TreeHouse Foods, Inc. - Annual Report: 2009 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

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

 

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

 

 

Securities registered pursuant to section 12(g) of the Act: None

 

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

 

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

 

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 þ     No o

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this Chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 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 o     No þ

 

The aggregate market value of the Registrant’s common stock held by non-affiliates as of June 30, 2009, based on the $28.77 per share closing price on the New York Stock Exchange on such date, was approximately $897.7 million. Shares of common stock held by executive officers and directors of the registrant have been excluded from this calculation because such persons may be deemed to be affiliates.

 

The number of shares of the registrant’s common stock outstanding as of January 29, 2010 was 32,000,919.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on April 29, 2010 are incorporated by reference into Part III of this Form 10-K.

 

 

TABLE OF CONTENTS

 

 

Certain statements and information in this Form 10-K may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words “believe,” “estimate”, “project”, “except,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could” or other similar expressions are intended to identify forward-looking statements, which are generally not historical in nature. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effect on us. These forward-looking statements and other information are based on our beliefs as well as assumptions made by us using information currently available. 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 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. Such factors include, but are not limited to, the outcome of litigation and regulatory proceedings to which we may be a party; the impact of product recalls; actions of competitors; changes and developments affecting our industry; quarterly or cyclical variations in financial results; our ability to obtain suitable pricing for our products; development of new products and services; our level of indebtedness; the availability of financing on commercially reasonable terms; cost of borrowing; our ability to maintain and improve cost efficiency of operations; changes in foreign currency exchange rates; interest rates and raw material and commodity costs; changes in economic conditions; political conditions; reliance on third parties for manufacturing of products and provision of services; delays in the consummation, or the failure to consummate, the proposed Sturm Foods, Inc. acquisition; general U.S. and global economic conditions; the financial condition of our customers and suppliers; consolidations in the retail grocery and foodservice industries; our ability to continue to make acquisitions in accordance with our business strategy or effectively manage the growth from acquisitions and other risks that are described Part I, Item 1A — “Risk Factors” and our other reports filed from time to time with the Securities and Exchange Commission (the “SEC”).

 

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

 

 

References herein to “we,” “us,” “our,” “Company” and “TreeHouse” refers to TreeHouse Foods, Inc. and its consolidated subsidiaries unless the context specifically states or implies otherwise.

 

TreeHouse is a Delaware corporation incorporated on January 25, 2005 by Dean Foods Company to accomplish a spin-off of certain specialty businesses to its shareholders which was completed on June 27, 2005. Since the Company began operating as an independent entity, it has expanded its product offerings through a number of acquisitions. On April 24, 2006, the Company acquired the private label soup and infant feeding business from Del Monte Corporation (“Soup and Infant Feeding”). On May 31, 2007, the Company acquired VDW Acquisition, Ltd (“San Antonio Farms”) a manufacturer of Mexican sauces. On October 15, 2007, the Company acquired the assets of E.D. Smith Income Fund (“E.D. Smith”), a manufacturer of salad dressings, jams and various sauces.

 

We are a food manufacturer servicing primarily the retail grocery and foodservice distribution channels. Our products include non-dairy powdered coffee creamers; private label soups, salad dressings and sauces; Mexican sauces; jams and pie fillings; pickles and related products; infant feeding products; aseptic sauces; refrigerated salad dressings and liquid non-dairy creamer. We manufacture and sell the following:

 

 

Effective January 1, 2008, we realigned the manner in which our business is managed and now focus on operating results based on channels of distribution, which resulted in a change to our operating and reportable segments. Previously, we managed our business based on product categories. Our change in operating and reportable segments from product categories to channel of distribution is consistent with management’s long-term growth strategy and was necessary due to the acquisitions that occurred during 2007. The change in operating and reportable segments will permit the Company to integrate future acquisitions more efficiently and provide our investors with greater comparability to our peer group, as many of them also present results based on channels of distribution.

 

We discuss the following segments in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”: North American Retail Grocery, Food Away From Home, and Industrial and Export. The key performance indicators of our segments are net sales dollars, gross profit and direct operating income, which is gross profit less the cost of transporting products to customer locations (referred to in the tables below as “freight out”), commissions paid to independent sales brokers, and direct selling and marketing expenses.

 

Our North American Retail Grocery segment sells branded and private label products to customers within the United States and Canada. These products include non-dairy powdered creamers; condensed and ready to serve soups, broths and gravies; infant feeding products; salad dressings and sauces; pickles, peppers and relishes; Mexican sauces; jams and pie fillings; aseptic products and liquid non-dairy creamer.

 

Our Food Away From Home segment sells non-dairy powdered creamers, pickle products, Mexican sauces, refrigerated dressings, and aseptic products to foodservice customers, including restaurant chains and food distribution companies, within the United States and Canada.

 

Our Industrial and Export segment includes the Company’s co-pack soup and infant feeding business; non-dairy powdered creamer sales to industrial customers for use in industrial applications, including products

for repackaging in portion control packages and for use as ingredients by other food manufacturers; pickles; Mexican sauces; and refrigerated dressings. Export sales are primarily to industrial customers.

 

See Note 21 to the Consolidated Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information related to the Company’s business segments.

 

We operate our business as Bay Valley Foods, LLC (“Bay Valley”) in the United States and E.D. Smith Foods, Ltd (“E.D. Smith”) in Canada. Bay Valley is a Delaware limited liability company, a wholly owned subsidiary of TreeHouse Foods, Inc. and holds all of the real estate and operating assets related to our business. E.D. Smith is a wholly owned subsidiary of Bay Valley.

 

Recent Developments

 

On December 20, 2009, TreeHouse entered into a definitive Purchase Agreement to acquire all of the issued and outstanding common stock of Sturm Foods, Inc. (“Sturm”) for a purchase price of approximately $660 million in cash (subject to adjustment). We believe Sturm is the leading manufacturer of private label sugar free drink mixes and hot cereals in the United States. The acquisition of Sturm will add two large categories to our dry grocery portfolio. TreeHouse intends to finance the transaction through a combination of approximately $400 million in new debt issuance, approximately $100 million in equity stock issuance, and the balance funded from borrowings under TreeHouse’s existing revolving credit facility.

 

The closing of the transaction is subject to customary closing conditions and is expected to close in the first quarter of 2010. There can be no assurances, however, that the parties will satisfy the closing conditions and consummate the transaction within the expected timeframe, or at all.

 

Our Products

 

Financial information about our North American Retail Grocery, Food Away From Home, and Industrial and Export segments can be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

The following table sets forth percentages of consolidated net sales contributed by classes of similar products, for the years ended December 31, 2009, 2008, and 2007:

 

Products

 

 

Soup and Infant Feeding — Soup, broth and gravy are produced and packaged in cans of various sizes, from single serve to larger sized cans. We primarily produce private label products sold to supermarkets and mass merchandisers. We also produce infant feeding products, primarily under the Nature’s Goodness^® brand, and we co-pack organic infant feeding products for a branded baby food company. Infant feeding production takes place in the same factory that produces most of our soup, broth and gravy products. In 2009, the

majority of the soup and infant feeding sales were to the retail channel and represented 22.8% of our consolidated net sales, with the majority of the sales coming from soup.

 

Non-Dairy Powdered Creamer — Non-dairy powdered creamer is used as coffee creamer or whitener and as an ingredient in baking, hot and cold beverages, gravy mixes and similar products. Product offerings in this category include private label products packaged for grocery retailers, such as supermarkets and mass merchandisers, foodservice products for use in coffee service and other industrial applications, such as portion control, repackaging and ingredient use by other food manufacturers. We believe we are the largest supplier of non-dairy powdered creamer in the United States. Non-dairy powdered creamer represented 21.4% of our consolidated net sales for the year ended December 31, 2009.

 

Pickles — We produce pickles and a variety of related products, including peppers, pickled vegetables, sauces and syrups. We produce private label and regional branded offerings in the pickles category. These products are sold to supermarkets, mass merchandisers, foodservice and industrial customers. We believe we are the largest producer of pickles with in the United States. Pickles and related products represented approximately 21.0% of our consolidated net sales in 2009.

 

Salad Dressings — We produce both pourable and spoonable salad dressings. Our salad dressings are sold primarily to supermarkets and mass merchandisers throughout the United States and Canada, and encompass many flavor varieties. We believe we are the largest supplier of private label salad dressings in both the United States and Canada. Salad dressings represented 12.3% of our consolidated net sales in 2009.

 

Jams and Other Sauces  — We produce jams, pie fillings and other sauces that we sell to supermarkets, mass merchandisers and foodservice customers in the United States and Canada. Jams and other sauces represented 10.3% of our consolidated net sales in 2009.

 

Aseptic Products — Aseptic products are processed under heat and pressure in a sterile production and packaging environment, creating a product that does not require refrigeration prior to use. Our principal aseptic products are cheese sauces and puddings. These products are sold primarily to foodservice customers in cans and flexible packages. Aseptic products represented 5.6% of our consolidated net sales in 2009.

 

Mexican Sauces — We produce a wide variety of Mexican sauces, including salsa, picante sauce, cheese dip, enchilada sauce and taco sauce that we sell to supermarkets, mass merchandisers and foodservice customers in the United States and Canada, as well as to industrial markets. Mexican sauces represented approximately 4.3% of our consolidated net sales in 2009.

 

Refrigerated Products — We produce refrigerated salad dressings and liquid non-dairy creamer, which are sold to retail and foodservice customers. Refrigerated products represented approximately 2.3% of our consolidated net sales in 2009.

 

See Note 21 to the Consolidated Financial Statements for financial information by segment and sales by major products.

 

Customers and Distribution

 

We sell our products through various distribution channels, including retail grocery, foodservice distributors and industrial and export, including food manufacturers and repackagers of foodservice products. We have an internal sales force that manages customer relationships and our broker network, which is used for sales to retail and foodservice accounts. Industrial food products are generally sold directly to customers without the use of a broker. Most of our customers, including long-standing customers, purchase products from us either by purchase order or pursuant to contracts that generally are terminable at will. We have many customer supply arrangements that are not evidenced by written agreements.

 

Products are shipped from our production facilities directly to customers or to our distribution centers, where products are consolidated for shipment to customers. We believe this consolidation of products enables us to improve customer service by offering our customers a single order, invoice and shipment.

We sell our products to a diverse customer base, including many of the leading grocery retailers and foodservice operators in the United States and Canada, and a variety of customers that purchase bulk products for industrial food applications. We currently supply more than 250 food retail customers in North America, including 47 of the 50 largest food retailers, and more than 450 foodservice customers, including 74 of the 100 largest restaurant chains and the 200 largest food distributors. A relatively limited number of customers account for a large percentage of our consolidated net sales. For the year ended December 31, 2009, our ten largest customers accounted for approximately 47% of the Company’s consolidated net sales. For the years ended December 31, 2009, 2008 and 2007, our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 14.4%, 15.1% and 13.8%, respectively, of our consolidated net sales. No other customer accounted for 10% or more of the Company’s consolidated net sales. Total trade receivables with Wal-Mart Stores, Inc. and affiliates represented 13.3% and 14.5% of our total trade receivables as of December, 31, 2009 and 2008, respectively.

 

Backlog

 

Our products are generally shipped from inventory upon receipt of a customer order. In certain cases, we produce to order. Sales order backlog is not material to our business.

 

Competition

 

We have several competitors in each of our segments. For sales of private label products to retailers, the principal competitive factors are price, product quality and quality of service. For sales of products to foodservice, industrial and export customers, the principal competitive factors are product quality and specifications, reliability of service and price. We believe we are the largest manufacturer of non-dairy powdered creamer and pickles in the United States and largest manufacturer of private label salad dressings in the United States and Canada based on sales volume.

 

Competition to obtain shelf space for our branded products with retailers generally is based on the expected or historical performance of our product sales relative to our competitors. The principal competitive factors for sales of our branded products to consumers are brand recognition and loyalty, product quality, promotion and price. Most of our branded competitors have significantly greater resources and brand recognition than we do.

 

The consolidation trend is continuing in the retail grocery and foodservice industries, and mass merchandisers are gaining market share. As our customer base continues to consolidate, we expect competition to intensify as we compete for the business of fewer, large customers.

 

We believe our strategies for competing in each of our business segments, which include superior product quality, effective cost control programs, an efficient supply chain, successful new products and price, allow us to compete effectively.

 

Patents and Trademarks

 

We own a number of registered trademarks. While we consider our trademarks to be valuable assets, we do not consider any trademark to be of such material importance that its absence would cause a material disruption of our business. No trademark is material to any one segment.

 

Brand names sold within the North American Retail Grocery segment include the following pickle brands, Farman’s^®, Nalley’s^®, Peter Piper ^® and Steinfeld^®. Also sold are brands related to sauces and syrups, Bennett’s^®, Hoffman House^®, Roddenbery’s Northwoods^® and San Antonio Farms^®. Infant feeding products are sold under the Nature’s Goodness^® brand, while our non-dairy powdered creamer is sold under our proprietary Cremora^® brand. Our refrigerated products are sold under the Mocha Mix^® and Second Nature^® brand names, and our jams and other sauces are sold under the E.D. Smith^® and Habitant^® brand names.

 

Trade names used in our Food Away From Home segment include Schwartz^® and Saucemaker^®.

Seasonality

 

In general, total demand for our products does not vary significantly by quarter. However, sales of soup products have a higher percentage of sales in the fourth quarter and lower sales in the second quarter while dressings have higher sales in the second quarter. Pickles tend to have higher sales in the second quarter and non-dairy powdered creamer tends to have higher sales in the first and fourth quarters.

 

Foreign Operations and Geographic Information

 

Foreign sales information is set forth in Note 21 to the “Consolidated Financial Statements.”

 

Raw Materials and Supplies

 

Our raw materials consist of ingredients and packaging materials. Principle ingredients used in our operations include processed vegetables and meats, soybean oil, coconut oil, casein, cheese, corn syrup, cucumbers, peppers and fruit. These ingredients generally are purchased under supply contracts, and we occasionally engage in forward buying, when we determine such buying to be to our advantage. We believe these ingredients to be generally available from a number of suppliers. The cost of raw materials used in our products may fluctuate due to weather conditions, regulations, industry and general U.S. and global economic conditions, fuel prices, energy costs, labor disputes, transportation delays or other unforeseen circumstances. The most important packaging materials and supplies used in our operations are glass, plastic containers, corrugated containers, metal closures and metal cans, operating supplies and energy. Most packaging materials are purchased under long-term supply contracts. We believe these packaging materials to be generally available from a number of suppliers. Volatility in the cost of our raw materials and supplies can adversely affect our performance, as price changes often lag behind changes in costs and we are not always able to adjust our pricing to reflect changes in raw material and supply costs.

 

For additional discussion of the risks associated with the raw materials used in our operations, see “Known Trends and Uncertainties — Prices of Raw Materials.”

 

Working Capital

 

Our short-term financing needs are primarily for financing working capital during the year. Due to the seasonality of pickle and fruit production, driven by harvest cycles, which occur primarily during late spring and summer, inventories generally are at a low point in late spring and at a high point during the fall, increasing our working capital requirements. In addition, we build inventories of salad dressings in the spring and soup in the summer months in anticipation of large seasonal shipments that begin late in the second and third quarters, respectively. Our long-term financing needs will depend largely on potential acquisition activity. Our revolving credit agreement, plus cash flow from operations, is expected to be adequate to provide liquidity for our current operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

Research and Development

 

Our research facilities include a Research and Development Center in Pecatonica, Illinois, which focuses on the development of aseptic and powdered creamer products. Product development work for aseptic products is also carried out at our production facility in Dixon, Illinois. Research and development for our pickle products is carried out at our production facility in Green Bay, Wisconsin. We conduct research and development activities for our soup and infant feeding products at our production facility in Pittsburgh, Pennsylvania. New formulations for salad dressings are created at our Seaforth, Canada location and new sauces and fruit based products are developed at our Winona, Canada facility. In addition, sample preparation, plant trials, ingredient approval and other quality control procedures are conducted at all our manufacturing facilities. Research and development expense totaled $8.3 million, $6.9 million, and $4.8 million in 2009, 2008, and 2007, respectively, and is included in the General and administrative line of the Consolidated Statements of Income.

Employees

 

As of December 31, 2009, our work force consisted of approximately 3,100 full-time employees in the United States and Canada.

 

Available Information

 

Our fiscal year ends on December 31. We furnish our stockholders with annual reports on Form 10-K containing audited financial reports. As a public company, we regularly file reports and proxy statements with the Securities and Exchange Commission (“SEC”). These reports are required by the Securities Exchange Act of 1934 and include annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy statements on Schedule 14A. Copies of any materials the Company files with the SEC can be obtained free of charge through the SEC’s website at http://www.sec.gov, at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549, or by calling the SEC’s Office of Investor Education and Assistance at 1-800-732-0330. We make our SEC filings available on our own internet site as soon as reasonably practicable after they have been filed with the SEC. Our internet address is http://www.treehousefoods.com. The information on our website is not incorporated by reference into this annual report on Form 10-K.

 

Regulatory Environment and Environmental Compliance

 

The conduct of our businesses, and the production, distribution, sale, labeling, safety, transportation and use of our products, are subject to various laws and regulations administered by federal, state, and local governmental agencies in the United States, as well as to foreign laws and regulations administered by government entities and agencies in markets where we operate. It is our policy to abide by the laws and regulations that apply to our businesses.

 

We are subject to national and local environmental laws in the United States and in foreign countries in which we do business including laws relating to water consumption and treatment, air quality, waste, handling and disposal and other regulations intended to protect public health and the environment. We are committed to meeting all applicable environmental compliance requirements.

 

The cost of compliance with U.S. and foreign laws does not have and are not expected to have, a material financial impact on our capital expenditures, earnings or competitive position.

 

Executive Officers

 

 

 

In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially and adversely affect the Company’s business, financial condition, results of operations and cash flows. Additional risks and uncertainties not presently known to the Company also may impair the Company’s business operations and financial condition.

Disruptions in the financial markets could affect our ability to fund acquisitions or to renew our outstanding credit agreements upon expiration at our current favorable terms.

 

As of December 31, 2009, we had $402.5 million of outstanding indebtedness which included $298.2 million under our $600 million revolving credit agreement, which expires August 31, 2011, and $100 million in senior notes from a private placement, which expires on September 30, 2013. The inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our debt obligations on commercially reasonable terms, would have a material adverse effect on our business, financial condition, and results of operations. In addition, the inability to access additional borrowing at commercially reasonable terms could affect our ability to pursue additional acquisitions. U.S. credit markets have experienced significant dislocations and liquidity disruptions which have caused credit spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in debt markets, making financial terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt refinancing. Continued uncertainty in the credit markets may negatively impact our ability to access additional debt financing or to refinance existing indebtedness on favorable terms, or at all. Events affecting the credit markets have also had an adverse effect on other financial markets in the U.S., which may make it more difficult or costly for us to raise capital through the issuance of common stock or other equity securities. Our business could also be negatively impacted if our suppliers or customers experience disruptions resulting from tighter capital and credit markets, or a slowdown in the general economy. Any of these risks could impair our ability to fund our operations or limit our ability to expand our business and could possibly increase our interest expense, which could have a material adverse effect on our financial results.

 

Increases in interest rates may negatively affect earnings.

 

We had outstanding variable rate debt of $298.2 million with an average interest rate of 0.91% as of December 31, 2009, which accounts for approximately 74.1% of our total debt outstanding at December 31, 2009. In October, 2008, we entered into an interest rate swap for two years, with an effective date of November 19, 2008, at a fixed rate of 2.9% on $200 million of our variable rate debt which effectively results in an average interest rate of 2.75% on our variable rate debt at December 31, 2009. However, because we have a significant portion of variable rate debt, we may still experience interest rate volatility. Increases in interest rates on our variable rate debt could materially affect our earnings.

 

Fluctuations in foreign currencies may adversely affect earnings.

 

The Company is exposed to fluctuations in foreign currency exchange rates primarily related to raw material purchases. We are also exposed to fluctuations in the value of our foreign currency investment in our Canadian subsidiary, E.D. Smith.

 

The Canadian assets, liabilities, revenues and expenses are translated into U.S. dollars at applicable exchange rates. Accordingly, we are exposed to volatility in the translation of foreign currency earnings due to fluctuations in the value of the Canadian dollar, which may negatively impact the Company’s results of operations and financial position.

 

As we are dependent upon a limited number of customers, the loss of a significant customer, or consolidation of our customer base, could adversely affect our operating results.

 

A limited number of customers represent a large percentage of our consolidated net sales. Our operating results are contingent on our ability to maintain our sales to these customers. The competition to supply products to these high volume customers is very high. We expect that a significant portion of our net sales will continue to be derived from a small number of customers. For the year ended December 31, 2009, our ten largest customers accounted for approximately 47% of the Company’s consolidated net sales. These customers typically do not enter into written contracts, and the contracts that they do enter into generally are terminable at will. Our customers make purchase decisions based on a combination of price, product quality and customer service performance.

If our product sales to one or more of these customers are reduced, this reduction may have a material adverse effect on our business, results of operations and financial condition.

 

Increases in input costs, such as ingredients, packaging materials and fuel costs, could adversely affect earnings.

 

The costs of ingredients, as well as packaging materials and fuel, 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. Many of the raw materials that we use in our products rose to unusually high levels during 2007 and 2008, including processed vegetables and meats, soybean oil, casein, cheese and packaging materials. During 2009, certain input costs have decreased from the high levels experienced in 2008, but continue to remain at levels in excess of historical costs. Other input costs such as metal cans, lids and caps continue to rise even though the underlying commodity cost has decreased. In addition, fuel costs, which represent the most important factor affecting utility costs at our production facilities and our transportation costs, rose to unusually high levels in the middle of 2008, but have decreased proportionately to the general reduction in overall economic activity in 2009. We expect the volatile nature of these costs to continue, with an overall slightly upward trend.

 

We manage the impact of increases in the costs of raw materials, wherever possible, by locking in prices on quantities required to meet our production requirements. In addition, we attempt to offset the effect of such increases by raising prices to our customers. However, changes in the prices of our products may lag behind changes in the costs of our materials. Competitive pressures also may limit our ability to quickly raise prices in response to increased raw materials, packaging and fuel costs. Accordingly, if we are unable to increase our prices to offset increasing raw material, packaging and fuel costs, our operating profits and margins could be materially adversely affected. In addition, in instances of declining input costs, customers may be looking for price reductions in situations where we have locked into purchases at higher costs.

 

Our private label and regionally branded products may not be able to compete successfully with nationally branded products.

 

For sales of private label products to retailers, the principal competitive factors are price, product quality and quality of service. For sales of private label products to consumers, the principal competitive factors are price and product quality. In many cases, competitors with nationally branded products have a competitive advantage over private label products primarily due to name recognition. In addition, when branded competitors focus on price and promotion, the environment for private label producers becomes more challenging because the price difference between private label products and branded products can become less significant.

 

Competition to obtain shelf space for our branded products with retailers is primarily based on the expected or historical performance of our product sales relative to our competitors. The principal competitive factors for sales of our branded products to consumers are brand recognition and loyalty, product quality, promotion and price. Most of our branded competitors have significantly greater resources and brand recognition than we do.

 

Competitive pressures or other factors could cause us to lose market share, which may require us to lower prices, increase marketing expenditures, or increase the use of discounting or promotional programs, each of which would adversely affect our margins and could result in a decrease in our operating results and profitability.

 

We operate in the highly competitive food industry.

 

We face competition across our product lines from other companies which have varying abilities to withstand changes in market conditions. Some of our competitors have substantial financial, marketing and other resources, and competition with them in our various business segments and product lines could cause us to reduce prices, increase capital, marketing or other expenditures, or lose category share, which could have a

material adverse effect on our business and financial results. Category share and growth could also be adversely impacted if we are not successful in introducing new products.

 

We may be unsuccessful in our future acquisition endeavors, if any, which may have an adverse effect on our business.

 

Consistent with our stated strategy, our future growth depends, in large part, on our acquisition of additional food manufacturing businesses, products or processes. As a result, we intend to engage in acquisition activity, including without limitation our pending acquisition of Sturm. We may be unable to identify suitable targets, opportunistic or otherwise, for acquisition or make acquisitions at favorable prices. If we identify a suitable acquisition candidate, our ability to successfully implement the acquisition would depend on a variety of factors, including our ability to obtain financing on acceptable terms.

 

Acquisitions, including the pending acquisition of Sturm, involve risks, including those associated with integrating the operations, financial reporting, disparate technologies and personnel of acquired companies; managing geographically dispersed operations; the diversion of management’s attention from other business concerns; the inherent risks in entering markets or lines of business in which we have either limited or no direct experience; unknown risks; and the potential loss of key employees, customers and strategic partners of acquired companies. We may not successfully integrate businesses or technologies we acquire in the future and may not achieve anticipated revenue and cost benefits. Acquisitions may not be accretive to our earnings and may negatively impact our results of operations as a result of, among other things, the incurrence of debt, one time write-offs of goodwill and amortization expenses of other intangible assets. In addition, future acquisitions could result in dilutive issuances of equity securities.

 

With respect to our pending acquisition of Sturm, there can be no assurances that the parties will satisfy the closing conditions contained in the purchase agreement and consummate the transaction within our expected timeframe or at all.

 

See Item 1 “Business” regarding the definitive agreement to purchase Sturm Foods.

 

We may be unable to anticipate changes in consumer preferences, which may result in decreased demand for our products.

 

Our success depends in part on our ability to anticipate the tastes and eating habits of consumers and to offer products that appeal to their preferences. Consumer preferences change from time to time and our failure to anticipate, identify or react to these changes could result in reduced demand for our products, which would adversely affect our operating results and profitability.

 

We may be subject to product liability claims for misbranded, adulterated, contaminated or spoiled food products.

 

We sell food products for human consumption, which involve risks such as product contamination or spoilage, misbranding, product tampering, and other adulteration of food products. Consumption of a misbranded, adulterated, contaminated or spoiled product may result in personal illness or injury. We could be subject to claims or lawsuits relating to an actual or alleged illness or injury, and we could incur liabilities that are not insured or that exceed our insurance coverage. Even if product liability claims against us are not successful or fully pursued, these claims could be costly and time consuming and may require management to spend time defending the claims rather than operating our business. A product that has been actually or allegedly misbranded or becomes adulterated could result in: product withdrawals, product recalls, destruction of product inventory, negative publicity, temporary plant closings, and substantial costs of compliance or remediation. Any of these events, including a significant product liability judgment against us, could result in a loss of confidence in our food products, which could have an adverse effect on our financial condition, results of operations or cash flows.

New laws or regulations or changes in existing laws or regulations could adversely affect our business.

 

The food industry is subject to a variety of federal, state, local and foreign laws and regulations, including those related to food safety, food labeling and environmental matters. Governmental regulations also affect taxes and levies, healthcare costs, energy usage, international trade, immigration and other labor issues, all of which may have a direct or indirect effect on our business or those of our customers or suppliers. Changes in these laws or regulations or the introduction of new laws or regulations could increase the costs of doing business for us or our customers or suppliers or restrict our actions, causing our results of operations to be adversely affected.

 

Our business could be harmed by strikes or work stoppages by our employees.

 

Currently, approximately 60% of our full time hourly distribution, production and maintenance employees are covered by collective bargaining agreements with the International Brotherhood of Teamsters, United Food and Commercial Workers Union, or Retail, Wholesale and Department Store Union Central States Council. No agreements expire within one year. If a dispute with one of these unions or the employees they represent were to arise, production interruptions caused by work stoppages could occur. If a strike or work stoppage were to occur, our business, financial condition and results of operations could be adversely affected.

 

 

None.

 

 

We currently operate sixteen production facilities, the majority of which are owned except for the facility in City of Industry, California, which is leased under an agreement that expires in September 2016; the Mendota, Illinois facility, which is leased from Del Monte Corporation under an agreement that expires in April 2035; the Springfield, Missouri facility, which is leased from Bell Carter under an agreement that expires in October 31, 2010. We believe that these facilities are suitable for our operations and provide sufficient capacity to meet our requirements for the foreseeable future. The Company closed the Cambridge, Ontario production facility in June 2009. The following chart lists the location and principal products by segment produced at our production facilities at December 31, 2009:

 

 

 

 

 

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 the Consolidated Financial Statements, annual results of operations or cash flows.

 

 

There were no matters submitted during the fourth quarter of fiscal year 2009 to a vote of security holders, through the solicitation of proxies or otherwise.

 

 

The Company’s common stock is traded on the New York Stock Exchange under the symbol “THS.” The high and low sales prices of our common stock as quoted on the New York Stock Exchange for 2009 and 2008 are provided in the table below

 

 

The closing sales price of our common stock on February 4, 2010 as reported on the NYSE, was $38.38 per share. On February 4, 2010, there were 4,060 shareholders of record of our common stock.

 

We have not paid any cash dividends on the common stock and currently anticipate that, for the foreseeable future, any earnings will be retained for the development of our business. Accordingly, no dividends are expected to be declared or paid on the common stock. Moreover, our revolving credit facility contains certain restrictions on our ability to pay cash dividends. The declaration of dividends is at the discretion of our Board of Directors.

 

The Company did not purchase any shares of its common stock in either 2009 or 2008.

PERFORMANCE GRAPH

 

The price information reflected for our common stock in the following performance graph and accompanying table represents the closing sales prices of the common stock for the period from June 28, 2005 through December 31, 2009. The graph and accompanying table compare the cumulative total stockholders’ return on our common stock with the cumulative total return of the S&P Small Cap 600 Index, Russell 2000 Index and a Peer Group Index consisting of the following group of companies selected based on the similar nature of their business: Kraft Foods Inc., Sara Lee Corp., General Mills, Inc., Kellogg Co., ConAgra Foods Inc., Archer Daniels Midland Co., H.J. Heinz Company, Campbell Soup Co., McCormick & Co. Inc., The JM Smucker Co., Del Monte Foods Co., Corn Products Int’l., Lancaster Colony Corp., Flowers Foods, Inc., Ralcorp Holdings Inc., The Hain Celestial Group, Inc., Lance, Inc., J&J Snack Foods Corp., B&G Foods, Inc., American Italian Pasta Co., Farmer Bros. Inc. and Peet’s Coffee and Tea. The graph assumes an investment of $100 on June 28, 2005, in each of TreeHouse Foods’ common stock, the stocks comprising the S&P Small Cap 600 Index, Russell 2000 Index and the Peer Group Index.

 

COMPARISON OF CUMULATIVE TOTAL RETURN OF $100 AMONG TREEHOUSE FOODS, INC., S&P SMALL CAP 600 INDEX, RUSSELL 2000 INDEX AND THE PEER GROUP INDEX

 

Comparison Of Cumulative Total Return

 

 

 

Equity Compensation Plan Information

 

 

The following table provides information about our common stock that may be issued upon the exercise of options under all of our equity compensation plans as of December 31, 2009:

 

 

 

The following selected financial data as of and for each of the five years in the period ended December 31, 2009 has been derived from the Consolidated Financial Statements. The selected financial data do not purport to indicate results of operations as of any future date or for any future period. The selected financial data should be read in conjunction with the Consolidated Financial Statements and related Notes. For periods prior to June 27, 2005, all of the historical assets, liabilities, sales, expenses, income, cash flows, products, businesses and activities of our business that we describe in this report as “ours” are in fact the historical assets, liabilities, sales, expenses, income, cash flows, products, businesses and activities of the businesses transferred to TreeHouse by Dean Foods.

 

 

 

Executive Overview

 

We believe we are the largest manufacturer of non-dairy powdered creamer and pickles in the United States, and the largest manufacturer of private label salad dressings in the United States and Canada, based upon total sales volumes. In 2009, based on available industry data, private label products sold in the retail grocery channel in the United States, which compete with branded products on the basis of equivalent quality at a lower price, represented approximately 37% of all pickle products, approximately 55% of all non-dairy powdered creamer, approximately 22% of all salad dressings and approximately 18% of all canned soup.

We sell our products primarily to the retail grocery and foodservice channels. For the year ended December 31, 2009, sales to the retail grocery and foodservice channels represented 64.2% and 19.4%, respectively, of our consolidated net sales. The remaining 16.4% represented industrial and export sales. A majority of our sales are private label products.

 

We intend to grow our business profitably through the following strategic initiatives:

 

 

The following discussion and analysis presents the factors that had a material effect on our financial condition, changes in financial condition and results of operations for the years ended December 31, 2009, 2008 and 2007. This should be read in conjunction with the Consolidated Financial Statements and the Notes

to those 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” for a discussion of the uncertainties, risks and assumptions associated with these statements.

 

The Company completed its annual assessment of goodwill and indefinite lived assets as of December 31, 2009 and did not have goodwill impairment. The Company recognized the impairment of one definite lived trademark resulting in a charge of approximately $7.6 million, which is related to the North American Retail Grocery segment. No other impairment was noted. For a more detailed description of the results of our analysis and the related assumptions, see our “Critical Accounting Policies.”

 

For most of 2009, the economy continued to show signs of weakness with continued high unemployment. The Company continued to focus its efforts on cost containment, margin improvement and volume retention. Our efforts resulted in direct operating income growth of 24.9% and 23.1% for the years ended December 31, 2009 and 2008, respectively.

 

The acquisition landscape in 2009, when compared to 2008, yielded better opportunities and types of companies we would be interested in acquiring. The improved landscape resulted in the announcement in December 2009 of a definitive agreement to acquire Sturm Foods, for approximately $660 million. We expect the acquisition to be completed in the first quarter of 2010. As we incorporate this acquisition into our operations, the Company will continue its pursuit of other businesses.

 

The Company’s exposure to foreign exchange rates is primarily limited to the Canadian dollar. At the beginning of 2009, the U.S. dollar was relatively strong versus the Canadian dollar. However, as the year progressed, the U.S. dollar weakened.

 

Recent Developments

 

On December 20, 2009, we entered into a definitive Purchase Agreement to acquire all of the issued and outstanding common stock of Sturm for a purchase price of approximately $660 million in cash (subject to adjustment). We intend to finance the transaction through a combination of approximately $400 million in new debt issuance, approximately $100 million in equity stock issuance, and the balance funded from borrowings under our existing revolving credit facility.

 

The closing of the transaction is subject to certain customary closing conditions and is expected to close in the first quarter of 2010. There can be no assurances, however, that the parties will satisfy the closing conditions and consummate the transaction within the expected timeframe, or at all.

Results of Operations

 

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

 

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

Net Sales — Net sales increased 0.7% to $1,511.7 million for the year ended December 31, 2009, compared to $1,500.7 million, for the year ended December 31, 2008. Net sales by segment are shown in the following table:

 

Total net sales increased 0.7% as decreases in volume in all segments and the impact of foreign currency were offset by increased pricing and a shift in sales mix.

 

Cost of Sales — All expenses incurred to bring a product to completion are included in cost of sales, such as raw material, ingredient and packaging costs, labor costs, facility and equipment costs, including costs to operate and maintain our warehouses, and costs associated with transporting our finished products from our manufacturing facilities to distribution centers. Cost of sales as a percentage of consolidated net sales decreased to 78.4% in 2009 from 80.5% in the prior year. We experienced increases in certain costs such as metal caps, cans and lids and meat products in 2009 compared to 2008; however, these increases were more than offset by decreases in the cost of casein, oils and plastic containers. The combination of price increases and a net decrease in costs in 2009 versus 2008 has resulted in improvement in our consolidated gross margins.

 

Operating Costs and Expenses — Operating expenses decreased to $195.6 million in 2009 compared to $204.9 million in 2008. The decrease in 2009 resulted from the following:

 

Selling and distribution expenses decreased $7.8 million in 2009 compared to 2008. The decrease is primarily due to a reduction in freight costs related to lower unit volume and a reduction in freight rates.

 

General and administrative expenses increased $18.7 million in 2009 compared to 2008, which was primarily due to increases in incentive based compensation and stock based compensation related to the Company’s performance and acquisition costs.

 

Amortization expense decreased slightly from $13.5 million in 2008 to $13.4 million in 2009.

 

Other operating income was $6.2 million in 2009 compared to operating expense of $13.9 million in 2008. Income in 2009 was related to the $14.5 million gain on insurance settlement relating to a fire at our New Hampton, Iowa facility, partially offset by an $7.6 million impairment of our Nature’s Goodness^® trademark. Operating expense in 2008 reflected costs associated with the closure of our Portland, Oregon facility.

 

Operating Income — Operating income in 2009 was $130.8 million, an increase of $43.7 million, or 50.1% from operating income of $87.1 million in 2008. Our operating margin was 8.7% in 2009 compared to 5.8% in 2008.

 

Other (income) expense — Other (income) expense includes interest expense, interest income, foreign exchange gains and losses, and other (income) and expenses.

 

Interest expense in 2009 was $18.4 million, a decrease of $9.2 million from 2008. The decrease is due to lower debt levels and lower average interest rates.

 

The impact of changes in foreign currency resulted in a gain of $7.4 million in 2009 versus an expense in 2008 of $13.0 million. In 2009, approximately $4.9 million of the foreign currency gain was due to the revaluation of an intercompany note, as compared to a currency loss of $9.1 million in 2008. The remaining $2.5 million of foreign currency gain is primarily due to currency exchange on cross-border purchases by our Canadian subsidiary, E.D. Smith, as compared to currency loss of $3.9 million in 2008.

 

Other (income) expense was a gain of $2.3 million in 2009 versus a loss of $7.1 million in 2008. The increase is primarily related to the gain associated with the mark to market adjustment of our interest rate swap agreement, totaling approximately $2.1 million, compared to a loss of $7.0 million in 2008.

 

Income Taxes — Income tax expense was recorded at an effective rate of 33.4% for 2009 compared to 27.6% for 2008. The higher effective tax rate in 2009 is due primarily to increased income which reduced the percentage benefit of the cross-border financing structure entered into in conjunction with the E.D. Smith acquisition.

 

Discontinued operations — Loss from discontinued operations was $0.3 million in 2008 due to the write off of assets held for sale. There were no discontinued operations in 2009.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008 — Results by Segment

 

North American Retail Grocery

 

 

Net sales in the North American Retail Grocery segment increased by $54.0 million, or 5.9%, for the year ended December 31, 2009 compared to the prior year. The change in net sales from 2008 to 2009 was due to the following:

 

 

The increase in net sales from 2008 to 2009 resulted from the carryover effect of price increases taken in the second half of 2008 to cover the cost of rising raw material and packaging costs, partially offset by lower case sales of infant feeding and retail branded pickles, and the impact of foreign currency. While overall case sales decreased in the segment, the Company experienced modest volume increases in soups, Mexican sauces, and salad dressings.

 

Cost of sales as a percentage of net sales decreased from 78.6% in 2008 to 76.0% in 2009 as price increases have now caught up to the raw material and packaging cost increases experienced by the Company in earlier periods. Also contributing to the decrease were several cost reduction initiatives, moving away from certain low margin customers over the past year and net declines in raw material and packaging costs.

 

Freight out and commissions paid to independent brokers decreased $6.9 million or 11.8%, to $51.8 million in 2009 compared to $58.8 million in 2008, as a result of reduced volumes and lower freight costs, as fuel costs have decreased since last year.

 

Direct selling and marketing was $28.4 million in 2009 compared to $23.4 million in 2008, an increase of $5.0 million or 21.2% primarily due to increased levels of incentive based compensation associated with the Company’s overall performance.

Food Away From Home

 

 

Net sales in the Food Away From Home segment decreased by $1.1 million, or 0.4%, for the year ended December 31, 2009 compared to the prior year. The change in net sales from 2008 to 2009 was due to the following:

 

 

Net sales decreased during 2009 compared to 2008 primarily due to reduced volumes resulting from the recent economic down turn as consumers reduced their spending on dining and eating out. This segment also experienced a decrease in net sales due to both a shift in the sales mix and the impact of foreign currency changes. Increased pricing in response to commodity cost increases over the past year and modest increases in sales units of aseptic products and Mexican sauces, offset the volume declines in pickles and other products.

 

Cost of sales as a percentage of net sales decreased from 82.3% in 2008 to 81.9% in 2009, as price increases to our customers have now caught up to the increases in raw material, packaging, and energy costs experienced by the Company in earlier periods, combined with improvements in operating efficiencies.

 

Freight out and commissions paid to independent brokers decreased $3.5 million or 25.8% to $10.1 million in 2009 compared to $13.6 million in 2008, primarily as a result of reduced volumes and lower freight costs, as fuel costs have decreased since last year.

 

Direct selling and marketing was $6.8 million in 2009 compared to $6.3 million in 2008, primarily due to increased levels of incentive based compensation associated with the Company’s overall performance.

Industrial and Export

 

 

Net sales in the Industrial and Export segment decreased by $41.9 million, or 14.5%, for the year ended December 31, 2009 compared to the prior year. The change in net sales from 2008 to 2009 was due to the following:

 

 

The decrease in net sales is primarily due to reduced volumes resulting from lower co-pack sales of branded products for other food companies. While the decline in net sales included the majority of the products sold within this segment, the most significant were in the non-dairy powdered creamer, soup and infant feeding products. Partially offsetting the volume declines was a favorable shift in the mix of products sold.

 

Cost of sales as a percentage of net sales decreased from 85.0% in 2008 to 82.4% in 2009 as price increases have caught up to input cost increases experienced in prior periods. Also contributing to the reduction were productivity improvements realized in 2009, and net decreases in raw material and packaging costs.

 

Freight out and commissions paid to independent brokers decreased by $3.0 million to $5.8 million primarily due to reduced volumes and lower freight costs, as fuel costs have decreased since last year.

 

Direct selling and marketing was $1.8 million in 2009 compared to $1.0 million in 2008, primarily due to increased levels of incentive based compensation associated with the Company’s overall performance.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Net Sales — Net sales increased 29.6% to $1,500.7 million for the year ended December 31, 2008, compared to $1,157.9 million, for the year ended December 31, 2007. Net sales by segment are shown in the following table:

 

 

The increase in net sales is primarily due to the full year impact in 2008 of the 2007 acquisitions of E.D. Smith and San Antonio Farms along with price increases taken to offset rising input costs, which were partially offset by volume decreases in the North American Retail Grocery and Food Away From Home segments. Volume decreases were primarily in the pickle and non-dairy powder creamer businesses, reflecting the Company’s decision to move away from low margin customers and the impact of the slowing global economy.

 

Cost of Sales — All expenses incurred to bring a product to completion are included in cost of sales, such as raw material, ingredient and packaging costs, labor costs, facility and equipment costs, including costs to operate and maintain our warehouses, and costs associated with transporting our finished products from our manufacturing facilities to our own distribution centers. Cost of sales as a percentage of consolidated net sales increased to 80.5% in 2008 from 79.2% in the prior year. Significant raw material cost increases in 2008 include a 43% increase in casein, a 39% increase in oils, an 11% increase in sweeteners and an 8% increase in cucumber crop costs. Packaging cost increases include a 21% increase in plastic containers and a 12% increase in glass containers. We continued to experience increased raw material and packaging costs that we were able to partially offset with increased operating efficiencies and increases in the prices of our products. See — “Results by Segment.”

 

Operating Costs and Expenses — Operating expenses increased to $204.9 million in 2008 compared to $155.3 million in 2007. The increase in 2008 resulted from the following:

 

Selling and distribution expenses increased $21.1 million, primarily due to the full year impact in 2008 of the acquisitions of San Antonio Farms in May, 2007 and E.D. Smith in October, 2007.

 

General and administrative expenses increased $7.8 million in 2008 compared to 2007, due to the acquisition of San Antonio Farms, in May 2007 and E.D. Smith in October 2007. However, due to synergies realized, general and administrative costs as a percent of revenue decreased from 4.7% in 2007 to 4.2% in 2008.

 

Amortization expenses increased to $13.5 million in 2008 from $7.2 million in 2007, due to the full year impact in 2008 of the acquisition of the San Antonio Farms in the second quarter of 2007 and the acquisition of E.D. Smith in the fourth quarter of 2007.

 

Other operating expense in 2008 increased $14.3 million primarily due to the closing of our pickle plant located in Portland, Oregon.

 

Operating Income — Operating income in 2008 was $87.1 million, an increase of $2.2 million, or 2.6% from operating income of $84.9 million in 2007. Our operating margin was 5.8% in 2008 compared to 7.3% in 2007. The impact of the Portland plant closure on operating margin for 2008 was a reduction of 0.9%.

 

Other (income) expense — Other (income) expense includes interest expense, interest income, foreign exchange gains and losses, and other (income) and expenses.

Interest expense in 2008 was $27.6 million, an increase of $5.6 million from 2007. The increase is primarily due to increased debt levels resulting from our 2007 acquisitions. The increase in interest expense was mitigated, as the Company paid down debt during the year and interest rates lowered. Interest income in 2008 and 2007 was $0.1 million.

 

The impact of changes in foreign currency resulted in an expense of $13.0 million in 2008 versus a gain in 2007 of $3.5 million. In 2008, approximately $9.1 million of the foreign currency expense was due to the revaluation of an intercompany note. The remaining $3.9 million of foreign currency expense is primarily due to a full year of foreign currency transaction gains and losses occurring in 2008. The gain in 2007 was primarily due to the forward purchase of Canadian currency used in the 2007 acquisition of E.D. Smith. This did not repeat in 2008.

 

Other (income) expense was a loss of $7.1 million in 2008 versus a gain of $36 thousand in 2007. The increase is primarily related to the mark to market adjustment of our interest rate swap agreement, totaling approximately $7.0 million.

 

Income Taxes — Income tax expense was recorded at an effective rate of 27.6% for 2008 compared to 37.4% for 2007. The lower effective tax rate in 2008 is due to the favorable intercompany financing structure entered into in conjunction with the E.D. Smith acquisition (See Note 8), combined with the tax benefit of the mark to market adjustment of our interest rate swap agreement.

 

Discontinued operations — Our loss on discontinued operations was $0.3 million in 2008 versus $30 thousand in 2007. The increase of $0.3 million was due to the write off of assets held for sale during 2008. The Company was unable to locate a buyer for these assets and has determined they have no value.

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 — Results by Segment

 

North American Retail Grocery

 

 

Net sales in the North American Retail Grocery segment increased by $253.6 million, or 38.2%, for the year ended December 31, 2008 compared to the prior year. The change in net sales from 2007 to 2008 was due to the following:

 

 

The increase in net sales from 2007 to 2008 resulted mainly from the full year impact in 2008 of the acquisition of San Antonio Farms in the second quarter of 2007 and E.D. Smith in the fourth quarter of 2007.

Price increases taken due to rising raw material and packaging costs more than offset lower case sales of baby food and retail branded pickles. The volume declines related to retail pickle low margin customer rationalization and a decline in branded baby food.

 

Cost of sales as a percentage of sales increased from 76.8% in 2007 to 78.6% in 2008 primarily as a result of input cost increases throughout 2008 which were not fully offset by price increases.

 

Freight out and commissions paid to independent brokers increased $13.6 million or 30.2%, to $58.8 million in 2008 compared to $45.1 million in 2007, as a result of increased sales and higher shipping costs primarily due to elevated fuel costs early in 2008.

 

Food Away From Home

 

 

Net sales in the Food Away From Home segment increased by $39.4 million, or 15.5%, for the year ended December 31, 2008 compared to the prior year. The change in net sales from 2007 to 2008 was due to the following:

 

 

Sales increased in 2008 compared to 2007 primarily due to the acquisitions of San Antonio Farms in May 2007, and the E.D. Smith acquisition in October 2007. Price increases taken in 2008 to offset rising input costs also contributed to the increase. Volume declined as the Company moved away from low margin pickle customers and experienced adverse economic conditions in the Food Away From Home industry in 2008.

 

Cost of sales as a percentage of net sales decreased from 82.5% in 2007 to 82.3% in 2008, as price increases to our customers offset increases in raw material, packaging, and energy costs, combined with improvements in operating efficiencies.

 

Freight out and commissions paid to independent brokers increased $2.6 million or 24.1% to $13.6 million in 2008 compared to $10.9 million in 2007, primarily as a result of the higher sales and increased shipping costs due to elevated fuel costs early in 2008.

Industrial and Export

 

 

Net sales in the Industrial and Export segment increased by $49.7 million, or 20.7%, for the year ended December 31, 2008 compared to the prior year. The change in net sales from 2007 to 2008 was due to the following:

 

 

Price increases were taken in 2008 in an effort to offset the significant increases in input costs. In addition, we realized volume increases during the year from the existing customer base.

 

Cost of sales as a percentage of net sales increased from 82.7% in 2007 to 85.0% in 2008 as price increases to our customers did not fully offset increases in raw materials and packaging costs. Also contributing to the increase was a shift in our mix of customers towards lower margin co-pack customers.

 

Freight out and commissions paid to independent brokers increased by $0.8 million to $8.8 million as a result of increased fuel costs early in 2008. However, these costs decreased as a percent of revenue from 3.3% in 2007 to 3.0% in 2008 due to combining shipments and leveraging freight rates with the other product lines.

 

Known Trends and Uncertainties

 

Prices of Raw Materials

 

We were adversely affected by rising input costs during 2008 and 2007, however, during 2009 certain input costs decreased from these high levels. Many of the raw materials used in our products rose to unusually high levels during 2008, including processed vegetables and meats, soybean oil, casein, cheese and packaging materials. Fluctuating fuel costs also impacted our results. While prices for many of our raw materials decreased during 2009 from their historic highs reached in the prior year, the Company expects moderate price volatility for the next year with an upward trend. We manage the impact, wherever possible, on commercially reasonable terms, by locking in prices on quantities required to meet our production requirements. In addition, we offset the effect by raising prices to our customers. However, for competitive reasons, we may not be able to pass along the full effect of increases in raw materials and other input costs as we incur them. In addition, in instances of declining input costs, customers may be looking for price reductions in situations where we have locked into purchases at higher costs.

Competitive Environment

 

There has been significant consolidation in the retail grocery and foodservice industries in recent years, and mass merchandisers are gaining market share. As our customer base continues to consolidate, we expect competition to intensify as we compete for the business of fewer, large customers. There can be no assurance that we will be able to keep our existing customers, or gain new customers. As the consolidation of the retail grocery and foodservice industry continues, we could lose sales if any one or more of our existing customers were to be sold.

 

Both the difficult economic environment and the increased competitive environment in the retail and foodservice channels have caused competition to become increasingly intense in our business. We expect this trend to continue for the foreseeable future.

 

Liquidity and Capital Resources

 

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 from operating activities and remains in a strong financial position, with resources available for reinvestment in existing businesses, acquisitions and managing its capital structure on a short and long-term basis. Over the last three years, the Company has generated $376.9 million in cash flow from operating activities by focusing on working capital management. If additional borrowings are needed, approximately $293.0 million was available on the revolving credit facility as of December 31, 2009. This facility expires in 2011. We believe that, given our cash flow from operating activities and our available credit capacity, we can comply with the current terms of the credit facility and meet foreseeable financial requirements.

 

Cash flows from operating activities:

 

 

Our cash from operations decreased from $175.6 million in 2008 to $104.8 million in 2009. Higher net income in the year ended December 31, 2009 compared to 2008 was more than offset by a decrease in accounts payable from the high level in 2008, a build in inventories due to higher pickle production resulting from a strong 2009 cucumber crop and the forward purchase of certain commodities.

Cash flows from investing activities: