TOOTSIE ROLL INDUSTRIES INC (TR) FY 2021 MD&A

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

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

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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.

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FINANCIAL REVIEW

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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.

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FINANCIAL CONDITION

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The Company’s overall financial position remains strong given that aggregate cash, cash equivalents and investments is $436,983 at December 31, 2021, including $89,736 in trading securities discussed below. Cash flows from 2021 operating activities totaled $85,298 compared to $74,710 in 2020, and are discussed in the section entitled Liquidity and Capital Resources. During 2021, the Company paid cash dividends of $24,136, purchased and retired $30,184 of its outstanding shares, and made capital expenditures of $31,426.

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The Company’s net working capital was $188,333 at December 31, 2021 compared to $250,851 at December 31, 2020. This change principally reflects the effects of a $71,155 increases in long-term investments because more of our investments have maturities greater than one year at December 31, 2021 compared to December 31, 2020. As of December 31, 2021, the Company’s total cash, cash equivalents and investments, including all long-term investments, was $436,983 compared to $428,951 at December 31, 2020, an increase of $8,032. See Liquidity And Capital Resources section below. The aforementioned includes $89,736 and $73,828 of investments in trading securities as of December 31, 2021 and 2020, 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.

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Shareholders’ equity increased from $763,327 at December 31, 2020 to $769,041 as of December 31, 2021, which principally reflects 2021 net earnings of $65,326, less cash dividends of $24,136 and share repurchases of $30,184.

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The Company has a relatively straight-forward financial structure and has historically maintained a conservative financial position. 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 2021. 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.

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RESULTS OF OPERATIONS

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2021 vs. 2020

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Twelve months 2021 consolidated net product sales were $566,043 compared to $467,427 in twelve months 2020, an increase of $98,616 or 21.1%. Fourth quarter 2021 net product sales were $166,598 compared to $127,866 in fourth quarter 2020, an increase of $38,732, or 30%. The growth in fourth quarter and twelve months 2021 sales reflect effective sales and marketing programs as well as the favorable effects of the continuing economic recovery from the adverse effects of the Covid-19 pandemic. The Company had continuing improvement in customer orders and sales throughout 2021 as consumers returned to more activities which included planned purchases of the Company’s products for “sharing” and “give-a-way” occasions. Many of the Company’s products are consumed at group events, outings, and other gatherings which had been significantly curtailed or in some cases eliminated in response to the Covid-19 virus. Fourth quarter 2021 sales also exceeded fourth quarter 2019 sales by 24% which provides a quarterly sales comparison to a period prior to the

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pandemic, and twelve months 2021 sales were 8% ahead of twelve months 2019 sales. Fourth quarter 2021 sales also benefited from the timing of some sales that were rescheduled from third to fourth quarter due to supply chain disruptions.

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Product cost of goods sold were $370,105 in 2021 compared to $299,710 in 2020, an increase of $70,395 or 23.5%. Product cost of goods sold includes $687 and $610 in certain deferred compensation expenses in 2021 and 2020, 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 $299,100 in 2020 to $369,418 in 2021, an increase of $70,318 or 23.5%. As a percent of net product sales, these adjusted costs increased from 64.0% in 2020 to 65.3% in 2021, a 1.3 unfavorable percentage point change. Fourth quarter and twelve months 2021 gross profit margins were adversely affected by increasing costs for ingredients, packaging materials, and certain manufacturing supplies and services. Fourth quarter and twelve months product cost of goods sold compared to the corresponding prior year periods, were also adversely impacted by inefficiencies caused by higher than expected sales demand, supply chain challenges and disruptions, longer supplier lead times, and some labor shortages. These factors resulted in additional costs related to our efforts to meet this higher demand. Certain cost and expense reductions, including Company initiatives to reduce costs did provide some benefit to 2021 gross profit margins.

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Selling, marketing and administrative expenses were $132,108 in 2021 compared to $112,117 in 2020, an increase of $19,991 or 17.8%. Selling, marketing and administrative expenses include $13,521 and $11,909 in certain deferred compensation expenses in 2021 and 2020, respectively. These deferred compensation expenses principally result from increases 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 $100,208 in 2020 to $118,587 in 2021, an increase of $18,379 or 18.3%. This increase was principally driven by the increase in certain variable expenses, primarily freight and delivery and direct selling expenses, relating to the increase in sales as discussed above. However, as a percent of net product sales, these adjusted expenses decreased from 21.4% of net product sales in 2020 to 21.0% of net product sales in 2021, a 0.4 favorable percentage point change.

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Selling, marketing and administrative expenses include freight, delivery and warehousing expenses. These expenses increased from $42,593 in 2020 to $55,289 in 2021, an increase of $12,696 or 29.8%. As a percent of net product sales, these adjusted expenses increased from 9.1% in 2020 to 9.8% in 2021, a 0.7 unfavorable percentage point change. Increasing energy costs and related effects on fuel surcharges, and the adverse effects of the continuing shortage of over-the-road drivers and high demand for carriers, were the principal drivers of these higher freight and delivery expenses in 2021 compared to 2020.

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In response to the higher input costs discussed above, the confectionary industry, as well as many companies in the broader consumer products industry, announced increases in selling prices. We have followed with price increases as well, with the objective of improving sales price realization and restoring margin declines. Price increases, which principally became effective during fourth quarter 2021, contributed to the improved results in fourth quarter 2021 as well as the twelve months 2021. Price increases for certain products that were not increased in 2021 have also been announced for first half 2022 in our continuing efforts to restore margins.

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Our input costs continued to remain elevated in fourth quarter 2021 and we expect even higher costs in 2022 as our 2021 supply contracts and hedging programs come to closure and new contracts and hedging at higher 2022 costs begin to take effect.  Higher commodity markets are driving up our costs for key ingredients, packaging materials and energy, including the adverse effects of higher energy costs on freight and delivery fuel surcharges and plant manufacturing utilities. We expect these higher input costs and the overall increase in inflation, some of which is driven by supply chain problems, to continue through most of, and possibly all of, 2022. The Company uses the Last-In-First-Out (LIFO) method of accounting for inventory and costs of goods sold which results in lower current income taxes during such periods of increasing costs, but this method does charge the most current costs to cost of goods sold and thereby accelerates the realization of these higher costs. Although the Company continues to monitor these higher input costs and price increases in the industry, we are mindful of the effects and limits of passing on all of the above discussed higher input costs to consumers of our products. As a result, we believe that margins for part or all of 2022 will not fully recover to historical norms.

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The Company has foreign operating businesses in Mexico, Canada and Spain, and exports products to many foreign markets. The Company’s Spanish subsidiary (97% owned by the Company) incurred an operating loss of $598 in 2021 which was an improvement compared to its $691 loss in 2020. Company management expects the competitive and business challenges in Spain to continue but believes that there will be continued reductions in operating losses in 2022 compared to 2021. Nonetheless, management believes that operating losses will likely continue beyond 2022 and that these future losses, as well as some capital expenditures, will likely require some additional cash financing.

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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 2021, 2020 or 2019. 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 2021 (and fourth quarters 2020 and 2019), 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 2021 (and fourth quarters 2020 and 2019) using discounted cash flows and estimated royalty rates. For these trademarks, holding all other assumptions constant at the test date, a 100 basis point increase in the discount rate or a 100 basis point decrease in the royalty rate would reduce the fair value of these trademarks by approximately 16% and 10%, respectively. Individually, a 100 basis point increase in the discount rate or a 100 basis point decrease in the royalty rate would not result in a potential impairment as of December 31, 2021.

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Earnings from operations were $67,133 in 2021 compared to $58,244 in 2020, an increase of $8,889. Earnings from operations include $14,208 and $12,519 in certain deferred compensation expense in 2021 and 2020, respectively, which are discussed above. Adjusting for these deferred compensation expenses, adjusted earnings from operations increased from $70,763 in 2020 to $81,341 in 2021, an increase of $10,578 or 14.9%. The above discussed increase in net product sales was the principal driver of higher operating earnings in 2021 compared to 2020. Although higher 2021 sales contributed to improved operating earnings compared to the corresponding prior year periods, higher input costs mitigated much of the benefits of increased sales.

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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.

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Other income, net was $18,596 in 2021 compared to $18,018 in 2020, an increase of $578. Other income, net principally reflects $14,208 and $12,519 of aggregate net gains and investment income on trading securities in 2021 and 2020, 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 $2,740 and $4,005 in 2021 and 2020, respectively. Other income, net also includes foreign exchange gains of $667 and $534 in 2021 and 2020, respectively.

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The Company’s effective income tax rate was 23.8% and 22.7% in 2021 and 2020, respectively. The increase in the effective tax rates in 2021 generally reflects higher rates for state income tax provisions. 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.

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The Company has provided a full valuation allowance on its Spanish subsidiaries’ tax loss carry-forward benefits of $4,376 and $4,508 as of December 31, 2021 and 2020, 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.

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U.S. tax reform (US Tax Cuts and Jobs Act enacted in December 2017) 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 U.S. tax reform significantly impact the accounting for the undistributed earnings of foreign subsidiaries. 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 determined that it would not be asserting permanent reinvestment of all of its foreign subsidiaries earnings as of December 31, 2017, and the Company continued to take this position as of December 31, 2021.

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Net earnings were $65,326 in 2021 compared to $58,995 in 2020, and net earnings per share were $0.97 and $0.86 in 2021 and 2020, respectively, an increase of $0.11 per share or 13%. Earnings per share in 2021 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 68,482 in 2020 to 67,431 in 2021 which reflects share repurchases of $30,184 during 2021.

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Fourth quarter 2021 and 2020 net earnings attributable to Tootsie Roll Industries, Inc. were $20,032 and $14,952, respectively, and net earnings per share were $0.30 and $0.22, respectively, an increase of $0.08 per share or 36%. The Company’s fourth quarter 2021 results were principally driven by its 30% increase in fourth quarter sales and price increases that became effective in fourth quarter 2021 as discussed above.

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Beginning in 2012, the Company received periodic notices from the Bakery and Confectionery Union and Industry International Pension Fund (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”, 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 2012. 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. The Company has continued to receive annual notices each year (2016 to 2021) that this Plan remains in “critical and declining status” and is projected to become insolvent within the next 20 years. These notices have 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 48.3%, 50.4%, and 51.6% as of the most recent valuation dates available, January 1, 2020, 2019, and 2018, 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, 2020 the funded percentage would be 51.6% (not 48.3%). As of the January 1, 2020 valuation date (most recent valuation available), only 16% of Plan participants were current active employees, 53% were retired or separated from service and receiving benefits, and 31% were retired or separated from service and entitled to future benefits. The number of current active employee Plan participants as of January 1, 2020 fell 4% from the previous year and 17% over the past two years. When compared to the Plan valuation date of January 1, 2011 (just prior to the Plan being certified to be in “critical status”), current active employee participants have declined 49%, whereas participants who were retired or separated from service and receiving benefits increased 4% and participants who were retired or separated from service and entitled to future benefits increased 12%.

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The Company has been advised that its withdrawal liability would have been $104,300, $99,300 and $99,800 if it had withdrawn from the Plan during 2021, 2020 and 2019, respectively. The Company’s relative share of the Plan’s contribution base, driven by employer withdrawals, has increased for the last several years, and management believes that this trend could continue indefinitely which will continue to add upward pressure on the Company’s withdrawal liability. Based on the above, including the Plan’s projected insolvency in the next 20 years, management believes that the Company’s withdrawal liability could increase further in future years.

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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 $2,793 which have a present value in the range of $32,800 to $46,600 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 $45,764 to $142,447 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.

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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 expiration of this union contract). 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 2021, 2020 and 2019 was $3,156, $2,866 and $2,961, respectively. The aforementioned expense includes surcharges of $1,112, $1,010 and $948 in 2021, 2020 and 2019, respectively, as required under the amended rehabilitation plan.

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In fourth quarter 2020, the Plan Trustees advised the Company that the surcharges would no longer increase annually and therefore be “frozen” at the rates and amounts in effect as of December 31, 2020 provided that the local bargaining union and the Company executed a formal consent agreement by March 31, 2021. The Trustees advised that they have concluded that continuing increases in surcharges would likely have a long-term adverse effect on the solvency of the Plan. The Trustees concluded that further increases would result in increasing financial hardships and withdrawals of participating employers, and that this change will not have a material effect on the Plan’s insolvency date. In first quarter 2021, the local bargaining union and the Company executed this agreement which resulted in the “freezing” of such surcharges as of December 31, 2020.

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The Plan recently advised the Company that it will be applying for benefits available to financial troubled plans under the American Rescue Plan Act of 2021. Company management understands that this legislation would provide financial assistance from the PBGC to shore up financially distressed multi-employer plans to ensure that they can remain solvent and continue to pay benefits to retirees through 2051 without any reduction in retiree benefits. Nonetheless, the Company’s actuary believes that given the Plan’s projected insolvency date of 2031 as well as other factors, that it still remains unclear if the Plan can remain solvent through the targeted date of 2051. The Company’s actuary also advised that the regulations under the aforementioned PBGC financial assistance could result in a higher withdrawal liability even with PBGC financial assistance. 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 of the Company’s Note to Consolidated Financial Statements on Form 10-K for the year ended December 31, 2021.

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2020 vs. 2019

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Twelve months 2020 consolidated net product sales were $467,427 compared to $523,616 in twelve months 2019, a decrease of $56,189 or 10.7%. Net product sales were adversely impacted by the effects of the Covid-19 pandemic, which curtailed and limited access to certain channels of trade where the Company has historically sold its products. Response to this pandemic has resulted in the disruption and changes in lifestyles, shopping habits, daily work routines, and consumer behaviors, all of which have adversely affected planned consumer purchases of the Company’s products for “sharing” and “give away” occasions. Many of the Company’s products are consumed at group events, outings, and other gatherings which have been significantly curtailed or in some cases eliminated due to concern of possible infection or spreading of the Covid-19 virus. Impulse purchases of Company products at retail outlets have also been adversely affected by these changes in consumer behavior. Unfavorable foreign exchange also had some adverse impact on 2020 net product sales compared to 2019.

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Fourth quarter 2020 net product sales were $127,866 compared to $134,663 in fourth quarter 2019, a decrease of $6,797 or 5.0%. After a 2% sales increase in first quarter 2020, sales declined 25% in second quarter 2020 at the height of the pandemic and economic downturn. In third quarter 2020 sales declined 14%, while in fourth quarter 2020 the sales decline was narrowed to 5% when compared to the corresponding quarterly periods in 2019.

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Product cost of goods sold were $299,710 in 2020 compared to $329,102 in 2019, a decrease of $29,392 or 8.9%. Product cost of goods sold includes $610 and $408 in certain deferred compensation expenses in 2020 and 2019, respectively. These deferred compensation expenses principally result from changes in the market value of investments and investment income from trading securities relating to compensation deferred in previous years and are not reflective of current operating results. Adjusting for the aforementioned, product cost of goods sold decreased from $328,694 in 2019 to $299,100 in 2020, a decrease of $29,594 or 9.0%. As a percent of net product sales, these adjusted costs increased from 62.8% in 2019 to 64.0% in 2020, a 1.2 unfavorable percentage point change. Lower sales and production volumes had an unfavorable impact on plant manufacturing overhead costs included in the aforementioned adjusted product cost of goods sold. These plant overhead costs are primarily fixed and recurring each year, and only partially decline with lower volumes.

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Product gross margin was $167,717 in 2020 compared to $194,514 in 2019, a decrease of $26,797 or 13.8%.  The above discussed sales decline was the principal driver that adversely impacted gross profit margins in 2020. Certain cost and expense reductions, including Company initiatives to reduce costs did provide some benefit to 2020 gross profit margins. The Company is continuing its investments in its plant manufacturing operations to meet new consumer and customer demands, achieve quality improvements, provide genuine value to consumers, and increase operational efficiencies.

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Selling, marketing and administrative expenses were $112,117 in 2020 compared to $127,802 in 2019, a decrease of $15,685 or 12.3%. Selling, marketing and administrative expenses include $11,909 and $10,884 in certain deferred compensation expenses in 2020 and 2019, 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 decreased from $116,918 in 2019 to $100,208 in 2020, a decrease of $16,710 or 14.3%. As a percent of net product sales, these adjusted expenses decreased from 22.3% of net product sales in 2019 to 21.4% of net product sales in 2020, a 0.9 favorable percentage point change. Reductions in travel and trade show expense resulting from changes in Company policies in response to the Covid-19 pandemic, and more favorable freight and delivery unit costs were the principal drivers in this expense reduction as a percentage of sales in 2020.

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Selling, marketing and administrative expenses include freight, delivery and warehousing expenses. These expenses decreased from $49,288 in 2019 to $42,593 in 2020, a decrease of $6,695 or 13.6%. As a percent of net product sales, these adjusted expenses decreased from 9.4% in 2019 to 9.1% in 2020, a 0.3 favorable percentage point change. More favorable freight and delivery rates from third-party over-the-road truck carriers, and certain operational and cost reduction initiatives, contributed to this favorable change.

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Earnings from operations were $58,244 in 2020 compared to $69,214 in 2019, a decrease of $10,970. Earnings from operations include $12,519 and $11,292 in certain deferred compensation expense in 2020 and 2019, respectively, which are discussed above. Adjusting for these deferred compensation expenses, adjusted earnings from operations decreased

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from $80,506 in 2019 to $70,763 in 2019, a decrease of $9,743 or 12.1%. The above discussed decline in net product sales was the principal driver of lower operating income in 2020 compared to 2019, however, 2020 earnings from operations did benefit from some cost and expense reductions as discussed above.

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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.

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Other income, net was $18,018 in 2020 compared to $16,190 in 2019, an increase of $1,828. Other income, net principally reflects $12,519 and $11,292 of aggregate net gains and investment income on trading securities in 2020 and 2019, 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 $4,005 and $4,423 in 2020 and 2019, respectively. Other income, net also includes foreign exchange gains (losses) of $534 and $(533) in 2020 and 2019, respectively.

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The Company’s effective income tax rate was 22.7% and 24.1% in 2020 and 2019, respectively. The decrease in the effective tax rate in 2020 reflects more favorable foreign tax rates, income tax credits and adjustments for reserves for uncertain tax positions.

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The Company utilized $617 and $1,227 of Canadian tax carry-forward benefits in 2020 and 2019, respectively. At December 31, 2019, the Company’s deferred tax assets included $617 of income tax benefits relating to its Canadian subsidiary tax loss carry-forwards. The Company fully utilized this deferred tax asset in 2020 as expected. The Company provided a full valuation allowance on its Spanish subsidiaries’ tax loss carry-forward benefits of $4,508 and $4,584 as of December 31, 2020 and 2019, respectively, because the Company concluded that it is not more-likely-than-not that these losses will be utilized before their expiration dates.

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On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into U.S. law. The CARES Act has provided a substantial stimulus and assistance package intended to address the economic impact of the Covid-19 pandemic, including tax relief and government loans, grants and investments. The Canadian government also enacted a stimulus program, Canadian Emergency Wage Subsidy (“CEWS”), to respond to the economic impact of Covid-19 during 2020. The Company’s financial results in 2020 did reflect some benefits, primarily in the second and third quarters of 2020, from these stimulus programs.

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Net earnings were $58,995 in 2020 compared to $64,920 in 2019, and net earnings per share were $0.86 and $0.94 in 2020 and 2019, respectively, a decrease of $0.08 per share of 9%. Earnings per share in 2020 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 69,386 in 2019 to 68,482 in 2020 which reflects share repurchases of $32,055 during 2020.

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Fourth quarter 2020 and 2019 net earnings attributable to Tootsie Roll Industries, Inc. were $14,952 and $14,555, respectively, and net earnings per share were $0.22 and $0.21, respectively, an increase of $0.01 per share or 5%. Certain cost and expense reductions, including Company operational changes and initiatives to reduce costs as discussed above, did provide some benefit to fourth quarter 2020 results. Although unfavorable foreign exchange adversely affected fourth quarter 2020 results, a lower effective income tax rate contributed to the increase in net earnings in fourth quarter 2020 compared to fourth quarter 2019.

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Our Company is focused on the longer term and therefore we are continuing to make investments in plant manufacturing operations to meet new consumer and customer product demands, achieve product quality improvements, and increase operational efficiencies in order to provide genuine value to consumers. We are continuing to focus on the supply chain and possible delays and disruptions, but this area continues to have much less predictability compared to past history. The effects of the Covid-19 pandemic, including variants and sub-variants, are unprecedented, and therefore the Company is unable to determine the related effects on its sales and net earnings in 2022 and beyond.

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LIQUIDITY AND CAPITAL RESOURCES

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Cash flows from operating activities were $85,298, $74,710 and $100,221 in 2021, 2020 and 2019, respectively. The $10,588 increase in cash flows from operating activities from 2020 to 2021 primarily reflects increases in net earnings as a result of higher revenue as the Company experienced the favorable effects of the continuing economic recovery from the adverse effects of the Covid-19 pandemic. Increases in accounts payable and accrued liabilities in 2021 compared to 2020 as a result of higher production to support the recovery in demand discussed above and payments of deferred compensation that reduced cash flows from operations in 2020 were offset by an increase in accounts receivable also due to higher revenue. The $25,511 decrease in cash flows from operating activities from 2019 to 2020 primarily reflects decreases in net earnings and payments of deferred compensation in 2020.

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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 in 2017; no contribution was made to the trust during 2019, 2020 or 2021. The Company uses these funds to pay the actual cost of such benefits over each union contract period. At December 31, 2021 and 2020, the VEBA trust held $3,941 and $8,272, respectively, of aggregate cash and cash equivalents, which the Company will use to pay certain union employee benefits through part or all of 2022. This asset value is included in prepaid expenses and long-term other assets in the Company’s Consolidated Statement of Financial Position and is categorized as Level 1 within the fair value hierarchy.

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Cash flows from investing activities reflect capital expenditures of $31,426, $17,970, and $20,258 in 2021, 2020 and 2019, respectively. The increase amounts from 2020 to 2021 principally reflects the timing of expenditures relating to plant manufacturing capital projects, primarily for the rehabilitation upgrade and expansion of one of its manufacturing plants in the U.S.A. The Company spent approximately $15,000, $6,000 and $2,000 in 2021, 2020 and 2019, respectively, for this plant rehabilitation upgrade and expansion and expects additional cash outlays for this project to approximate $2,000 in 2022. All capital expenditures have been or are expected to be funded from the Company’s cash flow from operations and internal sources including available for sale securities. The repayment of $2,514 of previously paid premiums on split dollar life insurance policies did provide additional cash from investing activities in 2021.

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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 2019, 2020, or 2021, and had no outstanding bank borrowings as of December 31, 2020 or 2021. Nonetheless, the Company would consider bank borrowing or other financing in the event that a business acquisition is completed.

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Financing activities include Company common stock purchases and retirements of $30,184, $32,055, and $34,116 in 2021, 2020 and 2019, respectively. Cash dividends of $24,136, $23,810, and $23,460 were paid in 2021, 2020 and 2019, respectively.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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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.

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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.

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Revenue recognition

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As further discussed in Note 1 of the Company’s Notes to Consolidated Financial Statements, the Company follows the revenue recognition guidance in ASC 606. ASC 606 requires adjustments for estimated customer cash discounts upon payment, discounts for price adjustments, product returns, allowances, and certain advertising and promotional costs, including consumer coupons, which are variable consideration and are recorded as a reduction of product sales revenue in the same period the related product sales are recorded. Such estimates are calculated using historical averages adjusted for any expected changes due to current business conditions and experience.  Revenue for net product sales is 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 of the Company’s Notes to Consolidated Financial Statements.

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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 2021, 2020 and 2019, and accordingly, have not been significant to the Company’s financial position or results of operations.

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Intangible assets

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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 2021, the Company performed a “step zero” test of its goodwill and certain trademarks, and concluded that there was no impairment based on this guidance.

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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 are reduced to fair value. The Company utilizes third-party professional valuation firms to assist in the determination of valuation of certain 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.

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Customer incentive programs, advertising and marketing

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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.

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Valuation of long-lived assets

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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.

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Income taxes

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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.

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Valuation of investments

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Investments primarily comprise high quality corporate 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.

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Other matters

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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, operational services, and capital expenditures, all entered into in the ordinary course of business, the Company does not have any significant contractual obligations or future commitments.

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RECENT ACCOUNTING PRONOUNCEMENTS

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

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MARKET RISKS

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

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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 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.

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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, if applicable, 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.

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Commodity future and foreign currency forward contracts

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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.

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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.

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The potential change in fair value of commodity and foreign currency derivative instruments held by the Company at December 31, 2021, assuming a 10% change in the underlying contract price, was $1,274. 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.

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Interest rates

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

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The majority of the Company’s investments, which are classified as available for sale, have historically been held until their maturity which is generally up to about 3 years, which limits the Company’s exposure to interest rate fluctuations. The Company also invests in variable rate demand notes which have interest rates that 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, 2021.

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The Company’s outstanding debt at December 31, 2021 and 2020 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.

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Investment in marketable securities

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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 higher interest rates, 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 and future outcomes may be less predictable than in the past.

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Equity price

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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.

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Foreign currency

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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, generally the European Union where the EURO is the currency.

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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.

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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 11 of the Company’s Notes to Consolidated Financial Statements for outstanding foreign exchange forward contracts as of December 31, 2021.

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QUARTERLY FINANCIAL DATA

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Net earnings per share is based upon average outstanding shares as adjusted for 3% stock dividends issued during the second quarter of each year as discussed above. The sum of the quarterly per share amounts may not equal annual amounts due to rounding.

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