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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 29, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO__________
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 Identification No.)
Incorporation or Organization)
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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.
31,440,831 OUTSTANDING AT MAY 9, 2003
Common Shares, voting, 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 six month
periods ended March 29, 2003 and March 30, 2002.............................................. 3
Condensed, Consolidated Statements of Cash Flows - Six month
periods ended March 29, 2003 and March 30, 2002.............................................. 4
Condensed, Consolidated Balance Sheets - March 29, 2003,
March 30, 2002 and September 30, 2002........................................................ 5
Notes to Condensed, Consolidated Financial Statements........................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 27
Item 4. Controls and Procedures...................................................................... 42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................ 43
Item 2. Changes in Securities and Use of Proceeds.................................................... 44
Item 6. Exhibits and Reports on Form 8-K............................................................. 44
Signatures................................................................................................. 46
Certifications............................................................................................. 47
Exhibit Index.............................................................................................. 49
2
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 SIX MONTHS
ENDED ENDED
MARCH 29, MARCH 30, MARCH 29, MARCH 30,
2003 2002 2003 2002
---- ---- ---- ----
Net sales .................................................... $ 676.2 $ 598.5 $ 856.9 $ 759.9
Cost of sales ................................................ 417.6 358.5 556.6 487.9
Restructuring and other charges .............................. 0.7 0.1 5.1 1.1
-------- -------- -------- --------
Gross profit ........................................... 257.9 239.9 295.2 270.9
Gross commission earned from marketing agreement ............. 11.3 8.4 11.3 8.4
Costs associated with marketing agreement .................... 7.1 5.8 14.2 11.7
-------- -------- -------- --------
Net commission (expense) earned from marketing agreement ..... 4.2 2.6 (2.9) (3.3)
Operating expenses:
Advertising ............................................... 34.9 30.9 43.5 38.0
Selling, general and administrative ....................... 92.5 75.2 160.4 144.7
Selling, general and administrative - lawn service business 13.1 8.9 23.1 14.7
Restructuring and other charges ........................... 2.4 0.4 4.3 1.2
Amortization of intangibles ............................... 2.1 1.8 4.1 3.7
Other income, net ......................................... (2.4) (1.9) (3.6) (3.9)
-------- -------- -------- --------
Income from operations ................................. 119.5 127.2 60.5 69.2
Interest expense ............................................. 18.7 21.6 35.2 40.2
-------- -------- -------- --------
Income before income taxes ............................. 100.8 105.6 25.3 29.0
Income taxes ................................................. 38.3 40.6 9.6 11.1
-------- -------- -------- --------
Income before cumulative effect of accounting change ... 62.5 65.0 15.7 17.9
Cumulative effect of change in accounting for intangible
assets, net of tax ........................................... - - - (18.5)
-------- -------- -------- --------
Net income (loss) ...................................... $ 62.5 $ 65.0 $ 15.7 $ (0.6)
======== ======== ======== ========
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Weighted-average common shares outstanding during the
period .................................................... 30.7 29.1 30.5 29.0
Basic earnings (loss) per common share:
Before cumulative effect of accounting change ............. $ 2.04 $ 2.23 $ 0.52 $ 0.62
Cumulative effect of change in accounting for intangible
assets, net of tax ..................................... - - - (0.64)
-------- -------- -------- --------
After cumulative effect of accounting change .............. $ 2.04 $ 2.23 $ 0.52 $ (0.02)
======== ======== ======== ========
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Weighted-average common shares outstanding during the
period .................................................... 32.2 31.5 32.1 31.4
Diluted earnings (loss) per common share:
Before cumulative effect of accounting change ............. $ 1.94 $ 2.06 $ 0.49 $ 0.57
Cumulative effect of change in accounting for intangible
assets, net of tax ..................................... - - - (0.59)
-------- -------- -------- --------
After cumulative effect of accounting change ................. $ 1.94 $ 2.06 $ 0.49 $ (0.02)
======== ======== ======== ========
See notes to condensed, consolidated financial statements
3
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in millions)
SIX MONTHS ENDED
MARCH 29, MARCH 30,
2003 2002
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .................................................... $ 15.7 $ (0.6)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Cumulative effect of change in accounting for intangible assets ... - 29.8
Stock-based compensation expense .................................. 1.6 -
Depreciation ...................................................... 18.8 16.0
Amortization ...................................................... 5.7 5.3
Deferred taxes .................................................... 9.9 (10.1)
Changes in assets and liabilities, net of acquired businesses:
Accounts receivable ............................................ (472.9) (326.2)
Inventories .................................................... (131.1) (58.3)
Prepaid and other current assets ............................... (21.1) (10.4)
Accounts payable ............................................... 158.9 119.1
Accrued taxes and liabilities .................................. 37.0 49.8
Restructuring reserves ......................................... (3.2) (19.0)
Other assets ................................................... 2.0 2.0
Other liabilities .............................................. (0.1) (2.7)
Other, net ........................................................ (1.8) 5.9
------- -------
Net cash used in operating activities .......................... (380.6) (199.4)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment ....................... (31.3) (22.3)
Investment in acquired businesses, net of cash acquired ........... (5.2) (3.1)
Payments on seller notes .......................................... (27.0) (16.0)
------- -------
Net cash used in investing activities .......................... (63.5) (41.4)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under revolving and bank lines of credit ........... 373.0 198.3
Issuance of 8 5/8% senior subordinated notes, net of issuance costs - 70.2
Gross repayments under term loans ................................. (25.8) (14.9)
Financing and issuance fees ....................................... (0.5) (1.8)
Cash received from the exercise of stock options .................. 9.0 10.3
------- -------
Net cash provided by financing activities ...................... 355.7 262.1
Effect of exchange rate changes on cash .............................. 1.0 (2.5)
------- -------
Net decrease in cash ................................................. (87.4) 18.8
Cash and cash equivalents at beginning of period ..................... 99.7 18.7
------- -------
Cash and cash equivalents at end of period ........................... $ 12.3 $ 37.5
======= =======
See notes to condensed, consolidated financial statements
4
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED BALANCE SHEETS
(in millions)
UNAUDITED
MARCH 29, MARCH 30, SEPTEMBER 30,
2003 2002 2002
-------- -------- --------
ASSETS
Current assets:
Cash and cash equivalents ................................................. $ 12.3 $ 37.5 $ 99.7
Accounts receivable, less allowances of $26.7,
$25.2 and $33.2, respectively .......................................... 722.8 547.0 249.9
Inventories, net .......................................................... 400.2 426.8 269.1
Current deferred tax asset ................................................ 72.5 52.2 74.6
Prepaid and other assets .................................................. 57.9 44.6 36.8
-------- -------- --------
Total current assets ................................................... 1,265.7 1,108.1 730.1
Property, plant and equipment, net ........................................... 342.6 313.4 329.2
Goodwill and intangible assets, net .......................................... 803.7 744.1 791.7
Other assets ................................................................. 47.5 74.7 50.4
-------- -------- --------
Total assets ........................................................... $2,459.5 $2,240.3 $1,901.4
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ................................................... $ 287.7 $ 205.6 $ 98.2
Accounts payable .......................................................... 292.8 270.1 134.0
Accrued liabilities ....................................................... 226.1 218.3 206.4
Accrued taxes ............................................................. 27.7 35.9 13.2
-------- -------- --------
Total current liabilities .............................................. 834.3 729.9 451.8
Long-term debt ............................................................... 873.0 921.1 731.2
Other liabilities ............................................................ 132.2 72.4 124.5
-------- -------- --------
Total liabilities ...................................................... 1,839.5 1,723.4 1,307.5
-------- -------- --------
Commitments and contingencies (Note 9) Shareholders' equity:
Common Shares, no par value per share, $.01 stated value
per share 31.3 shares issued for all periods .............................. 0.3 0.3 0.3
Capital in excess of par value ............................................... 388.2 400.1 398.6
Retained earnings ............................................................ 310.5 211.7 294.8
Treasury stock, 0.5, 2.1 and 1.2 shares, respectively, at cost ............... (20.7) (61.4) (41.8)
Accumulated other comprehensive loss ......................................... (58.3) (33.8) (58.0)
-------- -------- --------
Total shareholders' equity ............................................. 620.0 516.9 593.9
-------- -------- --------
Total liabilities and shareholders' equity ............................. $2,459.5 $2,240.3 $1,901.4
======== ======== ========
See notes to condensed, consolidated financial statements
5
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, marketing 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 primarily in North America and the
European Union. We also operate the Scotts LawnService(R) business which
provides lawn and tree and shrub fertilization, insect control and other
related services in the United States.
ORGANIZATION
The condensed, consolidated financial statements include the accounts of The
Scotts Company and its subsidiaries. All material intercompany transactions
have been eliminated.
BASIS OF PRESENTATION
The condensed, consolidated balance sheets as of March 29, 2003 and March
30, 2002, and the related condensed, consolidated statements of operations
for the three and six month periods then ended and condensed, consolidated
statements of cash flows for the six month periods then ended, are
unaudited; however, in the opinion of management, such financial statements
contain all adjustments necessary 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 The Scotts Company's fiscal 2002 Annual Report on
Form 10-K.
REVENUE RECOGNITION
Revenue is recognized when products are shipped and title and risk of loss
have transferred to the customer. Provisions for estimated returns and
allowances are recorded at the time of shipment based on historical rates of
returns applied as a percentage of sales. Scotts LawnService(R) revenues are
recognized at the time service is provided to the customer.
PROMOTIONAL ALLOWANCES
The Company promotes its branded products through cooperative advertising
programs with retailers. Retailers are also offered in-store promotional
allowances and rebates based on sales volumes. Certain products are also
promoted with direct consumer rebate programs. Promotion costs (including
allowances and rebates) incurred during the year are expensed to interim
periods in relation to revenues and are recorded as a reduction of net
sales.
ADVERTISING
The Company advertises its branded products through national and regional
media. Advertising costs incurred during the year are expensed to interim
periods in relation to revenues. All advertising costs, except for external
production costs, are expensed within the fiscal year in which such costs
are incurred. External production costs for advertising programs are
deferred until the period in which the advertising is first aired.
Scotts LawnService(R) promotes its service offerings through direct response
mail campaigns. The external costs associated with these campaigns are
deferred and recognized ratably in proportion to revenues as advertising
6
costs over a period not in excess of one year. The costs deferred at March
29, 2003, March 30, 2002 and September 30, 2002 are $2.2 million, $1.7
million and $0.9 million, respectively.
STOCK-BASED COMPENSATION AWARDS
In July 2002, the Company announced that it would begin expensing
prospective grants of employee stock based compensation awards beginning in
fiscal 2003 in accordance with Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation". The fair value of future
awards will be expensed ratably over the vesting period, which has
historically been three years except for grants to Directors, which have a
six month vesting period.
On November 7, 2002, the Company granted 372,000 stock options to officers
and other key employees. On January 30, 2003, the Company granted 209,000
stock appreciation rights to officers and on January 31, 2003, the Company
granted 63,000 stock options to members of the Board of Directors. The
exercise price for the option awards and the stated price for the stock
appreciation rights awards were determined by the closing price of the
Company's common shares on the date of grant. The related compensation
expense recorded in the three and six month periods ended March 29, 2003
was $1.2 million and $1.6 million, respectively.
The Black-Scholes value of options granted in fiscal 2001 and fiscal 2002
was $10.0 million and $10.7 million, respectively. The value of all
stock-based compensation grants awarded during the first six months of
fiscal 2003 is $12.4 million. Under the Company's prospective adoption of
SFAS No. 123, the expensing of awards commenced with awards granted in
fiscal 2003 and, for awards with a three-year vesting schedule, will be
fully phased in by fiscal 2006.
Had compensation expense been recognized for the periods ended March 29,
2003 and March 30, 2002 in accordance with the recognition provisions of
SFAS No. 123, the Company would have recorded net income (loss) and net
income (loss) per share as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 29, MARCH 30, MARCH 29, MARCH 30,
2003 2002 2003 2002
($ MILLIONS EXCEPT PER SHARE DATA)
Net income (loss) .................... $ 62.5 $ 65.0 $ 15.7 $ (0.6)
Stock-based compensation, net of tax . 1.0 1.2 2.1 2.5
------ ------ ------ ------
Net income (loss) as adjusted ........ $ 61.5 $ 63.8 $ 13.6 $ (3.1)
====== ====== ====== ======
Adjusted net income (loss) per share:
Basic ............................ $ 2.00 $ 2.19 $ 0.45 $ (0.11)
Diluted .......................... $ 1.91 $ 2.03 $ 0.42 $ (0.11)
The pro forma amounts shown above are not necessarily representative of the
impact on net income in future periods.
Prior to fiscal 2003, the Company accounted for stock options under APB 25,
"Accounting for Stock Issued to Employees" and, as allowable, adopted only
the disclosure provisions of SFAS No. 123.
LONG-LIVED ASSETS
Property, plant and equipment, including significant improvements, are
stated at cost. Expenditures for maintenance and repairs are charged to
expense as incurred. When properties are retired or otherwise disposed of,
the cost of the asset and the related accumulated depreciation are removed
from the accounts with the resulting gain or loss being reflected in results
of operations.
Interest is capitalized on capital projects with significant cost and
duration. The Company capitalized $0.6 million and $1.0 million of interest
costs during the three and six month periods ended March 29, 2003 compared
to $0.3 million and $0.6 million during the three and six month periods
ended March 30, 2002.
Management assesses the recoverability of property and equipment whenever
events or changes in circumstances
7
indicate that the carrying amount of an asset may not be recoverable from
its future undiscounted cash flows. If it is determined that an impairment
has occurred, an impairment loss will be recognized for the amount by which
the carrying amount of the asset exceeds its estimated fair value.
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
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 2003 classifications.
2. DETAIL OF CERTAIN FINANCIAL STATEMENT ACCOUNTS
Inventories, net of provisions for slow moving and obsolete inventory of
$25.5 million, $25.0 million, and $25.9 million, respectively, consisted of:
MARCH 29, MARCH 30, SEPTEMBER 30,
2003 2002 2002
---------------- -----------------------------------
($ MILLIONS)
INVENTORIES
Finished goods...................................... $ 308.7 $ 352.1 $ 196.6
Raw materials....................................... 91.5 74.7 72.5
--------- --------- ---------
Total............................................... 400.2 426.8 269.1
========= ========= =========
MARCH 29, MARCH 30, SEPTEMBER 30,
2003 2002 2002
---------------- -----------------------------------
($ MILLIONS)
PROPERTY, PLANT AND EQUIPMENT, NET:
Land and improvements............................... $ 37.3 $ 38.9 $ 38.0
Buildings........................................... 122.5 104.7 120.9
Machinery and equipment............................. 291.8 242.9 289.9
Furniture and fixtures.............................. 34.3 31.8 33.1
Software............................................ 53.8 44.6 47.6
Construction in progress............................ 62.2 78.4 45.7
Less: accumulated depreciation...................... (259.3) (227.9) (246.0)
---------- --------- ---------
Total............................................... $ 342.6 $ 313.4 $ 329.2
========= ========= =========
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.
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
8
million was required for the third year so that a total of $40 million of
the contribution payments were deferred. Beginning in fiscal 2003, 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 March 29, 2003, contribution payments
and related per annum charges of approximately $49.7 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 year 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.
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.
9
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
FISCAL 2003 CHARGES
During the three and six month periods ended March 29, 2003, the Company
recorded $3.1 million and $9.4 million of restructuring and other charges,
respectively.
Costs of $4.7 million for warehouse lease buyouts and relocation of
inventory associated with exiting certain warehouses in North America, and
$0.4 million of accelerated depreciation for the Bramford, England facility,
were included in cost of sales. Severance and consulting costs of $3.3
million for the continued European integration efforts that began in the
fourth quarter of fiscal 2002, and $1.0 million of administrative facility
exit costs in North America were charged to selling, general and
administrative expense.
FISCAL 2002 CHARGES
During fiscal 2002, the Company recorded $8.1 million of restructuring and
other charges.
During the fourth quarter of fiscal 2002, the Company recorded $4.0 million
of restructuring and other charges associated with reductions of headcount
from the closure of a manufacturing facility in Bramford, England. All
fiscal 2002 restructuring related activities and costs are expected to be
completed by the end of fiscal 2003.
The remaining $4.1 million expensed as restructuring and other costs in
fiscal 2002 pertained to personnel and inventory relocation. These
relocation charges related to a plan to optimize the North American supply
chain that was initiated in the third and fourth quarters of fiscal 2001.
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.
FISCAL 2001 CHARGES
During the third and fourth quarters of fiscal 2001, the Company recorded
$75.7 million of restructuring and other charges, primarily associated with
reductions in headcount and the closure or relocation of certain
manufacturing and administrative facilities.
The following is a rollforward of the cash portion of the restructuring and
other charges accrued in fiscal 2001, 2002 and thus far in fiscal 2003. The
balances remaining at March 29, 2003 are included in accrued liabilities and
other liabilities in the condensed, consolidated balance sheets. The portion
classified as other long-term liabilities is future lease obligations that
extend beyond one year.
BALANCE BALANCE
DESCRIPTION TYPE CLASSIFICATION SEPTEMBER 30, PAYMENT OTHER MARCH 29,
----------- ---- -------------- 2002 ------- ----- 2003
---- ----
($ MILLIONS)
Severance............ Cash SG&A $ 6.8 $ (2.9) $ 0.1 $ 4.0
Facility exit costs.. Cash SG&A 3.5 (1.5) - 2.0
Other related costs.. Cash SG&A 1.7 (0.3) 1.3 2.7
------- ------- ----- -----
Total cash....... $ 12.0 $ (4.7) $ 1.4 $ 8.7
======= ======= ===== =====
10
5. INTANGIBLE ASSETS, NET
Effective October 1, 2001, the Company 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 of SFAS No. 142 and at least annually
thereafter. The initial impairment analysis was completed in the second
quarter of fiscal 2002, taking into account additional guidance provided by
EITF 02-07, "Unit of Measure for Testing Impairment of Indefinite-Lived
Intangible 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 $29.8 million was recorded for the
writedown of the value of the tradenames in our International Consumer
businesses in Germany, France and the United Kingdom. This transitional
impairment charge was recorded as a cumulative effect of accounting change,
net of tax, as of October 1, 2001. After completing this initial valuation
and impairment of tradenames, an initial assessment for goodwill impairment
was performed. It was determined that a goodwill impairment charge was not
required.
Intangible assets include patents, tradenames and other intangible assets
which are valued at acquisition through independent appraisals where
material, or through other valuation techniques. Patents, trademarks and
other intangible assets are being amortized on a straight-line basis over
periods varying from 7 to 40 years. The useful lives of intangible assets
still subject to amortization were not revised as a result of the adoption
of SFAS No. 142.
Management assesses the recoverability of goodwill, tradenames and other
intangible assets whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable from its discounted
future cash flows. Goodwill and unamortizable intangible assets are reviewed
for impairment at least annually. If it is determined that an impairment has
occurred, an impairment loss is recognized for the amount by which the
carrying of the asset exceeds its estimated fair value.
In the first quarter of fiscal 2003, the Company updated its impairment
analysis and determined that a charge for annual impairment was not required
at this time.
The following table presents goodwill and intangible assets as of the end of
each period presented.
MARCH 29, 2003 MARCH 30, 2002
-------------- --------------
WEIGHTED GROSS NET GROSS NET
AVERAGE CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
LIFE AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
---- ------ ------------ ------ ------ ------------ ------
($ MILLIONS)
Amortized Intangible Assets:
Technology................................. 21 $ 64.5 $ (20.7) $ 43.8 $ 58.8 $ (18.2) $ 40.6
Customer accounts.......................... 7 37.1 (4.6) 32.5 23.0 (2.5) 20.5
Tradenames................................. 16 11.4 (2.6) 8.8 11.4 (2.0) 9.4
Other...................................... 36 52.7 (36.0) 16.7 44.7 (32.8) 11.9
------ ------
Total amortized intangible assets, net.... 101.8 82.4
Unamortized Intangible Assets:
Tradenames................................. 314.5 318.6
Other...................................... 3.2 3.1
------ ------
Total intangible assets, net ............. 419.5 404.1
Goodwill................................... 384.2 340.0
------ ------
Total goodwill and intangible assets, net. $803.7 $744.1
====== ======
11
SEPTEMBER 30, 2002
------------------
GROSS NET
CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT
------ ------------ ------
Amortized Intangible Assets:
Technology.................................... $ 61.9 $ (18.8) $ 43.1
Customer accounts............................. 33.2 (3.5) 29.7
Tradenames.................................... 11.3 (2.3) 9.0
Other......................................... 50.6 (34.0) 16.6
------
Total amortized intangible assets, net...... 98.4
Unamortized Intangible Assets:
Tradenames.................................... 312.7
Other......................................... 3.1
------
Total intangible assets, net ............... 414.2
Goodwill...................................... 377.5
------
Total goodwill and intangible assets, net... $791.7
======
The changes to the net carrying value of goodwill by segment for the six
months ended March 29, 2003 are as follows (in millions):
N.A. SCOTTS INTERNATIONAL GLOBAL
CONSUMER LAWNSERVICE(R) CONSUMER PROFESSIONAL TOTAL
-------- -------------- -------- ------------ -----
Balance as of September 30, 2002 $ 178.3 $ 68.5 $ 78.2 $ 52.5 $ 377.5
Increases due to acquisitions 9.4 9.4
Reduction of final purchase price
for previous acquisition (5.1) (5.1)
Other (reclassifications and
cumulative translation) (0.1) 2.5 2.4
------- ------ ------- ------- --------
Balance as of March 29, 2003 $ 173.1 $ 77.9 $ 80.7 $ 52.5 $ 384.2
======= ====== ======= ======= ========
Estimated amortization expense for the intangible assets existing as of
March 29, 2003 for the remainder of fiscal year ending September 30, 2003 is
$4.5 million.
Estimated future amortization expense for the intangible assets existing as
of March 29, 2003 is as follows (in millions)
YEAR ENDING
SEPTEMBER 30,
---------------
2004........................................... $ 7.5
2005........................................... 7.4
2006........................................... 7.4
2007........................................... 7.4
2008........................................... 7.4
6. LONG-TERM DEBT
MARCH 29, MARCH 30, SEPTEMBER 30,
2003 2002 2002
---------------- ---------------- --------------
($ MILLIONS)
Revolving loans under credit facility...... $ 372.0 $ 284.6 $ -
Term loans under credit facility........... 347.9 378.4 375.5
Senior subordinated notes.................. 392.5 391.2 391.8
Notes due to sellers....................... 23.7 48.6 43.4
Foreign bank borrowings and term loans..... 13.8 11.8 7.0
Capital lease obligations and other........ 10.8 12.1 11.7
-------- ---------- ---------
1,160.7 1,126.7 829.4
Less current portions...................... 287.7 205.6 98.2
-------- ---------- ---------
$ 873.0 $ 921.1 $ 731.2
======== ========== =========
The revolving credit facility under the Credit Agreement ("Credit
Agreement") provides for borrowings of up to $575 million, which are
available on a revolving basis over a term of 6 1/2 years ending June 30,
2005. A
12
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 $360 million is available for borrowings in optional
currencies, provided that the outstanding revolving loans in other
currencies do not exceed $200 million except for British Pounds Sterling,
which cannot exceed $360 million. The outstanding principal amount of all
revolving credit loans must be reduced below $150 million for at least 30
consecutive days during any calendar year.
Spreads on rates and commitment fees under the 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
borrowings under the revolving credit facility for the six months ended
March 29, 2003 and March 30, 2002 was 5.46% and 6.25%, respectively.
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 Credit Agreement. The Scotts Company and its subsidiaries also pledged
the stock in foreign subsidiaries that borrow under the Credit Agreement. At
March 29, 2003, the Company is in compliance with all applicable affirmative
and negative covenants.
The term loan facilities under the Credit Agreement consist of two tranches.
The Tranche A Term Loan Facility consists of three sub-tranches of Euros and
British Pounds Sterling in the aggregate principal amount of $265 million
which are to be repaid quarterly over a 6 1/2 year period ending June 30,
2005. The Tranche B Term Loan Facility has an aggregate principal amount of
$260 million and is to be repaid quarterly over a 6 1/2 year period ending
December 31, 2007. At March 29, 2003, the outstanding balances of the
Tranche A and Tranche B Term Loan Facilities are $106.7 and $241.2,
respectively. Minimum required repayments by fiscal years are as follows:
FOR THE REMAINDER FOR THE FISCAL YEARS ENDING
OF FISCAL YEAR SEPTEMBER 30,
ENDING SEPTEMBER 30, 2003 2004 2005 2006 2007 2008
------------------------- ---- ---- ---- ---- ----
($ MILLIONS)
Tranche A $ 26.4 $ 35.2 $ 45.1 $ - $ - $ -
Tranche B 0.7 0.9 0.9 0.9 178.4 59.4
These future payments are presented at foreign exchange rates in effect at
March 29, 2003.
The term loan facilities have a variable interest rate, which was 3.96% at
March 29, 2003.
Approximately $17.3 million of financing costs associated with the Credit
Agreement have been deferred and are being amortized over a period which
ends June 30, 2005. The unamortized balance at March 29, 2003, was $7.1
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 effective interest
rate for the notes is 8 3/8%. The issuance costs associated with the
offering totaled $1.6 million. Both the premium and the issuance costs are
being amortized over the remaining life of the notes.
In January 1999, the Company completed an offering of $330 million of 8 5/8%
Senior Subordinated Notes due 2009. The Company entered into two interest
rate locks in fiscal 1998 to hedge its anticipated interest rate exposure on
the 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. The effective interest rate for the Notes including the cost of
the interest rate locks is 9.24%.
13
In conjunction with past acquisitions, notes were issued for certain
portions of the total purchase price that are to be paid in future periods.
The present value of the remaining note payments is $23.7 million of which
$17.5 million pertains to lawn service business acquisitions. The Company is
imputing interest on the notes using the stated interest rate or an interest
rate prevalent for similar instruments at the time of acquisition for
non-interest bearing notes.
Foreign notes of $6.0 million issued on December 12, 1997, have an 8-year
term and bear interest at 1% below LIBOR. The remaining principal balance
of these loans at March 29, 2003 and March 30, 2002 was $0.6 million
and $2.6 million, respectively. The loans are denominated in British Pounds
Sterling and can be redeemed, on demand, by the note holder. The foreign
bank borrowings of $13.2 million at March 29, 2003 and $9.3 million at
March 30, 2002 represent lines of credit for foreign operations and are
primarily denominated in Euros.
7. EARNINGS PER COMMON SHARE
The following table presents information necessary to calculate basic and
diluted earnings per common share. Basic earnings per common share are
computed by dividing net income available to common shareholders by the
weighted average number of common share outstanding. Options to purchase 0.1
and 0.3 million shares of common stock for the three and six month periods
ended March 29, 2003, and 0.1 and 0.1 million shares for the three and six
month periods ended March 30, 2002 respectively were not included in the
computation of diluted earnings per common share. These options were
excluded from the calculation because the exercise price of these options
was greater than the average market price of the common shares in the
respective periods, and therefore, they were antidilutive.
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 29, MARCH 30, MARCH 29, MARCH 30,
2003 2002 2003 2002
---- ---- ---- ----
($ MILLIONS, EXCEPT PER
SHARE DATA)
NET INCOME (LOSS):
Income before cumulative effect of accounting change ...................... 62.5 $ 65.0 $ 15.7 $ 17.9
Cumulative effect of change in accounting for intangible assets, net of tax - - - (18.5)
------ ------ ------ ------
Net income (loss) ......................................................... 62.5 $ 65.0 $ 15.7 $ (0.6)
====== ====== ====== ======
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Weighted-average common shares outstanding during the period .............. 30.7 29.1 30.5 29.0
Basic income (loss) per common share:
Before cumulative effect of accounting change .......................... 2.04 $ 2.23 $ 0.52 $ 0.62
Cumulative effect of change in accounting for intangible assets,
net of tax .......................................................... - - - (0.64)
------ ------ ------ ------
After cumulative effect of accounting change ........................... 2.04 $ 2.23 $ 0.52 $(0.02)
====== ====== ====== ======
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Weighted-average common shares outstanding during the period .............. 30.7 29.1 30.5 29.0
Potential common shares:
Assuming exercise of options ........................................... 0.8 1.0 0.9 1.1
Assuming exercise of warrants .......................................... 0.7 1.4 0.7 1.3
------ ------ ------ ------
Weighted-average number of common shares outstanding
and dilutive potential common shares ................................... 32.2 31.5 32.1 31.4
Diluted income (loss) per common share:
Before cumulative effect of accounting change .......................... 1.94 $ 2.06 $ 0.49 $ 0.57
Cumulative effect of change in accounting for intangible assets,
net of tax .......................................................... - - - (0.59)
------ ------ ------ ------
After cumulative effect of accounting change ........................... 1.94 $ 2.06 $ 0.49 $(0.02)
====== ====== ====== ======
14
8. STATEMENT OF COMPREHENSIVE INCOME
The components of other comprehensive income and total comprehensive income
for the three and six month periods ended March 29, 2003 and March 30, 2002
are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 29, MARCH 30 MARCH 29 MARCH 30
2003 2002 2003 2002
---- ---- ---- ----
($ MILLIONS)
Net income (loss)............................... $ 62.5 $ 65.0 $ 15.7 $ (0.6)
Other comprehensive income (expense):
Foreign currency translation adjustments........ - (0.5) (0.6) (0.1)
Change in valuation of derivative instruments... 0.3 1.5 0.3 1.0
--------- -------- -------- --------
Comprehensive income............................ $ 62.8 $ 66.0 $ 15.4 $ 0.3
======== ======== ======== ========
9. 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 sought 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, the Company met with the Ohio Attorney General and
the Ohio EPA, and was 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. We are continuing our remediation activities with
the knowledge and oversight of 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 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, working in
conjunction with Friends of the Earth (U.K.), 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 net gain of approximately $5 million was
included in "Other Income" in fiscal 2002. Proceeds of approximately $13
million were 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.
15
The Company has determined that building materials at certain manufacturing
facilities in the United Kingdom contain asbestos and may require removal in
the future.
At March 29, 2003, $4.0 million is accrued for the environmental matters
described herein. The accrual is for future costs for site remediation. The
significant portion of the costs accrued as of March 29, 2003 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 March 29, 2003 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.
LEGAL PROCEEDINGS
As noted in the discussion above under "Environmental Matters", we are
involved in several pending environmental matters. We believe that our
assessment of contingencies is reasonable and that related reserves, in the
aggregate, are adequate; however, there can be no assurance that the final
resolution of these matters will not have a material adverse affect on our
results of operations, financial position and cash flows.
Pending material legal proceedings are as follows:
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 District
of New York ("the New York Action"), against Scotts, a subsidiary of Scotts
and Monsanto seeking damages and injunctive relief for alleged antitrust
violations and breach of contract by Scotts and its subsidiary and antitrust
violations and tortious interference with contract by Monsanto. Scotts
purchased 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). 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 court 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 June 29, 1999, AgrEvo also filed a complaint in the Superior Court of the
State of Delaware against two of Scotts' subsidiaries seeking damages for
alleged breach of contract. AgrEvo alleges that, under the contracts by
which a subsidiary of Scotts purchased a herbicide business from AgrEvo in
May 1998, two of Scotts'
16
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. Scotts' 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.
On May 15, 2002, AgrEvo filed an additional, duplicative complaint that
makes the same claims that are made in the amended complaint in the New York
Action, described above. On June 6, 2002, Scotts moved to dismiss this
duplicative complaint as procedurally improper. There has been no ruling by
the court on Scotts' motion.
On January 10, 2003, Scotts filed a supplemental counterclaim against AgrEvo
for breach of contract, claiming that AgrEvo owes Scotts approximately $1.4
million that Scotts overpaid to AgrEvo. Scotts' counterclaim is now part of
the underlying litigation.
Scotts believes that AgrEvo's claims in these matters are without merit and
intends to vigorously defend against them. If 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.
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, Scotts 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 $24 million in accounts receivable and
additional damages for other breaches of duty.
Central Garden filed counterclaims including allegations that Scotts and
Central Garden had entered into an oral agreement in April 1998 whereby
Scotts would allegedly share with Central Garden the benefits and
liabilities of any future business integration between Scotts and Pharmacia
Corporation (formerly Monsanto). The court dismissed a number of Central
Garden's counterclaims as well as Scotts' claims that Central Garden
breached other duties owed to Scotts. On April 22, 2002, a jury returned a
verdict in favor of Scotts of $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 Scotts
and Scotts 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.
Two counterclaims that the court permitted Central Garden to add on the eve
of trial also remain pending. In these counterclaims, Central Garden seeks
damages in an unspecified amount for Scotts' alleged breach of contract and
conversion with respect to certain inventory held by Central Garden's
subagents and subdistributors. A trial date of October 6, 2003 has been set
on these remaining claims, and discovery has recently commenced.
CENTRAL GARDEN V. SCOTTS & PHARMACIA, NORTHERN DISTRICT OF CALIFORNIA
On July 7, 2000, Central Garden filed suit against Scotts 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 April 15, 2002, Scotts and Central
Garden each filed summary judgment motions in this action. On June 26, 2002,
the court granted summary judgment in favor of Scotts and dismissed all of
Central Garden's then remaining claims. On July 28, 2002, Central Garden
filed a notice of appeal. The case is now pending on appeal in the Ninth
Circuit Court of Appeals.
CENTRAL GARDEN V. SCOTTS & PHARMACIA, CONTRA COSTA SUPERIOR COURT
On October 31, 2000, Central Garden filed a complaint against Scotts and
Pharmacia in the California Superior Court for Contra Costa County. That
complaint seeks to assert breach of contract claims and claims under
17
Section 17200 of the California Business and Professions Code. On December
4, 2000, Scotts and Pharmacia jointly filed a motion to stay this action
based on the pendency of prior lawsuits that involve the same subject
matter. By order dated February 23, 2001, the Superior Court stayed the
action pending before it.
All claims in the Contra Costa action currently remain stayed. A further
status conference is set for May 29, 2003. Central Garden and Pharmacia have
settled their claims relating to this action.
Scotts believes that Central Garden's remaining 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 affect 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 the claims brought against Scotts by Central
Garden, except for amounts ordered paid to Central Garden in the Ohio action
for which Scotts believes it has adequate reserves recorded for the amounts
it may ultimately be required to pay.
OTHER
We are involved in other lawsuits and claims which arise in the normal
course of our business. In our opinion, these claims individually and in the
aggregate are not expected to result in a material adverse effect on our
results of operations, financial position or cash flows.
GUARANTEES
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others"
("FIN45"). FIN45 elaborates on the existing disclosure requirements for most
guarantees, including loan guarantees and certain indemnification
arrangements. For new guarantees and indemnifications provided after
December 31, 2002, it requires that the Company must recognize an initial
liability for the fair value, or market value, of the obligations it assumes
and must disclose that information in its interim and annual financial
statements. The Company has determined that it has no material guarantees or
indemnifications that would require disclosure or valuation under this new
standard.
10. SEGMENT INFORMATION
For fiscal 2003, the Company is divided into four reportable segments -
North American Consumer, Scotts LawnService(R), International Consumer and
Global Professional. The North American Consumer segment consists of the
Lawns, Gardening Products, Ortho and Canadian business units.
The North American Consumer segment specializes in dry, granular
slow-release lawn fertilizers, combination lawn fertilizer and control
products, grass seed, spreaders, water-soluble and controlled-release garden
and indoor plant foods, plant care products, 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 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 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
18
growing media. Products are sold to lawn and landscape service companies,
commercial nurseries and greenhouses and specialty crop growers.
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).
NORTH AMERICAN SCOTTS INTERNATIONAL GLOBAL OTHER/
CONSUMER LAWNSERVICE(R) CONSUMER PROFESSIONAL CORPORATE TOTAL
-------- -------------- -------- ------------ --------- -----
(IN MILLIONS)
Net sales:
YTD 2003 ............ $ 577.8 $ 26.8 $ 151.4 $ 100.9 $ - $ 856.9
YTD 2002 ............ $ 524.8 $ 16.1 $ 127.4 $ 91.6 $ - $ 759.9
Q2 2003 ............. $ 493.1 $ 11.5 $ 108.2 $ 63.4 $ - $ 676.2
Q2 2002 ............. $ 448.5 $ 7.4 $ 87.3 $ 55.3 $ - $ 598.5
Operating income (loss):
YTD 2003 ............ $ 96.9 $ (17.1) $ 12.0 $ 10.6 $ (36.2) $ 66.2
YTD 2002 ............ $ 95.3 $ (10.1) $ 9.0 $ 9.0 $ (28.7) $ 74.5
Q2 2003 ............. $ 125.6 $ (12.4) $ 15.1 $ 10.2 $ (16.1) $ 122.4
Q2 2002 ............. $ 124.7 $ (8.0) $ 15.5 $ 9.2 $ (11.7) $ 129.7
Operating margin:
YTD 2003 ............ 16.8% (63.8%) 7.9% 10.5% nm 7.7%
YTD 2002 ............ 18.2% (62.7%) 7.1% 9.8% nm 9.8%
Q2 2003 ............. 25.5% (107.8%) 14.0% 16.1% nm 18.1%
Q2 2002 ............. 27.8% (108.1%) 17.8% 16.6% nm 21.7%
Goodwill:
Q2 2003 ............. $ 173.1 $ 77.9 $ 80.7 $ 52.5 $ - $ 384.2
Q2 2002 ............. $ 169.4 $ 46.3 $ 73.9 $ 50.4 $ - $ 340.0
Total assets:
Q2 2003 ............. $1,514.2 $ 103.9 $ 550.0 $ 166.5 $ 124.9 $2,459.5
Q2 2002 ............. $1,443.7 $ 62.3 $ 477.4 $ 158.0 $ 98.9 $2,240.3
nm Not meaningful.
Operating income (loss) reported for Scotts' four operating segments
represents earnings before interest, taxes, and amortization, since this is
the measure of profitability used by management. Accordingly, Corporate
operating loss for the three and six months ended March 29, 2003 and March
30, 2002 includes amortization of certain intangible assets, unallocated
corporate general and administrative expenses, and certain "other"
income/expense not allocated to the business segments and North America
restructuring charges.
During the first half of fiscal 2003, the Company's Scotts LawnService(R)
segment acquired 9 individual lawn service entities for a total cost of
$11.5 million. Of the total cost, $5.2 million was paid in cash, with notes
being issued for the remaining $6.3 million.
Goodwill recognized in the fiscal 2003 acquisitions amounted to $9.4 million
all of which is deductible for tax purposes. Other intangible assets,
primarily customer accounts and non-compete agreements, of $1.8 million and
working capital and property, plant and equipment of $0.3 million were also
recorded. These acquired assets all are recorded within the Scotts
LawnService(R) segment.
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
19
intangible assets as well as deferred tax assets.
11. 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. In January 2002, the
Company issued an additional $70 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.
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 six-month periods ended March 29, 2003 and
March 30, 2002 and consolidating Statements of Cash Flows and Balance Sheets
for the six month periods ended March 29, 2003 and March 30, 2003. Separate
unaudited financial statements of the individual guarantor subsidiaries have
not been provided because management does not believe they would be
meaningful to investors.
20
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 29, 2003 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales................................. $ 483.8 $ 23.8 $ 168.6 $ $ 676.2
Cost of sales............................. 341.8 (32.9) 108.7 417.6
Restructuring and other charges........... 0.4 0.3 0.7
-------- ------- -------- ------- --------
Gross profit.............................. 141.6 56.7 59.6 257.9
Gross commission earned from marketing
agreement............................... 10.3 1.0 11.3
Costs associated with marketing agreement. 7.1 7.1
-------- ------- ------- ------- --------
Net commission earned from marketing
agreement.............................. 3.2 - 1.0 4.2
Operating expenses:
Advertising............................. 25.6 0.1 9.2 34.9
Selling, general and administrative..... 66.1 0.4 39.1 105.6
Restructuring and other charges......... 1.0 0.1 1.3 2.4
Amortization of intangibles............. 0.1 0.4 1.6 2.1
Equity income in subsidiaries............. (40.1) - - 40.1 -
Intracompany allocations.................. (1.7) (2.6) 4.3 -
Other (income) expenses, net.............. (0.2) (0.4) (1.8) (2.4)
--------- --------- --------- ------- ---------
Income (loss) from operations............. 94.0 58.7 6.9 (40.1) 119.5
Interest (income) expense................. 17.9 (3.9) 4.7 18.7
-------- --------- -------- ------- --------
Income (loss) before income taxes......... 76.1 62.6 2.2 (40.1) 100.8
Income taxes.............................. 13.6 23.8 0.9 38.3
-------- -------- -------- ------- --------
Income (loss) before cumulative effect of
accounting change....................... 62.5 38.8 1.3 (40.1) 62.5
Cumulative effect of change in accounting
for intangible assets, net of tax....... - - -
-------- -------- -------- ------- --------
Net income (loss)......................... $ 62.5 $ 38.8 $ 1.3 $ (40.1) $ 62.5
======== ======== ======== ======= ========
FOR THE SIX MONTHS ENDED MARCH 29, 2003 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales................................. $ 570.9 $ 41.2 $ 244.8 $ $ 856.9
Cost of sales............................. 408.0 (8.8) 157.4 556.6
Restructuring and other charges........... 4.7 0.4 5.1
-------- -------- --------- -------- --------
Gross profit.............................. 158.2 50.0 87.0 295.2
Gross commission earned from marketing
agreement............................... 10.1 1.2 11.3
Costs associated with marketing agreement. 14.2 14.2
-------- -------- --------- -------- --------
Net commission earned from marketing
agreement............................. (4.1) 1.2 (2.9)
Operating expenses:
Advertising............................. 30.4 13.1 43.5
Selling, general and administrative..... 113.5 0.2 69.8 183.5
Restructuring and other charges......... 1.3 0.3 2.7 4.3
Amortization of intangibles............. 0.2 0.9 3.0 4.1
Equity income in subsidiaries............. (25.2) 25.2 -
Intracompany allocations.................. (10.9) 3.6 7.3 -
Other (income) expenses, net.............. (0.3) (0.5) (2.8) (3.6)
-------- -------- --------- -------- --------
Income (loss) from operations............. 45.1 45.5 (4.9) (25.2) 60.5
Interest expense.......................... 35.2 (7.8) 7.8 35.2
-------- -------- --------- -------- --------
Income (loss) before income taxes......... 9.9 53.3 (12.7) (25.2) 25.3
Income taxes.............................. (5.8) 20.2 (4.8) 9.6
-------- -------- --------- -------- --------
Income (loss) before cumulative effect of
accounting change....................... 15.7 33.1 (7.9) (25.2) 15.7
Cumulative effect of change in accounting
for intangible assets, net of tax....... -
-------- -------- --------- -------- --------
Net income (loss)......................... $ 15.7 $ 33.1 $ (7.9) $ (25.2) $ 15.7
======== ======== ========= ======== ========
21
THE SCOTTS COMPANY
STATEMENT OF CASH FLOWS
FOR THE SIX MONTH PERIOD ENDED MARCH 29, 2003 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................... $ 15.7 $ 33.1 $ (7.9) $ (25.2) $ 15.7
Adjustments to reconcile net income to
net cash used in operating activities:
Cumulative effect of change in accounting
for intangible assets................... - -
Stock-based compensation expense.......... 1.6 1.6
Depreciation.............................. 13.1 2.2 3.5 18.8
Amortization.............................. 1.8 0.7 3.2 5.7
Deferred Taxes............................ 9.9 9.9
Equity (income) loss in non-guarantors.... (25.2) 25.2 -
Net change in certain components
of working capital........................ (248.0) (73.0) (111.4) (432.4)
Net changes in other assets and
liabilities and other adjustments......... 13.0 1.2 (14.1) 0.1
-------- -------- -------- -------- --------
Net cash used in operating activities....... (218.1) (35.8) (126.7) - (380.6)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment. (17.6) (10.3) (3.4) (31.3)
Investment in acquired businesses,
net of cash acquired...................... (5.2) (5.2)
Payments on seller notes.................... (3.8) (3.4) (19.8) (27.0)
-------- -------- -------- -------- --------
Net cash used in investing activities....... (21.4) (13.7) (28.4) - (63.5)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under revolving
and bank lines of credit.................. 104.8 268.2 373.0
Issuance of 8 5/8% senior subordinated
notes, net of issuance costs............. -
Gross repayments under term loans........... (17.3) (8.5) (25.8)
Financing and issuance fees................. (0.5) (0.5)
Cash received from the exercise of stock
options................................... 9.0 9.0
Intracompany financing...................... 90.6 49.7 (140.3) -
-------- -------- -------- -------- --------
Net cash provided by financing activities... 186.6 49.7 119.4 - 355.7
-------- -------- -------- -------- --------
Effect of exchange rate changes on cash..... - - 1.0 1.0
-------- -------- -------- -------- --------
Net increase (decrease) in cash............. (52.9) 0.2 (34.7) (87.4)
Cash and cash equivalents, beginning of
period.................................... 54.7 0.2 44.8 99.7
-------- -------- -------- -------- --------
Cash and cash equivalents, end of period.... $ 1.8 $ 0.4 $ 10.1 $ - $ 12.3
======== ======== ======== ======== ========
22
THE SCOTTS COMPANY
BALANCE SHEET
AS OF MARCH 29, 2003 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents.................... $ 1.8 $ 0.4 $ 10.1 $ 12.3
Accounts receivable, net..................... 329.9 141.9 251.0 722.8
Inventories, net............................. 229.7 72.5 98.0 400.2
Current deferred tax asset................... 72.2 0.4 (0.1) 72.5
Prepaid and other assets..................... 24.2 2.8 30.9 57.9
--------- -------- -------- --------- ----------
Total current assets.................... 657.8 218.0 389.9 1,265.7
Property, plant and equipment, net............. 215.5 90.2 36.9 342.6
Goodwill and intangible assets, net............ 21.0 473.9 308.8 803.7
Other assets................................... 46.8 2.8 (2.1) 47.5
Investment in affiliates....................... 964.9 (964.9) -
Intracompany assets............................ 220.1 47.0 (267.1) -
--------- -------- -------- --------- ----------
Total assets............................ $ 1,906.0 $1,005.0 $ 780.5 $(1,232.0) $ 2,459.5
========= ======== ======== ========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt...................... $ 265.8 $ 1.5 $ 20.4 $ $ 287.7
Accounts payable............................. 125.4 39.8 127.6 292.8
Accrued liabilities.......................... 119.5 17.1 89.5 226.1
Accrued taxes................................ 18.6 2.0 7.1 27.7
--------- -------- -------- --------- ----------
Total current liabilities............... 529.3 60.4 244.6 834.3
Long-term debt................................. 489.7 2.1 381.2 873.0
Other liabilities.............................. 114.1 1.2 16.9 132.2
Intracompany liabilities....................... 152.9 114.2 (267.1) -
--------- -------- -------- --------- ----------
Total liabilities......................... 1,286.0 63.7 756.9 (267.1) 1,839.5
--------- -------- -------- --------- ----------
Commitments and contingencies
Shareholders' equity:
Investment from parent....................... 486.8 61.6 (548.4) -
Common shares, no par value per share,
$.01 stated value per share................ 0.3 0.3
Capital in excess of par value............... 388.2 388.2
Retained earnings............................ 310.5 456.9 (14.9) (442.0) 310.5
Treasury stock, 0.5 shares at cost........... (20.7) (20.7)
Accumulated other comprehensive expense...... (58.3) (2.4) (23.1) 25.5 (58.3)
--------- -------- -------- --------- ----------
Total shareholders' equity................ 620.0 941.3 23.6 (964.9) 620.0
--------- -------- -------- --------- ----------
Total liabilities and shareholders' equity $ 1,906.0 $1,005.0 $ 780.5 $(1,232.0) $ 2,459.5
========= ======== ======== ========= ==========
23
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 30, 2002 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales................................. $ 435.7 $ 30.9 $ 131.9 $ $ 598.5
Cost of sales............................. 313.8 (37.5) 82.2 358.5
Restructuring and other charges........... 0.1 0.1
-------- -------- -------- ------- --------
Gross profit.............................. 121.9 68.4 49.6 239.9
Gross commission earned from marketing
agreement............................... 7.6 0.8 8.4
Costs associated with marketing agreement. 5.8 5.8
-------- -------- -------- ------- --------
Net commission earned from marketing
agreement............................... 1.8 - 0.8 2.6
Operating expenses:
Advertising ............................ 19.0 4.0 7.9 30.9
Selling, general and administrative..... 50.4 4.9 28.8 84.1
Restructuring and other charges......... 0.4 0.4
Amortization of intangibles............. 0.1 0.7 1.0 1.8
Equity income in subsidiaries............. (37.8) 37.8 -
Intracompany allocations.................. (9.8) 7.4 2.4 -
Other (income) expenses, net.............. (1.0) (0.9) (1.9)
-------- -------- -------- ------- --------
Income (loss) from operations............. 101.4 52.4 11.2 (37.8) 127.2
Interest (income) expense................. 19.4 (3.5) 5.7 21.6
-------- -------- -------- ------- --------
Income (loss) before income taxes......... 82.0 55.9 5.5 (37.8) 105.6
Income taxes.............................. 17.0 21.5 2.1 40.6
-------- -------- -------- ------- --------
Income (loss) before cumulative effect of
accounting change....................... 65.0 34.4 3.4 (37.8) 65.0
Cumulative effect of change in accounting
for intangible assets, net of tax....... -
-------- -------- -------- ------- --------
Net income (loss)......................... $ 65.0 $ 34.4 $ 3.4 $ (37.8) $ 65.0
======== ======== ======== ======= ========
FOR THE SIX MONTHS ENDED MARCH 30, 2002 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
Net sales................................. $ 485.8 $ 79.2 $ 194.9 $ $ 759.9
Cost of sales............................. 348.4 13.4 126.1 487.9
Restructuring and other charges........... 1.0 0.1 1.1
-------- ------- -------- ------- --------
Gross profit.............................. 136.4 65.8 68.7 270.9
Gross commission earned from marketing
agreement............................... 7.3 1.1 8.4
Costs associated with marketing agreement. 11.7 11.7
-------- ------- ------- ------- --------
Net commission earned from marketing
agreement............................... (4.4) 1.1 (3.3)
Operating expenses:
Advertising............................. 22.4 4.7 10.9 38.0
Selling, general and administrative..... 94.3 8.6 56.5 159.4
Restructuring and other charges......... 1.1 0.1 1.2
Amortization of intangibles............. 0.2 1.4 2.1 3.7
Equity income in subsidiaries............. 6.2 (6.2) -.-
Intracompany allocations.................. (13.3) 9.3 4.0 -.-
Other (income) expenses, net.............. (0.3) (2.0) (1.6) (3.9)
--------- --------- --------- ------- ---------
Income (loss) from operations............. 21.4 43.7 (2.1) 6.2 69.2
Interest expense.......................... 36.9 (7.1) 10.4 40.2
-------- --------- -------- ------- --------
Income (loss) before income taxes......... (15.5) 50.8 (12.5) 6.2 29.0
Income taxes.............................. (3.6) 19.5 (4.8) 11.1
--------- -------- --------- ------- --------
Income (loss) before cumulative effect of
accounting change....................... (11.9) 31.3 (7.7) 6.2 17.9
Cumulative effect of change in accounting
for intangible assets, net of tax....... 11.3 (3.8) (26.0) (18.5)
--------- --------- --------- ------- ---------
Net income (loss)......................... $ (0.6) $ 27.5 $ (33.7) $ 6.2 $ (0.6)
========= ======== ========= ======= =========
24
THE SCOTTS COMPANY
STATEMENT OF CASH FLOWS
FOR THE SIX MONTH PERIOD ENDED MARCH 30, 2002 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................... $ (0.6) $ 27.5 $ (33.7) $ 6.2 $ (0.6)
Adjustments to reconcile net loss to
net cash used in operating activities:
Cumulative effect of change in accounting
for intangible assets................... 3.8 26.0 29.8
Stock-based compensation expense.......... -
Depreciation.............................. 4.2 9.7 2.1 16.0
Amortization.............................. 1.0 2.8 1.5 5.3
Deferred Taxes............................ (10.1) (10.1)
Equity (income) loss in non-guarantors.... 6.2 (6.2) -
Net change in certain components
of working capital........................ (165.6) 6.8 (86.2) (245.0)
Net changes in other assets and
liabilities and other adjustments......... 5.1 0.1 5.2
-------- -------- -------- -------- --------
Net cash used in operating activities....... (159.8) 50.6 (90.2) - (199.4)
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment. (6.6) (14.7) (1.0) (22.3)
Investment in acquired businesses,
net of cash acquired...................... (3.1) (3.1)
Payments on seller notes.................... (16.0) (16.0)
-------- -------- -------- -------- --------
Net cash used in investing activities....... (6.6) (14.7) (20.1) - (41.4)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under revolving
and bank lines of credit.................. 88.1 110.2 198.3
Issuance of 8 5/8% senior subordinated
notes, net of issuance costs.............. 70.2 70.2
Gross repayments under term loans........... (0.2) (14.7) (14.9)
Financing and issuance fees................. (1.8) (1.8)
Cash received from the exercise of stock 10.3 10.3
options.....................................
Intracompany financing...................... 21.5 (36.5) 15.0 -
-------- -------- -------- -------- --------
Net cash provided by financing activities... 188.1 (36.5) 110.5 - 262.1
-------- -------- -------- -------- --------
Effect of exchange rate changes on cash..... (2.5) (2.5)
-------- -------- -------- -------- --------
Net increase (decrease) in cash............. 21.7 (0.6) (2.3) 18.8
Cash and cash equivalents, beginning of
period.................................... 3.4 0.6 14.7 18.7
-------- -------- -------- -------- --------
Cash and cash equivalents, end of period.... $ 25.1 $ - $ 12.4 $ - $ 37.5
======== ======== ======== ======== ========
25
THE SCOTTS COMPANY
BALANCE SHEET
AS OF MARCH 30, 2002 (in millions)
(unaudited)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
-------- -------- -------- ---------- ----------
ASSETS
Current assets:
Cash and cash equivalents................. $ 25.1 $ $ 12.4 $ $ 37.5
Accounts receivable, net.................. 222.0 122.6 202.4 547.0
Inventories, net.......................... 261.5 79.0 86.3 426.8
Current deferred tax asset................ 52.2 0.5 (0.5) 52.2
Prepaid and other assets.................. 20.6 2.3 21.7 44.6
-------- -------- -------- ---------- ----------
Total current assets.................. 581.4 204.4 322.3 1,108.1
Property, plant and equipment, net........... 199.2 76.6 37.6 313.4
Goodwill and intangible assets, net.......... 31.7 471.2 241.2 744.1
Other assets................................. 61.1 2.5 11.1 74.7
Investment in affiliates..................... 931.3 (931.3) -
Intracompany assets.......................... 159.7 (159.7) -
-------- -------- -------- ---------- ----------
Total assets.......................... $1,804.7 $ 914.4 $ 612.2 $(1,091.0) $ 2,240.3
======== ======== ======== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt........................... $ 166.3 $ 7.3 $ 32.0 $ $ 205.6
Accounts payable.......................... 125.9 43.0 101.2 270.1
Accrued liabilities....................... 129.8 18.7 69.8 218.3
Accrued taxes............................. 28.9 2.5 4.5 35.9
-------- -------- -------- ---------- ----------
Total current liabilities............. 450.9 71.5 207.5 729.9
Long-term debt............................... 590.0 5.3 325.8 921.1
Other liabilities............................ 45.5 1.9 25.0 72.4
Intracompany liabilities..................... 141.0 18.7 (159.7) -
-------- -------- -------- ---------- ----------
Total liabilities....................... 1,227.4 78.7 577.0 (159.7) 1,723.4
-------- -------- -------- ---------- ----------
Commitments and contingencies
Shareholders' equity:
Investment from parent.................... 483.0 41.8 (524.8) -
Common shares, no par value per share,
$.01 stated value per share............. 0.3 0.3
Capital in excess of par value............ 400.1 400.1
Retained earnings......................... 246.4 355.1 16.7 (406.5) 211.7
Treasury stock, 2.1 shares at cost........ (61.4) (61.4)
Accumulated other comprehensive expense... (8.1) (2.4) (23.3) (33.8)
-------- -------- -------- ---------- ----------
Total shareholders' equity............. 577.3 835.7 35.2 (931.3) 516.9
-------- -------- -------- ---------- ----------
Total liabilities and shareholders'
equity............................... $1,804.7 $ 914.4 $ 612.2 $(1,091.0) $ 2,240.3
======== ======== ======== ========== ==========
26
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, Gardening
Products, Ortho and Canadian business groups. Gardening Products is the combined
operations of our Gardens (Miracle-Gro(R)) and Growing Media businesses.
In the United States, we operate the second largest residential lawn service
business, Scotts LawnService(R). In fiscal 2002, we continued the rapid
expansion of this business. Through acquisitions and internal growth, revenues
increased from nearly $42 million in fiscal 2001 to over $75 million in fiscal
2002. We expect to make at least $30 million of lawn service acquisitions
annually for the foreseeable future.
As a leading consumer branded lawn and garden company, we focus our consumer
marketing efforts, including advertising and consumer research, on creating
consumer 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 branded products. We believe
this level of spending gives us the largest share of advertising voice in the
lawn and garden category in North America. 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 make additional
significant investments in consumer marketing expenditures in the future to
continue to drive market share and sales growth. In fiscal 2003, we expect to
increase significantly our advertising spending and our advertising to net sales
ratio particularly in the second half of fiscal 2003, as we deliver a new media
message for the Ortho line, invest in our other North American brands and
increase our advertising reach in Europe.
Our sales are susceptible to global weather conditions, primarily in North
America and Europe. 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 followed a somewhat different pattern than our
historical experience due to retailer initiatives to reduce their investment in
inventory and improve their inventory turns. This caused a sales shift from the
second quarter to the third and fourth quarters that coincided more closely to
when consumers buy our products. Net sales by quarter were 9.3%, 34.2%, 39.3%
and 17.2% in fiscal 2002. The trend of operating losses in the first and fourth
quarters and significant operating profits in the second and third quarters
continued in fiscal 2002. There was also a slight shift in profitability between
the second and third quarters with the third quarter now more profitable than
the second. The trend towards more of our sales occurring in the latter half of
the fiscal year is expected to continue in fiscal 2003 as retailers maintain
emphasis on inventory investment more closely timed to consumer takeaway.
Scotts LawnService's(R) expansion and growth also adds revenue to the second
half of the fiscal year. Also, as Scotts LawnService(R) grows in revenues and
profitability, the second half of the fiscal year will show further growth in
profitability compared to past trends because our third and fourth fiscal
quarters are historically highly profitable periods for the lawn service
business.
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 fiscal
2001. These costs, which totaled $4.1 million, were recorded as they were
incurred in fiscal 2002 as required under generally accepted accounting
principles in the United States of America.
27
Late in fiscal 2002, we announced a major initiative to improve the
operations and profitability of our European-based consumer and professional
businesses. Over the next several years, we anticipate spending $50 to $60
million on various projects, approximately 25% of which will be capital
expenditures. Certain projects will result in the recognition of restructuring
and other charges over the duration of this initiative. In the fourth quarter of
fiscal 2002, as part of this initiative, we announced the closure of a
manufacturing plant in Bramford, England. The closure will occur in late fiscal
2003. The depreciation of fixed assets at the facility will be accelerated so
that they are fully depreciated by the closure date. In the fourth quarter of
fiscal 2002, approximately $4.0 million of severance and additional pension
costs related to the closure were recorded and reported as restructuring and
other charges. Additional restructuring and other charges will be incurred in
future periods as various aspects of the plan are implemented.
In fiscal 2002, we adopted Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets." This statement eliminates the
requirement to amortize indefinite-lived 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. 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 income taxes, the net charge was $18.5 million which
was recorded as a cumulative effect of a change in accounting principle. There
was no goodwill impairment as of the date of adoption. For fiscal 2003, we
completed the annual update of our impairment analysis in the first quarter and
concluded that there was no impairment of indefinite-lived assets to record.
Effective October 1, 2002, we elected to begin expensing prospectively the
cost of grants of stock-based compensation awards to employees and Directors in
accordance with Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation". We use the Black-Scholes valuation model to value
stock-based compensation grants. The Company intends to continue to grant awards
with a value of $10-12 million annually, in line with past practice. Most awards
have a three-year vesting period. The annual expense for stock-based awards is
expected to increase by approximately $4 million per year from fiscal 2003
through fiscal 2005 based on the vesting period and the prospective adoption of
this accounting standard.
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.
Our Annual Report on Form 10-K for the fiscal year ended September 30, 2002
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 disclosures 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 operations and financial position are as
follows:
- We have significant investments in property and equipment, intangible
assets and goodwill. Whenever changing conditions warrant, we review the
realizability of the assets that may be impacted. At least annually we
review indefinite-lived intangible assets for impairment. The review for
impairment of long-lived assets, intangibles and goodwill takes into
account estimates of future cash flows. Our estimates of future cash
flows are based upon budgets and longer-range plans. These budgets and
plans are used for internal purposes and are also the basis for
communication with outside parties (lenders, analysts, etc.)
28
about future business trends. While we believe the assumptions we use to
estimate future cash flows are reasonable, there can be no assurance
that the expected future cash flows will be realized. As a result,
impairment charges that possibly should have been recognized in earlier
periods may not be recognized until later periods if actual results
deviate unfavorably from earlier estimates.
- 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 from 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 consolidated financial
statements for the year ended September 30, 2002, and in the notes to
the unaudited, condensed consolidated financial statements included in
this Quarterly Report on Form 10-Q, 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.
- We accrue for the estimated costs of customer volume rebates,
cooperative advertising, consumer coupons and other trade programs as
the related sales occur during the year. These accruals involve the use
of estimates as to the total expected program costs and the expected
sales levels. Historical results are also used to evaluate the accuracy
and adequacy of amounts provided at interim dates and year end. There
can be no assurance that actual amounts paid for these trade programs
will not differ from estimated amounts accrued. However, we believe any
such differences would not be material to our financial position or
results of operations.
- We record income tax liabilities utilizing known obligations and
estimates of potential obligations. A deferred tax asset or liability is
recognized whenever there are future tax effects from existing temporary
differences and operating loss and tax credit carryforwards. Valuation
allowances are used to reduce deferred tax assets to the balance that is
more likely than not to be realized. We must make estimates and
judgments on future taxable income, considering feasible tax planning
strategies and taking into account existing facts and circumstances, to
determine the proper valuation allowance. When we determine that
deferred tax assets could be realized in greater or lesser amounts than
recorded, the asset balance and income statement reflects the change in
the period such determination is made. Due to changes in facts and
circumstances and the estimates and judgments that are involved in
determining the proper valuation allowance, differences between actual
future events and prior estimates and judgments could result in
adjustments to this valuation allowance. The Company uses an estimate of
its annual effective tax rate at each interim period based on the facts
and circumstances available at that time, while the actual effective tax
rate is calculated at year-end.
29
RESULTS OF OPERATIONS
The following table sets forth net sales by business segment for the three
and six month periods ended March 29, 2003 and March 30, 2002:
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 29, MARCH 30, MARCH 29, MARCH 30,
2003 2002 2003 2002
-------- -------- -------- --------
($ MILLIONS)
North American Consumer:
Lawns......................... 264.4 223.8 292.7 250.7
Gardening Products............ $ 146.4 $ 146.4 $ 184.2 $ 178.1
Ortho......................... 68.1 66.6 85.9 83.4
Canada........................ 14.2 11.7 15.0 12.6
-------- -------- -------- --------
Total.................. 493.1 448.5 577.8 524.8
Scotts LawnService(R)......... 11.5 7.4 26.8 16.1
International Consumer........ 108.2 87.3 151.4 127.4
Global Professional........... 63.4 55.3 100.9 91.6
-------- -------- -------- --------
Consolidated........... $ 676.2 $ 598.5 $ 856.9 $ 759.9
======== ======== ======== ========
The following table sets forth the components of income and expense as a
percentage of net sales for the three and six month period ended March 29, 2003
and March 30, 2002:
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 29, MARCH 30, MARCH 29, MARCH 30,
2003 2002 2003 2002
---- ---- ---- ----
Net sales.............................................. 100.0% 100.0% 100.0% 100.0%
Cost of sales.......................................... 61.7 59.9 65.0 64.2
Restructuring and other charges........................ 0.2 - 0.6 0.2
----- ----- ------ -------
Gross profit........................................... 38.1 40.1 34.4 35.6
Commission earned (expense) from agency agreement, net. 0.6 0.4 (0.3) (0.4)
Operating expenses:
Advertising........................................ 5.2 5.1 5.0 5.0
Selling, general and administrative................ 15.7 14.0 21.4 20.9
Restructuring and other charges.................... 0.4 0.1 0.5 0.2
Amortization of intangibles............................ 0.3 0.3 0.5 0.5
Other expense (income), net............................ (0.4) (0.3) (0.4) (0.5)
----- ----- ------ -------
Income from operations................................. 17.7 21.3 7.1 9.1
Interest expense....................................... 2.8 3.6 4.1 5.3
----- ----- ------ -------
Income before income taxes............................. 14.9 17.7 3.0 3.8
Income taxes........................................... 5.7 6.8 1.1 1.5
----- ----- ------ -------
Net income before cumulative effect of accounting
change............................................. 9.2 10.9 1.9 2.3
Cumulative effect of change in accounting for
intangible assets, net of tax...................... - - - (2.4)
----- ----- ------ -------
Net income (loss)...................................... 9.2% 10.9% 1.9% (0.1%)
===== ===== ====== =======
THREE MONTHS ENDED MARCH 29, 2003 COMPARED TO THREE MONTHS ENDED MARCH 30, 2002
Net sales for the three months ended March 29, 2003 were $676.2 million, an
increase of 13.0% from net sales for the three months ended March 30, 2002 of
$598.5 million. $23.9 million of the increase was due to the impact of exchange
rates on sales by our foreign entities resulting in a 9.0% increase in net sales
primarily due to shipments. Price increases are not material to the discussion
of net sales in total or by business segment for either fiscal period presented.
North American Consumer segment net sales were $493.1 million in the second
quarter of fiscal 2003, an
30
increase of 9.9% over net sales for the second quarter of fiscal 2002 of $448.5
million. The Lawns business group had a strong quarter with sales of Miracle
Gro(R) fertilizers, seed and durables leading the way to an 18.1% growth to net
sales of $264.4 million in the second quarter of fiscal 2003 compared to net
sales of $223.8 million in the second quarter of fiscal 2002. Sales of Gardening
Products (growing media and garden fertilizers) and Ortho were flat between the
second quarters of both fiscal years. The products sold by these business groups
are oriented toward late spring gardening activities as compared to lawn
products where seasonal demand starts in late winter to early spring. As
retailers continue to emphasize inventory ordering and replenishment based on
consumer take-away, our sales into the trade move closer to that consumer
activity. Net sales in Canada increased 21.4% to $14.2 million in the second
quarter of fiscal 2003 compared to $11.7 million in the second quarter of fiscal
2002. Excluding the effects of the stronger Canadian dollar, net sales increased
13.9% on new products and listings and increased support for the lawn and garden
category at key retailers.
Scotts LawnService(R) revenues increased 55.4% from $7.4 million in the
second quarter of fiscal 2002 to $11.5 million in the first quarter of fiscal
2003. The growth in revenue reflects the growth in the business from
acquisitions completed in fiscal 2002, and thus far in fiscal 2003, and the
growth in customers from our marketing campaigns. The very late end to winter
weather in the Midwest and Northeast hampered lawn service sales and treatment
activities in the second quarter of fiscal 2003.
Net sales for the International Consumer segment were $108.2 million in the
second quarter of fiscal 2003, an increase of 23.9%, over net sales for the
second quarter of fiscal 2002 of $87.3 million. Excluding the effects of
exchange rates, net sales increased 4.3%.
Net sales for the Global Professional segment were $63.4 million in the
second quarter of fiscal 2003, an increase of 14.6% over net sales for the
second quarter of fiscal 2002 of $55.3 million. Excluding the effects of
exchange rates, net sales increased 4.4%.
Gross profit was $257.9 million in the second quarter of fiscal 2003, an
increase of $18.0 million from gross profit of $239.9 million in the second
quarter of fiscal 2002. As a percentage of net sales, gross profit was 38.1% of
net sales in the second quarter of fiscal 2003 compared to 40.1% in the second
quarter of fiscal 2002. The decline in gross profit percentage was due to mix
related to higher sales of lower margin lawns products (seeds, spreaders and
certain fertilizers), the impact of a larger Scotts LawnService(R) business
infrastructure during a seasonally low revenue quarter, and favorable
manufacturing cost variances in the second quarter of fiscal 2002 which did not
recur in the second quarter of fiscal 2003.
The net commission earned from agency agreement in the second quarter of
fiscal 2003 increased to $4.2 million compared to $2.6 million in the second
quarter of fiscal 2002 even after an increase in the contribution payment due to
Monsanto to $25 million in fiscal 2003 from $20 million in fiscal 2003 or $1.250
million each quarter. Roundup sales are off to a strong early season start,
with worldwide net sales increasing over 25.0% from $83.9 million in the second
quarter of fiscal 2002 to $105.4 million in the second quarter of fiscal 2003.
Advertising expenses in the second quarter of fiscal 2003 were $34.9
million, an increase of 12.9% over the $30.9 million in the second quarter of
fiscal 2002. As a percentage of net sales, advertising expense was 5.2% in the
second quarter of fiscal 2003 compared to 5.1% in the second quarter of fiscal
2002. The Company intends to spend more aggressively on advertising in fiscal
2003, particularly in the second half of the fiscal year.
Selling, general and administrative expenses ("S, G&A") in the second
quarter of fiscal 2003 were $92.5 million compared to $75.2 million in the
second quarter of fiscal 2002 excluding S,G&A for the lawn service business and
restructuring and other charges. The increase in S,G&A costs is due to
investments in systems projects such as SAP in Europe, Manugistics software in
North America Supply Chain and branch operating/customer service software for
the Scotts LawnService(R) business, the European integration initiative, new
business development initiatives in North America, the cost of expensing
stock-based compensatory awards, increased pension costs, and the effects of
stronger foreign currencies converting results from our foreign operations into
higher U.S. dollars in fiscal 2003 compared to fiscal 2002. S, G&A in the Scotts
LawnService(R) business increased from $8.9 million in the second quarter of
fiscal 2002 to $13.1 million in the second quarter of fiscal 2003 reflecting the
increased number of locations added over the past year from acquisitions and
branch openings and expansions. S, G&A related to restructuring activities
increased from $0.4 million in fiscal 2002's second quarter to $2.4 million in
fiscal 2003's
31
second quarter due to the costs associated with the ongoing European integration
initiatives which kicked off late in the fourth quarter of fiscal 2002.
Other income was $2.4 million for the second quarter of fiscal 2003,
compared to $1.9 million in the first quarter of fiscal 2002. The increase is
due to the ongoing recognition of defined income from the April 2002 agreement
for cessation of peat activities in the United Kingdom that is being recognized
ratably over the related lease that expires in September 2004.
For segment reporting purposes, earnings before interest, taxes and
amortization ("EBITA") is used by management as the measure for income from
operations in assessing performance. Segment performance for the second quarter
of fiscal 2003 compared to the second quarter of fiscal 2002 was as follows:
- North American Consumer income from operations increased slightly from
$124.7 million in fiscal 2002 to $125.6 million in fiscal 2003 due to
higher sales in the fiscal 2003 period ($493.1 million compared to
$448.5 million) and increased commission income from the Roundup
agreement offset by lower gross margins and higher S,G&A expenses;
- Scotts LawnService(R) reported higher net sales ($11.5 million compared
to $7.4 million) but a larger loss from operations. As this highly
seasonal business grows, it will have larger losses in the first and
second quarters of the fiscal year due to seasonally low revenues and
high fixed overhead costs. Conversely, the second half of the fiscal
year is expected to provide higher revenues, margins and operating
income;
- International Consumer's operating income declined slightly to $15.1
million from $15.5 million due to restructuring charges of $2.2 million
in fiscal 2003 offsetting the benefits from higher net sales and the
favorable impact of foreign currency translation.
- The Global Professional business showed an operating profit of $10.2
million in fiscal 2003 compared to income from operations of $9.2
million in fiscal 2002 due to the favorable impact of foreign currency
translation on operating results.
- The operating loss for the other/corporate segment increased from $11.7
million in the second quarter of fiscal 2002 to $16.1 million in the
second quarter of fiscal 2003 due to higher costs related to the
expensing of stock-based compensatory awards in fiscal 2003, higher
pension costs, increased fringe benefit costs and systems related costs.
Interest expense for the second quarter of fiscal 2003 was $18.7 million, a
decrease of $2.9 million from interest expense for the second quarter of fiscal
2002 of $21.6 million. The decrease in interest expense was primarily due to
lower interest rates and a reduction in average borrowings for the quarter as
compared to the prior year. Average borrowings were $1,084.8 million in the
three months ended March 29, 2003 compared to $1,128.8 million in the three
months ended March 30, 2002. The weighted average interest rate for the three
months ended March 29, 2003 on the portion of our Credit Agreement that has a
variable rate was 5.06% compared to 5.931% for the three months ended March 30,
2002.
Income tax expense in the second quarter of fiscal 2003 was $38.3 million,
compared to $40.6 million in the second quarter of fiscal 2002. The effective
tax rate for the second quarter of fiscal 2003 was 38.0% compared to 38.5% for
the second quarter of fiscal 2002. The effective tax rate for fiscal 2002 was
later adjusted to 38.0% by the end of fiscal 2002 and remains at that level in
fiscal 2003.
The Company reported net income of $62.5 million for the second quarter of
fiscal 2003, compared to $65.0 million for the second quarter of fiscal 2002. In
addition to the matters described above, stronger foreign currencies compared to
the U.S. dollar in fiscal 2003 than in fiscal 2002 favorably impacted net income
by $2.4 million in fiscal 2003's second quarter.
Diluted earnings per share were $1.94 for the three months ended March 29,
2003 compared to $2.06 for the three months ended March 30, 2002. Average shares
outstanding increased from 31.5 million at March 30, 2002 to
32
32.2 million at March 29, 2003 due to option and warrant exercises and grants of
options and other stock-based compensatory awards during the intervening period.
SIX MONTHS ENDED MARCH 29, 2003 COMPARED TO SIX MONTHS ENDED MARCH 30, 2002
Net sales for the six months ended March 29, 2003 were $856.9 million, an
increase of 12.8% from net sales for the six months ended March 30, 2002 of
$759.9 million. $30.4 million of the increase was due to the impact of exchange
rates on sales by our foreign entities resulting in an 8.8% increase in net
sales, primarily due to volume.
Net sales in the second quarter of the fiscal year represent about 80% of
the net sales for the year-to-date period and thus, many of the same factors
that impacted results for the second quarter comparisons also pertain to the
year-to-date comparisons of results of operations between fiscal years.
Price increases are not material to the discussion of net sales in total or
by business segment for either fiscal period presented.
North American Consumer segment net sales were $577.8 million in the first
half of fiscal 2003, an increase of 10.1% over net sales for the first half of
fiscal 2002 of $524.8 million. Each business group in North America showed a net
sales increase with the Lawns group up 16.8% due to strong early season sales of
seed, durables and fertilizers. Gardening Products and Ortho products have a
later season start than lawns products and thus, with retailers ordering on the
basis of consumer take-away, more sell-in should be occurring later in the
fiscal year.
Scotts LawnService(R) revenues increased 66.5% from $16.1 million in the
first half of fiscal 2002 to $26.8 million in the first half of fiscal 2003. The
growth in revenue reflects the growth in the business from acquisitions
completed in fiscal 2002 and thus far in fiscal 2003 and the growth in customers
from our spring and fall marketing campaigns.
Net sales for the International Consumer segment were $151.4 million in the
first half of fiscal 2003, 18.8% higher than net sales for the first half of
fiscal 2002. Excluding the effect of exchange rates, net sales increased by
1.7%. The increase in sales reflects favorable late Winter/early Spring weather
throughout Europe in 2003.
Net sales for the Global Professional segment were $100.9 million in the
first half of fiscal 2003, or 10.2% higher than net sales for the first half of
fiscal 2002. Excluding the effect of exchange rates, net sales rose 1.8%.
Gross profit was $295.2 million in the first six months of fiscal 2003, an
increase of $24.3 million from gross profit of $270.9 million in the first six
months of fiscal 2002. As a percentage of net sales, gross profit was 34.4% of
sales in the first half of fiscal 2003 compared to 35.6% in the first half of
fiscal 2002. Excluding restructuring and other charges, the gross profit
percentage was 35.0% in the first half of fiscal 2003 compared to 35.8% in the
first half of fiscal 2002. The gross profit percentage declined due to a higher
mix of sales of lower margin products from the lawns business and an unfavorable
manufacturing cost comparison due to favorable price variances and purchasing
rebates in fiscal 2002 that did not recur thus far in fiscal 2003.
The net commission earned from agency agreement in the first half of fiscal
2003 represents net expense of $2.9 million compared to net expense of $3.3
million in the first half of fiscal 2002. The contribution payment due to
Monsanto increased to $25 million in fiscal 2003 from $20 million in fiscal
2002. Excluding the additional $2.5 million of contribution expense recorded in
the first six months of fiscal 2003, the net expense from the marketing
agreement improved from $3.3 million in fiscal 2002 to $0.4 million in fiscal
2003, reflecting strong worldwide early season sales of Roundup.
Advertising expenses in the first half of fiscal 2003 were $43.5 million, an
increase of 14.4% over the $38.0 million in the first half of fiscal 2002. As a
percentage of net sales, advertising expense was 5.0% in the first halves of
fiscal 2003 and fiscal 2002.
Selling, general and administrative expenses ("S, G&A") in the first half of
fiscal 2003 were $187.8 million compared to $160.6 million in the first half of
fiscal 2002. S,G&A for the Scotts Lawnservice(R) business increased
33
from $14.7 million in the first half of fiscal 2002 to $23.1 million in the
first half of fiscal 2003 reflecting the increased number of locations added
over the past year from acquisitions and branch openings and expansions. S, G&A
related to restructuring activities increased from $1.2 million in fiscal 2002's
first six months to $4.3 million in fiscal 2003's first six months due to the
costs associated with the ongoing European integration initiatives which kicked
off late in the fourth quarter of fiscal 2002. SG&A for the other segments
increased to $160.4 million in the first six months of fiscal 2003 from $144.7
million in the first six months of fiscal 2002 due to higher costs for fringe
benefits, the expensing of stock options, systems projects and operating costs,
investments in business development initiatives and the impact of higher foreign
exchange conversion rates in fiscal 2003.
Other income was $3.6 million for the first half of fiscal 2003, compared to
$3.9 million in the first half of fiscal 2002. The decrease is due to the gain
on sale of an idled growing media plant in Florida which occurred in the first
quarter of fiscal 2002, offset in part by income from the cessation of peat
extraction activities that is being recognized ratably through September 2004.
For segment reporting purposes, earnings before interest, taxes and
amortization ("EBITA") is used by management as the measure for income from
operations in assessing performance. Segment performance for the first half of
fiscal 2003 compared to the first half of fiscal 2002 was as follows:
- North American Consumer income from operations increased from $95.3
million in fiscal 2002 to $96.9 million in fiscal 2003 due to higher
sales in the fiscal 2003 period offset by lower margins and higher
spending on S, G&A and trade programs and advertising;
- Scotts LawnService(R) reported higher net sales ($26.8 million compared
to $16.1 million) but a larger loss from operations of $1.7 million in
fiscal 2003 compared to $10.1 million in fiscal 2002. As this highly
seasonal business grows it will have larger losses in the first and
second quarters of the fiscal year due to seasonally low revenues and
high fixed overhead costs;
- International Consumer's operating income increased to $12.0 million
from $9.0 million on improved supply chain results and S,G&A savings
offset by restructuring charges. Operating income also was impacted
favorably $2.0 million by higher exchange rates on foreign currencies;
- The Global Professional business showed a profit of $10.6 million in
fiscal 2003 compared to income from operations of $9.0 million in fiscal
2002 due to improved supply chain results and the favorable impact of
exchange rates on results from our operations outside the United States.
- The operating loss for the other/corporate segment increased from $28.7
million in the first half of fiscal 2002 to $36.2 million in the first
half of fiscal 2003 due to higher costs related to the expensing of
stock-based compensatory awards in fiscal 2003, higher pension costs,
increased fringe benefit costs, systems related costs and North American
restructuring and other related activities.
Interest expense for the first six months of fiscal 2003 was $35.2 million,
a decrease of $5.0 million from interest expense for the six months of fiscal
2002 of $40.2 million. The decrease in interest expense was due to lower
interest rates and lower average borrowings as compared to the prior year as a
result of fiscal 2002's strong cash flows providing for a large cash carryover
balance of nearly $100 million at September 30, 2002.
Income tax expense in the first half of fiscal 2003 was $9.6 million
compared with income tax expense for the first half of fiscal 2002 of $11.1
million. The estimated income tax rate for the first half of fiscal 2003 was
38.0% compared to 38.3% for the first half of fiscal 2002. The full year fiscal
2002 effective tax rate was 38.0% and remains at that level thus far in fiscal
2003.
The Company reported income before cumulative effect of accounting changes
of $15.7 million for the first six months of fiscal 2003, compared to $17.9
million for the first six months of fiscal 2002. 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 loss for the first six months
of fiscal 2002 was $0.6 million, or $0.2 per share, compared to net income of
$15.7 million or $0.49 per share for the first six months of fiscal 2003.
Average shares outstanding were 29.0 million at March 30, 2002 and 32.1 million
at March 29, 2003. Common stock equivalents were not included in
34
the shares used for earnings per share calculations in the fiscal 2002 period
due to their anti-dilutive effect in periods with net losses.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operating activities was $380.6 million for the six months
ended March 29, 2003 compared to $199.4 million for the six months ended March
30, 2002. The seasonal nature of our operations generally requires cash to fund
significant increases in working capital (primarily inventory and accounts
receivable) during the first half of the fiscal year. Cash used in operations in
the first half of fiscal 2003 was greater than the first half of fiscal 2002
because of larger increases in accounts receivable and inventory during the
fiscal period, partially offset by a corresponding increase in accounts payable.
Receivables increased from March 2002 to March 2003 due to higher sales in March
2003 compared to March 2002, the affect of foreign exchange rates and reduced
emphasis on customer anticipation payments in March 2003 than in the past.
Inventories declined from $426.8 million at March 30, 2002 to $400.2 million at
March 29, 2003. However, inventories at the beginning of fiscal 2003 were only
$269.1 million compared to $368.4 million at the beginning of fiscal 2002. Thus,
the seasonal buildup of inventory at the end of March required $131.1 million in
funds in fiscal 2003 compared to only $58.3 million in fiscal 2002. Accounts
payable was similarly affected by the increased production during the fiscal
2003 period as the comparable balances at the end of March 2003 and March 2002
were $292.8 million and $270.1 million respectively but the increase from the
beginning of the respective fiscal years was $158.9 million in fiscal 2003
compared to $119.1 in fiscal 2002.
Cash used in investing activities was $63.5 million for the first six months
of fiscal 2003 compared to $41.4 million in the prior year period. Capital
expenditures increased from $22.3 million in fiscal 2002 to $31.3 million in
fiscal 2003 in line with higher projected spending on plant, equipment and
technology systems in fiscal 2003. Scotts LawnService(R) completed 9
acquisitions costing $11.5 million thus far in fiscal 2003 compared to 16
acquisitions costing $9.2 million in the first half of fiscal 2002. Payments or
seller notes were $27.0 million in fiscal 2003 compared to $16.0 in fiscal 2002
as the timing of actual payments for acquisitions and seller notes reflects the
terms and conditions of the various acquisition agreements.
Financing activities provided cash of $355.7 million for the six three
months of fiscal 2003 compared to providing $262.1 million in the prior year
period. The increase in cash from financing activities was primarily due to
borrowings under our revolving credit facility to fund operations due to the
seasonal buildup in working capital as noted above. In the first quarter of
fiscal 2003, a mandatory prepayment of $24.4 million was made on the term loans
under our revolving credit facility as required by the level of excess cash
flow, as defined in the Credit Agreement, we achieved in fiscal 2002.
Our primary sources of liquidity are funds generated by operations and
borrowings under our Credit Agreement. The Credit Agreement initially provided
for borrowings in the aggregate principal amount of $1.1 billion consisting of
term loan facilities in the aggregate amount of $525 million and a revolving
credit facility in the amount of $575 million. Due to paydowns on our term
loans, the amount available under the term loan facilities has been reduced to
approximately $347.9 million as of March 29, 2003. Also, as of March 29, 2003,
approximately $11.5 million of the $575 million revolving credit facility is
committed for letters of credit; the balance of approximately $563.5 million is
available for use against which $372.0 million was outstanding at March 29,
2003.
Total debt was $1,160.7 million as of March 29, 2003, an increase of $34.0
million compared with total debt at March 30, 2002 of $1,126.7 million. Nearly
$60 million of the increase is due to the effects of foreign exchange rates on
the portions of our borrowings denominated in foreign currencies. The decline in
borrowings after adjusting for exchange rates is due to strong cash flow in
fiscal 2002 providing a beginning of the year cash balance of nearly $100
million at October 1, 2002 compared to only $19.7 million at October 1, 2001.
At March 29, 2003, we were in compliance with all debt covenants. The Credit
Agreement contains covenants on interest coverage and leverage. The Credit
Agreement and the Subordinated Note indenture also contain numerous negative
covenants which we are also in compliance with thus far in fiscal 2003. There
are no rating triggers in our Credit Agreement or the Subordinated Note
indenture.
Total cash was $12.3 million at March 29, 2003 a decline of $87.4 million
from September 30, 2002 reflecting
35
seasonal working capital needs.
We did not repurchase any common shares for treasury in fiscal 2001 or
fiscal 2002, or thus far in fiscal 2003. We have not paid dividends on the
common shares in the past and presently do not plan to pay dividends on the
common shares. We anticipate that cash will be retained and reinvested to
support the growth of our business or to pay down indebtedness. The payment of
future dividends, if any, on common shares will be determined by the Board of
Directors of Scotts in light of conditions then existing, including our
earnings, financial condition and capital requirements, restrictions in
financing agreements, business conditions and other factors.
All of our off-balance sheet financing is in the form of operating leases
which are disclosed in the notes to consolidated financial statements included
in our Annual Report of Form 10-K for the year ended September 30, 2002. We have
no financial guarantees or other arrangements with any related parties other
than our subsidiaries. All material intercompany transactions are eliminated in
our consolidated financial statements. Certain transactions with executive
officers are fully described and disclosed in our proxy statement. Such
transactions do not exceed $150,000 per annum.
In July 2002, the Company's Board of Directors approved a plan designed to
significantly improve the profitability of the International Consumer and
Professional businesses. The plan includes implementation of an SAP platform
throughout Europe, as well as efforts to optimize operations in the United
Kingdom, France and Germany, including the creation of a global supply chain. We
estimate that there will be a cash outlay of $50-$60 million, of which
approximately 25% will be capital expenditures, to implement this plan fully
over the next several years.
We are party to various pending judicial and administrative proceedings
arising in the ordinary course of business. These include, among others,
proceedings based on accidents or product liability claims and alleged
violations of environmental laws. We have reviewed our pending environmental and
legal proceedings, including the probable outcomes, reasonably anticipated costs
and expenses, availability and limits of our insurance coverage and have
established what we believe to be appropriate reserves. We do not believe that
any liabilities that may result from these proceedings are reasonably likely to
have a material adverse effect on our liquidity, financial condition or results
of operations.
In our opinion, cash flows from operations and capital resources will be
sufficient to meet debt service and working capital needs during fiscal 2003,
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.
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. Additional information on
environmental matters affecting us is provided in Note 9 of the Notes to
Condensed, Consolidated Financial Statements (unaudited) as of and for the three
month and six month periods ended March 29, 2003 and in the fiscal 2002 Annual
Report on Form 10-K under the "ITEM 1. BUSINESS - ENVIRONMENTAL AND REGULATORY
CONSIDERATIONS" and "ITEM 3. LEGAL PROCEEDINGS" sections.
FORWARD-LOOKING STATEMENTS
We have made and will make "forward-looking statements" within the meaning
of Section 27A of the Securities
36
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 in this Form
10-Q and in other contexts relating to future growth and profitability targets
and strategies designed to increase total shareholder value. Forward-looking
statements also include, but are not limited to, information regarding our
future economic 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.
Some forward-looking statements that we make in this Form 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 attributable to us or persons working on
our behalf are expressly qualified in their entirety by the following cautionary
statements.
- - 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 under
outstanding indebtedness and otherwise;
- 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,
advertising, 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 acquisitions 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 you that our business will generate sufficient cash flow
from operations or 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 you 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
37
to meet those financial ratios and tests can be affected by events
beyond our control, and we cannot assure you that we will meet those tests. A
breach of any of these covenants could result in a default under our Credit
Agreement and/or our outstanding senior subordinated notes. Upon the occurrence
of an event of default under our Credit Agreement and/or the senior subordinated
notes, the lenders and/or noteholders could elect to declare the applicable
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.
- - 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. 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, more than 70% 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 effect on our ability to conduct our business. Adverse weather
conditions could heighten this risk.
- - 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 one of our brand
names. On occasion, allegations are made that some of our products have failed
to perform up to expectations or have caused damage or injury to individuals or
property. Based on reports of contamination at a third party supplier's
vermiculite mine, the public may perceive that some of our products manufactured
in the past using vermiculite are or may also be contaminated. Public perception
that our products are not safe, whether justified or not, could impair
reputation, involve us in litigation, damage our brand names and have a material
adverse affect our business.
- - THE NATURE OF CERTAIN OF OUR PRODUCTS AND OUR BUSINESS SUCCESS CONTRIBUTE TO
THE RISK THAT THE COMPANY WILL BE SUBJECTED TO LAWSUITS.
The nature of certain of our products and our business success contribute to
the risk that the Company will be subjected to lawsuits. The following are among
the factors that contribute to this litigation risk:
- We manufacture and market a number of complex chemical products bearing
our brand names, including fertilizers, growing media, herbicides and
pesticides. There is a portion of the population that perceives all
chemical products as potentially hazardous. This perception, regardless
of its merits, enhances the risk that the Company will be subjected to
product liability claims that allege harm from exposure to our products.
Product liability claims are brought against the Company from time to
time. The Company believes that none of the product liability claims of
which it is aware are material either individually or in aggregate.
- A third party vendor supplied contaminated vermiculite ore to the
Company. Although our use of vermiculite ore from the contaminated
source ended over twenty years ago, our relationship with this supplier
enhances the risk that the Company will be subjected to personal injury
and product liability claims relating to the use of vermiculite in some
of our products. The Company believes that its finished products were
contamination-free and that consumers were not exposed to contaminated
products. Workers' compensation claims and third party invitee claims
(such as claims by contractors and railroad workers) alleging injury
from historical exposure on the Company's premises to this contaminated
vermiculite are brought against the Company from
38
time to time. The Company believes that none of the vermiculite related
claims of which it is aware are material either individually or in
aggregate.
- We are a significant competitor in many of the markets in which we
compete. Our success in our markets enhances the risk that the Company
will be targeted by plaintiffs' lawyers, consumer groups, competitors
and others asserting antitrust claims. Antitrust claims are brought
against the Company from time to time. The Company believes that the
antitrust claims of which it is aware are without merit.
Based on the facts, claims and circumstances known to the Company, the
Company believes that current claims of the types discussed above are without
merit, immaterial or both. However, there can be no assurance that current or
future claims of the types described above, or other types of claims, will not
be decided adversely to the Company, or that our involvement in such claims or
the cost of defending the Company against such claims will not impair our
reputation, damage our brand names or materially adversely affect our business,
results of operations, financial position and cash flows.
Please see Note 9 of the Notes to Condensed, Consolidated Financial
Statements (unaudited) of the Company as of and for the three month and six
months ended March 29, 2003 and Part II, Item 1 "Legal Proceedings" of this Form
10-Q for information concerning certain significant lawsuits and claims
involving the Company.
- - BECAUSE OF THE CONCENTRATION OF OUR SALES TO A SMALL NUMBER OF RETAIL
CUSTOMERS, THE LOSS OF ONE OR MORE OF, OR SIGNIFICANT DECLINE IN ORDERS
FROM, OUR TOP CUSTOMERS COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS.
North American Consumer net sales represent approximately 70% of our
worldwide net sales. Our top four North American retail customers together
accounted for over 75% of our North American Consumer fiscal 2002 net sales and
42% of our outstanding accounts receivable as of September 30, 2002. Home Depot,
Wal-Mart, Lowe's and Kmart represented approximately 37%, 18%, 11% and 10%,
respectively, of our fiscal 2002 North American Consumer net sales. The loss of,
or reduction in orders from, Home Depot, Wal-Mart, Lowe's, Kmart 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 a
deterioration in the financial condition of, or other adverse developments
involving our relationship with, one or more customers.
Kmart, one of our top customers, filed for bankruptcy relief under Chapter
11 of the bankruptcy code on January 22, 2002. Following such filing, and their
successful obtaining of debtor-in-possession financing, we recommenced shipping
products to Kmart, and we intend to continue shipping products to Kmart for the
foreseeable future. Kmart emerged from its bankruptcy reorganization in April
2003. However, we are unable to assess at this time the impact changes in their
business going forward may have on our future sales or earnings.
- - THE HIGHLY COMPETITIVE NATURE OF THE COMPANY'S MARKETS COULD ADVERSELY
AFFECT THE ABILITY OF THE COMPANY TO GROW OR MAINTAIN REVENUES.
Each of our segments participates in markets that are highly competitive.
Many of our competitors sell their products at prices lower than ours, and we
compete primarily on the basis of product quality, product performance, value,
brand strength, supply chain competency and advertising. Some of our competitors
have significant financial resources and research departments. The strong
competition that we face in all of our markets may prevent us from achieving our
revenue goals, which may have a material adverse affect on our financial
condition and results of operations.
- - IF MONSANTO WERE TO TERMINATE THE MARKETING AGREEMENT FOR CONSUMER
ROUNDUP(R) PRODUCTS WITHOUT BEING REQUIRED TO PAY ANY TERMINATION FEE, WE
39
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
for cause, we would not be entitled to any termination fee, and we would lose
all, or a significant portion, of this significant source of earnings and
overhead expense absorption 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 HAGEDORN PARTNERSHIP, L.P. BENEFICIALLY OWNS APPROXIMATELY 34% OF OUR
OUTSTANDING COMMON SHARES ON A FULLY DILUTED BASIS.
The Hagedorn Partnership, L.P. beneficially owns approximately 34% of our
outstanding common shares 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 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: 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 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
from retailers by December 2004 of residential uses of products containing
diazinon, used also 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 you 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.
40
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 is seeking corrective action under
the Resource Conservation Recovery Act. We have met with the Ohio EPA and the
Ohio Attorney General's office 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.
In fiscal 2002, we made $0.3 in environmental capital expenditures and
incurred approximately $5.4 million in other environmental expenses, compared
with approximately $0.6 million in environmental capital expenditures and $2.1
million in other environmental expenses in fiscal 2001. We expect spending on
environmental matters in fiscal 2003 will not vary materially from the amounts
spent in the past two fiscal years.
The adequacy of these estimated 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
- 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 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, France and the
Netherlands. In fiscal 2002, international sales accounted for approximately 24%
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
41
potentially adverse tax consequences. The costs related to our international
operations could adversely affect our operations and financial results in the
future.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days of the date of filing of this Quarterly Report on Form 10-Q,
an evaluation ("Evaluation") was performed under the supervision of, and with
the participation of, the Registrant's management, including the Registrant's
principal executive officer and principal financial officer, of the Registrant's
disclosure controls and procedures. Based upon the Evaluation, the principal
executive officer and principal financial officer concluded that:
(A) information required to be disclosed by the Registrant in this Quarterly
Report on Form 10-Q would be accumulated and communicated to the
Registrant's management, including its principal executive and financial
officers, as appropriate, to allow timely decisions regarding required
disclosure; and
(B) information required to be disclosed by the Registrant in this Quarterly
Report on Form 10-Q would be recorded, processed and summarized, and
would be reported within the time period specified in the SEC's rules
and forms.
No significant changes were made to the Registrant's internal controls or in
other factors that could significantly affect these internal controls subsequent
to the date of the Evaluation.
42
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
SCOTTS V. UNITED INDUSTRIES, SOUTHERN DISTRICT OF FLORIDA
On April 15, 2002, Scotts and OMS Investments, Inc., a subsidiary of Scotts
that holds various Scotts intellectual property assets, filed a six count
complaint against United Industries Corp. and Pursell Industries, Inc. -- now
known as U.S. Fertilizer Corporation -- for acts of (1) federal trademark and
trade dress infringement; (2) federal unfair competition; (3) federal dilution;
(4) common law trademark and trade dress infringement in violation of Florida
law and other applicable law; (5) common law unfair competition in violation of
Florida law and other applicable law; and (6) dilution in violation of Florida
law and other applicable law. The claims against U.S. Fertilizer were
subsequently resolved by a Settlement Agreement and Release dated February 6,
2003. In this Settlement Agreement and Release, U.S. Fertilizer acknowledged and
agreed "that Scotts' trade dress as well the overall color designs and design
layout that are utilized on the packaging of Scotts' TURF BUILDER(R) line as
identified in the Civil Action (the `Turf Builder Trade Dress') are valid,
protectable, and non-functional trade dress." U.S. Fertilizer is no longer a
party to this action.
Shortly after filing the original complaint in this matter, Scotts filed its
motion for preliminary injunction, which motion sought an injunction enjoining
United Industries, pending trial, from manufacturing, producing, shipping,
distributing, advertising, promoting, displaying, selling or offering for sale
products in the then current packaging for its Spectracide(R) No Odor Fire Ant
Killer Ready-to-Use Dust product and from otherwise using any trademarks, trade
dress, packaging, promotional materials or other items which incorporated or
were confusingly similar to the trademarks and trade dress featured in Scotts'
Ortho(R) Orthene(R) Fire Ant Killer product packaging. Despite finding that
United had intentionally copied Scotts' trade dress, the trial court denied the
motion for preliminary injunction. Scotts appealed, but the United States Court
of Appeals for the Eleventh Circuit affirmed.
On December 13, 2002, Scotts filed its amended complaint. The amended
complaint contains the same causes of action as the original complaint, but
asserts additional grounds in support of plaintiffs' claim that United has
infringed and diluted plaintiffs' Miracle-Gro(R) trade dress. The amended
complaint also revises certain of the allegations in the original complaint to
conform to facts recently learned.
United Industries subsequently filed its answer and counterclaim to the
amended complaint. This answer and counterclaim is virtually identical to its
original answer and counterclaim in that it seeks to cancel a specific Scotts'
Miracle-Gro(R)and Design trademark registration (Reg. No. 2,139,929) and Scotts'
pending Ortho(R) Orthene(R) Fire Ant Killer and Design trademark application
(Serial No. 76/126,545). We believe that this counterclaim is without merit.
On April 21, 2003, the parties mediated the matters. While several points of
tentative agreement were reached, no settlement agreement has been reached or
entered into.
We do not anticipate incurring any damages relating to this action.
SCOTTS V. AVENTIS S.A. AND STARLINK LOGISTICS, INC.
On August 9, 2002, Scotts filed suit against Aventis S.A. and its
wholly-owned subsidiary Starlink Logistics, Inc. in the U.S. District Court for
the Southern District of Ohio. In the complaint, Scotts alleges it is entitled
to injunctive and monetary relief arising from Aventis' and Starlink's
interference with Scotts' contractual right to purchase a company called
TechPac, L.L.C. from one of Aventis' former subsidiaries, Aventis CropScience.
The complaint alleges that pursuant to a contract between Scotts and a
predecessor-in-interest to Aventis CropScience, Aventis CropScience was
obligated to make a bona fide offer to sell its interest in TechPac to Scotts.
The complaint further alleges that Aventis directed Aventis CropScience to make
a belated sham offer to Scotts and that later, upon the sale of Aventis
CropScience to Bayer AG, Aventis transferred ownership of TechPac to Starlink,
an act which has made it impossible for Aventis CropScience's
successor-in-interest to make a bona fide offer to sell TechPac to Scotts.
43
In this suit, Scotts seeks to ensure that it is able to exercise its right
to receive a bona fide offer to acquire TechPac, and Scotts seeks to recover
compensatory and punitive damages in an amount as yet undetermined for Aventis'
and Starlink's interference with Scotts' right to receive such an offer. On
October 4, 2002, Starlink filed a motion to dismiss the complaint on
jurisdictional grounds. On December 17, 2002, Aventis filed a similar motion.
Scotts has opposed these motions and intends to vigorously prosecute its claims
against Aventis and Starlink. Discovery on jurisdictional issues is underway. A
trial date has not been set.
OTHER
During the first quarter of fiscal 2003, a fork lift accident occurred at
Scotts' plant in Chino, California. The accident resulted in the death of a
Scotts' associate. Scotts believes that workers' compensation insurance coverage
is the family's exclusive remedy against Scotts and therefore does not currently
anticipate any action by the family against Scotts. There is some risk, however,
that claims will be made by the employee's family against third parties, in
which case Scotts may become involved in the litigation. Scotts believes it has
defenses to any attempt to add Scotts as a defendant, but there can be no
guarantees at this point that the defense would be successful. As of May 9,
2003, we are not aware of any complaint that has been filed relating to the
accident or any other action by the employee's family.
We are involved in other lawsuits and claims which arise in the normal
course of our business. In our opinion, these claims individually and in the
aggregate are not expected to result in a material adverse effect on our results
of operations, financial position or cash flows.
FOR ADDITIONAL INFORMATION ON MATERIAL LITIGATION, PLEASE SEE NOTE 9 OF THE
NOTES TO THE COMPANY'S CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
AS OF AND FOR THE SIX MONTHS ENDED MARCH 29, 2003.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
As part of the consideration for the Miracle-Gro merger, The Scotts Company
issued Series B Warrants to purchase 977,786 common shares of The Scotts Company
to Hagedorn Partnership, L.P. in May 1995. The exercise term for the Series B
Warrants expires in November 2003.
Hagedorn Partnership, L.P. made the following exercises of Series B Warrants
during The Scotts Company's second quarter of fiscal 2003, all of which were
done on a cashless basis in accordance with the terms of the Series B Warrants:
Series B Warrants Common Shares
Date Exercised Exercise Price Received
- ---- ----------------- -------------- -------------
1/9/03 300,770 $25 152,549
1/10/03 278,662 $25 149,148
3/21/03 54,320 $25 28,028
3/24/03 50,000 $25 26,548
Series B Warrants to purchase 131,070 common shares of The Scotts Company
remained outstanding as of the end of The Scotts Company's second quarter of
fiscal 2003.
The Series B Warrants as well as the common shares issuable upon exercise of the
Series B Warrants were registered pursuant to a Registration Statement on Form
S-4 (Registration No. 33-57595) declared effective on March 15, 1995. If and to
the extent that the Securities and Exchange Commission were to determine that
such registration did not extend to the issuance of common shares of The Scotts
Company upon exercise of the Series B Warrants, The Scotts Company may also be
deemed to have issued the common shares in reliance upon the exemptions from
registration provided in Section 4(2) and other related provisions of the
Securities Act of 1933.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Index to Exhibits at page 49 for a list of the exhibits included
herewith.
44
(b) The Registrant filed no Current Reports on Form 8-K during the quarter
covered by this Report.
45
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: May 12, 2003 Chief Financial Officer, Executive Vice
President of Finance,
(Duly Authorized Officer) (Principal Financial
Officer)
46
CHIEF EXECUTIVE OFFICER CERTIFICATION
I, James Hagedorn, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Scotts Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 12, 2003 /s/ James Hagedorn
------------------------------------------------
James Hagedorn, President/
Chief Executive Officer/Chairman of the Board
47
CHIEF FINANCIAL OFFICER CERTIFICATION
I, Christopher L. Nagel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Scotts Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 12, 2003 /s/ Christopher L. Nagel
-----------------------------------------
Christopher L. Nagel, Executive Vice
President and Chief Financial Officer
48
THE SCOTTS COMPANY
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED MARCH 29, 2003
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.
49