Tootsie Roll Industries, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter ended June 29, 2013; year-to-date figures cover the first half of 2013. Financial statements are unaudited. Dollar amounts below are in millions unless otherwise stated.
Business context and results
Tootsie Roll manufactures and sells confectionery products. Management cautions that interim results are not necessarily indicative of full-year results because of seasonality; the third quarter is typically the largest sales quarter, driven by Halloween.
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net product sales | $101.988 | $108.156 | $212.267 | $217.919 |
| Total revenue | $102.886 | $109.139 | $214.172 | $219.959 |
| Total gross margin | $35.689 | $36.031 | $74.556 | $71.689 |
| Earnings from operations | $9.202 | $11.009 | $20.102 | $19.428 |
| Net earnings | $8.369 | $7.511 | $17.438 | $16.285 |
| EPS | $0.14 | $0.12 | $0.29 | $0.27 |
Product sales declined 5.7% in Q2 and 2.6% in the first half. Management attributed the Q2 decrease partly to sales timing between the first and second quarters; first-half sales also compared against promotional sales in 2012 that did not recur. Reported total gross margin was approximately 34.7% of revenue in Q2 2013 versus 33.0% a year earlier.
Profitability and period-to-period changes
- Product cost of goods sold fell 8.1% in Q2 and 5.8% in the first half, faster than product sales. Excluding specified deferred-compensation effects, it fell 8.7% and 6.1%, respectively. Management cited more favorable ingredient costs and plant efficiencies from capital investment, while noting that some key ingredient costs were higher.
- Selling, marketing and administrative expense increased to $26.487 million in Q2 and $54.454 million in the first half. Excluding specified deferred-compensation effects, Q2 expense was down 0.5%, while first-half expense rose 1.6%. Management said some expenses are fixed or do not move proportionately with sales.
- Reported operating earnings fell 16.4% in Q2 but rose 3.5% in the first half. Excluding deferred-compensation expense or gain effects, management reported operating earnings of $10.254 million in Q2, up 2.5%, and $24.207 million for the first half, up 11.4%. These non-GAAP adjustments are management’s view of underlying operations.
- Other income was $1.705 million in Q2, compared with a $0.444 million expense in Q2 2012; first-half other income was $4.296 million versus $2.891 million. Much of the change related to investment gains or losses associated with deferred-compensation programs, substantially offset by related compensation expense in operating costs.
- The Q2 effective tax rate declined to 23.3% from 28.9%, partly because the company released valuation allowances on prior capital losses following capital gains. First-half effective tax rates were 28.5% in 2013 and 27.0% in 2012.
Cash flow, debt and liquidity
- First-half operating cash flow was $37.093 million, up from $28.874 million. Management attributed the increase principally to higher earnings and a decrease in prepaid expenses and other assets, partly offset by increased inventories.
- Investing cash outflow was $53.691 million, mainly reflecting $63.992 million of purchases of available-for-sale securities, partly offset by proceeds from sales and maturities. Capital expenditures were $5.960 million, compared with $5.373 million. Management expected 2013 capital spending to be generally in line with historical annualized spending, funded by operating cash flow and internal sources.
- Financing cash outflow was $15.318 million, including $10.568 million of share purchases and $4.750 million of cash dividends. Cash and equivalents declined $31.916 million during the first half to $31.946 million.
- At June 29, 2013, current assets were $193.706 million and current liabilities $62.980 million; the current ratio was 3.1 to 1 and working capital was $130.726 million. Cash and short-term investments totaled $56.814 million; including long-term investments, cash and investments totaled $225.565 million.
- The company reported no bank borrowings at period-end. Industrial development bonds were $7.5 million; interest resets weekly. Interest paid in the first half was $17,000.
Outlook, risks and unusual items
- No specific earnings or sales guidance was provided. Management said margin recovery continued, with favorable costs and plant efficiencies supporting improvement, but identified higher costs for certain key ingredients. Results remain exposed to seasonal demand, competition, commodity and packaging costs, freight, customer purchasing patterns, and foreign exchange.
- The multi-employer Bakery and Confectionery Union pension plan was in “critical status.” Its rehabilitation plan calls for 5% compounded annual employer surcharges beginning January 2013, in addition to an interim surcharge, for an unspecified period. The company committed to participate through Q3 2017. It cited an estimated $37.2 million withdrawal liability based on a 2012 withdrawal, which could be higher; the ultimate financial effect is uncertain and could be material.
- The company held a Jefferson County, Alabama auction-rate security valued at $10.162 million, against original cost of $13.550 million. Auctions had failed since 2008, and both Jefferson County and its bond insurer were in bankruptcy. A proposed replacement-security agreement valued at approximately 80% of face value awaited bankruptcy court approval; adverse rulings could cause further impairment. The valuation uses Level 3 inputs.
- The company’s 50%-owned Spanish investments had a carrying value of $1.794 million at the end of the first half. Management cited continuing business and economic challenges in Spain and the possibility of further losses or impairment; a $0.850 million pre-tax impairment had been recorded in Q4 2012.
- A shareholder derivative complaint filed in April 2013 alleging director fiduciary-duty breaches was dismissed during Q2 after the parties stipulated to dismissal.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing identifies no material change in market risk from the 2012 Form 10-K.
Most important facts for investors to verify
- Whether the expected seasonal sales recovery, particularly around Halloween, materializes after first-half product sales declined 2.6%.
- Whether margin gains persist as ingredient, packaging, freight and other input costs fluctuate; compare reported results with management’s deferred-compensation-adjusted figures.
- Developments in the underfunded multi-employer pension plan, including future surcharges and any change to the potential withdrawal liability.
- Bankruptcy court outcomes and recoverability of the Jefferson County auction-rate security, including potential additional impairment.
- Cash deployment and liquidity trends, including investment purchases, share repurchases, dividends and inventory levels.