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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 29, 2003
Commission File Number 0-18339
SYLVAN INC.
(Exact name of registrant as specified in its charter)
NEVADA 25-1603408
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
333 MAIN STREET, P.O. BOX 249, SAXONBURG, PA 16056-0249
(Address of principal executive offices) (Zip Code)
(724) 352-7520
(Registrant's telephone number, including area code)
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 X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2).
Yes No X
--- ---
Number of shares of common stock outstanding as of August 6, 2003...5,144,131
SYLVAN INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets,
June 29, 2003 and December 29, 2002.......................................3
Condensed Consolidated Statements of Income, Three Months
Ended June 29, 2003 and June 30, 2002.....................................5
Condensed Consolidated Statements of Income, Six Months
Ended June 29, 2003 and June 30, 2002.....................................6
Condensed Consolidated Statements of Cash Flows, Six Months
Ended June 29, 2003 and June 30, 2002.....................................7
Notes to Condensed Consolidated Financial Statements,
June 29, 2003.............................................................8
Item 2. Management's Discussion and Analysis.....................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...............21
Item 4. Controls and Procedures..................................................21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................................21
Item 5. Other Information........................................................22
Item 6. Exhibits and Reports on Form 8-K.........................................23
Signatures........................................................................23
Index to Exhibits.................................................................24
Exhibit 31........................................................................25
Exhibit 31........................................................................26
Exhibit 32........................................................................27
Exhibit 32........................................................................28
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED BALANCE SHEETS
Sylvan Inc. and Subsidiaries
(In thousands)
June 29, 2003 December 29, 2002
------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 4,504 $ 5,624
Trade accounts receivable, net of allowance
for doubtful accounts of $864 and $795, respectively 14,709 14,399
Inventories 12,831 11,425
Prepaid income taxes and other expenses 2,066 1,495
Other current assets 1,472 1,494
- -------------------------------------------------------------------------------------------------------
Total current assets 35,582 34,437
Property, plant and equipment, net 60,132 58,787
Intangible assets, net of accumulated amortization
of $5,074 and $4,691, respectively 13,104 12,321
Other assets, net of accumulated amortization
of $646 and $597, respectively 1,066 1,261
- -------------------------------------------------------------------------------------------------------
TOTAL ASSETS $109,884 $106,806
=======================================================================================================
The accompanying notes are an integral part of these financial statements.
3
CONDENSED CONSOLIDATED BALANCE SHEETS
Sylvan Inc. and Subsidiaries
(In thousands except share data)
June 29, 2003 December 29, 2002
------------- -----------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 163 $ 223
Accounts payable - trade 4,138 3,895
Accrued salaries, wages and employee benefits 2,580 2,771
Other accrued liabilities 1,794 1,413
Income taxes payable 1,202 1,545
- -----------------------------------------------------------------------------------------------------------
Total current liabilities 9,877 9,847
- -----------------------------------------------------------------------------------------------------------
Long-term and revolving-term debt 36,140 38,162
- -----------------------------------------------------------------------------------------------------------
Other long-term liabilities:
Other employee benefits 9,770 9,538
Other 289 256
- -----------------------------------------------------------------------------------------------------------
Total other long-term liabilities 10,059 9,794
- -----------------------------------------------------------------------------------------------------------
Minority interest 2,122 1,741
SHAREHOLDERS' EQUITY:
Common stock, voting, par value $0.001, 10,000,000
shares authorized, 6,741,405 and 6,728,405 shares issued
at June 29, 2003 and December 29, 2002, respectively 7 7
Additional paid-in capital 17,428 17,284
Retained earnings 66,265 64,965
Less: Treasury stock at cost, 1,597,274 shares at
June 29, 2003 and December 29, 2002 (16,669) (16,669)
Accumulated other comprehensive deficit (15,345) (18,325)
- -----------------------------------------------------------------------------------------------------------
Total shareholders' equity 51,686 47,262
- -----------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 109,884 $ 106,806
===========================================================================================================
The accompanying notes are an integral part of these financial statements.
4
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Sylvan Inc. and Subsidiaries
(Unaudited, in thousands except share data)
------- Three Months Ended---------
June 29, 2003 June 30, 2002
------------- -------------
NET SALES $ 23,587 $ 21,388
- ------------------------------------------------------------------------------------------------------------
OPERATING COSTS AND EXPENSES:
Cost of sales 15,039 12,554
Selling, administration, research and development 5,816 5,570
Depreciation 1,580 1,421
- ------------------------------------------------------------------------------------------------------------
22,435 19,545
- ------------------------------------------------------------------------------------------------------------
OPERATING INCOME 1,152 1,843
INTEREST EXPENSE, NET, INCLUDING
AMORTIZATION OF DEBT ISSUANCE COSTS 401 447
OTHER INCOME 16 62
- ------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 767 1,458
PROVISION FOR INCOME TAXES 253 471
- ------------------------------------------------------------------------------------------------------------
INCOME BEFORE MINORITY INTEREST IN
INCOME OF CONSOLIDATED SUBSIDIARIES 514 987
MINORITY INTEREST IN INCOME OF
CONSOLIDATED SUBSIDIARIES 47 2
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 467 $ 985
============================================================================================================
NET INCOME PER SHARE - BASIC $ 0.09 $ 0.18
============================================================================================================
NET INCOME PER SHARE - DILUTED $ 0.09 $ 0.18
============================================================================================================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES 5,132,345 5,435,171
============================================================================================================
WEIGHTED AVERAGE NUMBER OF COMMON
AND COMMON EQUIVALENT SHARES 5,161,591 5,499,634
============================================================================================================
The accompanying notes are an integral part of these financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Sylvan Inc. and Subsidiaries
(Unaudited, in thousands except share data)
---------Six Months Ended----------
June 29, 2003 June 30, 2002
------------- -------------
NET SALES $ 45,969 $ 42,307
- ------------------------------------------------------------------------------------------------------------
OPERATING COSTS AND EXPENSES:
Cost of sales 28,830 24,632
Selling, administration, research and development 11,118 10,741
Depreciation 3,137 2,815
- ------------------------------------------------------------------------------------------------------------
43,085 38,188
- ------------------------------------------------------------------------------------------------------------
OPERATING INCOME 2,884 4,119
INTEREST EXPENSE, NET, INCLUDING
AMORTIZATION OF DEBT ISSUANCE COST 823 877
OTHER INCOME 20 64
- ------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 2,081 3,306
PROVISION FOR INCOME TAXES 687 1,082
- ------------------------------------------------------------------------------------------------------------
INCOME BEFORE MINORITY INTEREST IN
INCOME OF CONSOLIDATED SUBSIDIARIES 1,394 2,224
MINORITY INTEREST IN INCOME OF
CONSOLIDATED SUBSIDIARIES 94 24
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 1,300 $ 2,200
============================================================================================================
NET INCOME PER SHARE - BASIC $ 0.25 $ 0.40
============================================================================================================
NET INCOME PER SHARE - DILUTED $ 0.25 $ 0.40
============================================================================================================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES 5,131,738 5,433,561
============================================================================================================
WEIGHTED AVERAGE NUMBER OF COMMON
AND COMMON EQUIVALENT SHARES 5,152,550 5,491,152
============================================================================================================
The accompanying notes are an integral part of these financial statements.
6
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Sylvan Inc. and Subsidiaries
(Unaudited, in thousands)
--------Six Months Ended---------
June 29, 2003 June 30, 2002
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,300 $ 2,200
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 3,244 2,922
Employee benefits (114) (104)
Trade accounts receivable 316 670
Inventories (858) (433)
Prepaid expenses and other assets (220) 2,237
Accounts payable and accrued liabilities 238 1,130
Income taxes payable (318) 538
Other (104) (321)
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,484 8,839
- -------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property, plant and equipment (1,879) (2,905)
- -------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,879) (2,905)
- -------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt (119) (2,298)
Net repayments under revolving credit line (3,490) (3,385)
Proceeds from exercise of stock options 440 282
Purchase of treasury shares -- (271)
- -------------------------------------------------------------------------------------------------
Net cash used in financing activities (3,169) (5,672)
- -------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATES ON CASH 444 261
- -------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,120) 523
CASH AND CASH EQUIVALENTS, beginning of period 5,624 5,072
- -------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ 4,504 $ 5,595
=================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW DATA:
Interest paid $ 941 $ 1,012
Income taxes paid 1,249 954
The accompanying notes are an integral part of these financial statements.
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SYLVAN INC. AND SUBSIDIARIES
JUNE 29, 2003
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
General
These condensed consolidated financial statements of Sylvan Inc. are
unaudited and reflect all adjustments (consisting only of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the results of operations for the interim period. These
statements should be read in conjunction with the consolidated financial
statements and notes thereto contained in the company's Annual Report to
Shareholders and its Form 10-K, as amended, for the year ended December
29, 2002. The condensed consolidated December 29, 2002 balance sheet was
derived from the audited balance sheet included in the most recent Form
10-K, as amended.
Cash
The company had a French-franc denominated loan of FF16.2 million ($2.2
million) that was repaid in January 2002.
Inventories
Inventories at June 29, 2003 and December 29, 2002 consisted of the
following:
(in thousands) June 29, 2003 December 29, 2002
------------- -----------------
Growing crops and compost material $ 5,533 $ 4,975
Stores and other supplies 2,263 2,039
Finished products 5,035 4,411
------- -------
$12,831 $11,425
======= =======
Earnings Per Common Share
Earnings per share were calculated using the weighted average number of
shares outstanding during the period, including the effect of stock
options outstanding. Pursuant to the company's 1990 and 1993 stock option
plans, options for a total of 1,366,081 shares of the company's common
stock have been granted and options for a total of 584,826 of these shares
have been exercised as of June 29, 2003.
8
The following tables reconcile the number of shares utilized in the
earnings per share calculations for the three months and six months ended
June 29, 2003 and June 30, 2002:
Three Months Ended Six Months Ended
(in thousands) June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
------------- ------------- ------------- -------------
Net income $ 467 $ 985 $ 1,300 $ 2,200
========== ========== ========== ==========
Earnings per common share - basic $ 0.09 $ 0.18 $ 0.25 $ 0.40
========== ========== ========== ==========
Earnings per common share - diluted $ 0.09 $ 0.18 $ 0.25 $ 0.40
========== ========== ========== ==========
Common shares - basic 5,132,345 5,435,171 5,131,738 5,433,561
Effect of dilutive securities:
Stock options 29,246 64,463 20,812 57,591
---------- ---------- ---------- ----------
Common shares - diluted 5,161,591 5,499,634 5,152,550 5,491,152
========== ========== ========== ==========
Options to purchase approximately 446,000 and 487,000 shares of common
stock in the three and six months ended June 29, 2003 and 298,000 shares
of common stock in the three and six months ended June 30, 2002,
respectively, were outstanding, but were not included in the computation
of diluted earnings per share because the exercise prices of these options
were greater than the average market prices of the company's common shares
for the respective periods.
Intangible Assets
Sylvan's intangible assets, which relate solely to its Spawn Products
Segment, are as follows:
Gross Carrying Amount Accumulated Amortization
Cultures Cultures
(in thousands) Goodwill and Other Goodwill and Other Net
-------- --------- -------- --------- ---
December 29, 2002 $15,998 $ 1,014 $(4,262) $ (429) $12,321
Additions -- -- -- (64) (64)
Currency Translation 1,165 1 (319) -- 847
------- ------- ------- ------- -------
June 29, 2003 $17,163 $ 1,015 $(4,581) $ (493) $13,104
======= ======= ======= ======= =======
The remaining useful lives of the cultures range from six to nine years
and the other intangible assets range from one to four years.
Amortization expense for intangible assets was $32,000 and $64,000 for the
three and six months ended June 29, 2003, respectively. Estimated
amortization expense for the remainder of 2003 and the five succeeding
years is as follows:
(in thousands)
2003 (remainder) $ 63
2004 122
2005 67
2006 67
2007 65
2008 59
9
2. LONG-TERM DEBT AND BORROWING ARRANGEMENTS:
The company has a Revolving Credit Agreement with two commercial banks,
dated August 6, 1998 and amended, in part, December 29, 2002. It provides
for revolving credit loans on which the aggregate outstanding balance
available to the company may not initially exceed $55.0 million. The
maximum aggregate outstanding balance will decline over the life of the
agreement as follows:
Maximum Aggregate
Period Beginning Outstanding Balance
---------------- -------------------
August 6, 2003 $50.0 million
August 6, 2004 45.0 million
Outstanding borrowings under the agreement bear interest at either the
Prime Rate or LIBOR (plus an applicable margin) at the company's option.
On June 29, 2003, the company had outstanding borrowings under the
agreement of $35.0 million. The revolving credit loans mature on August 5,
2005.
The agreement provides for the maintenance of various financial covenants
and includes limitations as to incurring additional indebtedness and the
granting of security interests to third parties. Obligations under the
agreement are guaranteed by certain wholly owned subsidiaries of the
company.
The company has several additional loan obligations. The outstanding
balances related to these loans totaled approximately $1.3 million as of
June 29, 2003 and $1.4 million as of December 29, 2002. Interest rates on
these loans vary.
3. COMPREHENSIVE INCOME:
Comprehensive income consisted of the following:
Three Months Ended Six Months Ended
(in thousands) June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
------------- ------------- ------------- -------------
Net income $ 467 $ 985 $ 1,300 $ 2,200
Other comprehensive income:
Foreign currency translation
adjustment 2,134 3,169 3,070 2,746
Unrealized losses on derivatives
and qualified cash flow hedges (144) (344) (136) (212)
Tax benefit 49 101 46 62
------- ------- ------- -------
Total comprehensive income $ 2,506 $ 3,911 $ 4,280 $ 4,796
======= ======= ======= =======
10
The components of accumulated other comprehensive deficit consist of the
following:
(in thousands) June 29, 2003 December 29, 2002
------------- -----------------
Unrealized losses on derivatives and
qualified cash flow hedges, net of tax of $487
and $441, respectively $ (945) $ (855)
Foreign currency translation adjustments (4,888) (7,958)
Minimum pension liability adjustment,
net of tax of $4,902 (9,512) (9,512)
----------- -----------
Total accumulated other comprehensive deficit $ (15,345) $ (18,325)
=========== ===========
Floating-to-fixed interest rate swap agreements, designated as cash flow
hedges, hedge the company's floating rate debt and will mature at various
times through August 2007. The fair value of these contracts is recorded
in the balance sheet, with the offset to "Accumulated Other Comprehensive
Deficit," net of tax. Based on interest rates at June 29, 2003, the
company expects to expense $36,000 in the next 12 months related to
derivative instruments.
4. BUSINESS SEGMENT INFORMATION:
Sylvan is a worldwide producer and distributor of products for the
mushroom industry, specializing in spawn (the equivalent of seed for
mushrooms) and spawn-related products and services, and is a major grower
of fresh mushrooms in the United States. The company has two reportable
business segments: Spawn Products, which includes spawn-related products,
services and bioproducts; and Fresh Mushrooms. Spawn-related products
include casing inoculum, nutritional supplements and disease-control
agents. During the quarter and six months ended June 29, 2003, the company
made no changes in the basis of segmentation or in the basis of
measurement of segment profit or loss from that reported in the December
29, 2002 financial statements.
11
(in thousands) Three Spawn Fresh Total
Months Products Mushrooms Reportable
Ended Segment Segment Segments
----- ------- --------- ----------
Total revenues 2003 $ 16,684 $ 7,233 $ 23,917
2002 15,401 6,316 21,717
Intersegment revenues 2003 330 -- 330
2002 329 -- 329
Operating income 2003 1,951 672 2,623
2002 2,390 748 3,138
(in thousands) Six Spawn Fresh Total
Months Products Mushrooms Reportable
Ended Segment Segment Segments
----- ------- --------- ----------
Total revenues 2003 $ 32,136 $ 14,490 $ 46,626
2002 30,407 12,555 42,962
Intersegment revenues 2003 657 -- 657
2002 655 -- 655
Operating income 2003 4,188 1,525 5,713
2002 4,957 1,565 6,522
Reconciliation to Consolidated Financial Data:
Three Months Ended Six Months Ended
(in thousands) June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
------------- ------------- ------------- -------------
Total revenues for reportable segments $ 23,917 $ 21,717 $ 46,626 $ 42,962
Elimination of intersegment revenues (330) (329) (657) (655)
-------- -------- -------- --------
Total consolidated revenues $ 23,587 $ 21,388 $ 45,969 $ 42,307
======== ======== ======== ========
Total operating income for reportable
segments $ 2,623 $ 3,138 $ 5,713 $ 6,522
Unallocated corporate expenses (1,471) (1,295) (2,829) (2,403)
Interest expense, net (401) (447) (823) (877)
Other income 16 62 20 64
-------- -------- -------- --------
Consolidated income before
income taxes $ 767 $ 1,458 $ 2,081 $ 3,306
======== ======== ======== ========
12
5. STOCK OPTIONS:
In June 1991, the shareholders approved a stock option plan (the 1990 Plan)
for employees and others who perform substantial services for the company.
In April 1999, the shareholders approved an amendment and restatement of
the 1990 Plan to provide for an increase to 1,700,000 in the number of
shares of the company's stock which are available for the granting of
options. In June 1993, the shareholders approved a stock option plan (the
1993 Plan) for nonemployee directors of the company, covering 100,000
shares of common stock. The company accounts for both plans under the
Accounting Principles Board Opinion No. 25, under which no compensation
cost is recognized for options granted at fair market value.
In December 2002, the Financial Accounting Standards Board issued SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure."
SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition to SFAS No.
123's fair value method of accounting for stock-based compensation. While
the Statement does not amend SFAS No. 123 to require companies to account
for employee stock options using the fair value method, the disclosure
provisions of the Statement are applicable to all companies with
stock-based compensation. Had compensation cost for these plans been
determined in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," the company's net income and earnings per share (EPS) would
have been reduced to the following pro forma amounts:
Three Months Ended Six Months Ended
(in thousands except per share data) June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
------------- ------------- ------------- -------------
Net income as reported $ 467 $ 985 $ 1,300 $ 2,200
Total stock-based employee
compensation determined under
fair value method for all awards (48) (91) (96) (177)
Tax benefit of fair value method 16 30 32 59
------- ------- --------- ---------
Pro forma net income $ 435 $ 924 $ 1,236 $ 2,082
Basic earnings per share
As reported $ 0.09 $ 0.18 $ 0.25 $ 0.40
Pro forma $ 0.08 $ 0.17 $ 0.24 $ 0.38
Diluted earnings per share
As reported $ 0.09 $ 0.18 $ 0.25 $ 0.40
Pro forma $ 0.08 $ 0.17 $ 0.24 $ 0.38
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants made in 2002: risk-free interest rates of
3.17%; no expected dividend yields; expected lives of 8.0 years; expected
volatility of 34%.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
SYLVAN INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS (Three Months Ended June 29, 2003 and June 30, 2002)
CONSOLIDATED REVIEW
Net Sales
(in thousands) 2003 2002 % Change
---- ---- --------
Net sales $ 23,587 $ 21,388 10.3
Net sales increased 10.3% to $23.6 million, when compared with $21.4 million for
the corresponding 2002 quarter. Net sales of the Fresh Mushrooms Segment
increased $0.9 million, or 14.5%, while net sales of the Spawn Products Segment
increased $1.3 million, or 8.3%. On average, for the second quarter of 2003, the
U.S. dollar was approximately 24% weaker, when measured against the company's
applicable foreign currencies, than for the second quarter of 2002. The
weakening had the effect of increasing sales and operating income during the
2003 quarter, as compared with the corresponding 2002 quarter, by approximately
$2.4 million and $120,000, respectively. Overseas sales, as a percentage of net
sales, were 47% in both the quarter ended June 29, 2003 and the quarter ended
June 30, 2002.
Operating Costs and Expenses
(in thousands) 2003 2002 % Change
---- ---- --------
Cost of sales $ 15,039 $ 12,554 19.8
Selling, administration,
research and development 5,816 5,570 4.4
Depreciation 1,580 1,421 11.2
The company's cost of sales, expressed as a percentage of net sales, was 63.8%
for the second quarter of 2003, as compared with 58.7% for the second quarter of
2002. The cost of sales percentage increased in both the Fresh Mushrooms and
Spawn Products Segments, as detailed in the Business Segments presentation
below. Selling, administration, research and development expenses were $5.8
million for the June 29, 2003 quarter and $5.6 million for the June 30, 2002
quarter and were 24.7% and 26.0% of net sales, respectively.
During the second quarter of 2003, the company incurred costs of approximately
$320,000 related to the activities of the company's special committee of
independent directors that was established by the company's board in April 2003
when it received an indication of interest by a group of Sylvan Inc. senior
officers and private investors to acquire shares of Sylvan's common stock.
Approximately $95,000 in similar costs were incurred during the second quarter
of 2002 in the course of a similar committee's evaluation of strategic plans and
business alternatives that was conducted at that time.
The company recorded a net periodic pension expense of $167,500 during the
quarter ended June 29, 2003 from a pension plan of a former subsidiary, as
compared with a net periodic pension benefit of $37,500 for the quarter ended
June 30, 2002. This expense increase was related to poor plan asset performance
and a decrease in the plan's discount rate assumption.
Interest Expense
Net interest expense for the second quarter of 2003 decreased to $401,000 from
$447,000 for the second quarter of 2002. The effective borrowing rate for the
second quarter of 2003 was 4.2%, as compared with 5.3% for the
14
second quarter of 2002. The company recorded interest income of $71,000 in the
second quarter of 2003, as compared with $18,000 of interest expense in the
second quarter of 2002, related to SFAS No. 133. The effective borrowing rates,
excluding the effect of SFAS No. 133, were 4.9% for the quarter ended June 29,
2003 and 5.1% for the quarter ended June 30, 2002. During the 2003 quarter, the
company had $20.0 million of variable-to-fixed interest rate swaps in place to
manage interest rate risk that increased the average borrowing rate 1.6%. During
2002, $15.0 million of swaps increased the average borrowing rate 1.5%.
Income Tax Expense
The effective income tax rate for the second quarter of 2003 was 33%, as
compared with 32% for the corresponding 2002 quarter.
BUSINESS SEGMENTS
Spawn Products
(in thousands) 2003 2002 % Change
---- ---- --------
Sales, including intersegment $ 16,684 $ 15,401 8.3
Operating expenses 14,733 13,011 13.2
Operating income 1,951 2,390 (18.4)
Net sales of spawn and spawn-related products increased 8.3%. The effect of a
weaker U.S. dollar on overseas sales increased net sales on a
quarter-over-quarter comparison by $2.4 million. Spawn product sales volume
decreased 4.8%, with a 2.4% decrease in the Americas and a 6.3% decrease in
overseas markets. Most of the volume decrease in the overseas markets resulted
from a reduction in sales in the United Kingdom due to farm closures and in
France due to challenging competitive conditions. Sales of disease-control
agents and nutritional supplements increased 6.2% and accounted for 17.8% of
Sylvan's consolidated net sales for the second quarter.
The overseas U.S. dollar-equivalent selling price was 19.1% higher during the
second quarter of 2003, as compared with the corresponding quarter of 2002,
primarily due to the weakening of the U.S. dollar. Overseas local currency
selling prices decreased approximately 3.6% due to the loss of sales in
higher-priced territories. The selling price in the Americas decreased 5.8% as a
result of adjustments to the pricing structure of some products in order to
compete with the lower-priced spawn offerings of other suppliers.
Operating expenses increased 13.2% when compared with the second quarter of
2002. The effect of a weaker U.S. dollar increased operating expenses on a
quarter-over-quarter comparison by $2.3 million. Within operating expenses, cost
of sales was 58.3% of net sales, as compared with 53.7% for the corresponding
2002 quarter. Spawn production in overseas markets was 15.2% lower than for the
second quarter of 2002, spreading costs that are primarily fixed in nature over
fewer units. Operating income, as a percentage of net sales, was 11.7% for the
second quarter of 2003, as compared with 15.5% for the corresponding 2002
quarter. Operating income was positively impacted by the weakening of the U.S.
dollar, with an effect of approximately $120,000.
The company's Bioproducts division recorded net sales of $950,000 for the second
quarter of 2003, as compared with $330,000 for the second quarter of 2002. Sales
growth was experienced in both the Red Yeast Rice and dried Agaricus mushroom
products. Operating income for the second quarter of 2003 was $375,000, as
compared with a $75,000 operating loss for the second quarter of 2002.
15
Fresh Mushrooms
(in thousands) 2003 2002 % Change
---- ---- --------
Sales $ 7,233 $ 6,316 14.5
Operating expenses 6,561 5,568 17.8
Operating income 672 748 (10.2)
Net sales of fresh mushrooms increased to $7.2 million during the second
quarter, as compared with $6.3 million for the corresponding quarter of 2002.
The number of pounds sold increased 4.7%, while the average selling price per
pound was virtually unchanged.
The Fresh Mushrooms Segment's cost of sales was $5.3 million, or 73.5% of net
sales, for the quarter ended June 29, 2003, as compared with $4.3 million, or
67.8%, for the 2002 second quarter. The segment's operating income for the
quarter was $0.7 million, or 9.3% of net sales, and was 10.2% lower than the
amount reported for the second quarter of 2002, primarily due to increased labor
costs on a per pound basis. Labor costs and Workers' Compensation expense for
the second quarter of 2003 were approximately $130,000 higher, when compared
with the costs recorded for the corresponding 2002 quarter. The positive
performance of the company's satellite farms helped minimize the adverse effect
of these increased costs.
Quincy sold $0.9 million of ready-to-grow mushroom compost to its satellite
farms and purchased $1.9 million of high-quality mushrooms from the satellites
for immediate resale to its third-party wholesaler during the second quarter of
2003. By comparison, Quincy sold $0.3 million of ready-to-grow mushroom compost
to its satellite farms and purchased $0.6 million of high-quality mushrooms in
the second quarter of 2002.
RESULTS OF OPERATIONS (Six Months Ended June 29, 2003 and June 30, 2002)
CONSOLIDATED REVIEW
Net Sales
(in thousands) 2003 2002 % Change
---- ---- --------
Net sales $ 45,969 $ 42,307 8.7
Net sales increased 8.7% to $46.0 million for the first six months of 2003, when
compared with $42.3 million for the corresponding 2002 period. Net sales of the
Fresh Mushrooms Segment increased $1.9 million, or 15.4%, while net sales of the
Spawn Products Segment increased $1.7 million, or 5.7%. On average, for the
first six months of 2003, the U.S. dollar was approximately 23% weaker, when
measured against the company's applicable foreign currencies, than for the first
six months of 2002. The weakening had the effect of increasing sales and
operating income during the 2003 period, as compared with the corresponding 2002
period, by approximately $4.8 million and $380,000, respectively. Overseas
sales, as a percentage of net sales, were 48% in both the six months ended June
29, 2003 and June 30, 2002.
Operating Costs and Expenses
(in thousands) 2003 2002 % Change
---- ---- --------
Cost of sales $ 28,830 $ 24,632 17.0
Selling, administration,
research and development 11,118 10,741 3.5
Depreciation 3,137 2,815 11.4
16
The company's cost of sales, expressed as a percentage of net sales, was 62.7%
for the first six months of 2003, as compared with 58.2% for the first six
months of 2002. The cost of sales percentage increased in both the Fresh
Mushrooms and Spawn Products Segments, as detailed in the Business Segments
presentation below. Selling, administration, research and development expenses
were $11.1 million for the six months ended June 29, 2003 and $10.7 million for
the six months ended June 30, 2002 and were 24.2% and 25.4% of net sales,
respectively.
During the first six months of 2003, the company incurred costs of approximately
$320,000 related to the activities of the company's special committee of
independent directors. Approximately $95,000 in similar costs were incurred
during the first six months of 2002 in the course of a similar committee's
evaluation of strategic plans and business alternatives that was conducted at
that time.
The company recorded a net periodic pension expense of $335,000 during the six
months ended June 29, 2003 from a pension plan of a former subsidiary, as
compared with a net periodic pension benefit of $75,000 for the six months ended
June 30, 2002. This expense increase was related to poor plan asset performance
and a decrease in the plan's discount rate assumption.
Interest Expense
Net interest expense for the first six months of 2003 decreased to $823,000 from
$877,000 for the second quarter of 2002. The effective borrowing rate for the
first six months of 2003 was 4.3%, as compared with 5.0% for the first six
months of 2002. The company recorded interest income of $107,000 in the 2003
period, as compared with $28,000 of interest income in the corresponding 2002
period, related to SFAS No. 133. The effective borrowing rates, excluding the
effect of SFAS No. 133, were 4.9% for the six months ended June 29, 2003 and
5.1% for the six months ended June 30, 2002. During the 2003 period, the company
had $20.0 million of variable-to-fixed interest rate swaps in place to manage
interest rate risk that increased the average borrowing rate 1.5%. During the
2002 period, $15.0 million of swaps increased the average borrowing rate 1.5%.
Income Tax Expense
The effective income tax rate for both the first six months of 2003 and for the
first six months of 2002 was 33%.
BUSINESS SEGMENTS
Spawn Products
(in thousands) 2003 2002 % Change
---- ---- --------
Sales, including intersegment $ 32,136 $ 30,407 5.7
Operating expenses 27,948 25,450 9.8
Operating income 4,188 4,957 (15.5)
Net sales of spawn and spawn-related products increased 5.7%. The effect of a
weaker U.S. dollar on overseas sales increased net sales on a six-month over
six-month comparison by $4.8 million. Spawn product sales volume decreased 5.9%,
with a 1.8% decrease in the Americas and an 8.3% decrease in overseas markets.
Most of the volume decrease in the overseas markets was associated with a
reduction in sales in the United Kingdom due to farm closures and in France due
to challenging competitive conditions. Sales of disease-control agents and
nutritional supplements increased 4.9% and accounted for 16.3% of Sylvan's
consolidated net sales for the six-month period.
The overseas U.S. dollar-equivalent selling price was 20.0% higher during the
first six months of 2003, as compared with the corresponding period of 2002,
primarily due to the weakening of the U.S. dollar. Overseas local currency
selling prices decreased approximately 2.6%. The selling price in the Americas
decreased 5.1% as
17
a result of adjustments to the pricing structure of some products in order to
compete with the lower-priced spawn offerings of other suppliers.
Operating expenses increased 9.8% when compared with the first six months of
2002. The effect of a weaker U.S. dollar increased operating expenses on a
six-month over six-month comparison by $4.4 million. Within operating expenses,
cost of sales was 57.3% of net sales, as compared with 53.2% for the
corresponding 2002 period. Spawn production in overseas markets was 15.8% lower
than for the first six months of 2002, spreading costs that are primarily fixed
in nature over fewer units. Inventory levels were also lowered in response to
the lower sales volumes. Operating income, as a percentage of net sales, was
13.0% for the first six months of 2003, as compared with 16.3% for the first six
months of 2002. Operating income was positively impacted by the weakening of the
U.S. dollar, with an effect of approximately $380,000.
The company's Bioproducts division recorded net sales of $1,300,000 for the
six-month period ended June 29, 2003, as compared with $720,000 for the first
six months of 2002. Sales growth was experienced in both the Red Yeast Rice and
dried Agaricus mushroom products. Operating income for the first six months of
2003 was $388,000, as compared with an operating loss of $213,000 for the first
six months of 2002.
Fresh Mushrooms
(in thousands) 2003 2002 % Change
---- ---- --------
Sales $ 14,490 $ 12,555 15.4
Operating expenses 12,965 10,990 18.0
Operating income 1,525 1,565 (2.6)
Net sales of fresh mushrooms increased during the first six months of 2003 to
$14.5 million, as compared with $12.6 million for the corresponding period of
2002. The number of pounds sold increased 6.5%, while the average selling price
per pound was virtually unchanged.
The cost of sales in the Fresh Mushrooms Segment was $10.4 million, or 71.9% of
net sales, for the six months ended June 29, 2003, as compared with $8.4
million, or 67.2%, for the first six months of 2002. The segment's operating
income for the first six months of 2003 was $1.5 million, or 10.5% of net sales,
and was 2.6% lower than the amount reported for the first six months of 2002.
Labor costs for the first six months of 2003 were approximately $160,000 higher
when compared with the costs recorded for the corresponding 2002 period. The
positive performance of the company's satellite farms helped minimize the
adverse effect of the higher labor costs.
Quincy sold $1.7 million of ready-to-grow mushroom compost to its satellite
farms and purchased $3.6 million of high-quality mushrooms from the satellites
for immediate resale to its third-party wholesaler during the first six months
of 2003. By comparison, Quincy sold $0.6 million of ready-to-grow mushroom
compost to its satellite farms and purchased $1.2 million of high-quality
mushrooms in the first six months of 2002.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities for the six months ended June 29, 2003
was $3.5 million, as compared with $8.8 million for the corresponding period of
2002. During the first quarter of 2002, the company reduced "Other Current
Assets" by approximately $2.2 million due to the release of cash that had been
collateralized to support a loan from a European bank. This loan was repaid in
the first quarter of 2002. Also during the first six months of 2002, the company
increased accounts payable by approximately $1.1 million primarily related to
the construction of satellite farms at Quincy. No corresponding increase
occurred in the first six months of 2003.
18
Cash used by investing activities was $1.9 million for the six months ended June
29, 2003, as compared with $2.9 million used during the corresponding period of
2002. During the first six months of 2003, approximately $0.4 million was
expended on growth opportunities, primarily for the satellite farms at Quincy.
Total capital expenditures in 2003 are not expected to exceed $4.0 million, with
additional expenditures as required for any acquisitions or new initiatives. The
company routinely assesses its requirements for additional capital investments
and believes that it has sufficient cash resources from current cash balances,
internally generated funds and available bank credit facilities to meet its
ongoing capital needs.
Available credit under the company's revolving credit arrangement was $20.0
million as of June 29, 2003. Term and revolving credit decreased by $3.6 million
during the six months ended June 29, 2003, as compared with a decrease of $5.7
million during the corresponding six-month period of 2002. The larger reduction
in 2002 was related to the repayment of a European bank loan supported by the
cash deposit mentioned earlier.
No shares of Sylvan common stock were purchased during the first six months of
2003. The share purchase program was suspended due to the announcement of the
receipt of the nonbinding indication of interest mentioned above and continued
activity of the special committee of Sylvan's board of directors which is
detailed in Item 5.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Financial Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the
requirements of SFAS No. 5, "Accounting for Contingencies," relating to a
guarantor's accounting for, and disclosure of, the issuance of certain types of
guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor
must recognize a liability for the fair value of the obligation it assumes under
that guarantee. FIN 45 also requires enhanced disclosures in the company's
interim and annual filings. The provisions of FIN 45 are effective for financial
statements issued or modified after December 31, 2002. The disclosure
requirements were effective for financial statements of both interim and fiscal
years after December 15, 2002. The adoption of FIN 45 did not have a material
impact on the company's financial statements or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). A variable interest entity ("VIE") is
one where the contractual or ownership interests in an entity change with
changes in the entity's net asset value. This interpretation requires the
consolidation of a VIE by the primary beneficiary, and also requires disclosure
about VIEs where an enterprise has a significant variable interest, but is not
the primary beneficiary. The company does not believe that this statement will
have a material impact on the company's financial statements or results of
operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
except in certain instances, and for hedging relationships designated after June
30, 2003. In addition, except in those certain instances, all provisions of this
Statement should be applied prospectively. The application of SFAS No. 149 is
not expected to have a material effect on the company's financial statements or
results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." The provisions
of SFAS No. 150 require issuers to classify as liabilities, or assets in some
circumstances, certain classes of freestanding financial instruments that embody
obligations for the issuer. The provisions of SFAS No. 150 are effective for
financial instruments entered into or modified after
19
May 31, 2003, and otherwise shall be effective at the beginning of the first
interim period beginning after June 15, 2003. The adoption of SFAS No. 150 is
not expected to have a material effect on the company's financial statements or
results of operations.
CRITICAL ACCOUNTING POLICIES
The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make judgments, estimates,
and assumptions regarding uncertainties that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses. Areas of uncertainty that require
judgments, estimates, and assumptions include the accounting for derivatives,
environmental matters, the testing of goodwill and other intangible assets for
impairment, pensions and other postretirement benefits, and tax matters.
Management uses historical experience and all available information to make
these judgments and estimates, and actual results will differ from those
estimates and assumptions that are used to prepare the company's financial
statements. Despite these inherent limitations, management believes that
Management's Discussion and Analysis (MD&A) and the financial statements and
related footnotes provide a fair presentation. A discussion of the judgments and
uncertainties associated with accounting for derivatives can be found in the
Market Risks section of the MD&A included in the company's Form 10-K, as
amended.
A summary of the company's significant accounting policies is included in Note 1
to the Consolidated Financial Statements, included with the Form 10-K, as
amended, filed with the Securities and Exchange Commission for the year ended
December 29, 2002. Management believes that the application of these policies on
a consistent basis enables the company to provide the users of the financial
statements with useful and reliable information about the company's operating
results and financial condition.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 eliminates amortization of
goodwill and amortization of indefinitely lived intangible assets and provides
for impairment tests to be performed at least annually. Sylvan adopted this
pronouncement on December 31, 2001, which was the first day of Sylvan's 2002
fiscal year. During the quarter ended March 31, 2002, the company retained a
professional services firm to complete the initial assessment to test for
transitional goodwill impairment as of December 31, 2001 and a subsequent
assessment as of September 29, 2002. The assessments determined that there was
no goodwill impairment.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." Under its
provisions, all tangible long-lived assets, whether to be held and used or to be
disposed of by sale or other means, will be tested for recoverability whenever
events or changes in circumstances indicate the carrying amount may not be
recoverable. Sylvan adopted this pronouncement on December 31, 2001. The
adoption of this pronouncement did not have a material impact on the company.
Other areas of significant judgments and estimates include the liabilities and
expenses for pensions and other postretirement benefits. These amounts are
determined using actuarial methodologies and incorporate significant
assumptions, including the rate used to discount the future estimated liability
and the long-term rate of return on plan assets. The rate used to discount
future estimated liabilities is determined considering the rates available at
year-end on debt instruments that could be used to settle the obligations. The
long-term rate of return is estimated by considering historical returns and
expected returns on current and projected asset allocations and is generally
applied to a five-year average market value of assets. Effective October 31,
2002, Sylvan reduced the assumption for the expected long-term return on plan
assets to 8.5% from 9.0%.
Sylvan is a global company and records an estimated liability for income taxes
based on what it determines will likely be paid in the various tax jurisdictions
in which it operates. Management uses its best judgment in the determination of
these amounts; however, the liabilities ultimately realized and paid are
dependent on various matters and may differ from the amounts recorded. An
adjustment to the estimated liability would be recorded
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through income in the period in which it becomes probable that the amount of the
actual liability differs from the amount recorded.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
References are made in this report to expectations regarding capital
expenditures, share repurchases, future cash availability and the future
performance of the company, in general. These "forward-looking statements" are
based on currently available, competitive, financial and economic data and the
company's operating plans, but they are inherently uncertain. The outcome of
events could prove significantly different from what is expected, depending upon
such factors as the presentment of strategically attractive acquisition
opportunities or new business initiatives, mushroom growing process
inconsistencies, specific pricing or product initiatives of the company's spawn
business competitors, competitive conditions in the mushroom market in general,
changes in currency and exchange risks, a loss of a major customer, fluctuations
in the values of the assets in the defined benefit plan of a former subsidiary
of the company, or changes in a specific country's or region's political or
economic conditions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information presented under this item in the company's Form 10-K report, for
the fiscal year ended December 29, 2002, as amended, has not changed materially.
Information relating to the sensitivity to foreign currency exchange rate
changes of the company's firmly committed sales transactions, in addition to
what is presented in Item 2 of this filing, is omitted because it is an
immaterial portion of total sales.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Sylvan's chief executive officer and chief financial officer evaluated the
company's disclosure controls and procedures as of August 7, 2003, and they
concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There are no significant changes in internal controls or in other factors that
could significantly affect these controls subsequent to August 7, 2003.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In April and May 2003, Sylvan and the six members of its board of directors, as
individuals, were served with notice that they were named as defendants in a
total of five lawsuits. Two were filed in the District Court of Clark County,
Nevada; two in the Court of Common Pleas, Butler County, Pennsylvania; and one
in the District Court of Washoe County, Nevada. The suits were putative class
actions brought by and on behalf of Sylvan's shareholders alleging that the
defendants breached their fiduciary duties and had conflicts of interest in
connection with the board's undertaking of an assessment of the indication of
interest to acquire Sylvan's shares mentioned above. As a result of the
withdrawal of the indication of interest, as announced by the company on June
16, 2003, each of the plaintiff shareholders withdrew their lawsuits, but
reserved the right to refile them.
There are no other pending legal proceedings to which Sylvan or any of its
subsidiaries is a party, or of which any of their property is subject, other
than ordinary, routine litigation incidental to their respective businesses.
21
ITEM 5. OTHER INFORMATION
SHAREHOLDER PROPOSALS FOR THE 2003 ANNUAL MEETING OF SHAREHOLDERS
As previously announced, Sylvan postponed its 2003 annual meeting of
shareholders to provide the special committee of independent directors that the
company established when it received the indication of interest referenced
earlier in this report with sufficient time to evaluate the indication of
interest. The company will notify its shareholders when it selects a date for
the 2003 annual meeting and the dates on which any shareholder proposals must be
received in order to be properly brought before the meeting.
22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31 Certifications pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934
32 Certifications pursuant to 18 U.S.C. Section 1350
------------------
(b) Reports on Form 8-K
During the three-month period ended June 29, 2003, Sylvan:
o Furnished a current report on May 15, 2003,
containing a press release reporting earnings for the
first quarter ended March 30, 2003 and providing a
financial outlook; and
o Filed a current report on June 16, 2003, containing
a press release announcing the withdrawal of an
indication of interest to acquire shares of Sylvan
common stock that was submitted to the company on
April 16, 2003.
SIGNATURES
Pursuant to the requirements 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.
Date: August 13, 2003 SYLVAN INC.
-------------------
By: /s/ DONALD A. SMITH
-------------------------------
Donald A. Smith
Chief Financial Officer
By: /s/ FRED Y. BENNITT
-------------------------------
Fred Y. Bennitt
Secretary/Treasurer
23
INDEX TO EXHIBITS
Exhibit No. Description Page
- ----------- ----------- ----
31 Rule 13a-14(a) Certification of Dennis C. Zensen 25
31 Rule 13a-14(a) Certification of Donald A. Smith 26
32 Section 1350 Certification of Dennis C. Zensen 27
32 Section 1350 Certification of Donald A. Smith 28
- ------------------
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