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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 1-13292
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THE SCOTTS COMPANY
(Exact Name of Registrant as Specified in Its Charter)
OHIO 31-1414921
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
14111 SCOTTSLAWN ROAD, MARYSVILLE, OHIO 43041
(Address of Principal Executive Offices) (Zip Code)
(937) 644-0011
(Registrant's Telephone Number, Including Area Code)
NO CHANGE
(Former name, former address and former fiscal year, if
changed since last report.)
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 the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date.
29,744,790
----------------- Outstanding at August 13, 2002
Common Shares, no par value
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THE SCOTTS COMPANY AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Condensed, Consolidated Statements of Operations - Three and nine
month periods ended June 29, 2002 and June 30, 2001................................... 2
Condensed, Consolidated Statements of Cash Flows - Nine month
periods ended June 29, 2002 and June 30, 2001......................................... 3
Condensed, Consolidated Balance Sheets - June 29, 2002,
June 30, 2001 and September 30, 2001.................................................. 4
Notes to Condensed, Consolidated Financial Statements................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................. 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................... 48
Item 6. Exhibits and Reports on Form 8-K...................................................... 49
Signatures............................................................................ 50
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
---- ---- ---- ----
Net sales ........................................... $ 692.2 $ 598.6 $ 1,457.3 $ 1,459.1
Cost of sales ....................................... 421.2 379.4 914.2 916.6
Restructuring and other charges ..................... 0.4 0.9 1.5 0.9
----------- ----------- ------------- -----------
Gross profit ..................................... 270.6 218.3 541.6 541.6
Gross commission earned from marketing agreement .... 22.4 20.7 30.8 37.2
Costs associated with marketing agreement ........... 5.8 4.6 17.5 13.8
----------- ----------- ------------- -----------
Net commission earned from marketing agreement ... 16.6 16.1 13.3 23.4
Operating expenses:
Advertising ...................................... 30.6 31.0 68.6 77.2
Selling, general and administrative .............. 86.4 84.4 245.9 253.3
Restructuring and other charges .................. 0.6 15.1 1.8 15.1
Amortization of goodwill and other intangibles ... 0.2 6.9 3.8 21.1
Other income, net ................................ (5.1) (6.1) (8.9) (8.6)
----------- ----------- ------------- -----------
Income from operations .............................. 174.5 103.1 243.7 206.9
Interest expense .................................... 18.7 22.3 58.8 69.7
----------- ----------- ------------- -----------
Income before income taxes .......................... 155.8 80.8 184.9 137.2
Income taxes ........................................ 60.0 35.4 71.2 58.3
----------- ----------- ------------- -----------
Income before cumulative effect of
accounting change ................................ 95.8 45.4 113.7 78.9
Cumulative effect of change in accounting
for intangible assets, net of tax ................ -- -- (18.5) --
----------- ----------- ------------- -----------
Net income ......................................... $ 95.8 $ 45.4 $ 95.2 $ 78.9
=========== =========== ============= ===========
BASIC EARNINGS PER COMMON SHARE:
Weighted-average common shares outstanding during
the period ....................................... $ 29.5 $ 28.3 $ 29.1 $ 28.3
Basic earnings per common share:
Before cumulative effect of accounting change..... $ 3.25 $ 1.60 $ 3.91 $ 2.79
Cumulative effect of change in accounting for
intangible assets, net of tax.................. -- -- (0.64) --
----------- ----------- ------------- -----------
After cumulative effect of accounting change...... $ 3.25 $ 1.60 $ 3.27 $ 2.79
=========== =========== ============= ===========
DILUTED EARNINGS PER COMMON SHARE:
Weighted-average common shares outstanding during
the period ....................................... 31.8 30.6 31.6 $ 30.3
Diluted earnings per common share:
Before cumulative effect of accounting change .... $ 3.02 $ 1.49 $ 3.60 2.61
Cumulative effect of change in accounting for
intangible assets, net of tax ................. -- -- (0.59) --
----------- ----------- ------------- -----------
After cumulative effect of accounting change...... $ 3.02 $ 1.49 $ 3.01 $ 2.61
=========== =========== ============= ===========
See notes to condensed, consolidated financial statements
2
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
NINE MONTHS ENDED
-----------------
JUNE 29, JUNE 30,
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................... $ 95.2 $ 78.9
Adjustments to reconcile net income to net cash used in
operating activities:
Cumulative effect of change in accounting for intangible assets,
pre-tax ............................................................. 29.8 --
Restructuring and other charges ........................................ -- 9.4
Depreciation ........................................................... 26.0 24.4
Amortization ........................................................... 6.3 23.5
Deferred taxes ......................................................... (10.8) 2.4
Changes in assets and liabilities, net of acquired businesses:
Accounts receivable .................................................. (214.3) (142.1)
Inventories .......................................................... 66.5 (52.4)
Prepaid and other current assets ..................................... (11.1) 5.4
Accounts payable ..................................................... 46.4 80.8
Accrued liabilities .................................................. 99.4 45.7
Other assets ......................................................... (1.6) 1.7
Other liabilities .................................................... 16.4 (8.9)
Other, net ............................................................. 3.8 (3.3)
-------- --------
Net cash provided by operating activities ............................ 152.0 65.5
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in property, plant and equipment .............................. (33.9) (36.2)
Investments in acquired businesses, net of cash acquired .................. (4.0) (10.0)
Payments on seller notes .................................................. (28.7) (24.5)
-------- --------
Net cash used in investing activities ................................ (66.6) (70.7)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) borrowings under revolving and bank lines of credit ...... (95.7) 82.2
Issuance of 8 5/8% senior subordinated notes, net of issuance costs ....... 70.2 --
Gross borrowings under term loans ......................................... -- 260.0
Gross repayments under term loans ......................................... (23.3) (309.8)
Cash received from the exercise of stock options .......................... 19.0 13.3
-------- --------
Net cash (used in) provided by financing activities .................. (29.8) 45.7
-------- --------
Effect of exchange rate changes on cash ...................................... 2.1 (0.4)
-------- --------
Net increase in cash ......................................................... 57.7 40.1
Cash and cash equivalents at beginning of period ............................. 18.7 33.0
-------- --------
Cash and cash equivalents at end of period ................................... $ 76.4 $ 73.1
======== ========
See notes to condensed, consolidated financial statements
3
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
UNAUDITED
---------
JUNE 29, JUNE 30, SEPTEMBER 30,
2002 2001 2001
---- ---- ----
ASSETS
Current assets:
Cash and cash equivalents ............................................... $ 76.4 $ 73.1 $ 18.7
Accounts receivable, less allowances of $24.6, $21.9 and
$23.9, respectively ................................................. 435.1 358.1 220.8
Inventories, net ........................................................ 301.9 359.0 368.4
Current deferred tax asset .............................................. 52.1 27.5 52.2
Prepaid and other assets ................................................ 45.2 60.0 34.1
---------- ---------- ----------
Total current assets ................................................ 910.7 877.7 694.2
Property, plant and equipment, net ......................................... 317.1 291.9 310.7
Goodwill and intangible assets, net ........................................ 765.3 762.1 771.1
Other assets ............................................................... 77.0 72.2 67.0
---------- ---------- ----------
Total assets ........................................................ $ 2,070.1 $ 2,003.9 $ 1,843.0
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ................................................. $ 68.8 $ 60.8 $ 71.3
Accounts payable ........................................................ 197.4 233.8 150.9
Accrued liabilities ..................................................... 231.5 200.2 208.0
Accrued taxes ........................................................... 91.8 50.7 14.9
---------- ---------- ----------
Total current liabilities ........................................... 589.5 545.5 445.1
Long-term debt ............................................................. 767.2 835.9 816.5
Other liabilities .......................................................... 91.6 55.9 75.2
---------- ---------- ----------
Total liabilities ................................................... 1,448.3 1,437.3 1,336.8
========== ========== ==========
Commitments and contingencies
Shareholders' equity:
Preferred shares, no par value, none issued ............................. -- -- --
Common shares, no par value per share, $.01 stated
value per share, issued 31.3 for all periods ........................ 0.3 0.3 0.3
Capital in excess of par value .......................................... 402.0 386.3 398.3
Retained earnings ....................................................... 307.5 275.7 212.3
Treasury stock, 1.7, 2.7 and 2.6 shares,
respectively, at cost ............................................... (54.6) (72.2) (70.0)
Accumulated other comprehensive loss .................................... (33.4) (23.5) (34.7)
---------- ---------- ----------
Total shareholders' equity ................................................. 621.8 566.6 506.2
---------- ---------- ----------
Total liabilities and shareholders' equity ................................. $ 2,070.1 $ 2,003.9 $ 1,843.0
========== ========== ==========
See notes to condensed, consolidated financial statements
4
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Scotts Company and its subsidiaries (collectively "Scotts" or the
"Company") are engaged in the manufacture and sale of lawn care and
garden products. The Company's major customers include home improvement
centers, mass merchandisers, large hardware chains, independent
hardware stores, nurseries, garden centers, food and drug stores, lawn
and landscape service companies, commercial nurseries and greenhouses,
and specialty crop growers. The Company's products are sold in the
United States, Canada, the European Union, the Caribbean, South
America, Southeast Asia, the Middle East, Africa, Australia, New
Zealand, Mexico, Japan, and several Latin American countries. We also
operate the Scotts LawnService(R) business which provides lawn, tree
and shrub fertilization, insect control and other related services in
the United States.
ORGANIZATION AND BASIS OF PRESENTATION
The condensed, consolidated financial statements include the accounts
of The Scotts Company and its subsidiaries. All material intercompany
transactions have been eliminated.
The condensed, consolidated balance sheets as of June 29, 2002 and June
30, 2001, and the related condensed, consolidated statements of
operations for the three month and nine month periods then ended and
condensed, consolidated statements of cash flows for the nine month
periods then ended, are unaudited; however, in the opinion of
management, such financial statements contain all adjustments
necessary, consisting solely of normal recurring adjustments, for the
fair presentation of the Company's financial position, results of
operations and cash flows. Interim results reflect all normal recurring
adjustments and are not necessarily indicative of results for a full
year. The interim financial statements and notes are presented as
specified by Regulation S-X of the Securities and Exchange Commission,
and should be read in conjunction with the financial statements and
accompanying notes in Scotts' fiscal 2001 Annual Report on Form 10-K.
REVENUE RECOGNITION
Revenue is recognized when products are shipped and when title and risk
of loss transfer to the customer. Provisions for estimated returns and
allowances are recorded at the time of shipment based on historical
rates of return applied as a percentage of sales.
ADVERTISING AND PROMOTION
Scotts advertises its branded products through national and regional
media, and through cooperative advertising programs with retailers.
Retailers are also offered in-store promotional allowances and in prior
years were offered pre-season stocking allowances. Certain products are
also promoted with direct consumer rebate programs. Advertising and
promotion costs (including allowances and rebates) incurred during the
year are expensed ratably to interim periods in relation to revenues.
All advertising and promotion costs, except for production costs, are
expensed within the fiscal year in which such costs are incurred.
Production costs for advertising programs are deferred until the period
in which the advertising is first aired. All amounts paid or payable to
customers or consumers in connection with the purchase of our products
are recorded as a reduction of net sales.
5
DERIVATIVE INSTRUMENTS
In the normal course of business, Scotts is exposed to fluctuations in
interest rates and the value of foreign currencies. Scotts has
established policies and procedures that govern the management of these
exposures through the use of a variety of financial instruments. Scotts
employs various financial instruments, including forward exchange
contracts, and swap agreements, to manage certain of the exposures when
practical. By policy, Scotts does not enter into such contracts for the
purpose of speculation or use leveraged financial instruments. The
Company's derivative activities are managed by the chief financial
officer and other senior management of the Company in consultation with
the Finance Committee of the Board of Directors. These activities
include establishing a risk-management philosophy and objectives,
providing guidelines for derivative-instrument usage and establishing
procedures for control and valuation, counterparty credit approval and
the monitoring and reporting of derivative activity. Scotts' objective
in managing its exposure to fluctuations in interest rates and foreign
currency exchange rates is to decrease the volatility of earnings and
cash flows associated with changes in the applicable rates and prices.
To achieve this objective, Scotts primarily enters into forward
exchange contracts and swap agreements whose values change in the
opposite direction of the anticipated cash flows. Derivative
instruments related to forecasted transactions are considered to hedge
future cash flows, and the effective portion of any gains or losses are
included in other comprehensive income until earnings are affected by
the variability of cash flows. Any remaining gain or loss is recognized
currently in earnings. The cash flows of the derivative instruments are
expected to be highly effective in achieving offsetting cash flows
attributable to fluctuations in the cash flows of the hedged risk. If
it becomes probable that a forecasted transaction will no longer occur,
the derivative will continue to be carried on the balance sheet at fair
value, and gains and losses that were accumulated in other
comprehensive income will be recognized immediately in earnings.
To manage certain of its cash flow exposures, Scotts has entered into
forward exchange contracts and interest rate swap agreements. The
forward exchange contracts are designated as hedges of the Company's
foreign currency exposure associated with future cash flows. Amounts
payable or receivable under forward exchange contracts are recorded as
adjustments to selling, general and administrative expense. The
interest rate swap agreements are designated as hedges of the Company's
interest rate risk associated with certain variable rate debt. Amounts
payable or receivable under the swap agreements are recorded as
adjustments to interest expense. Unrealized gains or losses resulting
from valuing these swaps at fair value are recorded in other
comprehensive income.
Scotts adopted FAS 133 as of October 2000. Since adoption, there have
been no gains or losses recognized in earnings for hedge
ineffectiveness or due to excluding a portion of the value from
measuring effectiveness.
STOCK OPTIONS
In July 2002, the Company announced that it would begin expensing
employee stock options prospectively beginning in fiscal 2003 in
accordance with SFAS No. 123 "Accounting for Stock-Based Compensation".
The fair value of future stock option grants will be expensed over the
option vesting period, which has historically been three years. The
Company currently accounts for stock options under APB 25 and, as
allowable, adopted only the disclosure provisions of Statement 123.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
6
reported in the consolidated financial statements and accompanying
disclosures. Although these estimates are based on management's best
knowledge of current events and actions the Company may undertake in
the future, actual results ultimately may differ from the estimates.
RECLASSIFICATIONS
Certain reclassifications have been made in prior periods' financial
statements to conform to fiscal 2002 classifications.
2. DETAIL OF CERTAIN FINANCIAL STATEMENT ACCOUNTS
INVENTORIES
Inventories, net of provisions for slow moving and obsolete inventory
of $26.2 million, $22.4 million, and $22.3 million, respectively,
consisted of:
JUNE 29, JUNE 30, SEPTEMBER 30,
2002 2001 2001
---- ---- ----
($ MILLIONS)
Finished goods ................................... $ 228.7 $ 272.5 $ 295.8
Raw Materials..................................... 73.2 86.5 72.6
--------- -------- ---------
Total........................................ $ 301.9 $ 359.0 $ 368.4
========= ======== =========
PROPERTY, PLANT AND EQUIPMENT, NET
JUNE 29, JUNE 30, SEPTEMBER 30,
2002 2001 2001
---- ---- ----
($ MILLIONS)
Land and Improvements ............................ $ 35.9 $ 38.7 $ 38.9
Buildings......................................... 107.4 101.6 119.5
Machinery and equipment........................... 251.6 228.8 203.4
Furniture and fixtures............................ 32.7 31.6 31.9
Software.......................................... 46.0 34.1 42.0
Construction in progress.......................... 81.6 67.3 79.6
Less accumulated depreciation..................... (238.1) (210.2) (204.6)
--------- -------- ---------
Total........................................ $ 317.1 $ 291.9 $ 310.7
========= ======== =========
3. MARKETING AGREEMENT
Effective September 30, 1998, the Company entered into an agreement
with Monsanto Company ("Monsanto") for exclusive domestic and
international marketing and agency rights to Monsanto's consumer
Roundup(R) herbicide products. Under the terms of the agreement, the
Company is entitled to receive an annual commission from Monsanto in
consideration for the performance of its duties as agent. The annual
commission is calculated as a percentage of the actual earnings before
interest and income taxes (EBIT), as defined in the agreement, of the
Roundup(R) business. Each year's percentage varies in accordance with
the terms of the agreement based on the achievement of two earnings
thresholds and on commission rates that vary by threshold and program
year.
7
The agreement also requires the Company to make fixed annual payments
to Monsanto as a contribution against the overall expenses of the
Roundup(R) business. The annual fixed payment is defined as $20
million. However, portions of the annual payments for the first three
years of the agreement are deferred. No payment was required for the
first year (fiscal 1999), a payment of $5 million was required for the
second year and a payment of $15 million was required for the third
year so that a total of $40 million of the contribution payments were
deferred. Beginning in the fifth year of the agreement, the annual
payments to Monsanto increase to at least $25 million, which include
per annum interest charges at 8%. The annual payments may be increased
above $25 million if certain significant earnings targets are exceeded.
If all of the deferred contribution amounts are paid prior to 2018, the
annual contribution payments revert to $20 million. Regardless of
whether the deferred contribution amounts are paid, all contribution
payments cease entirely in 2018.
The Company is recognizing a charge each year associated with the
annual contribution payments equal to the required payment for that
year. The Company is not recognizing a charge for the portions of the
contribution payments that are deferred until the time those deferred
amounts are paid. The Company considers this method of accounting for
the contribution payments to be appropriate after consideration of the
likely term of the agreement, the Company's ability to terminate the
agreement without paying the deferred amounts, and the fact that
approximately $18.6 million of the deferred amount is never paid, even
if the agreement is not terminated prior to 2018, unless significant
earnings targets are exceeded.
The express terms of the agreement permit the Company to terminate the
agreement only upon Material Breach, Material Fraud or Material Willful
Misconduct by Monsanto, as such terms are defined in the agreement, or
upon the sale of the Roundup(R) business by Monsanto. In such
instances, the agreement permits the Company to avoid payment of any
deferred contribution and related per annum charge. The Company's basis
for not recording a financial liability to Monsanto for the deferred
portions of the annual contribution and per annum charge is based on
our assessment and consultations with our legal counsel and the
Company's independent accountants. In addition, the Company has
obtained a legal opinion from The Bayard Firm, P.A., which concluded,
subject to certain qualifications, that if the matter were litigated, a
Delaware court would likely conclude that the Company is entitled to
terminate the agreement at will, with appropriate prior notice, without
incurring significant penalty, and avoid paying the unpaid deferred
amounts. We have concluded that, should the Company elect to terminate
the agreement at any balance sheet date, it will not incur significant
economic consequences as a result of such action.
The Bayard Firm was special Delaware counsel retained during fiscal
2000 solely for the limited purpose of providing a legal opinion in
support of the contingent liability treatment of the agreement
previously adopted by the Company and has neither generally represented
or advised the Company nor participated in the preparation or review of
the Company's financial statements or any SEC filings. The terms of
such opinion specifically limit the parties who are entitled to rely on
it.
The Company's conclusion is not free from challenge and, in fact, would
likely be challenged if the Company were to terminate the agreement. If
it were determined that, upon termination, the Company must pay any
remaining deferred contribution amounts and related per annum charges,
the resulting charge to earnings could have a material impact on the
Company's results of operations and financial position. At June 29,
2002, contribution payments and related per annum charges of
approximately $49.2 million had been deferred under the agreement. This
amount is considered a contingent obligation and has not been reflected
in the financial statements as of and for the period then ended.
Monsanto has disclosed that it is accruing the $20 million fixed
contribution fee per year beginning in the fourth quarter of Monsanto's
fiscal year 1998, plus interest on the deferred portion.
8
The agreement has a term of seven years for all countries within the
European Union (at the option of both parties, the agreement can be
renewed for up to 20 years for the European Union countries). For
countries outside of the European Union, the agreement continues
indefinitely unless terminated by either party. The agreement provides
Monsanto with the right to terminate the agreement for an event of
default (as defined in the agreement) by the Company or a change in
control of Monsanto or the sale of the Roundup(R) business. The
agreement provides the Company with the right to terminate the
agreement in certain circumstances including an event of default by
Monsanto or the sale of the Roundup(R) business. Unless Monsanto
terminates the agreement for an event of default by the Company,
Monsanto is required to pay a termination fee to the Company that
varies by program year. The termination fee is $150 million for each of
the first five program years, gradually declines to $100 million by
year ten of the program and then declines to a minimum of $16 million
if the program continues for years 11 through 20.
In consideration for the rights granted to the Company under the
agreement for North America, the Company was required to pay a
marketing fee of $32 million to Monsanto. The Company has deferred the
expense relating to this amount on the basis that the payment will
provide a future benefit through commissions that will be earned under
the agreement and is amortizing the balance over ten years, which is
the estimated likely term of the agreement.
4. RESTRUCTURING AND OTHER CHARGES
2002 CHARGES
Under accounting principles generally accepted in the United States of
America, certain restructuring costs related to relocation of
personnel, equipment and inventory are to be expensed in the period the
costs are actually incurred. During the first nine months of fiscal
2002, inventory relocation costs of approximately $1.5 million were
incurred and paid and were recorded as restructuring and other charges
in cost of sales. Approximately $1.8 million of employee relocation
costs were also incurred and paid in the first nine months of fiscal
2002 and were recorded as restructuring and other charges in operating
expenses. These charges related to restructuring activities initiated
in the third and fourth quarters of fiscal 2001.
2001 CHARGES
During the third and fourth quarters of fiscal 2001, the Company
recorded $75.7 million of restructuring and other charges, primarily
associated with reductions in headcount and the closure or relocation
of certain manufacturing and administrative facilities. The $75.7
million in charges was segregated in the Statements of Operations in
two components: (i) $7.3 million included in cost of sales for the
write-off of inventory that was rendered unusable as a result of the
restructuring activities and (ii) $68.4 million included in selling,
general and administrative costs. Included in the $68.4 million charge
in selling, general and administrative costs was $20.4 million to
write-down to fair value certain property and equipment and other
assets; $5.8 million of facility exit costs; $27.0 million of severance
costs; and $15.2 million in other restructuring and other costs. The
severance costs related to reduction in force initiatives and facility
closures and consolidations in North America and Europe cover
approximately 340 administrative, production, selling and other
employees. Remaining severance costs are expected to be paid in fiscal
2002 with some payments extending into 2003. All other fiscal 2001
restructuring related activities and costs are expected to be completed
by the end of fiscal 2002.
9
The following is a rollforward of the cash portion of the restructuring
and other charges accrued in the third and fourth quarters of fiscal
2001. The balance of the accrued charges at June 29, 2002 are included
in accrued liabilities and other long-term liabilities on the
condensed, consolidated balance sheets. The portion classified as other
long-term liabilities are future lease obligations that extend beyond
one year.
BALANCE BALANCE
DESCRIPTION TYPE CLASSIFICATION SEPT. 30, 2001 PAYMENT JUNE 29, 2002
----------- ---- -------------- -------------- ------- -------------
($ MILLIONS)
Severance................. Cash SG&A $ 25.1 $ 16.3 $ 8.8
Facility exit costs....... Cash SG&A 5.2 2.2 3.0
Other related costs....... Cash SG&A 7.0 6.9 0.1
--------- ---------- ---------
Total cash............ $ 37.3 $ 25.4 $ 11.9
========= ========== =========
5. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Effective October 1, 2001, Scotts adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
In accordance with this standard, goodwill and certain other intangible
assets, primarily tradenames, have been classified as indefinite-lived
assets no longer subject to amortization. Indefinite-lived assets are
subject to impairment testing upon adoption and at least annually. The
impairment analysis was completed in the second quarter of 2002, taking
into account additional guidance provided by EITF 02-07 "Unit of
Measure for Testing Impairment of Indefinite-Lived Intangibles Assets".
The value of all indefinite-lived tradenames as of October 1, 2001 was
determined using a "royalty savings" methodology that was employed when
the businesses associated with these tradenames were acquired but using
updated estimates of sales and profitability. As a result, a pre-tax
impairment loss of $29.8 million was recorded for the writedown of the
value of the tradenames in our International Consumer businesses in
Germany, France and the United Kingdom. This transitional impairment
charge was recorded as a cumulative effect of accounting change, net of
tax, as of October 1, 2001. After completing this initial valuation and
impairment of tradenames, an initial assessment for goodwill impairment
was performed. It was determined that a goodwill impairment charge was
not required.
The useful lives of intangible assets still subject to amortization
were not revised as a result of the adoption of Statement 142.
The following table presents goodwill and intangible assets as of the
end of each period presented.
JUNE 29, 2002 JUNE 30, 2001 SEPTEMBER 30, 2001
------------- ------------- ------------------
GROSS NET GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
------ ------------ ------ ------ ------------ ------ ------ ------------ ------
($ MILLIONS)
Amortized Intangible
Assets:
Technology ............... $ 62.1 $ (18.0) $ 44.1 $ 60.2 $ (15.7) $ 44.5 $ 61.9 $ (15.8) $ 46.1
Customer accounts ........ 27.7 (3.2) 24.5 22.5 (1.9) 20.6 24.1 (2.5) 21.6
Tradenames ............... 11.3 (2.1) 9.2 11.4 (1.5) 9.9 11.3 (1.6) 9.7
Other .................... 49.9 (33.4) 16.5 50.3 (31.5) 18.8 47.2 (32.6) 14.6
------ ------ ------
Total amortized
intangible assets,
net ................. 94.3 93.8 92.0
Unamortized Intangible Assets:
Tradenames ............... 327.9 347.9 349.0
Other .................... 3.1 3.2 3.2
------ ------ ------
Total intangible
assets, net........... 425.3 444.9 444.2
Goodwill.................. 340.0 317.2 326.9
------ ------ ------
Total goodwill and
intangible assets,
net ................. $765.3 $762.1 $771.1
====== ====== ======
10
During the first nine months of fiscal 2002, our Scotts LawnService(R)
business acquired several lawn care businesses. The assets and
liabilities of these businesses were recorded at their fair values as
of the dates of acquisition. The fair value of customer accounts,
customer lists and non-compete agreements were determined based on
their estimated impact on discounted future cash flows. The excess of
the amounts paid for these businesses over the fair values of the
assets was recorded as goodwill. The fair value of customer accounts
acquired during the first nine months of fiscal 2002 was $1.6 million;
the value assigned to non-compete agreements was $0.9 million. Customer
accounts are being amortized over an estimated seven year life;
non-compete agreements are amortized over the contract periods which
range from three to five years. Total goodwill added during the first
nine months of fiscal 2002 was $21.2 million. Goodwill was reduced by
$4.8 million and tradenames by $1.8 million as a result of the
settlement reached with Rhone-Poulenc Jardin regarding litigation
related to the price paid for international consumer businesses we
acquired in Europe in 1998. The effects of exchange rate fluctuations
resulted in the changes in balances not otherwise explained by the
impairment charge, the settlement with Rhone-Poulenc Jardin or the
acquisition activity described above.
The following table presents a reconciliation of recorded net income to
adjusted net income and related earnings per share data as if the
provision of Statement 142 relating to non-amortization of
indefinite-lived intangible assets had been adopted as of the earliest
period presented.
FOR THE PERIODS
ENDED JUNE 30, 2001
-------------------
THREE MONTHS NINE MONTHS
-------------------------
($ MILLIONS, EXCEPT
PER SHARE DATA)
Net income
Reported net income ....................... $ 45.4 $ 78.9
Goodwill amortization ..................... 2.6 8.6
Tradename amortization .................... 2.5 7.3
Taxes ..................................... (1.1) (3.6)
-------- --------
Net income as adjusted .................... $ 49.4 $ 91.2
======== ========
Basic EPS
Reported net income ....................... $ 1.60 $ 2.79
Goodwill amortization ..................... 0.10 0.30
Tradename amortization .................... 0.09 0.26
Taxes ..................................... (0.04) (0.13)
--------- ---------
Net income as adjusted .................... $ 1.75 $ 3.22
========= =========
Diluted EPS
Reported net income ....................... $ 1.49 $ 2.61
Goodwill amortization ..................... 0.09 0.28
Tradename amortization .................... 0.08 0.24
Taxes ..................................... (0.04) (0.12)
--------- ---------
Net income as adjusted .................... $ 1.62 $ 3.01
========= =========
Estimated amortization expense is as follows:
YEAR ENDED
SEPTEMBER 30, $ MILLIONS
------------ ----------
2002 ................................................... $ 4.6
2003 ................................................... 4.2
2004 ................................................... 3.1
2005 ................................................... 2.7
2006 ................................................... 2.7
11
6. LONG-TERM DEBT
JUNE 29, JUNE 30, SEPTEMBER 30,
2002 2001 2001
---- ---- ----
($ MILLIONS)
Revolving loans under credit facility......................... $ 0.3 $ 115.0 $ 94.7
Term loans under credit facility.............................. 383.4 396.4 398.6
Senior Subordinated Notes..................................... 391.5 320.2 320.5
Notes due to sellers ......................................... 38.7 50.2 53.7
Foreign bank borrowings and term loans........................ 10.7 4.3 9.4
Capital lease obligations and other .......................... 11.4 10.6 10.9
---------- ---------- ------------
836.0 896.7 887.8
Less current portions......................................... 68.8 60.8 71.3
---------- ---------- ------------
$ 767.2 $ 835.9 $ 816.5
========== ========== ============
On December 4, 1998, The Scotts Company and certain of its subsidiaries
entered into a credit facility (the "Original Credit Agreement") which
provided for borrowings in the aggregate principal amount of $1.025
billion and consisted of term loan facilities in the aggregate amount
of $525 million and a revolving credit facility in the amount of $500
million. Proceeds from borrowings under the Original Credit Agreement
of approximately $241.0 million were used to repay amounts outstanding
under the then existing credit facility.
On December 5, 2000, The Scotts Company and certain of its subsidiaries
entered into an Amended and Restated Credit Agreement (the "Amended
Credit Agreement"), amending and restating in its entirety the Original
Credit Agreement. Under the terms of the Amended Credit Agreement, the
revolving credit facility was increased from $500 million to $575
million and the net worth covenant was amended.
In December 2001, the Amended Credit Agreement was amended to redefine
earnings under the covenants, to eliminate the net worth covenant and
to modify the covenants pertaining to interest coverage and leverage
and amended how proceeds from future equity or subordinated debt
offerings, if any, will be used towards mandatory prepayments of
revolving credit facility borrowings.
The term loan facilities consist of two tranches. The Tranche A Term
Loan Facility consists of three sub-tranches of Euros and British
Pounds Sterling in an aggregate principal amount of $265 million which
are to be repaid quarterly over a 6 1/2 year period. The Tranche B Term
Loan Facility replaced the Tranche B and Tranche C facilities from the
Original Credit Agreement. Those facilities were prepayable without
penalty. The new Tranche B Term Loan Facility has an aggregate
principal amount of $260 million and is repayable in installments as
follows: quarterly installments of $0.25 million beginning June 30,
2001 through December 31, 2006, quarterly installments of $63.5 million
beginning March 31, 2007 through September 30, 2007 and a final
quarterly installment of $63.8 million on December 31, 2007.
The revolving credit facility provides for borrowings of up to $575
million, which are available on a revolving basis over a term of 6 1/2
years. A portion of the revolving credit facility not to exceed $100
million is available for the issuance of letters of credit. A portion
of the facility not to exceed $258.8 million is available for
borrowings in optional currencies, including Euros, British Pounds
Sterling and other specified currencies, provided that the outstanding
revolving loans in optional currencies other than British Pounds
Sterling does not exceed $138 million. The outstanding principal amount
of all revolving credit loans may not exceed $150 million for at least
30 consecutive days during any calendar year. The December 2001
amendment increased the amount that may be borrowed in optional
currencies to $360 million from $258.8 million.
12
Interest rates and commitment fees under the Amended Credit Agreement
vary according to the Company's leverage ratios and interest rates also
vary within tranches. The weighted-average interest rate on the
Company's variable rate borrowings at June 29, 2002 was 7.71% and at
September 30, 2001 was 7.85%. In addition, the Amended Credit Agreement
requires that Scotts enter into hedge agreements to the extent
necessary to provide that at least 50% of the aggregate principal
amount of the 8 5/8% Senior Subordinated Notes due 2009 and term loan
facilities is subject to a fixed interest rate or interest rate
protection for a period of not less than three years.
Financial covenants include interest coverage and net leverage ratios.
Other covenants include limitations on indebtedness, liens, mergers,
consolidations, liquidations and dissolutions, sale of assets, leases,
dividends, capital expenditures, and investments. The Scotts Company
and all of its domestic subsidiaries pledged substantially all of their
personal, real and intellectual property assets as collateral for the
borrowings under the Amended Credit Agreement. The Scotts Company and
its subsidiaries also pledged the stock in foreign subsidiaries that
borrow under the Amended Credit Agreement.
Approximately $17.0 million of financing costs associated with the
revolving credit facility have been deferred as of June 29, 2002 and
are being amortized over a period of approximately 7 years, beginning
in fiscal year 1999.
In January 1999, The Scotts Company completed an offering of $330
million of 8 5/8% Senior Subordinated Notes due 2009. The net proceeds
from the offering, together with borrowings under the Original Credit
Agreement, were used to fund the Ortho acquisition and to repurchase
approximately $97 million of outstanding 9 7/8% Senior Subordinated
Notes due August 2004. The Company recorded an extraordinary loss
before tax on the extinguishment of the 9 7/8% Notes of approximately
$9.3 million, including a call premium of $7.2 million and the
write-off of unamortized issuance costs and discounts of $2.1 million.
In August 1999, Scotts repurchased the remaining $2.9 million of the 9
7/8% Notes, resulting in an extraordinary loss, net of tax, of $0.1
million.
In January 2002, The Scotts Company completed an offering of $70
million of 8 5/8% Senior Subordinated Notes due 2009. The net proceeds
from the offering were used to pay down borrowings on our revolving
credit facility. The notes were issued at a premium of $1.8 million.
The issuance costs associated with the offering totaled $1.6 million.
Both the premium and the issuance costs are being amortized over the
life of the notes.
Scotts entered into two interest rate locks in fiscal 1998 to hedge its
anticipated interest rate exposure on the $330 million 8 5/8% Notes
offering. The total amount paid under the interest rate locks of $12.9
million has been recorded as a reduction of the 8 5/8% Notes' carrying
value and is being amortized over the life of the 8 5/8% Notes as
interest expense. Approximately $11.8 million of issuance costs
associated with the 8 5/8% Notes were deferred and are being amortized
over the term of the Notes.
In conjunction with the acquisition of Rhone-Poulenc Jardin, a note was
issued for a certain portion of the total purchase price that was to be
paid in annual installments over a four-year period. The present value
of the remaining note payments is $8.9 million. The Company is imputing
interest on the non-interest bearing note using an interest rate
prevalent for similar instruments at the time of acquisition
(approximately 9%). In conjunction with other acquisitions, notes were
issued for certain portions of the total purchase price that are to be
paid in annual installments over periods ranging from four to five
years. The present value of remaining note payments is $19.7 million.
The Company is imputing interest on the non-interest bearing notes
using an interest rate prevalent for similar instruments at the time of
the acquisitions (approximately 8%).
In conjunction with the Substral(R) acquisition, notes were issued for
certain portions of the total purchase price that are to be paid in
semi-annual installments over a two-year period. The present value of
remaining note payments total $8.7 million. The interest rate on these
notes is 5.5%.
13
The foreign term loans of $2.7 million issued on December 12, 1997,
have an 8-year term and bear interest at 1% below LIBOR. The loans are
denominated in British Pounds Sterling and can be redeemed, on demand,
by the note holder. The foreign bank borrowings of $8.0 million at June
29, 2002 and $4.3 million at June 30, 2001 represent lines of credit
for foreign operations and are primarily denominated in French Francs.
7. STATEMENT OF COMPREHENSIVE INCOME
The components of other comprehensive income and total comprehensive
income for the three and nine months ended June 29, 2002 and June 30,
2001 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
---- ---- ---- ----
Net income........................................... $ 95.8 $ 45.4 $ 95.2 $ 78.9
Other comprehensive income (expense):
Foreign currency translation adjustments............. 1.7 (4.0) 1.6 (0.8)
Change in valuation of derivative instruments........ (1.3) -- (0.3) (0.7)
--------- --------- --------- --------
Comprehensive income................................. $ 96.2 $ 41.4 $ 96.5 $ 77.4
======== ========= ======== ========
8. CONTINGENCIES
Management continually evaluates the Company's contingencies, including
various lawsuits and claims which arise in the normal course of
business, product and general liabilities, property losses and other
fiduciary liabilities for which the Company is self-insured. In the
opinion of management, its assessment of contingencies is reasonable
and related reserves, in the aggregate, are adequate; however, there
can be no assurance that future quarterly or annual operating results
will not be materially affected by final resolution of these matters.
The following matters are the more significant of the Company's
identified contingencies.
ENVIRONMENTAL MATTERS
In June 1997, the Ohio Environmental Protection Agency ("Ohio EPA")
initiated an enforcement action against us with respect to alleged
surface water violations and inadequate treatment capabilities at our
Marysville facility and seeking corrective action under the federal
Resource Conservation Recovery Act. The action relates to several
discontinued on-site disposal areas which date back to the early
operations of the Marysville facility that we had already been
assessing voluntarily. Since initiation of the action, we met with the
Ohio Attorney General and the Ohio EPA, and we were ultimately able to
negotiate an amicable resolution of these issues. On December 3, 2001,
an agreed judicial Consent Order was submitted to the Union County
Common Pleas Court and was entered by the court on January 25, 2002.
Now that the Consent Order has been entered, we have paid a $275,000
fine and must satisfactorily remediate the Marysville site. We have
continued our remediation activities with the knowledge and oversight
of the Ohio EPA. We completed an updated evaluation of our expected
liability related to this matter based on the fine paid and remediation
actions that we have taken and that we expect to take in the future
and, based on the latest estimates, we recorded a charge of $3 million
in the third quarter of fiscal 2002 to increase our reserve
accordingly.
In addition to the dispute with the Ohio EPA, we are negotiating with
the Philadelphia District of the U.S. Army Corps of Engineers ("Corps")
regarding the terms of site remediation and the resolution of the
Corps' civil penalty demand in connection with our prior peat
harvesting operations at our Lafayette, New Jersey facility. We are
also addressing remediation concerns raised by the Environment Agency
of the United
14
Kingdom with respect to emissions to air and groundwater at our
Bramford (Suffolk), United Kingdom facility. We have reserved for our
estimates of probable losses to be incurred in connection with each of
these matters.
Regulations and environmental concerns also exist surrounding peat
extraction in the United Kingdom and the European Union. In August
2000, English Nature, the nature conservation advisory body to the U.K.
government notified us that three of our peat harvesting sites in the
United Kingdom were under consideration as possible "Special Areas of
Conservation" under European Union Law. In April 2002 we reached
agreement with English Nature to transfer our interests in the
properties and for the immediate cessation of all but a limited amount
of peat extraction on one of the three sites in exchange for $18.1
million received in April 2002 and an additional approximately $3
million which will be received when we cease extraction at the third
site. A gain of approximately $5 million is included in "Other Income"
in the third quarter of fiscal 2002. Proceeds of approximately $13
million have been recorded as deferred income and will be recognized
into income over the 29 month period beginning May, 2002 which
coincides with the expected peat extraction period at the third site.
As a result of this transaction we have withdrawn our objection to the
proposed European designations as Special Areas of Conservation and
will undertake restoration work on the sites for which we will receive
additional compensation from English Nature. We consider that we have
sufficient raw material supplies available to replace the peat
extracted from such sites.
The Company has determined that cement containing asbestos material at
certain manufacturing facilities in the United Kingdom may require
removal in the future.
At June 29, 2002, $8.7 million is accrued for the environmental matters
described herein. The significant components of the accrual are costs
for site remediation of $6.9 million and costs for asbestos abatement
and other environmental exposures in the United Kingdom of $1.8
million. The significant portion of the costs accrued as of June 29,
2002 are expected to be paid in fiscal 2003 and 2004; however, payments
could be made for a period thereafter.
We believe that the amounts accrued as of June 29, 2002 are adequate to
cover known environmental exposures based on current facts and
estimates of likely outcome. However, the adequacy of these accruals is
based on several significant assumptions:
(i) that we have identified all of the significant sites that must
be remediated;
(ii) that there are no significant conditions of potential
contamination that are unknown to the Company; and
(iii) that with respect to the agreed judicial Consent Order in
Ohio, that potentially contaminated soil can be remediated in
place rather than having to be removed and only specific
stream segments will require remediation as opposed to the
entire stream.
If there is a significant change in the facts and circumstances
surrounding these assumptions, it could have a material impact on the
ultimate outcome of these matters and the Company's results of
operations, financial position and cash flows.
For the nine months ended June 29, 2002, we made approximately
$1.9 million in environmental expenditures, compared with approximately
$0.6 million in environmental capital expenditures and $2.1 million in
other environmental expenses for the entire fiscal year 2001.
Management anticipates that environmental capital expenditures and
other environmental expenses for the remainder of fiscal year 2002 will
not differ significantly from those incurred in fiscal year 2001.
AGREVO ENVIRONMENTAL HEALTH, INC.
On June 3, 1999, AgrEvo Environmental Health, Inc. ("AgrEvo") (which
subsequently changed its name to Aventis Environmental Health Science
USA LP) filed a complaint in the U.S. District Court for the Southern
15
District of New York (the "New York Action"), against the Company, a
subsidiary of the Company and Monsanto seeking damages and injunctive
relief for alleged antitrust violations and breach of contract by the
Company and its subsidiary, and antitrust violations and tortious
interference with contract by Monsanto. The suit arises out of Scotts'
purchase of a consumer herbicide business from AgrEvo in May 1998.
AgrEvo claims in the suit that Scotts' subsequent agreement to become
Monsanto's exclusive sales and marketing agent for Monsanto's consumer
Roundup(R) business violated the federal antitrust laws. AgrEvo
contends that Monsanto attempted to, or did, monopolize the market for
non-selective herbicides and conspired with Scotts to eliminate the
herbicide Scotts previously purchased from AgrEvo, which competed with
Monsanto's Roundup(R), in order to achieve or maintain a monopoly
position in that market. AgrEvo also contends that Scotts' execution of
various agreements with Monsanto, including the Roundup(R) marketing
agreement, as well as Scotts' subsequent actions, violated the purchase
agreements between AgrEvo and Scotts.
AgrEvo is requesting unspecified damages, as well as affirmative
injunctive relief, and seeking to have the courts invalidate the
Roundup(R) marketing agreement as violative of the federal antitrust
laws. Under the indemnification provisions of the Roundup(R) marketing
agreement, Monsanto and Scotts each have requested that the other
indemnify against any losses arising from this lawsuit. On September 5,
2001, the magistrate judge, over the objections of Scotts and Monsanto,
allowed AgrEvo to file another amended complaint to add claims
transferred to it by its German parent, AgrEvo GmbH, and its 100
percent commonly owned affiliate, AgrEvo USA Company. Scotts and
Monsanto have objected to the magistrate judge's order allowing the new
claims. The district court will resolve these objections; if sustained,
the newly-added claims will be stricken.
On June 29, 1999, AgrEvo also filed a complaint in the Superior Court
of the State of Delaware (the "Delaware Action") against two of the
Company's subsidiaries seeking damages for alleged breach of contract.
AgrEvo alleges that, under the contracts by which a subsidiary of the
Company purchased a herbicide business from AgrEvo in May 1998, two of
the Company's subsidiaries have failed to pay AgrEvo approximately $0.6
million. AgrEvo is requesting damages in this amount, as well as pre-
and post-judgment interest and attorneys' fees and costs. The Company's
subsidiaries have moved to dismiss or stay this action. On January 31,
2000, the Delaware court stayed AgrEvo's action pending the resolution
of a motion to amend the New York Action, and the resolution of the New
York Action. The Company's subsidiaries intend to vigorously defend the
asserted claims.
The Company believes that AgrEvo's claims in this matter are without
merit and intends to vigorously defend against them. If the above
actions are determined adversely to the Company, the result could have
a material adverse effect on Scotts' results of operations, financial
position and cash flows. Any potential exposure that Scotts may face
cannot be reasonably estimated. Therefore, no accrual has been
established related to these matters.
CENTRAL GARDEN & PET COMPANY
SCOTTS V. CENTRAL GARDEN, SOUTHERN DISTRICT OF OHIO.
On June 30, 2000, the Company filed suit against Central Garden & Pet
Company in the U.S. District Court for the Southern District of Ohio
(the "Ohio Action") to recover approximately $17 million in outstanding
accounts receivable from Central Garden with respect to the Company's
2000 fiscal year. The Company's complaint was later amended to seek
approximately $24 million in accounts receivable and additional damages
for other breaches of duty.
On April 13, 2001, Central Garden filed an answer and counterclaim in
the Ohio action. On April 24, 2001, Central Garden filed an amended
counterclaim. Central Garden's counterclaims included allegations that
the Company and Central Garden had entered into an oral agreement in
April 1998 whereby the Company would allegedly share with Central
Garden the benefits and liabilities of any future business integration
between the
16
Company and Pharmacia Corporation (formerly Monsanto). Based on these
allegations, Central Garden asserted several causes of action,
including fraudulent misrepresentation, and sought damages in excess of
$900 million. In addition, Central Garden asserted various other causes
of action and sought damages in excess of $76 million based on the
allegations that Central Garden was entitled to receive a cash payment
rather than a credit for the value of inventory Central Garden alleged
was improperly seized by the Company.
Prior to trial, the court dismissed Central Garden's $900 million
counterclaim for breach of oral agreement and promissory estoppel, and
entered summary judgment against Central Garden on Central Garden's
$900 million counterclaim for fraudulent misrepresentation. In
addition, as a result of the resolution of the Missouri Action
described below, Central Garden's counterclaim for illegal inventory
seizure was resolved.
In April 2002, trial on the remaining claims and counterclaims took
place in this action. Prior to the conclusion of the trial, the court
dismissed certain of Central Garden's counterclaims as well as the
Company's claims that Central Garden breached other duties owed to the
Company. On April 22, 2002, a jury returned a verdict in favor of the
Company for $22.5 million and for Central Garden on its remaining
counterclaims in an amount of approximately $12.1 million. Various
post-trial motions have been filed in the Ohio Action, but so far
Central Garden has not challenged the propriety of the $22.5 million
award to the Company and the Company has challenged only $750,000 of
the $12.1 million awarded to Central Garden on its counterclaim.
Central Garden has challenged, however, the dismissal during trial of
several other counterclaims.
PHARMACIA CORPORATION V. CENTRAL GARDEN, CIRCUIT COURT OF ST. LOUIS,
MISSOURI.
On June 30, 2000 Pharmacia Corporation filed suit against Central
Garden in Missouri state court ("Missouri Action") seeking unspecified
damages allegedly due Pharmacia under a series of agreements, generally
referred to as the four-year "Alliance Agreement" between Pharmacia and
Central Garden. Scotts was, for a short time, an assignee of the
Alliance Agreement, which Scotts has reassigned to Pharmacia. Pursuant
to an order granting Central Garden's motion, on January 18, 2001,
Pharmacia joined Scotts as a nominal defendant in the Missouri state
court action.
On January 28, 2002, Central Garden and Pharmacia reported that they
reached a settlement in the Missouri action pursuant to which Pharmacia
dismissed its claims against Central Garden in the Missouri action, and
Central Garden dismissed its counterclaims against Pharmacia in the
Missouri action and its claims against Pharmacia in the California
federal and state actions described below. In connection with its
settlement with Pharmacia, Central Garden also dismissed all of its
legal claims against Scotts arising under the Alliance Agreements,
reserving only such equitable claims as it might have under the
Alliance Agreements. On July 22, 2002 Scotts and Central Garden
stipulated, and the court ordered, that each dismiss all remaining
claims against the other without prejudice.
CENTRAL GARDEN V. SCOTTS & PHARMACIA, NORTHERN DISTRICT OF CALIFORNIA.
On July 7, 2000, Central Garden filed suit against the Company and
Pharmacia in the U.S. District Court for the Northern District of
California (San Francisco Division) alleging various claims, including
breach of contract and violations of federal antitrust laws, and
seeking an unspecified amount of damages and injunctive relief. On
October 26, 2000, the District Court granted the Company's motion to
dismiss Central Garden's breach of contract claims for lack of subject
matter jurisdiction. On November 17, 2000, Central Garden filed an
amended complaint in the District Court, re-alleging various claims for
violations of federal antitrust laws and also alleging state antitrust
claims. As described above, Central Garden and Pharmacia have settled
some or all of their claims relating to this action.
On April 15, 2002, the Company and Central Garden each filed summary
judgment motions in this action. On
17
June 26, 2002, the court granted summary judgment in favor of the
Company and dismissed all of Central Garden's claims.
CENTRAL GARDEN V. SCOTTS & PHARMACIA, CONTRA COSTA SUPERIOR COURT.
On October 31, 2000, Central Garden filed an additional complaint
against the Company and Pharmacia in the California Superior Court for
Contra Costa County. That complaint seeks to assert the breach of
contract claims previously dismissed by the District Court in the
California federal action described above, and additional claims under
Section 17200 of the California Business and Professions Code. On
December 4, 2000, the Company and Pharmacia jointly filed a motion to
stay this action based on the pendency of prior lawsuits (including the
three actions described above) that involve the same subject matter. By
order dated February 23, 2001, the Superior Court stayed the action
pending before it.
On April 6, 2001, Central Garden filed a motion to lift the stay of the
Contra Costa County action. Scotts and Pharmacia filed a joint
opposition to Central Garden's motion. On May 4, 2001, the Court issued
a tentative ruling denying Central Garden's motion to lift the stay of
the action. Central Garden did not challenge the tentative ruling,
which accordingly became the ruling of the court. Consequently, all
claims in the Contra Costa action currently remain stayed. A further
status conference is set for November 26, 2002. As described above,
Central Garden and Pharmacia have settled some or all of their claims
relating to this action.
Scotts believes that Central Garden's remaining state claims are
without merit and intends to vigorously defend against them. Although
Scotts has prevailed consistently and extensively in the litigation
with Central Garden, the decisions in Scotts' favor are subject to
appeal. If, upon appeal or otherwise, the above actions are determined
adversely to Scotts, the result could have a material adverse effect on
Scotts' results of operations, financial position and cash flows.
Scotts believes that it will continue to prevail in the Central Garden
matters and that any potential exposure that Scotts may face cannot be
reasonably estimated. Therefore, no accrual has been established
related to claims brought against Scotts by Central Garden, except for
amounts ordered paid to Central Garden in the Ohio Action for which the
Company believes it has adequate reserves recorded for the amounts it
may ultimately be required to pay.
9. NEW ACCOUNTING STANDARDS
In June 2001, the FASB issued Statement of Accounting Standard No. 143,
"Accounting for Asset Retirement Obligations". SFAS No. 143 addresses
accounting and reporting standards for legal obligations associated
with the retirement of tangible long-lived assets. SFAS No. 143 is
effective for financial statements issued for fiscal years beginning
after June 15, 2002. Scotts will adopt the provisions of this statement
in the first quarter of fiscal year 2003, and does not anticipate that
the new accounting policy will impact results of operations.
In August 2001, the FASB issued Statement of Accounting Standard No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets".
SFAS No. 144 supersedes Financial Accounting Standard No. 121, "
Accounting for Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of" and Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations; Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequent Occurring and Events and Transactions". SFAS No. 144
addresses accounting and reporting standards for the impairment or
disposal of long-lived assets. It is effective for financial statements
issued for fiscal years beginning after December 15, 2001. The Company
will adopt the provisions of this statement in the first quarter of
fiscal year 2003 and expects there will be no impact on its reporting
results of operations or financial conditions as a result.
In April 2002, the Financial Accounting Standards Board issued
Statement 145 "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections". Scotts
will
18
adopt the provision of this statement in the first quarter of fiscal
2003 and expects there will be no impact on its reporting results of
operations or financial condition as a result.
In July 2002, the Financial Accounting Standards Board issued Statement
146 "Accounting for Costs Associated with Exit or Disposal Activities".
This Statement provides new guidance that primarily affects in which
period charges related to restructuring activities will be recorded.
This statement modifies and amends the accounting for restructuring
activities that are currently accounted for in accordance with EITF
Issue 94-3 "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)". Statement 146 requires most charges to
be recorded when they are incurred, rather than when it is identified
that a cost resulting from a restructuring activity is likely to be
incurred. This Statement applies to restructuring activities occurring
after December 31, 2002. The Company is currently evaluating the impact
that the standard will have on future periods.
10. SUPPLEMENTAL CASH FLOW INFORMATION
NINE MONTHS ENDED
-----------------
JUNE 29, JUNE 30,
2002 2001
---- ----
($ MILLIONS)
Net assets acquired.................................................... $ 23.5 $ 45.9
Cash paid ............................................................. (11.0) (10.0)
Notes issued to seller................................................. 12.5 35.9
Cash received in settlement of prior purchase price................... 7.0 --
11. EARNINGS PER COMMON SHARE
The following table presents information necessary to calculate basic
and diluted earnings per common share. Basic earnings per common share
are computed by dividing net income available to common shareholders by
the weighted average number of common shares outstanding. Options to
purchase 0.1 and 0.1 million shares of common stock for the three and
nine month periods ended June 29, 2002, and 0.1 and 0.2 million shares
for the three and nine month periods ended June 30, 2001 respectively
were not included in the computation of diluted earnings per common
share. These options were excluded from the calculation because the
exercise price of these options was greater than the average market
price of the common shares in the respective periods, and therefore,
they are antidilutive.
19
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
---- ---- ---- ----
($ MILLIONS, EXCEPT PER SHARE DATA)
NET INCOME:
Income before cumulative effect of accounting change ..... $ 95.8 $ 45.4 $ 113.7 $ 78.9
Cumulative effect of change in accounting for
intangible assets, net of tax.......................... -- -- (18.5) --
-------- -------- -------- --------
Net income ............................................... $ 95.8 $ 45.4 $ 95.2 $ 78.9
======== ======== ======== ========
BASIC EARNINGS PER COMMON SHARE:
Weighted-average common shares outstanding
during the period ..................................... 29.5 28.3 29.1 28.3
Basic earnings per common share:
Before cumulative effect of accounting change ......... $ 3.25 $ 1.60 $ 3.91 $ 2.79
Cumulative effect of change in accounting for
intangible assets, net of tax.......................... -- -- (0.64) --
-------- -------- -------- --------
After cumulative effect of accounting change .......... $ 3.25 $ 1.60 $ 3.27 $ 2.79
======== ======== ======== ========
DILUTED EARNINGS PER COMMON SHARE:
Weighted-average common shares outstanding
during the period ..................................... 29.5 28.3 29.1 28.3
Potential common shares:
Assuming exercise of options .......................... 0.9 1.1 1.2 0.9
Assuming exercise of warrants ......................... 1.4 1.2 1.3 1.1
-------- -------- -------- --------
Weighted-average number of common shares outstanding and
dilutive potential common shares ...................... 31.8 30.6 31.6 30.3
Diluted earnings per common share:
Before cumulative effect of accounting change ......... $ 3.02 $ 1.49 $ 3.60 $ 2.61
Cumulative effect of change in accounting
for intangible assets, net of tax...................... -- -- (0.59) --
-------- -------- -------- --------
After cumulative effect of accounting change .......... $ 3.02 $ 1.49 $ 3.01 $ 2.61
======== ======== ======== ========
12. SEGMENT INFORMATION
For fiscal 2002, the Company is divided into four reportable segments -
North American Consumer, Scotts LawnService(R), Global Professional and
International Consumer. The North American Consumer segment consists of
the Lawns, Gardens, Growing Media, Ortho and Canadian business units.
These segments differ from those used in the prior year due to
segregating of the Scotts LawnService(R) business from the North
American Consumer business because of a change in reporting structure
whereby Scotts LawnService(R) no longer reports to senior management of
the North American Consumer segment.
The North American Consumer segment specializes in dry, granular
slow-release lawn fertilizers, lawn fertilizer combination and lawn
control products, grass seed, spreaders, water-soluble and
controlled-release garden and indoor plant foods, plant care products,
and potting soils, barks, mulches and other growing media products, and
pesticide products. Products are marketed to mass merchandisers, home
improvement centers, large hardware chains, nurseries and gardens
centers.
The Scotts LawnService(R) segment provides lawn fertilization, insect
control and other related services such as core aeration primarily to
residential consumers through company-owned branches and franchises. In
most company markets, Scotts LawnService(R) also offers tree and shrub
fertilization, disease and insect control treatments and, in our larger
branches, we also offer an exterior barrier pest control service.
The Global Professional segment is focused on a full line of
horticulture products including controlled-release and water-soluble
fertilizers and plant protection products, grass seed, spreaders,
custom application services and growing media. Products are sold to
lawn and landscape service companies, commercial nurseries and
greenhouses and specialty crop growers.
20
The International Consumer segment provides products similar to those
described above for the North American Consumer segment to consumers in
countries other than the United States and Canada.
The following table presents segment financial information in
accordance with SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". Pursuant to that statement, the
presentation of the segment financial information is consistent with
the basis used by management (i.e., certain costs not allocated to
business segments for internal management reporting purposes are not
allocated for purposes of this presentation). Prior period amounts have
been restated to conform to this basis of presentation.
NORTH AMERICAN SCOTTS GLOBAL INTERNATIONAL OTHER/
CONSUMER LAWNSERVICE(R) PROFESSIONAL CONSUMER CORPORATE TOTAL
-------- -------------- ------------ -------- --------- -----
($ MILLIONS)
Net Sales:
2002 YTD............................ $1,061.7 $ 44.8 $ 140.4 $ 210.4 $ -- $ 1,457.3
2001 YTD............................ $1,073.7 $ 24.5 $ 142.3 $ 218.6 $ -- $ 1,459.1
2002 Q3............................. $ 531.7 $ 28.7 $ 49.7 $ 82.1 $ -- $ 692.2
2001 Q3............................. $ 460.9 $ 15.2 $ 47.9 $ 74.6 $ -- $ 598.6
Income (loss) from Operations:
2002 YTD............................ $ 258.0 $ (3.0) $ 15.3 $ 26.7 $ (47.0) $ 250.0
2001 YTD............................ $ 255.7 $ (1.5) $ 15.4 $ 16.6 $ (55.8) $ 230.4
2002 Q3............................. $ 162.7 $ 7.1 $ 6.5 $ 17.6 $ (18.4) $ 175.5
2001 Q3............................. $ 125.1 $ 2.9 $ 5.8 $ 4.8 $ (27.9) $ 110.7
Operating Margin:
2002 YTD............................ 24.3% (6.7%) 10.9% 12.7% nm 17.2%
2001 YTD............................ 23.8% (6.1%) 10.8% 7.6% nm 15.8%
2002 Q3............................. 30.6% 24.7% 13.1% 21.4% nm 25.4%
2001 Q3............................. 27.1% 19.1% 12.1% 6.4% nm 18.5%
Goodwill:
2002 Q3............................. $ 146.1 $ 47.0 $ 50.4 $ 96.5 $ -- $ 340.0
2001 Q3............................. $ 169.0 $ 19.0 $ 56.6 $ 72.6 $ -- $ 317.2
Total Assets:
2002 Q3............................. $1,273.1 $ 69.8 $ 142.7 $ 487.3 $ 97.2 $ 2,070.1
2001 Q3............................. $1,240.3 $ 38.4 $ 148.5 $ 458.1 $ 118.6 $ 2,003.9
nm Not meaningful.
Income (loss) from Operations reported for Scotts' four operating
segments represents earnings before amortization, interest and taxes,
since this is the measure of profitability used by management.
Accordingly, corporate operating loss for the three and nine months
ended June 29, 2002 and June 30, 2001 includes amortization of certain
assets, corporate general and administrative expenses, and certain
"other" income/expense not allocated to the business segments and North
America restructuring charges.
Total assets reported for Scotts' operating segments include the
intangible assets for the acquired business within those segments.
Corporate assets primarily include deferred financing and debt issuance
costs, corporate intangible assets as well as deferred tax assets.
21
13. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTORS
In January 1999, the Company issued $330 million of 8 5/8% Senior
Subordinated Notes due 2009 to qualified institutional buyers under the
provisions of Rule 144A of the Securities Act of 1933. These Notes were
subsequently registered in December 2000. In January 2002, the Company
issued an additional $70 million of Senior Subordinated Notes and a
Form S-4 registration has been filed to register the notes.
The Notes are general obligations of The Scotts Company and are
guaranteed by all of the existing wholly-owned, domestic subsidiaries
and all future wholly-owned, significant (as defined in Regulation S-X
of the Securities and Exchange Commission) domestic subsidiaries of The
Scotts Company. These subsidiary guarantors jointly and severally
guarantee The Scotts Company's obligations under the Notes. The
guarantees represent full and unconditional general obligations of each
subsidiary that are subordinated in right of payment to all existing
and future senior debt of that subsidiary but are senior in right of
payment to any future junior subordinated debt of that subsidiary.
The following unaudited information presents consolidating Statements
of Operations for the three and nine-month periods ended June 29, 2002
and June 30, 2001 and consolidating Statements of Cash Flows and
Balance Sheets for the nine month periods ended June 29, 2002 and June
30, 2001. Separate unaudited financial statements of the individual
guarantor subsidiaries have not been provided because management does
not believe they would be meaningful to investors.
22
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 29, 2002 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales.......................................... $ 48.9 $ 494.7 $ 148.6 $ $ 692.2
Cost of sales ..................................... (56.7) 391.6 86.3 421.2
Restructuring and other charges.................... 0.4 0.4
-------- -------- --------- -------- ----------
Gross profit ...................................... 105.2 103.1 62.3 270.6
Gross commission earned from marketing agreement... 21.7 0.7 22.4
Costs associated with marketing agreement ......... 5.8 5.8
-------- -------- --------- -------- ----------
Net commission earned from marketing agreement. 15.9 -- 0.7 16.6
Operating expenses:
Advertising.................................... 16.4 5.7 8.5 30.6
Selling, general and administrative............ 52.8 5.3 28.3 86.4
Restructuring and other charges................ 0.2 0.4 0.6
Amortization of intangible assets ............. 0.1 (1.1) 1.2 0.2
Equity (income) loss in subsidiaries............... (72.2) 72.2 --
Intercompany allocations........................... (4.7) 0.4 4.3 --
Other income, net ................................. (0.4) (0.6) (4.1) (5.1)
-------- -------- --------- -------- ----------
Income (loss) from operations ..................... 128.9 93.4 24.4 (72.2) 174.5
Interest (income) expense ......................... 18.3 (3.7) 4.1 18.7
-------- -------- --------- -------- ----------
Income (loss) before income taxes ................. 110.6 97.1 20.3 (72.2) 155.8
Income taxes ...................................... 14.8 37.4 7.8 60.0
-------- -------- --------- -------- ----------
Income (loss) before cumulative effect of
accounting change.............................. 95.8 59.7 12.5 (72.2) 95.8
Cumulative effect of change in accounting for
intangible assets, net of tax ................. --
-------- -------- --------- -------- ----------
Net income (loss).................................. $ 95.8 $ 59.7 $ 12.5 $ (72.2) $ 95.8
======== ======== ========= ========= ==========
23
FOR THE NINE MONTHS ENDED JUNE 29, 2002 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales.......................................... $ 540.0 $ 573.8 $ 343.5 $ $ 1,457.3
Cost of sales ..................................... 297.0 404.9 212.3 914.2
Restructuring and other charges.................... 1.4 0.1 1.5
-------- -------- --------- ------- ----------
Gross profit ...................................... 241.6 168.9 131.1 541.6
Gross commission earned from marketing agreement... 29.1 1.7 30.8
Costs associated with marketing agreement ......... 17.5 17.5
-------- -------- --------- ------- ----------
Net commission earned from marketing agreement. 11.6 -- 1.7 13.3
Operating expenses:
Advertising ................................... 38.8 10.4 19.4 68.6
Selling, general and administrative............ 147.2 13.8 84.9 245.9
Restructuring and other charges................ 1.3 0.1 0.4 1.8
Amortization of intangible assets ............. 0.3 0.2 3.3 3.8
Equity (income) loss in subsidiaries............... (66.2) 66.2 --
Intercompany allocations........................... (17.9) 9.7 8.2 --
Other income, net ................................. (0.6) (2.6) (5.7) (8.9)
-------- -------- --------- ------- ----------
Income (loss) from operations ..................... 150.3 137.3 22.3 (66.2) 243.7
Interest (income) expense ......................... 55.2 (10.8) 14.4 58.8
-------- -------- --------- ------- ----------
Income (loss) before income taxes ................. 95.1 148.1 7.9 (66.2) 184.9
Income taxes ...................................... 11.2 57.0 3.0 71.2
-------- -------- --------- ------- ----------
Income (loss) before cumulative effect of
accounting change................................ 83.9 91.1 4.9 (66.2) 113.7
Cumulative effect of change in accounting for
intangible assets, net of tax ................. 11.3 (3.3) (26.5) (18.5)
-------- -------- --------- ------- ----------
Net income (loss).................................. $ 95.2 $ 87.8 $ (21.6) $(66.2) $ 95.2
======== ======== ========== ======= ==========
24
THE SCOTTS COMPANY
STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 29, 2002 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ................................. $ 95.2 $ 87.8 $ (21.6) $ (66.2) $ 95.2
Adjustments to reconcile net income (loss) to
net to cash used in operating activities:
Cumulative effect of change in accounting for
intangible assets ........................... 3.3 26.5 29.8
Depreciation .................................. 13.2 7.2 5.6 26.0
Amortization .................................. 2.8 0.2 3.3 6.3
Deferred taxes ................................ (10.8) (10.8)
Equity (income) loss in subsidiaries .......... (66.2) 66.2 --
Net change in certain components
of working capital ............................ 81.4 (69.0) (25.5) (13.1)
Net changes in other assets and
liabilities and other adjustments ............. 1.6 26.3 (9.3) 18.6
-------- -------- -------- -------- --------
Net cash provided by (used in) operating
activities....................................... 117.2 55.8 (21.0) -- 152.0
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment ....... (17.9) (12.1) (3.9) (33.9)
Investment in acquired businesses,
net of cash acquired .......................... (4.0) (4.0)
Payments on seller notes .......................... (2.1) (5.9) (20.7) (28.7)
-------- -------- -------- -------- --------
Net cash used in investing activities ............. (20.0) (18.0) (28.6) -- (66.6)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (repayments) borrowings under revolving
and bank lines of credit ...................... (3.7) (92.0) (95.7)
Gross borrowings under term loans ................. --
Gross repayments under term loans ................. (0.5) (22.8) (23.3)
Issuance of 8 5/8% senior subordinated notes ...... 70.2 70.2
Cash received from the exercise of stock options .. 19.0 19.0
Intracompany financing ............................ (131.1) (38.7) 169.8 --
-------- -------- -------- -------- --------
Net cash (used in) provided by financing
activities....................................... (46.1) (38.7) 55.0 -- (29.8)
-------- -------- -------- -------- --------
Effect of exchange rate changes on cash ........... 2.1 2.1
-------- -------- -------- -------- --------
Net increase (decrease) in cash ................... 51.1 (0.9) 7.5 -- 57.7
Cash and cash equivalents, beginning of period .... 3.4 0.6 14.7 -- 18.7
-------- -------- -------- -------- --------
Cash and cash equivalents, end of period .......... $ 54.5 $ (0.3) $ 22.2 $ -- $ 76.4
======== ======== ======== ======== ========
25
THE SCOTTS COMPANY
BALANCE SHEET
AS OF JUNE 29, 2002 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 54.5 $ (0.3) $ 22.2 $ $ 76.4
Accounts receivable, net ........................ 148.8 127.4 158.9 435.1
Inventories, net ................................ 175.4 46.8 79.7 301.9
Current deferred tax asset ...................... 52.2 0.5 (0.6) 52.1
Prepaid and other assets ........................ 20.4 2.3 22.5 45.2
--------- -------- -------- ---------- ----------
Total current assets .......................... 451.3 176.7 282.7 910.7
Property, plant and equipment, net .................. 201.4 77.1 38.6 317.1
Goodwill and intangible assets, net ................. 30.0 473.0 262.3 765.3
Other assets ........................................ 60.0 2.5 14.5 77.0
Investment in affiliates ............................ 964.2 (964.2) --
Intercompany assets ................................. -- 231.5 (231.5) --
--------- -------- -------- ---------- ----------
Total assets .................................. $ 1,706.9 $ 960.8 $ 598.1 $ (1,195.7 $ 2,070.1
========= ======== ======== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ......................... $ 39.6 $ 1.3 $ 27.9 $ $ 68.8
Accounts payable ................................ 78.4 25.4 93.6 197.4
Accrued liabilities ............................. 131.2 22.8 77.5 231.5
Accrued taxes ................................... 84.5 2.4 4.9 91.8
--------- -------- -------- ---------- ----------
Total current liabilities ..................... 333.7 51.9 203.9 589.5
Long-term debt ...................................... 624.7 5.4 137.1 767.2
Other liabilities ................................... 50.3 2.0 39.3 91.6
Intercompany liabilities ............................ 52.3 179.2 (231.5) --
--------- -------- -------- ---------- ----------
Total liabilities ............................. 1,061.0 59.3 559.5 (231.5) 1,448.3
--------- -------- -------- ---------- ----------
Commitments and contingencies
Shareholders' equity:
Investment from parent .......................... 486.8 61.6 (548.4) --
Preferred shares, no par value .................. --
Common shares, no par value per share,
$.01 stated value per share; 31.3 shares issued 0.3 0.3
Capital in excess of par value .................. 402.0 402.0
Retained earnings ............................... 307.5 417.1 (1.3) (415.8) 307.5
Treasury stock, 1.7 shares at cost .............. (54.6) (54.6)
Accumulated other comprehensive expense ......... (9.3) (2.4) (21.7) (33.4)
--------- -------- -------- ---------- ----------
Total shareholders' equity .......................... 645.9 901.5 38.6 (964.2) 621.8
--------- -------- -------- ---------- ----------
Total liabilities and shareholders' equity .......... $ 1,706.9 $ 960.8 $ 598.1 $ (1,195.7) $ 2,070.1
========= ======== ======== ========== ==========
26
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2001 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales ......................................... $ 241.1 $ 234.8 $ 122.7 $ 598.6
Cost of sales ..................................... 183.7 122.6 73.1 379.4
Restructuring and other charges.................... 0.9 0.9
--------- ---------- ---------- --------- -----------
Gross profit ...................................... 56.5 112.2 49.6 -- 218.3
Gross commission earned from marketing agreement .. 19.9 0.8 20.7
Costs associated with marketing agreement.......... 4.6 4.6
--------- ---------- ---------- --------- -----------
Net commission earned from marketing agreement. 15.3 -- 0.8 -- 16.1
Operating expenses:
Advertising ................................... 11.5 11.5 8.0 31.0
Selling, general and administrative ........... 44.3 10.7 29.4 84.4
Restructuring and other charges................ 15.1 15.1
Amortization of goodwill and other intangibles 2.7 1.7 2.5 6.9
Equity (income) loss in subsidiaries............... (51.1) 51.1 --
Intercompany allocations .......................... (12.6) 9.4 3.2 --
Other expense (income), net........................ (4.7) (1.8) 0.4 (6.1)
--------- ---------- ---------- --------- -----------
Income (loss) from operations ..................... 66.6 80.7 6.9 (51.1) 103.1
Interest (income) expense ......................... 19.6 (3.8) 6.5 22.3
--------- ---------- ---------- --------- -----------
Income (loss) before income taxes ................. 47.0 84.5 0.4 (51.1) 80.8
Income taxes ...................................... 1.6 33.7 0.1 35.4
--------- ---------- ---------- --------- -----------
Income (loss) before cumulative effect of
accounting change.............................. 45.4 50.8 0.3 (51.1) 45.4
Cumulative effect of change in accounting for
intangible assets, net of tax.................. --
--------- ---------- ---------- --------- -----------
Net income (loss) ................................. $ 45.4 $ 50.8 $ 0.3 $ (51.1) $ 45.4
========= ========== ========== ========= ===========
27
FOR THE NINE MONTHS ENDED JUNE 30, 2001 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales ......................................... $ 660.8 $ 469.1 $ 329.2 $1,459.1
Cost of sales ..................................... 447.9 268.8 199.9 916.6
Restructuring and other charges.................... 0.9 0.9
------- ------- -------- ------- --------
Gross profit ...................................... 212.0 200.3 129.3 -- 541.6
Gross commission earned from marketing agreement .. 34.4 2.8 37.2
Costs associated with marketing agreement ......... 13.8 13.8
------- ------- -------- ------- --------
Net commission earned from marketing agreement 20.6 -- 2.8 -- 23.4
Operating expenses:
Advertising ................................... 36.8 21.8 18.6 77.2
Selling, general and administrative ........... 137.9 29.5 85.9 253.3
Restructuring and other charges ............... 15.1 15.1
Amortization of goodwill and other intangibles 8.7 5.0 7.4 21.1
Equity (income) loss in subsidiaries............... (71.7) 71.7 --
Intercompany allocations .......................... (37.5) 30.0 7.5 --
Other expense (income), net ....................... (7.2) (1.8) 0.4 (8.6)
------- ------- -------- ------- --------
Income (loss) from operations ..................... 150.5 115.8 12.3 (71.7) 206.9
Interest (income) expense ......................... 62.2 (11.2) 18.7 69.7
------- ------- -------- ------- --------
Income (loss) before income taxes ................. 88.3 127.0 (6.4) (71.7) 137.2
Income taxes ...................................... 9.4 51.5 (2.6) 58.3
------- ------- -------- ------- --------
Income (loss) before cumulative effect
of accounting change........................... 78.9 75.5 (3.8) (71.7) 78.9
Cumulative effect of change in accounting for
intangible assets, net of tax.................. --
------- ------- -------- ------- --------
Net income (loss) ................................. $ 78.9 $ 75.5 $ (3.8) $ (71.7) $ 78.9
======= ======= ======== ======= ========
28
THE SCOTTS COMPANY
STATEMENT OF CASH FLOWS
FOR THE NINE MONTH PERIOD ENDED JUNE 30, 2001 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ................................. $ 78.9 $ 75.5 $ (3.8) $ (71.7) $ 78.9
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Cumulative effect of change in accounting for
intangible assets............................ --
Restructuring and other charges................ 9.4 9.4
Depreciation .................................. 4.7 14.4 5.3 24.4
Amortization .................................. 11.2 4.9 7.4 23.5
Deferred taxes................................. 2.4 2.4
Equity (income) loss in subsidiaries........... (71.7) 71.7 --
Net change in certain components of
working capital ............................. 25.1 (60.5) (27.2) (62.6)
Net changes in other assets and
liabilities and other adjustments ........... 7.9 (26.0) 7.6 (10.5)
-------- ------- --------- -------- ---------
Net cash provided by (used in) operating
activities....................................... 67.9 8.3 (10.7) -- 65.5
-------- ------- --------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment ....... (25.7) (6.0) (4.5) (36.2)
Investments in acquired businesses,
net of cash acquired .......................... (0.3) 2.2 (11.9) (10.0)
Payments on seller notes........................... (1.1) (23.4) (24.5)
-------- ------- --------- -------- ---------
Net cash used in investing activities ............. (26.0) (4.9) (39.8) -- (70.7)
-------- ------- --------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net (repayments) borrowings under revolving and
bank lines of credit .......................... 82.2 82.2
Gross borrowings under term loans.................. 260.0 260.0
Gross repayments under term loans ................. (258.5) (51.3) (309.8)
Cash received from exercise of stock options ...... 13.3 13.3
Intercompany financing ............................ (18.0) (3.3) 21.3 --
-------- ------- --------- -------- ---------
Net cash (used in) provided by financing
activities....................................... (3.2) (3.3) 52.2 45.7
-------- ------- --------- -------- ---------
Effect of exchange rate changes on cash ........... (0.4) (0.4)
-------- ------- --------- -------- ---------
Net increase in cash .............................. 38.7 0.1 1.3 -- 40.1
Cash and cash equivalents, beginning of period .... 16.0 (0.6) 17.6 -- 33.0
-------- ------- --------- -------- ---------
Cash and cash equivalents, end of period........... $ 54.7 $ (0.5) $ 18.9 -- $ 73.1
======== ======= ========= ======== =========
29
THE SCOTTS COMPANY
BALANCE SHEET
AS OF JUNE 30, 2001 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ..................... $ 54.7 $ (0.5) $ 18.9 $ $ 73.1
Accounts receivable, net ...................... 134.8 84.2 139.1 358.1
Inventories, net .............................. 232.8 49.4 76.8 359.0
Current deferred tax asset .................... 28.1 0.5 (1.1) 27.5
Prepaid and other assets ...................... 41.0 1.2 17.8 60.0
--------- -------- -------- ---------- ----------
Total current assets ........................ 491.4 134.8 251.5 -- 877.7
Property, plant and equipment, net ................ 180.8 74.4 36.7 291.9
Goodwill and other intangible assets, net.......... 269.3 228.8 264.0 762.1
Other assets ...................................... 74.6 (2.4) 72.2
Investment in affiliates .......................... 1,005.8 (1,005.8) --
Intercompany assets ............................... 541.7 (541.7) --
--------- -------- -------- ---------- ----------
Total assets ................................ $ 2,021.9 $ 979.7 $ 549.8 $ (1,547.5) $ 2,003.9
========= ======== ======== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt........................ $ 32.4 $ 0.4 $ 28.0 $ $ 60.8
Accounts payable .............................. 117.4 39.0 77.4 233.8
Accrued liabilities ........................... 128.2 24.6 47.4 200.2
Accrued taxes ................................. 44.3 2.2 4.2 50.7
--------- -------- -------- ---------- ----------
Total current liabilities ................... 322.3 66.2 157.0 -- 545.5
Long-term debt..................................... 564.0 271.9 835.9
Other liabilities ................................. 39.9 16.0 55.9
Intercompany liabilities........................... 527.1 14.6 (541.7) --
--------- -------- -------- ---------- ----------
Total liabilities ........................... 1,453.3 66.2 459.5 (541.7) 1,437.3
--------- -------- -------- ---------- ----------
Commitments and contingencies
Shareholders' equity:
Investment from parent ........................ 589.2 54.7 (643.9) --
Preferred shares, no par value................. --
Common shares, no par value per share,
$.01 stated value per share; 31.3 shares
issued....................................... 0.3 0.3
Capital in excess of par value................. 386.3 386.3
Retained earnings ............................. 275.7 327.2 34.7 (361.9) 275.7
Treasury stock, 2.7 shares at cost ............ (72.2) (72.2)
Accumulated other comprehensive expense........ (21.5) (2.9) 0.9 (23.5)
--------- -------- -------- ---------- ----------
Total shareholders' equity ........................ 568.6 913.5 90.3 (1,005.8) 566.6
--------- -------- -------- ---------- ----------
Total liabilities and shareholders' equity......... $ 2,021.9 $ 979.7 $ 549.8 $ (1,547.5) $ 2,003.9
========= ======== ======== ========== ==========
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Scotts is a leading manufacturer and marketer of consumer branded
products for lawn and garden care and professional horticulture in the United
States and Europe. We also have a presence in Australia, the Far East, Latin
America and South America. Our operations are divided into four business
segments: North American Consumer, Scotts LawnService(R), International
Consumer, and Global Professional. The North American Consumer segment includes
the Lawns, Gardens, Growing Media, Ortho and Canadian business groups.
As a leading consumer branded lawn and garden company, we focus on our
consumer marketing efforts, including advertising and consumer research, to
create demand to pull products through the retail distribution channels. In the
past three years, we have spent approximately 5% of our gross sales annually on
media advertising to support and promote our products and brands. We have
applied this consumer marketing focus for the past several years, and we believe
that Scotts receives a significant return on these marketing expenditures. We
expect that we will continue to focus our marketing efforts toward the consumer
and to make a significant investment in consumer marketing expenditures in the
future to drive market share and sales growth.
Our sales are susceptible to global weather conditions, primarily in
North America and Europe. For instance, periods of wet weather can slow
fertilizer sales but can create increased demand for pesticide sales. Periods of
dry, hot weather can have the opposite effect on fertilizer and pesticide sales.
We believe that our past acquisitions have diversified both our product line
risk and geographic risk to weather conditions.
Our operations are also seasonal in nature. In fiscal 2001, net sales
by quarter were 8.7%, 42.1%, 35.2% and 14.0% of total year net sales,
respectively. Operating losses were reported in the first and fourth quarters of
fiscal 2001 while significant profits were recorded for the second and third
quarters. The sales trend in fiscal 2002 has followed a somewhat different
pattern than our historical experience due to retailer initiatives to reduce
their investment in inventory and improve their inventory turns. We believe that
this has caused a sales shift from the second quarter to the third and, to a
lesser extent, fourth quarters that coincides more closely to when consumers buy
our products.
In fiscal 2001, restructuring and other charges of $75.7 million were
recorded for reductions in work force, facility closures, asset writedowns, and
other related costs. Certain costs associated with this restructuring
initiative, including costs related to the relocation of equipment, personnel
and inventory, were not recorded as part of the restructuring costs in 2001.
These costs are being recorded as they are incurred in fiscal 2002 as required
under generally accepted accounting principles in the United States of America.
In fiscal 2001, Scotts adopted accounting policies that required
certain amounts payable to customers or consumers related to the purchase of our
products to be recorded as a reduction in net sales rather than as advertising
and promotion expense (e.g., volume rebates). In fiscal 2002, Scotts adopted
EITF-00-25, "Accounting for Consideration from a Vendor to a Retailer in
Connection with the Purchase or Promotion of the Vendor's Products". This
standard requires Scotts to record certain of its cooperative advertising
expenditures as reductions of net sales rather than as advertising and promotion
expense. Results for fiscal 2001 have been reclassified to conform to this new
presentation method for these expenses.
In addition, in fiscal 2002 we adopted Statement of Accounting
Standards No. 142, "Goodwill and Other Intangible Assets". This statement
eliminates the requirement to amortize indefinite-lived intangible assets and
goodwill. It also requires an initial impairment test on all indefinite-lived
assets as of the date of adoption of this standard and impairment tests done at
least annually thereafter. As a result of adopting the standard as of October 1,
2001, amortization expense for the first three quarters of fiscal 2002 was
reduced by approximately $15.9 million. The full year effect in fiscal 2002 is
expected to exceed $21.0 million.
31
We completed our impairment analysis in the second quarter of 2002,
taking into account additional guidance provided by EITF 02-07, "Unit of Measure
for Testing Impairment of Indefinite-Lived Intangible Assets". As a result, a
pre-tax impairment charge related to the value of tradenames in our German,
French and United Kingdom consumer businesses of $29.8 million was recorded as
of October 1, 2001. After taxes, the net charge was $18.5 million. There is no
goodwill impairment as of the date of adoption.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following discussion and analysis of the consolidated results of
operations and financial position should be read in conjunction with our
Condensed, Consolidated Financial Statements included elsewhere in this report.
Scotts' Annual Report on Form 10-K for the fiscal year ended September 30, 2001
includes additional information about the Company, our operations, and our
financial position, and should be read in conjunction with this Quarterly Report
on Form 10-Q.
Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to customer programs and incentives, product returns, bad debts,
inventories, intangible assets, income taxes, restructuring, environmental
matters, contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances. Actual results may differ from these estimates under
different assumptions or conditions. The estimates that we believe are most
critical to our reporting of results of operation and financial position are as
follows:
- We continually assess the adequacy of our reserves for
uncollectible accounts due from customers. However, future
changes in our customers' operating performance and cash flows or
in general economic conditions could have an impact on their
ability to fully pay these amounts which could have a material
impact on our operating results.
- Reserves for product returns are based upon historical data and
current program terms and conditions with our customers. Changes
in economic conditions, regulatory actions or defective products
could result in actual returns being materially different than
the amounts provided for in our interim or annual results of
operations.
- Reserves for excess and obsolete inventory are based on a variety
of factors, including product changes and improvements, changes
in active ingredient availability and regulatory acceptance, new
product introductions and estimated future demand. The adequacy
of our reserves could be materially affected by changes in the
demand for our products or by regulatory or competitive actions.
- As described more fully in the notes to the unaudited condensed,
consolidated financial statements, we are involved in significant
environmental and legal matters which have a high degree of
uncertainty associated with them. We continually assess the
likely outcomes of these matters and the adequacy of amounts, if
any, provided for these matters. There can be no assurance that
the ultimate outcomes will not differ materially from our
assessment of them. There can also be no assurance that all
matters that may be brought against us or that we may bring
against other parties are known to us at any point in time.
Also, as described more fully in the notes to the unaudited condensed,
consolidated financial statements, we have not accrued the deferred contribution
under the Roundup(R) marketing agreement with Monsanto or the per annum
32
charges thereon. The Company considers this method of accounting for the
contribution payments to be appropriate after consideration of the likely term
of the agreement, the Company's ability to terminate the agreement without
paying the deferred amounts, and the fact that approximately $18.6 million of
the deferred amount is never paid, even if the agreement is not terminated prior
to 2018, unless significant earnings targets are exceeded. At June 29, 2002,
contribution payments and related per annum charges of approximately $49.2
million had been deferred under the agreement.
RESULTS OF OPERATIONS
The following table sets forth sales by business segment for the three
and nine month periods ended June 29, 2002 and June 30, 2001:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
-------------------------- -------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
---- ---- ---- ----
North American Consumer:
Lawns............................................. $ 181.8 $ 134.9 $ 432.5 $ 439.8
Gardens........................................... 61.3 66.7 124.9 136.1
Growing Media..................................... 173.5 145.7 288.1 260.0
Ortho............................................. 100.7 95.4 184.1 192.4
Canada............................................ 11.2 11.2 23.7 24.8
Other............................................. 3.2 7.0 8.4 20.6
---------- --------- --------- ---------
Total.......................................... 531.7 460.9 1,061.7 1,073.7
Scotts LawnService(R)................................ 28.7 15.2 44.8 24.5
International Consumer............................... 82.1 74.6 210.4 218.6
Global Professional.................................. 49.7 47.9 140.4 142.3
---------- --------- --------- ---------
Total.......................................... $ 692.2 $ 598.6 $ 1,457.3 $ 1,459.1
========== ========= ========= =========
33
The following table sets forth the components of income and expense as
a percentage of sales for the three and six month periods ended June 29, 2002
and June 30, 2001:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
-------------------------- -------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
---- ---- ---- ----
Net sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales........................................ 60.8 63.4 62.7 62.8
Restructuring and other charges...................... 0.1 0.1 0.1 0.1
Gross profit......................................... 39.1 36.5 37.2 37.1
Commission earned from marketing agreement, net...... 2.4 2.7 0.9 1.6
Operating expenses:
Advertising....................................... 4.4 5.2 4.7 5.3
Selling, general and administrative............... 12.5 14.1 16.9 17.4
Restructuring and other charges................... 0.1 2.5 0.1 1.0
Amortization of goodwill and other intangibles....... -- 1.1 0.3 1.4
Other income, net.................................... (0.7) (1.0) (0.6) (0.6)
---------- --------- --------- ---------
Income from operations............................... 25.2 17.2 16.7 14.2
Interest expense..................................... 2.7 3.7 4.0 4.8
---------- --------- --------- ---------
Income before income taxes and cumulative
effect of accounting change....................... 22.5 13.5 12.7 9.4
Income taxes......................................... 8.7 5.9 4.9 4.0
---------- --------- --------- ---------
Income before cumulative effect of
accounting change................................. 13.8 7.6 7.8 5.4
Cumulative effect of change in accounting for
intangible assets, net of tax..................... -- -- (1.3) --
---------- --------- --------- ---------
Net income........................................... 13.8% 7.6% 6.5% 5.4%
========== ========= ========= =========
THREE MONTHS ENDED JUNE 29, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Net sales for the three months ended June 29, 2002 were $692.2 million,
an increase of 15.6% from net sales for the three months ended June 30, 2001 of
$598.6 million.
North American Consumer net sales were $531.7 million in the third
quarter of fiscal 2002, an increase of $70.8 million, or 15.4%, over net sales
in the third quarter of fiscal 2001. Lawns net sales increased 34.8% while Ortho
net sales increased 5.6%. The increased net sales in these businesses reflect
retailer initiatives to improve their inventory turnover ratios by more closely
timing their orders from us to when consumers take away at the store level
occurs. Thus in fiscal 2002 we have seen a shift in our net sales from the
second quarter to the third quarter. The Lawns business also had strong sales of
its new Summer Guard products during the quarter. Net sales of the Gardens
business declined 8.1% from the third quarter of fiscal 2001 to the third
quarter of fiscal 2002. Net sales increased from the second quarter of fiscal
2002 to the third quarter of fiscal 2002 in line with the shift in retailer
order trends this year. However, cool wet weather in the Midwest and Northeast
during May, a peak outdoor gardening month, hurt sales of garden fertilizers.
Consumer take away improved in June with improved weather but did fully offset
May's impact. Net sales of the Growing Media segment increased 19.1% in the
third quarter of fiscal 2002 compared to the third quarter of fiscal 2001. The
Growing Media business is less impacted by the shift in retailer ordering
patterns because its "big bag" products have always required delivery to the
retailer closer to the time of consumer takeaway. The net sales increase
reflects the continued success of the Miracle Gro(R) branded line of value-added
soils and potting mixes.
34
Scotts LawnService(R) revenues increased 88.8% from $15.2 million in
the third quarter of fiscal 2001 to $28.7 million in the third quarter of fiscal
2002. The growth in revenue reflects the growth in the business from the
acquisitions completed in late winter and early spring of fiscal 2002, new
branch openings in late winter of fiscal 2002 and the growth in customers from
our spring 2002 and fall 2001 marketing campaigns.
Net sales for the International Consumer segment were $82.1 million in
the third quarter of fiscal 2002, which were $7.5 million, or 10.1%, higher than
net sales for the third quarter of fiscal 2001. Sales growth for this segment
also was affected by retailers in Europe waiting until closer to the season to
place orders for delivery in an effort to control inventory levels and also
reduce their exposure to weather and/or low consumer take away.
Net sales for the Global Professional segment were $49.7 million in the
third quarter of fiscal 2002, which were $1.8 million, or 3.8%, above net sales
for the third quarter of fiscal 2001. Our Global Professional customers,
growers, have experienced the same inventory pressures by the retailers as we
have, which in turn has impacted our sales to them in fiscal 2002.
Gross profit was $270.6 million in the third quarter of fiscal 2002, an
increase of $52.3 million from gross profit of $218.3 million in the third
quarter of fiscal 2001. As a percentage of net sales, gross profit was 39.1% of
sales in the third quarter of fiscal 2002 compared to 36.5% in the third quarter
of fiscal 2001. The increase in gross margin percentage is due to improved
product mix, particularly in our North American Lawns, and Growing Media
businesses. Lawns had higher sales of higher margin fertilizers and less of
lower margin seed and Growing Media had increased sales of higher margin branded
soils and potting mix.
The net commission earned from marketing agreement in the third quarter
of fiscal 2002 was net income of $16.6 million compared to net income of $16.1
million in the third quarter of fiscal 2001. The increased income from the prior
year is primarily due to increased sales volume offset by the increase in the
annual contribution payment due to Monsanto to $20 million in fiscal 2002
compared to $15 million in fiscal 2001.
Advertising expenses in the third quarter of fiscal 2002 were $30.6
million, a decrease of $0.4 million from the third quarter of fiscal 2001 of
$31.0 million. As a percentage of sales, advertising expense was 4.4% in the
third quarter of 2002 compared to 5.2% in the third quarter of fiscal 2001. The
decline is due to lower advertising rates in 2002, which enabled us to reach our
target audience on a more cost-effective basis, and the Ortho business' focus in
2002 on in-store promotional activities and radio advertising.
Selling, general and administrative expenses in the third quarter of
fiscal 2002 were $86.4 million compared to $84.4 million for the third quarter
of fiscal 2001. The increase from the third quarter of fiscal 2001 to the third
quarter of fiscal 2002 is due to higher costs for information technology
services, environmental compliance and legal services. Information services
expenses have increased due to higher costs to support the new SAP system which
went fully operational in North America in fiscal 2001, and additional costs to
support other new systems and systems enhancements underway in fiscal 2002. In
the third quarter of fiscal 2002, we recorded a charge of $3 million to increase
our reserve for the remediation of various sites in and around our Marysville,
Ohio facilities after reaching an agreement with the Ohio EPA earlier in fiscal
2002 and finalizing our update of expected spending to complete the agreed to
procedures. Legal expenses were incurred during the quarter in the Central
Garden & Pet matters which were heard during the quarter and adjudicated,
subject to appeal, in our favor.
One of our stated goals is to grow SG&A spending at a slower pace than
the growth in revenues, excluding unusual charges and Scotts LawnService(R)
which is adding overhead at a faster pace due to accelerated growth and
acquisition related activity. Excluding the environmental charge in fiscal 2002
and selling, general and administrative expenses of the Scotts LawnService(R)
business from both fiscal 2002 and 2001 third quarter results, SG&A expenses
were $74.4 million, or 10.7% of net sales, in the third quarter of fiscal 2002
compared to $79.2 million, or 13.2% of net sales in the third quarter of fiscal
2001.
35
The third quarter of fiscal 2002 includes $0.4 million of restructuring
charges in costs of goods sold related to the redeployment of inventory from
closed plants and warehouses and $0.6 million in selling, general and
administrative expenses related to the relocation of personnel. Under generally
accepted accounting principles in the United States, these costs have been
expensed in the period incurred. Restructuring charges were $16.0 million in the
third quarter of fiscal 2001 which is when the first phase of the 2001
restructuring activities was finalized and approved by senior management.
Amortization of goodwill and intangibles in the third quarter of fiscal
2002 was $0.2 million compared to $6.9 million in the third quarter of fiscal
2001, primarily due to the cessation of amortization of certain indefinite-lived
intangibles and goodwill under the provisions of a new accounting standard.
Other income was $5.1 million for the third quarter of fiscal 2002,
compared to other income of $6.1 million in the third quarter of fiscal 2001.
Royalties earned on sales of licensed products were down by $1.1 million due to
the phase out of Scotts branded mowers at a major U.S. retailer. Gains from
asset sales were $3.5 million higher primarily due to the finalization in the
third quarter of 2002, of the arrangement to cease peat extraction activities in
the UK. The third quarter of fiscal 2001 also included an insurance settlement
gain of approximately $2 million which did not recur in fiscal 2002.
Income from operations for the third quarter of fiscal 2002 was $174.5
million, compared with $103.1 million for the third quarter of fiscal 2001. The
increase in income from operations from the prior year is the result of higher
sales and margins, lower amortization expense due to the adoption of SFAS 142
and lower restructuring charges.
For segment reporting purposes, earnings before interest, taxes and
amortization is used as the measure for Income from Operations ("operating
income"). On that basis, operating income in the North American Consumer segment
increased from $125.1 million in the third quarter of fiscal 2001 to $162.7
million in the third quarter of fiscal 2002 due to the shift in net sales into
the third quarter from the second quarter and margin improvement due to
favorable product mix and increased fixed cost recovery on higher sales. Scotts
LawnService(R) recorded an increase in operating income to $7.1 million in the
third quarter of fiscal 2002 from $2.9 million in the third quarter of fiscal
2001 on a nearly 90% increase in net sales from $15.2 million in fiscal 2001 to
$28.7 million in fiscal 2002. Global Professional operating income increased
slightly to $6.5 million in the third quarter of fiscal 2002 from $5.8 million
in the third quarter of fiscal 2001 on a $1.8 million, or approximately 4%,
increase in net sales. International Consumer operating income increased from
$4.8 million in the third quarter of fiscal 2001 to $17.6 million in the third
quarter of fiscal 2002 on the strength of a 10% increase in net sales from $74.6
million in fiscal 2001 to $82.1 million in fiscal 2002, and reductions in
operating expenses following the restructuring activities in fiscal 2001,
including reductions in headcount. The operating results for the fiscal 2002
third quarter were also favorably impacted by the settlement received for the
cessation of peat extraction activities at our sites in the United Kingdom.
Interest expense for the third quarter of fiscal 2002 was $18.7
million, a decrease of $3.6 million from interest expense for the third quarter
of fiscal 2001 of $22.3 million. The decrease in interest expense was primarily
due to a reduction in average borrowings for the quarter as compared to the
prior year, and lower interest rates on our variable rate debt.
Income tax expense for the third quarter of fiscal 2002 was $60.0
million, compared with an income tax expense for the third quarter of fiscal
2001 of $35.4 million. The increase in tax expense from the prior year is the
result of the higher pre-tax income for the third quarter of fiscal 2002 for the
reasons noted above. The lower estimated income tax rate for the third quarter
of fiscal 2002 of 38.5% compared to 43.8% for the third quarter of fiscal 2001
was due to the elimination of amortization expense for book purposes that was
not deductible for tax purposes and the impact that lower earnings after
restructuring charges had on permanent items in deriving the effective tax rate
in fiscal 2001.
36
The Company reported net income of $95.8 million for the third quarter
of fiscal 2002, or $3.02 per common share on a diluted basis, compared to a net
income of $45.4 million for the third quarter of fiscal 2001, or $1.49 per
common share on a diluted basis. If SFAS had been adopted as of the beginning of
fiscal 2001, diluted earnings per share for the third quarter of fiscal 2001
would have been $1.62. Diluted shares increased to 31.8 million from 30.6
million due to option exercises during the past year and the effect of a higher
average stock price on the number of common stock equivalents.
NINE MONTHS ENDED JUNE 29, 2002 COMPARED TO NINE MONTHS ENDED JUNE 30, 2001
Net sales for the nine months ended June 29, 2002 of $1,457.3 million
were flat with net sales for the nine months ended June 30, 2001 of $1,459.1
million.
North American Consumer segment net sales were $1,061.7 million in the
first nine months of fiscal 2002, a decrease of $12.0 million, or 1.1%, from net
sales for the first nine months of fiscal 2001 of $1,073.7 million. While North
American Consumer net sales for the third quarter of fiscal 2002 increased over
$70 million compared to fiscal 2001, year-to-date net sales were flat because
retailers reduced their overall inventory levels, even though consumer take away
of our products remains strong across all lines as indicated from point of sale
data from our major North American retail partners. Net sales declined in all
lines except Growing Media where strong demand for branded soils and potting
mixes has driven an 11.0% increase in year over year net sales.
Scotts LawnService(R) revenues increased 82.9% from $24.5 million in
the first three quarters of fiscal 2001 to $44.8 million in the first three
quarters of fiscal 2002. The growth in revenue reflects the growth in the
business from the acquisitions completed in late winter and early spring of
fiscal 2002, new branch openings in late winter of fiscal 2002 and the growth in
customers from our spring 2002 and fall 2001 marketing campaigns.
Net sales for the International Consumer segment were $210.4 million in
the first three quarters of fiscal 2002, which were $8.2 million, or 3.8%, lower
than net sales for the first three quarters of fiscal 2001. The net sales
reduction in Europe reflects efforts by retailers to reduce their inventory
investment and more closely time their purchases to consumer purchases.
Net sales for the Global Professional segment were $140.4 million in
the first nine months of fiscal 2002, which were $1.9 million, or 1.3%, lower
than net sales for the first nine months of fiscal 2001. The decline was
primarily in North America where growers have been impacted by retailers
increasing their focus on managing inventory levels.
Gross profit was flat at $541.6 million in the first nine months of
fiscal 2002 and 2001. As a percentage of net sales, gross profit was 37.2% of
sales in the first three quarters of fiscal 2002 compared to 37.1% in the first
three quarters of fiscal 2001. Cost savings from our supply chain and purchasing
initiatives to reduce manufacturing costs were offset by lower absorption of
fixed costs due to lower production levels. Production levels were lowered in
order to reduce working capital, particularly inventory levels. These factors,
along with higher fixed operating costs in Scotts LawnService(R) during the
winter months when revenue production ceases, continued to keep margins flat as
a percentage of sales on a year to date basis when compared to the prior year.
The net commission earned from marketing agreement in the first three
quarters of fiscal 2002 was $13.3 million compared to $23.4 million in the first
three quarters of fiscal 2001. The decrease from the prior year is primarily due
to a $5.0 million increase in the contribution payment due to Monsanto to $20.0
million in fiscal 2002 compared to $15.0 million in fiscal 2001 and lower sales
in the Roundup business due to retailer inventory management initiatives.
Advertising expenses in the first nine months of fiscal 2002 were $68.6
million, a decrease of $8.6 million from advertising expenses in the first nine
months of fiscal 2001 of $77.2 million. The decrease in advertising expenses
from the prior year is primarily due to lower rates and the change in the focus
of Ortho advertising described previously.
37
Selling, general and administrative expenses in the first three
quarters of fiscal 2002 were $245.9 million compared to $253.3 million for the
first three quarters of fiscal 2001. The decrease from the first three quarters
of fiscal 2001 to the first three quarters of fiscal 2002 is due to cost savings
achieved through restructuring activities that occurred in fiscal 2001, offset
in part by higher spending on information services, legal matters and
environmental compliance as described earlier. Excluding the environmental
charge in fiscal 2002 and selling, general and administrative expenses of the
Scotts LawnService(R) business from both fiscal 2002 and 2001 year to date
results, SG&A expenses were $219.2 million, or 15.0% of net sales, in fiscal
2002 compared to $240.7 million, or 16.5% of net sales in fiscal 2001.
The first three quarters of fiscal 2002 includes $1.5 million of
restructuring charges in costs of goods sold related to the redeployment of
inventory from closed plants and warehouses and $1.8 million in selling, general
and administrative expenses related to the relocation of personnel for the
restructuring activities initiated in fiscal 2001. Under generally accepted
accounting principles in the United States, these costs have been expensed in
the period incurred. In the first three quarters of fiscal 2001, $0.9 million of
restructuring and other charges were recorded in cost of goods sold and $15.1
million in selling, general and administrative costs. As were described above,
these costs were all recorded in the third quarter of fiscal 2001 when the first
phase of 2001's restructuring activities was approved by senior management.
Amortization of goodwill and intangibles in the first three quarters of
fiscal 2002 was $3.8 million compared to $21.1 million in the first three
quarters of fiscal 2001, primarily due to the adoption of the new accounting
standard described previously.
Other income was $8.9 million for the first three quarters of fiscal
2002, compared to other income of $8.6 million in the first three quarters of
fiscal 2001. The increase is primarily due to the gain from the peat bog
cessation of approximately $5.1 million, offset by lower royalty income from
licensees and a one-time insurance settlement gain in fiscal 2001.
Income from operations for the first nine months of fiscal 2002 was
$243.7 million, compared with $206.9 million for the first nine months of fiscal
2001. The increase in income from operations over the prior year is the result
of lower advertising, selling, general and administrative expenses, the effect
of the change in accounting for amortization of indefinite-lived assets and
lower restructuring expenses.
For segment reporting purposes, earnings before interest, taxes and
amortization is used as the measure for Income from Operations ("operating
income"). On that basis, operating income in the North American Consumer segment
increased from $255.7 million for the nine months ended June 30, 2001 to $258.0
for the nine months ended June 29, 2002 on a slight decrease in net sales from
$1,073.7 in the fiscal 2001 year to date period to $1,061.7 in the fiscal 2002
year to date period. The lower RoundUp(R) commission due to the higher
contribution expense required in fiscal 2002, and lower net sales of RoundUp(R)
due to retailer inventory initiatives, offset reductions in operating expenses
arising from fiscal 2001 restructuring activities and lower media advertising
costs in fiscal 2002. Fiscal 2001 results were also favorably impacted by higher
licensee royalties on mowers, which are being phased out in fiscal 2002, and an
insurance settlement gain of approximately $2 million. Scotts LawnService's(R)
operating loss increased from $1.5 million in the first nine months of fiscal
2001 to $3.0 million in the first nine months of fiscal 2002 due to higher
operating expenses for the greater number of locations open during the
low-revenue winter months in fiscal 2002 as compared to fiscal 2001. Global
Professional operating income decreased slightly to $15.3 million in fiscal 2002
from $15.4 million in fiscal 2001 on a slight reduction in net sales due to cost
controls implemented in fiscal 2002. International Consumer segment operating
income was $26.7 million for the nine months ended June 29, 2002 compared to
$16.6 million for the nine months ended June 30, 2001 even though net sales
declined to $210.4 million from $218.6 million during the periods, due to lower
spending on selling, general and administrative expenses, and the gain from the
agreement to cease peat extraction activities at our sites in the United
Kingdom.
38
Interest expense for the first three quarters of fiscal 2002 was $58.8
million, a decrease of $10.9 million from interest expense for the first three
quarters of fiscal 2001 of $69.7 million. The decrease in interest expense was
primarily due to a reduction in average borrowings for the quarter as compared
to the prior year, and lower interest rates on our variable rate debt.
Income tax expense for the first three quarters of fiscal 2002 was
$71.2 million, compared with income tax expense for the first three quarters of
fiscal 2001 of $58.3 million. The increase in tax expense from the prior year is
the result of the higher pre-tax income in fiscal 2002 for the reasons noted
above and the lower estimated income tax rate for the first three quarters of
fiscal 2002 of 38.5% compared to 42.5% for the first three quarters of fiscal
2001 primarily due to the elimination of amortization expense for book purposes
that was not deductible for tax purposes.
The Company reported income before cumulative effect of accounting
changes of $113.7 million for the first nine months of fiscal 2002, compared to
$78.9 million for the first nine months of fiscal 2001. After the charge of
$29.8 million ($18.5 million, net of tax), for the impairment of tradenames in
our German, French and United Kingdom businesses, net income for the first nine
months of fiscal 2002 was $95.2 million, or $3.01 per diluted share, compared to
net income of $78.9 million or $2.61 per diluted share in the first nine months
of fiscal 2001. If SFAS 142 had been adopted as of the beginning of fiscal 2001
diluted earnings per share for the first nine months of fiscal 2001 would have
been $3.01, excluding impairment charges, if any, that would have been recorded
upon adoption at October 1, 2000. Average diluted shares outstanding increased
from 30.3 million in fiscal 2001 to 31.6 million in fiscal 2002 due to option
exercises and a higher average share price in fiscal 2002.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $152.0 million for the nine
months ended June 29, 2002 compared to $65.5 million for the nine months ended
June 30, 2001. The improvement in cash provided by operations was primarily from
improved working capital driven by a reduction in inventory of $66.5 million.
The seasonal nature of our operations generally requires cash to fund
significant increases in working capital (primarily inventory) during the first
half of the year. Receivables and payables also build substantially in the
second quarter in line with increasing sales as the season begins. These
balances liquidate over the latter part of the second half of the year as the
lawn and garden season winds down. As of the end of the third quarter of fiscal
2002, accounts receivable has not declined at the same pace as in the prior year
because of the shift in sales to the third quarter from the second quarter in
fiscal 2002. Inventory levels declined at a faster pace in the third quarter of
fiscal 2002 than 2001 due to our internal initiatives to drive down inventory
levels.
In April 2002, our subsidiary in the United Kingdom reached agreement
with English Nature on the cessation of peat extraction activities at three peat
bogs leased by us. In late April 2002, we received payments totaling $18.1
million for the transfer of our interests in the properties and for the
immediate cessation of all but a limited amount of peat extraction on one of the
three sites. Approximately $13.0 million has been recorded as deferred income
and will be recognized in income over the 29 month period which began in May
2002 and coincides with the period we are allowed to complete extraction
activities at one of the sites. An additional $2.8 million was received for peat
inventory sold to English Nature which will be used for restoration activities
to be conducted at the various sites. We will also receive compensation for
services rendered from time to time in assisting English Nature in restoration
activities. Further amounts of $2.9 million will be payable to us on cessation
of peat extraction on the remaining site before October 2004 and the final
transfer of interests in the property. This agreement is not expected to have an
impact on the Company's ability to source these raw materials.
Cash used in investing activities was $66.6 million for the first nine
months of fiscal 2002 compared to $70.7 million in the prior year period.
Investments in acquired businesses declined due to the acquisition of Substral
at the end of the first quarter of fiscal 2001 while payments on seller notes
increased because of payments made on the Substral deferred purchase obligation
in fiscal 2002. Cash payments on acquisitions completed by Scotts LawnService(R)
during both years were similar. However, the total value of acquisitions by
Scotts LawnService(R) in the first half of fiscal 2002 was up by over $15
million from the first half of fiscal 2001.
In March 2002, an arbitration with Rhone-Poulenc Jardin concerning the
amount paid for businesses acquired in 1998 was settled for a cash payment of
$10.4 million of which $0.8 million was interest. After payment of legal fees
39
of $2.6 million, the net proceeds of $6.9 were recorded as reductions in
goodwill and other indefinite-lived intangible assets.
Financing activities used cash of $29.8 million for the first nine
months of fiscal 2002 compared to providing $45.7 million in the prior year. The
decrease in cash from financing activities was primarily due to the repayment of
borrowings under our credit facility in fiscal 2002 from increased cash provided
by operations during the first nine months of fiscal 2002 compared to fiscal
2001 as noted above, partially offset by the $70 million issuance of senior
subordinated notes in January 2002. The net proceeds of this issuance were used
to pay down borrowings on our revolving credit facility.
Our primary sources of liquidity are funds generated by operations and
borrowings under our credit facility. The credit facility provides for
borrowings in the aggregate principal amount of $1.1 billion and consists of
term loan facilities in the aggregate amount of $525 million and a revolving
credit facility in the amount of $575 million.
Total debt was $836.0 million as of June 29, 2002, a decrease of $60.7
million compared with total debt at June 30, 2001 of $896.7 million. The
decrease in debt compared to the prior year was primarily due to scheduled debt
repayments on our term loans during fiscal 2001 and the repayment of all
borrowings on our revolver as of June 29, 2002 due to improved cash flow from
operations.
We did not repurchase any treasury shares in fiscal 2001 or in the
first three quarters of fiscal 2002.
Scotts has no off balance sheet financing except for operating leases
which are disclosed in the Notes to Consolidated Financial Statements included
in the Company's fiscal 2001 Annual Report on Form 10-K or any financial
arrangements with any related parties. All related party transactions are with
and between our subsidiaries or management. All material intercompany
transactions are eliminated in our consolidated financial statements. All
transactions with management are fully described and disclosed in our proxy
statement. Such transactions pertain primarily to office space provided to and
administrative services provided by Hagedorn Partnership, L.P. and do not exceed
$150,000 per annum.
In late April 2002, a jury awarded us payment of $22.5 million for
amounts owed to us by Central Garden & Pet, a former distributor. At the same
time, we were ordered to pay Central Garden & Pet $12.1 million for fees and
credits owed to them. The verdict is subject to further revision by post trial
motions and is also appealable. The final outcome cannot be determined until the
final judgment is entered by the court and all appeals, if any, are concluded.
We are unable to predict at this time when the determination of a final amount
will occur.
In July 2002, the Company's Board of Directors approved a plan to
significantly improve the profitability of the International business; both
consumer and professional. The plan includes implementation of a SAP platform
throughout Europe, as well as efforts to optimize operations in the United
Kingdom, France and Germany, and create a global supply chain. We expect there
will be a significant cash outlay to implement this plan fully over the next
three fiscal years.
In our opinion, cash flows from operations and capital resources will
be sufficient to meet debt service and working capital needs during fiscal 2002,
and thereafter for the foreseeable future. However, we cannot ensure that our
business groups will generate sufficient cash flow from operations or that
future borrowings will be available under our credit facilities in amounts
sufficient to pay indebtedness or fund other liquidity needs. Actual results of
operations will depend on numerous factors, many of which are beyond our
control. We cannot ensure that we will be able to refinance any indebtedness,
including our credit facility, on commercially reasonable terms, or at all.
40
ENVIRONMENTAL MATTERS
We are subject to local, state, federal and foreign environmental
protection laws and regulations with respect to our business operations and
believe we are operating in substantial compliance with, or taking action aimed
at ensuring compliance with, such laws and regulations. We are involved in
several legal actions with various governmental agencies related to
environmental matters. While it is difficult to quantify the potential financial
impact of actions involving environmental matters, particularly remediation
costs at waste disposal sites and future capital expenditures for environmental
control equipment, in the opinion of management, the ultimate liability arising
from such environmental matters, taking into account established reserves,
should not have a material adverse effect on our financial position; however,
there can be no assurance that the resolution of these matters will not
materially affect future quarterly or annual operating results.
RELATIONSHIPS WITH CUSTOMERS
We do not have long-term sales agreements or other contractual
assurances as to future sales to any of our major retail customers. In addition,
continued consolidation in the retail industry has resulted in an increasingly
concentrated retail base in North America. To the extent such concentration
continues to occur, our net sales and operating income may be increasingly
sensitive to a deterioration in the financial condition of, or other adverse
developments involving our relationship with, one or more customers. As a result
of consolidation in the retail industry, our customers are able to exert
increasing pressure on us with respect to pricing and new product introductions.
KMART
Kmart, one of our largest customers, filed for bankruptcy relief under
Chapter 11 of the bankruptcy code on January 22, 2002. Following such filing, we
recommenced shipping products to Kmart, and we intend to continue shipping
products to Kmart for the foreseeable future. If Kmart does not successfully
emerge from its bankruptcy reorganization, our business could be adversely
affected. We believe the reserves we have recorded for amounts due from Kmart as
of the date of its bankruptcy filing are adequate.
FORWARD-LOOKING STATEMENTS
We have made and will make "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 in our Annual Report, Forms 10-K and 10-Q and in
other contexts relating to future growth and profitability targets, and
strategies designed to increase total shareholder value. Forward-looking
statements include, but are not limited to, information regarding our future
economic performance and financial condition, the plans and objectives of our
management and our assumptions regarding our performance and these plans and
objectives.
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements to encourage companies to provide
prospective information, so long as those statements are identified as
forward-looking and are accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those discussed in the forward-looking statements. We desire to
take advantage of the "safe harbor" provisions of that Act.
The forward-looking statements that we make in our Annual Report, Forms
10-K and 10-Q and in other contexts represent challenging goals for our company,
and the achievement of these goals is subject to a variety of risks and
assumptions and numerous factors beyond our control. Important factors that
could cause actual results to differ materially from the forward-looking
statements we make are described below. All forward-looking statements
41
attributable to us or persons working on our behalf are expressly qualified in
their entirety by the following cautionary statements:
- - ADVERSE WEATHER CONDITIONS COULD ADVERSELY IMPACT FINANCIAL RESULTS.
Weather conditions in North America and Europe have a significant
impact on the timing of sales in the spring selling season and overall annual
sales. Periods of wet weather can slow fertilizer sales, while periods of dry,
hot weather can decrease pesticide sales. In addition, an abnormally cold spring
throughout North America and/or Europe could adversely affect both fertilizer
and pesticide sales and therefore our financial results.
- - OUR HISTORICAL SEASONALITY COULD IMPAIR OUR ABILITY TO PAY OBLIGATIONS
AS THEY COME DUE IN ADDITION TO OUR OPERATING EXPENSES.
Because our products are used primarily in the spring and summer, our
business is highly seasonal. For the past two fiscal years, approximately 75% to
77% of our net sales have occurred in the second and third fiscal quarters
combined. Our working capital needs and our borrowings peak near the middle of
our second fiscal quarter because we are generating fewer revenues while
incurring expenditures in preparation for the spring selling season. If cash on
hand is insufficient to pay our obligations as they come due, including interest
payments on our indebtedness, or our operating expenses, at a time when we are
unable to draw on our credit facility, this seasonality could have a material
adverse affect on our ability to conduct our business. Adverse weather
conditions could heighten this risk.
- - PUBLIC PERCEPTIONS THAT THE PRODUCTS WE PRODUCE AND MARKET ARE NOT
SAFE COULD ADVERSELY AFFECT US.
We manufacture and market a number of complex chemical products, such
as fertilizers, growing media, herbicides and pesticides, bearing our brands. On
occasion, customers and some current or former employees have alleged that some
products failed to perform up to expectations or have caused damage or injury to
individuals or property. Public perception that our products are not safe,
whether justified or not, could impair our reputation, damage our brand names
and materially adversely affect our business.
- - BECAUSE OF THE CONCENTRATION OF OUR SALES TO A SMALL NUMBER OF RETAIL
CUSTOMERS, THE LOSS OF ONE OR MORE OF OUR TOP CUSTOMERS COULD ADVERSELY
AFFECT OUR FINANCIAL RESULTS.
Our top 10 North American retail customers together accounted for
approximately 70% of our fiscal year 2001 net sales and 37% of our outstanding
accounts receivable as of September 30, 2001. Our top four customers, Home
Depot, Wal*Mart, Kmart and Lowe's represented approximately 25%, 12%, 8% and 7%,
respectively, of our fiscal year 2001 net sales. These customers hold
significant positions in the retail lawn and garden market. The loss of, or
reduction in orders from, Home Depot, Wal*Mart, Kmart, Lowe's or any other
significant customer could have a material adverse effect on our business and
our financial results, as could customer disputes regarding shipments, fees,
merchandise condition or related matters. Our inability to collect accounts
receivable from any of these customers could also have a material adverse
affect.
We do not have long-term sales agreements or other contractual
assurances as to future sales to any of our major retail customers. In addition,
continued consolidation in the retail industry has resulted in an increasingly
concentrated retail base. To the extent such concentration continues to occur,
our net sales and operating income may be increasingly sensitive to
deterioration in the financial condition of, or other adverse developments
involving our relationship with, one or more customers. As a result of
consolidation in the retail industry, our customers are able to exert increasing
pressure on us with respect to pricing and new product introductions.
42
Kmart, one of our top customers, filed for bankruptcy relief under
Chapter 11 of the bankruptcy code on January 22, 2002. Following such filing, we
recommenced shipping products to Kmart, and we intend to continue shipping
products to Kmart for the foreseeable future. If Kmart does not successfully
emerge from its bankruptcy reorganization, our business could be adversely
affected.
- - OUR SUBSTANTIAL INDEBTEDNESS COULD ADVERSELY AFFECT OUR FINANCIAL
HEALTH AND PREVENT US FROM FULFILLING OUR OBLIGATIONS.
We have a significant amount of debt. Our substantial indebtedness
could have important consequences. For example, it could:
- make it more difficult for us to satisfy our obligations;
- increase our vulnerability to general adverse economic and
industry conditions;
- require us to dedicate a substantial portion of cash flows from
operations to payments on our indebtedness, which would reduce
the cash flows available to fund working capital, capital
expenditures, research and development efforts and other general
corporate requirements;
- limit our flexibility in planning for, or reacting to, changes in
our business and the industry in which we operate;
- place us at a competitive disadvantage compared to our
competitors that have less debt;
- limit our ability to borrow additional funds; and
- expose us to risks inherent in interest rate fluctuations because
some of our borrowings are at variable rates of interest, which
could result in higher interest expense in the event of increases
in interest rates.
Our ability to make payments on and to refinance our indebtedness and
to fund planned capital expenditures and research and development efforts will
depend on our ability to generate cash in the future. This, to some extent, is
subject to general economic, financial, competitive, legislative, regulatory and
other factors that are beyond our control.
We cannot assure that our business will generate sufficient cash flow
from operations or that currently anticipated cost savings and operating
improvements will be realized on schedule or at all. We also cannot assure that
future borrowings will be available to us under our credit facility in amounts
sufficient to enable us to pay our indebtedness or to fund our other liquidity
needs. We may need to refinance all or a portion of our indebtedness, on or
before maturity. We cannot assure that we will be able to refinance any of our
indebtedness on commercially reasonable terms or at all.
- - RESTRICTIVE COVENANTS MAY ADVERSELY AFFECT US.
Our credit facility and the indenture governing our outstanding senior
subordinated notes contain restrictive covenants that require us to maintain
specified financial ratios and satisfy other financial condition tests. Our
ability to meet those financial ratios and tests can be affected by events
beyond our control, and we cannot assure that we will meet those tests. A breach
of any of these covenants could result in a default under our credit facility
and/or the senior subordinated notes. Upon the occurrence of an event of default
under our credit facility and/or the senior subordinated notes, the lenders
and/or noteholders could elect to declare all of our outstanding indebtedness to
be immediately due and payable and terminate all commitments to extend further
credit. We cannot be sure that our lenders or the noteholders would waive a
default or that we could pay the indebtedness in full if it were accelerated.
43
- - IF MONSANTO WERE TO TERMINATE THE MARKETING AGREEMENT FOR CONSUMER
ROUNDUP(R) PRODUCTS, WE WOULD LOSE A SUBSTANTIAL SOURCE OF FUTURE
EARNINGS.
If we were to commit a serious default under the marketing agreement
with Monsanto for consumer Roundup(R) products, Monsanto may have the right to
terminate the agreement. If Monsanto were to terminate the marketing agreement
rightfully, we would not be entitled to any termination fee, and we would lose
all, or a significant portion, of the significant source of earnings we believe
the marketing agreement provides. Monsanto may also be able to terminate the
marketing agreement within a given region, including North America, without
paying us a termination fee if sales to consumers in that region decline:
- Over a cumulative three fiscal year period; or
- By more than 5% for each of two consecutive fiscal years.
- - THE EXPIRATION OF PATENTS RELATING TO ROUNDUP(R) AND THE SCOTTS TURF
BUILDER(R) LINE OF PRODUCTS COULD SUBSTANTIALLY INCREASE OUR
COMPETITION IN THE UNITED STATES.
Glyphosate, the active ingredient in Roundup(R), was subject to a
patent in the United States that expired in September 2000. We cannot predict
the success of Roundup(R) now that glyphosate is no longer patented. Substantial
new competition in the United States could adversely affect us. Glyphosate is no
longer subject to patent in Europe and is not subject to patent in Canada. While
sales of Roundup(R) in such countries have continued to increase despite the
lack of patent protection, sales in the United States may decline as a result of
increased competition. Any such decline in sales would adversely affect our
financial results through the reduction of commissions as calculated under the
Roundup(R) marketing agreement. We are aware that Spectrum Brands produced
glyphosate one-gallon products for Home Depot and Lowe's to be sold under the
Real-Kill(R) and No-Pest(R) brand names, respectively, in fiscal year 2001.
Additional competitive products have been introduced in fiscal year 2002. It is
too early to determine whether these product introductions will have a material
adverse effect on our sales of Roundup(R).
Our methylene-urea product composition patent, which covered Scotts
Turf Builder(R), Scotts Turf Builder(R) Plus 2(R) with Weed Control and Scotts
Turf Builder(R) with Halts(R) Crabgrass Preventer, expired in July 2001. This
could also result in increased competition. Any decline in sales of Turf
Builder(R) products after the expiration of the methylene-urea product
composition patent could adversely affect our financial results.
- - HAGEDORN PARTNERSHIP, L.P. BENEFICIALLY OWNS APPROXIMATELY 40% OF THE
OUTSTANDING COMMON SHARES OF SCOTTS ON A FULLY DILUTED BASIS.
Hagedorn Partnership, L.P. beneficially owns approximately 40% of the
outstanding common shares of Scotts on a fully diluted basis and has sufficient
voting power to significantly influence the election of directors and the
approval of other actions requiring the approval of our shareholders.
- - COMPLIANCE WITH ENVIRONMENTAL AND OTHER PUBLIC HEALTH REGULATIONS
COULD INCREASE OUR COST OF DOING BUSINESS.
Local, state, federal and foreign laws and regulations relating to
environmental matters affect us in several ways. In the United States, all
products containing pesticides must be registered with the United States
Environmental Protection Agency ("U.S. EPA") and, in many cases, similar state
agencies before they can be sold. The inability to obtain or the cancellation of
any registration could have an adverse effect on our business. The severity of
the effect would depend on which products were involved, whether another product
could be substituted and whether our
44
competitors were similarly affected. We attempt to anticipate regulatory
developments and maintain registrations of, and access to, substitute chemicals.
We may not always be able to avoid or minimize these risks.
The Food Quality Protection Act, enacted by the U.S. Congress in August
1996, establishes a standard for food-use pesticides, which is that a reasonable
certainty of no harm will result from the cumulative effect of pesticide
exposures. Under this act, the U.S. EPA is evaluating the cumulative risks from
dietary and non-dietary exposures to pesticides. The pesticides in our products,
certain of which may be used on crops processed into various food products,
continue to be evaluated by the U.S. EPA as part of this exposure risk
assessment. It is possible that the U.S. EPA or a third party active ingredient
registrant may decide that a pesticide we use in our products will be limited or
made unavailable to us. For example, in June 2000, DowAgroSciences, an active
ingredient registrant, voluntarily agreed to a gradual phase-out of residential
uses of chlorpyrifos, an active ingredient used by us in our lawn and garden
products. In December 2000, the U.S. EPA reached agreement with various parties,
including manufacturers of the active ingredient diazinon, regarding a phased
withdrawal of residential uses of products containing diazinon, used also by us
in our lawn and garden products. We cannot predict the outcome or the severity
of the effect of the U.S. EPA's continuing evaluations of active ingredients
used in our products.
The use of certain pesticide and fertilizer products is regulated by
various local, state, federal and foreign environmental and public health
agencies. Regulations regarding the use of some pesticide and fertilizer
products may include requirements that only certified or professional users
apply the product, that the products be used only in specified locations or that
certain ingredients not be used. Users may be required to post notices on
properties to which products have been or will be applied and may be required to
notify individuals in the vicinity that products will be applied in the future.
Even if we are able to comply with all such regulations and obtain all necessary
registrations, we cannot assure that our products, particularly pesticide
products, will not cause injury to the environment or to people under all
circumstances. The costs of compliance, remediation or products liability have
adversely affected operating results in the past and could materially affect
future quarterly or annual operating results.
The harvesting of peat for our growing media business has come under
increasing regulatory and environmental scrutiny. In the United States, state
regulations frequently require us to limit our harvesting and to restore the
property to an agreed-upon condition. In some locations, we have been required
to create water retention ponds to control the sediment content of discharged
water. In the United Kingdom, our peat extraction efforts are also the subject
of legislation.
In addition to the regulations already described, local, state, federal
and foreign agencies regulate the disposal, handling and storage of waste, air
and water discharges from our facilities. In June 1997, the Ohio Environmental
Protection Agency ("Ohio EPA") initiated an enforcement action against us with
respect to alleged surface water violations and inadequate treatment
capabilities at our Marysville facility and seeking corrective action under the
Resource Conservation Recovery Act. We negotiated a mutually agreeable
resolution of these issues with the Ohio EPA and the Ohio Attorney General's
office in 2001. On December 3, 2001, an agreed judicial Consent Order was
submitted to the Union County Common Pleas Court and was entered by the court on
January 25, 2002.
For the nine months ended June 29, 2002, we made approximately $1.9
million in environmental expenditures, compared with approximately $0.6 million
in environmental capital expenditures and $2.1 million in other environmental
expenses for the entire fiscal year 2001. Management anticipates that
environmental capital expenditures and other environmental expenses for the
remainder of fiscal year 2002 will not differ significantly from those incurred
in fiscal year 2001. The adequacy of these anticipated future expenditures is
based on our operating in substantial compliance with applicable environmental
and public health laws and regulations and several significant assumptions:
- that we have identified all of the significant sites that must be
remediated;
- that there are no significant conditions of potential
contamination that are unknown to us; and
45
- that with respect to the agreed judicial Consent Order in Ohio,
that potentially contaminated soil can be remediated in place
rather than having to be removed and only specific stream
segments will require remediation as opposed to the entire
stream.
If there is a significant change in the facts and circumstances
surrounding these assumptions or if we are found not to be in substantial
compliance with applicable environmental and public health laws and regulations,
it could have a material impact on future environmental capital expenditures and
other environmental expenses and our results of operations, financial position
and cash flows.
- - OUR SIGNIFICANT INTERNATIONAL OPERATIONS MAKE US MORE SUSCEPTIBLE TO
FLUCTUATIONS IN CURRENCY EXCHANGE RATES AND TO THE COSTS OF
INTERNATIONAL REGULATION.
We currently operate manufacturing, sales and service facilities
outside of North America, particularly in the United Kingdom, Germany and
France. Our international operations have increased with the acquisitions of
Levington, Miracle Garden Care Limited, Ortho and Rhone-Poulenc Jardin and with
the marketing agreement for consumer Roundup(R) products. In fiscal year 2001,
international sales accounted for approximately 20% of our total sales.
Accordingly, we are subject to risks associated with operations in foreign
countries, including:
- fluctuations in currency exchange rates;
- limitations on the conversion of foreign currencies into U.S.
dollars;
- limitations on the remittance of dividends and other payments by
foreign subsidiaries;
- additional costs of compliance with local regulations; and
- historically, higher rates of inflation than in the United
States.
In addition, our operations outside the United States are subject to
the risk of new and different legal and regulatory requirements in local
jurisdictions, potential difficulties in staffing and managing local operations
and potentially adverse tax consequences. The costs related to our international
operations could adversely affect our operations and financial results in the
future.
- - TERRORIST ATTACKS, SUCH AS THE ATTACKS THAT OCCURRED IN NEW YORK AND
WASHINGTON, D.C., ON SEPTEMBER 11, 2001, AND OTHER ACTS OF VIOLENCE OR
WAR MAY AFFECT THE MARKETS ON WHICH OUR COMMON SHARES AND REGISTERED
SENIOR SUBORDINATED NOTES TRADE, THE MARKETS IN WHICH WE OPERATE, OUR
OPERATIONS AND OUR PROFITABILITY.
Terrorist attacks may negatively affect our operations and your
investment. There can be no assurance that there will not be further terrorist
attacks against the United States or U.S. businesses. These attacks or armed
conflicts may directly impact our physical facilities or those of our suppliers
or customers. Furthermore, these attacks may make travel and the transportation
of our supplies and products more difficult and more expensive and ultimately
affect our sales. Also as a result of terrorism, the United States has entered
into an armed conflict which could have a further impact on our sales, our
supply chain and our ability to deliver product to our customers. Political and
economic instability in some regions of the world may also result and could
negatively impact our business. The consequences of any of these armed conflicts
are unpredictable, and we may not be able to foresee events that could have an
adverse effect on our business or your investment. More generally, any of these
events could cause consumer confidence and spending to decrease or result in
increased volatility in the United States and worldwide financial markets and
economy. They also could result in economic recession in the United States or
abroad. Any of these occurrences could have a
46
significant impact on our operating results, revenues and costs and may result
in the volatility of the market price for our securities and on the future price
of our securities.
47
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As noted in Note 8 to the Company's unaudited Condensed, Consolidated
Financial Statements as of and for the period ended June 29, 2002, the Company
is involved in several pending legal and environmental matters. Pending other
material legal proceedings are as follows:
RHONE-POULENC, S.A., RHONE-POULENC AGRO S.A. AND HOECHST, A.G.
On October 15, 1999, the Company began arbitration proceedings before
the International Court of Arbitration of the International Chamber of Commerce
("ICA") against Rhone-Poulenc S.A. and Rhone-Poulenc Agro S.A. (collectively,
"Rhone-Poulenc") under arbitration provisions contained in contracts relating to
the purchase by the Company of Rhone-Poulenc's European lawn and garden
business, Rhone-Poulenc Jardin, in 1998. The Company alleged that the
combination of Rhone-Poulenc and Hoechst Schering AgrEvo GmbH ("AgrEvo") into a
new entity, Aventis S.A., would result in the violation of non-compete and other
provisions in the contracts mentioned above.
On October 9, 2000, the ICA issued a First Partial Award by the
Tribunal which, inter alia: (i) found that Rhone-Poulenc breached its duty of
good faith under the French law by not disclosing to the Company the
contemplated combination of Rhone-Poulenc and AgrEvo; (ii) directed that the
parties re-negotiate a non-compete provision; and (iii) ruled that a Research
and Development Agreement entered into ancillary to the purchase of
Rhone-Poulenc Jardin is binding upon both Rhone-Poulenc and its post-merger
successor. On February 12, 2001, because of the parties' failure to agree on
revisions to the non-compete provision, the ICA issued a Second Partial Award by
the Tribunal revising that provision.
On February 18, 2002, the ICA issued a Third Partial Award by the
Tribunal directing that Rhone-Poulenc pay to the Company the sum of
approximately 11.9 million Euros including interest from October 15, 1999. In
early March, 2002, Rhone-Poulenc paid the amounts awarded by the Tribunal to the
Company.
Also on October 15, 1999, the Company filed a complaint styled The
Scotts Company, et al. v. Rhone-Poulenc, S.A., Rhone-Poulenc Agro S.A. and
Hoechst, A.G. in the Court of Common Pleas for Union County, Ohio, seeking
injunctive relief maintaining the status quo in aid of the arbitration
proceedings as well as an award of damages against Hoechst for Hoechst's
tortious interference with the Company's contractual rights. On October 19,
1999, the defendants removed the Union County action to the United States
District Court for the Southern District of Ohio. On December 8, 1999, the
Company requested that this action be stayed pending the outcome of the
arbitration proceedings. Said stay was granted by the District Court on February
18, 2000.
SCOTTS V. UNITED INDUSTRIES AND PURSELL, SOUTHERN DISTRICT OF FLORIDA.
On April 15, 2002, Scotts and OMS Investments, Inc., a subsidiary of
Scotts which holds various Scotts intellectual property assets, (collectively
"Scotts" or "Plaintiffs") filed a six count complaint against United Industries
Corp. ("United") and Pursell Industries, Inc. ("Pursell") (collectively
"Defendants") for various acts including federal and state trademark and trade
dress infringement and federal and state unfair competition.
The claims in the complaint center upon Defendants' use of trade dress
on the packaging of their lawn care,
48
garden care, and insecticide/herbicide products that closely mimics our unique,
proprietary, and famous trademarks and trade dress. The complaint seeks an
injunction enjoining Defendants from using any trademarks, trade dress,
packaging, promotional materials, or other items which incorporate, which are
confusingly similar to, or which dilute the trademarks and trade dress
encompassed in and featured on our MIRACLE-GRO(R) Line, ORTHO(R) Line, or TURF
BUILDER(R) Line. The complaint also seeks compensatory damages, treble damages,
costs and attorney's fees.
The Court held a hearing on July 24th and 25th, 2002 on our motion for
preliminary injunction. Closing arguments were held on August 6, 2002 and the
judge expects to issue a written opinion shortly.
The Company does not anticipate incurring any damages relating to this
action.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Index to Exhibits at Page 51.
(b1) The Company filed a Current Report on Form 8-K dated June 24, 2002
reporting under "Item 5. Other Events" the Company's intention to file a
registration statement on Form S-4 for the purpose of registering $70 million of
its 8.625% Senior Subordinated Notes due 2009 which had previously been sold
through a private placement to qualified institutional buyers pursuant to Rule
144A and in offshore transactions pursuant to Regulation S under the Securities
Act of 1933, as amended. The Company's Annual Report on Form 10-K as of and for
the year ended September 30, 2001 is incorporated by reference into the Form S-4
Registration Statement. The financial statements, footnotes and certain related
disclosures in the Company's Form 10-K for fiscal 2001 were updated in the Form
8-K to reflect disclosure and presentation changes that are required in the
financial statements and related disclosures for the fiscal year ending
September 30, 2002 as a result of new accounting pronouncements adopted by The
Scotts Company in fiscal 2002.
(b2) The Company filed a Current Report on Form 8-K dated August 8,
2002 reporting under Item 9. Regulation FD Disclosure" sworn statements by the
Principal Executive Officer, James Hagedorn, and Principal Financial Officer,
Patrick J. Norton, of the Scotts Company pursuant to Securities and Exchange
Commission Order No. 4-460.
49
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.
THE SCOTTS COMPANY
/s/ Christopher L. Nagel
---------------------------------------
Christopher L. Nagel
Date: August 13, 2002 Chief Accounting Officer,
Senior Vice President of Finance,
Corporate North America
(Duly Authorized Officer)
50
THE SCOTTS COMPANY
ANNUAL REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED JUNE 29, 2002
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
99.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted *
pursuant to section 906 of the Sarbanes-Oxley Act of 2002
*Filed herewith
51