrow in U.S. Government securities including TIPS, Treasury Notes and Treasury Bonds. These investments are classified as available-for-sale and carried at fair value. Realized losses are prohibited under the MSA. Thus, any investment in an unrealized loss position will be held until the value is recovered or until maturity. The following shows the fair value of the MSA escrow account:

 

Fair value for the U.S. Governmental agency obligations are Level 2. The following schedule shows the maturities of the U.S. Governmental agency obligations:

The following table represents the amount of deposits by sales year for the MSA escrow account and reflects the decline in annual deposits beginning in 2009, due to the significant increase in federal excise taxes:

 Food and Drug Administration (“FDA”)

On June 22, 2009, the Family Smoking Prevention and Tobacco Control Act (“FSPTCA”) authorized the Food and Drug Administration (“FDA”) to immediately regulate the manufacture, sale and marketing of four categories of tobacco products – cigarettes, cigarette tobacco, roll-your-own tobacco and smokeless tobacco. On August 8, 2016, the FDA deeming regulation became effective. The deeming regulation gave the FDA the authority to additionally regulate cigars, pipe tobacco, e-cigarettes, vaporizers and e-liquids as “deemed” tobacco products under the FSPTCA.

 

The FDA assesses tobacco product user fees on six classes of regulated tobacco products and computes user fees using a methodology similar to the methodology used by the U.S. Department of Agriculture to compute the Tobacco Transition Payment Program (“TTPP”, also known as the “Tobacco Buyout”) assessment. First, the total annual congressionally established user fee assessment is allocated among the various classes of tobacco products using the federal excise tax weighted market share of tobacco products subject to regulation. Then, the assessment for each class of tobacco products is divided among individual manufacturers and importers.

Prior to October 1, 2016, these FDA user fees applied only to those products then regulated by the FDA. Effective October 1, 2016, the FDA began additionally applying FDA user fees to newly deemed tobacco products subject to FDA user fees as described above, i.e., cigars and pipe tobacco.

On July 28, 2017, the FDA announced a new direction in regulating tobacco products, including the newly “deemed” markets, such as cigars and vapor products. The FDA stated it intends to begin several new rulemaking processes, some of which will outline foundational rules governing the premarket application process for the deemed products, including Substantial Equivalence Applications and Premarket Tobacco Applications. Compliance and related costs could be significant and could increase the costs of operating in our NewGen Segment. The original filing deadlines for newly “deemed” products on the market as of August 8, 2016, have been postponed until August 8, 2021, for “combustible” products (e.g., cigar and pipe), and August 8, 2022, for “non-combustible” products (e.g., vapor products). No other filing deadlines were altered. The FDA also acknowledged a “continuum of risk” among tobacco products, i.e., certain tobacco products pose a greater risk to individual and public health than others; that it intends to seek public comment on the role flavors play in attracting youth and the role flavors may play in helping some smokers switch to potentially less harmful forms of nicotine delivery; and that it would be increasing its focus on the regulation of cigarette products.

Stock-Based Compensation

The Company accounts for stock-based compensation using the fair value method, which requires that compensation costs related to employee share based payment transactions are measured in the financial statements at the fair value on the date of grant and are recognized over the vesting period of the award.

Recent Accounting Pronouncements Adopted

The Company adopted Accounting Standards Update (“ASU”), ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment on January 1, 2017.  This ASU simplifies the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The adoption of the ASU had no effect on the Company’s consolidated financial statements.

The Company adopted ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory on January 1, 2017. The amendments in this ASU require entities that measure inventory using the first-in, first-out or average cost methods to measure inventory at the lower of cost and net realizable value. Net realizable value is defined as estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. The adoption of this ASU had no effect on the Company’s consolidated financial statements.

 

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either a full retrospective or retrospective with cumulative effect transition method. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606), which delayed the effective date of ASU 2014-09 by one year. ASU 2014-09 is now effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting year. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption ("modified retrospective method"). The Company currently expects to apply the modified retrospective method upon adoption. The Company does not believe the standard will materially impact its recognition of revenue as the Company is primarily a distributor of goods; however, the Company continues to assess the potential impacts to other less significant revenue transactions.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes Topic 840, Leases. ASU 2016-02 requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less for which there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities and should recognize lease expense for such leases generally on a straight-line basis over the lease term. Certain qualitative disclosures along with specific quantitative disclosures will be required, so that users are able to understand more about the nature of an entity’s leasing activities. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. At transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, which includes a number of optional practical expedients related to the identification and classification of leases that commenced before the effective date of ASU 2016-02. An entity that elects to use the practical expedients will, in effect, continue to account for leases that commenced before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees are required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. The Company is currently evaluating the effect the adoption of this standard will have on its financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The amendments in this ASU require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU 2016-18 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, on a retrospective basis. The Company is currently evaluating the effect the adoption of this standard will have on its financial statements.

In March 2017, the FASB issued ASU 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.  This ASU requires that an employer disaggregate the service cost component from the other components of net benefit cost. This ASU also allows only the service cost component of net benefit cost to be eligible for capitalization. ASU 2017-07 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is currently evaluating the effect the adoption of this standard will have on its financial statements.

 

Note 3. Acquisitions

Acquisitions by SDOI

On November 25, 2016, SDOI and Standard General Master Fund L.P., P Standard General Ltd. and Standard General Focus Fund L.P. (collectively the “SG Parties”), entered into a Contribution and Exchange Agreement, as amended by the: (1) First Amendment to Contribution and Exchange Agreement, dated January 25, 2017, (2) Second Amendment to Contribution and Exchange Agreement, dated April 5, 2017, and (3) Third Amendment to Contribution and Exchange Agreement, dated May 3, 2017 (as amended, the “Contribution and Exchange Agreement”).  Pursuant to the Contribution and Exchange Agreement, the SG Parties agreed to contribute approximately 9,842,373 shares of voting Turning Point Common Stock in exchange for shares of the Company based on an exchange ratio, calculated as of the closing of the Contribution and Exchange, equal to the lesser of (i) the 30-calendar day trailing VWAP of the Turning Point Common Stock divided by the 30-calendar day trailing VWAP of the Common Stock of the Company (as adjusted to reflect the reclassification of the Common Stock of the Company and (ii) the 30-calendar day trailing VWAP of the Turning Point Common Stock divided by the pro forma book value per share of the Company.

On June 1, 2017, at the consummation of the Contribution and Exchange, the SG Parties contributed to SDOI 9,842,373 shares of Turning Point Common Stock, representing a 52.1% ownership interest of Turning Point in exchange for 7,335,018 shares of Class A Common Stock of SDOI, based on the exchange ratio described above. Immediately after the consummation of the Contribution and Exchange, SDOI distributed a dividend of 7,335,018 shares of Class B Common Stock to the SG Parties. As of September 30, 2017, SDOI has an ownership interest of 51.3% in Turning Point.

 

The transaction was accounted for as a recapitalization or reverse acquisition. Turning Point was the accounting acquirer and SDOI was the accounting acquiree for financial reporting purposes. Accordingly, the historical financial statements of Turning Point became the Company’s historical financial statements, including the comparative prior periods. As such, the historical cost bases of assets and liabilities of Turning Point are maintained in the consolidated financial statements of the merged company and the assets and liabilities of the SDOI are accounted for at fair value. In this case, since the assets of SDOI at the acquisition date consist principally of cash and cash equivalents, there is no significant difference between book value and fair value. Results of operations of SDOI are included in the financial statements of the combined company only from the June 1, 2017 transaction date.

 

During the third quarter of 2017, the Company recorded a measurement period adjustment, to the opening balance sheet, relating to an accrued liability that was not recorded previously. The measurement period adjustment had no impact on the Company’s results of operations. The following table summarizes the preliminary allocation of the purchase price to the assets acquired and liabilities assumed as of the acquisition date and as of September 30, 2017:

 

The Company's condensed consolidated financial statements for the nine months ended September 30, 2017 include SDOI results of operations from the acquisition date of June 1, 2017 through September 30, 2017. Net loss attributable to SDOI during this period and included in the Company's condensed consolidated statements of income for the three and nine months ended September 30, 2017 was $1.0 million and $1.6 million, respectively.

 

On July 3, 2017, the Company acquired assets consisting of five billboards located in several counties near Austin, Texas for consideration of $0.3 million.

 

Acquisitions by Turning Point

In March 2017, Turning Point entered into a strategic partnership with Vapor Shark in which Turning Point agreed to make a deposit to Vapor Shark in exchange for a warrant to purchase 100% of the equity interest in Vapor Shark on or before April 15, 2018. In the event Turning Point exercised the warrant, Turning Point granted Vapor Shark’s shareholder the option to purchase from Vapor Shark the retail stores it owns effective as of January 1, 2018.   In April 2017, Turning Point entered into a management agreement with Vapor Shark whereby Turning Point obtained control of the operations.

As a result of the management agreement, Vapor Shark became a VIE. Turning Point determined that it is the primary beneficiary and consolidated Vapor Shark as of April 1, 2017. Since Vapor Shark is a business, Turning Point accounted for the consolidation of the VIE as if it were an acquisition and recorded the assets and liabilities at fair value. The Company exercised its warrant on June 30, 2017 and obtained ownership of Vapor Shark as of that date for a nominal purchase price. There was no goodwill assigned as a result of the transaction. Turning Point acquired $3.9 million in assets and assumed $3.9 million in liabilities which includes a liability relating to the option provided to Vapor Shark’s shareholder to purchase the Vapor Shark retail stores it owns.

In November 2016, Turning Point purchased five chewing tobacco brands from Wind River Tobacco Company for $2.5 million. Turning Point paid $0.6 million at closing with the remaining $1.9 million payable quarterly through November 2019 of which $1.4 million was outstanding at September 30, 2017. The transaction was accounted for as an asset purchase with the fair value of the purchase price of $2.4 million assigned to trade names which have an indefinite life.

In November 2016, Turning Point also acquired the outstanding stock of VaporBeast for total consideration of $26.5 million, net of working capital adjustment of $0.4 million. The purchase price was satisfied through $4.0 million in cash at closing, $19.0 million in short-term notes paid in December 2016, plus $4.0 million in payments deferred for eighteen months. Turning Point completed the accounting for the acquisition of VaporBeast in 2017, resulting in an increase in goodwill of $0.2 million.

The following purchase price and goodwill are based on the excess of the acquisition price over the estimated fair value of the tangible and intangible assets acquired:

 

The goodwill of $5.9 million consists of the synergies and scale expected from combining the operations. The goodwill is deductible for tax purposes.

Note 4. Fair Value of Financial Instruments

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of ASC 825, Financial Instruments. The estimated fair value amounts have been determined by the Company using the methods and assumptions described below. However, considerable judgment is required to interpret market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

Cash and Cash Equivalents

The Company has used Level 1 inputs to determine the fair value of its cash equivalents. As of September 30, 2017 and December 31, 2016, cost represented fair value of the Company's cash and cash equivalents.

Accounts Receivable

The fair value of accounts receivable approximates their carrying value due to their short-term nature.

Revolving Credit Facility

The fair value of the revolving credit facility approximates its carrying value as the interest rate fluctuates with changes in market rates.

Long-Term Debt

The fair value of Turning Point’s long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to Turning Point for debt of the same remaining maturities.

 

As of September 30, 2017, the fair values of the 2017 First Lien Term Loans and the 2017 Second Lien Term Loan approximate their face amounts of $142.1 million and $55.0 million, respectively as the agreements were initiated during the first quarter of 2017. As of December 31, 2016, the fair values of the First Lien Term Loans and the Second Lien Term Loan approximated their face amounts of $147.3 million and $60.0 million, respectively as they were paid off in February 2017 at face amounts. See Note 8. Notes Payable and Long-Term Debt for details regarding Turning Point’s credit facilities.

Foreign Exchange

Turning Point had no forward contracts outstanding as of September 30, 2017. Turning Point had forward contracts as of December 31, 2016 for the purchase of €4.9 million. The fair value of the foreign exchange forward contracts was based upon the quoted market price that resulted in an insignificant liability as of December 31, 2016.

Note 5. Inventories

Inventories are stated at the lower of cost or market.  Cost is determined on the last-in, first-out (“LIFO”) method for approximately 47% of the inventories and the first-in, first out (“FIFO”) method for the remaining inventories.  Leaf tobacco is presented in current assets in accordance with standard industry practice, notwithstanding the fact that such tobaccos are carried longer than one year for curing.

The components of inventories are as follows:

The inventory valuation allowance at September 30, 2017 and December 31, 2016 was $0.7 million and $0.6 million, respectively.

 

Note 6. Property, Plant and Equipment

Property, plant and equipment consists of:

 

Note 7. Accrued Liabilities

Accrued liabilities consist of:

Other liabilities include $1,466 of SDOI related accruals at September 30, 2017. There were no SDOI related accrued liabilities at December 31, 2016.

Note 8. Notes Payable and Long-Term Debt

Notes payable and long-term debt consists of the following:

 

Long-term Debt

On February 17, 2017, Turning Point and its wholly-owned subsidiary, NATC Holding Company, Inc. (“NATC”), entered into a new $250 million secured credit facility, comprised of (i) a First Lien Credit Facility with Fifth Third Bank, as administrative agent, and other lenders (the “2017 First Lien Credit Facility”), and (ii) a Second Lien Credit Facility with Prospect Capital Corporation, as administrative agent, and other lenders (the “2017 Second Lien Credit Facility,” and together with the 2017 First Lien Credit Facility, the “2017 Credit Facility”). Turning Point used the proceeds of the 2017 Credit Facility to repay in full Turning Point’s First Lien Term Loan, Second Lien Term Loan, Revolving Credit Facility and to pay related fees and expenses.

The 2017 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 2017 Credit Facility also contains certain negative covenants customary for facilities of these types including, covenants that, subject to exceptions described in the 2017 Credit Facility, restrict the ability of the Company and its subsidiary guarantors: (i) to pledge assets; (ii) to incur additional indebtedness; (iii) to pay dividends; (iv) to make distributions; (v) to sell assets; and (vi) to make investments.

2017 First Lien Credit Facility

The 2017 First Lien Credit Facility consists of: (i) a $50 million revolving credit facility (the “2017 Revolving Credit Facility”); (ii) a $110 million first out term loan facility (the “2017 First Out Term Loan”), and (iii) a $35 million second out term loan facility (the “2017 Second Out Term Loan”), which will be repaid in full only after repayment in full of the 2017 First Out Term Loan. The 2017 First Lien Credit Facility also includes an accordion feature allowing Turning Point to borrow up to an additional $40 million upon the satisfaction of certain conditions, including obtaining commitments from one or more lenders. Borrowings under the 2017 Revolving Credit Facility may be used for general corporate purposes, including acquisitions.

The 2017 First Out Term Loan and the 2017 Revolving Credit Facility have a maturity date of February 17, 2022, and the 2017 Second Out Term Loan has a maturity date of May 17, 2022. The 2017 First Out Term Loan and the 2017 Revolving Credit Facility bear interest at LIBOR plus a spread of 2.5% to 3.5% based on Turning Point’s senior leverage ratio. The 2017 First Out Term Loan has quarterly required payments of $1.4 million beginning June 30, 2017 increasing to $2.1 million on June 30, 2019 and increasing to $2.8 million on June 30, 2021. The 2017 Second Out Term Loan bears interest at LIBOR plus 6% (subject to a floor of 1.00%). The 2017 Second Out Term Loan has quarterly required payments of $0.1 million beginning June 30, 2017. The 2017 First Lien Credit Facility contains certain financial covenants, including maximum senior leverage ratio of 3.75x with step-downs to 3.00x, a maximum total leverage ratio of 4.75x with step-downs to 4.00x, and a minimum fixed charge coverage ratio of 1.20x. The weighted average interest rate at September 30, 2017 on the 2017 Revolving Credit Facility was 4.3%. The weighted average interest rate at September 30, 2017 on the 2017 First Out Term Loan was 4.3%. The weighted average interest rate at September 30, 2017 on the 2017 Second Out Term Loan was 7.3%.

2017 Second Lien Credit Facility

The 2017 Second Lien Credit Facility consists of a $55 million second lien term loan (the “2017 Second Lien Term Loan”) having a maturity date of August 17, 2022. The 2017 Second Lien Term Loan bears interest at a fixed rate of 11%. The 2017 Second Lien Credit Facility contains certain financial covenants, including a maximum senior leverage ratio of 4.25x with step-downs to 3.50x, a maximum total leverage ratio of 5.25x with step-downs to 4.50x, and a minimum fixed charge coverage ratio of 1.10x.

Note Payable – VaporBeast

On November 30, 2016, Turning Point issued a note payable to VaporBeast’s former shareholders (“VaporBeast Note.”) The VaporBeast Note is $2.0 million principal with 6% interest compounded monthly and matures on May 30, 2018.

 

The VaporBeast Note may be prepaid at any time without penalty and is subject to a late payment penalty of 5% and a default rate of 13% per annum. The VaporBeast Note is subject to customary defaults, including defaults for nonpayment, nonperformance, any material breach under the purchase agreement and bankruptcy or insolvency.

First Lien Term Loan

All of NATC’s subsidiaries, as well as Turning Point and NATC Holding, were guarantors under the First Lien Term Loan. Turning Point Brands, LLC and its subsidiary were not guarantors of the First Lien Term Loan. The First Lien Term Loan was secured by a first priority lien on substantially all of the assets of the borrowers and the guarantors thereunder, including a pledge of the capital stock of NATC and its subsidiaries held by NATC Holding, NATC or any guarantor, other than certain excluded assets (the “Collateral”). The loans designated as LIBOR loans bore interest at the LIBOR then in effect (but not less than 1.25%) plus 6.50% and the loans designated as base rate loans bore interest at the (i) highest of (A) the Prime Rate, (B) the Federal Funds Rate plus 0.50%, (C) LIBOR for an interest period of one month plus 1.00% and (D) 2.25% per year plus (ii) 5.50%. The First Lien Term Loan was paid in full with the proceeds from the 2017 Credit Facility.

Second Lien Term Loan

The Second Lien Term Loan was secured by a second priority security interest in the Collateral and was guaranteed by the same entities as the First Lien Term Loan.

Under the Second Lien Term Loan the loans designated as LIBOR loans bore interest at LIBOR then in effect (but not less than 1.25%) plus 10.25%. The loans designated as base rate loans bore interest at (i) the highest of (A) the Prime Rate, (B) the Federal Funds Rate plus 0.50%, (C) LIBOR for an interest period of one month plus 1.00% and (D) 2.25% per year plus (ii) 9.25%. The Second Lien Term Loan was paid in full with the proceeds from the 2017 Credit Facility.

Revolving Credit Facility

The Revolving Credit Facility provided for aggregate commitments of up to $40 million, subject to a borrowing base, which was calculated as the sum of (i) 85% of eligible accounts receivable, plus (ii) the lesser of (A) the product of 70% and the value of eligible inventory or (B) the product of 85%, the net recovery percentage identified in the most recent inventory appraisal,  and the value of eligible inventory, plus (iii) the lesser of (A) the product of 75% and the value of eligible inventory or (B) the product of 85%, the net recovery percentage identified in the most recent inventory appraisal, and the value of the eligible finished goods inventory, minus (iv) the aggregate amount of reserves established by the administrative agent. The outstanding balance on the Revolving Credit Facility was paid in full with proceeds from the 2017 Credit Facility.

PIK Toggle Notes

On January 13, 2014, Turning Point issued PIK Toggle Notes (“PIK Toggle Notes”) to Standard General Master Fund, L.P. (“Standard General”) with a principal amount of $45 million and warrants to purchase 42,424 of Turning Point’s common stock at $.01 per share, as adjusted for stock splits and other events specified in the agreement. After adjustment for the stock split effected in connection with the IPO of 10.43174381 to 1, the warrants provide for the purchase of 442,558 of Turning Point’s common stock. Due to the issuance of the warrants the PIK Toggle Notes had an original issue discount of $1.7 million and were initially valued at $43.3 million. The PIK Toggle Notes were scheduled to mature and the warrants to expire, on January 13, 2021.

 

The PIK Toggle Notes accrued interest based on LIBOR then in effect (but not less than 1.25%) plus 13.75%. Interest was payable on the last day of each quarter and upon maturity. Turning Point had the flexibility to pay interest in kind through an increase in the principal amount at the same interest rate as the PIK Toggle Notes. Turning Point chose to increase the PIK Toggle Notes for all interest for the first three months of 2016.

In connection with the Turning Point IPO, in May of 2016, Turning Point redeemed and retired all of the outstanding PIK Toggle Notes in exchange for a combination of cash and shares of Turning Point’s voting common stock. As a result of this transaction, Turning Point incurred a loss on extinguishment of debt of $2.8 million during the second quarter of 2016.

7% Senior Notes

In January of 2014, Turning Point issued 7% Senior Notes to various stockholders with a principal amount of $11 million and warrants to purchase 11,000,000 units of membership interests in Intrepid, a subsidiary of Turning Point, which represented 40% of the Intrepid Common Units outstanding on a fully diluted basis, at a purchase price of $1.00 per unit. Due to the issuance of the Intrepid warrants, the 7% Senior Notes had an original issue discount of $2.8 million and were initially valued at $8.2 million. The 7% Senior Notes were scheduled to mature and the warrants to expire on December 31, 2023.

The 7% Senior Notes accrued interest at a fixed rate of 7% per annum. The 7% Senior Notes were general unsecured obligations of Turning Point and ranked equally with Turning Point’s other unsecured and unsubordinated debt from time to time outstanding. Redemptions of the 7% Senior Notes could be made by Turning Point at any time without penalty or premium.

In connection with the Turning Point IPO in May of 2016, Turning Point redeemed and retired all of the outstanding 7% Senior Notes in exchange for shares of the Company’s voting common stock.

Note 9. 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 plan is frozen. Turning Point expects to make no contributions to the pension plan in the year ending December 31, 2017.

Turning Point also 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 expects to contribute approximately $0.2 million to its postretirement plan in 2017 for the payment of benefits.

The components of Net Periodic Benefit Cost are as follows:

 

 

Note 10. Stockholders’ Equity

Common Stock

As described in Note 1, just prior to the Contribution and Exchange, the Company’s issued and outstanding common stock was reclassified such that every 25 shares of common stock became one fully paid and nonassessable share of Class A Common Stock. Any fractional shares were rounded up and an additional share was issued. 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 the third quarter of 2017, the Company adjusted the Class A and Class B Common Stock balances as of January 1, 2017 (adjusted for the reverse stock split and reclassification) by to appropriately reflect the correct beginning share balance for the Class A and Class B Common Stock.

The Sixth 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.

 

Preferred Stock

On May 30, 2017, under the Fifth Amended and Restated Certificate of Incorporation, the Company increased the number of authorized shares of the Company’s Preferred Stock, $0.01 par value per share, from 19,664,362 to 500,000,000, all of which is designated as blank check preferred stock. No changes with respect to Preferred Stock were made in the Sixth Amended and Restated Certificate of Incorporation.

Common Stock Repurchase Program

On June 29, 2017, the Company’s Board of Directors authorized a program, effective immediately, to repurchase over a period of twelve months 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 the 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. No repurchases of common stock were made pursuant to this program during the nine months ended September 30, 2017.

Note 11. Share-Based Compensation

The Company has a stock option plan (the “2000 Plan”) which authorizes the granting of incentive and nonqualified stock options and restricted stock units. Incentive stock options are granted at not less than 100% of fair market value at the date of grant (110% for stockholders owning more than 10% of the Company’s common stock). Nonqualified stock options are granted at not less than 85% of fair market value at the date of grant. A maximum of 8,000,000 shares of common stock are issuable under the 2000 Plan. Certain additional options have been granted outside the 2000 Plan. These options generally follow the provisions of the 2000 Plan. The Company issues new shares to satisfy option exercises and the vesting of restricted stock awards.  As of the effective date of the 2017 Plan, described further below, no additional grants will be made under the 2000 Plan.

On June 9, 2017, the Company’s Board of Directors 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 Directors 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. No awards were made under this plan during the nine months ended September 30, 2017.

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 SDOI’s subsidiaries, there was share-based compensation expense of $0.3 million and $0.6 million recorded for the three and nine months ended September 30, 2017 and $0.1 million for the three and nine months ended September 30, 2016. This expense is a component of selling, general and administrative expense.

No options of SDOI were exercised in the three and nine month periods ended September 30, 2017 and 2016.

Upon consummation of the reverse merger with Turning Point on June 1, 2017, all outstanding options to purchase SDOI common shares were converted into stock options to purchase SDOI Class A common stock on terms substantially identical to those in effect prior to the reverse merger, except for adjustments to the underlying number of shares and the exercise price based on the 25-for-1 reverse stock split and reclassification. Information with respect to the adjusted activity of outstanding stock options is summarized as follows:

 

The following table provides additional information about the Company’s stock options outstanding and exercisable at September 30, 2017:

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, 2017:

 

The RSAs outstanding as of January 1, 2017 vested upon the consummation of the Contribution and Exchange transaction as the performance-based criteria required for vesting were satisfied. As of September 30, 2017, there was $1.1 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 2.61 years.

Note 12. Income Taxes

On June 1, 2017, SDOI consummated the Contribution and Exchange to acquire a 52.1% controlling interest in Turning Point (see Note 3 above). The structuring of this acquisition results in SDOI consolidating Turning Point in its consolidated financial statements.  However, SDOI’s controlling interest does not meet the ownership threshold to file a consolidated federal tax return with Turning Point. Therefore, the parent company will continue to file a separate federal tax return apart from Turning Point.

The Company’s income tax expense for the three and nine months ended September 30, 2017 does not bear the normal relationship to income before income taxes of approximately 41% due to tax benefits of $0.9 million and $4.5 million relating to Turning Point stock options exercised during the three and nine months ended September 30, 2017, respectively. In addition, SDOI incurred a net operating loss for its three and four months of operating results included in the three and nine months ended September 30, 2017, respectively, for which no tax benefit has been recorded due to its full valuation allowance offsetting its net deferred tax assets, as described below. The Company’s income tax expense for the three and nine months ended September 30, 2016, does not bear the normal relationship to income before income taxes because of Turning Point net operating loss carryforwards that were utilized by Turning Point and were partially offset by certain minimum state income taxes.

SDOI has recorded a full valuation allowance, as of September 30, 2017, offsetting its U.S. federal and state net deferred tax assets which primarily represent net operating loss carry forwards (“NOLs”). At September 30, 2017, 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 SDOI has experienced a “change in control” as defined in Internal Revenue Code Section 382, which will result in an annual limitation on SDOI’s utilization of NOLs in future periods.  The Company is currently evaluating the effects of Section 382 on SDOI’s future utilization of its NOLs.

 

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. A tax position must be more-likely-than-not to be sustained upon examination by taxing authorities for those benefits to be recognized. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. As of September 30, 2017, SDOI had approximately $628 of unrecognized tax benefits under the provisions of ASC 740-10-25, $622 of which were recorded as a reduction to existing net operating loss and tax credit carry forwards, and therefore require no accrual for interest or penalty. The remaining $6 includes de minimis interest and penalties where required. SDOI does not expect that the total amount of unrecognized tax benefits related to positions taken in prior periods will change significantly during the next twelve months. Turning Point has determined that it 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 and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. For federal purposes, SDOI’s post-2001 tax years remain open to examination as a result of net operating losses generated during those years that are carried forward to be potentially utilized in future years. For state purposes, the statute of limitations for SDOI remains open in a similar manner for states that have generated NOLs. In general, Turning Point is no longer subject to U.S. federal and state tax examinations for years prior to 2014.

 

Note 13. Contingencies

 

The Company is involved in various claims and actions that arise in the normal course of business. While the outcome of these legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of the proceedings should not have a material adverse effect on the financial position, results of operations or cash flows of the Company.

Note 14. 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 per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income 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. Due to the reverse acquisition, the basic weighted average number of common shares outstanding for the three and nine months ended September 30, 2016 have been calculated using Turning Point’s historical weighted average number of common shares outstanding multiplied by the conversion ratio used in the reverse acquisition. For the nine months ended September 30, 2017, the basic weighted average shares outstanding has been calculated using the number of common shares outstanding of Turning Point from January 1, 2017 through the June 1, 2017 acquisition date multiplied by the exchange ratio used in the transaction and the number of common shares outstanding of the Company from June 1, 2017 through September 30, 2017.  For the three months ended September 30, 2017, the basic weighted average shares outstanding has been calculated using the number of common shares outstanding of SDOI from July 1, 2017 through September 30, 2017.

 

The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock (in thousands, except share amounts and per share amounts):

 

(1)

The dilutive impact of subsidiary stock-based awards on the Company’s reported net income is recorded as an adjustment to net income for the three and nine months ended September 30, 2017, for the purposes of calculating income per share. There is no adjustment to the three and nine months ended September 30, 2016 because the reverse acquisition of Turning Point by SDOI did not occur until June 1, 2017.

The following outstanding securities at September 30, 2017 have been excluded from the computation of diluted weighted average shares outstanding, as they are anti-dilutive:

 

Note 15. Segment Information

In accordance with ASC 280, Segment Reporting, the Company has three reportable segments, (1) Smokeless products; (2) Smoking products; and (3) NewGen products. The smokeless products segment: (a) manufactures and markets moist snuff and (b) contracts for and markets chewing tobacco products. The smoking products segment: (a) imports and markets cigarette papers, tubes and related products and (b) imports and markets finished cigars and MYO cigar wraps. The NewGen products segment (a) markets e-cigarettes, e-liquids, vaporizers and other related products and (b) distributes a wide assortment of vaping products to non-traditional retail outlets. The Company’s smoking and smokeless products are distributed primarily through wholesale distributors in the United States. The Other segment includes the results of operations of SDOI, assets of the Company not assigned to the three reportable segments. Elimination includes the elimination of intercompany accounts between segments.

 

Accounting policies of these segments are the same as those of the Company. Segment data includes a charge allocating corporate costs to the three reportable segments based on their respective net sales. The Company evaluates the performance of its segments and allocates resources to them based on operating income.

The tables below present financial information about reported segments: