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TR > SEC Filings for TR > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for TOOTSIE ROLL INDUSTRIES INC

Form 10-Q for TOOTSIE ROLL INDUSTRIES INC


8-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This financial review discusses the Company's financial condition, results of operations, liquidity and capital resources, new accounting pronouncements and other matters. Dollars are presented in thousands, except per share amounts. It should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related footnotes.

Net product sales were $101,988 in second quarter 2013 compared to $108,156 in second quarter 2012, a decrease of $6,168 or 5.7%. First half 2013 net product sales were $212,267 compared to $217,919 in first half 2012, a decrease of $5,652 or 2.6%. The decline in second quarter 2013 sales compared to second quarter 2012 reflects some timing of sales between the first and second quarters in 2013. The decline in first half 2013 sales reflects some special promotional sales in first half 2012 that were not repeated in first half 2013.

Product cost of goods sold were $66,972 in second quarter 2013 compared to $72,858 in second quarter 2012 and first half 2013 product cost of goods sold were $139,141 compared to $147,763 in first half 2012. Product cost of goods sold includes $241 and $(223) of certain deferred compensation expenses in second quarter 2013 and 2012, respectively, and $937 and $516 of certain deferred compensation expenses in first half 2013 and 2012, respectively. These deferred compensation expenses principally result from an increase or decrease 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 $73,081 in second quarter 2012 to $66,731 in second quarter 2013, a decrease of $6,350 or 8.7%; and decreased from $147,247 in first half 2012 to $138,204 in first half 2013, a decrease of $9,043 or 6.1%. As a percentage of net product sales, adjusted product cost of goods sold was 65.4% and 67.6% in second quarter 2013 and 2012, respectively, a decrease of 2.2%; and adjusted product cost of goods sold was 65.1% and 67.6% in first half 2013 and 2012, respectively, a decrease of 2.5%. These changes reflect more favorable ingredient costs as well as plant efficiencies driven by capital investments. Although overall comparative ingredient costs were more favorable in second quarter and first half 2013 compared to the corresponding periods in the prior year, certain key ingredient costs are higher this year. The Company is continuing to make progress on restoring its margins to their historical levels before the significant increases in commodity and other input costs in recent years.

Selling, marketing and administrative expenses were $26,487 in second quarter 2013 compared to $25,022 in second quarter 2012, and first half 2013 and 2012 selling, marketing and administrative expenses were $54,454 and $52,261, respectively. Selling, marketing and administrative expenses includes $811 and $(786) of certain deferred compensation expenses (gains) in second quarter 2013 and 2012, respectively, and $3,168 and $1,789 of certain deferred compensation expenses in first half 2013 and 2012, respectively. As discussed above, these 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 decreased from $25,808 in second quarter 2012 to $25,676 in second quarter 2013, a decrease of $132 or 0.5%, and selling, marketing and administrative expenses increased from $50,472 in first half 2012 to $51,286 in first half 2013, an increase of $814 or 1.6%. As a percentage of net product sales, adjusted selling, marketing and administrative expenses unfavorably increased from 23.9% in second quarter 2012 to 25.2% in second quarter 2013, an increase of 1.3% as a percent of net sales; and adjusted selling, marketing and administrative expenses unfavorably increased from 23.2% in first half 2012 to 24.2% in first half 2013, an increase of 1.0%. These increases as a percentage of net sales reflect increases in certain expenses that are generally fixed or do not change in the same direction or degree as changes in sales. Selling, marketing and administrative expenses include $10,380 and $10,565 for freight, delivery and warehousing expenses in second quarter 2013 and 2012, respectively, and $20,504 and $20,560 for freight, delivery and warehousing expenses in first half 2013 and 2012, respectively. These expenses were 10.2% and 9.8% of net product sales in second quarter 2013 and 2012, respectively, and 9.7% and 9.4% of net product sales in first half 2013 and 2012, respectively.

Earnings from operations were $9,202 in second quarter 2013 compared to $11,009 in second quarter 2012, and were $20,102 in first half 2013 compared to $19,428 in first half 2012. Earnings from operations include $1,052 and ($1,009) of certain deferred compensation expenses (gains) in second quarter 2013 and 2012, respectively, and include $4,105 and $2,305 of certain deferred compensation expenses in first half 2013 and 2012, respectively. As discussed above, these deferred compensation expenses relate to changes in deferred compensation liabilities resulting from corresponding changes in the market value of trading securities and related investment income that hedge these liabilities. Adjusting for the aforementioned, operating earnings were $10,254 and $10,000 in second quarter 2013 and 2012, respectively, an increase of $254 or 2.5%; and operating earnings were $24,207 and $21,733 in first half 2013 and 2012, respectively, an increase of $2,474 or 11.4%. As a percentage of net product sales, these adjusted operating earnings were 10.1% and 9.2% in second quarter 2013 and 2012, respectively, an increase of 0.9% as a percentage of net product sales; and operating earnings were 11.4% and 10.0% in first half 2013 and 2012, respectively, an increase of 1.4% as a percentage of net product sales. The above discussed


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increases in adjusted operating earnings principally reflect more favorable gross profit margins offset by the adverse effects of lower sales as discussed above. Management believes the presentation in this and the preceding paragraphs relating to amounts adjusted for deferred compensation expense are more reflective of the underlying operations of the Company.

Other income (expense) net, was $1,705 in second quarter 2013 compared to $(444) in second quarter 2012, a favorable increase of $2,149; and other income (expense), net, was $4,296 in first half 2013 compared to $2,891 in first half 2012, a favorable increase of $1,405. Other income (expense), net for second quarter 2013 and 2012 includes aggregate net gains and investment income of $1,052 and $(1,009), respectively, on trading securities relating to deferred compensation programs as discussed above; and other income, net for first half 2013 and 2012 includes aggregate net gains and investment income of $4,105 and $2,305, respectively, on trading securities relating to these programs. These increases in trading securities were substantially offset by a like amount of deferred compensation expense included in product cost of goods sold and selling, marketing, and administrative expenses in the respective periods as discussed above.

Other income (expense) net, includes gains on foreign exchange of $281 and $605 in second quarter 2013 and 2012, respectively, and includes (losses) gains on foreign exchange of $(323) and $413 in first half 2013 and 2012, respectively. Other income (expense), net also includes $(196) and $(468) in second quarter 2013 and 2012, respectively, and $(477) and $(589) in first half 2013 and 2012, respectively, relating to the Company's equity investment in two 50% owned Spanish companies. Management believes that the business and economic challenges in Spain are likely to continue and may result in additional equity investment losses in the future, and that the Company's investment (carrying value of $1,794 at end of first half 2013) could suffer additional impairment loss at a future date (a pre-tax impairment loss of $850 was recorded in fourth quarter 2012).

The consolidated effective tax rates were 23.3% and 28.9% in second quarter 2013 and 2012, respectively, and 28.5% and 27.0% in first half 2013 and 2012, respectively. The lower effective income tax rate in second quarter 2013 compared to second quarter 2012 reflects the release of certain tax valuation allowances relating to prior capital losses as a result of capital gains realized in second quarter 2013. In addition, the Company's overall effective tax rate on foreign earnings, primarily Canada and Mexico, reflect statutory rates which are lower than the 35.0% U.S. statutory corporate income tax rate.

Net earnings were $8,369 in second quarter 2013 compared to $7,511 in second quarter 2012, and earnings per share were $0.14 and $0.12 in second quarter 2013 and second quarter 2012, respectively, an increase of $0.02 per share or 16.7%. First half 2013 net earnings were $17,438 compared to first half 2012 net earnings of $16,285, a $1,153 or 7.1% increase. First half net earnings per share were $0.29 in 2013 compared to $0.27 per share in first half 2012, an increase of $0.02 per share or 7.4%. The increase in earnings per share in second quarter and first half 2013 principally results from the improvements in gross profit margins as discussed above. Second quarter 2013 also benefited from a lower effective income tax rate as discussed above. Earnings per share for second quarter and first half 2013 did benefit from the reduction in average shares outstanding resulting from common stock purchases in the open market by the Company. Average shares outstanding decreased from 60,652 in second quarter 2012 to 59,667 in second quarter 2013, and from 60,728 in first half 2012 to 59,785 in first half 2013.

Goodwill and intangibles are assessed annually as of December 31 or whenever events or circumstances indicate that the carrying values may not be recoverable from future cash flows. The Company has not identified any triggering events, as defined, or other adverse information that would indicate a material impairment of its goodwill or intangibles in second quarter or first half 2013.

During 2012 and 2013, the Company received Annual Funding Notices, Notices of Funded Status, and a Rehabilitation Plan (Notices), as defined by the Pension Protection Act (PPA), from the Bakery and Confectionery Union and Industry International (BC&T) Pension Fund (Plan), a multi-employer defined benefit pension plan for certain Company union employees. The Notices indicate that the Plan's actuary has certified that the Plan is in critical status, the "Red Zone", as defined by the PPA, and that a plan of rehabilitation was adopted by the Trustees of the Plan (Trustees) in fourth quarter 2012. The Plan's actuary has certified that the Plan is 66.9% funded as of January 1, 2012. This funding percentage is based on actuarial values and not market values of investments. As of January 1, 2012 and 2011, the Plan was 66.9% and 83.6% funded based on the actuarial value of investments; however, it was only 55.6% and 70.0% funded based on the then current market value of its investments at these same dates.

Under the Rehabilitation Plan adopted, the Plan is projected to emerge from critical status sometime beyond the 30 year projection period. The Rehabilitation Plan requires that employer contributions include 5% compounded annual surcharges each year for an unspecified period of time beginning January 2013 (in addition to the 5% interim surcharge initiated in June 2012) as well as certain plan benefit reductions. The Trustees will review the Plan's progress each year and will consider if further adjustments, including employer surcharges or plan benefit modifications, are necessary to meet the objectives of


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the Rehabilitation Plan. The Company was advised by the Plan that if the Company had withdrawn from the Plan during 2012 its estimated withdrawal liability would have been $37,200. In first quarter 2013, the Company executed a new labor contract with its BC&T local union which included the Company's commitment to continue participating in this Plan through third quarter 2017. Should the Company actually withdraw from the Plan at a future date, a withdrawal liability, which could be higher than $37,200, would be payable to the Plan.

The risks of participating in multi-employer pension plans are different from single-employer plans. Assets contributed to a multi-employer plan by one employer may be used to provide benefits to employees of other participating employers. If a participating employer stops contributing to the plan, the remaining participating employers may be required to bear the unfunded obligations of the plan. The Company is currently unable to determine the ultimate outcome of the above discussed 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 in one or more future periods. See also the Company's consolidated financial statements and related notes and Management and Discussion and Analysis included in the Company's 2012 Form 10-K and annual report.

LIQUIDITY AND CAPITAL RESOURCES

Net cash flows provided by operating activities were $37,093 and $28,874 in first half 2013 and 2012, respectively. The $8,219 increase in cash flows from operating activities from first half 2012 to first half 2013 principally reflects higher net earnings and the decrease in prepaid expenses and other assets partially offset by increased inventories.

Net cash used in investing activities was $53,691 in first half 2013 compared to $24,517 in first half 2012. Cash flows from investing activities reflect $63,992 and $20,071 relating to the purchase of available for sale securities during first half 2013 and 2012, respectively. First half 2013 and first half 2012 also includes capital expenditures of $5,960 and $5,373, respectively. Capital expenditures for the 2013 year are anticipated to be generally in line with historical annualized spending, and are to be funded from the Company's cash flow from operations and internal sources.

The Company had no bank borrowings or repayments in first half 2013 or 2012, and had no outstanding bank borrowings as of the end of second quarter or first half 2013 or 2012.

Financing activities include Company common stock purchases and retirements of $10,568 and $7,076 in first half 2013 and 2012, respectively. Cash dividends of $4,750 and $9,276 were paid in first half 2013 and 2012, respectively. Fourth quarter 2012 included an accelerated payment of the regular quarterly dividend of $4,656 ($0.08 per share) which had historically been paid during the first week in January. This was in response to the uncertainty surrounding the future federal tax treatment of dividends at that time after giving consideration to the Company's cash and investment position.

The Company's current ratio (current assets divided by current liabilities) was 3.1 to 1 as of the end of first half 2013 as compared to 3.2 to 1 as of the end of fourth quarter 2012 and 3.4 to 1 as of the end of first half 2012. Net working capital was $130,726 as of the end of first half 2013 as compared to $136,476 and $148,884 as of the end of fourth quarter and first half 2012, respectively.

The aforementioned net working capital amounts include aggregate cash and cash equivalents and short-term investments of $56,814 as of the end of first half 2013 compared to $82,608 and $79,437 as of the end of fourth quarter and first half 2012, respectively. In addition, long term investments, principally debt securities comprising municipal bonds (including $10,163 of Jefferson County auction rate securities discussed below) and trading securities, were $168,751 as of the end of first half 2013, as compared to $124,685 and $114,889 as of the end of fourth quarter and first half 2012, respectively. Aggregate cash and cash equivalents and short and long-term investments were $225,565, $207,293, $194,326, as of the end of first half 2013, and as of the end of fourth quarter and first half 2012, respectively. The aforementioned includes $55,753, $49,378, and $46,240 as of the end of the first half 2013, and fourth quarter and first half 2012, respectively, relating to trading securities which are used as an economic hedge for the Company's deferred compensation liabilities. Investments in municipal bonds and other debt securities that matured during first half 2013 and 2012 were generally used to purchase the Company's common stock or were replaced with debt securities of similar maturities.

During 2008, the Company contributed $16,050 to a VEBA trust to fund the estimated future costs of certain employee health, welfare and other benefits. The Company used these funds, as well as investment income in this VEBA trust, to pay the actual cost of such benefits since 2008. As of the end of the first half 2013, the VEBA trust holds $419 of aggregate cash, cash equivalents and investments; this asset value is included in prepaid expenses in the Company's current assets.


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As of June 29, 2013, the Company's long-term investments include $10,162 ($13,550 original cost) of Jefferson County Alabama Sewer Revenue Refunding Warrants, originally purchased with an insurance-backed AAA rating. This is an auction rate security that is classified as an available-for-sale security. Due to adverse events related to Jefferson County and its bond insurance carrier, Financial Guaranty Insurance Company (FGIC), as well as events in the credit markets, the auctions for this auction rate security have failed since 2008. As such, the Company continues to estimate the fair value of this auction rate security utilizing a valuation model with Level 3 inputs, as defined by guidance. This valuation model considered, among others items, a limited number of market trades, the credit risk of the collateral underlying the auction rate security, the credit risk of the bond insurer, interest rates, and the amount and timing of expected future cash flows including assumptions about the market expectation of the next successful auction or possible negotiated settlement between Jefferson County and the debt holders. The trading range of these inputs was between 67.4% and 82.8% of the original par value. Both Jefferson County and FGIC are in bankruptcy. During the second quarter 2013, Jefferson County and the holders of its bonds and warrants reached an agreement whereby Jefferson County would issue replacement securities with a value of approximately 80% of the face value of the original bonds and warrants. The agreement is subject to approval by the bankruptcy court which is scheduled to meet at a future date. Nonetheless, future rulings by the bankruptcy courts could have adverse effects to the holders of warrants and other debt, and further reduce the market value of this auction rate security resulting in an additional other-than-temporary impairments and charges to net earnings. The Company is not currently able to determine with certainty the outcome of this matter, or the amount and timing of the ultimate net proceeds that it may recover. See also the Company's consolidated financial statements and related notes and Management and Discussion and Analysis included in the Company's 2012 Form 10-K and annual report.

ACCOUNTING PRONOUNCEMENTS

In July 2013, the FASB issued ASU 2013-11, which requires certain presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 provides explicit guidance on presentation in financial statements. The amendment is effective for reporting periods beginning after December 15, 2013. The Company does not expect adoption of this ASU to significantly impact its consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02 which requires additional disclosures regarding the reporting of reclassifications out of accumulated other comprehensive income. ASU 2013-02 requires an entity to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. This guidance is effective for reporting periods beginning after December 15, 2012. The Company adopted this guidance effective January 1, 2013. The Company's adoption of this standard did not have a significant impact on its consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, which allows an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test of an indefinite-lived intangible asset. Per the terms of this ASU, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on qualitative assessment, that it is not more likely than not, the indefinite-lived intangible asset is impaired. The revised standard is effective for annual and interim impairment tests performed for fiscal years beginning after December 15, 2012; however, early adoption is permitted. The Company does not expect adoption of this ASU to significantly impact its consolidated financial statements.

In March 2013, the FASB issued ASU 2013-05, which permits an entity to release cumulative translation adjustments into net income when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided, or, if a controlling financial interest is no longer held. The revised standard is effective for fiscal years beginning after December 15, 2013; however, early adoption is permitted. The Company does not expect adoption of this ASU to significantly impact its consolidated financial statements.


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RISK FACTORS

The Company's operations and financial results are subject to a number of risks and uncertainties that could adversely affect the Company's operating results and financial condition. Significant risk factors, without limitations, that could impact the Company, are the following: (i) significant competitive activity, including advertising, promotional and price competition, and changes in consumer demand for the Company's products; (ii) fluctuations in the cost and availability of commodities and ingredients, including the effects adverse weather and climate change, and packaging materials, and the ability to recover cost increases through product sales price increases; (iii) inherent risks in the marketplace, including uncertainties about trade and consumer acceptance of higher price realization and seasonal events such as Halloween; (iv) the effect of acquisitions on the Company's results of operations and financial condition;
(v) the effect of changes in foreign currencies on the Company's foreign subsidiaries operating results, and the effect of the fluctuation of the Canadian dollar on products manufactured in Canada and marketed and sold in the United States in U.S. dollars; (vi) the Company's reliance on third party vendors for various goods and services, including commodities used for ingredients that are primarily grown or sourced from foreign locations;
(vii) the Company's ability to successfully implement new production processes and lines, and new computer software systems; (viii) the effect of changes in assumptions, including discount rates, sales growth and profit margins and the capability to pass along higher ingredient and other input costs through price increases, relating to the Company's impairment testing and analysis of its goodwill and trademarks; (ix) changes in the confectionery marketplace including actions taken by major retailers and customers; (x) customer, consumer and competitor response to marketing programs and price and product weight adjustments, and new products; (xi) dependence on significant customers, including the volume and timing of their purchases, and availability of shelf space; (xii) increases in energy costs, including freight and delivery, that cannot be passed along to customers through increased price realization due to competitive reasons; (xiii) any significant labor stoppages, strikes or production interruptions; (xiv) changes in governmental laws and regulations including taxes and tariffs; (xv) the adverse effects should the Company either voluntarily or involuntarily recall its product(s) from the marketplace;
(xvi) the risk that the market value of Company's investments could decline including being classified as "other-than-temporary" as defined; (xvii) the Company's dependence on its enterprise resource planning computer system to manage its supply chain and customer deliveries, and the risk that the Company's information technology systems fail to perform adequately or the Company is unable to protect such information technology systems against data corruption, cyber-based attacks or network security breaches; (xviii) the potential effects of adverse effects, including rulings by bankruptcy courts, relating to the investment in the Jefferson County auction rate security and its insurance carrier; (xix) the potential adverse effects on the Company as to changes to improve the underfunding status of the Bakery and Confectionary Union and Industry Pension Plan (Plan), a multi-employer plan which covers certain Company union employees, and future adverse Plan investment results and/or actuarial changes to the Plan; (xx) the potential adverse effects of deteriorating economic and business conditions in Spain and the effects on the Company's equity investment in two 50% owned Spanish companies, and (xxi) the potential effects of current and future macroeconomic conditions and geopolitical events.

FORWARD-LOOKING STATEMENTS

This discussion and certain other sections contain forward-looking statements that are based largely on the Company's current expectations and are made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by the use of words such as "anticipated," "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. Such factors, risks, trends and uncertainties, which in some instances are beyond the Company's control, include the overall competitive environment in the Company's industry, changes in assumptions and judgments discussed above under the heading "Significant Accounting Policies and Estimates," and factors identified and referred to above under the heading "Risk Factors."

The risk factors identified and referred to above are believed to be significant factors, but not necessarily all of the significant factors that could cause actual results to differ from those expressed in any forward-looking statement. Readers are cautioned not to place undue reliance on such forward-looking statements, which are made only as of the date of this report. The Company undertakes no obligation to update such forward-looking statements.

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