Tootsie Roll Industries, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing. Amounts below are in U.S. dollars, generally millions unless noted.
Business context
The Company manufactures and sells confectionery products as its sole business segment. Its principal markets are the United States, Canada, and Mexico. Sales are seasonal, with a substantial third-quarter increase ahead of Halloween. Wal-Mart accounted for 24.1% of 2018 net product sales; Dollar Tree 11.2%; and McLane 17.4% (including sales and deliveries to multiple customers).
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Net product sales | $515.3 | $515.7 |
| Total revenue, including rental and royalty | $518.9 | $519.3 |
| Product gross margin | $185.4; 36.0% of product sales | $189.3; 36.7% |
| Operating earnings | $70.5 | $70.4 |
| Net earnings attributable to Tootsie Roll | $56.9 | $80.9 |
| EPS | $0.89 | $1.24 |
| Operating cash flow | $100.9 | $43.0 |
| Capital expenditures | $27.6 | $16.7 |
| Working capital at year-end | $242.7 | $207.1 |
| Cash, cash equivalents and investments | $356.4 | $328.4 |
| Total assets | $947.4 | $930.9 |
| Long-term debt | $7.5 | $7.5 |
Net product sales were essentially flat year over year. Product costs rose 1.1%, while reported product gross margin declined. Excluding deferred-compensation-related costs and credits, operating earnings fell 13.7%, to $69.4 million from $80.4 million; management considers these adjusted comparisons more representative of underlying operations. Adjusted selling, marketing and administrative expenses rose 4.7%, with freight, delivery and warehousing costs up 12.4% to $49.5 million.
Operating cash flow increased by $58.0 million, mainly due to timing of income tax payments and refunds, prepaid expenses, and deferred-compensation payments. The Company paid $23.0 million in cash dividends and repurchased and retired $19.3 million of shares. It reported no outstanding bank borrowings at year-end other than its $7.5 million industrial development bonds; the balance sheet also includes $0.4 million of current bank loans, associated with its Spanish subsidiary.
Fourth quarter: Net product sales were $127.3 million, up 1.7% year over year. Net earnings attributable to the Company were $12.2 million, or $0.19 per share, versus $32.0 million, or $0.49, in the prior-year quarter. The 2017 quarter included a $20.3 million tax benefit; excluding that benefit, comparable EPS was $0.18 in 2017 versus $0.19 in 2018.
Material changes and unusual items
- Full-year net earnings declined from $80.9 million to $56.9 million. The comparison is affected by the 2017 one-time $20.3 million deferred-tax benefit from U.S. tax reform; excluding it, comparable EPS declined 4.3%, from $0.93 to $0.89.
- Higher wages, benefits, plant overhead, packaging-line start-up costs, freight rates and fuel costs pressured margins. More favorable key-ingredient costs and manufacturing efficiencies partly offset the increases.
- Foreign exchange, primarily involving Mexico, adversely affected 2018 sales. Foreign sales were $43.7 million, or 8.5% of product sales.
- The Spanish subsidiary recorded a $1.1 million impairment charge in 2018 and operating losses of $2.8 million; management provided approximately $4.5 million in additional cash for losses and certain capital expenditures.
- Adoption of ASC 606 increased opening 2018 retained earnings by $3.3 million after tax. The Company said the standard did not materially affect 2018 results.
Outlook, risks and contingencies
- The Company implemented selective price increases effective at the start of 2019 to help recover input-cost increases. Management expects elevated truck freight and delivery costs to continue in 2019 and said it may not fully pass costs through to customers.
- Management expects some reduction in Spanish operating losses in 2019, but anticipates continuing losses beyond 2019 and additional cash financing needs.
- A U.S. manufacturing plant rehabilitation and expansion project is expected to cost approximately $17 million, with projected cash outlays of $6 million in 2019, $8 million in 2020 and $3 million in 2021. Management expects operating cash flow and internal resources to fund capital needs in 2019.
- The multi-employer pension plan covering certain union employees is in “critical and declining” status and is projected to become insolvent in 2030. The Company’s estimated withdrawal liability was $81.6 million for a 2018 withdrawal; management believes statutory limits would likely constrain payments, but the ultimate exposure is uncertain and could materially affect results or cash flows. Plan contributions were $2.8 million in 2018, including $0.8 million in surcharges. The labor agreement requires participation through September 2022.
- Other key risks include reliance on large retailers, commodity and packaging costs and availability, pricing acceptance, seasonality and Halloween demand, product safety and recalls, production concentration in specialized facilities, tariffs and regulation, cybersecurity and supply-chain disruption. The Gordon family controls a majority of combined voting power.
- Management reported that legal proceedings in the ordinary course are not expected to have a material effect on financial condition, results or cash flows. Goodwill and trademarks had no impairment in 2018; sensitivity analysis indicated that a 100-basis-point increase in the discount rate could create potential impairment of up to $4 million for certain trademarks.
Important facts for investors to verify
- Whether 2019 pricing actions offset persistent freight, labor, benefit and other operating-cost inflation without weakening sales volume or customer acceptance.
- The trend in operating performance excluding deferred-compensation items, and the extent to which 2017 tax benefits distort reported earnings comparisons.
- Progress, cash requirements and impairment risk related to the Spanish subsidiary, plus the expected financing of its continuing losses.
- Updated multi-employer pension plan status, contribution requirements, and the Company’s actual and potential withdrawal-liability exposure.
- Execution and cost of the planned plant upgrade, along with the continuing concentration of sales among major customers and production at specialized facilities.