UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2017.

or

For the Transition Period from                to

Commission File Number 001-32504

TreeHouse Foods, Inc.

(Exact name of the registrant as specified in its charter)

 

(Registrant’s telephone number, including area code) (708) 483-1300

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

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

Indicate by check mark 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” and “smaller reporting 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  ☒

Number of shares of Common Stock, $0.01 par value, outstanding as of October 31, 2017: 57,215,184

 

 

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Table of Contents

 

 

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Part I — Financial Information

Item 1. Financial Statements

TREEHOUSE FOODS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions, except per share data)

 

 

See Notes to Condensed Consolidated Financial Statements.

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TREEHOUSE FOODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In millions, except per share data)

 

 

See Notes to Condensed Consolidated Financial Statements.

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TREEHOUSE FOODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME  

(In millions)

 

 

See Notes to Condensed Consolidated Financial Statements.

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TREEHOUSE FOODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of and for the nine months ended September 30, 2017

(Unaudited)

1. BASIS OF PRESENTATION

The unaudited Condensed Consolidated Financial Statements included herein have been prepared by TreeHouse Foods, Inc. and its consolidated subsidiaries (the “Company,” “TreeHouse,” “we,” “us,” or “our”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to quarterly reporting on Form 10-Q. In our opinion, these statements include all adjustments necessary for a fair presentation of the results of all interim periods reported herein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted as permitted by such rules and regulations. Certain prior year amounts in the Condensed Consolidated Statements of Cash Flows have been reclassified to conform to the current period presentation. The Condensed Consolidated Financial Statements and related notes should be read in conjunction with the Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016. Results of operations for interim periods are not necessarily indicative of annual results.

In the first quarter of 2017, the Company completed changes in its organizational structure that resulted in a change in how the Company manages its business and allocates resources. As a result, the Company revised its reportable segments to reflect how management currently reviews financial information and makes operating decisions. See Note 18 for additional details. All prior period amounts have been recast to reflect the change in reportable segments.  

On February 1, 2016, the Company acquired all of the outstanding common stock of Ralcorp Holdings, Inc., the Missouri corporation through which the private brands business (“Private Brands Business”) of ConAgra Foods, Inc. was operated. Ralcorp Holdings, Inc. was renamed TreeHouse Private Brands, Inc. during the first quarter of 2016. The results of operations of the Private Brands Business are included in our financial statements from the date of acquisition and are included in the Baked Goods, Condiments, Meals, and Snacks segments, as applicable.

The Private Brands Business was on a 4-4-5 fiscal calendar during the third quarter of 2016, and September 25, 2016 was the fiscal period end closest to the Company’s fiscal quarter end. This difference did not have a significant impact on the results of operations of the Private Brands Business. In the fourth quarter of 2016, the Company changed the fiscal year end of the Private Brands Business to December 31. The Company did not retrospectively apply the effects of this change to the three and nine month periods ended September 30, 2016 due to impracticability, and believes the effects would be immaterial.

The preparation of our Condensed Consolidated Financial Statements in conformity with GAAP requires us to use our judgment to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements, and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from these estimates.

A detailed description of the Company’s significant accounting policies can be found in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

2. RESTRUCTURING AND MARGIN IMPROVEMENT ACTIVITIES

The Company’s restructuring and margin improvement activities are part of an enterprise-wide transformation to improve long-term profitability of the Company. Upon completion of our multi-year multi-phase programs, the projects are expected to deliver higher margin sales growth and reduced expenses resulting in margin expansion.

 

Expenses associated with these programs are primarily aggregated in the Other operating expense, net line of the Condensed Consolidated Statements of Operations, with the exception of asset-related costs, which are recorded in Cost of sales. During the three months ended September 30, 2017, the Company recorded total charges $20.7 million across all restructuring programs and margin improvement activities.  The charges included $10.2 million recorded in Cost of sales and $10.5 million recorded in Other operating expenses, net.  During the three months ended September 30, 2016, the Company recorded total charges of $5.9 million across all restructuring programs and margin improvement activities.  The charges included $1.0 million recorded in Cost of sales and $4.9 million recorded in Other operating expenses, net.  During the nine months ended September 30, 2017, the Company recorded charges of $39.5 million across all restructuring programs and margin improvement activities.  These charges included $13.5 million recorded in Cost of sales and $26.0 million recorded in Other operating expenses, net.  During the nine months ended September 30, 2016, the Company recorded charges of $12.9 million across all restructuring programs and margin improvement activities.  These charges included $3.9 million recorded in Cost of sales and $9.0 million recorded in Other operating expenses, net.  The Company does not allocate restructuring and margin improvement activities costs to reportable segments when evaluating the performance of its

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

segments.  As a result, restructuring and margin improvement activities costs by reportable segment has not been presented. See Note 18 for more information.

TreeHouse 2020

 

In the third quarter of 2017, the Company announced TreeHouse 2020, a program intended to accelerate long-term growth through optimization of our manufacturing network, transformation of our mixing centers and warehouse footprint, and leveraging of systems and processes to drive performance.  TreeHouse 2020 is expected to produce significant savings to achieve our operating margin expansion targets creating reinvestment opportunities to drive future growth.

 

This program will be executed in multiple phases over the next several years.  The key elements of Phase 1 include the closure of the Company’s Brooklyn Park, Minnesota and Plymouth, Indiana facilities, as well as the downsizing of the Dothan, Alabama facility.  Production at the Brooklyn Park, Minnesota and Plymouth, Indiana facilities is expected to cease in the fourth quarter of 2017.  The facility downsizing at Dothan, Alabama is expected to be complete in the third quarter of 2018.  In addition, we have taken steps toward increasing our capacity utilization, operational margin expansion, and streamlining our plant structure to optimize our supply chain.    

 

Below is a summary of costs by type associated with TreeHouse 2020:

 

 

For the three months ended September 30, 2017 asset-related costs primarily consisted of accelerated depreciation; employee-related costs primarily consisted of severance; and other costs primarily consisted of third-party costs.  

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 Other Restructuring and Plant Closing Costs

 

The Company continually analyzes its plant network to align operations with the current and future needs of its customers. Facility closure decisions are made when the Company identifies opportunities to lower production costs or eliminate excess manufacturing capacity while maintaining a competitive cost structure, service levels, and product quality. Expenses associated with facility closures are primarily aggregated in the Other operating expense, net line of the Condensed Consolidated Statements of Operations, with the exception of asset-related costs, which are recorded in Cost of sales. The key information regarding the Company’s announced facility closures is outlined in the table below. 

 

 

Total expected costs to close the City of Industry, California, Ayer, Massachusetts, Ripon, Wisconsin, and Delta, British Columbia facilities have been reduced by approximately $4.9 million, $0.6 million, $1.2  million, and $1.5 million, respectively, since the initial announcements, while total expected costs to close the Azusa, California and Battle Creek, Michigan facilities have been increased by approximately $4.6 million and $0.9 million, respectively, since their initial announcement.

Below is a summary of the plant closing costs by type of cost:

 

 

For the three months ended September 30, 2017, asset-related costs primarily consisted of accelerated depreciation; employee-related costs primarily consisted of severance; and other costs primarily consisted of third-party costs.  

 

Other individually insignificant cost reduction activities not related to our plant closings above totaled $3.1 million for the three months ended September 30, 2017 and $5.4 million for the nine months ended September 30, 2017 and were primarily the result of a Private Brands plant closure initiated prior to TreeHouse’s acquisition.  Other cost reduction activities were insignificant for the three months ended September 30, 2016 and $2.5 million for the nine months ended September 30, 2016.  

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Liabilities recorded as of September 30, 2017 associated with total exit cost reserves relate to severance, the partial withdrawal from a multiemployer pension plan, and lease termination costs. The severance and lease termination liabilities were included in the Accounts payable and accrued expenses line of the Condensed Consolidated Balance Sheets, while the multiemployer pension plan withdrawal liability was included in the Other long-term liabilities line of the Condensed Consolidated Balance Sheets. The table below presents a reconciliation of the liabilities as of September 30, 2017:

 

 

 

3. ACQUISITIONS

Private Brands Business

On February 1, 2016, the Company acquired the Private Brands Business, which is primarily engaged in manufacturing, distributing, and marketing private label products to retail grocery, food away from home, and industrial and export customers. The business’s primary product categories include snacks, retail bakery, pasta, cereal, bars, and condiments. The purchase price, after considering working capital adjustments, was $2,644.4 million, net of acquired cash.   

The Private Brands Business acquisition was accounted for under the acquisition method of accounting and the results of operations were included in our Condensed Consolidated Financial Statements from the date of acquisition in the Baked Goods, Condiments, Meals, and Snacks segments. Included in the Company’s Condensed Consolidated Statements of Operations are the Private Brands Business’s net sales of approximately $2,074.6 million and income before income taxes of $55.6 million from the date of acquisition through September 30, 2016. Integration costs of $7.5 million, which were included in the Cost of sales and General and administrative expense lines of the Condensed Consolidated Statements of Operations, were included in determining income before income taxes.

We have completed the purchase price allocation to net tangible and intangible assets acquired and liabilities assumed as follows:

 

 

The Company allocated $496.1 million to customer relationships with retail grocery customers, which have an estimated life of 13 years, and $14.8 million to customer relationships with food away from home customers, which have an estimated life of 10 years. The Company allocated $33.0 million to trade names, which have an estimated life of 10 years. The Company allocated $23.2 million to formulas, which have an estimated life of 5 years. The Company allocated $19.6 million to capitalized software with estimated lives

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

of 1 to 5 years, depending on expected use. The aforementioned intangibles will be amortized over their expected useful lives. Indemnification assets related to taxes of approximately $13.8 million were also recorded. The Company increased the cost of acquired inventories by approximately $8.4 million and expensed the amount as a component of Cost of sales. The Company has allocated $555.0 million, $73.3 million, $413.8 million, and $97.9 million of goodwill to the Baked Goods, Condiments, Meals, and Snacks segments, respectively. Goodwill arises principally as a result of expansion opportunities and synergies across both new and legacy product categories. None of the goodwill resulting from this acquisition is tax deductible. The Company incurred approximately $35.2 million in acquisition costs in 2016 and none in 2017. These costs are included in the General and administrative expense line of the Condensed Consolidated Statements of Operations.

The fair values for customer relationships at the acquisition date were determined using the excess earnings method under the income approach. Trade name fair values were determined using the relief from royalty method, while the fair value of formulas was determined using the cost approach. Real property fair values were determined using the cost and market approaches, while the fair value of personal property was determined using the indirect cost approach. The fair value measurements of intangible assets are based on significant unobservable inputs, and thus represent Level 3 inputs. Significant assumptions used in assessing the fair values of intangible assets include discounted future cash flows, customer attrition rates, and royalty rates.

Since the preliminary purchase price allocation included in the Company’s Annual Report for the fiscal year ended December 31, 2016, the Company recorded purchase price adjustments related to taxes, resulting in an increase to goodwill of approximately $3.0 million in the first quarter of 2017. These adjustments did not impact the Condensed Consolidated Statements of Operations.

The following unaudited pro forma information shows the results of operations for the Company as if its acquisition of the Private Brands Business had been completed as of January 1, 2016. Adjustments have been made for the pro forma effects of depreciation and amortization of tangible and intangible assets recognized as part of the business combination, the issuance of common stock, interest expense related to the financing of the business combination, and related income taxes. Excluded from the 2016 pro forma results were $35.2 million of costs incurred by the Company in connection with the acquisition. The pro forma results may not necessarily reflect actual results of operations that would have been achieved, nor are they necessarily indicative of future results of operations.

 

 

4. INVENTORIES

 

 

Inventory was generally accounted for under the FIFO method, and a portion was accounted for under the last-in, first-out (“LIFO”) method and the weighted average costing approach. Approximately $95.1 million and $105.9 million of our inventory was accounted for under the LIFO method of accounting at September 30, 2017 and December 31, 2016, respectively. Approximately $197.8 million and $116.2 million of our inventory was accounted for using the weighted average costing approach at September 30, 2017 and December 31, 2016, respectively.

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

5. PROPERTY, PLANT, AND EQUIPMENT

 

 

Depreciation expense was $45.7 million and $46.7 million for the three months ended September 30, 2017 and 2016, respectively, and $127.4 million and $127.2 million for the nine months ended September 30, 2017 and 2016, respectively.

6. GOODWILL AND INTANGIBLE ASSETS

As a result of the changes in organizational structure completed in the first quarter of 2017, the Company has the following five operating segments, which are also its reporting units: Baked Goods, Beverages, Condiments, Meals, and Snacks. See Note 18 for more information.

The Company allocated the goodwill balance as of January 1, 2017 between the new reporting units using a relative fair value allocation approach. The change was considered a triggering event indicating a test for goodwill impairment was required as of January 1, 2017. The Company performed the first step of the impairment test, which did not result in the identification of any impairment losses. Changes in the carrying amount of goodwill for the nine months ended September 30, 2017 are as follows:

 

 

The carrying amounts of our intangible assets with indefinite lives, other than goodwill, as of September 30, 2017 and December 31, 2016 are as follows:

 

 

The increase in the indefinite lived intangibles balance is due to foreign currency translation.

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The gross carrying amounts and accumulated amortization of intangible assets with finite lives as of September 30, 2017 and December 31, 2016 are as follows:

 

 

Total intangible assets, excluding goodwill, as of September 30, 2017 and December 31, 2016 were $1,068.3 million and $1,137.6 million, respectively. Amortization expense on intangible assets for the three months ended September 30, 2017 and 2016 was $28.5 million and $28.6 million, respectively, and $85.8 million and $80.9 million for the nine months ended September 30, 2017 and 2016, respectively. Estimated amortization expense on intangible assets for 2017 and the next four years is as follows:

 

 

7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

 

 

 

8. INCOME TAXES

 

Income taxes were recorded at an effective rate of 4.3% and (65.2)% for the three and nine months ended September 30, 2017, respectively, compared to 28.9% and 24.0% for the three and nine months ended September 30, 2016, respectively. The changes in the effective tax rates for the three and nine months ended September 30, 2017 compared to September 30, 2016 was primarily a result of the income tax benefits related to share-based payments, the income tax benefit from the release of reserves for unrecognized tax benefits, and the income tax benefit derived from foreign tax credits.  Our effective tax rate may change from period to period based on recurring and non-recurring factors including the jurisdictional mix of earnings, enacted tax legislation, state income taxes, settlement of tax audits, and the expiration of the statute of limitations in relation to unrecognized tax benefits.  

The Company’s effective tax rate differs from the U.S. federal statutory tax rate primarily due to state tax expense, the benefits associated with the federal domestic production activities deduction, and an intercompany financing structure entered into in

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

conjunction with the E.D. Smith Foods, Ltd. (“E.D. Smith”) acquisition in 2007. In addition, the Company’s effective tax rate for the nine months ended September 30, 2017 reflects a discrete benefit of approximately 17.7% attributable to the vesting and exercise of share-based awards.

The Internal Revenue Service (“IRS”) is currently examining the TreeHouse Foods, Inc. & Subsidiaries’ 2015 tax year. Our Canadian operations are under exam by the Canadian Revenue Agency (“CRA”) for tax years 2008 through 2015. These examinations are expected to be completed in 2017 or 2018. The Italian Agency of Revenue (“IAR”) is examining the 2007 through 2009 and 2013 tax years of our Italian operations. The IAR examinations are not expected to be completed prior to 2020 due to a backlog of appeals before the agency. The Company has examinations in process with various state taxing authorities, which are expected to be completed in 2017 and 2018.

Management estimates that it is reasonably possible that the total amount of unrecognized tax benefits could decrease by as much as $9.2 million within the next 12 months, primarily as a result of the resolution of audits currently in progress and the lapsing of statutes of limitations. Approximately $1.5 million of the $9.2 million would affect net income when settled.

9. LONG-TERM DEBT

 

 

On February 1, 2016, coincident with the closing of the acquisition of the Private Brands Business, the Company entered into the Amended and Restated Credit Agreement. The Amended and Restated Credit Agreement (1) amended the maturity dates of the Revolving Credit Facility, Term Loan A, and Term Loan A-1 so that they are conterminous and mature on February 1, 2021, (2) provided for the issuance of Term Loan A-2, and (3) increased credit spreads. The proceeds from Term Loan A-2 were used to fund a portion of the purchase price of the Private Brands Business.   After satisfying all of the required collateral release conditions set forth in the Credit Agreement, the Credit Facility became unsecured in August 2017.  Amongst other conditions, the Company had to reach a leverage ratio of 3.5 as defined in the Credit Agreement and have no other pari-passu secured debt outstanding to become unsecured.

The Revolving Credit Facility, Term Loan A, Term Loan A-1, and Term Loan A-2 are known collectively as the “Amended and Restated Credit Agreement.” The Company’s average interest rate on debt outstanding under its Amended and Restated Credit Agreement for the three months ended September 30, 2017 was 3.106%. Including the interest rate swap agreements described below with a weighted average fixed interest rate base of approximately 0.86% on $500 million, the average rate decreases to 2.99%.

Revolving Credit Facility — As of September 30, 2017, $729.5 million of the aggregate commitment of $900 million of the Revolving Credit Facility was available. Under the Amended and Restated Credit Agreement, the Revolving Credit Facility matures on February 1, 2021. In addition, as of September 30, 2017, there were $50.5 million in letters of credit under the Revolving Credit Facility that were issued but undrawn, which have been included as a reduction to the calculation of available credit.

10. EARNINGS PER SHARE

Basic earnings per share is computed by dividing net income by the number of weighted average common shares outstanding during the reporting period. The weighted average number of common shares used in the diluted earnings per share calculation is determined using the treasury stock method and includes the incremental effect related to the Company’s outstanding stock-based compensation awards.

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table summarizes the effect of the share-based compensation awards on the weighted average number of shares outstanding used in calculating diluted earnings per share:

 

 

11. STOCK-BASED COMPENSATION

The Board of Directors adopted, and the Company’s stockholders approved, the “TreeHouse Foods, Inc. Equity and Incentive Plan” (the “Plan”). On April 27, 2017, the Plan was amended and restated to increase the number of shares available for issuance under the Plan by 3.8 million shares, effective February 14, 2017. The Plan is administered by our Compensation Committee, which consists entirely of independent directors. The Compensation Committee determines specific awards for our executive officers. For all other employees, if the committee designates, our Chief Executive Officer or such other officers will, from time to time, determine specific persons to whom awards under the Plan will be granted, and the terms and conditions of each award. The Compensation Committee or its designee, pursuant to the terms of the Plan, will also make all other necessary decisions and interpretations under the Plan.

Under the Plan, the Compensation Committee may grant awards of various types of compensation, including stock options, restricted stock, restricted stock units, performance shares, performance units, other types of stock-based awards, and other cash-based compensation. The maximum number of shares available to be awarded under the Plan is approximately 16.1 million, of which approximately 4.9 million remain available at September 30, 2017.

Income before income taxes for the three and nine month periods ended September 30, 2017 includes stock-based compensation expense of $6.6 million and $25.2 million, respectively. Stock-based compensation expense for the three and nine months ended September 30, 2016 was $8.5 million and $22.8 million, respectively. The tax benefit recognized related to the compensation cost of these share-based awards was approximately $2.4 million and $9.3 million for the three and nine months ended September 30, 2017, respectively, and $3.1 million and $8.3 million for the three and nine months ended September 30, 2016, respectively.

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 Stock Options — The following table summarizes stock option activity during the nine months ended September 30, 2017. Stock options generally vest in approximately three equal installments on each of the first three anniversaries of the grant date, and expire ten years from the grant date.

 

 

 

Compensation costs related to unvested options totaled $16.3 million at September 30, 2017 and will be recognized over the remaining vesting period of the grants, which averages 2.1 years. The Company uses the Black-Scholes option pricing model to value its stock option awards. The assumptions used to calculate the fair value of stock options issued in 2017 include the following: weighted average expected volatility of 26.71%, expected term of six years, weighted average risk free rate of 2.07%, and no dividends. The weighted average grant date fair value of awards granted in 2017 was $24.41.

Restricted Stock Units — Employee restricted stock unit awards generally vest based on the passage of time. These awards generally vest in approximately three equal installments on each of the first three anniversaries of the grant date. Director restricted stock units generally vest on the first anniversary of the grant date. Certain directors have deferred receipt of their awards until either their departure from the Board of Directors or a specified date. As of September 30, 2017, 100 thousand director restricted stock units have been earned and deferred.

The following table summarizes the restricted stock unit activity during the nine months ended September 30, 2017:

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Future compensation costs related to restricted stock units are approximately $33.9 million as of September 30, 2017 and will be recognized on a weighted average basis over the next 2.0 years. The grant date fair value of the awards is equal to the Company’s closing stock price on the grant date.

Performance Units — Performance unit awards are granted to certain members of management. These awards contain service and performance conditions. For each of the three performance periods, one-third of the units will accrue, multiplied by a predefined percentage between 0% and 200%, depending on the achievement of certain operating performance measures. Additionally, for the cumulative performance period, a number of units will accrue, equal to the number of units granted multiplied by a predefined percentage between 0% and 200%, depending on the achievement of certain operating performance measures, less any units previously accrued. Accrued units will be converted to stock or cash, at the discretion of the Compensation Committee, generally, on the third anniversary of the grant date. The Company intends to settle these awards in stock and has the shares available to do so. On June 27, 2017, based on an achievement of operating performance measures, 72,335 performance units were converted into 81,556 shares of stock, an average conversion of 1.13 shares for each performance unit. The following table summarizes the performance unit activity during the nine months ended September 30, 2017:

 

 

 

Future compensation costs related to the performance units are estimated to be approximately $6.2 million as of September 30, 2017, and are expected to be recognized over the next 2.2 years. The grant date fair value of the awards is equal to the Company’s closing stock price on the date of grant.

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

12. ACCUMULATED OTHER COMPREHENSIVE LOSS

Accumulated other comprehensive loss consists of the following components, all of which are net of tax, except for the foreign currency translation adjustment:

 

 

 

The Condensed Consolidated Statements of Operations lines impacted by reclassifications out of Accumulated other comprehensive loss are outlined below:

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

13. EMPLOYEE RETIREMENT AND POSTRETIREMENT BENEFITS

Pension, Profit Sharing, and Postretirement Benefits — Certain employees and retirees participate in pension and other postretirement benefit plans. Employee benefit plan obligations and expenses included in the Condensed Consolidated Financial Statements are determined based on plan assumptions, employee demographic data, including years of service and compensation, benefits and claims paid, and employer contributions. In connection with the divestiture of the canned soup and infant feeding (“SIF”) business in the second quarter of 2017, the Company divested a pension plan and a postretirement benefit plan. The net unfunded liability associated with these plans as of the closing date, which is included in the Other operating expense, net line of the Condensed Consolidated Statements of Operations, was $10.5 million.

Components of net periodic pension expense are as follows:

 

 

The Company does not expect to make any contributions to the pension plans in 2017.

Components of net periodic postretirement expense are as follows:

 

 

The Company expects to contribute approximately $1.6 million to the postretirement health plans during 2017.

Net periodic pension and postretirement costs are recorded in the Cost of sales and General and administrative lines of the Condensed Consolidated Statements of Operations.

14. OTHER OPERATING EXPENSE, NET

The Company incurred other operating expense for the three and nine months ended September 30, 2017 and 2016, which consisted of the following:

 

 

On May 22, 2017, the Company completed the divestiture of its SIF business. The SIF business was based in Pittsburgh, Pennsylvania and produced private label condensed and ready-to-serve soup, baby food, and gravies for the Meals segment. The divestiture of this business did not meet the criteria to be presented as discontinued operations as it did not represent a strategic shift that would have a

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

major effect on the Company’s results of operations. The transaction remains subject to working capital adjustments that are expected to be finalized in the fourth quarter of 2017.

 

 

15. COMMITMENTS AND CONTINGENCIES

Litigation, Investigations, and Audits — On November 16, 2016, a purported TreeHouse shareholder filed a putative class action captioned Tarara v. TreeHouse Foods, Inc., et al., Case No. 1:16-cv-10632, in the United States District Court for the Northern District of Illinois against TreeHouse and certain of its officers. The complaint, amended on March 24, 2017, is purportedly brought on behalf of all purchasers of TreeHouse common stock from January 20, 2016 through and including November 2, 2016, asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and seeks, among other things, damages and costs and expenses. On December 22, 2016, another purported TreeHouse shareholder filed an action captioned Wells v. Reed, et al., Case No. 2016-CH-16359, in the Circuit Court of Cook County, Illinois, against TreeHouse and certain of its officers. This complaint, purportedly brought derivatively on behalf of TreeHouse, asserts state law claims against certain officers for breach of fiduciary duty, unjust enrichment, and corporate waste. On February 7, 2017, another purported TreeHouse shareholder filed an action captioned Lavin v. Reed, Case No. 17-cv-01014, in the Northern District of Illinois, against TreeHouse and certain of its officers. This complaint, like Wells, is purportedly brought derivatively on behalf of TreeHouse, and it asserts state law claims against certain officers for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and corporate waste.

All three complaints make substantially similar allegations (though the amended complaint in Tarara now contains additional detail). Essentially, the complaints allege that TreeHouse, under the authority and control of the individual defendants: (i) made certain false and misleading statements regarding the Company’s business, operations, and future prospects; and (ii) failed to disclose that (a) the Company’s private label business was underperforming; (b) the Company’s Flagstone business was underperforming; (c) the Company’s acquisition strategy was underperforming; (d) the Company had overstated its full-year 2016 guidance; and (e) TreeHouse’s statements lacked reasonable basis. The complaints allege that these actions artificially inflated the market price of TreeHouse common stock during the class period, thus purportedly harming investors. We believe that these claims are without merit and intend to defend against them vigorously.

Since its initial docketing, the Tarara matter has been re-captioned as Public Employees’ Retirement Systems of Mississippi v. TreeHouse Foods, Inc., et al., in accordance with the Court’s order appointing Public Employees’ Retirement Systems of Mississippi as the lead plaintiff. The Public Employees’ defendants have filed a motion to dismiss, which has been fully briefed.

Additionally, due to the similarity of the complaints, the parties in Wells and Lavin have entered stipulations deferring the litigation until the earlier of (i) the court in Public Employees’ entering an order resolving defendants’ anticipated motion to dismiss therein or (ii) plaintiffs’ counsel receiving notification of a settlement of Public Employees’ or until otherwise agreed to by the Parties. The next status date in Wells is April 27, 2018.  There is no set status date in Lavin at this time, but the parties are directed to file a joint status report on the progress of the related litigation by October 26, 2017, after which point the Lavin court could set a new status date.

In addition, we are party to a variety of legal proceedings arising out of the conduct of our business. While the results of proceedings cannot be predicted with certainty, management believes that the final outcome of these proceedings will not have a material adverse effect on our consolidated financial statements, results of operations, or cash flows.

16. DERIVATIVE INSTRUMENTS

The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by derivative instruments include interest rate risk, foreign currency risk, and commodity price risk. Derivative contracts are entered into for periods consistent with the related underlying exposure and do not constitute positions independent of those exposures. The Company does not enter into derivative instruments for trading or speculative purposes.

The Company manages its exposure to changes in interest rates by optimizing the use of variable-rate and fixed-rate debt and by utilizing interest rate swaps to hedge our exposure to changes in interest rates, to reduce the volatility of our financing costs, and to achieve a desired proportion of fixed versus floating-rate debt, based on current and projected market conditions, with a bias toward fixed-rate debt.

In June 2016, the Company entered into $500 million of long-term interest rate swap agreements to lock into a fixed LIBOR interest rate base. Under the terms of the agreements, $500 million in variable-rate debt was swapped for a weighted average fixed interest rate

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

base of approximately 0.86% for a period of 37 months, beginning on January 31, 2017 and ending on February 28, 2020. These agreements do not qualify for hedge accounting and changes in their fair value are recorded in the Condensed Consolidated Statements of Operations, with their fair value recorded on the Condensed Consolidated Balance Sheets.

Due to the Company’s foreign operations, we are exposed to foreign currency risk. The Company enters into foreign currency contracts to manage the risk associated with foreign currency cash flows. The Company’s objective in using foreign currency contracts is to establish a fixed foreign currency exchange rate for the net cash flow requirements for purchases that are denominated in U.S. dollars. These contracts do not qualify for hedge accounting and changes in their fair value are recorded in the Condensed Consolidated Statements of Operations, with their fair value recorded on the Condensed Consolidated Balance Sheets. As of September 30, 2017, the Company had $46.5 million of U.S. dollar foreign currency contracts outstanding, expiring throughout 2018.

Certain commodities we use in the production and distribution of our products are exposed to market price risk. The Company utilizes derivative contracts to manage this risk. The majority of commodity forward contracts are not derivatives, and those that are generally qualify for the normal purchases and normal sales scope exception under the guidance for derivative instruments and hedging activities and, therefore, are not subject to its provisions. For derivative commodity contracts that do not qualify for the normal purchases and normal sales scope exception, the Company records their fair value on the Condensed Consolidated Balance Sheets, with changes in value being recorded in the Condensed Consolidated Statements of Operations.

The Company’s derivative commodity contracts may include contracts for diesel, oil, plastics, natural gas, electricity, and other commodity contracts that do not meet the requirements for the normal purchases and normal sales scope exception.

Diesel contracts are used to manage the Company’s risk associated with the underlying cost of diesel fuel used to deliver products. Contracts for oil and plastics are used to manage the Company’s risk associated with the underlying commodity cost of a significant component used in packaging materials. Contracts for natural gas and electricity are used to manage the Company’s risk associated with the utility costs of its manufacturing facilities, and commodity contracts that are derivatives that do not meet the normal purchases and normal sales scope exception are used to manage the price risk associated with raw material costs. As of September 30, 2017, the Company had outstanding contracts for the purchase of 66,473 megawatts of electricity, expiring throughout 2017 and 2018; 8.8 million gallons of diesel, expiring throughout 2017 and early 2018; 1.9 million dekatherms of natural gas, expiring throughout 2017 and 2018; 0.1 million bushels of wheat, expiring throughout 2017 and early 2018; and 0.9 million bushels of corn, expiring throughout 2017 and early 2018.

 The following table identifies the derivative, its fair value, and location on the Condensed Consolidated Balance Sheets:

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

We recorded the following gains and losses on our derivative contracts in the Condensed Consolidated Statements of Operations:

 

 

17. FAIR VALUE

The following table presents the carrying value and fair value of our financial instruments as of September 30, 2017 and December 31, 2016:

 

 

Cash and cash equivalents and accounts receivable are financial assets with carrying values that approximate fair value. Accounts payable are financial liabilities with carrying values that approximate fair value.

The fair value of the Revolving Credit Facility, Term Loan A, Term Loan A-1, Term Loan A-2, 2022 Notes, 2024 Notes, commodity contracts, foreign currency contracts, and interest rate swap agreements are determined using Level 2 inputs. Level 2 inputs are inputs other than quoted market prices that are observable for an asset or liability, either directly or indirectly. The fair values of the Revolving Credit Facility, Term Loan A, Term Loan A-1, and Term Loan A-2 were estimated using present value techniques and

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

market based interest rates and credit spreads. The fair values of the Company’s 2022 Notes and 2024 Notes were estimated based on quoted market prices for similar instruments, where the inputs are considered Level 2, due to their infrequent trading volume. The fair values of the commodity contracts, foreign currency contracts, and interest rate swap agreements are based on an analysis comparing the contract rates to the market rates at the balance sheet date. The commodity contracts, foreign currency contracts, and interest rate swap agreements are recorded at fair value on the Condensed Consolidated Balance Sheets.

The fair value of the investments was determined using Level 1 inputs. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement dates. The investments are recorded at fair value on the Condensed Consolidated Balance Sheets.

18. SEGMENT AND GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS

In the first quarter of 2017, the Company completed changes in its organizational structure that resulted in a change in how the Company manages its business and allocates resources. Our reportable segments are now organized and managed by products: Baked Goods, Beverages, Condiments, Meals, and Snacks. Previously, our reportable segments were organized and managed by customer channels: North American Retail Grocery, Food Away From Home, and Industrial and Export. All prior period information has been recast to reflect this change.

The Company manages operations on a company-wide basis, thereby making determinations as to the allocation of resources in total rather than on a segment-level basis. The Company has designated reportable segments based on how management views its business. The Company does not segregate assets between segments for internal reporting. Therefore, asset-related information has not been presented. The reportable segments, as presented below, are consistent with the manner in which the Company reports its results to the Chief Operating Decision Maker. Our segments are as follows:

Baked Goods – Our Baked Goods segment sells candy; cookies; crackers; in-store bakery products; pita chips; pretzels; refrigerated dough; and retail griddle waffles, pancakes, and French toast.

Beverages – Our Beverages segment sells broths; liquid non-dairy creamer; non-dairy powdered creamers; powdered drinks; single serve hot beverages; specialty teas, and sweeteners.

Condiments – Our Condiments segment sells aseptic cheese and pudding products; jams, preserves, and jellies; mayonnaise; Mexican, barbeque, and other sauces; pickles and related products; refrigerated and shelf stable dressings and sauces; and table and flavored syrups.

Meals – Our Meals segment sells baking and mix powders; powdered soups and gravies; macaroni and cheese; pasta; ready-to-eat and hot cereals; and skillet dinners. Condensed and ready to serve soup and infant feeding products were sold within the Meals segment through the divestiture of the SIF business on May 22, 2017.

Snacks – Our Snacks segment sells bars; dried fruit; snack nuts; trail mixes; and other wholesome snacks.

The Company evaluates the performance of its segments based on net sales dollars and direct operating income. In conjunction with the change in segments, the Company revised its calculation of direct operating income to include direct general and administrative expenses. Direct operating income is now defined as gross profit less freight out, sales commissions, and direct selling, general, and administrative expenses. All prior period information has been recast to reflect this change. The amounts in the following tables are obtained from reports used by senior management and do not include income taxes. Other expenses not allocated include unallocated selling, general, and administrative expenses, unallocated costs of sales, and unallocated corporate expenses (amortization expense and other operating expense). The accounting policies of the Company’s segments are the same as those described in the summary of significant accounting policies set forth in Note 1 to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2016.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Financial information relating to the Company’s reportable segments is as follows:

 

 

Geographic Information — The Company had revenues from customers outside of the United States of approximately 8.7% and 8.9% of total consolidated net sales in the nine months ended September 30, 2017 and 2016, respectively, with 6.9% and 7.1% of total consolidated net sales in Canada, respectively. The Company held 12.2% and 10.8% of its property, plant, and equipment outside of the United States as of September 30, 2017 and 2016, respectively.

Major Customers — Walmart Stores, Inc. and affiliates accounted for approximately 21.0% and 18.2% of consolidated net sales in the nine months ended September 30, 2017 and 2016, respectively.   Costco accounted for approximately 10.1% of consolidated net sales in the nine months ended September 30, 2017, with less than 10% for the same period in the prior year.  No other customer accounted for more than 10% of our consolidated net sales during these periods.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Product Information — The following table presents the Company’s net sales by major products for the three and nine months ended September 30, 2017 and 2016. In the first quarter of 2017, the Company changed the product categories to align with the changes in organizational structure described above. All prior period information has been recast to reflect this change.

 

 

 

19. RECENT ACCOUNTING PRONOUNCEMENTS

Recently Adopted

In the fourth quarter of 2016, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No 2016-09, Improvements to Employee Share-Based Payment Accounting. Under this ASU, excess tax benefits and deficiencies are no longer recognized as additional paid-in capital in the Condensed Consolidated Balance Sheets. The ASU requires recognition of excess tax benefits and deficiencies in the Condensed Consolidated Statements of Operations. As the Company adopted the ASU in the fourth quarter, any related adjustments were required to be reflected as of the beginning of the fiscal year of adoption. The results for the three and nine months periods ended September 30, 2016 have been recast to reflect the adoption of the ASU as of January 1, 2016, resulting in income tax benefits of $0.2 million and $3.8 million, respectively, related to the recognition of excess tax benefits and deficiencies, which are included in the Income taxes line of the Condensed Consolidated Statements of Operations. The effect on basic net earnings per common share was $0.01 for the three months ended September 30, 2016, with no impact on diluted net earnings per common share.  The effect on basic and diluted net earnings per common share for the nine months ended September 30, 2016 was $0.07 and $0.06, respectively.   Additionally, the ASU requires excess tax benefits to be reported as a component of operating activities in the Condensed Consolidated Statements of Cash Flows. Excess tax benefits of $3.7 million were retrospectively reclassified from financing to operating activities in the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016. The effects of the adoption of the other provisions of this ASU were immaterial.

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, which requires entities to measure inventory at the lower of cost and net realizable value (“NRV”). This ASU will not apply to inventory valued under the last-in-first-out method. Under current guidance, an entity is required to measure inventory at the lower of cost or market, with market defined as replacement cost, NRV, or NRV less a normal profit margin. The three market measurements added complexity and reduced comparability in the valuation of inventory. FASB issued this ASU as part of its simplification initiative to address these issues. The ASU is effective on a prospective basis for fiscal years, and interim periods within those years, beginning after December 15, 2016. The Company prospectively adopted the ASU during the first quarter of 2017, the impact of which was not significant.

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment, to eliminate the second step of the goodwill impairment test. This ASU requires an entity to measure a goodwill impairment loss as the amount by which the carrying value of a reporting unit exceeds its fair value. Additionally, an entity should include the income tax effects from any tax deductible goodwill on the carrying value of the reporting unit when measuring a goodwill impairment loss, if applicable. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company early adopted the ASU during the third quarter of 2017, and will apply to any goodwill impairment losses prospectively.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Recently Issued

In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which revises how employers that sponsor defined benefit pension and other postretirement plans present net periodic benefit cost. The ASU requires an employer to present the service cost component in the same income statement line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside of any subtotal of operating income. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The standard requires adoption on a retrospective basis for the presentation of net benefit cost components. The Company is currently assessing the impact that this standard will have upon adoption.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, to require that restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts on the statement of cash flows. The Company currently classifies changes in restricted cash as an investing activity in the Consolidated Statements of Cash Flows. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The standard requires adoption on a retrospective basis. The Company is currently assessing the impact that this standard will have upon adoption, which is not expected to be significant.

In February 2016, the FASB issued ASU No. 2016-02, Leases, to increase transparency and comparability by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The main difference between existing GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under existing GAAP. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. The standard requires that entities apply the effects of these changes using a modified retrospective approach, which includes a number of optional practical expedients. The adoption of this ASU will result in a significant increase to the Company’s Balance Sheets for lease liabilities and lease assets, and the Company is currently assessing the impact that this standard will have upon adoption.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which introduced a new framework to be used when recognizing revenue in an attempt to reduce complexity and increase comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The standard requires that entities apply the effects of these changes to all prior years presented, upon adoption, using either the full retrospective method, which presents the impact of the change separately in each prior year presented, or the modified retrospective method, which includes the cumulative changes to all prior years presented in beginning retained earnings in the year of initial adoption. The Company expects to use the modified retrospective method. The FASB also issued ASU No. 2016-10, Identifying Performance Obligations and Licensing, and ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients, in April 2016 and May 2016, respectively, which amend the guidance in ASU 2014-09 and have the same effective date as the original standard. The Company is currently finalizing the impact that these standards will have on its accounting policies, processes, system requirements, internal controls, and disclosures using internal resources and the assistance of a third-party. The Company has established a project plan, completed an initial review of its customer contracts, and is updating policies and procedures. Based upon implementation procedures to date, the Company does not expect significant changes in its revenue recognition policies once the standard is adopted.

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

20. GUARANTOR AND NON-GUARANTOR FINANCIAL INFORMATION

The Company’s 2022 Notes and 2024 Notes are guaranteed fully and unconditionally, as well as jointly and severally, by its Guarantor Subsidiaries. The guarantees of the Guarantor Subsidiaries are subject to release in limited circumstances, only upon the occurrence of certain customary conditions. There are no significant restrictions on the ability of the parent company or any guarantor to obtain funds from its subsidiaries by dividend or loan. The following condensed supplemental consolidating financial information presents the results of operations, financial position, and cash flows of the parent company, its Guarantor Subsidiaries, its non-guarantor subsidiaries, and the eliminations necessary to arrive at the information for the Company on a consolidated basis as of September 30, 2017 and 2016, and for the three and nine months ended September 30, 2017 and 2016. The equity method has been used with respect to investments in subsidiaries. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions.

Condensed Supplemental Consolidating Balance Sheet

September 30, 2017

(In millions)

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Balance Sheet

December 31, 2016

(In millions)

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Statement of Operations

Three Months Ended September 30, 2017

(In millions)

 

 

 

Condensed Supplemental Consolidating Statement of Operations

Three Months Ended September 30, 2016

(In millions)

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Statement of Operations

Nine Months Ended September 30, 2017

(In millions)

 

 

 

Condensed Supplemental Consolidating Statement of Operations

Nine Months Ended September 30, 2016

(In millions)

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Statement of Comprehensive Income (Loss)

Three Months Ended September 30, 2017

(In millions)

 

 

 

Condensed Supplemental Consolidating Statement of Comprehensive Income (Loss)

Three Months Ended September 30, 2016

(In millions)

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Statement of Comprehensive Income (Loss)

Nine Months Ended September 30, 2017

(In millions)

 

 

 

Condensed Supplemental Consolidating Statement of Comprehensive Income (Loss)

Nine Months Ended September 30, 2016

(In millions)

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Statement of Cash Flows

Nine Months Ended September 30, 2017

(In millions)

 

 

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TREEHOUSE FOODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Condensed Supplemental Consolidating Statement of Cash Flows

Nine Months Ended September 30, 2016

(In millions)

 

 

21. SUBSEQUENT EVENTS

 

On November 2, 2017, the Company announced that the Board of Directors adopted a stock repurchase program. The stock repurchase program authorizes the Company to repurchase up to $400 million of the Company’s common stock at any time, or from time to time. Any repurchases under the program may be made by means of open market transactions, negotiated block transactions, or otherwise, including pursuant to a repurchase plan administered in accordance with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The size and timing of any repurchases will depend on price, market and business conditions, and other factors. Provided, however, that the Company is authorized to enter into an administrative repurchase plan for $50 million of the $400 million in the twelve months following November, 6 2017. The Company will repurchase shares opportunistically with a total annual cap of $150 million. Any shares repurchased will be held as treasury stock.

 

On October 29, 2017 Mr. Robert Aiken resigned as the Company’s President and Chief Operating Officer. The Company is in discussions with Mr. Aiken regarding the satisfaction of his monetary obligations to the Company under his employment agreement.

 

 

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Overview

TreeHouse Foods, Inc. is a manufacturer of packaged foods and beverages with more than 50 manufacturing facilities across the United States, Canada, and Italy that focuses primarily on private label products for both retail grocery and food away from home customers. We manufacture shelf stable, refrigerated, frozen, and fresh products within our five segments (Baked goods, Beverages, Condiments, Meals, and Snacks). We have a comprehensive offering of packaging formats and flavor profiles, and we also offer natural, organic, and preservative free ingredients in many categories. We believe we are the largest manufacturer of private label snack nuts, trail mixes, refrigerated dough, retail griddle items, in-store bakery cookies, pretzels, pickles, salsa, macaroni and cheese dinners, non-dairy powdered creamer, ready-to-eat cereals, and dry pasta in the United States, the largest manufacturer of private label powdered drink mixes, salad dressings, and instant hot cereals in both the United States and Canada, and the largest manufacturer of private label jams in Canada, based on volume. We also believe we are one of the largest manufacturers of private label crackers, snack bars, table syrup, flavored syrup, barbeque sauce, preserves, and jellies in the United States, based on volume.

The following discussion and analysis presents the factors that had a material effect on our results of operations for the three and nine month periods ended September 30, 2017 and 2016. Also discussed is our financial position as of the end of the current period. This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes to those Condensed Consolidated Financial Statements included elsewhere in this report. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. See Cautionary Statement Regarding Forward-Looking Statements on page 53 for a discussion of the uncertainties, risks, and assumptions associated with these statements.

Segments

In the first quarter of 2017, the Company completed changes in its organizational structure that resulted in a change in how the Company manages its business and allocates resources. Our reportable segments are now organized and managed by products: Baked Goods, Beverages, Condiments, Meals, and Snacks. Our reportable segments are discussed in greater detail in Note 18 within the Notes to Condensed Consolidated Financial Statements.  

Current Market Environment

Despite the overall improvement in the U.S. economy, consumer spending continues to remain challenged. Specifically, retail food volumes continue to be weak compared to overall consumer spending. September total retail food sales and volumes showed sequential declines month-to-month as consumers executed stock-up trips to stores in advance of early September hurricanes. On a quarterly basis, third quarter total retail food sales across the industry increased sequentially over the second quarter of 2017 with sales up nearly 0.6%. The sequential improvement in sales was mirrored, though to a lesser extent, in the third quarter year-over-year comparison. Total retail food sales across the industry increased 0.3% in the third quarter of 2017 compared to the same period last year as volume declines (-1.8%) were more than offset by price increases (+2.1%). Although volume softness continued in the industry, pricing actions have mostly offset this impact.  Branded products continue to be the hardest hit as volumes were 2.7% lower in the third quarter of 2017 compared to 2016 with pricing offsetting 2.5% of the decline. Comparatively, private label food volumes were down 0.1% for the third quarter year-over-year with a corresponding 2.7% increase in pricing. As such, comparatively stable industry volumes combined with similar pricing actions demonstrates private label products are well positioned against their branded counterparts.

While overall volume growth continues to be a challenge, certain retail sectors are experiencing growth as consumers continue to snack, with a focus on “healthy” and “better for you” foods. “Healthy” and “better for you” foods include items such as fresh or freshly prepared foods, natural, organic, or specialty foods, most of which are located in the perimeter of the store. Recent data shows that these product offerings are expected to be the primary growth area for both branded and private label products, and that growth in private label is expected to drive the overall growth in these product categories. These trends are prompting companies to increase or adjust their offerings, while retaining their commitment to provide products at reasonable prices. In an effort to respond to shifting consumer demand, the Company offers an increasing variety of snacks, natural, and organic products.

TreeHouse 2020 – Operating Margin Improvement Plan

On August 3, 2017, the Company announced the TreeHouse 2020 program, which is a comprehensive strategic blueprint intended to accelerate long-term growth through optimization of our manufacturing network, transformation of our mixing centers and warehouse footprint, and leveraging of systems and processes to drive performance.  TreeHouse 2020 is a multi-year plan to fully integrate the business and reduce its cost structure in order to invest in market-differentiated capabilities, including higher growth potential product categories to serve the rapidly evolving needs of customers which are strategically focused and highly committed to their corporate brands. TreeHouse 2020 is expected to produce significant savings to achieve our operating margin expansion targets creating reinvestment opportunities to drive future growth. Specifically, we are targeting to improve our operating margin structure by

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approximately 300 basis points by the end of 2020. In the short-term, while we continue to execute on these margin improvement initiatives we might experience modest sales declines due to the rationalization of low margin business.

The TreeHouse 2020 program will be executed in multiple phases over the next several years.  The key elements of Phase 1 include the closure of the Company’s Brooklyn Park, Minnesota and Plymouth, Indiana facilities, as well as the downsizing of the Dothan, Alabama facility.  Production at the Brooklyn Park, Minnesota and Plymouth, Indiana facilities is expected to cease in the fourth quarter of 2017.  The facility downsizing at Dothan, Alabama is expected to be complete in the third quarter of 2018. In addition, we have taken steps toward increasing our capacity utilization, operational margin expansion, and streamlining our plant structure to optimize our supply chain. See Note 2 to our Condensed Consolidated Financial Statements for additional information regarding restructuring and margin improvement activities.

Recent Developments

Share Repurchase Authorization

On November 2, 2017, the Company announced that the Board of Directors adopted a stock repurchase program. The stock repurchase program authorizes the Company to repurchase up to $400 million of the Company’s common stock at any time, or from time to time. Any repurchases under the program may be made by means of open market transactions, negotiated block transactions, or otherwise, including pursuant to a repurchase plan administered in accordance with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The size and timing of any repurchases will depend on price, market and business conditions, and other factors. Provided, however, that the Company is authorized to enter into an administrative repurchase plan for $50 million of the $400 million in the twelve months following November, 6 2017. The Company will repurchase shares opportunistically with a total annual cap of $150 million. Any shares repurchased will be held as treasury stock.

 

Sale of the Soup and Infant Feeding Business

On April 25, 2017, the Company announced that it had entered into a definitive agreement to sell its canned soup and infant feeding (“SIF”) business. The SIF business is based in Pittsburgh, Pennsylvania and produces private label condensed and ready-to-serve soup, baby food, and gravies for the Meals segment. The transaction closed on May 22, 2017 and remains subject to working capital adjustments that are expected to be finalized in the fourth quarter of 2017.

Results of Operations

The following table presents certain information concerning our financial results, including information presented as a percentage of consolidated net sales:

 

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Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

Net Sales —
Third quarter net sales decreased by $38.1 million, or 2.4%, in 2017 compared to 2016. The change in net sales from the third quarter of 2016 to the third quarter of 2017 was due to the following:

 

 

The change in net sales was more than explained by the divestiture of the SIF business which contributed 2.9% to the year-over-year decline. Volume/mix, pricing, and foreign exchange were slightly favorable compared to the prior year, partially offsetting the decline from the divestiture. Included in net sales was a $1.7 million product recall reimbursement, compared to a $0.1 million impact in 2016, that contributed an increase of 0.1% to net sales year-over-year.

Cost of Sales — Cost of sales as a percentage of net sales was 83.2% in the third quarter of 2017, compared to 82.0% in the third quarter of 2016. Included in cost of sales in the third quarter of 2017 was $1.5 million related to product recall reimbursement compared to expense of $0.2 million in the third quarter of 2016. Also included in cost of sales was $10.2 million of restructuring and other margin improvement activities in the third quarter of 2017 compared to $1.0 million in the prior year. These transactions, coupled with the product recall reimbursement outlined above in net sales, increased cost of sales as a percentage of net sales by 0.5% in the third quarter of 2017 and 0.1% in the third quarter of 2016. The remaining 0.8% increase in cost of sales as a percentage of net sales was primarily due to higher operating costs, higher commodity costs, and unfavorable mix, partially offset by a reduction in variable incentive compensation and depreciation.

Operating Expenses — Total operating expenses were $202.3 million in the third quarter of 2017 compared to $208.0 million in the third quarter of 2016. The decrease in 2017 resulted from the following:

Selling and distribution expenses decreased $6.6 million, or 6.5%, in the third quarter of 2017 compared to the third quarter of 2016. Selling and distribution expenses as a percentage of net sales decreased to 6.2% in the third quarter of 2017, compared to 6.4% in the third quarter of 2016.  The decrease was primarily related to lower volumes, a reduction in variable incentive compensation, and cost savings in 2017, partially offset by unfavorable freight rates.

General and administrative expenses decreased $4.8 million, or 6.7%, in the third quarter of 2017 compared to the third quarter of 2016. General and administrative expenses as a percentage of net sales decreased slightly to 4.3% in the third quarter of 2017, compared to 4.5% in the third quarter of 2016 mostly related to lower revenues and a reduction in variable incentive compensation.

Amortization expense was relatively flat in the third quarter of 2017 compared to the third quarter of 2016.

Other operating expense was $11.1 million in the third quarter of 2017 compared to $5.3 million in the third quarter of 2016. The increase was entirely due to higher costs associated with restructuring and other margin improvement activities that were announced in recent quarters with respect to the TreeHouse 2020 margin improvement plan and the Company’s closure of the Brooklyn Park, Minnesota; Plymouth, Indiana; City of Industry, California; Ayer, Massachusetts; Azusa, California; Delta, British Columbia (frozen griddle); and Ripon, Wisconsin facilities as well as the downsizing of the Dothan, Alabama and Battle Creek, Michigan facilities. See Note 2 to our Condensed Consolidated Financial Statements for additional information regarding restructuring and margin improvement activities.

Interest Expense — Interest expense increased to $31.4 million in the third quarter of 2017, compared to $30.8 million in 2016, primarily due to higher interest rates associated with Federal interest rate increases partially offset by lower net debt.

Interest Income – Interest income of $0.4 million primarily relates to cash held by our Canadian subsidiaries and gains on investments. Interest income increased slightly from the third quarter of 2016.

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Foreign Currency — The Company’s foreign currency impact was a $2.5 million gain for the third quarter of 2017, compared to a gain of $1.1 million in the third quarter of 2016, primarily due to fluctuations in currency exchange rates between the U.S. and Canadian dollar during the respective periods.

Other (Income) Expense, net — Other income was $0.8 million for the third quarter of 2017, compared to income of $4.6 million in the third quarter of 2016. The change was primarily due to lower gains from hedging activities, primarily foreign currency contracts, commodity contracts, and interest rate swaps.

Income Taxes — Income tax expense of $1.3 million was recorded in the third quarter of 2017 compared to expense of $15.2 million for the same period of 2016. The effective rate was 4.3% for the third quarter of 2017 compared to 28.9% for the third quarter of 2016. The change in the effective tax rate for the three months ended September 30, 2017 as compared to September 30, 2016 is primarily a result of the income tax benefit from the release of reserves for unrecognized tax benefits due to the lapse of statutes and a benefit from foreign tax credits on a year-over-year basis. Our effective tax rate may change from period to period based on recurring and non-recurring factors including the jurisdictional mix of earnings, enacted tax legislation, state income taxes, settlement of tax audits, and the expiration of the statute of limitations in relation to unrecognized tax benefits.

The Company’s effective tax rate differs from the U.S. federal statutory tax rate primarily due to state tax expense, the benefits associated with the federal domestic production activities deduction, the excess tax benefits related to share-based payments, the benefit of an intercompany financing structure entered into in conjunction with the E.D. Smith Foods, Ltd. (“E.D. Smith”) acquisition in 2007, and the benefit derived from foreign tax credits.

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016 — Results by Segment

Baked Goods

 

 

Net sales in the Baked Goods segment increased $21.8 million, or 6.6%, in the third quarter of 2017 compared to the third quarter of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales increased during the third quarter of 2017 compared to the third quarter of 2016 primarily due to favorable volume/mix from increased distribution predominantly in the cracker and cookie categories, partially offset by unfavorable pricing from competitive pressure.

Cost of sales as a percentage of net sales decreased 2.8%, from 81.1% in the third quarter of 2016 to 78.3% in the third quarter of 2017, primarily due to lower commodity costs (flour, sugar, and eggs) and lower operating costs.

Freight out and commissions paid to independent sales brokers was $22.2 million in the third quarter of 2017, compared to $20.8 million in the third quarter of 2016.  Freight and commissions as a percentage of net sales was flat year-over-year.

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Direct selling, general, and administrative expenses were $7.0 million in the third quarter of 2017 compared to $7.8 million in the third quarter of 2016. The decrease in direct selling, general, and administrative expenses as a percentage of net sales was primarily due to lower spend due to cost saving activities.

Beverages

 

 

Net sales in the Beverages segment increased $10.0 million, or 4.3%, in the third quarter of 2017 compared to the third quarter of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales increased during the third quarter of 2017 compared to the third quarter of 2016 primarily due to favorable volume/mix from increased distribution, principally in the single serve beverages, creamer, broth, and liquid beverages categories, partially offset by unfavorable pricing from competitive pressure.

 

Cost of sales as a percentage of net sales increased 5.3%, from 67.5% in the third quarter of 2016 to 72.8% in the third quarter of 2017, primarily due to higher operating costs and unfavorable commodity costs (primarily related to oils).

 

Freight out and commissions paid to independent sales brokers was $10.3 million in the third quarter of 2017, compared to $6.9 million in the third quarter of 2016. The increase is primarily related to increased volume year-over-year and a shift in mix from customer pick-up to delivery.

Direct selling, general, and administrative expenses were $4.6 million in the third quarter of 2017, compared to $5.7 million in the third quarter of 2016. The decrease in direct selling, general, and administrative expenses as a percentage of net sales was primarily due to cost saving activities.

Condiments

 

 

Net sales in the Condiments segment increased $10.9 million, or 3.4%, in the third quarter of 2017 compared to the third quarter of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

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Net sales increased during the third quarter of 2017 compared to the third quarter of 2016 primarily due to favorable volume/mix from increased distribution, predominantly in the pickles, dressings, cheese, and salsa categories, favorable pricing, and favorable foreign currency exchange rates.

 

Cost of sales as a percentage of net sales increased 1.9%, from 81.6% in the third quarter of 2016 to 83.5% in the third quarter of 2017, primarily due to higher commodity costs (soy bean oil and dairy) and higher operating costs.

Freight out and commissions paid to independent sales brokers was $14.8 million in the third quarter of 2017, compared to $14.3 million in the third quarter of 2016. Costs remained consistent with sales activity as freight out and commissions as a percentage of net sales was 4.4% for both the third quarter of 2017 and 2016.

Direct selling, general, and administrative expenses were $5.8 million in the third quarter of 2017 and $7.0 million in the third quarter of 2016. The decrease in direct selling, general, and administrative expenses as a percentage of net sales was primarily due to cost saving activities.

Meals

 

 

Net sales in the Meals segment decreased $63.3 million, or (18.2)%, in the third quarter of 2017 compared to the third quarter of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales decreased during the third quarter of 2017 compared to the third quarter of 2016 which is more than explained by the divestiture of the SIF business, unfavorable volume/mix from competitive pressure (principally in the ready-to-eat cereal category), and unfavorable pricing from competitive pressure.

 

Cost of sales as a percentage of net sales decreased 1.7%, from 83.8% in the third quarter of 2016 to 82.1% in the third quarter of 2017, primarily due to lower costs related to the SIF divestiture and favorable depreciation, partially offset by higher operating costs.

Freight out and commissions paid to independent sales brokers was $11.6 million in the third quarter of 2017, compared to $14.5 million in the third quarter of 2016. Freight out and commissions as a percentage of net sales was relatively flat in the third quarter of 2017 compared to the third quarter of 2016.

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Direct selling, general, and administrative expenses were $7.2 million in the third quarter of 2017 compared to $8.7 million in 2016. Direct selling, general, and administrative expenses as a percentage of net sales was flat to prior year as the costs associated with the divested business decreased proportionately with the decline in net sales.

Snacks

 

 

Net sales in the Snacks segment decreased $19.1 million, or (5.4)%, in the third quarter of 2017 compared to the third quarter of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales decreased during the third quarter of 2017 compared to the third quarter of 2016 primarily due to unfavorable volume/mix from soft consumer trends and the exit of low margin co-pack business, partially offset by favorable pricing from commodity-based price increases.

Cost of sales as a percentage of net sales increased 4.8%, from 90.7% in the third quarter of 2016 to 95.5% in the third quarter of 2017, primarily due to higher commodity costs (predominantly in cashews), unfavorable mix, and higher operating costs. Contributing to higher operating costs in the third quarter was the launch of a large scale private label customer in snack nuts.

Freight out and commissions paid to independent sales brokers was $8.4 million in the third quarter of 2017, compared to $8.6 million in 2016. Freight out and commissions as a percentage of net sales was relatively flat in the third quarter of 2017 compared to the third quarter of 2016.

Direct selling, general, and administrative expenses were $4.8 million in the third quarter of 2017 compared to $5.5 million in the third quarter of 2016. Direct selling, general, and administrative expenses as a percentage of net sales decreased slightly year-over-year due to cost saving activities.

 

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016

Net Sales — Net sales increased by $208.7 million, or 4.7%, in the first nine months of 2017 compared to the first nine months of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

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The change in net sales is primarily due to an additional month of sales from the 2016 acquisition of the Private Brands Business, partially offset by the divestiture of the SIF business in the second quarter of 2017 and unfavorable pricing. Volume/mix and foreign currency was relatively flat year-over-year. Included in net sales was $5.4 million of product recall reimbursement in the first nine months of 2017, compared to a $9.8 million cost in 2016, that contributed an increase of 0.3% to net sales year-over-year.

Cost of Sales — Cost of sales as a percentage of net sales was 82.1% in the first nine months of 2017, compared to 82.4% in the first nine months of 2016. Included in cost of sales in the first nine months of 2017 was $3.0 million related to product recall reimbursement compared to expense of $5.5 million in the first nine months of 2016. Also included in cost of sales was $13.5 million of restructuring and other margin improvement activities in the first nine months of 2017 compared to $3.9 million in the prior year. Finally, included in cost of sales for the nine months ended 2016 was $8.5 million of acquisition, integration, divestiture, and related costs compared to none in 2017. These transactions, coupled with the product recall reimbursement and costs outlined above in net sales, increased cost of sales as a percentage of net sales by 0.1% in the first nine months of 2017 and 0.6% in the first nine months of 2016. The remaining 0.2% increase in cost of sales as a percentage of net sales was primarily due to higher operating costs, higher commodity costs, and unfavorable mix, partially offset by a reduction in variable incentive compensation and depreciation.

Operating Expenses — Total operating expenses were $722.0 million in the first nine months of 2017 compared to $627.8 million in the first nine months of 2016. The increase in 2017 resulted from the following:

Selling and distribution expenses increased $3.0 million, or 1.0%, in the first nine months of 2017 compared to the first nine months of 2016. Selling and distribution expenses as a percentage of net sales decreased to 6.4% in the first nine months of 2017 compared to 6.6% in the first nine months of 2016.  The increase in selling and distribution expense dollars is primarily related to the additional month of Private Brands Business in 2017, while the decrease in selling and distribution expense as a percentage of net sales was primarily due to cost saving activities and reduced variable incentive compensation.

General and administrative expenses decreased by $15.3 million, or 6.3%, in the first nine months of 2017 compared to the first nine months of 2016. This decrease is primarily related to lower acquisition, integration, divestiture, and related costs in the first nine months of 2017 compared to the first nine months of 2016, partially offset by an additional month of Private Brands business in 2016. General and administrative expenses as a percentage of net sales decreased from 5.6% in the first nine months of 2016 to 5.0% in the first nine months of 2017 due to the change in acquisition, integration, divestiture, and related costs year-over-year. In the first nine months of 2016, the Company incurred approximately $42.0 million of acquisition, integration, divestiture, and related costs primarily related to the Private Brands Business acquisition, compared to $12.7 million in the first nine months of 2017. Excluding the impact of acquisition, integration, divestiture, and related costs, general and administrative expenses as a percentage of net sales was relatively flat year-over-year as an additional month of Private Brands business, increased stock compensation costs related to the shift of the annual grant period to the first quarter in 2017, and the build-out of the new segment structure was mostly offset by a reduction in variable incentive compensation.

Amortization expense increased $4.9 million in the first nine months of 2017 compared to the first nine months of 2016, primarily due to the amortization of intangible assets from the acquisition of Private Brands.

Other operating expense was $111.9 million in the first nine months of 2017 compared to $10.3 million in the first nine months of 2016. The increase was entirely due to a loss on the divestiture of the SIF business of $85.6 million and higher costs associated with restructuring and other margin improvement activities that were announced in recent quarters with respect to the TreeHouse 2020 margin improvement plan and the Company’s closure of the Brooklyn Park, Minnesota; Plymouth, Indiana; City of Industry, California; Ayer, Massachusetts; Azusa, California; Delta, British Columbia (frozen griddle); and Ripon, Wisconsin facilities as well as the downsizing of the Dothan, Alabama and Battle Creek, Michigan facilities. See Note 2 to our Condensed Consolidated Financial Statements for additional information regarding restructuring and margin improvement activities.

Interest Expense — Interest expense increased to $92.9 million in the first nine months of 2017, compared to $88.0 million in 2016, due to higher average interest rates from financing the acquisition and Federal interest rate increases.

Interest Income – Interest income of $3.5 million includes $1.6 million of interest income related to annual patronage refunds pertaining to Term Loan A. The patronage refund represents our participation in a capital plan related to our Term Loan A and is an annual payment based on a percentage of our average daily loan balance. The remaining $1.9 million in interest income primarily relates to cash held by our Canadian subsidiaries and gains on investments.

Foreign Currency — The Company’s foreign currency impact was a $2.8 million gain for the first nine months of 2017, compared to a gain of $6.0 million in the first nine months of 2016, primarily due to fluctuations in currency exchange rates between the U.S. and Canadian dollar during the respective periods.

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Other (Income) Expense, net — Other expense was $1.0 million for the first nine months of 2017, compared to income of $0.3 million in the first nine months of 2016. The change was mostly due to hedging activities, primarily foreign currency contracts, commodity contracts, and interest rate swaps.

Income Taxes — Income tax benefit of $9.0 million was recorded in the first nine months of 2017 compared to expense of $16.8 million for the same period of 2016. The effective tax rate was (65.2)% for the first nine months of 2017 and 24.0% for the first nine months of 2016. The change in the effective tax rate for the nine months ended September 30, 2017 compared to September 30, 2016 is primarily a result of the income tax benefits related to share-based payments, the income tax benefit from the release of reserves for unrecognized tax benefits due to the lapse of statutes, and a benefit from foreign tax credits on a year-over-year basis. Our effective tax rate may change from period to period based on recurring and non-recurring factors including the jurisdictional mix of earnings, enacted tax legislation, state income taxes, settlement of tax audits, and the expiration of the statute of limitations in relation to unrecognized tax benefits.

The Company’s effective tax rate differs from the U.S. federal statutory tax rate primarily due to state tax expense, the benefits associated with the federal domestic production activities deduction, the excess tax benefits related to share-based payments, the benefit of an intercompany financing structure entered into in conjunction with the E.D. Smith Foods, Ltd. (“E.D. Smith”) acquisition in 2007, and the benefit derived from foreign tax credits.

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016 — Results by Segment

Baked Goods

 

 

Net sales in the Baked Goods segment increased $144.8 million, or 16.6%, in the first nine months of 2017 compared to the first nine months of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales increased from 2016 to 2017 mostly due to an additional month of Private Brands Business in 2017 and favorable volume/mix (predominantly in the cracker, griddle, and dough categories), partially offset by unfavorable pricing mostly from competitive pressure.

Cost of sales as a percentage of net sales decreased 0.7%, from 80.1% in the first nine months of 2016 to 79.4% in the first nine months of 2017, primarily due to lower commodity costs (flour, sugar, and eggs), partially offset by higher operating costs and the non-repeat of a rebate received in the second quarter of 2016.

Freight out and commissions paid to independent sales brokers was $63.8 million in the first nine months of 2017, compared to $54.4 million in the first nine months of 2016. The increase is primarily associated with the additional month of Private Brands Business in 2017. Freight and commissions as a percentage of net sales was relatively flat year-over-year.

Direct selling, general, and administrative expenses were $23.9 million in the first nine months of 2017 compared to $21.8 million in the first nine months of 2016. The increase in direct selling, general, and administrative expenses was primarily due an additional

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month of Private Brands Business in 2017. Direct selling, general, and administrative expenses as a percentage of net sales was relatively flat year-over-year.

Beverages

 

 

Net sales in the Beverages segment increased $86.4 million, or 12.8%, in the first nine months of 2017 compared to the first nine months of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales increased from 2016 to 2017 primarily due to favorable volume/mix associated with additional distribution, primarily in the single serve beverage, broth, non-dairy creamer, and tea categories, partially offset by unfavorable pricing due to competitive pressure and lower sales due to the sale of a part of the Tetra re-cart broth business associated with the divestiture of the SIF business in the second quarter of 2017.

Cost of sales as a percentage of net sales increased 3.4%, from 68.3% in the first nine months of 2016 to 71.7% in the first nine months of 2017, primarily due to higher commodity costs (primarily oils) and unfavorable mix.

Freight out and commissions paid to independent sales brokers was $28.3 million in the first nine months of 2017, compared to $20.0 million in the first nine months of 2016.  Freight out and commissions paid as a percentage of net sales increased year-over-year by 0.8%.  The increase is primarily related to increased volume year-over-year and a shift in mix from customer pick-up to delivery.

Direct selling, general, and administrative expenses were $15.5 million in the first nine months of 2017 and $17.7 million in the first nine months of 2016. The decrease in direct selling, general, and administrative expenses as a percentage of net sales (0.6%) was due to cost saving activities.

Condiments

 

 

Net sales in the Condiments segment increased $29.8 million, or 3.1%, in the first nine months of 2017 compared to the first nine months of 2016. The change in net sales from 2016 to 2017 was due to the following:

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Net sales increased from 2016 to 2017 mostly due to an additional month of Private Brands Business in 2017, favorable volume/mix from increased distribution (predominantly in the pickles and dressings categories), and favorable foreign currency and pricing.

Cost of sales as a percentage of net sales increased 2.0%, from 81.4% in the first nine months of 2016 to 83.4% in the first nine months of 2017, primarily due to higher operating costs and higher commodity costs primarily for soy bean oil, cucumbers, peppers, and packaging.

Freight out and commissions paid to independent sales brokers was $42.2 million in the first nine months of 2017, compared to $41.1 million in the first nine months of 2016. Costs remained consistent with sales activity as freight out and commissions as a percentage of net sales was 4.3% for both the first nine months of 2017 and 2016.

Direct selling, general, and administrative expenses were $19.9 million in the first nine months of 2017 and $22.6 million in the first nine months of 2016. The decrease in direct selling, general, and administrative expenses as a percentage of net sales (0.3%) was due to cost saving activities.

Meals

 

 

Net sales in the Meals segment decreased $40.3 million, or (4.3)%, in the first nine months of 2017 compared to the first nine months of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales decreased from 2016 to 2017 primarily due to the divestiture of the SIF business, unfavorable volume/mix (predominantly in the cereal and pasta categories), and unfavorable pricing related to commodity-based price reductions and competitive pressure, partially offset by an additional month of Private Brands Business in 2017.

Cost of sales as a percentage of net sales decreased 1.7%, from 83.7% in the first nine months of 2016 to 82.0% in the first nine months of 2017, primarily due to an additional month of higher margin Private Brands Business and lower depreciation, commodity, and operating costs.

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Freight out and commissions paid to independent sales brokers was $39.2 million in the first nine months of 2017, compared to $39.4 million in the first nine months of 2016. Freight out and commissions as a percentage of net sales was 4.4% in the first nine months of 2017 compared to 4.2% in 2016. The increase is associated with temporarily higher freight costs associated with one customer primarily in the first quarter.

Direct selling, general, and administrative expenses were $22.3 million in the first nine months of 2017 compared to $24.1 million in the first nine months of 2016. Direct selling, general, and administrative expenses as a percentage of net sales was relatively flat in the first nine months of 2017 compared to the first nine months of 2016.

Snacks

 

 

Net sales in the Snacks segment decreased $27.3 million, or (2.8)%, in the first nine months of 2017 compared to the first nine months of 2016. The change in net sales from 2016 to 2017 was due to the following:

 

 

Net sales decreased from 2016 to 2017 primarily due to unfavorable volume/mix from weak consumer trends in the first nine months of 2017 compared to the prior year and the exit from low margin co-pack business, partially offset by an additional month of Private Brands Business in 2017 and favorable pricing.

Cost of sales as a percentage of net sales increased 2.2%, from 90.8% in the first nine months of 2016 to 93.0% in the first nine months of 2017, primarily due to the impact of higher commodity costs (mostly in cashews) and higher operating costs, partially offset by lapping a 2016 quality issue.

Freight out and commissions paid to independent sales brokers decreased to $22.2 million in the first nine months of 2017, compared to $23.5 million in the first nine months of 2016 primarily due to lower volumes. Freight out and commissions as a percentage of net sales was relatively flat in the first nine months of 2017 compared to the first nine months of 2016.

Direct selling, general, and administrative expenses were $18.8 million in the first nine months of 2017 compared to $17.8 million in the first nine months of 2016. The increase in direct selling, general, and administrative expenses was primarily due to an additional month of Private Brands Business in 2017. Direct selling, general, and administrative expenses as a percentage of net sales increased slightly year-over-year due to the realignment of the Company’s organizational structure and the associated build-out of the Snacks segment.

Liquidity and Capital Resources

Cash Flow

Management assesses the Company’s liquidity in terms of its ability to generate cash to fund its operating, investing, and financing activities. The Company continues to generate substantial cash flow from operating activities and remains in a strong financial position, with resources available for reinvesting in existing businesses, conducting acquisitions, and managing its capital structure on a short and long-term basis. If additional borrowings are needed, approximately $729.5 million was available under the Revolving

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Credit Facility as of September 30, 2017. See Note 9 to our Condensed Consolidated Financial Statements for additional information regarding our Revolving Credit Facility. We believe that, given our cash flow from operating activities and our available credit capacity, we comply with the current terms of the Revolving Credit Facility and can meet foreseeable financial requirements.

The following table is derived from our Condensed Consolidated Statement of Cash Flows:

 

Operating Activities

Our cash from operations was $263.4 million in the first nine months of 2017 compared to $298.4 million in 2016, a decrease of $35.0 million. The decrease in cash provided by operating activities was primarily due to lower net income of $30.4 million mostly due to higher operating and commodity costs. Cash provided by working capital declined $109.2 million primarily due to a build of inventory associated with recent distribution gains, partially offset by improved payable and cash management resulting in a reduction in accounts payable and accrued expenses.

 

 

 

Investing Activities

In the first nine months of 2017, cash used in investing activities decreased by $2.7 billion compared to 2016, due to the acquisition of the Private Brands Business in the first quarter of 2016.

We expect capital spending programs to be approximately $175 million in 2017. Capital spending in 2017 is focused on food safety, quality, productivity improvements, continued implementation of an Enterprise Resource Planning system, TreeHouse 2020, and routine equipment upgrades or replacements at our plants.  

 

Financing Activities

Net cash used in financing activities decreased by $2.6 billion in the first nine months of 2017 compared to 2016.  The Company reduced net debt by approximately $300 million since September 30, 2016 consistent with our objective of using available cash to pay down outstanding debt. The cash used in 2016 was related to the Company funding the acquisition of the Private Brands Business primarily through the issuance of common stock, the 2024 Notes, and Term Loan A-2 in the first quarter.

As of September 30, 2017, $55.0 million of cash held by our foreign subsidiaries as cash and cash equivalents is expected to be used for general corporate purposes in foreign jurisdictions, including capital projects and acquisitions. The cash relates to foreign earnings that, if repatriated, would result in a tax liability. As of September 30, 2017, $2.6 million of cash is restricted from use to meet certain insurance requirements.

Cash provided by operating activities is used to pay down debt and fund investments in property, plant, and equipment.

Our short-term financing needs are primarily for financing working capital. As discussed in “Seasonality”, our financing needs are generally highest in the second and third quarters due to inventory builds, while cash flow is highest in the fourth and first quarters following the corresponding sale of this built-up inventory. We expect our Revolving Credit Facility, plus cash flow from operations, to be adequate to provide liquidity for current operations. Our long-term financing needs depend largely on potential acquisition activity.

Free Cash Flow
In addition to measuring our cash flow generation and usage based upon the operating, investing, and financing classifications included in the Condensed Consolidated Statements of Cash Flows, we also measure free cash flow (a Non-GAAP measure) which represents net cash provided by operating activities less capital expenditures.  We believe free cash flow is an important measure of operating performance because it provides management and investors a measure of cash generated from operations that is available for mandatory payment obligations and investment opportunities such as funding acquisitions, repaying debt, and repurchasing our common stock.

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The following table reconciles our free cash flow to cash flow provided by operating activities, the most comparable GAAP measure:

 

For the nine months ended September 30, 2017, we generated free cash flow of $142.3 million.  Free cash flow in 2017 decreased $13.3 million over the prior year primarily due to lower cash flow provided by operations.

Debt Obligations

At September 30, 2017, we had $120.0 million in borrowings outstanding under our Revolving Credit Facility, $276.7 million outstanding under Term Loan A, $172.5 million outstanding under Term Loan A-1, $973.8 million outstanding under Term Loan A-2, $400.0 million of the 2022 Notes outstanding, $775.0 million of the 2024 Notes outstanding, and $3.0 million of other obligations. In addition, at September 30, 2017, there were $50.5 million in letters of credit under the Revolving Credit Facility that were issued but undrawn.

Also, at September 30, 2017, our Revolving Credit Facility provided for an aggregate commitment of $900 million, of which $729.5 million was available. Interest rates on debt outstanding under the Revolving Credit Facility, Term Loan A, Term Loan A-1, and Term Loan A-2 (collectively known as the “Amended and Restated Credit Agreement”) for the three months ended September 30, 2017 averaged 3.11%. Including the interest rate swap agreements with a weighted average fixed interest rate base of approximately 0.86% on $500 million, the average rate decreases to 2.99%.

We are in compliance with all applicable debt covenants as of September 30, 2017. From an interest coverage ratio perspective, the Company’s actual ratio as of September 30, 2017 is 105.0% higher than the minimum required level. As it relates to the leverage ratio, the Company was 2.86% below the maximum level.

See Note 9 to our Condensed Consolidated Financial Statements for additional information regarding our indebtedness and related agreements.

Seasonality

In the aggregate, our sales are slightly weighted toward the second half of the year, particularly the fourth quarter, with a more pronounced impact on profitability. As our product portfolio has grown, we have shifted to a higher percentage of cold weather products. Products that show a higher level of seasonality include non-dairy powdered creamer, coffee, specialty teas, cappuccinos, hot cereal, saltine and entertainment crackers, in-store bakery items, refrigerated dough products, and certain pasta products, all of which generally have higher sales in the first and fourth quarters. Additionally, sales of broths and snack nuts are generally higher in the fourth quarter. Warmer weather products such as dressings, pickles, and condiments typically have higher sales in the second quarter, while drink mixes generally show higher sales in the second and third quarters. As a result of our product portfolio and the related seasonality, our financing needs are generally highest in the second and third quarters due to inventory builds, while cash flow is highest in the fourth and first quarters following the seasonality of our sales.

Non-GAAP Measures

We have included in this report measures of financial performance that are not defined by GAAP (“Non-GAAP”). A Non-GAAP financial measure is a numerical measure of financial performance that excludes or includes amounts so as to be different than the most directly comparable measure calculated and presented in accordance with GAAP in the Company’s Condensed Consolidated Financial Statements. We believe these measures provide useful information to the users of the financial statements as we also have included these measures in other communications and publications.

For each of these Non-GAAP financial measures, we provide a reconciliation between the Non-GAAP measure and the most directly comparable GAAP measure, an explanation of why management believes the Non-GAAP measure provides useful information to financial statement users, and any additional purposes for which management uses the Non-GAAP measure. This Non-GAAP

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financial information is provided as additional information for the financial statement users and is not in accordance with, or an alternative to, GAAP. These Non-GAAP measures may be different from similar measures used by other companies.

Adjusted Diluted Earnings Per Share, Adjusting for Certain Items Affecting Comparability

Adjusted earnings per fully diluted share (“Adjusted Diluted EPS”) reflects adjustments to GAAP earnings per fully diluted share to identify items that, in management’s judgment, significantly affect the assessment of earnings results between periods. This information is provided in order to allow investors to make meaningful comparisons of the Company’s earnings performance between periods and to view the Company’s business from the same perspective as Company management. This measure is also used as a component of the Board of Director’s measurement of the Company’s performance for incentive compensation purposes. As the Company cannot predict the timing and amount of charges that include, but are not limited to, items such as acquisition, integration, divestiture, and related costs, mark-to-market adjustments on derivative contracts, foreign currency exchange impact on the re-measurement of intercompany notes, or restructuring and margin improvement activities, management does not consider these costs when evaluating the Company’s performance, when making decisions regarding the allocation of resources, in determining incentive compensation for management, or in determining earnings estimates.

The reconciliation of Adjusted Diluted EPS, excluding certain items affecting comparability, to the relevant GAAP measure of diluted EPS as presented in the Condensed Consolidated Statements of Operations, is as follows:

 

 

During the three and nine months ended September 30, 2017 and 2016, the Company entered into transactions that affected the year-over-year comparison of its financial results that included acquisition, integration, divestiture, and related costs, mark-to-market adjustments, restructuring and margin improvement activities, product recall (reimbursement) costs, foreign currency (gains) loss on intercompany notes, and the related tax impact of these items.

As the Company continues to grow, consolidation, restructuring, and margin improvement activities are necessary. During the third quarter of 2017, the Company incurred approximately $20.7 million in costs versus $5.9 million last year. For the nine months ended September 30, 2017 and 2016, the Company incurred restructuring and margin improvement activity costs of approximately $39.5 million and $12.9 million, respectively.

The acquisition, integration, divestiture, and related costs line represents costs associated with completed and potential acquisitions, the related integration of the acquisitions, and divestitures. Costs incurred in the first nine months of 2017 primarily related to the divestiture of the SIF business, which closed on May 22, 2017, while costs incurred in the first nine months of 2016 primarily related to the acquisition and integration of the Private Brands Business, which was acquired on February 1, 2016. Costs associated with integrating businesses into the Company’s operations are also included in this line.

The Company’s derivative contracts are marked-to-market each period with the changes being recorded in the Condensed Consolidated Statements of Operations. These are non-cash charges. As the contracts are settled, realized gains and losses are recognized.

The Company has Canadian dollar denominated intercompany loans and incurred foreign currency gains of $4.2 million in the third quarter of 2017 versus foreign currency losses of $1.4 million in the prior year to re-measure the loans at quarter end. For the nine months ended September 30, 2017 and 2016, the Company incurred foreign currency gains of $7.6 million and $5.2 million, respectively. These charges are non-cash and the loans are eliminated in consolidation.

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The product recall (reimbursement) costs line primarily represents insurance proceeds related to an announced voluntary recall of products that may have been impacted by sunflower seeds contaminated with Listeria monocytogenes (L.mono) that were provided by a supplier. Product was distributed nationwide through retail stores. TreeHouse initiated the voluntary recall as a cautionary measure to protect public health. Related costs include, but are not limited to, customer fees, customer reimbursements, inventory write-offs, and other costs to manage the recall. The Company expects to be reimbursed for these costs and will exclude any gains from adjusted earnings in the period in which the proceeds are received, consistent with the Company’s exclusion from adjusted earnings of the costs incurred in 2016. In February 2017 and August 2017, the Company received a $4.0 million reimbursement ($8.0 million combined) and has included it in this line. Other product recalls during the first nine months of 2017 were insignificant.

The tax impact on adjusting items is calculated based upon the tax laws and statutory tax rates applicable in the tax jurisdiction of the underlying non-GAAP adjustments.

Adjusted Net Income and Adjusted EBITDAS, Adjusting for Certain Items Affecting Comparability

Adjusted net income represents GAAP net income as reported in the Condensed Consolidated Statements of Operations adjusted for items that, in management’s judgment, significantly affect the assessment of earnings results between periods as outlined in the Adjusted Diluted EPS section above. This information is provided in order to allow investors to make meaningful comparisons of the Company’s earnings performance between periods and to view the Company’s business from the same perspective as Company management. This measure is also used as a component of the Board of Director’s measurement of the Company’s performance for incentive compensation purposes and is the basis of calculating the Adjusted Diluted EPS metric outlined above.

Adjusted EBITDAS represents adjusted net income before interest expense, interest income, income tax expense, depreciation and amortization expense, and non-cash stock-based compensation expense. Adjusted EBITDAS is a performance measure commonly used by management to assess operating performance, and the Company believes it is commonly reported and widely used by investors and other interested parties as a measure of a company’s operating performance between periods.

The following table reconciles the Company’s net income as presented in the Condensed Consolidated Statements of Operations, the relevant GAAP measure, to Adjusted net income and Adjusted EBITDAS for the three and nine months ended September 30, 2017 and 2016:

 

 

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Other Commitments and Contingencies

We also have the following commitments and contingent liabilities, in addition to contingent liabilities related to the ordinary course of litigation, investigations, and tax audits:

See Note 15 to our Condensed Consolidated Financial Statements included herein and Note 19 to our Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 for more information about our commitments and contingent obligations.

Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is provided in Note 19 to the Company’s Condensed Consolidated Financial Statements.

Critical Accounting Policies

A description of the Company’s critical accounting policies is contained in our Annual Report on Form 10-K for the year ended December 31, 2016. There were no material changes to our critical accounting policies in the nine months ended September 30, 2017.

 

As discussed in greater detail in our Annual Report on Form 10-K for the year ended December 31, 2016, the Company evaluates goodwill for impairment using an income approach, which is corroborated by a market approach. The Company believes the income approach is the most reliable indicator of the fair value of its reporting units. Key assumptions used in the income approach include growth and discount rates, margins, and the weighted average cost of capital. Historical performance and management estimates of future performance are used to determine margins and growth rates. Discount rates vary by reporting unit, with the weighted average

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of all discount rates approximating the Company’s total discount rate. Weighted average cost of capital is determined based on a review and assessment of market and capital structure assumptions.

 

As discussed in greater detail in Note 6 to our Condensed Consolidated Financial Statements in Part I – Item 1 of this Form 10-Q, the Company has the following five operating segments as of the first quarter of 2017, which are also its reporting units: Baked Goods, Beverages, Condiments, Meals, and Snacks. Reporting units are based on the components one level below operating segments. These components have been aggregated in determining the Company’s reporting units. The change in reporting units was considered a triggering event indicating a test for goodwill impairment was required as of January 1, 2017. The Company performed the first step of the impairment test, which did not result in the identification of any impairment losses.

 

The estimated fair value of the Snacks reporting unit exceeded its carrying value by approximately 18% as of January 1, 2017, and the reporting unit has allocated goodwill of $276.4 million. The reporting unit has not achieved the forecasted results for the nine months ended September 30, 2017.  The Company’s long-term commitment to the Snacks reporting unit remains consistent. If the reporting unit does not achieve forecasted results in future periods or if other key assumptions change, the estimated fair value of the reporting unit could decline, which may result in a material impairment in a subsequent period.

Off-Balance Sheet Arrangements

We do not have any obligations that meet the definition of an off-balance sheet arrangement, other than operating leases and letters of credit, which have or are reasonably likely to have a material effect on our Condensed Consolidated Financial Statements.

Cautionary Statement Regarding Forward Looking Statements

From time to time, we and our representatives may provide information, whether orally or in writing, including certain statements in this Quarterly Report on Form 10-Q, which are deemed to be “forward-looking” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”). These forward-looking statements and other information are based on our beliefs as well as assumptions made by us using information currently available.

The words “anticipate,” “believe,” “estimate,” “project,” “expect,” “intend,” “plan,” “should,” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties, and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, or intended. We do not intend to update these forward-looking statements following the date of this report.

In accordance with the provisions of the Litigation Reform Act, we are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q and other public statements we make. Such factors include, but are not limited to: our level of indebtedness and related obligations; disruptions in the financial markets; interest rates; changes in foreign currency exchange rates; customer consolidation; raw material and commodity costs; competition; integration of the Private Brands Business acquisition and our ability to continue to make acquisitions in accordance with our business strategy or effectively manage the growth from acquisitions; changes and developments affecting our industry, including consumer preferences; the outcome of litigation and regulatory proceedings to which we may be a party; product recalls; changes in laws and regulations; and other risks that are set forth in the Risk Factors section, the Legal Proceedings section, the Management’s Discussion and Analysis of Financial Condition and Results of Operations section, and other sections of this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the year ended December 31, 2016, and from time to time in our filings with the Securities and Exchange Commission.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Fluctuations

As of September 30, 2017, the Company was party to the Revolving Credit Facility with an aggregate commitment of $900 million, with an interest rate based on the Company’s consolidated leverage ratio, and determined by either LIBOR plus a margin ranging from 1.25% to 3.00%, or a base rate (as defined in the Amended and Restated Credit Agreement) plus a margin ranging from 0.25% to 2.00%. The Company was also party to Term Loan A, Term Loan A-1, and Term Loan A-2. Interest rates for the Term Loans are based on the Company’s consolidated leverage ratio and determined as follows: by either LIBOR plus a margin ranging from 1.25% to 3.00%, or a base rate (as defined in the Amended and Restated Credit Agreement) plus a margin ranging from 0.25% to 2.00%.

In June 2016, the Company entered into $500 million of long-term interest rate swap agreements to lock into a fixed LIBOR interest rate base. Under the terms of the agreements, $500 million in variable-rate debt was swapped for a weighted average fixed interest rate base of approximately 0.86% for a period of 37 months, beginning on January 31, 2017 and ending on February 28, 2020. The borrowing cost on the swapped principal will range from 2.11% to 3.86% during the life of the swap agreement based on the credit spreads under the Amended and Restated Credit Agreement.

We do not hold any derivative financial instruments, other than the interest rate swap agreements discussed above, which could expose us to significant interest rate market risk as of September 30, 2017. Our exposure to market risk for changes in interest rates relates primarily to the increase in the amount of interest expense we expect to pay with respect to our Amended and Restated Credit Agreement, which is tied to variable market rates. Based on our outstanding debt balance of $1,543.0 million under the Amended and Restated Credit Agreement at September 30, 2017, and adjusting for the impact of the $500 million in interest rate swap agreements that have a fixed interest rate base, each 1% rise in our interest rate would increase our annual interest expense by approximately $10.4 million.

Input Costs

The costs of raw materials, packaging materials, fuel, and energy have varied widely in recent years and future changes in such costs may cause our results of operations and our operating margins to fluctuate significantly. When comparing the third quarter of 2017 to the third quarter of 2016, price decreases in almonds, flour, rice, grains, sugars, and eggs were more than offset by price increases in cashews, coffee, soybean and other oils, dairy, corn sweeteners, and packaging materials. We expect the volatile nature of these costs to continue with an overall long-term upward trend.

We manage the cost of certain raw materials by entering into forward purchase contracts. Forward purchase contracts help us manage our business and reduce cost volatility. Some of these forward purchase contracts qualify as derivatives; however, the majority of commodity forward contracts are not derivatives. Those that are derivatives generally qualify for the normal purchases and normal sales scope exception under the guidance for derivative instruments and hedging activities and, therefore, are not subject to its provisions. For derivative commodity contracts that do not qualify for the normal purchases and normal sales scope exception, the Company records their fair value on the Condensed Consolidated Balance Sheets, with changes in value being recorded in the Condensed Consolidated Statements of Operations.

We use a significant volume of fruits, vegetables, and nuts in our operations as raw materials. Certain of these inputs are purchased under seasonal grower contracts with a variety of growers strategically located to supply our production facilities. Bad weather or disease in a particular growing area can damage or destroy the crop in that area. If we are unable to buy the inputs from local suppliers, we would purchase them from more distant locations, including other locations within the United States, Mexico, or India, thereby increasing our raw material costs. When entering into contracts for input costs, the Company generally seeks contract lengths between nine and twelve months.

Changes in the prices of our products may lag behind changes in the costs of our products. Competitive pressures also may limit our ability to quickly raise prices in response to increased raw materials, packaging, fuel, and energy costs. Accordingly, if we are unable to increase our prices to offset increasing costs, our operating profits and margins could be materially affected. In addition, in instances of declining input costs, customers may seek price reductions in situations where we are locked into input prices at higher costs.

Fluctuations in Foreign Currencies

The Company is exposed to fluctuations in foreign currency as a result of our Canadian and Italian subsidiaries, where the functional currency is the Canadian dollar and Euro, respectively. Items that give rise to foreign exchange transaction gains and losses primarily include foreign denominated intercompany loans and input costs. The foreign exchange gain or loss on intercompany loans and foreign denominated working capital balances are recorded in the Gain on foreign currency exchange line of the Condensed

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Consolidated Statements of Operations where the Company recognized gains of $2.8 million and $6.0 million for the nine months ended September 30, 2017 and 2016, respectively.

A significant portion of the Company’s Canadian operations purchase their inputs and packaging materials in U.S. dollars, resulting in higher costs when the U.S. dollar strengthens as compared to the Canadian dollar. The Company estimates the impact on input costs (and Cost of sales) to be approximately $2 million for each one cent change in the exchange rate between the U.S. and Canadian dollar.

Also impacted by foreign exchange is the translation of the Company’s Canadian and Italian financial statements. For the nine months ended September 30, 2017 and 2016, the Company recognized translation gains of $34.5 million and $21.6 million, respectively, as a component of Accumulated other comprehensive loss.

The Company enters into foreign currency contracts due to the exposure to Canadian/U.S. dollar currency fluctuations on cross border transactions. The Company does not apply hedge accounting to these contracts and records them at fair value on the Condensed Consolidated Balance Sheets. The contracts are entered into for the purchase of U.S. dollar denominated raw materials by our Canadian subsidiaries. As of September 30, 2017, the Company had $46.5 million of U.S. dollar foreign currency contracts outstanding.

Item 4. Controls and Procedures

The Company maintains a system of disclosure controls and procedures to give reasonable assurance that information required to be disclosed in the Company’s reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. These controls and procedures also give reasonable assurance that information required to be disclosed in such reports is accumulated and communicated to management to allow timely decisions regarding required disclosures.

As of September 30, 2017, the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), together with management, conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation, the CEO and CFO concluded that these disclosure controls and procedures are effective.

There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2017 that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

TreeHouse Foods, Inc.

Oak Brook, Illinois

We have reviewed the accompanying condensed consolidated balance sheet of TreeHouse Foods, Inc. and subsidiaries (the "Company") as of September 30, 2017, and the related condensed consolidated statements of operations and comprehensive income (loss) for the three-month and nine-month periods ended September 30, 2017 and 2016, and of cash flows for the nine-month periods ended September 30, 2017 and 2016. This interim financial information is the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial information taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of TreeHouse Foods, Inc. and subsidiaries as of December 31, 2016, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated February 16, 2017, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2016 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ DELOITTE & TOUCHE LLP

Chicago, Illinois

November 2, 2017

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Part II — Other Information

Item 1. Legal Proceedings

Litigation, Investigations and Audits — On November 16, 2016, a purported TreeHouse shareholder filed a putative class action captioned Tarara v. TreeHouse Foods, Inc., et al., Case No. 1:16-cv-10632, in the United States District Court for the Northern District of Illinois against TreeHouse and certain of its officers. The complaint, amended on March 24, 2017, is purportedly brought on behalf of all purchasers of TreeHouse common stock from January 20, 2016 through and including November 2, 2016, asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and seeks, among other things, damages and costs and expenses. On December 22, 2016, another purported TreeHouse shareholder filed an action captioned Wells v. Reed, et al., Case No. 2016-CH-16359, in the Circuit Court of Cook County, Illinois, against TreeHouse and certain of its officers. This complaint, purportedly brought derivatively on behalf of TreeHouse, asserts state law claims against certain officers for breach of fiduciary duty, unjust enrichment, and corporate waste. On February 7, 2017, another purported TreeHouse shareholder filed an action captioned Lavin v. Reed, Case No. 17-cv-01014, in the Northern District of Illinois, against TreeHouse and certain of its officers. This complaint, like Wells, is purportedly brought derivatively on behalf of TreeHouse, and it asserts state law claims against certain officers for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and corporate waste.

All three complaints make substantially similar allegations (though the amended complaint in Tarara now contains additional detail). Essentially, the complaints allege that TreeHouse, under the authority and control of the individual defendants: (i) made certain false and misleading statements regarding the Company’s business, operations, and future prospects; and (ii) failed to disclose that (a) the Company’s private label business was underperforming; (b) the Company’s Flagstone business was underperforming; (c) the Company’s acquisition strategy was underperforming; (d) the Company had overstated its full-year 2016 guidance; and (e) TreeHouse’s statements lacked reasonable basis. The complaints allege that these actions artificially inflated the market price of TreeHouse common stock during the class period, thus purportedly harming investors. We believe that these claims are without merit and intend to defend against them vigorously.

Since its initial docketing, the Tarara matter has been re-captioned as Public Employees’ Retirement Systems of Mississippi v. TreeHouse Foods, Inc., et al., in accordance with the Court’s order appointing Public Employees’ Retirement Systems of Mississippi as the lead plaintiff. The Public Employees’ defendants have filed a motion to dismiss, which has been fully briefed.

Additionally, due to the similarity of the complaints, the parties in Wells and Lavin have entered stipulations deferring the litigation until the earlier of (i) the court in Public Employees’ entering an order resolving defendants’ anticipated motion to dismiss therein or (ii) plaintiffs’ counsel receiving notification of a settlement of Public Employees’ or until otherwise agreed to by the Parties. The next status date in Wells is April 27, 2018.  There is no set status date in Lavin at this time, but the parties are directed to file a joint status report on the progress of the related litigation by October 26, 2017, after which point the Lavin court could set a new status date.

In addition, we are party to a variety of legal proceedings arising out of the conduct of our business. While the results of proceedings cannot be predicted with certainty, management believes that the final outcome of these proceedings will not have a material adverse effect on our consolidated financial statements, results of operations, or cash flows.

Item 1A. Risk Factors

Information regarding risk factors appears in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Information Related to Forward-Looking Statements, in Part I — Item 2 of this Form 10-Q, and in Part I — Item 1A of the TreeHouse Foods, Inc. Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes from the risk factors previously disclosed in the TreeHouse Foods, Inc. Annual Report on Form 10-K for the year ended December 31, 2016, with the exception of the following:

 

Our TreeHouse 2020 restructuring plan could result, from time to time, in the impairment of assets, including goodwill and other intangible assets, and we may not realize some or all of the anticipated benefits of this plan in the anticipated time frame or at all.

 

On August 3, 2017, the Company announced the TreeHouse 2020 restructuring plan, which will be executed in multiple phases over the next several years. The plan targets a 300 basis point operating margin improvement by the end of 2020 through a comprehensive program of category and customer portfolio management, as well as manufacturing and supply chain optimization. Phase 1 of TreeHouse 2020 consists of the closure of the Company’s Brooklyn Park, Minnesota and Plymouth, Indiana facilities as well as the downsizing of the Dothan, Alabama facility. TreeHouse 2020 could result, from time to time, in significant financial charges for the impairment of assets, including goodwill and other intangible assets. The calculation of anticipated charges, as well as cost savings and other benefits, resulting from our corporate restructuring are based on estimates and assumptions which are subject to

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uncertainties. If any of our estimates or assumptions prove to be inaccurate, we may incur greater than expected charges, which could have a material adverse effect on our financial condition and results of operations.

 

Events and circumstances, such as financial or strategic difficulties, delays and unexpected costs may occur that could result in our not realizing all or any of the anticipated benefits on our expected timetable or at all, and there can be no assurance that any benefits we realize from these restructuring efforts will be sufficient to offset the restructuring charges and other costs that we expect to incur. If our restructuring measures are not successful, we may need to undertake additional cost reduction efforts, which could result in future charges. If we fail to realize the anticipated benefits from these measures, our financial condition and operating results may be adversely affected.

 

In addition, we expect that our restructuring plan will require a substantial amount of management and operational resources. These and related demands on our resources may divert the Company’s attention from existing core businesses, potentially disrupting our operations and adversely affecting our relationships with suppliers and customers. As a result, our financial condition, results of operations or cash flows may be adversely affected.

Item 6. Exhibits

 

*Filed herewith.

 

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SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

November 2, 2017

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