TOOTSIE ROLL INDUSTRIES INC - Annual Report: 2017 (Form 10-K)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

(Mark One)

 

☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2017

 

OR

 

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                   

 

Commission file number 1-1361

 

 

TOOTSIE ROLL INDUSTRIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

7401 South Cicero Avenue, Chicago, Illinois 60629

(Address of principal executive offices) (Zip Code)

 

Registrant’s Telephone Number:  (773) 838-3400

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

Class B Common Stock — Par Value $.69-4/9 Per Share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☒  No ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐  No ☒

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

As of February 15, 2018, there were outstanding 37,701,872 shares of Common Stock par value $.69-4/9 per share, and 24,891,136 shares of Class B Common Stock par value $.69-4/9 per share.

 

As of June 30, 2017, the aggregate market value of the Common Stock (based upon the closing price of the stock on the New York Stock Exchange on such date) held by non-affiliates was approximately $604,596,000. Class B Common Stock is not traded on any exchange, is restricted as to transfer or other disposition, but is convertible into Common Stock on a share-for-share basis. Upon such conversion, the resulting shares of Common Stock are freely transferable and publicly traded. Assuming all 24,891,136 shares of outstanding Class B Common Stock were converted into Common Stock, the aggregate market value of Common Stock held by non-affiliates on June 30, 2017 (based upon the closing price of the stock on the New York Stock Exchange on such date) would have been approximately $753,775,000. Determination of stock ownership by non-affiliates was made solely for the purpose of this requirement, and the Registrant is not bound by these determinations for any other purpose.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s Definitive Proxy Statement for the Company’s Annual Meeting of Shareholders (the “2018 Proxy Statement”) scheduled to be held on May 7, 2018 are incorporated by reference in Part III of this report.

 

 

 

 

 

TABLE OF CONTENTS

 

 

 

Forward-Looking Information

 

From time to time, in the Company’s statements and written reports, including this report, the Company discusses its expectations regarding future performance by making certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the use of words such as “anticipate,” “believe,” “expect,” “intend,” “estimate,” “project,” and other words of similar meaning in connection with a discussion of future operating or financial performance and are subject to certain factors, risks, trends and uncertainties that could cause actual results and achievements to differ materially from those expressed in the forward-looking statements. These forward-looking statements are based on currently available competitive, financial and economic data and management’s views and assumptions regarding future events. Such forward-looking statements are inherently uncertain, and actual results may differ materially from those expressed or implied herein. Consequently, the Company wishes to caution readers not to place undue reliance on any forward-looking statements. Factors, among others, which could cause the Company’s future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein include general factors, such as economic conditions, political developments, currency exchange rates, interest and inflation rates, accounting standards, taxes, and laws and regulations affecting the Company in markets where it competes and those factors described in Item 1A “Risk Factors” and elsewhere in this Form 10-K and in other Company filings with the Securities and Exchange Commission. The Company does not undertake to update any of these forward-looking statements.

 

PART I

 

ITEM 1.               Business.

 

Tootsie Roll Industries, Inc. and its consolidated subsidiaries (the “Company”) have been engaged in the manufacture and sale of confectionery products for over 100 years. This is the only industry segment in which the Company operates and is its only line of business. The majority of the Company’s products are sold under the registered trademarks TOOTSIE ROLL, TOOTSIE POPS, CHILD’S PLAY, CARAMEL APPLE POPS, CHARMS, BLOW-POP, CHARMS MINI POPS, CELLA’S, DOTS, JUNIOR MINTS, CHARLESTON CHEW, SUGAR DADDY, SUGAR BABIES, ANDES, FLUFFY STUFF, DUBBLE BUBBLE, RAZZLES, CRY BABY, NIK-L-NIP, and TUTSI POP (Mexico).

 

The Company’s products are marketed in a variety of packages designed to be suitable for display and sale in different types of retail outlets. They are sold through approximately 30 candy and grocery brokers and by the Company itself to approximately 4,000 customers throughout the United States. These customers include wholesale distributors of candy and groceries, supermarkets, variety stores, dollar stores, chain grocers, drug chains, discount chains, cooperative grocery associations, mass merchandisers, warehouse and membership club stores, vending machine operators, the U.S. military and fund-raising charitable organizations.

 

The Company’s principal markets are in the United States, Canada and Mexico. The majority of production from the Company’s Canadian plants is sold in the United States. The majority of production from the Company’s Mexican plant is sold in Mexico.

 

The domestic confectionery business is highly competitive. The Company competes primarily with other manufacturers of confectionery products sold to the above mentioned customers. Although accurate statistics are not available, the Company believes it is among the ten largest domestic manufacturers in this field. In the markets in which the Company competes, the main forms of competition comprise brand recognition, as well as competition for retail shelf space and a fair price for the Company’s products at various retail price points.

 

The Company did not have a material backlog of firm orders at the end of the calendar years 2017 or 2016.

 

The Company experienced higher costs for ingredients in 2017 compared to 2016. The Company had increased price realization on its unit selling prices in 2016,  and has made progress toward restoring margins to their historical levels before the increases in commodity and other input costs in past years.

 

The Company has historically hedged certain of its future sugar and corn syrup needs with derivatives at such times that it believes that the forward markets are favorable. The Company’s decision to hedge its major ingredient requirements is dependent on the Company’s evaluation of forward commodity markets and their comparison to vendor quotations, if available, and/or historical costs. The Company has historically hedged some of these major ingredients with derivatives, primarily commodity futures and option contracts, before the commencement of the next calendar year to better ascertain the need for product pricing changes or product weight decline (indirect price change) adjustments to its product sales portfolio and better manage ingredient costs. The Company will generally purchase forward derivative contracts (i.e., “long” position) in selected future months that correspond to the Company’s estimated procurement and usage needs of the respective commodity in the respective forward periods.

 

From time to time, the Company also changes the size and weight of certain of its products in response to significant changes in ingredient and other input costs.

 

The Company does not hold any material patents, licenses, franchises or concessions. The Company’s major trademarks are registered in the United States, Canada, Mexico and in many other countries. Continued trademark protection is of material importance to the Company’s business as a whole.

 

Although the Company does research and develops new products and product line extensions for existing brands, it also improves the quality of existing products, improves and modernizes production processes, and develops and implements new technologies to enhance the quality and reduce the costs of products. The Company does not expend material amounts of money on research or development activities.

 

The manufacture and sale of consumer food products is highly regulated. In the United States, the Company’s activities are subject to regulation by various government agencies, including the Food and Drug Administration, the Department of Agriculture, the Federal Trade Commission, the Department of Commerce and the Environmental Protection Agency, as well as various state and local agencies. Similar agencies also regulate the businesses outside of the United States. The Company maintains quality assurance and other programs to help ensure that all products the Company manufactures and distributes are safe and of high quality and comply with all applicable laws and regulations.

 

The Company’s compliance with federal, state and local regulations which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect on the capital expenditures, earnings or competitive position of the Company nor does the Company anticipate any such material effects from presently enacted or adopted regulations.

 

The Company employs approximately 2,000 persons.

 

The Company has found that its sales normally maintain a consistent level throughout the year except for a substantial increase in the third quarter which reflects pre-Halloween and back-to-school sales. In anticipation of this high sales period, the Company generally begins building inventories in the second quarter of each year. The Company historically offers extended credit terms for sales made under seasonal sales programs, including Halloween. Each year, after accounts receivables related to third quarter sales have been collected, the Company invests such funds in various marketable securities.

 

Sales revenues from Wal-Mart Stores, Inc. aggregated approximately 24.0%, 23.3%, and 23.7% of net product sales during the years ended December 31, 2017, 2016 and 2015, respectively. Some of the aforementioned sales to Wal-Mart are sold to McLane Company, a large national grocery wholesaler, which services and delivers certain of the Company’s products to Wal-Mart and other retailers in the U.S.A. Net product sales revenues from McLane, which includes these Wal-Mart sales as well as sales and deliveries to other Company customers, were 16.9% in 2017 and 16.3% in 2016 and 16.7% in 2015. Although no customer other than McLane Company, Inc. and Wal-Mart Stores, Inc. accounted for more than 10% of net product sales, the loss of one or more significant customers could have a material adverse effect on the Company’s business.

 

For a summary of sales and long-lived assets of the Company by geographic area see Note 9 of the “Notes to Consolidated Financial Statements” which is incorporated herein by reference.

 

Information regarding the Company’s Form 10-K, Form 10-Q, current reports on Form 8-K, and any amendments to these reports, will be made available, free of charge, upon written request to Tootsie Roll Industries, Inc., 7401 South Cicero Avenue, Chicago, Illinois 60629, Attention: Barry Bowen, Treasurer and Assistant Secretary. The Company does not make all such reports available on its website at www.tootsie.com because it believes that they are readily available from the Securities Exchange Commission at www.sec.gov, and because the Company provides them free of charge upon request. Interested parties, including shareholders, may communicate to the Board of Directors or any individual director in writing, by regular mail, addressed to the Board of Directors or an individual director, in care of Tootsie Roll Industries, Inc., 7401 South Cicero Avenue, Chicago, Illinois 60629, Attention: Ellen R. Gordon, Chairman and Chief Executive Officer. If an interested party wishes to communicate directly with the Company’s non-employee directors, it should be noted on the cover of the communication.

 

ITEM 1A.            Risk Factors.

 

Significant factors that could impact the Company’s financial condition or results of operations include, without limitation, the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The factors identified above are believed to be significant factors, but not necessarily all of the significant factors, that could impact the Company’s business.  Unpredictable or unknown factors could also have material effects on the Company.

 

Additional significant factors that may affect the Company’s operations, performance and business results include the risks and uncertainties listed from time to time in filings with the Securities and Exchange Commission and the risk factors or uncertainties listed herein or listed in any document incorporated by reference herein.

 

ITEM 1B.            Unresolved Staff Comments.

 

None.

 

ITEM 2.               Properties.

 

The Company owns its principal manufacturing, warehousing and distribution and offices facilities which are located in Chicago, Illinois in a building consisting of approximately 2,354,000 square feet. In addition, the Company leases manufacturing and warehousing facilities at a second location in Chicago which comprises 137,000 square feet. The lease is renewable by the Company every five years through June, 2041; the Company expects to renew this lease prior to termination. The Company also periodically leases additional warehousing space at this second location as needed on a month-to-month basis.

 

The Company’s other principal manufacturing, warehousing and distribution facilities, all of which are owned, are:

 

 

The Company owns substantially all of the production machinery and equipment located in its plants. The Company also holds four commercial real estate properties for investment which were acquired with the proceeds from a sale of surplus real estate in 2005.

 

ITEM 3.               Legal Proceedings.

 

There are no material pending legal proceedings known to the Company to which the Company or any of its subsidiaries is a party or of which any of their property is the subject, and no penalties have been imposed by the Internal Revenue Service on the Company.

 

ADDITIONAL ITEM.     Executive Officers of the Registrant.

 

See the information on Executive Officers set forth in the table in Part III, Item 10.

 

ITEM 4.               Mine Safety Disclosures.

 

None.

 

PART II

 

ITEM 5.               Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

The Company’s common stock is traded on the New York Stock Exchange. The Company’s Class B common stock is subject to restrictions on transferability. The Class B common stock is convertible at the option of the holder into shares of common stock on a share-for-share basis. As of March 1, 2018, there were approximately 2,600 and 1,000 registered holders of record of common and Class B common stock, respectively. In addition, the Company estimates that as of March 1, 2018 there were 12,500 and 4,300 beneficial holders of common and Class B common stock, respectively.

 

The following table sets forth information about the shares of its common stock the Company purchased on the open market during the fiscal quarter ended December 31, 2017:

 

Issuer Purchases of Equity Securities

 

 

While the Company does not have a formal or publicly announced Company common stock purchase program, the Company repurchases its common stock on the open market from time to time as authorized by the Board of Directors.

 

Quarterly Stock Prices and Dividends

 

The high and low quarterly prices for the Company’s common stock, as reported on the New York Stock Exchange and quarterly dividends in 2017 and 2016 were:

 

NOTE: In addition to the above cash dividends, a 3% stock dividend was issued on April 17, 2017 and April 8, 2016.  

 

 

 

 

 

 

 

Performance Graph

 

The following performance graph compares the cumulative total shareholder return on the Company’s common stock for a five-year period (December 31, 2012 to December 31, 2017) with the cumulative total return of Standard & Poor’s 500 Stock Index (“S&P 500”) and the Dow Jones Industry Food Index (“Peer Group,” which includes the Company), assuming (i) $100 invested on December 31 of the first year of the chart in each of the Company’s common stock, S&P 500 and the Dow Jones Industry Food Index and (ii) the reinvestment of cash and stock dividends.

 

 

 

 

 

ITEM 6.               Selected Financial Data.

 

Five Year Summary of Earnings and Financial Highlights

 

(Thousands of dollars except per share, percentage and ratio figures)

 

 

 

 

 

ITEM 7.               Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

                            (Thousands of dollars except per share, percentage and ratio figures)

 

The following discussion should be read in conjunction with the other sections of this report, including the consolidated financial statements and related notes contained in Item 8 of this Form 10-K.

 

FINANCIAL REVIEW

 

This financial review discusses the Company’s financial condition, results of operations, liquidity and capital resources, significant accounting policies and estimates, new accounting pronouncements, market risks and other matters. It should be read in conjunction with the Consolidated Financial Statements and related Notes that follow this discussion.

 

FINANCIAL CONDITION

 

The Company’s overall financial position remains strong as a result of net earnings increasing from $67,318 in 2016 to 80,654 in 2017, and aggregate cash, cash equivalents, and investments, including long-term investments, of $328,430 at December 31, 2017. Cash flows from 2017 operating activities totaled $42,973 and are discussed in the section entitled Liquidity and Capital Resources.  During 2017, the Company paid cash dividends of $22,621, purchased and retired $34,133 of its outstanding shares, and made capital expenditures of $16,673.

 

The Company’s net working capital was $207,132 at December 31, 2017 compared to $235,739 at December 31, 2016 which generally reflects lower aggregate cash, cash equivalents and short-term investments. As of December 31, 2017, the Company’s total cash, cash equivalents and investments, including all long-term investments in marketable securities, was $328,430 compared to $351,323 at December 31, 2016, a decrease of $22,893, which generally reflects increases in prepaid expenses and current income taxes receivable as well as payments of deferred compensation in 2017. The aforementioned includes $60,520 and $67,995 in trading securities as of December 31, 2017 and 2016, respectively. The Company invests in trading securities to provide an economic hedge for its deferred compensation liabilities, as further discussed herein and in Note 7 of the Company’s Notes to Consolidated Financial Statements.

 

Shareholders’ equity increased from $711,364 at December 31, 2016 to $733,840 as of December 31, 2017, principally reflecting 2017 net earnings of $80,864, less cash dividends of $22,621, share repurchases of $34,133,  and an increase in accumulated other comprehensive loss, primarily foreign translation, of $1,545 during 2017.

 

The Company has a relatively straight-forward financial structure and has historically maintained a conservative financial position. Except for an immaterial amount of operating leases, the Company has no special financing arrangements or “off-balance sheet” special purpose entities. Cash flows from operations plus maturities of short-term investments are expected to be adequate to meet the Company’s overall financing needs, including capital expenditures, in 2018. Periodically, the Company considers possible acquisitions, and if the Company were to pursue and complete such an acquisition, that could result in bank borrowings or other financing.

 

RESULTS OF OPERATIONS

 

2017 vs. 2016

 

Twelve months 2017 consolidated net sales were $515,674 compared to $517,373 in twelve months 2016, a decrease of $1,699 or 0.3%. Twelve months 2017 consolidated sales were adversely affected by currency translation of $2,047 due to a stronger U.S. dollar in 2017 compared to 2016, principally relating to the Company’s Mexican subsidiary.  Fourth quarter 2017 net sales were $125,179 compared to $124,279 in fourth quarter 2016, an increase of $900 or 0.7%. Unfavorable foreign exchange, primarily Mexico, also contributed to lower sales in fourth quarter 2017 compared to the prior year corresponding period. The Company’s unit selling prices and price realization in 2017 was consistent with 2016. The

Company’s sales results in the United States continue to reflect the challenges of many of the Company’s retail customers including their profit margin pressures and other competitive factors.

 

Product cost of goods sold were $325,924 in 2017 compared to $320,290 in 2016, an increase of $5,634 or 1.8%. Product cost of goods sold includes $1,953 and $1,137 in certain deferred compensation expenses in 2017 and 2016, respectively. These deferred compensation expenses principally result from changes in the market value of investments and investment income from trading securities relating to compensation deferred in previous years and are not reflective of current operating results. Adjusting for the aforementioned, product cost of goods sold increased from $319,153 in 2016 to $323,971 in 2017, an increase of $4,818 or 1.5%. As a percent of net product sales, these adjusted costs increased from 61.7% in 2016 to 62.8% in 2017, an unfavorable increase of 1.1% as a percent of net product sales. Higher costs for ingredients, packaging materials, and manufacturing plant overhead, including increases in wages, salaries and benefits, contributed to higher product cost of goods sold and adversely affected gross profit margins in 2017 compared to 2016. Continuing improvements in manufacturing plant efficiencies driven by capital investments and ongoing cost containment programs mitigated some of these higher costs and expenses. The Company is continuing its focus on capital expenditures that will result in operational efficiencies and cost reductions, as well as product improvements.

 

Selling, marketing and administrative expenses were $120,977 in 2017 compared to $107,377 in 2016, an increase of $13,600 or 12.7%. Selling, marketing and administrative expenses include $8,024 and $3,138 in certain deferred compensation expenses in 2017 and 2016, respectively. These deferred compensation expenses principally result from changes in the market value of investments and investment income from trading securities relating to compensation deferred in previous years and are not reflective of current operating results. Adjusting for the aforementioned, these expenses increased from $104,239 in 2016 to $112,953 in 2017, an increase of $8,714 or 8.4%. As a percent of net product sales, these adjusted expenses increased from 20.1% of net product sales in 2016 to 21.9% of net product sales in 2017, a 1.7% unfavorable increase as a percentage of sales.

 

Selling, marketing and administrative expenses include freight, delivery and warehousing expenses. These expenses increased from $40,629 in 2016 to $43,973 in 2017, an increase of $3,344 or 8.2%. As a percent of net product sales, these adjusted expenses increased from 7.9% in 2016 to 8.5% in 2017, an unfavorable increase of 0.6% as a percent of net product sales. Increasing demand for over-the-road truck freight and delivery, and an imbalance in supply and demand for freight carriers, has resulted in higher prices for these services, particularly in fourth quarter 2017. There is a shortage of over-the-road trucks and truck drivers, and the Company expects these related cost pressures to continue in 2018. Increases in marketing and sales expenses relating to new product development and packaging changes to comply with product labeling requirements also contributed to higher selling, marketing and administrative expenses in 2017 compared to 2016, and these expenses also were much higher in fourth quarter 2017.

 

The Company has foreign operating businesses in Mexico, Canada and Spain, and exports products to many foreign markets. Such foreign sales were $43,452 and comprised 8% of the Company’s consolidated net product sales in 2017. In fourth quarter 2017, the Company recorded a pre-tax impairment charge of $2,371 relating to its Spanish subsidiaries. The Company currently has a 97% ownership of two Spanish companies (93% ownership at December 31, 2016). During 2017 and 2016, these Spanish subsidiaries incurred operating losses of $3,212 and $1,689, respectively, and the Company provided approximately $2,734 and $886, respectively, of additional cash to finance these losses. Company management expects the competitive and business challenges in Spain to continue and expects operating losses in 2018 and likely beyond; and these future losses will require additional cash financing.

The Company believes that the carrying values of its goodwill and trademarks have indefinite lives as they are expected to generate cash flows indefinitely. In accordance with current accounting guidance, these indefinite-lived intangible assets are assessed at least annually for impairment as of December 31 or whenever events or circumstances indicate that the carrying values may not be recoverable from future cash flows. No impairments were recorded in 2017, 2016 or 2015. Current accounting guidance provides entities an option of performing a qualitative assessment (a "step-zero" test) before performing a quantitative analysis. If the entity determines, on the basis of certain qualitative factors, that it is more-likely-than-not that the intangibles (goodwill and certain trademarks) are not impaired, the entity would not need to proceed to the two step impairment testing process (quantitative analysis) as prescribed in the guidance. During fourth quarter 2017, the Company performed a “step zero” test of its goodwill and certain trademarks, and concluded that there was no impairment based on this guidance. For the fair value assessment of certain trademarks where the “step-zero” analysis was not considered appropriate, impairment testing was performed in fourth quarter 2017 using discounted cash flows and

estimated royalty rates. For these trademarks, holding all other assumptions constant at the test date, a 100 basis point increase in the discount rate or a 100 basis point decrease in the royalty rate would reduce the fair value of such trademarks by approximately 16% and 10%, respectively. Individually, a 100 basis point increase in the discount rate or a 100 basis point decrease in the royalty rate would not result in a potential impairment of these trademarks as of December 31, 2017.

 

Earnings from operations were $71,416 in 2017 compared to $92,414 in 2016, a decrease of $20,998. Earnings from operations include $9,977 and $4,275 in certain deferred compensation expense in 2017 and 2016, respectively, which are discussed above. Adjusting for these deferred compensation expenses, earnings from operations decreased from $96,689 in 2016 to $81,393 in 2017, a decrease of $15,296 or 15.8%. Twelve months results were adversely affected by lower gross profit margins, including the effects of higher costs and expenses for ingredients, packaging materials, and manufacturing plant overhead as discussed above. In addition, earnings from operations were also adversely affected by higher selling, marketing and administrative expenses, primarily freight and delivery, marketing and sales expenses relating to new product development and packaging changes to comply with product labeling requirements, and declines in foreign results and an impairment of foreign subsidiaries, all of which are discussed above. Many of these increased costs and expenses accelerated in fourth quarter 2017. 

 

Management believes the comparisons presented in the preceding paragraphs, after adjusting for changes in deferred compensation, are more reflective of the underlying operations of the Company.

 

Other income, net was $13,145 in 2017 compared to $5,498 in 2016, an increase of $7,647. Other income, net principally reflects $9,977 and $4,275 of aggregate net gains and investment income on trading securities in 2017 and 2016, respectively. These trading securities provide an economic hedge of the Company’s deferred compensation liabilities; and the related net gains and investment income were offset by a like amount of expense in aggregate product cost of goods sold and selling, marketing, and administrative expenses in the respective years as discussed above. Other income, net includes investment income on available for sale securities, including variable rate demand notes, of $2,851 and $2,130 in 2017 and 2016, respectively. Other income, net also includes foreign exchange gains/(losses) of $259 and $(955) in 2017 and 2016, respectively. 

 

In connection with enactment of the U.S. Tax Cuts and Jobs Act (Tax Reform Act) in December 2017, the Company recorded a favorable accounting adjustment of $20,318, or $0.32 per share, during the fourth quarter of 2017. This reflects the estimated benefit from the revaluation of net deferred income tax liabilities based on the new lower U.S. corporate income tax rate effective January 1, 2018. U.S. tax reform also includes a one-time toll charge resulting from the mandatory deemed repatriation of undistributed foreign earnings and profits. The Company determined that there were no net undistributed foreign earnings and profits subject to this toll charge. Based on SEC guidance in Staff Accounting Bulletin No. 118, the Company considers its accounting for the effects of U.S. tax reform to be provisional as of December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to, among other things, additional regulatory guidance that may be issued by the Internal Revenue Service and state authorities.

 

The consolidated effective tax rate was 4.6% and 31.2% in 2017 and 2016, respectively. The principal drivers of the lower 2017 effective tax rate are the effects of U.S. tax reform and a worthless stock deduction relating to the Company’s Spanish subsidiaries, which favorably reduced the Company’s effective 2017 tax rate by 24.2% and 3.8%, respectively. A reconciliation of the differences between the U.S. statutory rate and these effective tax rates is provided in Note 4 of the Company’s Notes to Consolidated Financial Statements. At December 31, 2017 and 2016, the Company’s deferred tax assets include $3,740 and $6,346 of income tax benefits relating to its Canadian subsidiary tax loss carry-forwards which the Company expects to realize before their expiration dates (2029 through 2031). The Company utilized $2,606 and $1,776 of these tax carry-forward benefits in 2017 and 2016, respectively. The Company has concluded that it is more-likely-than-not that it would realize these deferred tax assets relating to its Canadian tax loss carry-forwards because it is expected that sufficient levels of taxable income will be generated during the carry-forward periods. The Company has provided a full valuation allowance on its Spanish subsidiaries’ tax loss carry-forward benefits of $3,038 and $2,106 as of December 31, 2017 and 2016, respectively, because the Company has concluded that it is not more-likely-than-not that these losses will be utilized before their expiration dates. The Spanish subsidiaries have a history of net operating losses and it is not known when and if they will generate taxable income in the future.

 

U.S. tax reform changes the United States approach to the taxation of foreign earnings to a territorial system by providing a one hundred percent dividends received deduction for certain qualified dividends received from foreign subsidiaries. These provisions of the U.S. tax reform significantly impact the accounting for the undistributed earnings of foreign subsidiaries, and as a result the Company intends to distribute approximately $10,000 of the earnings held in excess cash by its foreign subsidiaries in 2018. The costs associated with a future distribution, including foreign withholding taxes, are not material to the Company’s financial statements. After carefully considering these facts, the Company has determined that it will not be asserting permanent reinvestment of its foreign subsidiaries earnings as of December 31, 2017.

 

Net earnings attributable to Tootsie Roll Industries, Inc. were $80,864 in 2017 compared to $67,510 in 2016, and earnings per share were $1.28 and $1.05 in 2017 and 2016, respectively, an increase of $0.23 per share or 21.9%. The increase in earnings per share in 2017 principally resulted from U.S. tax reform ($20,318 or $.32 per share), however, many of the above discussed increases in input costs and operating expenses and the impairment of the Company’s Spanish subsidiaries adversely affected 2017 net earnings when compared to 2016. In addition, 2017 earning per share benefited from the reduction in average shares outstanding resulting from purchases of the Company’s common stock in the open market by the Company. Average shares outstanding decreased from 64,086 in 2016 to 63,179 in 2017.

 

Fourth quarter 2017 net earnings were $31,985 compared to $17,841 in fourth quarter 2016, and net earnings per share were $0.51 and $0.28 in fourth quarter 2017 and 2016, respectively, an increase of $0.23 or 82.1%. This increase was driven by the favorable accounting adjustment relating to U.S. tax reform of $20,318, or $0.32 per share. Higher input costs and expenses as discussed above also adversely affected fourth quarter results, and many of the input cost increases, primarily freight and delivery, accelerated in fourth quarter 2017 compared to fourth quarter 2016.

 

Beginning in 2012, the Company received periodic notices from the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union Pension Plan (Plan), a multi-employer defined benefit pension plan for certain Company union employees, that the Plan’s actuary certified the Plan to be in “critical status”, the “Red Zone”, as defined by the Pension Protection Act (PPA) and the Pension Benefit Guaranty Corporation (PBGC); and that a plan of rehabilitation was adopted by the trustees of the Plan in fourth quarter 2012. During 2015, the Company received notices that the Plan’s status was changed to “critical and declining status”, as defined by the PPA and PBGC, for the plan year beginning January 1, 2015, and that the Plan was projected to have an accumulated funding deficiency for the 2017 through 2024 plan years. A designation of “critical and declining status” implies that the Plan is expected to become insolvent in the next 20 years. In second quarter 2016, the Company received new notices that the Plan’s trustees adopted an updated Rehabilitation Plan effective January 1, 2016, and that the Plan remains in “critical and declining status” and is projected to become insolvent the year 2030. These new notices also advise that the Plan trustees were considering the reduction or elimination of certain retirement benefits and may seek assistance from the PBGC. Plans in “critical and declining status” may elect to suspend (temporarily or permanently) some benefits payable to all categories of participants, including retired participants, except retirees that are disabled or over the age of 80. Suspensions must be equally distributed and cannot drop below 110% of what would otherwise be guaranteed by the PBGC.  

   

Based on these updated notices, the Plan’s funded percentage (plan investment assets as a percentage of plan liabilities), as defined, were 57.0%, 62.8%, and 65.1%  as of the most recent valuation dates available, January 1, 2016, 2015, and 2014, respectively (these valuation dates are as of the beginning of each Plan year). These funded percentages are based on actuarial values, as defined, and do not reflect the actual market value of Plan investments as of these dates. If the market value of investments had been used as of January 1, 2016 the funded percentage would be 53.0% (not 57.0%). The Plan’s market value of its investments declined by 3.7% and its unfunded vested benefits increased by 6.4% during 2016. As of the January 1, 2016 valuation date (most recent valuation available), only 20% of Plan participants were current active employees, 51% were retired or separated from service and receiving benefits, and 29% were retired or separated from service and entitled to future benefits. The number of current active employee Plan participants as of January 1, 2016 fell 2% from the previous year and 4% over the past two years. When compared to the Plan valuation date of January 1, 2011 (five years earlier), current active employees participants have declined 31%, whereas participants who were retired or separated from service and receiving benefits increased 6% and participants who were retired or separated from service and entitled to future benefits increased 8%. The bankruptcy of a major participating employer in the Plan contributed to the above discussed Plan results. The Company understands that the Plan is currently exploring additional restructuring measures which include incentives to participating employers in exchange for providing additional future cash contributions as well as suspension of certain retirement benefits. 

   

The Company has been advised that its withdrawal liability would have been $82,200, $72,700, and $61,000 if it had withdrawn from the Plan during 2017, 2016 and 2015, respectively. The increase from 2016 to 2017 principally reflects a decrease in the PBGC interest rates, a decrease in the assets and increase in the Plan’s unfunded vested benefits during 2016 and the Company comprising a larger share of the Plan’s contribution base. Based on the above, including the Plan’s projected insolvency in the year 2030, management believes that the Company’s withdrawal liability will likely increase further in future years. Based on the Company’s actuarial study and certain provisions in ERISA and the law relating to withdrawal liability payments, management believes that the Company’s liability would likely be limited to twenty annual payments of $3,059 which have a present value in the range of $35,900 to $46,900 depending on the interest rate used to discount these payments. The aforementioned is based on a range of valuation interest rates which management understands is provided under the statute. Should the Company actually withdraw from the Plan at a future date, a withdrawal liability, which could be higher than the above discussed amounts, could be payable to the Plan.

   

The Company and the union are currently in labor contract negotiations and are continuing to operate under extensions of the recently expired contract which requires the Company’s continued participation in this Plan. The amended rehabilitation plan, which continues, requires that employer contributions include 5% compounded annual surcharge increases each year for an unspecified period of time beginning 2012 as well as certain plan benefit reductions. The Company’s pension expense for this Plan for 2017, 2016 and 2015 was $2,617,  $2,541 and $2,574, respectively. The aforementioned expense includes surcharges of $656,  $542 and $447 in 2017, 2016 and 2015, respectively, as required under the plan of rehabilitation as amended.

   

The Company is currently unable to determine the ultimate outcome of the above discussed multi-employer union pension matter and therefore is unable to determine the effects on its consolidated financial statements, but the ultimate outcome or the effects of any modifications to the current rehabilitation plan could be material to its consolidated results of operations or cash flows in one or more future periods. See also Note 7 in the Company’s Consolidated Financial Statements on Form 10-K for the year ended December 31, 2017.

 

 

2016 vs. 2015

 

 

Twelve months 2016 consolidated net sales were $517,373 compared to $536,692 in twelve months 2015, a decrease of $19,319 or 3.6%. Twelve months 2016 consolidated sales were adversely affected by currency translation of $3,473 due to a stronger U.S. dollar in 2016 compared to 2015, principally relating to Mexico and Canada. The timing of sales between fourth quarter 2016 and first quarter 2017 also had some adverse effect on twelve months 2016 sales when compared to the twelve months in the prior year. The Company had higher sales price realization in 2016 compared to 2015 in order to recover increased costs for ingredients and certain other inputs. Fourth quarter 2016 net sales were $124,279 compared to $139,881 in fourth quarter 2015, a decrease of $15,602 or 11.2%. Fourth quarter 2016 net sales were adversely affected by the timing of certain customer sales at both the beginning and end of the quarter when compared to the prior year fourth quarter in 2015. Unfavorable foreign exchange also contributed to lower sales in fourth quarter 2016 compared to the prior year corresponding period.

 

Product cost of goods sold were $320,290 in 2016 compared to $340,090 in 2015, a decrease of $19,800 or 5.8%. Product cost of goods sold includes $1,137 and $497 in certain deferred compensation expenses in 2016 and 2015, respectively. These deferred compensation expenses principally result from changes in the market value of investments and investment income from trading securities relating to compensation deferred in previous years and are not reflective of current operating results. Adjusting for the aforementioned, product cost of goods sold decreased from $339,593 in 2015 to $319,153 in 2016, a decrease of $20,440 or 6.0%. As a percent of net product sales, these adjusted costs decreased from 63.3% in 2015 to 61.7% in 2016, a favorable decrease of 1.6% as a percent of net product sales. Higher price realization on sales, continuing improvements in manufacturing plant efficiencies driven by capital investments, and ongoing cost containment programs contributed to this improvement in lower costs of goods sold and the resulting improvement in gross profit margins in twelve months 2016 compared to 2015. Higher costs for ingredients and additional manufacturing costs relating to changes in and uncertainties relating to product labeling requirements adversely affected gross profit margins in 2016. These higher manufacturing costs in 2016 include the effects of lower production volumes runs for many products

in order to reduce and minimize finished goods inventory levels and additional costs to meet new product labeling requirements. This inventory reduction was in response to uncertainties surrounding changes in state and national labeling regulations and requirements during 2016. The Company is continuing its focus on cost reductions and savings, including savings resulting from capital investments, in order to achieve manufacturing efficiencies and productivity improvements. The Company has made progress on restoring margins to their historical levels before the increases in commodity and other input costs in past years.

 

Selling, marketing and administrative expenses were $107,377 in 2016 compared to $108,051 in 2015, a decrease of $674 or 0.6%. Selling, marketing and administrative expenses include $3,138 and $953 in certain deferred compensation expenses in 2016 and 2015, respectively. These deferred compensation expenses principally result from changes in the market value of investments and investment income from trading securities relating to compensation deferred in previous years and are not reflective of current operating results. Adjusting for the aforementioned, these expenses decreased from $107,098 in 2015 to $104,239 in 2016, a decrease of $2,859 or 2.7%. As a percent of net product sales, these adjusted expenses increased slightly from 20.0% of net product sales in 2015 to 20.1% of net product sales in 2016, a 0.1% unfavorable increase as a percentage of sales. Selling, marketing and administrative expenses include $40,629 and $42,619 of freight, delivery and warehousing expenses in 2016 and 2015, respectively, were 7.9% of net product sales in both 2016 and 2015. Internal expense reduction initiatives mitigated some of the higher costs of freight, delivery and warehousing in 2016 compared to 2015.

 

The Company has foreign operating businesses in Mexico, Canada and Spain, and exports products to many foreign markets. The strength of the U.S. dollar and related devaluations of most these related foreign currencies, primarily Mexico and Canada, have adversely affected these foreign and export operations in 2016 compared to 2015. The operating income of these foreign and export operations decreased by $3,269 in 2016 compared to 2015. The Company currently has a 93% ownership of two Spanish companies (93% and 83% ownership at December 31, 2016 and 2015, respectively) which had operating losses for each of the years 2008 through 2016. Company management has restructured the Spanish operations and made other changes to its business plan but these companies continue to have operating losses. 

 

Earnings from operations were $92,414 in 2016 compared to $91,082 in 2015, an increase of $1,332. Earnings from operations include $4,275 and $1,450 in certain deferred compensation expense in 2016 and 2015, respectively, which are discussed above. Adjusting for these deferred compensation expenses, earnings from operations increased from $92,532 in 2015 to $96,689 in 2016, an increase of $4,157 or 4.5%. Although ingredient costs and results from foreign operations adversely affected adjusted 2016 earnings from operations, higher price realization on sales and the cost and expense reductions, as discussed above, allowed the Company to achieve these higher adjusted operating earnings in 2016 despite the decline in 2016 net sales compared to 2015.

 

Management believes the comparisons presented in the preceding paragraphs, after adjusting for changes in deferred compensation, are more reflective of the underlying operations of the Company.

 

Other income, net was $5,498 in 2016 compared to $1,496 in 2015, an increase of $4,002. Other income, net principally reflects $4,275 and $1,450 of aggregate net gains and investment income on trading securities in 2016 and 2015, respectively. Other income, net includes investment income on available for sale securities, including variable rate demand notes, of $2,130 and $1,421 in 2016 and 2015, respectively.  Other income, net also includes foreign exchange losses of $955 and $1,427 in 2016 and 2015, respectively. 

 

The consolidated effective tax rate was 31.2% and 28.6% in 2016 and 2015, respectively. The lower effective tax rate for 2015 principally reflects benefits from favorable prior year income tax settlements, including a $1,066 release of an uncertain income tax liability resulting from a decision by a foreign court in second quarter 2015. The Company utilized $1,776 and $2,758 of its Canadian subsidiary’s tax carry-forward benefits in 2016 and 2015, respectively. The Company has provided a full valuation allowance on its Spanish subsidiaries’ tax loss carry-forward benefits of $2,106 and $1,834 as of December 31, 2016 and 2015, respectively, because the Company has concluded that it is not more-likely-than-not that these losses will be utilized before their expiration dates. The Company did not provide for U.S. federal or foreign withholding taxes on approximately $22,081 and $20,174 of foreign subsidiaries’ undistributed earnings as of December 31, 2016 and December 31, 2015, respectively, because such earnings were considered to be permanently

reinvested. The Company estimates that the federal income tax liability on such undistributed earnings would approximate 30% of these amounts.

 

Net earnings attributable to Tootsie Roll Industries, Inc. were $67,510 in 2016 compared to $66,089 in 2015, and earnings per share were $1.05 and $1.02 in 2016 and 2015, respectively, an increase of $0.03 per share or 2.9%. As discussed above, net earnings principally benefited from higher price realization on domestic sales and cost and expense reductions, although higher ingredient costs, lower foreign operating income, and the adverse effects of lower sales mitigated some of these benefits. In addition, a lower effective income tax rate in prior year 2015 adversely affects the comparison to 2016 net earnings. Earnings per share in 2016 benefited from the reduction in average shares outstanding resulting from purchases of the Company’s common stock in the open market by the Company. Average shares outstanding decreased from 65,103 in 2015 to 64,086 in 2016. Fourth quarter 2016 net earnings were $17,841 compared to $19,705 in fourth quarter 2015, and net earnings per share were $.28 and $.30 in fourth quarter 2016 and 2015, respectively, a decrease of $.02 or 6%.

 

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash flows from operating activities were $42,973, $98,550 and $91,073 in 2017, 2016 and 2015, respectively. The $55,577 decrease in cash flows from operating activities from 2016 to 2017 primarily reflects increases in income taxes receivable and prepaid expenses and other assets; and  a decrease in income taxes payable and payments of deferred compensation during 2017. Cash flows in 2016 benefited from decreases in accounts receivable and inventories, net of a decrease in income taxes payable.  

 

The Company manages and controls a VEBA trust, to fund the estimated future costs of certain union employee health, welfare and other benefits. A contribution of $20,024 was made to this trust during fourth quarter 2017; no contribution was made to the trust during 2016. The Company uses these funds to pay the actual cost of such benefits over each union contract period. At December 31, 2017 and 2016, the VEBA trust held $19,713 and $3,027, respectively, of aggregate cash and cash equivalents. This asset value is included in prepaid expenses and long-term other assets in the Company’s Consolidated Statement of Financial Position. These assets are categorized as Level 1 within the fair value hierarchy.

 

Cash flows from investing activities reflect capital expenditures of $16,673, $16,090, and $15,534 in 2017, 2016 and 2015, respectively. The changes in amounts each year principally reflects the timing of expenditures relating to plant manufacturing projects. Company management has recently committed approximately $15,000 to a manufacturing plant rehabilitation upgrade and expansion of one of its manufacturing plants in the U.S.A. Management’s projected cash outlays for this project are approximately $6,000 in each of 2018 and 2019 and  $3,000 in 2020. In addition, Company management has committed approximately $13,000 to new packaging lines in 2018 which will result in additional capital spending in 2018 in excess of historical levels. All capital expenditures are to be funded from the Company’s cash flow from operations and internal sources including available for sale securities.

 

Other than the bank loans and the related restricted cash of the Company’s Spanish subsidiaries, which are discussed in Note 1 of the Company’s Notes to Consolidated Financial Statements, the Company had no bank borrowings or repayments in 2015, 2016, or 2017, and had no outstanding bank borrowings as of December 31, 2016 or 2017. Nonetheless, the Company would consider bank borrowing or other financing in the event that a business acquisition is completed.

 

Financing activities include Company common stock purchases and retirements of $34,133, $29,093, and $33,004 in 2017, 2016 and 2015, respectively. Cash dividends of $22,621, $22,266, and $20,775 were paid in 2017, 2016 and 2015, respectively.

 

SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES

 

Preparation of the Company’s financial statements involves judgments and estimates due to uncertainties affecting the application of accounting policies, and the likelihood that different amounts would be reported under different conditions or using different assumptions. The Company bases its estimates on historical experience and other assumptions, as discussed herein, that it believes are reasonable. If actual amounts are ultimately different from previous estimates, the

revisions are included in the Company’s results of operations for the period in which the actual amounts become known. The Company’s significant accounting policies are discussed in Note 1 of the Company’s Notes to Consolidated Financial Statements.

 

Following is a summary and discussion of the more significant accounting policies and estimates which management believes to have a significant impact on the Company’s operating results, financial position, cash flows and footnote disclosure.

 

 

Revenue recognition

 

Revenue, net of applicable provisions for discounts, returns, allowances and certain advertising and promotional costs, is recognized when products are delivered to customers based on an accepted customer purchase order. These include quantity, sales price and other relevant terms of sale, and collectability is reasonably assured. The accounting for promotional costs is discussed under “Customer incentive programs, advertising and marketing” below. Accounts receivable are unsecured.

 

Provisions for bad debts are recorded as selling, marketing and administrative expenses. Write-offs of bad debts did not exceed 0.1% of net product sales in each of 2017, 2016 and 2015, and accordingly, have not been significant to the Company’s financial position or results of operations.

 

Customer freight and delivery, and finished goods warehousing and handling expenses are included in selling, marketing and administrative expenses.

 

The Company is continuing its review and evaluation of revenue recognition under new guidance (ASC 606, “Revenue with Contracts from Customers”) which is effective at the beginning of the first quarter 2018. The Company will adopt this new guidance via the modified retrospective approach with the initial adoption impacting opening retained earnings effective January 1, 2018. Company management does not believe that the adoption of this new guidance will have a material effect on its consolidated statements of earnings, but management is expecting to reduce certain accrued liabilities (and increase retained earnings) relating to variable consideration, as defined by the new guidance on its consolidated statement financial position (balance sheet) of January 1, 2018.

 

 

Intangible assets

 

The Company’s intangible assets consist primarily of goodwill and acquired trademarks.  In accordance with accounting guidance, goodwill and other indefinite-lived assets, trademarks, are not amortized, but are instead subjected to annual testing for impairment unless certain triggering events or circumstances are noted. The Company performs its annual impairment review and assessment as of December 31. All trademarks have been assessed by management to have indefinite lives because they are expected to generate cash flows indefinitely. The Company reviews and assesses certain trademarks (non-amortizable intangible assets) for impairment by comparing the fair value of each trademark with its carrying value. Current accounting guidance provides entities an option of performing a qualitative assessment (a "step-zero" test) before performing a quantitative analysis. If the entity determines, on the basis of certain qualitative factors, that it is more-likely-than-not that the intangibles (goodwill and certain trademarks) are not impaired, the entity would not need to proceed to the two step impairment testing process (quantitative analysis) as prescribed in the guidance. During fourth quarter 2017, the Company performed a “step zero” test of its goodwill and certain trademarks, and concluded that there was no impairment based on this guidance.

 

The Company determines the fair value of certain trademarks using discounted cash flows and estimates of royalty rates. If the carrying value exceeds fair value, such trademarks are considered impaired and is reduced to fair value. The Company utilizes third-party professional valuation firms to assist in the determination of valuation of such trademarks. Impairments have not generally been material to the Company’s historical operating results.

 

Cash flow projections require the Company to make assumptions and estimates regarding the Company’s future plans, including sales projections and profit margins, market based discount rates, competitive factors, and economic conditions; and the Company’s actual results and conditions may differ over time. A change in the assumptions relating to the impairment analysis including but not limited to a reduction in projected cash flows, the use of a different discount rate to discount future cash flows or a different royalty rate applied to such trademarks, could cause impairment in the future.

 

 

Customer incentive programs, advertising and marketing

 

Advertising and marketing costs are recorded in the period to which such costs relate. The Company does not defer the recognition of any amounts on its consolidated balance sheet with respect to such costs. Customer incentives and other promotional costs, including consumer coupon (price reduction) incentives, are recorded at the time of the Company’s sale based upon incentive program terms and historical utilization statistics, which are generally consistent from year to year. The liabilities associated with these programs are reviewed quarterly and adjusted if utilization rates differ from management’s original estimates. Such adjustments have not historically been material to the Company’s operating results.

 

 

Split dollar officer life insurance

 

The Company provides split dollar life insurance benefits to certain executive officers and records an asset principally equal to the cumulative premiums paid. The Company will fully recover these premiums in future years under the terms of the plan. The Company retains a collateral assignment of the cash surrender values and policy death benefits payable to insure recovery of these premiums.

 

Valuation of long-lived assets

 

Long-lived assets, primarily property, plant and equipment, are reviewed for impairment as events or changes in business circumstances occur indicating that the carrying value of the asset may not be recoverable. The estimated cash flows produced by assets or asset groups, are compared to the asset carrying value to determine whether impairment exists. Such estimates involve considerable management judgment and are based upon assumptions about expected future operating performance. As a result, actual cash flows could differ from management’s estimates due to changes in business conditions, operating performance, and economic and competitive conditions. Such impairments have not historically been material to the Company’s operating results.

 

 

Income taxes

 

Deferred income taxes are recognized for future tax effects of temporary differences between financial and income tax reporting using tax rates in effect for the years in which the differences are expected to reverse. The Company records valuation allowances in situations where the realization of deferred tax assets, including those relating to net operating tax losses, is not more-likely-than-not; and the Company adjusts and releases such valuation allowances when realization becomes more-likely-than-not as defined by accounting guidance. The Company periodically reviews assumptions and estimates of the Company’s probable tax obligations and effects on its liability for uncertain tax positions, using informed judgment which may include the use of third-party consultants, advisors and legal counsel, as well as historical experience.

 

 

Valuation of investments

 

Investments primarily comprise corporate and municipal (tax-free) bonds, including variable rate demand notes (generally long term bonds where interest rates are reset weekly, and provide a weekly “put” which allows the holder to also sell each week with no loss in principal), which are reviewed for impairment at each reporting period by comparing the carrying value or amortized cost to the fair market value. In the event that an investment security’s fair value is below carrying value or amortized cost, the Company will record an other-than-temporary impairment or a temporary impairment based on accounting guidance. The Company’s investment policy, which guides investment decisions, is focused on high quality

investments which mitigates the risk of impairment. The Company may utilize third-party professional valuation firms as necessary to assist in the determination of the value of investments that utilize Level 3 inputs (as defined by guidance) should any of its investments be downgraded to such level.

 

 

Other matters

 

In the opinion of management, other than contracts for foreign currency forwards and raw materials, including currency and commodity hedges and outstanding purchase orders for packaging, ingredients, supplies, and operational services, all entered into in the ordinary course of business, the Company does not have any significant contractual obligations or future commitments. The Company’s outstanding contractual commitments as of December 31, 2017, all of which are generally normal and recurring in nature, are summarized in the chart which follows below.

 

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

See Note 1 of the Company’s Notes to Consolidated Financial Statements.

 

MARKET RISKS

 

The Company is exposed to market risks related to commodity prices, interest rates, investments in marketable securities, equity price and foreign exchange.

 

The Company’s ability to forecast the direction and scope of changes to its major input costs is impacted by significant potential volatility in crude oil and energy, sugar, corn, edible oils, cocoa and cocoa powder, and dairy products markets. The prices of these commodities are influenced by changes in global demand, changes in weather and crop yields, including the possible effects of climate change, changes in import tariffs and governments’ farm policies, including mandates for ethanol and bio-fuels, environmental matters, fluctuations in the U.S. dollar relative to dollar-denominated commodities in world markets, and in some cases, geo-political risks. The Company believes that its competitors face the same or similar challenges.

 

In order to address the impact of changes in input and other costs, the Company periodically reviews each item in its product portfolio to ascertain if price realization adjustments or other actions should be taken. These reviews include an evaluation of the risk factors relating to market place acceptance of such changes and their potential effect on future sales volumes. In addition, the estimated cost of packaging modifications associated with weight changes is evaluated. The Company also maintains ongoing cost reduction and productivity improvement programs under which cost savings initiatives are encouraged and progress monitored. The Company is not able to accurately predict the outcome of these cost savings initiatives and their effects on its future results.

 

Changes in U.S.A. tax policy, including a “border tax” and possible new tariffs on foreign imports which are under discussion, could have an adverse impact on such products made in Canada and sold in the U.S.A. as well as certain other ingredients and materials which are imported.

 

 

Commodity future and foreign currency forward contracts

 

Commodity price risks relate to ingredients, primarily sugar, cocoa and cocoa powder, chocolate, corn syrup, dextrose, edible oils, milk, whey and gum base ingredients. The Company believes its competitors face similar risks, and the industry has historically adjusted prices, and/or product weights, to compensate for adverse fluctuations in commodity costs. The Company, as well as competitors in the confectionery industry, has historically taken actions, including higher price realization to mitigate rising input costs for ingredients, packaging, labor and fringe benefits, energy, and freight and delivery. Although management seeks to substantially recover cost increases over the long-term, there is risk that higher price realization cannot be fully passed on to customers and, to the extent they are passed on, they could adversely affect customer and consumer acceptance and resulting sales volume.

 

The Company utilizes commodity futures contracts, as well as annual supply agreements, to hedge and plan for anticipated purchases of certain ingredients, including sugar, in order to mitigate commodity cost fluctuation. The Company also may purchase forward foreign exchange contracts to hedge its costs of manufacturing certain products in Canada for sale and distribution in the United States (U.S.A.), and periodically does so for purchases of equipment or raw materials from foreign suppliers. Such commodity futures and currency forward contracts are cash flow hedges and are effective as hedges as defined by accounting guidance. The unrealized gains and losses on such contracts are deferred as a component of accumulated other comprehensive loss (or gain) and are recognized as a component of product cost of goods sold when the related inventory is sold.

 

The potential change in fair value of commodity and foreign currency derivative instruments held by the Company at December 31, 2017, assuming a 10% change in the underlying contract price, was $1,476. The analysis only includes commodity and foreign currency derivative instruments and, therefore, does not consider the offsetting effect of changes in the price of the underlying commodity or foreign currency. This amount is not significant compared with the net earnings and shareholders’ equity of the Company.

 

Interest rates

 

Interest rate risks primarily relate to the Company’s investments in marketable securities with maturities dates of generally up to three years.

 

The majority of the Company’s investments, which are classified as available for sale, have historically been held until their maturity, which limits the Company’s exposure to interest rate fluctuations. The Company also invests in variable rate demand notes which have interest rates which are reset weekly and can be “put back” and sold each week through a remarketing agent, generally a large financial broker, which also substantially eliminates the Company’s exposure to interest rate fluctuations on the principal invested. The accompanying chart summarizes the maturities of the Company’s investments in debt securities at December 31, 2017.

 

 

The Company’s outstanding debt at December 31, 2017 and 2016 was $7,500 in an industrial revenue bond in which interest rates reset each week based on the current market rate. Therefore, the Company does not believe that it has significant interest rate risk with respect to its interest bearing debt.

 

Investment in marketable securities

 

As stated above, the Company invests primarily in marketable securities including variable rate demand notes (VRDNs). The VRDNs have weekly “puts” which are collateralized by bank letters of credit or other assets, and interest rates are reset weekly.  Except for VRDN’s the Company’s marketable securities are held to maturity with maturities generally not exceeding three years. The Company utilizes professional money managers and maintains investment policy guidelines which emphasize high quality and liquidity in order to minimize the potential loss exposures that could result in the event of a default or other adverse event. The Company continues to monitor these investments and markets, as well as its investment policies, however, the financial markets could experience unanticipated or unprecedented events as it did in 2008 and 2009, and future outcomes may be less predictable than in the past.

 

Equity price

 

Equity price risk relates to the Company’s investments in mutual funds which are principally used to fund and hedge the Company’s deferred compensation liabilities. These investments in mutual funds are classified as trading securities. Any change in the fair value of these trading securities is completely offset by a corresponding change in the respective hedged

deferred compensation liability, and therefore the Company does not believe that it has significant equity price risk with respect to these investments.

.

 

Foreign currency

 

Foreign currency risk principally relates to the Company’s foreign operations in Canada, Mexico and Spain, as well as periodic purchase commitments of machinery and equipment from foreign sources.

 

Certain of the Company’s Canadian manufacturing costs, including local payroll and plant operations, and a portion of its packaging and ingredients are sourced in Canadian dollars. The Company may purchase Canadian forward contracts to receive Canadian dollars at a specified date in the future and uses its Canadian dollar collections on Canadian sales as a partial hedge of its overall Canadian manufacturing obligations sourced in Canadian dollars. The Company also periodically purchases and holds Canadian dollars to facilitate the risk management of these currency changes.

 

From time to time, the Company may use foreign exchange forward contracts and derivative instruments to mitigate its exposure to foreign exchange risks, as well as those related to firm commitments to purchase equipment from foreign vendors. See Note 10 of the Company’s Notes to Consolidated Financial Statements for outstanding foreign exchange forward contracts as of December 31, 2017.

 

Open Contractual Commitments as of December 31, 2017:

 

 

Note: Commodity hedges and foreign currency hedges reflect the amounts at which the Company will settle the related contracts. The above amounts exclude deferred income tax liabilities of $41,457, liabilities for uncertain tax positions of $4,817, postretirement health care benefits of $13,497 and deferred compensation of $66,588 because the timing of payments relating to these items cannot be reasonably determined.

ITEM 7A.           Quantitative and Qualitative Disclosures About Market Risk.

 

The information required by this item is included under the caption “Market Risk” in Item 7 above.

 

See also Note 1 of the Notes to Consolidated Financial Statements.

 

ITEM 8.               Financial Statements and Supplementary Data.

 

Management’s Report on Internal Control Over Financial Reporting

 

The management of Tootsie Roll Industries, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Securities Exchange Act of 1934 (SEC) Rule 13a-15(f). Company management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017 as required by SEC Rule 13a-15(c). In making this assessment, the Company used the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Based on the Company’s evaluation under the COSO criteria, Company management concluded that its internal control over financial reporting was effective as of December 31, 2017.

 

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2017 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Tootsie Roll Industries, Inc.:

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the consolidated financial statements, including the related notes, as listed in the index appearing under Item 15(a)(1) and the financial statement schedule listed in the index appearing under Item 15(a)(2), of Tootsie Roll Industries, Inc. and its subsidiaries (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and December 31, 2016,  and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

 

As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it classifies deferred taxes in the Statement of Financial Position effective January 1, 2017.

 

Basis for Opinions

 

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting.  Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB.  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. 

 

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements.  Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

Definition and Limitations of Internal Control over Financial Reporting

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

/s/PricewaterhouseCoopers LLP

Chicago, Illinois

March 1, 2018

 

 

We have served as the Company’s auditor since 1968. 

 

 

 

 

CONSOLIDATED STATEMENTS OF

Earnings and Retained Earnings

 

 

 

(The accompanying notes are an integral part of these statements.)

CONSOLIDATED STATEMENTS OF

Comprehensive Earnings

 

 

(The accompanying notes are an integral part of these statements.)

 

 

 

 

 

 

 

 

Assets

 

 

 

(The accompanying notes are an integral part of these statements.)