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 Inc. (“SDI”), a holding company, and its subsidiaries (collectively, “the Company”). SDI (f/k/a Standard Diversified Opportunities Inc., 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, SDI 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, SDI 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 SDI was because SDI 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 SDI from June 1, 2017, the date the reverse acquisition was consummated. As of March 31, 2018, SDI has a 51.2% ownership interest in Turning Point.

Prior to the consummation of the Contribution and Exchange, SDI 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 SDI designated as Class B Common Stock (the “Class B Common Stock”). In connection with the closing of the Contribution and Exchange, SDI 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, SDI, 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 SDI shares outstanding prior to the consummation of the Contribution and Exchange.

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, SDI is no longer a shell company.

Recent acquisitions

On January 2, 2018, SDI, through its wholly-owned subsidiary, Pillar General Inc. (“Pillar General”), acquired all 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 offers personal automobile insurance, primarily in the State of New York (See Note 3. Acquisitions).

 

On January 18, 2018, SDI, through its wholly-owned subsidiary, Standard Outdoor LLC, acquired assets consisting of 83 billboard structures located in Alabama, as well as the ground leases and advertising contracts relating to such billboard structures for total consideration with a fair value of approximately $9.7 million (See Note 3. Acquisitions).

On February 20, 2018, SDI, through Standard Outdoor LLC, acquired assets consisting of 86 billboard structures located in Georgia and Florida, as well as the ground leases and advertising contracts relating to such billboard structures for total consideration with a fair value of approximately $6.8 million (See Note 3. Acquisitions).

Note 2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

SDI is a holding company and its consolidated financial statements include Turning Point and its subsidiaries, Pillar General and its subsidiaries, and Standard Outdoor LLC and its subsidiaries.

 

Turning Point is 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, LLC (“NTFLLC”), North Atlantic Operating Company, Inc. (“NAOC”), North Atlantic Cigarette Company, Inc. (“NACC”), and RBJ Sales, Inc. (“RBJ”); and TPLLC and its subsidiaries Intrepid Brands, LLC (“Intrepid”), VaporBeast, LLC (“VaporBeast,” f/k/a Smoke Free Technologies, Inc.), and Vapor Shark, LLC, and its subsidiaries (collectively, “Vapor Shark,” f/k/a The Hand Media).

Pillar General, a wholly-owned subsidiary of the Company, owns 100% of Interboro Holdings, Inc. which is a holding company and includes the accounts of its wholly-owned subsidiaries (collectively, “Interboro”) which consist of Interboro Management, Inc. (“Interboro Management”), Maidstone Insurance Company (“Maidstone”), formerly known as AutoOne Insurance Company (“AOIC”) and AIM Insurance Agency Inc. (“AIM”). Maidstone is domiciled in the State of New York and is a property and casualty insurance company which provides automobile insurance.

 

Standard Outdoor LLC, a wholly-owned subsidiary of the Company, and its subsidiaries (collectively, “Standard Outdoor”), consists of Standard Outdoor Southeast I LLC, Standard Outdoor Southeast II LLC and Standard Outdoor Southwest LLC. Standard Outdoor is an out-of-home advertising business with billboard structures located in Texas, Alabama, Georgia and Florida.

 

The unaudited condensed consolidated financial statements presented herein have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, including normal recurring adjustments, considered necessary for a fair statement of the financial statements have been included. Operating results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

As a result of the consummation of the Contribution and Exchange, the historical financial statements of Turning Point became the Company’s historical financial statements. Accordingly, the historical financial statements of Turning Point are included in the comparative prior periods. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes of SDI as of and for the year ended December 31, 2017 filed on Form 10-K with the Securities and Exchange Commission on March 12, 2018.  The operating results of SDI are included in these financial statements beginning on June 1, 2017.

The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated.

 

Certain prior years amounts have been reclassified to conform to the current year’s presentation. The changes did not have an impact on the Company’s consolidated financial position, results of operations or cash flows in any of the periods presented.

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.

SDI acquired a 52.1% interest in Turning Point on June 1, 2017 through a reverse acquisition as described in Note 1. Organization and Description of Business. 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 March 31, 2018, SDI has an ownership interest of 51.2% in Turning Point.

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, the adequacy of the Company’s insurance reserves, 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.  These investments are both readily convertible to cash and near maturity such that they present insignificant risk of changes in fair value. At times, cash and cash equivalents may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. Management does not consider the cash balances above FDIC limits to be significant risks.

Revenue Recognition

 

Turning Point: Turning Point adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) , which supersedes nearly all existing revenue recognition guidance under U.S. GAAP, on January 1, 2018. Turning Point recognizes revenues, net of sales incentives and sales returns, including shipping and handling charges billed to customers, upon delivery of goods to the customer at an amount that it expects to be entitled to in exchange for those goods in accordance with the five-step analysis outlined in Topic 606: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations, and (v) recognize revenue when (or as) performance obligations are satisfied.

 

A further requirement of ASU 2014-09 is for entities to disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. Turning Point’s management views business performance through segments that closely resemble the performance of major product lines. Thus, the primary, and most useful, disaggregation of Turning Point’s contract revenue for decision making purposes is the disaggregation by segment which can be found in Note 19. Segment Information. An additional disaggregation of contract revenue by sales channel can be found within Note 19. Segment Information as well.

 

Standard Outdoor: The Company’s out-of-home advertising business revenues are derived from billboard space contracts with customers which are currently accounted for as leases under ASC 840, Leases . The Company will continue to account for these revenues under ASC 840, Leases , through December 31, 2018. The Company is still evaluating the impact that ASU No. 2016-02, Leases (Topic 842), effective for the Company on January 1, 2019, will have on its out-of-home advertising business revenues.

Maidstone: Maidstone recognizes revenues from insurance contracts, including premiums and fees, under the guidance in ASC 944, Financial Services-Insurance Premiums . Insurance contracts are out of scope of ASC 606. Maidstone’s premiums, which are recorded at the policy inception, are earned pro rata over the period for which the coverage is provided, generally six months for auto policies. Unearned premiums represent the portion of premiums written that are applicable to the unexpired terms of policies in force. Premiums ceded to other companies pursuant to reinsurance agreements have been reported as a reduction to premiums earned. Take-out fees are received by Maidstone in the form of credits when it writes business from the state assigned pool. These credits can be used by Maidstone to reduce the amount of business it writes from the assigned pool in the future or they can be sold to third-party insurance companies for them to reduce their exposure to the assigned risk pool. Maidstone collects other miscellaneous fees such as installment and late fees. Broker fee income is received from non-affiliated insurance companies for which Maidstone’s management acts as an agent to sell their state mandated obligations for assigned risks. These fees are shown as other income in the condensed consolidated statements of income.

Shipping Costs

The Company records shipping costs incurred as a component of selling, general and administrative expenses. Shipping costs incurred were approximately $3.2 million and $2.2 million for the three months ended March 31, 2018 and 2017, 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 that are derived principally from or corroborated by observable market data by correlation or other means.

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

Derivative Instruments

Foreign Currency Forward Contracts: The Company enters into foreign currency forward contracts to hedge a portion of its exposure to changes in foreign currency exchange rates on inventory purchase commitments. The Company accounts for its forward contracts under the provisions of ASC 815, Derivatives and Hedging . Under the Company’s policy, the Company may hedge up to 100% of its anticipated purchases of inventory in the denominated invoice currency over a forward period not to exceed twelve months. The Company may also, from time to time, hedge up to ninety percent of its non-inventory purchases in the denominated invoice currency. Forward contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date, except any hedge ineffectiveness which is recognized currently in income. Gains and losses on these forward contracts are transferred from other comprehensive income into net income as the related inventories are received. Changes in fair value of any contracts that do not qualify for hedge accounting or are not designated as hedges are recognized currently in income.

 

Interest Rate Swap Agreements: The Company enters into interest rate swap contracts to manage interest rate risk and reduce the volatility of future cash flows. The Company accounts for its interest rate swap contracts under the provisions of ASC 815, Derivatives and Hedging. Swap contracts that qualify as hedges are adjusted to their fair value through other comprehensive income as determined by market prices on the measurement date, except any hedge ineffectiveness which is recognized currently in income. Gains and losses on these swap contracts are transferred from other comprehensive income into net income upon settlement of the derivative position or at maturity of the interest rate swap contract. Changes in fair value of any contracts that do not qualify for hedge accounting or are not designated as hedges are recognized currently in income.

Risks and Uncertainties

Manufacturers and sellers of tobacco products are subject to regulation at the federal, state, and local levels. Such regulations include, among others, labeling requirements, limitations on advertising, and prohibition of sales to minors. The trend in recent years has been toward increased regulation of the tobacco industry. There can be no assurance as to the ultimate content, timing, or effect of any regulation of tobacco products by any federal, state, or local legislative or regulatory body, nor can there be any assurance that any such legislation or regulation would not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

The tobacco industry has experienced, and is experiencing, significant product liability litigation. Most tobacco liability lawsuits have been brought against manufacturers and sellers of cigarettes for injuries allegedly caused by smoking or exposure to smoke. However, several lawsuits have been brought against manufacturers and sellers of smokeless products for injuries to health allegedly caused by use of smokeless products. Typically, such claims assert that use of smokeless products is addictive and causes oral cancer. Additionally, several lawsuits have been brought against manufacturers and distributors of Turning Point’s NewGen products due to malfunctioning devices. There can be no assurance the Company will not sustain losses in connection with such lawsuits and that such losses will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Master Settlement Agreement 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. The Company chose to open and fund an escrow account as its method of compliance. It is the Company’s policy to record amounts on deposit in the escrow account for prior years as a non-current asset. 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 March 31, 2018, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $30.3 million. At December 31, 2017, the Company had on deposit approximately $32.1 million, the fair value of which was approximately $30.8 million. Effective in the third quarter of 2017, the Company no longer sells any product covered under the MSA. Thus, pending a change in legislation, the Company will no longer be required to make deposits to the MSA escrow account.

 

The Company has chosen to invest a portion of the MSA escrow deposits in U.S. Government securities including TIPS, Treasury Notes, and Treasury Bonds. These investments are classified as available-for-sale and carried at fair value. Realized losses are prohibited under the MSA; any investment in an unrealized loss position will be held until the value is recovered, or until maturity. 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 shows the maturities of the U.S. Governmental agency obligations:

 

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

 

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 manufacturing, sale, and marketing of four categories of tobacco products – cigarettes, cigarette tobacco, roll-your-own tobacco, and smokeless tobacco. On August 8, 2016, the FDA deeming regulation became effective. The deeming regulation gave the FDA the authority to additionally regulate cigars, pipe tobacco, electronic cigarettes (“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 Turning Point’s 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.

Fixed Maturity Securities

 

Investments in fixed maturity securities including bonds, loan-backed and structured securities are classified as available-for-sale and reported at fair value. Significant changes in prevailing interest rates and other economic conditions may adversely affect the timing and amount of cash flows on fixed income investments, as well as their related fair values. Fixed maturities are recorded on a trade date basis. Amortization of bond premium and accretion of bond discount are calculated using the scientific method. Changes in fair values of these securities, after deferred income tax effects, are reflected as unrealized gains or losses in accumulated other comprehensive income (loss). Realized gains and losses from the sale of investments are calculated as of the trade date in the consolidated statements of operations and comprehensive loss and are based upon the specific identification of securities sold. Investment income consists of interest and is reported net of investment expenses. Prepayment assumptions are considered when determining the amortization of discount or premium for loan-backed and structured securities.

 

An investment is considered impaired when the fair value of the investment is less than its cost or amortized cost. When an investment is impaired, the Company must make a determination as to whether the impairment is other than temporary (“OTTI”).

 

With respect to an investment in an impaired fixed maturity security, OTTI occurs if the Company (a) intends to sell the fixed maturity security, (b) more likely than not will be required to sell the fixed maturity security before its anticipated recovery, or (c) it is probable that the Company will be unable to collect all amounts due to the recovery of the entire cost basis of the security. The Company conducts a periodic review to identify and evaluate securities having OTTI, which include the above factors as well as the following:  (1) the likelihood of the recoverability of principal and interest for fixed maturity securities (i.e., whether there is a credit loss); (2) the length of time and extent to which the fair value has been less than amortized cost for fixed maturity securities; and (3) the financial condition, near term and long-term prospects for the issuer, including the relevant industry conditions and trends, and implications of rating agency actions and offering prices. If the Company intends to sell the fixed maturity security, or will more likely than not be required to sell the fixed maturity security before the anticipated recovery, a loss in the entire amount of the impairment is reflected in net investment gains (losses) in net income (loss). If the Company determines that it is probable it will be unable to collect all amounts and the Company has no intent to sell the fixed maturity security, a credit loss is recognized in net investment gains (losses) in net income (loss) to the extent that the present value of expected cash flows is less than the amortized cost basis; any difference between fair value and the new amortized cost basis (net of the credit loss) is reflected in other comprehensive income (losses), net of applicable income taxes.

 

Upon recognizing an OTTI, the new cost basis of the security is the previous amortized cost basis less the OTTI recognized in net investment gains (losses). The new cost basis is not adjusted for any subsequent recoveries in fair value; however, for fixed maturity securities, the difference between the new cost basis and the expected cash flows is accreted to net investment gains (losses) over the remaining expected life of the investment.

Deferred Policy Acquisition Costs (“DAC”)

Policy acquisition costs, which vary with and are directly related to the production of successful new business, are deferred. The costs deferred consist principally of commissions and policy issuance costs and are amortized into expense as the related premiums are earned.

 

The Company, utilizing assumptions for future expected claims, premium rate increases and interest rates, reviews the recoverability of its deferred acquisition costs on a periodic basis. If the Company determines that the future gross profits of its in-force policies are not sufficient to recover its deferred policy acquisition costs, the Company recognizes a premium deficiency by charging any unamortized acquisition costs to expense to the extent required in order to eliminate the deficiency. If the premium deficiency exceeds the unamortized acquisition costs, then a liability is accrued for the excess deficiency. The Company anticipates investment income as a factor in its premium deficiency reserve calculation.

Premiums Receivable

Premiums and agents’ balances in the course of collection are reported at the amount management expects to collect from outstanding balances. Past due amounts are determined based on contractual terms. Maidstone provides an allowance for doubtful accounts based upon review of outstanding receivables and historical collection information. Maidstone recorded an allowance for doubtful accounts of less than $0.1 million as of March 31, 2018.

 

Investment Income Due and Accrued

Investment income consists of interest, which is recognized on an accrual basis. Due and accrued income is not recorded on fixed maturity securities in default and on delinquent fixed maturities where collection of interest is improbable. As of March 31, 2018, no investment income amounts were excluded from the Company balances.

Incurred Losses and Loss Adjustment Expenses

Incurred losses and loss adjustment expenses (“LAE”) are charged to operations as incurred. The liability for losses and LAE is based upon individual case estimates for reported claims and a factor for incurred but not reported (“IBNR”) claims. Losses, LAE and related liabilities are reported net of estimated salvage and subrogation. Inherent in the estimate of ultimate losses and LAE are expected trends in claim severity and frequency and other factors which may vary significantly as claims are settled; however, management believes that its aggregate provision for losses and LAE at March 31, 2018 is reasonable and adequate to meet the ultimate net cost of covered losses, but such provision is necessarily based on estimates and the ultimate net cost may vary significantly from such estimates. As adjustments to these estimates become necessary, such adjustments are reflected in current operations.

Insurance Company Assessments

Assessments from various state insurance departments are incurred by the insurance company in the normal course of business. Assessments based upon premium volumes are accrued during the year while non-premium assessments are expensed in the period they are reported to the insurance company. There were no significant assessments incurred in the period from January 2, 2018 to March 31, 2018.

Reinsurance

 

The Company accounts for reinsurance in accordance with the accounting guidance concerning the accounting and reporting for reinsurance of short-duration contracts. Management believes the Company’s reinsurance arrangements qualify for reinsurance accounting. Reinsurance premiums, losses, LAE and commissions are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. The Company relies on ceded reinsurance to limit its insurance risk.

 

Reinstatement premiums for the Company’s insurance operations are recognized at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. The accrual of reinstatement premiums is based on an estimate of losses and LAE, which reflects management’s judgment.

 

Amounts recoverable from reinsurers are estimated and recognized in a manner consistent with the claims liabilities arising from reinsured policies and incurred but not reported losses. In entering into reinsurance agreements, management considers a variety of factors including the creditworthiness of reinsurers. In preparing consolidated financial statements, management makes estimates of amounts recoverable from reinsurers, which include consideration of amounts, if any, estimated to be uncollectible. As of March 31, 2018, no amounts were deemed to be uncollectible from reinsurers.

 

As changes in the estimated ultimate liability for loss and LAE are determined, ceded reinsurance premiums may also change based on the terms of the reinsurance agreements. As adjustments to these estimates become necessary, such adjustments are reflected in current operations.

Asset Retirement Obligations

The Company records obligations associated with the retirement of tangible long-lived assets, such as advertising structures, in the period in which the assets are acquired . The liability is capitalized as part of the related long-lived asset’s carrying amount. Over time, accretion of the liability is recognized as an operating expense and the capitalized costs is depreciated over the expected useful life of the related asset. The Company’s asset retirement obligations relate primarily to the dismantlement and removal of the structure , and site reclamation on leased properties. The Company’s management determined a minimum estimated cost to be incurred per billboard structure based on historical experience with respect to the dismantling of the structures and the reclamation of the sites. The Company will continue to assess the adequacy of this liability on a regular basis .

 

Income tax policy

The Company’s insurance subsidiary is taxed at the Federal corporate level applying special rules applicable to property and casualty insurance companies. The insurance company is generally exempt from corporate income tax under state tax law. In lieu of corporate income tax, the insurance company pays a premium tax based on a percentage of direct annual premiums written in each state.

Deferred income taxes are recorded for temporary differences in reporting certain transactions for financial statement and income tax purposes, principally deferred policy acquisition costs, loss and LAE reserves and net operating losses. Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities result from temporary differences between the amounts recorded in the financial statements and the tax basis of the Company’s assets and liabilities .

Recent Accounting Pronouncements Adopted

The Company adopted ASU 2014-09, Revenue from Contracts with Customers (ASC 606) , on January 1, 2018, using a modified retrospective adoption method. The guidance in ASC 606 requires 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 and replaces most existing revenue recognition guidance in U.S. GAAP. The adoption of the standard had no effect on the timing or amount of revenue recognition, or on net income.

The Company adopted ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash , on January 1, 2018 using the full retrospective method.  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. As a result of the adoption of this ASU, the Company’s statements of cash flows include changes in restricted cash, such as changes in the portion of the MSA escrow deposits held in cash.

The Company adopted ASU 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost on January 1, 2018 using the full retrospective method. This ASU requires an entity to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. The adoption of this ASU resulted in a reclassification of less than $0.1 million from cost of sales and selling, general, and administrative expenses to net periodic benefit expense (income), excluding service cost, for both periods presented.

The Company adopted ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , on January 1, 2018 on a prospective basis. The amendments in this Update allow a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“TCJA”). Consequently, the amendments eliminate the stranded tax effects resulting from the TCJA and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the TCJA, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this Update also require certain disclosures about stranded tax effects. The adoption of this ASU resulted in a reclassification of stranded tax effects related to the TCJA from AOCI to retained earnings of less than $0.1 million.

 

Recent Accounting Pronouncements Not Yet Adopted

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 June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , that changes the impairment model for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace today’s “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost and require entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount, as they do today under the other-than-temporary impairment model. It also simplifies the accounting model for purchased credit-impaired debt securities and loans. Entities will apply the standard’s provisions as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The guidance is effective for the Company for interim and annual periods beginning after December 15, 2019. The Company is currently evaluating the effect the adoption of this standard will have on its financial statements.

Note 3. Acquisitions

Acquisitions by SDI

Maidstone acquisition

On January 2, 2018, the Company acquired all the outstanding capital stock of Interboro for cash consideration of $2.5 million. Under the name Maidstone Insurance Company, Maidstone offers personal automobile insurance, primarily in the state of New York. On February 1, 2018, Maidstone began to write homeowners insurance.

The transaction was accounted for as a business combination under the acquisition method of accounting. Accordingly, the tangible and identifiable intangible assets acquired and liabilities assumed were recorded at fair value as of the date of acquisition. The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed at the date of acquisition:

 

		At January 2, 2018
		(preliminary)
Fixed maturities available for sale		$	25,386
Cash and cash equivalents			12,795
Investment income due and accrued			203
Premiums receivable			7,158
Property, plant and equipment			408
Intangible assets			2,100
Other assets			615
Reserves for losses and loss adjustment expenses			(29,366	)
Unearned premiums			(12,784	)
Advance premium collected			(651	)
Deferred tax liability			(420	)
Other liabilities			(3,230	)
Total net assets acquired			2,214
Consideration exchanged			2,500
Goodwill		$	286

	Three months ended March 31, 2017
	As reported				Maidstone				Proforma
Total revenue, net		$	66,788			$	10,087			$	76,875
Net income		$	1,877			$	(178	)		$	1,699

Note 4. Investments

The Company currently classifies all of its investments held by Maidstone as available-for-sale and, accordingly, they are carried at estimated fair value. The amortized cost, gross unrealized gains and losses, and fair value of investments in fixed maturity securities at March 31, 2018 are as follows:

 

		March 31, 2018
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
U.S Treasury and U.S Government		$	5,343			$	-			$	(41	)		$	5,302
U.S. Tax-exempt Municipal			4,386				-				(78	)			4,308
Corporate			6,988				-				(141	)			6,847
Mortgage and Asset-backed Securities			6,454				-				(139	)			6,315
Total Fixed Maturity Securities		$	23,171			$	-			$	(399	)		$	22,772

		March 31, 2018
		Amortized Cost				Fair Value
Due in one year or less		$	2,820			$	2,816
Due after one year through five years			7,612				7,505
Due after five years through ten years			6,304				6,136
Mortgage and Asset-backed Securities			6,435				6,315
Total		$	23,171			$	22,772

		March 31, 2018
		Less Than 12 Months
		Fair Value				Gross Unrealized Losses
Bonds:
U.S. Treasury and U.S. Government		$	5,302			$	(41	)
U.S. Tax-exempt Municipal			4,308				(78	)
Corporate Bonds			6,847				(141	)
Mortgage and Asset-backed Securities			6,315				(139	)
Total Investments		$	22,772			$	(399	)

		Period from January 2, 2018 to March 31, 2018
Investment income:
Bonds		$	153
Cash and cash equivalents			60
Total investment income			213
Less: Investment expenses			(19	)
Net investment income		$	194

		March 31, 2018
		Level 1				Level 2				Level 3				Total Fair Value
Bonds:
U.S. Treasury and U.S. Government		$	-			$	5,302			$	-			$	5,302
U.S. Tax-exempt Municipal			-				4,308				-				4,308
Corporate			-				6,847				-				6,847
Mortgage and Asset-backed Securities			-				6,315				-				6,315
Total bonds		$	-			$	22,772			$	-			$	22,772

Assets used for collateral or guarantees:
Deposits with U.S. Regulatory Authorities		$	2,614

Note 7. Inventories

The components of inventories are as follows:

 

		March 31, 2018				December 31, 2017
Raw materials and work in process		$	2,403			$	2,545
Leaf tobacco			29,300				30,308
Finished goods - smokeless products			6,503				5,834
Finished goods - smoking products			11,510				14,110
Finished goods - electronic / vaporizer products			12,910				14,532
Other			699				1,290
			63,325				68,619
LIFO reserve			(5,266	)			(5,323	)
		$	58,059			$	63,296

Note 8. Property, Plant and Equipment

Property, plant and equipment consist of:

 

		March 31, 2018				December 31, 2017
Land		$	22			$	22
Building and improvements			2,072				2,072
Leasehold improvements			1,873				1,873
Machinery and equipment			12,960				12,635
Advertising structures			17,715				329
Furniture, fixtures and other			4,285				3,821
			38,927				20,752
Accumulated depreciation			(12,347	)			(11,580	)
		$	26,580			$	9,172

Note 9. Accrued Liabilities

Accrued liabilities consist of:

		March 31, 2018				December 31, 2017
Accrued payroll and related items		$	2,277			$	5,683
Customer returns and allowances			2,175				2,707
Other			9,818				11,624
		$	14,270			$	20,014

		Period from January 2, 2018 to March 31, 2018
Reserve for losses and LAE at January 2, 2018		$	29,366
Provision for claims, net of insurance:
Incurred related to:
Current year			5,812
Total incurred			5,812
Deduct payment of claims, net of reinsurance:
Paid related to:
Prior year			5,478
Current year			2,704
Total paid			8,182
Reserve for losses and LAE at March 31, 2018		$	26,996

		As of March 31, 2018
Case basis reserves		$	18,024
Incurred but not reported reserves			8,972
Total		$	26,996

	Period from January 2, 2018 to March 31, 2018
Written premiums		$	4
Premiums earned		$	2

Maidstone evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurance to minimize exposure to significant losses from reinsurance insolvency.  As of March 31, 2018, Maidstone had no net unsecured reinsurance recoverable from individual unaffiliated reinsurers, which were equal to or greater than 3% of surplus.

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 retained the $40 million accordion feature of the 2017 Credit Facility. 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 Turning Point’s and its subsidiary guarantors’ ability: (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. Refer to Note 14. Stockholders’ Equity for further information regarding dividend restrictions.

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 Term Loan has a maturity date of March 7, 2023. The 2018 First Lien Credit Facility contains certain financial covenants including maximum senior leverage ratio of 3.50x with step-downs to 3.00x, a maximum total leverage ratio of 4.50x with step-downs to 4.00x, and a minimum fixed charge coverage ratio of 1.20x. The weighted average interest rate of the 2018 First Lien Term Loan was 5.13% at March 31, 2018. Turning Point had no borrowings outstanding under the 2018 Revolving Credit Facility at March 31, 2018.

 

2018 Second Lien Credit Facility: The 2018 Second Lien Credit Facility bears interest at a rate of LIBOR plus 7.00% and has a maturity date of March 7, 2024. The 2018 Second Lien Credit Facility contains 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. The weighted average interest rate of the 2018 Second Lien Term Loan was 8.70% at March 31, 2018.

2017 Credit Facility

On February 17, 2017, Turning Point and NATC, entered into a $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, its First Lien Term Loan, Second Lien Term Loan, and Revolving Credit Facility and to pay related fees and expenses. As a result of this transaction, Turning Point incurred a loss on extinguishment of debt of $6.1 million during the first quarter of 2017.

The 2017 Credit Facility contained customary events of default including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to certain other material indebtedness in excess of specified amounts, certain events of bankruptcy and insolvency, certain ERISA events, judgments in excess of specified amounts, and change in control defaults. The 2017 Credit Facility also contained certain negative covenants customary for facilities of these types including covenants that, subject to exceptions described in the 2017 Credit Facility, restricted Turning Point’s and its subsidiary guarantors’ ability: (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 consisted 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”). The 2017 First Lien Credit Facility also included 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 could be used for general corporate purposes, including acquisitions.

The 2017 First Out Term Loan and the 2017 Revolving Credit Facility had a maturity date of February 17, 2022, and the 2017 Second Out Term Loan had a maturity date of May 17, 2022. The 2017 First Out Term Loan and the 2017 Revolving Credit Facility bore 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 had 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 bore interest at LIBOR plus 6% (subject to a floor of 1.00%). The 2017 Second Out Term Loan had quarterly required payments of $0.1 million beginning June 30, 2017.  The 2017 First Lien Credit Facility contained 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 December 31, 2017, on the 2017 Revolving Credit Facility was 5.05%. The weighted average interest rate at December 31, 2017, on the 2017 First Out Term Loan was 4.61%.  The weighted average interest rate at December 31, 2017, on the 2017 Second Out Term Loan was 7.61%.

2017 Second Lien Credit Facility:   The 2017 Second Lien Credit Facility consisted 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 bore interest at a fixed rate of 11%. The 2017 Second Lien Credit Facility contained 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

Turning Point Brands, Inc. (“TPBI”), along with NATC and its subsidiaries, were guarantors under the First Lien Term Loan.  TPLLC and its sole subsidiary at the date of the agreement, Intrepid, 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 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 (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) 5.50%.

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%.

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.

SDI and Standard Outdoor

 

On February 2, 2018, SDI and its Outdoor advertising subsidiaries (the “Borrowers”) entered into a term loan agreement with Crystal Financial LLC (“Crystal Term Loan”). The Crystal Term Loan provides for an initial term loan of $10.0 million and a commitment to provide additional term loans of up to $15.0 million. Subject to the satisfaction of certain conditions, the Company may request an additional increase in the commitment of up to $25.0 million. The proceeds were used to finance a portion of the acquisition of certain billboard structures, fund certain fees and expenses, and provide working capital for the Borrowers. Any incremental term loans will be used to finance permitted acquisitions. The Crystal Term Loan bears 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 is payable monthly and is also subject to an agency fee of $50,000, payable upon execution of the Term Loan 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 term loan agreement. The principal balance is payable at maturity, on February 2, 2023.

The obligations of the Borrowers under the Term Loan Agreement are secured by all the assets of the Borrowers, subject to certain exceptions and exclusions as set forth in the Term Loan Agreement and other loan documents.

 

The Term Loan Agreement contains certain affirmative and negative covenants that are binding on the Borrowers, including, but not limited to, restrictions (subject to specified exceptions and qualifications) on the ability of the Borrowers 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.

In addition, the Term Loan Agreement requires the Borrowers to abide by certain financial covenants. Specifically, the Term Loan Agreement requires that the Borrowers:

·

Maintain unrestricted cash and cash equivalents of at least $3,000,000 in accounts subject to account control agreements in favor of the Agent at all times (i) prior to March 31, 2019 and (ii) after March 31, 2019 unless the Fixed Charge Coverage Ratio (as defined in the Term Loan Agreement) is greater than or equal to 1.10 to 1.00.

·

Maintain a Turning Point Consolidated Total Leverage Ratio (as defined in the Term Loan Agreement) of less than 6.00 to 1.00 prior to December 30, 2018, 5.75 to 1.00 from December 31, 2018 to December 30, 2019, and 5.50 to 1.00 starting December 31, 2019 and thereafter.

·

Maintain a Turning Point Consolidated Senior Leverage Ratio (as defined in the Term Loan Agreement) of less than 5.00 to 1.00 prior to December 30, 2018, 4.75 to 1.00 from December 31, 2018 to December 30, 2019, and 4.50 to 1.00 starting December 31, 2019 and thereafter.

Under the Term Loan Agreement, the Borrowers must also not permit amounts outstanding under the Term Loan Agreement to exceed the sum of (i) Billboard Cash Flow (as defined in the Term Loan Agreement) multiplied by the Applicable BCF Multiple (as defined in the Term Loan Agreement) and (ii) the aggregate value of the shares of common stock of Turning Point pledged by the Registrant to the Agent multiplied by 0.35.

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.

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. Interest expense of $0.1 million, including amortization of the discount, was recorded for the three months ended March 31, 2018.

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. A principal payment of $0.9 million on the promissory note is payable 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 of less than $0.1 million, including amortization of the discount, was recorded for the three months ended March 31, 2018.

Note 13. 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 2018.

 

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 $0.3 million to its postretirement plan in 2018 for the payment of benefits.

The following table provides the components of net periodic pension and postretirement benefit costs and total costs for the plans:

Note 14. Stockholders’ Equity

Common Stock

As described in Note 1. Organization and Description of Business, 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) to appropriately reflect the correct beginning share balance for the Class A and 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. Shares of Class A Common Stock and Class B Common Stock have the same rights and powers, rank equally (including as to   dividends and distributions, and upon any liquidation, dissolution or winding up of the Company), share ratably and are identical in all respects and as to all matters. The holders of shares of Class A Common Stock and Class B Common Stock will vote together as a single class on all matters (including the election of directors) submitted to a vote or for the written consent of the stockholders of the Company. Each holder of Class A Common Stock has the right to one vote per share of Class A Common Stock and each holder of Class B Common Stock has the right to ten votes per share of Class B Common Stock. The shares of Class B Common Stock are 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. During the three months ended March 31, 2018, 11,001   shares of Class B Common Stock were converted to Class A 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. No shares of Preferred Stock have been issued.

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. No repurchases of Common Stock were made pursuant to this program since its authorization. The Crystal Term Loan, as described in Note 12, Notes Payable and Long-Term Debt, generally prohibits such repurchases of the Company’s Common Stock.

 

Equity Issuance

On January 12, 2018, the Company issued 181,825 shares of its Class A common stock in a private placement for gross proceeds of $2.0 million.

On March 9, 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.

Turning Point Dividends

On November 9, 2017, the Board of Directors of Turning Point approved the initiation of a cash dividend to its shareholders. The initial quarterly dividend of $0.04 per common share was paid on December 15, 2017 to shareholders of record at the close of business on November 27, 2017 and $0.4 million was paid to noncontrolling interest holders as a result of this dividend. The most recent dividend of $0.04 per common share was paid on April 13, 2018, to shareholders of record at the close of business on March 26, 2018 and $0.4 million was paid to noncontrolling interest holders as a result of this dividend.

Turning Point 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 15. 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 have been made to date 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, there was share-based compensation expense of $0.4 million recorded for the three months ended March 31, 2018 and less than $0.1 million for the three months ended March 31, 2017. This expense is a component of selling, general and administrative expense.

 

No options of SDI were exercised in the three months ended March 31, 2018 and 2017.

 

Stock option activity is summarized as follows:

 

 

The following table provides additional information about the Company’s stock options outstanding and exercisable at March 31, 2018:

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. In March 2018, the Company granted employees of the Company 97,657 shares of restricted stock with vesting terms ranging from two to three years. In addition, the Company granted 18,834 shares of restricted stock with immediate vesting to individuals for services performed.

The following table summarizes the changes in non-vested RSAs for the three months ended March 31, 2018:

 

As of March 31, 2018, there was $1.9 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 2.2 years.

Note 16. Income Taxes

On June 1, 2017, SDI consummated the Contribution and Exchange to acquire a 52.1% controlling interest in Turning Point (see Note 3. Acquisitions above). This acquisition was a reverse acquisition, with Turning Point as the accounting acquirer. 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 consolidated financial statements include the results of SDI from June 1, 2017, the date the reverse acquisition was consummated. However, SDI’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.   In the first quarter of 2018, the Company acquired Maidstone, which will be included in the SDI consolidated federal tax return.

 

SDI has recorded a full valuation allowance as of March 31, 2018, offsetting its U.S. federal and state net deferred tax assets which primarily represent net operating loss carry forwards (“NOLs”). At March 31, 2018, 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 is currently evaluating the effects of Section 382 on SDI’s future utilization of its NOLs. The Company’s income tax benefit for the three months ended March 31, 2017, which reflects only the results of Turning Point, does not bear the normal relationship to loss before income taxes because of tax benefits of $2.0 million relating to Turning Point stock options exercised during the quarter.  Turning Point’s effective income tax rate for the three months ended March 31, 2018, was 21%.

 

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 March 31, 2018, SDI had approximately $523 thousand of unrecognized tax benefits under the provisions of ASC 740-10-25, $517 thousand 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 thousand includes de minimis interest and penalties where required. SDI 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, SDI’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 SDI 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.

 

On December 22, 2017, H.R. 1, commonly known as the Tax Cuts and Jobs Act (“TCJA”) was signed into law. As a result, the federal corporate income tax rate was reduced from 35% to 21%, effective January 1, 2018. The Company’s 2017 financial results included an SDI-related charge of $3.2 million to income tax expense, offset by a reduction in the valuation allowance of $3.2 million, primarily resulting from re-measuring SDI’s net deferred tax assets to reflect the recently enacted lower tax rate effective January 1, 2018. The rate change also resulted in a re-measurement of the full valuation allowance already established against the deferred tax asset. Turning Point was also required to re-measure its deferred tax assets and liabilities at the newly enacted rate, resulting in $0.2 million of income tax expense for the year ended December 31, 2017.

 

Note 17. Contingencies

 

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. Plaintiffs’ counsel is in the process of voluntarily dismissing those claims.

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, 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 the financial position, results of operations, or cash flows of Turning Point and the consolidated Company.

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.

Concentrations

 

Maidstone writes primarily personal automobile and homeowners 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 writes 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.

 

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 Maidstone’s discretion, on certain transactions based on the creditworthiness of the counterparty.

 

The Company’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. The Company reported no investment in excess of 10% of the Company’s surplus at March 31, 2018, other than investments issued or guaranteed by the United States government or its agencies.

Note 18. 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. S hares 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 months ended March 31, 2017 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 three months ended March 31, 2018, the basic weighted average shares outstanding has been calculated using the number of common shares outstanding of SDI from January 1, 2018 through March 31, 2018.

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 Company records an adjustment to net income in the relevant period for the dilutive impact of subsidiary stock-based awards on the Company’s reported net income for purposes of calculating income per share. There is no adjustment to the three months ended March 31, 2017 because the reverse acquisition of Turning Point by SDI did not occur until June 1, 2017.

The following outstanding securities at March 31, 2018 have been excluded from the computation of diluted weighted average shares outstanding, as they are anti-dilutive:

 

		March 31, 2018
Stock options			5,063

 

Note 19. 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) imports and markets cigarette papers, tubes, and related products; (ii) imports and markets finished cigars, MYO cigar tobaccos, and cigar wraps; and (iii) processes, packages, markets, and distributes traditional pipe tobaccos. The NewGen products segment (i) markets e-cigarettes, e-liquids, vaporizers, and other related products; (ii) distributes a wide assortment of vaping products to non-traditional retail outlets via VaporBeast and Vapor Shark, and (iii) distributes a wide assortment of vaping related products to individual consumers via Vapor Shark branded retail outlets. The Company’s smoking and smokeless products are distributed primarily through wholesale distributors in the United States while the NewGen products are distributed primarily through e-commerce to non-traditional retail outlets in the United States.

Beginning in the first quarter of 2018, as a result of the recently completed 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 Insurance, a New York domiciled seller of auto and personal lines.

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. Elimination includes the elimination of intercompany accounts between segments.

Accounting policies of these segments are the same as those of the Company. Segment data for the three Turning Point segments includes a charge allocating Turning Point corporate costs to the three reportable segments based on their respective gross 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: