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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 APRIL 4, 2004
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 May 15, 2004...5,155,131
SYLVAN INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets,
April 4, 2004 and December 28, 2003 ............................................................3
Condensed Consolidated Statements of Income, Three Months
Ended April 4, 2004 and March 30, 2003..........................................................5
Condensed Consolidated Statements of Cash Flows, Three Months
Ended April 4, 2004 and March 30, 2003..........................................................6
Notes to Condensed Consolidated Financial Statements,
April 4, 2004...................................................................................7
Item 2. Management's Discussion and Analysis...........................................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................20
Item 4. Controls and Procedures........................................................................20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings..............................................................................21
Item 5. Other Information..............................................................................21
Item 6. Exhibits and Reports on Form 8-K...............................................................22
Signatures..............................................................................................22
Index to Exhibits.......................................................................................23
Exhibit 31..............................................................................................24
Exhibit 31..............................................................................................25
Exhibit 32..............................................................................................26
Exhibit 32..............................................................................................27
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED BALANCE SHEETS
Sylvan Inc. and Subsidiaries
(In thousands)
April 4, December 28,
2004 2003
---------- ----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 4,508 $ 5,849
Trade accounts receivable, net of allowance
for doubtful accounts of $977 and $1,059, respectively 14,912 15,901
Inventories 13,142 12,514
Prepaid income taxes and other expenses 2,132 1,868
Other current assets 1,534 1,468
---------- ----------
Total current assets 36,228 37,600
Property, plant and equipment, net 59,737 61,134
Intangible assets, net of accumulated amortization
of $5,413 and $5,472, respectively 15,805 13,999
Other assets, net of accumulated amortization
of $717 and $694, respectively 959 1,132
---------- ----------
TOTAL ASSETS $ 112,729 $ 113,865
========== ==========
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)
April 4, December 28,
2004 2003
----------- -----------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 76 $ 110
Accounts payable - trade 4,307 5,739
Accrued salaries, wages and employee benefits 1,921 2,649
Other accrued liabilities 848 1,164
Income taxes payable 1,342 999
----------- -----------
Total current liabilities 8,494 10,661
----------- -----------
Long-term and revolving-term debt 33,659 33,548
----------- -----------
Other long-term liabilities:
Other employee benefits 10,207 10,208
Other 282 230
----------- -----------
Total other long-term liabilities 10,489 10,438
----------- -----------
Minority interest 2,312 2,195
SHAREHOLDERS' EQUITY:
Common stock, voting, par value $0.001, 10,000,000 shares
authorized 6,752,405 shares issued at April 4,
2004 and December 28, 2003 7 7
Additional paid-in capital 17,524 17,524
Retained earnings 68,647 67,804
Less: Treasury stock at cost, 1,597,274 shares at
April 4, 2004 and December 28, 2003 (16,669) (16,669)
Accumulated other comprehensive deficit (11,734) (11,643)
----------- -----------
Total shareholders' equity 57,775 57,023
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 112,729 $ 113,865
=========== ===========
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
--------------------------
April 4, March 30,
2004 2003
---------- ----------
NET SALES $ 24,582 $ 22,382
---------- ----------
OPERATING COSTS AND EXPENSES:
Cost of sales 15,111 13,791
Selling, administration, research and development 6,180 5,302
Depreciation 1,614 1,557
---------- ----------
22,905 20,650
---------- ----------
OPERATING INCOME 1,677 1,732
INTEREST EXPENSE, NET, INCLUDING
AMORTIZATION OF DEBT ISSUANCE COSTS 351 422
OTHER INCOME, NET 152 4
---------- ----------
INCOME BEFORE INCOME TAXES 1,478 1,314
PROVISION FOR INCOME TAXES 517 434
---------- ----------
INCOME BEFORE MINORITY INTEREST IN
INCOME OF CONSOLIDATED SUBSIDIARIES 961 880
MINORITY INTEREST IN INCOME OF
CONSOLIDATED SUBSIDIARIES 118 47
---------- ----------
NET INCOME $ 843 $ 833
========== ==========
NET INCOME PER SHARE - BASIC $ 0.16 $ 0.16
========== ==========
NET INCOME PER SHARE - DILUTED $ 0.16 $ 0.16
========== ==========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES 5,155,131 5,131,131
========== ==========
WEIGHTED AVERAGE NUMBER OF COMMON
AND COMMON EQUIVALENT SHARES 5,208,082 5,144,419
========== ==========
The accompanying notes are an integral part of these financial statements.
5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Sylvan Inc. and Subsidiaries
(Unaudited, in thousands)
Three Months Ended
----------------------------
April 4, March 30,
2004 2003
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 843 $ 833
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,667 1,610
Employee benefits (676) (673)
Trade accounts receivable 952 413
Inventories (677) (958)
Prepaid expenses and other assets (72) 216
Accounts payable and accrued liabilities (1,708) 71
Income taxes payable 362 (67)
Derivatives (70) 5
Minority interest 118 47
Other 31 15
---------- ----------
Net cash provided by operating activities 770 1,512
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for property, plant and equipment (421) (813)
Expenditures for intangibles (2,000) --
---------- ----------
Net cash used in investing activities (2,421) (813)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt (37) (66)
Net borrowings under revolving credit line 361 411
---------- ----------
Net cash provided by financing activities 324 345
---------- ----------
EFFECT OF EXCHANGE RATES ON CASH (14) 189
---------- ----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,341) 1,233
CASH AND CASH EQUIVALENTS, beginning of period 5,849 5,624
---------- ----------
CASH AND CASH EQUIVALENTS, end of period $ 4,508 $ 6,857
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW DATA:
Interest paid $ 498 $ 716
Income taxes paid 206 417
The accompanying notes are an integral part of these financial statements.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SYLVAN INC. AND SUBSIDIARIES
APRIL 4, 2004
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
General
These condensed consolidated financial statements of Sylvan Inc.
("Sylvan", "the company") 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 28, 2003. The condensed
consolidated December 28, 2003 balance sheet was derived from the audited
balance sheet included in the most recent Form 10-K, as amended.
Cash
All cash equivalents are stated at cost, which approximates market. The
company considers all highly liquid investments with a maturity of three
months or less to be cash equivalents.
Inventories
Inventories at April 4, 2004 and December 28, 2003 consisted of the
following:
April 4, December 28,
(in thousands) 2004 2003
---------- ----------
Growing crops and compost material $ 5,651 $ 5,683
Stores and other supplies 2,040 2,005
Finished products 5,451 4,826
---------- ----------
$ 13,142 $ 12,514
========== ==========
Warranty Costs
Warranty costs are accrued based on management's best estimates of the
replacement costs related to spawn products and historical warranty
experience. Actual costs will vary from these estimates. The following
table reconciles the changes in the company's spawn product warranty
reserves:
April 4, March 30,
(in thousands) 2004 2003
---------- ----------
Beginning balance $ 275 $ 275
Expense accrual 50 67
Warranty expenditures 49 35
---------- ----------
Ending balance $ 276 $ 307
========== ==========
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 1,365,081 shares of the company's common
stock have been granted and options for a total of 607,612 of these shares
have been exercised as of April 4, 2004.
7
The following tables reconcile the number of shares utilized in the
earnings per share calculations for the three months ended April 4, 2004
and March 30, 2003:
Three Months Ended
------------------------------
April 4, March 30,
2004 2003
---------- ----------
Net income (in thousands) $ 843 $ 833
========== ==========
Earnings per common share - basic $ 0.16 $ 0.16
========== ==========
Earnings per common share - diluted $ 0.16 $ 0.16
========== ==========
Common shares - basic 5,155,131 5,131,131
Effect of dilutive securities: stock options 52,951 13,288
---------- ----------
Common shares - diluted 5,208,082 5,144,419
Options to purchase approximately 290,000 and 618,000 shares of common
stock in the three months ended April 4, 2004 and March 30, 2003,
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 28, 2003 $ 18,455 $ 1,016 $ (4,916) $ (556) $ 13,999
Additions -- 2,000 -- (28) 1,972
Currency translation (253) -- 87 -- (166)
---------- ---------- ---------- ---------- ----------
April 4, 2004 $ 18,202 $ 3,016 $ (4,829) $ (584) $ 15,805
========== ========== ========== ========== ==========
The remaining useful lives of the cultures range from seven to ten years
and the other intangible assets range from two to five years.
Amortization expense for intangible assets was $27,500 for the three
months ended April 4, 2004. Estimated amortization expense for the
remainder of 2004 and the five succeeding years is as follows:
(in thousands)
2004 (remainder) $ 429
2005 518
2006 518
2007 451
2008 119
2009 115
During the first quarter of 2004, the company entered into a long-term
supply agreement with and purchased cultures from a spawn producer and
grower of fresh mushrooms. The aggregate purchase price of $2.0 million
was allocated based on the respective fair values of the assets purchased.
8
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 could not initially exceed $55.0 million. The
maximum aggregate outstanding balance declines over the remaining term 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.
The effective borrowing rates, excluding the effect of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", were 4.46%
for the quarter ended April 4, 2004 and 4.80% for the quarter ended March
30, 2003. On April 4, 2004, the company had outstanding borrowings under
the agreement of $32.5 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, consisting primarily of a mortgage on the
company's Netherlands facility for $0.8 million and a loan from the
minority shareholders of the company's Netherlands subsidiary for $0.4
million, totaled approximately $1.2 million as of April 4, 2004. The
interest rates of these loans vary between 6.75% and 8.55%.
3. COMPREHENSIVE INCOME:
Comprehensive income consisted of the following:
Three Months Ended
----------------------------
April 4, March 30,
(in thousands) 2004 2003
---------- ----------
Net income $ 843 $ 833
Other comprehensive income:
Foreign currency translation adjustment (21) 935
Unrealized (losses) income on derivatives
and qualified cash flow hedges (106) 8
Tax effect 36 (3)
---------- ----------
Total comprehensive income $ 752 $ 1,773
========== ==========
9
The components of accumulated other comprehensive deficit consist of the
following:
(in thousands) April 4, 2004 December 28, 2003
------------- -----------------
Unrealized losses on derivatives and
qualified cash flow hedges, net of tax of $386
and $350, respectively $ (750) $ (680)
Foreign currency translation adjustments (1,095) (1,074)
Minimum pension liability adjustment,
net of tax of $5,095 (9,889) (9,889)
-------- --------
Total accumulated other comprehensive deficit $(11,734) $(11,643)
======== ========
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 April 4, 2004, 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 ended April 4, 2004, 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 28, 2003
financial statements.
(in thousands) Three Spawn Fresh Total
Months Products Mushrooms Reportable
Ended Segment Segment Segments
----- ------- ------- --------
Total revenues 2004 $17,086 $ 7,849 $24,935
2003 15,452 7,258 22,710
Intersegment revenues 2004 353 -- 353
2003 328 -- 328
Operating income 2004 2,340 828 3,168
2003 2,237 853 3,090
10
Reconciliation to Consolidated Financial Data:
Three Months Ended
(in thousands) April 4, 2004 March 30, 2003
------------- --------------
Total revenues for reportable segments $ 24,935 $ 22,710
Elimination of intersegment revenues (353) (328)
-------- --------
Total consolidated revenues $ 24,582 $ 22,382
======== ========
Total operating income for reportable segments $ 3,168 $ 3,090
Unallocated corporate expenses (1,491) (1,358)
Interest expense, net (351) (422)
Other income, net 152 4
-------- --------
Consolidated income before income taxes $ 1,478 $ 1,314
======== ========
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
(in thousands except per share data) April 4, 2004 March 30, 2003
------------- --------------
Net income as reported $ 843 $ 833
Total stock-based employee compensation determined
under fair value method for all awards, net of tax (5) (32)
------------- -------------
Pro forma net income $ 838 $ 801
============= =============
Basic earnings per share
As reported $ 0.16 $ 0.16
============= =============
Pro forma $ 0.16 $ 0.16
============= =============
Diluted earnings per share
As reported $ 0.16 $ 0.16
============= =============
Pro forma $ 0.16 $ 0.16
============= =============
11
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 3.2%; no expected dividend yields; expected lives of 8.0 years;
expected volatility of 34%. No options have been granted since May 2002.
6. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS:
The following is a summary of net expense relating to the company's
pension and other postretirement benefit plans.
Three Months Ended
(in thousands) April 4, 2004 March 30, 2003
------------- --------------
Pension benefits:
Service cost $ 39 $ 39
Interest cost 531 545
Expected return on plan assets (553) (520)
Amortization of net loss, prior service cost and
transition obligation 110 104
----- -----
Net periodic pension benefit cost $ 127 $ 168
===== =====
Other benefits:
Interest cost $ 11 $ 11
Amortization of net loss and prior service cost (4) (2)
----- -----
Net periodic other benefit cost $ 7 $ 9
===== =====
7. CONTINGENCIES:
On September 23, 2003, the company's Sylvan Bioproducts, Inc. subsidiary
received an administrative order from the Borough of Kennett Square,
Pennsylvania ("the Borough"), alleging that Sylvan Bioproducts failed to
comply with certain wastewater sampling and reporting requirements under
the terms of a water contribution permit issued to the company for its
facility in Kennett Square. A fine of $105,109 was assessed by the order.
The company believes that the requirements were substantially fulfilled
and it filed an appeal to the order on October 1, 2003. Discussions have
been undertaken with the Borough and the company believes that the dispute
will be resolved in a manner that will have no material impact on the
company's financial statements or results of operations.
8. MERGER DISCLOSURE DISCUSSION:
As announced on November 16, 2003, Sylvan entered into a definitive
agreement with Snyder Associated Companies, Inc. of Kittanning,
Pennsylvania, which will result in a merger between Sylvan and a Snyder
affiliate. The Sylvan board of directors, upon the unanimous
recommendation of its special committee of independent directors, approved
the merger and the agreement. The merger is subject to certain conditions,
including the approval by a majority of the shareholders of Sylvan. Sylvan
has scheduled a special meeting of its shareholders for that purpose on
June 9, 2004. If approved by Sylvan's shareholders at the meeting, the
merger transaction is expected to be completed shortly thereafter. Upon
completion of the merger, Sylvan will be obligated to pay approximately
$1.6 million in professional fees. Sylvan currently anticipates completing
the merger by the merger termination deadline of June 15, 2004.
12
9. RECENT ACCOUNTING PRONOUNCEMENTS:
In November 2002, the Financial Accounting Standards Board (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 FIN No. 46, "Consolidation of Variable
Interest Entities." In December 2003, the FASB revised FIN 46 to clarify
certain provisions and modify its effective date. FIN 46 expands upon and
strengthens existing accounting guidance that addresses when a company
should include in its financial statements the assets, liabilities and
activities of another entity. It requires that companies determine whether
a non-consolidated entity is a variable interest entity, as defined by FIN
46, and which company is the primary beneficiary of the variable interest
entity's activities. The requirements of FIN 46 apply to all variable
interest entities held no later than the end of the interim reporting
period ending after March 15, 2004. Variable interest entities held in
special purpose entities shall apply FIN 46 no later than the end of the
first interim reporting period ending after December 15, 2003. The
adoption of FIN 46 did not have a material impact on the company's
financial statements or results of operations.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
SYLVAN INC. AND SUBSIDIARIES
RESULTS OF OPERATIONS (Three Months Ended April 4, 2004 and March 30, 2003)
CONSOLIDATED REVIEW
Net Sales
(in thousands) 2004 2003 % Change
---- ---- --------
Net sales $ 24,582 $ 22,382 10
Net sales increased 10% to $24.6 million, when compared with $22.4 million for
the corresponding 2003 quarter. The weaker U.S. dollar was the primary reason
for this increase. On average, for the first quarter of 2004, the U.S. dollar
was approximately 16% weaker, when measured against the company's applicable
foreign currencies, than for the first quarter of 2003. The weakening had the
effect of increasing sales during the 2004 quarter, as compared with the
corresponding 2003 quarter, by approximately 11%, or $2.4 million. Net sales of
the Fresh Mushrooms Segment increased $0.6 million, or 8.1%, and net sales of
the Spawn Products Segment, after adjusting for the weaker U.S. dollar,
decreased $0.7 million, or 4.8%. Overseas sales, as a percentage of net sales,
were 49% in both the first quarter of 2004 and the first quarter of 2003.
Operating Costs and Expenses
(in thousands) 2004 2003 % Change
---- ---- --------
Cost of sales $ 15,111 $ 13,791 10
Selling, administration,
research and development 6,180 5,302 17
Depreciation 1,614 1,557 4
The company's cost of sales, expressed as a percentage of net sales, was 61.6%
for both the first quarter of 2004 and first quarter of 2003. Selling,
administration, research and development expenses were $6.2 million for the
April 4, 2004 quarter and $5.3 million for the March 30, 2003 quarter and were
25.1% and 23.7% of net sales, respectively. During the first quarter of 2004,
the company incurred costs of approximately $450,000, primarily consisting of
professional and legal fees related to the activities of the company's special
committee of independent directors that was established by the company's board
in April 2003. No comparable costs were incurred during the first quarter of
2003.
Interest Expense
Net interest expense for the first quarter of 2004 decreased to $351,000 from
$422,000 for the first quarter of 2003. This decrease was primarily due to a
lower average outstanding debt level during the first quarter of 2004, when
compared with the first quarter of 2003. The effective borrowing rate for the
first quarter of 2004 was 4.3%, as compared with 4.4% for the first quarter of
2003. The company recorded interest income of $20,000 in the first quarter of
2004, as compared with $35,000 of interest income in the first quarter of 2003,
related to certain interest rate swap agreements. During the 2004 quarter, the
company had $15.0 million of variable-to-fixed interest rate swaps in place to
manage interest rate risk that increased the average borrowing rate 1.48%.
During the 2003 quarter, $20.0 million of swaps increased the average borrowing
rate 1.53%.
14
Income Tax Expense
The effective income tax rate for the first quarter of 2004 was 35%, as compared
with 33% for the corresponding 2003 quarter. The higher effective tax rate for
2004 was a result of a larger portion of the company's taxable income being
derived from higher-tax-rate jurisdictions.
BUSINESS SEGMENTS
Spawn Products
(in thousands) 2004 2003 % Change
---- ---- --------
Sales, including intersegment $ 17,086 $ 15,452 11
Operating expenses 14,746 13,215 12
Operating income 2,340 2,237 5
Net sales of spawn and spawn-related products increased 11% primarily due to a
weaker U.S. dollar, which had the effect of increasing net sales on a
quarter-over-quarter comparison by $2.4 million. Spawn product sales volume
increased 3.9%, with a 6.3% increase in the Americas and a 1.1% decrease in
overseas markets. Most of the volume increase in the Americas resulted from an
additional week of sales included in the first quarter of 2004. Sylvan's U.S.
companies report results on a 52-53 week fiscal-year basis. The 2004 first
quarter results, for Sylvan's U.S. companies, are for the fourteen weeks ended
April 4, 2004, while the corresponding 2003 quarter was a thirteen-week period.
Sales of disease-control agents and nutritional supplements decreased 4.8%,
after adjusting for the weaker U.S. dollar, and accounted for 14% of Sylvan's
consolidated net sales for the first quarter of 2004, as compared with 15% for
the first quarter of 2003.
The overseas U.S. dollar-equivalent selling price was 15.3% higher during the
first quarter of 2004, as compared with the corresponding quarter of 2003,
primarily due to the weakening of the U.S. dollar. Overseas local currency
selling prices decreased approximately 1.1% and the selling price in the
Americas increased 1.9%.
Operating expenses increased 11.6% when compared with the first quarter of 2003.
The effect of a weaker U.S. dollar increased operating expenses on a
quarter-over-quarter comparison by $2.2 million. Within operating expenses, cost
of sales was 54.9% of net sales, as compared with 56.3% for the corresponding
2003 quarter. The increase in spawn product sales volumes contributed to the
improved cost of sales percentage, spreading costs that are primarily fixed in
nature over more units. Selling, administration, research and development
expenses were $3.8 million for the April 4, 2004 quarter and $3.0 million for
the March 30, 2003 quarter. Approximately one-half of this increase is
attributable to the weaker U.S. dollar. The segment also recorded higher
professional fees related to the acquisition of intangible assets, bad debt
expense and warranty costs during the first quarter of 2004, when compared with
the first quarter of 2003.
Operating income, as a percentage of net sales, was 13.7% for the first quarter
of 2004, as compared with 14.5% for the corresponding 2003 quarter. Operating
income was positively impacted by the weakening of the U.S. dollar, with an
effect of approximately $225,000.
The company's bioproducts division recorded net sales of $277,000 for the first
quarter of 2004, as compared with $349,000 for the first quarter of 2003. The
company experienced sales growth in its Red Yeast Rice product, but recorded no
sales of its Agaricus mushroom product during the first quarter of 2004, due to
relatively high inventory levels held by the Japanese customer who purchases
this product. The operating loss in the bioproducts division for the first
quarter of 2004 was $64,000, as compared with an operating income of $11,000 for
the first quarter of 2003.
15
Fresh Mushrooms
(in thousands) 2004 2003 % Change
---- ---- --------
Sales $ 7,849 $ 7,258 8
Operating expenses 7,021 6,405 10
Operating income 828 853 (3)
Net sales of fresh mushrooms increased to $7.8 million during the first quarter,
as compared with $7.3 million for the corresponding quarter of 2003. The number
of pounds sold increased 3.2% and the average selling price per pound increased
7.0%. The Fresh Mushrooms Segment reports results on a 52-53 week fiscal-year
basis. The 2004 first quarter results are for the fourteen weeks ended April 4,
2004, while the corresponding 2003 quarter was a thirteen-week period.
The Fresh Mushrooms Segment's cost of sales was $5.7 million, or 72.9% of net
sales, for the quarter ended April 4, 2004, as compared with $5.1 million, or
70.2%, for the 2003 first quarter. Lower yields per square foot and higher
employee benefit costs contributed to the increase in the cost of sales
percentage.
Quincy sold $1.0 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 first quarter of
2004. By comparison, Quincy sold $0.8 million of ready-to-grow mushroom compost
to its satellite farms and purchased $1.3 million of high-quality mushrooms in
the first quarter of 2003.
The segment's operating income for the quarter was $828,000, or 10.6% of net
sales, as compared with $853,000 and 11.8% for the first quarter of 2003.
Operating income, when measured on a weekly basis, decreased 9.9% to $59,000.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities for the three months ended April 4,
2004 was $0.8 million, as compared with $1.5 million for the corresponding
period of 2003. This decrease was primarily the result of a reduction in the
company's accounts payable and accrued benefits, which were partially offset by
a decrease in trade accounts receivable.
Cash used by investing activities was $2.4 million for the three months ended
April 4, 2004, as compared with $0.8 million used during the corresponding
period of 2003. During the first quarter of 2004, the company entered into a
long-term supply agreement with and purchased cultures from a spawn producer and
grower of fresh mushrooms. The aggregate purchase price of $2.0 million was
allocated based on the respective fair values of the assets purchased. The
company also expended $0.4 million on maintenance capital expenditures during
the first quarter of 2004.
Total capital expenditures in 2004 are not expected to exceed $4.0 million,
although additional expenditures may be 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 $17.5
million as of April 4, 2004. Term and revolving credit increased by $0.3 million
during the three months ended April 4, 2004, and during the corresponding
three-month period of 2003.
The company did not purchase any shares of Sylvan common stock during the first
three months of 2004. The share purchase program was suspended by Sylvan's board
of directors in April 2003.
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RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (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 FIN No. 46, "Consolidation of Variable Interest
Entities." In December 2003, the FASB revised FIN 46 to clarify certain
provisions and modify its effective date. FIN 46 expands upon and strengthens
existing accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
It requires that companies determine whether a non-consolidated entity is a
variable interest entity, as defined by FIN 46, and which company is the primary
beneficiary of the variable interest entity's activities. The requirements of
FIN 46 apply to all variable interest entities held no later than the end of the
interim reporting period ending after March 15, 2004. Variable interest entities
held in special purpose entities shall apply FIN 46 no later than the end of the
first interim reporting period ending after December 15, 2003. The adoption of
FIN 46 did not 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 did
not 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 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 did not have a material impact 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
17
uncertainties associated with accounting for derivatives can be found in Item
7A. Quantitative and Qualitative Disclosures about Market Risk, presented under
Item 3 in the company's Form 10-K report for the fiscal year ended December 28,
2003, as amended.
A summary of the company's significant accounting policies is included in Note 1
to the Consolidated Financial Statements, presented in the company's Form 10-K
report for the fiscal year ended December 28, 2003, as amended. 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 addition to the significant accounting policies described in Note 1 to the
Consolidated Financial Statements, presented in the company's Form 10-K report
for the fiscal year ended December 28, 2003, as amended, the company believes
the following discussion addresses its critical accounting policies:
- - the company recognizes revenue when the title and risk of loss of the
goods pass to the customers at the time of shipment;
- - the company maintains an allowance for doubtful accounts for estimated
losses resulting from the inability of customers to make required
payments. If the financial condition of the company's customers were to
deteriorate, resulting in an inability to make payments, additional
allowances may be required;
- - the company writes down its inventory to the lower of cost (first-in,
first-out method) or market, which includes an estimate for obsolete or
excess inventory based upon assumptions about future demand and market
conditions; and
- - the company monitors the recoverability of the carrying value of its
long-lived assets. An impairment charge would be recognized when the
expected net undiscounted future cash flows from an asset's use (including
any proceeds from disposition) are less than the asset's carrying value,
and the asset's carrying value exceeds its fair value.
In order to manage interest rate exposure, the company utilizes interest rate
swaps under its fair value hedging strategy in order to convert a portion of its
floating rate debt to a fixed-rate basis. Accordingly, changes in the fair value
of these derivatives, along with changes in the fair value of the hedged debt
obligations that are attributable to the hedged risk, are recognized in current
period earnings. Based on the amount of floating rate debt converted to fixed as
of April 4, 2004, a variance of 10% in the related interest rate would cause
annual interest expense related to this debt to change by approximately $50,000.
The company is subject to various environmental laws and regulations that govern
the discharge of wastewater, which may require that we investigate and remediate
the effects of such discharge at our operations. Environmental liabilities are
recorded when our liability is probable and the costs are reasonably estimable.
The company's outstanding environmental liability at April 4, 2004 was $25,000.
The company believes that an accounting estimate related to asset impairment is
a "critical accounting estimate" as it is susceptible to change from period to
period, because it requires management to make assumptions about cash flows over
future years. These assumptions impact the amount of an impairment, which would
have an impact on the income statement. Management's assumptions about future
cash flows require significant judgment because actual operating levels have
fluctuated in the past and are expected to do so in the future.
Goodwill and indefinitely lived intangible assets are reviewed annually for
impairment, or more frequently if impairment indicators arise. The company
performs this annual impairment test in the fourth quarter of each fiscal year.
The goodwill impairment test requires a comparison of the fair value of the
company's reporting unit that has goodwill associated with its operations with
its carrying amount, including goodwill. If this comparison reflects impairment,
then the loss would be measured as the excess of recorded goodwill over its
implied fair value. Implied fair value is the excess of the fair value of the
reporting unit over the fair value of all
18
recognized and unrecognized assets and liabilities. The company believes that an
accounting estimate related to the goodwill impairment is a "critical accounting
estimate" because the underlying assumptions used for the discounted cash flow
can change from period to period and these changes could cause a material impact
to the income statement. Management's assumptions about discount rates,
inflation rates and other internal and external economic conditions require
significant judgment based on fluctuating rates and anticipated future revenues.
Additionally, SFAS No. 142, "Goodwill and Other Intangible Assets", requires
that the goodwill be analyzed for impairment on an annual basis using the
assumptions that apply at the time the analysis is updated.
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.
Lowering the discount rate by 0.5% (from 6.10% to 5.60%) would increase the
company's projected benefit obligation as of April 4, 2004 approximately $2.1
million. 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%. Pension expense increases as the
expected long-term rate of return decreases. Therefore, had Sylvan assumed an
expected long-term rate of return of 8.5% for all of 2002, the company's pension
expense for 2002 would have been approximately $145,000 higher than the amount
recorded.
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 upon various matters and may differ from the amounts recorded. An
adjustment to the estimated liability would be recorded through income in the
period in which it becomes probable that the amount of the actual liability
differs from the amount recorded. Included in net deferred tax liabilities as of
December 28, 2003 are unrealized tax benefits amounting to approximately $2.3
million related to net operating loss carryforwards. The realization of these
tax benefits is contingent on future taxable net income being generated by
certain foreign and domestic operations. The life of the carryforwards is
determined by various foreign and state taxation jurisdictions. Approximately
$0.3 million of the net operating losses has an indefinite carryforward period.
The remaining $2.0 million of net operating losses will expire between 2004 and
2018. The company has recognized a valuation allowance of $1.6 million that
reduces the carrying value of unrealized net deferred tax benefits relating to
net operating loss carryforward to offset the deferred tax benefits that may not
be realized.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
From time to time in this quarterly report, references are made to expectations
capable of influencing Sylvan's future financial performance, such as the profit
contribution and cost of sales impact of the satellite farms, changes in capital
expenditures and in research and development expenditures, the continuation of
the company's share purchase program, cash flows from operations and bank
borrowings, and future interest rate sensitivity. Events could turn out to be
significantly different from what is expected. The following factors, among
others, in some cases have affected and in the future could affect the company's
financial performance and could cause actual results to differ materially from
those expressed or implied in such forward-looking statements:
- pricing or product initiatives of the company's competitors;
- changes in exchange risks with respect to currencies used in the
company's markets;
- the loss of key executives or other employees of the company;
- failure to achieve production yield expectations;
- the loss of a major customer;
19
- market-driven fluctuations of the asset values in the defined
benefit plan of a former subsidiary of the company;
- failure of Sylvan's shareholders to approve the Agreement and Plan
of Merger, dated November 16, 2003, that is expected to be voted on
by the shareholders at a special meeting scheduled for June 9, 2004;
and
- acts of terrorism, war or concerns of the public about such acts or
threats of such acts.
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 28, 2003, 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 April 4, 2004, 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 April 4, 2004.
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 17, 2003, a complaint was filed in Nevada by Alan Kahn, an alleged
Sylvan shareholder, on behalf of himself and purportedly on behalf of similarly
situated shareholders. It alleged generally that Sylvan and its directors
breached their fiduciary and other duties to the plaintiff by entering into a
merger agreement with Snyder Associated Companies of Kittanning, Pennsylvania
(see Note 7 to the Condensed Consolidated Financial Statements). On March 29,
2004, Sylvan received notice of an order entered by the court granting Sylvan's
motion to dismiss plaintiff's complaint and denying plaintiff's motion to amend
his complaint.
On September 23, 2003, the company's Sylvan Bioproducts, Inc. subsidiary
received an administrative order from the Borough of Kennett Square,
Pennsylvania, alleging that Sylvan Bioproducts failed to comply with certain
wastewater sampling and reporting requirements under the terms of a water
contribution permit issued to the company for its facility in Kennett Square. A
fine of $105,109 was assessed by the order. The company believes that the
requirements were substantially fulfilled and it filed an appeal to the order on
October 1, 2003. Discussions have been undertaken with the Borough and the
company believes that the dispute will be resolved in a manner that will have no
material impact on the company's financial statements or results of operations.
Except as described above, 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.
ITEM 5. OTHER INFORMATION
PROPOSED MERGER OF SYLVAN INC. AND SNYDER ASSOCIATED COMPANIES
Sylvan recently announced entering into a definitive agreement with Snyder
Associated Companies, Inc. and SAC Holding Company that will result in a merger
of Sylvan and a Snyder affiliate if approved by shareholders at a special
meeting that is expected to be held on June 9, 2004. The proxy statements with
respect to the proposed merger and the special meeting were mailed to
shareholders beginning May 10, 2004.
21
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 April 4, 2004, Sylvan filed and
furnished the following reports on Form 8-K:
On March 29, 2004, the company furnished a current report containing
a press release, dated March 26, 2004, reporting earnings for the
quarter ended December 28, 2003, and providing a financial outlook.
On April 6, 2004, the company filed a current report containing a
press release, dated April 2, 2004, announcing that Sylvan and
Snyder Associated Companies, Inc. of Kittanning, Pennsylvania,
agreed to extend the deadline for completing the merger between
Sylvan and a Snyder affiliate.
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: May 19, 2004 SYLVAN INC.
------------------
By: /s/ DONALD A. SMITH
-------------------------------------
Donald A. Smith
Chief Financial Officer
By: /s/ FRED Y. BENNITT
-------------------------------------
Fred Y. Bennitt
Secretary/Treasurer
22
INDEX TO EXHIBITS
Exhibit No. Description Page
- ----------- ----------- ----
31 Rule 13a-14(a) Certification of Dennis C. Zensen 24
31 Rule 13a-14(a) Certification of Donald A. Smith 25
32 Section 1350 Certification of Dennis C. Zensen 26
32 Section 1350 Certification of Donald A. Smith 27
23