Tootsie Roll Industries, Inc. — Q3 2015 Form 10-Q
Business context and reporting period. The quarter ended September 30, 2015; comparisons are with the quarter ended September 27, 2014. The company makes confectionery products and notes that Q3 is historically its largest sales quarter because of pre-Halloween demand. Interim results are seasonal and are not necessarily indicative of full-year results. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Year to date 2015 | Year to date 2014 |
|---|---|---|---|---|
| Total revenue | $184.6 | $192.0 | $399.4 | $404.7 |
| Operating earnings | $41.0 | $36.8 | $67.6 | $62.0 |
| Net earnings attributable to Tootsie Roll | $26.2 | $26.7 | $46.4 | $45.3 |
| Earnings per share | $0.43 | $0.43 | $0.75 | $0.72 |
| Operating cash flow | Not separately provided for the quarter | $30.3 | $9.8 |
- Q3 net product sales fell 3.8% to $183.8 million; year-to-date product sales declined 1.3% to $396.8 million. Currency translation reduced sales by approximately $2.9 million in Q3 and $5.8 million year to date; management also cited the timing of sales between Q3 and Q4.
- Reported Q3 and year-to-date operating earnings include deferred-compensation-related credits that largely offset losses on trading securities reported in other income. Excluding those items, management’s adjusted operating earnings were $37.9 million in Q3, up 2.1%, and $66.3 million year to date, up 1.8%. Adjusted operating earnings were 20.6% and 16.7% of product sales, respectively.
- Gross margin was $67.4 million in Q3 versus $68.6 million, and $145.8 million year to date versus $147.8 million. Management cited favorable ingredient costs, partly offset by higher fixed manufacturing overhead. It said efficiencies and cost-containment efforts mitigated some overhead pressure.
- Year-to-date operating cash flow increased to $30.3 million from $9.8 million, reflecting earnings and working-capital movements. Capital expenditures were $12.4 million versus $7.3 million. Cash and cash equivalents were $70.7 million at quarter-end, down from $100.1 million at December 31, 2014.
- At September 30, current assets were $317.8 million and current liabilities $101.1 million; the current ratio was 3.1, versus 4.1 at year-end 2014. Working capital was $216.8 million.
- Cash, short- and long-term investments totaled $276.6 million, including $71.4 million of trading securities used as an economic hedge for deferred compensation liabilities. Total bank loans were $0.7 million and industrial development bonds were $7.5 million.
- Year-to-date financing included $23.0 million of share purchases and $15.3 million of cash dividends. The quarterly cash dividend increased from $0.08 to $0.09 per share. The company also issued a 3% stock dividend in April 2015.
Material changes and management commentary
- Q3 net earnings attributable to the company declined to $26.2 million from $26.7 million despite higher reported operating earnings; EPS remained $0.43, supported in part by fewer average shares outstanding. Year-to-date attributable earnings rose to $46.4 million from $45.3 million, and EPS increased to $0.75 from $0.72.
- Year-to-date 2015 earnings benefited by $1.1 million, or approximately $0.02 per share, from the release of an uncertain tax liability following a foreign court decision. Q3’s effective tax rate was 31.5%, versus 27.9%; the year-to-date rate was 30.2%, versus 32.8%.
- Management expects overall ingredient costs to be higher in 2016. It also expects 2015 capital spending to exceed historical annualized levels, including an approximately $10 million production-line replacement and renovation planned for the second half of 2015 and early 2016; $2.98 million of that project had been spent by September 30. The company expected to fund 2015 capital spending from operating cash flow and internal sources.
- Management expected to pay approximately $13.5 million of deferred compensation liabilities and sell a similar amount of trading securities in Q4 2015.
Risks, contingencies and unusual items
- Multiemployer pension plan: The BC&T plan was reported in critical and declining status, with projected funding deficiencies for 2017–2024. The company’s labor agreement requires participation through Q3 2017. Estimated withdrawal liability was $56.4 million based on a hypothetical 2014 withdrawal; management’s actuarial analysis estimated 20 annual payments of $2.999 million, with a stated present value of $35.193 million. The company said the eventual outcome and financial effects were uncertain and could be material.
- Spanish subsidiaries: The company owned 83% of two subsidiaries that had operating losses in each year from 2008 through 2014 and during the first nine months of 2015. They had not met business-plan objectives, and management considered additional financing and investment likely in 2015 and 2016. The subsidiaries were described as not material to consolidated financial statements.
- Operating and market risks: Disclosed risks include competition and consumer demand, commodity and ingredient availability and costs, ability to pass through cost increases, Halloween-season sales timing, foreign exchange, customer concentration, labor interruptions, product recalls, investment-value declines, IT and cybersecurity issues, and execution of manufacturing, automation and Spanish restructuring plans. The filing reported no material change in market risks from the 2014 Form 10-K.
- Deferred compensation and derivatives: Market-value changes in trading securities and related deferred-compensation expenses or credits materially affected reported operating and other income, but management said these items substantially offset and were not reflective of current operating results. Derivative contracts hedge commodity and foreign-currency exposures; the filing says they are not used for speculation.
- The filing reported no goodwill or intangible-asset impairment indicators in the first nine months of 2015. Management stated that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Investor verification priorities
- Verify whether Halloween-related sales timing shifts from Q3 to Q4 and the stronger U.S. dollar explain the reported sales decline.
- Track ingredient-cost trends, particularly management’s expectation of higher overall costs in 2016, and whether pricing or product-weight changes can offset them.
- Monitor the BC&T plan’s funding status, potential changes to its rehabilitation plan, and the company’s ultimate contribution or withdrawal-liability exposure.
- Assess the Spanish subsidiaries’ operating performance and any additional financing or investment requirements.
- Reconcile reported results with deferred-compensation-related credits and losses, and distinguish the one-time tax benefit from recurring earnings.
- Check completion, cost and funding of the planned production-line project, and the effects of share repurchases and dividends on cash and share count.