Business context and reporting period
Tootsie Roll Industries, Inc. filed this unaudited Form 10-Q for the quarter ended September 28, 2013. The company notes that its third quarter is historically its largest sales quarter because of Halloween demand; interim results are not necessarily indicative of full-year results. Dollar amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $192.7 | $201.2 | $406.9 | $421.1 |
| Net earnings | $26.0 | $22.9 | $43.5 | $39.2 |
| Diluted earnings per share | $0.44 | $0.38 | $0.73 | $0.65 |
| Gross margin | $66.7 | $65.1 | $141.2 | $136.8 |
| Earnings from operations | $33.5 | $32.4 | $53.6 | $51.8 |
| Operating cash flow | — | $44.6 | $24.1 |
Product gross margin as a percentage of product sales was 34.4% for Q3 and 34.4% year to date, compared with 32.2% and 32.2%, respectively, in 2012. Management’s adjusted operating earnings, excluding deferred compensation expense, were $36.4 million for Q3 and $60.6 million year to date, up 6.2% and 8.2%; adjusted operating margins on product sales were 19.0% and 15.0%, respectively.
At September 28, 2013, cash and cash equivalents were $32.7 million, current investments $31.6 million, and long-term investments $162.4 million. Cash plus short- and long-term investments totaled $226.7 million, including $59.0 million of trading securities that economically hedge deferred compensation liabilities. Current assets were $246.5 million, current liabilities $80.8 million, and the current ratio was 3.1:1. The company had no bank borrowings; industrial development bonds were $7.5 million. Shareholders’ equity was $667.6 million.
Material changes versus the prior comparable period
- Q3 net product sales fell 4.2% to $191.8 million; nine-month sales fell 3.4% to $404.1 million. Management attributed the quarterly decline partly to sales shifting from Q3 to Q4 and the year-to-date decline partly to promotional sales in 2012 that did not recur.
- Despite lower sales, gross margin and earnings improved. Management cited more favorable ingredient costs and plant efficiencies from capital investments, partly offset by fixed or less variable operating expenses.
- The effective tax rate declined to 28.8% from 32.5% for Q3 and to 28.7% from 30.3% year to date, reflecting lower state tax expense and, year to date, release of tax valuation allowances related to prior capital losses.
- Average shares outstanding declined, partly reflecting share repurchases, supporting per-share earnings growth.
- Operating cash flow increased to $44.6 million from $24.1 million. Investing used $54.8 million, including $64.0 million of purchases of available-for-sale securities and $10.6 million of capital expenditures; financing used $20.9 million, including $11.4 million of share purchases and $9.5 million of cash dividends. Cash declined $31.1 million from year-end to $32.7 million.
Outlook, risks, contingencies and unusual items
- No specific earnings or sales guidance was provided. Management expected 2013 capital expenditures to be generally in line with historical annualized spending, funded from operating cash flow and internal sources.
- Deferred compensation investment-related expenses were $2.9 million in Q3 and $7.0 million year to date, with substantially offsetting gains and investment income in other income. Management presented adjusted results excluding these items as more reflective of underlying operations.
- The BC&T multi-employer pension plan is in critical “Red Zone” status. The rehabilitation plan requires compounded annual employer surcharges of 5% beginning in 2013, in addition to an interim surcharge. A 2012 estimated withdrawal liability was $37.2 million; actual future liability could be higher. The company committed to continue participation through Q3 2017 and said the ultimate financial impact is uncertain and could be material.
- A Jefferson County, Alabama auction-rate security was valued at $10.2 million versus $13.6 million original cost. Jefferson County and its bond insurer are in bankruptcy; a proposed replacement-security agreement at approximately 80% of face value awaited court approval. Further adverse rulings could cause additional impairment.
- The company reported continuing operating challenges at its two 50%-owned Spanish companies, with a $1.4 million carrying value and potential for further losses or impairment; it may consider strategic alternatives.
- Key risks include competition and consumer demand, commodity and packaging costs and ability to pass them through, seasonal sales and retailer activity, foreign currency exposure, labor, pension-plan funding, investment values, and operational and cybersecurity risks. Management said market risks had not materially changed from the 2012 Form 10-K.
Important facts for investors to verify
- Whether Q3 sales shifted into Q4 as management described, and how seasonal demand affects full-year results.
- Whether improved ingredient costs and plant efficiencies continue to support margins amid higher costs for certain key ingredients.
- Developments in the BC&T plan’s funding, required surcharges and potential future company obligations.
- Bankruptcy-court outcomes and recoveries for the Jefferson County auction-rate security.
- Performance and strategic direction of the Spanish equity investment, and the company’s cash deployment through investments, dividends and repurchases.