Business context and reporting period
Tootsie Roll Industries, Inc. filed its annual report for the fiscal year ended December 31, 2019. The company operates in one segment: manufacturing and selling confectionery products, principally in the United States, Canada, and Mexico. Sales are seasonal, with a substantial third-quarter increase ahead of Halloween.
Financial performance and position
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | FY 2019 | FY 2018 |
|---|---|---|
| Net product sales | $523.6 | $515.3 |
| Total revenue, including rental and royalty revenue | $527.1 | $518.9 |
| Product gross margin | $194.5 (37.1% of product sales) | $185.4 (36.0%) |
| Operating earnings | $69.2 | $70.5 |
| Net earnings attributable to Tootsie Roll | $64.9 | $56.9 |
| Earnings per share | $0.99 | $0.86 |
| Operating cash flow | $100.2 | $100.9 |
| Capital expenditures | $20.3 | $27.6 |
Fourth-quarter 2019 net product sales were $134.7 million, up 5.8% year over year; attributable net earnings were $14.6 million, or $0.22 per share, versus $12.2 million, or $0.18 per share.
At year-end, cash, cash equivalents, and investments totaled $392.4 million, versus $356.4 million a year earlier; working capital was $273.8 million. Total assets were $977.9 million and shareholders’ equity was $759.9 million. Long-term industrial development bonds were $7.5 million; the Spanish subsidiary also had $0.7 million of short-term bank loans. The company reported no other outstanding bank borrowings. Cash dividends paid were $23.5 million and share repurchases were $34.1 million.
Material changes versus the prior comparable period
- Full-year product sales rose 1.6%; management attributed growth to marketing and sales programs. Fourth-quarter sales growth also reflected the timing of sales between the third and fourth quarters.
- Reported product gross margin improved by $9.1 million. Excluding deferred-compensation-related costs and credits, product cost of goods sold fell 0.4% and declined to 62.8% of sales from 64.0%. Management cited higher price realization, plant efficiencies, and cost containment.
- Reported operating earnings declined $1.3 million. Management’s adjusted comparison, excluding deferred-compensation effects, showed operating earnings increasing 16.0% to $80.5 million from $69.4 million. These adjustments are non-GAAP and should not be treated as reported results.
- Net earnings increased 14.1%, helped by a $13.5 million increase in other income, which included $11.3 million of gains and investment income on trading securities. Those gains were offset by related deferred-compensation expenses in operating costs and therefore were not reflective of underlying operations.
- The effective income tax rate increased to 24.1% from 22.4%, principally due to higher state taxes and valuation allowances. The prior-year comparison was not affected by the 2017 tax-reform benefit, which had boosted 2017 earnings.
- Operating cash flow was broadly stable, while capital expenditures declined. Cash and investments increased by $36.0 million.
Outlook, risks, contingencies, and unusual items
- Outlook: No quantified sales or earnings guidance is provided. Management expected operating cash flows and investment maturities to cover 2020 financing needs. It projected approximately $15 million of cash outlays in 2020 and $8 million in 2021 for a U.S. plant rehabilitation and expansion project.
- Spain: The Spanish subsidiary recorded a $0.4 million impairment charge in 2019 and operating losses of $1.1 million. Management expected further reduction in losses in 2020 but said losses could continue and require additional funding.
- Multi-employer pension plan: The plan remained in “critical and declining” status and was projected to become insolvent within 20 years. The company’s estimated withdrawal liability was $99.8 million if it withdrew in 2019; management estimated the present value of likely payments at $35.7–$46.7 million under its assumptions. The company stated that the ultimate outcome could materially affect results or cash flows in future periods. Its 2018 labor agreement requires participation through September 2022.
- Concentration and operating risks: Wal-Mart, Dollar Tree, and McLane together accounted for 37.1% of 2019 net product sales; the company notes that some sales overlap among these customers. These customers represented about 30% of year-end receivables. Other risks include volatile ingredient, energy, and freight costs; pricing acceptance; seasonal demand; competition and shelf space; supply-chain or production interruptions; product recalls; currency movements; and regulatory changes.
- Intangible valuation: No goodwill or trademark impairment was recorded. A 100-basis-point increase in the discount rate used for certain trademark valuations could, individually, produce potential impairment of up to $2 million. The auditor identified trademark impairment assessment as a critical audit matter because of the judgment involved in forecasts and discount rates.
- Other: The company reported ordinary-course legal proceedings that management did not expect to have a material effect. It also disclosed no material effect from environmental compliance and no off-balance-sheet special-purpose financing arrangements.
Important facts for investors to verify
- Review the quality of earnings: reported 2019 operating earnings were lower, while net earnings benefited from trading-security gains that were offset by deferred-compensation expenses.
- Track the pension plan’s funded status, surcharge contributions, potential withdrawal liability, and any legislative or plan changes.
- Monitor Spanish subsidiary losses, cash support, and impairment indicators.
- Assess customer concentration and the effect of any purchasing changes, accounting for overlapping sales through McLane.
- Confirm execution, spending, and expected benefits of the planned plant rehabilitation and expansion.
- Review commodity and freight cost trends, pricing effectiveness, and the assumptions underlying trademark impairment tests.