Tootsie Roll Industries, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in millions of dollars except per-share data. The company notes that the third quarter is historically its largest sales quarter because of pre-Halloween demand; interim results may not indicate full-year performance.
Financial results and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $182.3 | $183.0 | $390.9 | $393.3 |
| Operating earnings | $30.2 | $34.6 | $50.4 | $60.1 |
| Net earnings attributable to Tootsie Roll | $26.1 | $26.9 | $44.7 | $48.9 |
| Diluted earnings per share as reported | $0.41 | $0.42 | $0.70 | $0.75 |
| Total gross margin | $66.8 | $67.8 | $141.7 | $146.6 |
- Net product sales fell 0.4% in Q3 and 0.6% year to date. Management attributed the Q3 decrease partly to the timing of sales between Q2 and Q3.
- Management’s adjusted operating earnings, excluding specified deferred-compensation expense, declined 11.6% in Q3 to $32.6 million and 18.3% year to date to $54.8 million. Adjusted operating earnings as a share of product sales fell 2.2 and 3.1 percentage points, respectively.
- Operating cash flow was $41.0 million for the nine months, versus $18.4 million a year earlier. Capital expenditures were $16.8 million; cash used in investing activities was $39.5 million and cash used in financing was $34.1 million.
- Cash, cash equivalents and restricted cash totaled $64.7 million at September 30, 2018. Cash plus short-term investments was $132.7 million; total cash and short- and long-term investments was $321.1 million, including trading securities that economically hedge deferred-compensation liabilities.
- Current assets were $302.3 million and current liabilities $74.5 million; the current ratio was 4.1 to 1. Industrial development bonds were $7.5 million and Spanish subsidiaries had $0.2 million of bank loans. The company reported no other outstanding bank borrowings.
- Cash dividends paid were $17.2 million and share repurchases were $16.7 million in the first nine months. The company had no formal publicly announced repurchase program.
Changes and management commentary
- Product costs rose, including higher wages, healthcare and other benefits, manufacturing overhead, and costs from packaging quality improvements and new production-line start-ups. Management said capital-investment efficiencies and cost controls offset some increases.
- Adjusted selling, marketing and administrative expense rose 9.0% in Q3 and 6.9% year to date. Higher freight, delivery and warehousing costs were a principal driver: these costs increased 15.2% in Q3 and 14.0% year to date. Management cited higher fuel costs, a driver shortage and transportation regulations, and expects elevated transportation costs to continue.
- Other income declined year over year, partly reflecting foreign-exchange results. Trading-security gains and deferred-compensation expenses substantially offset each other.
- The effective tax rate declined to 21.5% for Q3 and 22.1% year to date, from 31.0% and 29.8%, respectively, principally reflecting the 21% U.S. federal statutory rate. The company said parts of its tax-reform accounting remained provisional and the ultimate impact could differ, possibly materially.
- Effective January 1, 2019, the company announced selective price increases on certain products and retail price points to help mitigate cost pressures. Management had not determined the amount of price realization expected from the increases.
- The company committed approximately $17 million to a U.S. manufacturing facility rehabilitation and expansion, with projected outlays of about $0.8 million in 2018, $10.0 million in 2019, and $3.1 million in each of 2020 and 2021. It expects 2018 capital expenditures to be funded from operating cash flow and internal sources.
Risks, contingencies and unusual items
- A multi-employer pension plan covering certain union employees is in “critical and declining status” and projected to become insolvent in 2030. The company’s estimated withdrawal liability was $82.2 million if it had withdrawn in 2017; any future liability could be higher. The company said outcomes or plan changes could materially affect future results or cash flows. Its labor contract requires continued participation through September 2022.
- The company adopted ASC 606 in 2018 using the modified retrospective method, increasing opening retained earnings by $3.3 million after tax. Prior-year comparisons were not restated; management expects no material ongoing net-income impact.
- Ordinary-course legal proceedings were not expected by management to have a material effect. Management reported no material change in risk factors from the 2017 Form 10-K, and no material change in internal control over financial reporting.
- Commodity and foreign-currency exposures include sugar and other ingredients, packaging, freight fuel, and Canadian-dollar costs and sales in several foreign markets. The company uses derivatives as hedges and stated it does not use them speculatively.
Important facts for investors to verify
- Whether the January 2019 selective price increases achieve meaningful price realization and offset structurally higher freight and manufacturing costs.
- Subsequent trends in sales, gross margins and operating expenses, bearing in mind the seasonal importance of Q3 and the timing-related sales comparison.
- Progress, timing and cash requirements for the manufacturing facility project and other capital spending.
- Updates on the multi-employer pension plan’s solvency, required contributions, restructuring and potential withdrawal liability.
- Final tax-reform accounting and any material effects from provisional estimates or further tax guidance.