Tootsie Roll Industries, Inc. — Q3 2017 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2017; amounts below are in millions unless stated otherwise. Candy sales are seasonal, with the third quarter typically the largest because of back-to-school and pre-Halloween demand. Management said customer-order timing adversely affected sales comparisons.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $183.0 | $186.4 | $393.3 | $395.9 |
| Gross margin | $67.9 | $71.4 | $147.0 | $149.6 |
| Operating earnings | $34.8 | $39.3 | $60.9 | $67.8 |
| Net earnings attributable to Tootsie Roll | $26.9 | $28.6 | $48.9 | $49.7 |
| EPS | $0.43 | $0.45 | $0.77 | $0.77 |
| Operating margin, based on total revenue | 19.0% | 21.1% | 15.5% | 17.1% |
Q3 net product sales declined 1.8%; nine-month sales declined 0.7%. Operating earnings fell 11.3% in Q3 and 10.2% year to date. Management’s adjusted operating earnings, excluding deferred-compensation costs it considers nonrepresentative of current operations, were down 10.0% in Q3 and 4.3% year to date. Adjusted operating margins were 20.4% versus 22.2% in Q3 and 17.4% versus 18.0% year to date.
Management attributed weaker operating performance principally to lower sales, higher ingredient costs, and greater customer freight, delivery and warehousing expense. Q3 adjusted cost of goods sold as a share of product sales rose 1.1 percentage points; adjusted selling, marketing and administrative costs as a share of product sales rose 0.7 points. Manufacturing efficiencies and cost-containment efforts partly mitigated ingredient-cost pressure. Higher trading-security gains related to deferred compensation were largely offset by corresponding compensation expense.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $18.4 million, down from $47.0 million. Management cited timing of customer collections and seasonal shipments, higher finished-goods inventory, and increased broker margin deposits for commodity hedges.
- Capital expenditures were $11.7 million. Investing cash flow was negative $42.2 million and financing cash flow was negative $47.2 million. Cash and cash equivalents fell to $49.5 million from $119.1 million at year-end 2016.
- At September 30, cash plus short-term investments was $123.8 million; long-term investments were $194.0 million. Combined cash and short- and long-term investments totaled $317.8 million, including $75.1 million of trading securities associated with deferred-compensation liabilities.
- Current assets were $296.5 million and current liabilities $78.8 million; the current ratio was 3.8:1 and working capital was $217.7 million. Total bank loans were $0.4 million, and industrial development bonds were $7.5 million. The filing reports no other outstanding bank borrowings.
- The company repurchased and retired $30.0 million of shares and paid $17.0 million in cash dividends during the first nine months. It issued a 3% stock dividend in April 2017. A further $10–15 million VEBA contribution was planned for Q4 to prepay employee benefits.
Outlook, risks and unusual items
- The filing provides no quantified full-year earnings or sales guidance. Management cautioned that interim results may not indicate full-year performance because of seasonal sales patterns.
- The multiemployer Bakery and Confectionery Union pension plan remains in “critical and declining” status and is projected to become insolvent in 13 years. The company’s estimated withdrawal liability was $72.7 million based on a hypothetical 2016 withdrawal; management said future liability could rise. Actual consequences remain uncertain and could materially affect future results or cash flows.
- A proposed “hybrid plan” could require additional annual payments of $2.1 million for 30 years beginning in 2019, or a roughly $40.7 million lump sum in 2019. If elected, the company estimated an after-tax earnings charge of approximately $25.6 million. The company was evaluating the proposal and had not committed to it.
- A U.S. manufacturing-facility rehabilitation and expansion is expected to cost about $15 million, with planned outlays of $0.5 million in 2017, $6 million in each of 2018 and 2019, and $2.5 million in 2020.
- Key exposures include ingredient, packaging and fuel costs; foreign-exchange movements; and market values of investments and hedging instruments. Management reported no material changes to previously disclosed risk factors or market risks. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the pension plan’s proposed hybrid arrangement is finalized, and the resulting liability, cash-payment schedule and accounting charge.
- Whether the weaker sales and operating margins persist after seasonal shipment timing, and how ingredient and freight costs trend.
- Whether operating cash flow recovers as receivables and seasonal inventory convert to cash; cash declined substantially during the nine-month period.
- Whether planned facility investment and the proposed VEBA contribution proceed as scheduled, and their effects on liquidity and capital allocation.
- How much reported earnings variability stems from deferred-compensation investment gains and matching expenses, rather than underlying operations.