Tootsie Roll Industries, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 27, 2014. Dollar amounts below are in millions unless noted. The third quarter is historically the company’s largest sales quarter because of Halloween; interim results may not indicate full-year performance.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $192.0 | $192.7 | $404.7 | $406.9 |
| Total gross margin | $68.6 | $66.7 | $147.8 | $141.2 |
| Operating earnings | $36.8 | $33.5 | $62.0 | $53.6 |
| Net earnings attributable to Tootsie Roll | $26.7 | $26.0 | $45.3 | $43.5 |
| Earnings per share | $0.44 | $0.42 | $0.75 | $0.71 |
- Q3 net product sales fell 0.4%; nine-month sales fell 0.5%. Rental and royalty revenue was $0.9 million for the quarter and $2.8 million year to date.
- Management’s adjusted operating earnings, excluding specified deferred-compensation effects, were $37.1 million for Q3, up 2.1%, and $65.1 million year to date, up 7.5%. Adjusted operating margin was 19.4% and 16.2%, respectively, versus 19.0% and 15.0% in the comparable periods.
- Net cash provided by operations was $9.8 million year to date, versus $44.8 million. Investing used $21.1 million and financing used $31.3 million. Cash and cash equivalents were $45.1 million at quarter-end, down from $88.3 million at December 31, 2013.
- Quarter-end current assets were $273.8 million and current liabilities $78.5 million; the reported current ratio was 3.5 to 1. Cash, cash equivalents and short-term investments totaled $81.2 million. Cash and short- and long-term investments together totaled $241.4 million.
- Borrowings at quarter-end were $1.081 million, all related to the majority-owned Spanish companies; this included $0.285 million current and $0.796 million noncurrent bank loans. Industrial development bonds were $7.5 million.
- Capital expenditures were $7.3 million for nine months. The company repurchased and retired $16.8 million of shares and paid $14.4 million in cash dividends during the period.
Material changes and management commentary
- Gross margin improved as product costs declined, reflecting lower ingredient costs, manufacturing efficiencies from capital investment, and cost-containment measures. Some key ingredient costs remained higher, and management said it was continuing to restore margins toward historical levels.
- Sales were affected by challenges at certain U.S. retail customers, lower sales in Mexico and Canada, and the weaker Canadian dollar. Freight, delivery, warehousing and certain marketing expenses increased.
- Management attributed the sharp decline in operating cash flow primarily to seasonal production timing and higher inventories; favorable changes in prepaid expenses and other assets had boosted prior-year cash flow.
- In Q1, the company gained operating control of two previously 50%-owned Spanish companies and increased ownership to 75% by the end of Q2. The step acquisition produced a $0.529 million net loss, including a $2.350 million deferred-tax provision reversal. Management said restructuring could bring the operations near operating cash-flow break-even, but further funding may be needed; approximately $0.750 million of additional funding was anticipated in Q4 2014 or 2015.
- The nine-month effective tax rate was 32.8%, compared with 28.7% a year earlier; the increase reflected the deferred-tax-asset reversal associated with the Spanish acquisition. Q3 rates were 27.9% and 28.8%, respectively.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided. Capital expenditures for 2014 were expected to be generally in line with historical annualized spending and funded from operations and internal sources.
- The company identified commodity and ingredient prices and availability, including cocoa exposure to the Ebola epidemic’s potential effects on West African producing countries, as risks. Other stated risks include competition and consumer demand, Halloween seasonality, retailer/customer concentration, foreign exchange, freight and energy costs, labor disruptions, product recalls, investment values, cybersecurity and execution of Spanish restructuring.
- The Bakery and Confectionery Union and Industry multi-employer pension plan is in critical “Red Zone” status. Employer contributions include compounded annual surcharges. The company cited a 2012 estimated withdrawal liability of $37.2 million, noted that it had no updated estimate and that a future liability could be higher, and said its labor contract commits participation through Q3 2017. Management said the ultimate outcome and financial effects cannot be determined and could be material in future periods.
- Other unusual items include deferred-compensation expense and offsetting investment income tied to trading securities, which management excludes in its adjusted operating analysis. Foreign-exchange losses were $0.380 million in Q3 and $1.169 million year to date.
- Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the seasonal Halloween quarter supports full-year sales and earnings, given modest reported sales declines and retailer/customer pressures.
- Whether gross-margin improvement persists as ingredient, freight and other input costs fluctuate, and how much reported performance depends on deferred-compensation adjustments.
- Whether operating cash flow recovers as seasonal inventory is sold and receivables are collected.
- The Spanish subsidiaries’ progress toward break-even, further funding requirements and any effect on consolidated results.
- Potential exposure from the multi-employer pension plan, including the current withdrawal-liability estimate and future surcharges.
- Commodity, currency and investment risks, including cocoa supply exposure and the company’s substantial investment portfolio.