TOOTSIE ROLL INDUSTRIES INC - Annual Report: 2018 (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, 2018

 

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 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).  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 21, 2019, there were outstanding 38,541,273 shares of Common Stock par value $.69-4/9 per share, and 25,583,209 shares of Class B Common Stock par value $.69-4/9 per share.

 

As of June 30, 2018, 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 $545,405,000. 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 25,604,704 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, 2018 (based upon the closing price of the stock on the New York Stock Exchange on such date) would have been approximately $680,400,000. 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 “2019 Proxy Statement”) scheduled to be held on May 6, 2019 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 3,100 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 2018 or 2017.

 

Because of increased pricing pressures and cost increases facing the confectionary industry, companies in the confectionary industry are taking pricing actions to recover many of the same input cost increases that we have and continue to experience including higher freight and delivery expenses. In particular, the Company has taken selective price increases, effective at the beginning of 2019, to recover these same input cost increases.

 

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 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, food safety 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 24.1%, 24.0%, and 23.3% of net product sales during the years ended December 31, 2018, 2017 and 2016, respectively. Sales revenues from Dollar Tree, Inc. (which includes Family Dollar which was acquired by Dollar Tree) aggregated approximately 11.2%, 10.9%, and 10.4% of net product sales during the years ended December 31, 2018, 2017 and 2016, respectively. Some of the aforementioned sales to Wal-Mart and Dollar Tree are sold to McLane Company, a large national grocery wholesaler, which services and delivers certain of the Company’s products to Wal-Mart, Dollar Tree and other retailers in the U.S.A. Net product sales revenues from McLane, which includes these Wal-Mart and Dollar Tree sales as well as sales and deliveries to other Company customers, were 17.4% in 2018 and 16.9% in 2017 and 16.3% in 2016.  At December 31, 2018 and 2017, the Company’s three largest customers discussed above accounted for approximately 31% and 32% of

total accounts receivable, respectively.  Although no customer other than McLane Company, Inc., Wal-Mart Stores, Inc. and Dollar Tree 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.

 

In the ordinary course of business, the Company is, from time to time, subject to a variety of active or threatened legal proceedings and claims. While it is not possible to predict the outcome of such matters with certainty, in the Company’s opinion, both individually and in the aggregate, they are not expected to have a material effect on the Company’s financial condition, results of operations or cash flows. 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, 2019, there were approximately 2,500 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, 2019 there were 17,500 and 1,000 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, 2018:

 

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 2018 and 2017 were:

 

NOTE: In addition to the above cash dividends, a 3% stock dividend was issued on April 6, 2018 and April 17, 2017.  

 

 

 

 

 

 

 

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, 2013 to December 31, 2018) 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 given that aggregate cash, cash equivalents and investments is $356,448 at December 31, 2018, including $62,260 in trading securities discussed below. Cash flows from 2018 operating activities totaled $100,929 compared to $42,973 in 2017, and are discussed in the section entitled Liquidity and Capital Resources. During 2018, the Company paid cash dividends of $22,978, purchased and retired $19,317 of its outstanding shares, and made capital expenditures of $27,612.

 

The Company’s net working capital was $242,655 at December 31, 2018 compared to $207,132 at December 31, 2017 which reflects higher aggregate cash, cash equivalents and short-term investments. As of December 31, 2018, the Company’s total cash, cash equivalents and investments, including all long-term investments in marketable securities, was $356,448 compared to $328,430 at December 31, 2017, an increase of $28,018. The aforementioned includes $62,260 and $60,520 of investments in trading securities as of December 31, 2018 and 2017, 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 $733,840 at December 31, 2017 to $750,622 as of December 31, 2018, principally reflecting 2018 net earnings of $56,893, less cash dividends of $22,978 and share repurchases of $19,317.

 

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 2019. 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

 

2018 vs. 2017

 

Twelve months 2018 consolidated net sales were $515,251 compared to $515,674 in twelve months 2017, a decrease of $423 or 0.1%. Fourth quarter 2018 net sales were $127,264 compared to $125,179 in fourth quarter 2017, an increase of $2,085 or 1.7%. Fourth quarter 2018 sales reflects an increase of 3.4% in U.S. sales in the quarter,  however, foreign sales declined in fourth quarter 2018. The timing of certain foreign sales between third and fourth quarter in the comparative 2018 and 2017 periods adversely affected fourth quarter consolidated 2018 sales. Unfavorable foreign exchange, primarily Mexico, also contributed to lower sales in fourth quarter and twelve months 2018 compared to the prior year corresponding period. The Company’s unit selling prices and price realization in 2018 was consistent with 2017. Because of increased pricing pressures and cost increases facing the confectionary industry, companies in the confectionary industry are taking pricing actions to recover many of the same input cost increases that we have and continue to experience which are

discussed below, including higher freight and delivery expenses. In particular, the Company has taken selective price increases, effective at the beginning of 2019, to recover these same input cost increases.

 

Product cost of goods sold were $329,880 in 2018 compared to $326,411 in 2017, an increase of $3,469 or 1.1%. Product cost of goods sold includes $(39) and $1,953 in certain deferred compensation expenses (credits) in 2018 and 2017, 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 $324,458 in 2017 to $329,919 in 2018, an increase of $5,461 or 1.7%. As a percent of net product sales, these adjusted costs increased from 62.9% in 2017 to 64.0% in 2018, a 1.1 unfavorable percentage point change. Although costs for key ingredients were more favorable in 2018 compared to 2017, higher manufacturing costs for wages, salaries and benefits and plant overhead operations contributed to higher product cost of goods sold in 2018 compared to 2017. Increases in employee healthcare and other benefit costs, principally resulting from unfavorable experience under our self-insurance programs, adversely affected gross profit margins in 2018 compared to 2017. Costs relating to quality improvements in product packaging and start-up of new manufacturing packaging lines being phased into service during 2018 also had an unfavorable impact on twelve months 2018 gross profit margins when compared to 2017. The above discussed cost factors also affected fourth quarter 2018 gross profit margins compared to fourth quarter 2017.

 

The Company is continuing its investments in its manufacturing operations and products to meet new consumer and customer demands, achieve quality improvements to increase consumer product acceptance, and realize operational efficiencies and savings. Manufacturing efficiencies driven by capital investments and ongoing cost containment programs mitigated some of these higher input costs and expenses discussed above.

 

Selling, marketing and administrative expenses were $117,691 in 2018 compared to $121,484 in 2017, a decrease of $3,793 or 3.1%. Selling, marketing and administrative expenses include $(1,064) and $8,024 in certain deferred compensation expenses (credits) in 2018 and 2017, 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, selling, marketing and administrative expenses increased from $113,460 in 2017 to $118,755 in 2018, an increase of $5,295 or 4.7%. As a percent of net product sales, these adjusted expenses increased from 22.0% of net product sales in 2017 to 23.1% of net product sales in 2018, a 1.1 unfavorable percentage point change.

 

Selling, marketing and administrative expenses include freight, delivery and warehousing expenses. These expenses increased from $44,082 in 2017 to $49,527 in 2018, an increase of $5,445 or 12.4%. As a percent of net product sales, these adjusted expenses increased from 8.6% in 2017 to 9.6% in 2018, a 1.0 unfavorable percentage point change. These expenses principally reflect higher freight rates driven by the continuing imbalance between supply and demand for over-the-road truck delivery as well as higher fuel costs. Freight and delivery expenses began their significant acceleration in fourth quarter 2017, and therefore, this impact was less significant in the comparative fourth quarters of 2018 and 2017, than for the twelve months 2018 and 2017. Higher legal and professional fees also contributed to this increase in selling, marketing and administrative expenses in both fourth quarter and twelve months 2018.

 

The Company has foreign operating businesses in Mexico, Canada and Spain, and exports products to many foreign markets. Such foreign sales were $43,690 and comprised 8.5% of the Company’s consolidated net product sales in 2018. In fourth quarter 2018 and 2017, the Company recorded a pre-tax impairment charge of $1,126 and $2,371, respectively, relating to its Spanish operations. The Company had a 97% ownership of a Spanish company at both December 31, 2018 and 2017. During 2018 and 2017, this Spanish subsidiary incurred operating losses of $2,840 and $3,212, respectively, and the Company provided approximately $4,484 and $2,734, respectively, of additional cash to finance these losses and certain capital expenditures. Company management expects the competitive and business challenges in Spain to continue but expects some reduction in operating losses in 2019 compared to 2018. Nonetheless, management believes that operating losses beyond 2019 are likely and that 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 2018, 2017 or 2016.  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 2018 (and 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 2018 using discounted cash flows and estimated royalty rates. For certain 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 certain trademarks by approximately 15% and 10%, respectively. Individually, a 100 basis point increase in the discount rate may result in potential impairment of up to $4 million.  A 100 basis point decrease in the royalty rate would not result in a potential impairment as of December 31, 2018. 

 

Earnings from operations were $70,482 in 2018 compared to $70,422 in 2017, an increase of $60. Earnings from operations include $(1,103) and $9,977 in certain deferred compensation expense (credits) in 2018 and 2017, respectively, which are discussed above. Adjusting for these deferred compensation expenses, adjusted earnings from operations decreased from $80,399 in 2017 to $69,379 in 2018, a decrease of $11,020 or 13.7%. Twelve months and fourth quarter results were adversely affected primarily by higher costs and expenses for freight and delivery and manufacturing operations as discussed above.

 

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 $2,724 in 2018 compared to $14,139 in 2017, a decrease of $11,415. Other income, net principally reflects $(1,103) and $9,977 of aggregate net gains (losses) and investment income on trading securities in 2018 and 2017, respectively. These trading securities provide an economic hedge of the Company’s deferred compensation liabilities; and the related net gains (losses) 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 of $3,535 and $2,851 in 2018 and 2017, respectively. Other income, net also includes foreign exchange gains (losses) of $(659) and $259 in 2018 and 2017, respectively. 

 

Fourth quarter and twelve months 2018 net earnings benefited from a lower U.S. federal income tax rate resulting from U.S. tax reform legislation enacted in December 2017. In connection with this tax reform legislation, the Company recorded a net tax benefit of $20,318, or $0.31 per share, during fourth quarter 2017. This benefit reflected the estimated accounting adjustment from the revaluation of the Company’s net deferred income tax liabilities as of December 31, 2017 to reflect the new lower U.S. corporate income tax rate. As a result of this tax legislative change, including the above discussed revaluation of deferred tax liabilities, the Company’s effective income tax rate was 23.5% in fourth quarter 2018 compared to negative 110.9%, a net tax credit, in fourth quarter 2017; and 22.4% in twelve months 2018 compared to 4.6% in twelve months 2017. 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, 2018 and 2017, the Company’s deferred tax assets include $1,844 and $3,740 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 $1,896 and $2,606 of these tax carry-forward benefits in 2018 and 2017, 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 $3,651 and $3,038 as of December 31, 2018 and 2017, 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 subsidiary has 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 included 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. U.S. tax reform also changed 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 between $7,000 to $10,000 of the earnings held in excess cash by its foreign subsidiaries in 2019. The tax 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.

 

Based on SEC guidance in Staff Accounting Bulletin No. 118, the Company considered its accounting for the effects of U.S. tax reform to be provisional as of December 31, 2017 and through the first three quarters ended September 30, 2018 because the ultimate impact might have differed from these provisional amounts, due to, among other things, additional regulatory guidance from the Internal Revenue Service and state authorities. The accounting for Tax Cuts and Jobs Act was completed as of December 31, 2018 and there were no material adjustment to the previously recorded provisional amounts.

 

Net earnings attributable to Tootsie Roll Industries, Inc. were $12,175 in fourth quarter 2018 compared to $31,985 in fourth quarter 2017, and net earnings per share were $0.19 and $0.49 in fourth quarter 2018 and 2017, respectively. The prior year fourth quarter 2017 net earnings includes a favorable deferred income tax accounting adjustment of $20,318 or $0.31 per share which is discussed above. Adjusting for the effects of this fourth quarter 2017 tax adjustment, comparable net earnings per share were $0.19 and $0.18, an increase of $0.01 or 5.6%. Twelve months 2018 net earnings were $56,893 compared to $80,864 in twelve months 2017, and net earnings per share were $.89 and $1.24 in twelve months 2018 and 2017, respectively. Adjusting for the effects of the 2017 tax adjustment discussed above, comparable net earnings per share were $0.89 and $0.93, a decrease of $0.04 or 4.3%. Earnings per share in 2018 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 65,048 in 2017 to 64,216 in 2018.

 

The Company has included a non-GAAP discussion regarding the impacts of tax reform.  The Company believes this discussion provides meaningful supplemental information to both management and investors that is indicative of the Company's core net results and facilitates comparison of net results across reporting periods.  The Company uses this non-GAAP measure when evaluating its financial results as well as for internal evaluation and analysis purposes.  This non-GAAP measure should not be viewed as a substitute for the Company's GAAP results.

 

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 in 2030. These new notices also advised 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 54.7%, 57.0%, and 62.8% as of the most recent valuation dates available, January 1, 2017, 2016, and 2015, 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, 2017 the funded percentage would be 52.5% (not 54.7%). As of the January 1, 2017 valuation date (most recent valuation available), only 19% of Plan participants were current active employees, 52% 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, 2017 fell 8% from the previous year and 9% over the past two years. When compared to the Plan valuation date of January 1, 2011 (six years earlier), current active employee participants have declined 36%, 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 $81,600, $82,200, and $72,700 if it had withdrawn from the Plan during 2018, 2017 and 2016, respectively. The decrease from 2017 to 2018 was driven by an increase in the PBGC interest rate, resulting in a decrease in the value of vested benefits, and an increase in the Plan’s assets, as well as some decrease in the Plan’s affected benefits; however, the aforementioned was off-set by effects of the Company comprising a larger share of the Plan’s contribution base. The Company’s relative share of the Plan’s contribution base has increased for the last several years, and management believes that this trend could continue indefinitely which will add upward pressure on the Company’s withdrawal liability. Based on the above, including the Plan’s projected insolvency in the year 2030, management believes that the Company’s withdrawal liability could increase further in future years.

 

Based on the Company’s updated 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. While the Company’s actuarial consultant does not believe that the Plan will suffer a future mass withdrawal (as defined) of participating employers, in the event of a mass withdrawal, the Company’s annual withdrawal payments would theoretically be payable in perpetuity. Based on the Company’s updated actuarial study, the present value of such perpetuities is in the range of $50,100 to $105,000 and would apply in the unlikely event that substantially all employers withdraw from the Plan. The aforementioned is based on a range of valuations and interest rates which the Company’s actuary has advised 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 concluded a new labor contract in 2018 which requires the Company’s continued participation in this Plan through September 2022. The amended rehabilitation plan, which also continues, requires that employer contributions include 5% compounded annual surcharge increases each year for an unspecified period of time beginning in 2012 as well as certain plan benefit reductions. The Company’s pension expense for this Plan for 2018, 2017 and 2016 was $2,836, $2,617 and $2,541, respectively. The aforementioned expense includes surcharges of $811, $656 and $542 in 2018, 2017 and 2016, respectively, as required under the plan of rehabilitation as amended. 

   

The U.S. Congress formed a joint select committee in 2018 to address the insolvency crisis affecting many multi-employer pension plans and provide long-term solvency to troubled multi-employer pension plans. The Company understands that the U.S Congress has proposed legislation that would provide low interest loans and PBGC assistance to troubled plans. 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 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, 2018.

 

 

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 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.

 

Product cost of goods sold were $326,411 in 2017 compared to $320,869 in 2016, an increase of $5,542 or 1.7%. 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 $319,732 in 2016 to $324,458 in 2017, an increase of $4,726 or 1.5%. As a percent of net product sales, these adjusted costs increased from 61.8% in 2016 to 62.9% in 2017, a 1.1 unfavorable percentage point change. 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.

 

Selling, marketing and administrative expenses include freight, delivery and warehousing expenses. These expenses increased from $40,759 in 2016 to $44,082 in 2017, an increase of $3,323 or 8.2%. As a percent of net product sales, these adjusted expenses increased from 7.9% in 2016 to 8.5% in 2017, a 0.6 unfavorable percentage change. 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. 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.

 

Earnings from operations were $70,422 in 2017 compared to $91,233 in 2016, a decrease of $20,811. 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, adjusted earnings from operations decreased from $95,508 in 2016 to $80,399 in 2017, a decrease of $15,109 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, these adjusted earnings from operations were also adversely affected by higher selling, marketing and administrative expenses, primarily freight and delivery, 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 $14,139 in 2017 compared to $6,679 in 2016, an increase of $7,460. 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 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. 

 

As discussed above, the Company recorded a favorable accounting adjustment of $20,318 during the fourth quarter of 2017 relating to the enactment of the U.S. Tax Cuts and Jobs Act (Tax Reform Act). 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.  The consolidated effective tax rate was 4.6% and 31.2% in 2017 and 2016, respectively.  

 

Net earnings attributable to Tootsie Roll Industries, Inc. were $80,864 in 2017 compared to $67,510 in 2016, and earnings per share were $1.24 and $1.02 in 2017 and 2016, respectively, an increase of $0.22 per share or 21.6%. The increase in earnings per share in 2017 principally resulted from U.S. tax reform ($20,318 or $0.31 per share). Adjusting for the effects of the 2017 tax adjustment discussed above, comparable net earnings per share were $0.93 and $1.02, a decrease of $0.09 

or 8.8%. 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 65,955 in 2016 to 65,048 in 2017. The Company has included this non-GAAP discussion regarding the impact of tax reform which is discussed above.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash flows from operating activities were $100,929, $42,973 and $98,550 in 2018, 2017 and 2016, respectively. The $57,956 increase in cash flows from operating activities from 2017 to 2018 primarily reflects the timing of payments and refunds of income taxes, an increase in prepaid expenses as of December 31, 2017, and the decrease in deferred compensation payments in 2018. Cash flows from operating activities decreased from 2016 to 2017 which primarily reflects increases in income tax refunds receivable and prepaid expenses; and an increase in deferred compensation payments during 2017.

 

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 2018. The Company uses these funds to pay the actual cost of such benefits over each union contract period. At December 31, 2018 and 2017, the VEBA trust held $15,921 and $19,713, 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 $27,612, $16,673, and $16,090 in 2018, 2017 and 2016, respectively. The changes in amounts from 2017 to 2018 principally reflect new manufacturing packaging lines in 2018 and the timing of expenditures relating to other plant manufacturing capital projects. Company management has recently committed approximately $17,000 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 2019, $8,000 in 2020 and $3,000 in 2021. 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 subsidiary which are discussed in Note 1 of the Company’s Notes to Consolidated Financial Statements, the Company had no bank borrowings or repayments in 2016, 2017, or 2018, and had no outstanding bank borrowings as of December 31, 2017 or 2018. 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 $19,317, $34,133, and $29,093 in 2018, 2017 and 2016, respectively. Cash dividends of $22,978, $22,621, and $22,266 were paid in 2018, 2017 and 2016, 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

 

As more fully discussed in Note 1, the Company adopted the new accounting revenue recognition guidance (ASC 606) effective January 1, 2018. As a result of adoption, the cumulative impact to retained earnings at January 1, 2018 was a net after-tax increase of $3,319 ($4,378 pre-tax). The adoption principally changed the timing of recognition of certain trade promotions and related adjustments thereto which affect net product sales. The comparative prior information has not been restated and continues to be reported under the accounting standards in effect for such period. The adoption of the new standard in 2018 did not have a material effect on 2018 results, and management does not believe that it will have a material effect on results in future years. Revenue for net product sales continues to be recognized at a point in time when products are delivered to or picked up by the customer, as designated by customers’ purchase orders, as discussed in Note 1.

 

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 2018, 2017 and 2016, and accordingly, have not been significant to the Company’s financial position or results of operations.

 

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 2018, 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 in accordance with ASU 606 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 an executive officer 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 does not invest in Level 3 securities, as defined, but 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 Level 3.

 

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, 2018, 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.

 

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, 2018, assuming a 10% change in the underlying contract price, was $2,063. 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, 2018.

 

 

The Company’s outstanding debt at December 31, 2018 and 2017 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, 2018.

 

Open Contractual Commitments as of December 31, 2018:

 

 

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 $43,941, liabilities for uncertain tax positions of $3,816, postretirement health care benefits of $12,451 and deferred compensation of $68,143 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, 2018 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, 2018.

 

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders

Tootsie Roll Industries, Inc.

 

Opinions on the financial statements and internal control over financial reporting

We have audited the accompanying consolidated statement of financial position of Tootsie Roll Industries, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2018, and the related consolidated statements of earnings and retained earnings, comprehensive earnings, and cash flows for the year then ended and the related notes and financial statement schedule included under Item 15(a) (2) (collectively referred to as the “financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the statement of earnings and retained earnings, comprehensive earnings and its cash flows for the year ended December 31, 2018 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, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

Basis for opinions

The Company’s management is responsible for these 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 the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion 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 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 audit of the financial statements included performing procedures to assess the risks of material misstatement of the 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 financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the 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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 (3) 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/ GRANT THORNTON LLP

 

We have served as the Company’s auditor since 2018. 

Chicago, Illinois

March 1, 2019

 

 

Report of Independent Registered Public Accounting Firm

 

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

 

In our opinion, the consolidated statement of financial position as of December 31, 2017 and the related consolidated statements of earnings and retained earnings, comprehensive income and cash flows for each of the two years in the period ended December 31, 2017, present fairly, in all material respects, the financial position of Tootsie Roll Industries, Inc. and its subsidiaries as of December 31, 2017, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) for each of the two years in the period ended December 31, 2017 presents fairly, in all material respects, the information set forth there in when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

 

/s/ PricewaterhouseCoopers LLP

 

Chicago, Illinois

March 1, 2018

 

 

 

 

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.)