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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 27, 2004
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.
32,653,222 OUTSTANDING AT APRIL 29, 2004
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 (Unaudited)
Condensed, Consolidated Statements of Operations - Three and six month
periods ended March 27, 2004 and March 29, 2003...................................... 3
Condensed, Consolidated Statements of Cash Flows - Six month
periods ended March 27, 2004 and March 29, 2003...................................... 4
Condensed, Consolidated Balance Sheets - March 27, 2004,
March 29, 2003 and September 30, 2003................................................ 5
Notes to Condensed, Consolidated Financial Statements................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations... 27
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................. 38
Item 4. Controls and Procedures................................................................. 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................... 39
Item 6. Exhibits and Reports on Form 8-K........................................................ 40
Signatures............................................................................................. 41
Index to Exhibits...................................................................................... 42
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 ENDED SIX MONTHS ENDED
---------------------- ----------------------
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
-------- -------- -------- --------
Net sales .................................................... $ 729.2 $ 676.2 $ 915.4 $ 856.9
Cost of sales ................................................ 439.0 417.6 575.4 556.6
Restructuring and other charges .............................. 0.2 0.7 0.7 5.1
-------- -------- -------- --------
Gross profit ........................................... 290.0 257.9 339.3 295.2
Gross commission earned from marketing agreement ............. 15.3 11.3 15.3 11.3
Costs associated with marketing agreement .................... 7.1 7.1 14.2 14.2
-------- -------- -------- --------
Net commission from marketing agreement ...................... 8.2 4.2 1.1 (2.9)
Operating expenses:
Advertising ............................................... 39.8 34.9 48.1 43.5
Selling, general and administrative ....................... 107.1 91.3 185.1 158.8
Selling, general and administrative - lawn service business 15.2 13.1 27.6 23.1
Stock-based compensation .................................. 3.1 1.2 4.4 1.6
Restructuring and other charges ........................... 0.2 2.4 0.7 4.3
Amortization of intangibles ............................... 2.3 2.1 4.8 4.1
Other income, net ......................................... (2.1) (2.4) (3.9) (3.6)
-------- -------- -------- --------
Income from operations ................................. 132.6 119.5 73.6 60.5
Interest expense ............................................. 13.5 18.7 25.4 35.2
Costs related to refinancing ................................. 0.6 -- 44.3 --
-------- -------- -------- --------
Income before income taxes ............................. 118.5 100.8 3.9 25.3
Income taxes ................................................. 45.4 38.3 1.5 9.6
-------- -------- -------- --------
Net income ............................................. $ 73.1 $ 62.5 $ 2.4 $ 15.7
======== ======== ======== ========
BASIC EARNINGS PER COMMON SHARE:
Weighted-average common shares outstanding during the period . 32.2 30.7 32.1 30.5
Basic earnings per common share .............................. $ 2.27 $ 2.04 $ 0.07 $ 0.52
DILUTED EARNINGS PER COMMON SHARE:
Weighted-average common shares outstanding during the period . 33.0 32.2 32.9 32.1
Diluted earnings per common share ............................ $ 2.21 $ 1.94 $ 0.07 $ 0.49
See notes to condensed, consolidated financial statements
3
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
SIX MONTHS ENDED
----------------
MARCH 27, MARCH 29,
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income .................................................................. $ 2.4 $ 15.7
Adjustments to reconcile net income to net cash used in operating activities:
Costs related to refinancing.............................................. 44.3 --
Stock-based compensation expense ......................................... 4.4 1.6
Depreciation ............................................................. 21.7 18.8
Amortization ............................................................. 6.5 5.8
Deferred taxes ........................................................... (0.1) 9.9
Changes in assets and liabilities, net of acquired businesses:
Accounts receivable ................................................... (485.5) (461.9)
Inventories ........................................................... (142.5) (131.1)
Prepaid and other current assets ...................................... (13.0) (13.8)
Accounts payable ...................................................... 130.2 141.5
Accrued taxes and liabilities ......................................... 38.4 36.1
Restructuring reserves ................................................ (2.9) (3.2)
Other assets .......................................................... (0.9) 2.0
Other liabilities ..................................................... 7.0 (0.1)
Other, net ............................................................... (14.5) (1.9)
-------- --------
Net cash used in operating activities ................................ (404.5) (380.6)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment .............................. (10.9) (31.3)
Investment in acquired businesses, net of cash acquired .................. (5.3) (5.2)
Payments on seller notes ................................................. (8.9) (27.0)
-------- --------
Net cash used in investing activities ................................. (25.1) (63.5)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under revolving and bank lines of credit .................. 330.7 373.0
Proceeds from issuance of term loans - New Credit Agreement .............. 500.0 --
Repayment of term loans - former Credit Agreement ........................ (326.5) (25.8)
Issuance of 6 5/8% Senior Subordinated Notes ............................. 200.0 --
Redemption of 8 5/8% Senior Subordinated Notes ........................... (418.0) --
Financing fees, net ...................................................... (11.5) (0.5)
Cash received from the exercise of stock options ......................... 12.2 9.0
-------- --------
Net cash provided by financing activities .............................. 286.9 355.7
Effect of exchange rate changes on cash .................................. 1.0 1.0
-------- --------
Net decrease in cash ..................................................... (141.7) (87.4)
Cash and cash equivalents at beginning of period ......................... 155.9 99.7
-------- --------
Cash and cash equivalents at end of period ............................... $ 14.2 $ 12.3
======== ========
See notes to condensed, consolidated financial statements
4
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN MILLIONS)
MARCH 27, MARCH 29, SEPTEMBER 30,
2004 2003 2003
-------- -------- --------
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 14.2 $ 12.3 $ 155.9
Accounts receivable, less allowances of $22.3, $26.7 and $20.0, respectively 776.0 724.3 290.5
Inventories, net ........................................................... 418.6 400.2 276.1
Current deferred tax asset ................................................. 60.7 72.5 56.9
Prepaid and other assets ................................................... 46.2 50.8 33.2
-------- -------- --------
Total current assets .................................................... 1,315.7 1,260.1 812.6
Property, plant and equipment, net of accumulated depreciation of $285.6,
$259.3 and $270.5, respectively ............................................ 329.5 342.6 338.2
Goodwill ...................................................................... 423.3 384.2 406.5
Intangible assets, net ........................................................ 431.7 419.5 429.0
Other assets .................................................................. 41.1 47.5 44.0
-------- -------- --------
Total assets ............................................................ $2,541.3 $2,453.9 $2,030.3
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt .................................................... $ 27.7 $ 287.7 $ 55.4
Accounts payable ........................................................... 279.2 264.2 149.0
Accrued liabilities ........................................................ 263.1 249.1 234.3
Accrued taxes .............................................................. 23.3 27.7 9.5
-------- -------- --------
Total current liabilities ............................................... 593.3 828.7 448.2
Long-term debt ................................................................ 1,039.9 873.0 702.2
Other liabilities ............................................................. 162.3 132.2 151.7
-------- -------- --------
Total liabilities ....................................................... 1,795.5 1,833.9 1,302.1
Commitments and contingencies (notes 3 and 9)
Shareholders' equity:
Common Shares, no par value per share, $.01 stated value per share, 32.3,
31.3, 32.0 shares issued, respectively .................................. 0.3 0.3 0.3
Deferred compensation - stock awards ....................................... (18.8) (10.4) (8.3)
Capital in excess of par value ............................................. 426.8 398.6 398.4
Retained earnings .......................................................... 401.0 310.5 398.6
Treasury stock, 0.0, 0.5, and 0.0 shares, respectively, at cost ............ -- (20.7) --
Accumulated other comprehensive loss ....................................... (63.5) (58.3) (60.8)
-------- -------- --------
Total shareholders' equity .............................................. 745.8 620.0 728.2
-------- -------- --------
Total liabilities and shareholders' equity .............................. $2,541.3 $2,453.9 $2,030.3
======== ======== ========
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 and
garden care 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, 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 AND BASIS OF PRESENTATION
The Company's condensed, consolidated financial statements are unaudited;
however, in the opinion of management, are presented in accordance with
accounting principles generally accepted in the United States of America.
The condensed, consolidated financial statements include the accounts of
The Scotts Company and all wholly-owned and majority-owned subsidiaries.
All material intercompany transactions have been eliminated in
consolidation. The Company's criteria for consolidating entities is based
on majority ownership (as evidenced by a majority voting interest in the
entity) and an objective evaluation and determination of effective
management control. 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 2003 Annual Report on Form 10-K.
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 primarily through
direct response mail campaigns. The external costs associated with these
campaigns are deferred and recognized ratably as advertising expense in
proportion to revenues over a period not in excess of one year. The costs
deferred at March 27, 2004, March 29, 2003 and September 30, 2003 are $1.9
million, $2.2 million and $1.0 million, respectively.
STOCK-BASED COMPENSATION AWARDS
Beginning in fiscal 2003, the Company began expensing prospective grants
of employee stock-based compensation awards in accordance with Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" as amended by Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure -- an Amendment of SFAS No. 123". Beginning in fiscal 2003, the
fair value of new awards is expensed ratably over the vesting period,
which has historically been three years, except for grants to members of
the Board of Directors, which have a six month vesting period.
On March 31, 2004, the Financial Accounting Standards Board (FASB) issued
its Exposure Draft, "Share-Based Payment" which is a proposed amendment to
SFAS No. 123. Generally, the approach in the Exposure Draft is similar to
the approach described in SFAS No. 123. The Exposure Draft would require
all share-based payments to employees, including grants of employee stock
options, to be recognized in the income statement based on their fair
values. Companies would no longer have the option to account for their
share-based awards to employees using APB Opinion No. 25 (the intrinsic
value model) or SFAS No. 123 (the fair value model). As the Company is
accounting for its employee stock-based compensation awards in accordance
with SFAS No. 123, the issuance of the proposed amendment is not expected
to have a significant effect on the Company's results of operations.
In the first quarter of fiscal 2004, the Company granted 44,000 options
and 493,000 stock appreciation rights to officers and other
6
key employees. In the second quarter of fiscal 2004, the Company granted
73,500 options to members of the Company's Board of Directors. In the
first half of fiscal 2003, the Company granted 435,000 options and 209,000
stock appreciation rights to officers, key employees and members of the
Board of Directors. The exercise price for the option awards and the
stated price for the stock appreciation right awards were determined by
the closing price of the Company's common shares on the date of grant.
The Black-Scholes value of options granted in fiscal 2002 was $10.7
million. The Black-Scholes value of all stock-based compensation grants
awarded during fiscal 2003 and thus far in fiscal 2004 was $13.1 million
and $14.0 million, respectively. Had compensation expense been recognized
for stock-based compensation awards granted in periods prior to fiscal
2003 in accordance with the recognition provisions of SFAS No. 123, the
Company would have recorded net income and net income per share as
follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
-------------------------- ------------------------
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
-------- -------- -------- --------
($ MILLIONS,
EXCEPT PER SHARE DATA)
Net income $ 73.1 $ 62.5 $ 2.4 $ 15.7
Stock-based compensation expense included in reported net
income, net of tax 1.9 0.7 2.7 1.0
Total stock-based employee compensation expense determined
under fair value based method for all awards, net of tax (2.4) (1.7) (3.7) (3.1)
-------- -------- -------- --------
Net income as adjusted $ 72.6 $ 61.5 $ 1.4 $ 13.6
======== ======== ======== ========
Net income per share:
Basic $ 2.27 $ 2.04 $ 0.07 $ 0.52
Diluted $ 2.21 $ 1.94 $ 0.07 $ 0.49
Net income per share, as adjusted:
Basic $ 2.25 $ 2.00 $ 0.04 $ 0.45
Diluted $ 2.20 $ 1.91 $ 0.04 $ 0.42
The pro forma amounts shown above are not necessarily representative of
the impact on net income/loss 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
Management assesses the recoverability of property and equipment whenever
events or changes in circumstances 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 is
recognized for the amount by which the carrying amount of the asset
exceeds its estimated fair value.
Management also 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 during the first
fiscal quarter. If it is determined that an impairment of intangible
assets has occurred, an impairment loss is recognized for the amount by
which the carrying value of the asset exceeds its estimated fair value. No
impairment charges were recorded during the first half of fiscal 2004 or
during fiscal 2003.
EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per
common share is calculated including common stock equivalents pertaining
to options, stock appreciation rights and warrants where the exercise
price was less than the average market price of the common shares. These
common stock equivalents equate to 0.8 million common shares for both the
three and six month periods ending March
7
27, 2004, and 1.5 million and 1.6 million common shares for the three and
six month periods ending March 29, 2003. Options to purchase 0.1 million
shares of common stock for both the three and six month periods ended
March 27, 2004, and 0.1 million and 0.3 million shares for the three and
six month periods ended March 29, 2003, respectively, were not included in
the computation of diluted earnings per share. These options were excluded
from the calculation because the exercise price was greater than the
average market price of the common shares in the respective periods, and
therefore, were anti-dilutive.
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 2004 classifications. In particular, a
reclassification of trade program liabilities within our International
segment was recorded in order to be consistent with the classification
used by our North America segment.
2. DETAIL OF INVENTORIES, NET
Inventories, net of provisions for slow moving and obsolete inventory of
$23.6 million, $25.5 million, and $22.0 million, respectively, consisted
of:
MARCH 27, MARCH 29, SEPTEMBER 30,
2004 2003 2003
-------- -------- --------
($ MILLIONS)
INVENTORIES, NET
Finished goods . $ 335.0 $ 308.7 $ 203.7
Raw materials .. 83.6 91.5 72.4
-------- -------- --------
Total .......... $ 418.6 $ 400.2 $ 276.1
======== ======== ========
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 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 increased 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.
8
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 27, 2004, contribution
payments and related per annum charges of approximately $48.7 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 quarter 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.
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 2004 CHARGES
During the three and six month periods ended March 27, 2004, the Company
recorded $0.4 million and $1.4 million of restructuring and other charges,
respectively. These charges, related to our North American distribution
restructuring and our International Profit Improvement Plan, were included
in cost of sales and selling, general and administrative costs in the
amounts of $0.7 million and $0.7 million, respectively, for the six months
ended March 27, 2004.
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.
During the entire fiscal year 2003, the Company recorded $17.1 million of
restructuring and other charges.
9
Costs of $5.3 million for warehouse lease buyouts and relocation of
inventory associated with exiting certain warehouses in North America, as
part of improvements to the North American supply chain, and $3.8 million
related to a plan to optimize our international supply chain were included
in cost of sales. Severance and consulting costs of $5.3 million for the
continued European integration efforts that began in the forth quarter of
fiscal 2002, and $2.7 million of administrative facility exit costs in
North America were charged to selling, general and administrative expense.
The severance costs incurred in fiscal 2003 were related to the reduction
of 78 administrative and production employees.
The following is a rollforward from September 30, 2003 of the cash portion
of the restructuring and other charges. The accrued charges are included
in accrued liabilities on the Condensed, Consolidated Balance Sheets. We
expect spending against these reserves to be completed by the end of
fiscal year 2005.
SEPTEMBER 30, MARCH 27,
2003 2004
------------- ---------
DESCRIPTION TYPE CLASSIFICATION BALANCE PAYMENT ACCRUAL BALANCE
----------- ---- -------------- ------- ------- ------- -------
($ MILLIONS)
Severance Cash SG&A $ 1.6 $ (1.5) $ 0.5 $ 0.6
Facility exit costs Cash SG&A and COS 0.9 (0.7) 0.8 1.0
Other related costs Cash SG&A 2.0 (2.1) 0.1 --
-------- -------- -------- --------
Total cash $ 4.5 $ (4.3) $ 1.4 $ 1.6
======== ======== ======== ========
5. LONG-TERM DEBT
MARCH 27, MARCH 29, SEPTEMBER 30,
2004 2003 2003
-------- -------- --------
($ MILLIONS)
Former Credit Agreement:
Revolving loans .................... $ -- $ 372.0 $ --
Term loans ......................... -- 347.9 326.5
New Credit Agreement:
Revolving loans .................... 323.2 -- --
Term loans ......................... 500.0 -- --
Senior Subordinated Notes:
8 5/8% Notes ....................... -- 392.5 393.1
6 5/8% Notes ....................... 200.0 -- --
Notes due to sellers ................. 18.4 23.7 21.6
Foreign bank borrowings and term loans 17.0 13.8 6.3
Capital lease obligations and other .. 9.0 10.8 10.1
-------- -------- --------
1,067.6 1,160.7 757.6
Less current portions ................ 27.7 287.7 55.4
-------- -------- --------
$1,039.9 $ 873.0 $ 702.2
======== ======== ========
In October 2003, the Company substantially completed a refinancing of the
former Credit Agreement ("Credit Agreement") and its $400 million 8 5/8%
Senior Subordinated Notes ("8 5/8% Notes") in a series of transactions. On
October 8, 2003, the Company issued $200 million of 6 5/8% Senior
Subordinated Notes due November 15, 2013 ("6 5/8% Notes"). On October 21,
2003, substantially all of the outstanding 8 5/8% Notes were tendered,
with the remainder being called on January 15, 2004. Finally, on October
22, 2003, the Company consummated a series of transactions which included
the repayment of the term loans outstanding under the former Credit
Agreement, the termination of the Credit Agreement, the execution of the
Second Amended and Restated Credit Agreement ("New Credit Agreement"), and
the borrowing of $500 million in the form of term loans under the New
Credit Agreement. The cost recognized in the first half of fiscal 2004 on
the extinguishment of the former Credit Agreement and retirement of the 8
5/8% Notes was $44.3 million, of which $19.4 million related to the
write-off of deferred costs, $24.0 million related to premiums paid on the
redemption of the 8 5/8% Notes and $0.9 million related to transaction
fees.
The New Credit Agreement was entered into with a syndicate of commercial
banks and institutional lenders. The New Credit Agreement consists of a
$700 million multi-currency revolving credit commitment and a $500 million
term loan B facility. Financial covenants consist of a minimum interest
coverage ratio and a maximum leverage ratio. There also are negative
covenants similar to those in the former Credit Agreement. All such
covenants are less restrictive than those contained in the former Credit
Agreement. Collateral for the borrowings under the New Credit Agreement
consists of pledges by the Company and all of its domestic subsidiaries of
substantially all of their personal, real and intellectual property
assets. The Company and its subsidiaries also pledged a majority of the
stock in foreign subsidiaries that borrow under the New Credit Agreement.
At March 27, 2004, the
10
Company is in compliance with all applicable covenants. Financing costs
approximating $7.1 million incurred in conjunction with the New Credit
Agreement have been deferred and are being amortized over the term of the
New Credit Agreement.
The revolving credit facilities under the New Credit Agreement provide for
a $700 million commitment, which can be increased to $750 million based on
the borrowing requirements of the Company, expiring on October 22, 2008.
Borrowings may be made in U.S. Dollars and optional currencies including,
but not limited to, Euros, British Pounds Sterling, Canadian Dollars and
Australian Dollars. The revolving credit facilities provide that up to $65
million of the $700 million commitment may be used for letters of credit.
Interest rate spreads under the New Credit Agreement will be determined by
a pricing grid corresponding to a quarterly calculation of the Company's
leverage ratio comprised of averaged components for the most recent four
quarters.
The $500 million term loan B facility expires on September 30, 2010.
Repayment of the term loan B commenced on March 31, 2004 with minimum
quarterly principal payments of $500,000 through June 30, 2010 followed by
a balloon maturity on September 30, 2010. The term loans carry a variable
interest rate based on prime or LIBOR at the Company's election (currently
LIBOR) plus a spread. The Company entered into interest rate swap
agreements with major financial institutions to effectively convert a
portion of the variable rate term loans to a fixed rate. The notional
amount and the terms of the swap agreements vary. At March 27, 2004, swap
agreements with a total notional amount of $175 million were in effect.
Under the terms of these swap agreements, the Company pays fixed rates
ranging from 2.76% to 3.77%, plus a spread based on the pricing grid
contained in the New Credit Agreement, and receives payments based on
three-month LIBOR in return.
The 6 5/8% Notes were issued in accordance with Rule 144A and Regulation S
under the Securities Act of 1933. The 6 5/8% Notes were sold at par, pay
interest semi-annually on May 15 and November 15, have a ten-year maturity
with a five-year no-call provision, and are guaranteed by certain current
and future domestic restricted subsidiaries of the Company (see Note 13).
Such guarantees are unsecured senior subordinated obligations of the
Company. The covenants contained in the 6 5/8% Notes indenture are less
restrictive than those contained in the 8 5/8% Notes indenture. Financing
costs approximating $4.4 million incurred with the issuance of the 6 5/8%
Notes have been deferred and are being amortized over the term of the
Notes. On May 7, 2004, the Company commenced an offer to exchange its 6
5/8% Notes for an equal principal amount of its 6 5/8% notes which have
been registered under the Securities Act of 1933, as amended. The terms of
the 6 5/8% notes issued in the exchange offer will be substantially
identical to the original 6 5/8% Notes, except that the original 6 5/8%
Notes contain transfer restrictions and registration rights that the
6 5/8% notes issued in the exchange offer will not contain.
The Company called the 8 5/8% Notes at 106.05% per $1,000 Note resulting
in a principal tendered amount of $386.8 million on October 21, 2003. The
Company redeemed the remaining $13.2 million of 8 5/8% Notes, that were
not tendered, on the first call date of January 15, 2004 at 104.313% per
$1,000 Note plus accrued interest. Additional costs of $0.6 million were
recognized in conjunction with the redemption during the three month
period ended March 27, 2004.
6. STATEMENT OF COMPREHENSIVE INCOME
The components of other comprehensive income and total comprehensive
income for the three and six month periods ended March 27, 2004 and March
28, 2003, are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
-------- -------- -------- --------
Net income .................................. $ 73.1 $ 62.5 $ 2.4 $ 15.7
Other comprehensive income (expense):
Change in valuation of derivative instruments (1.3) 0.3 (1.2) 0.3
Foreign currency translation adjustments .... (0.7) -- (1.5) (0.6)
-------- -------- -------- --------
Comprehensive income (loss).................. $ 71.1 $ 62.8 $ (0.3) $ 15.4
======== ======== ======== ========
11
7. RETIREMENT AND RETIREE MEDICAL PLANS COST INFORMATION
The Financial Accounting Standards Board has revised Statement 132,
"Employers' Disclosure about Pensions and Other Postretirement Benefits"
to require disclosure of cost information in interim reports. The
following summarizes the net periodic benefit cost for the various plans
sponsored by the Company (in millions):
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
-------- -------- -------- --------
Curtailed defined benefit plan $ 0.8 $ 0.7 $ 1.6 $ 1.5
International benefit plans .. 1.8 2.1 3.7 4.2
Retiree medical plan ......... 0.6 0.2 1.2 0.5
8. AIRCRAFT LEASE
In late January 2004, the Company took final delivery of a used aircraft
in a synthetic operating lease transaction. The lease agreement provides
that the Company pays taxes, insurance and maintenance on the aircraft.
The lease term expires in August 2008, but provides for a purchase option
and two one-year renewal options at a fair market rental value, as defined
in the lease agreement. The Company also has a maximum contingent
obligation approximating $9.3 million based on the provisions of a
residual value guarantee.
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, worker's compensation, property losses
and other fiduciary liabilities for which the Company is self-insured or
retains a high exposure limit. Insurance reserves are established within
an actuarially determined range. 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 EPA initiated an enforcement action against us with
respect to alleged surface water violations and inadequate treatment
capabilities at our Marysville, Ohio facility and seeking corrective
action under the federal Resource Conservation and Recovery Act. The
action related to several discontinued on-site disposal areas which dated
back to the early operations of the Marysville facility that we had
already been assessing and, in some cases, remediating, on a voluntary
basis. 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. Pursuant to the Consent Order, we paid a $275,000 fine
and must satisfactorily remediate the Marysville site. We have continued
our remediation activities with the knowledge and oversight of the Ohio
EPA.
In addition to the dispute with the Ohio EPA, we are negotiating with the
Philadelphia District of the U.S. Army Corps of Engineers 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.
At March 27, 2004, $5.9 million was accrued for the environmental site
remediation and regulatory matters described herein. Most of the costs
accrued as of the end of the current fiscal quarter, are expected to be
paid in fiscal 2004 and 2005; however, payments could be made for a period
thereafter.
12
We believe that the amounts accrued as of the end of the current fiscal
quarter are adequate to cover our known environmental exposures based on
current facts and estimates of likely outcome. However, the adequacy of
these accruals is based on 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, it could have a material impact on the
ultimate outcome of these matters and our results of operations, financial
position and cash flows.
During the first six months of fiscal 2004, we have expended approximately
$0.9 million related to environmental matters, compared with approximately
$1.5 million in environmental expenditures for all of fiscal 2003.
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 The Scotts Company, a
subsidiary of The Scotts Company and Monsanto seeking damages and
injunctive relief for alleged antitrust violations and breach of contract
by The Scotts Company and its subsidiary and antitrust violations and
tortious interference with contract by Monsanto. The Scotts Company
purchased a consumer herbicide business from AgrEvo in May 1998. AgrEvo
claims in the suit that The Scotts Company's 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 The Scotts Company to
eliminate the herbicide The Scotts Company previously purchased from
AgrEvo, which competed with Monsanto's Roundup(R). AgrEvo also contends
that The Scotts Company's execution of various agreements with Monsanto,
including the Roundup(R) marketing agreement, as well as The Scotts
Company's subsequent actions, violated agreements between AgrEvo and The
Scotts Company.
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 The Scotts Company 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 The Scotts Company's subsidiaries
seeking damages for alleged breach of contract. AgrEvo alleges that, under
the contracts by which a subsidiary of The Scotts Company purchased a
herbicide business from AgrEvo in May 1998, two of The Scotts Company's
subsidiaries have failed to pay AgrEvo approximately $0.6 million. AgrEvo
is requesting damages in this amount, as well as pre- and post-judgment
interest and attorneys' fees and costs. The Scotts Company's subsidiaries
have moved to dismiss or stay this action. On January 31, 2000, the
Delaware court stayed AgrEvo's action pending the resolution of a motion
to amend the New York Action, and the resolution of the New York Action.
On January 10, 2003, The Scotts Company filed a supplemental counterclaim
against AgrEvo for breach of contract. The Scotts Company alleges that
AgrEvo owes The Scotts Company for amounts that The Scotts Company
overpaid to AgrEvo. The Scotts
13
Company's counterclaim is now part of the underlying litigation. The
parties are in the process of preparing summary judgment motions. A trial
date has been set for November 1, 2004.
The Scotts Company believes that AgrEvo's claims in these matters are
without merit and is vigorously defending against them. If the above
actions are determined adversely to The Scotts Company, the result could
have a material adverse effect on The Scotts Company's results of
operations, financial position and cash flows. Any potential exposure that
The Scotts Company may face cannot be reasonably estimated. Therefore, no
accrual has been established related to these matters.
CENTRAL GARDEN & PET COMPANY
THE SCOTTS COMPANY V. CENTRAL GARDEN, SOUTHERN DISTRICT OF OHIO
On June 30, 2000, The Scotts Company filed suit against Central Garden &
Pet Company ("Central Garden") 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 The Scotts
Company and Central Garden had entered into an oral agreement in April
1998 whereby The Scotts Company would allegedly share with Central Garden
the benefits and liabilities of any future business integration between
The Scotts Company and Monsanto. The court dismissed a number of Central
Garden's counterclaims as well as The Scotts Company's claims that Central
Garden breached other duties owed to The Scotts Company. On April 22,
2002, a jury returned a verdict in favor of The Scotts Company of $22.5
million and for Central Garden on its remaining counterclaims in an amount
of approximately $12.1 million. Various post-trial motions were filed. As
a result of those motions, the trial court has reduced Central Garden's
verdict by $750,000, denied Central Garden's motion for a new trial on two
of its counterclaims and granted the parties pre-judgment interest on
their respective verdicts. On September 22, 2003, the court entered a
final judgment, which provided for a net award to The Scotts Company of
approximately $14 million, together with interest at 2.31% through the
date of payment. Central Garden has appealed and The Scotts Company has
cross-appealed from that final judgment.
Two counterclaims that the court permitted Central Garden to add on the
eve of trial were subsequently settled.
CENTRAL GARDEN V. THE SCOTTS COMPANY & PHARMACIA, NORTHERN DISTRICT OF
CALIFORNIA
On July 7, 2000, Central Garden filed suit against The Scotts Company and
Pharmacia in the U.S. District Court for the Northern District of
California (San Francisco Division) alleging various claims, including
breach of contract and violations of federal antitrust laws, and seeking
an unspecified amount of damages and injunctive relief. On April 15, 2002,
The Scotts Company and Central Garden each filed summary judgment motions
in this action. On June 26, 2002, the court granted summary judgment in
favor of The Scotts Company and dismissed all of Central Garden's then
remaining claims. That judgment has been affirmed by the United States
Court of Appeals.
CENTRAL GARDEN V. THE SCOTTS COMPANY & PHARMACIA, CONTRA COSTA SUPERIOR
COURT
On October 31, 2000, Central Garden filed a complaint against The Scotts
Company and Pharmacia in the California Superior Court for Contra Costa
County. That complaint sought to assert breach of contract claims and
claims under Section 17200 of the California Business and Professions
Code. On December 4, 2000, The Scotts Company and Pharmacia jointly filed
a motion to stay this action based on the pendency of prior lawsuits that
involved the same subject matter. By order dated February 23, 2001, the
Superior Court stayed the action pending before it. Central Garden and
Pharmacia later settled their claims relating to this action. Recently,
Central Garden voluntarily dismissed its claims against The Scotts
Company.
Although The Scotts Company has prevailed consistently and extensively in
the litigation with Central Garden, some of the decisions in The Scotts
Company's favor are subject to appeal and possible further proceedings.
If, upon appeal or otherwise, the above actions are determined adversely
to The Scotts Company, the result could have a material adverse affect on
The Scotts Company's results of operations, financial position and cash
flows. The Scotts Company believes that it will continue to prevail in the
Central Garden matters and that any potential exposure that The Scotts
Company may face cannot be reasonably estimated. Therefore, no accrual has
been established related to the claims brought against The Scotts Company
by Central Garden, except for amounts ordered paid to Central Garden in
the Ohio Action. The Scotts Company believes it has adequate reserves
recorded for the amounts it may ultimately be required to pay.
14
U.S. HORTICULTURAL SUPPLY, INC. (F/K/A E.C. GEIGER, INC.) V. THE SCOTTS
COMPANY, EASTERN DISTRICT OF PENNSYLVANIA
On February 7, 2003, U.S. Horticultural Supply filed suit against The
Scotts Company in the U.S. District Court for the Eastern District of
Pennsylvania. U.S. Horticultural Supply alleges claims of breach of
contract, promissory estoppel and a violation of federal antitrust laws,
and seeks an unspecified amount of damages.
On March 14, 2003, The Scotts Company filed a motion to dismiss the
antitrust claim, and a motion to dismiss, or in the alternative stay, the
promissory estoppel claims pending arbitration. The motion is pending.
Discovery has commenced. No trial date has been set.
The Scotts Company believes that U.S. Horticultural Supply's claims are
without merit and intends to vigorously defend against them. If the above
action is determined adversely to The Scotts Company, the result could
have a material adverse effect on The Scotts Company's results of
operations, financial position and cash flows. Any potential exposure that
The Scotts Company may face cannot be reasonably estimated. Therefore, no
accrual has been established related to this matter.
OTHER
The Scotts Company recently has been named a defendant in a number of
cases alleging injuries that the lawsuits claim resulted from exposure to
asbestos-containing products. The complaints in these cases, most of which
are in their preliminary stages, are not specific about the plaintiffs'
contacts with The Scotts Company or its products. The Scotts Company in
each case is one of numerous defendants and none of the claims seeks
damages from The Scotts Company alone. The Scotts Company is vigorously
defending the cases and does not believe they are material to The Scotts
Company's results of operations, financial position or cash flows.
It is not currently possible to reasonably estimate a probable loss, if
any, associated with the cases and, accordingly, no accrual or reserves
have been recorded in The Scotts Company's consolidated financial
statements. There can be no assurance that these cases, whether as a
result of adverse outcomes or as a result of significant defense costs,
will not have a material adverse effect on The Scotts Company, its
financial condition or its results of operations. The Scotts Company is
reviewing agreements and policies that may provide insurance coverage or
indemnity as to these claims and is pursuing coverage under some of these
agreements.
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.
10. NEW ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46). In December 2003, the FASB
modified FIN 46 to make certain technical corrections and address certain
implementation issues that had arisen. FIN 46 provides a new framework for
identifying variable interest entities (VIEs) and determining when a
company should include the assets, liabilities, noncontrolling interests,
and results of activities of a VIE in its consolidated financial
statements.
In general, a VIE is a corporation, partnership, limited-liability
company, trust, or any other legal structure used to conduct activities or
hold assets that either (1) has an insufficient amount of equity to carry
out its principal activities without additional subordinated financial
support, (2) has a group of equity owners that are unable to make
significant decisions about its activities, or (3) has a group of equity
owners that do not have the obligation to absorb losses or the right to
receive returns generated by its operations.
FIN 46 requires a VIE to be consolidated if a party with an ownership,
contractual or other financial interest in the VIE (a variable interest
holder) is obligated to absorb a majority of the risk of loss from the
VIE's activities, is entitled to receive a majority of the VIE's residual
returns (if no party absorbs a majority of the VIE's losses), or both. A
variable interest holder that consolidates the VIE is called the primary
beneficiary. Upon consolidation, the primary beneficiary generally must
initially record all of the VIE's assets, liabilities and noncontrolling
interests at fair value and subsequently account for the VIE as if it were
consolidated based on
15
majority voting interest. FIN 46 also requires disclosures about VIEs that
the variable interest holder is not required to consolidate but in which
it has a significant variable interest.
The Company has evaluated FIN 46 and believes that as of March 27, 2004,
the only entities for which it may be the primary beneficiary are certain
of the Company's Scotts LawnService(R) franchises. The Company has
evaluated the potential significance of its interest in the franchises for
which it may be the primary beneficiary from a consolidation perspective
as well as from a maximum exposure to loss perspective. Based on the
results of the evaluation process, the Company has concluded that the
effect of consolidating certain franchises where the Company may be the
primary beneficiary would be immaterial to both the statement of
operations and balance sheet.
11. MEDICARE PRESCRIPTION DRUG, IMPROVEMENT AND MODERNIZATION ACT
As disclosed in Note 8 to our consolidated financial statements for the
year ended September 30, 2003, the Company provides comprehensive major
medical benefits to certain of its retired associates and their
dependents. These benefits include prescription drug coverage. On December
8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act
(the "Act") became law. The Act provides for a federal subsidy to sponsors
of retiree health care benefit plans that provide a benefit that is at
least actuarially equivalent to the benefit established by the Act. The
Company has evaluated the Act and believes it will be eligible for the
federal subsidy.
Specific authoritative guidance governing the accounting requirements
pertaining to any federal subsidy the Company might receive has not yet
been issued by the FASB. Pending the issuance of authoritative guidance,
the FASB has issued FSP No. FAS 106-1, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003," that provides a one-time election to defer
accounting for the effects of the Act. The Company has not completed the
analysis necessary to estimate the effect, if any, that any such subsidy
will have on its accumulated postretirement benefit obligation or net
periodic postretirement benefit cost. Accordingly, the Company has elected
to defer accounting for the effects of the Act until authoritative
guidance is issued by the FASB.
12. SEGMENT INFORMATION
For fiscal 2004, the Company is divided into three reportable segments -
North America, Scotts LawnService(R) and International. The North America
segment primarily consists of the Lawns, Gardening Products, Ortho(R),
Canada and North American Professional business groups. These segments
differ from those used in the prior year due to the absorption of the
Global Professional segment into the North America and International
segments based on geography. This new division of reportable segments is
consistent with how the segments report to and are managed by senior
management of the Company. The prior year amounts have been reclassified
to conform with the fiscal 2004 segments.
The North America segment manufactures, markets and sells 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,
pottery, barks, mulches and other growing media products, pesticide
products and a full line of horticulture products. Products are marketed
to mass merchandisers, home improvement centers, large hardware chains,
nurseries and gardens centers and specialty crop growers in the United
States, Canada, Latin America and South America.
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, an exterior barrier pest control service.
The International segment provides products similar to those described
above for the North America segment to consumers outside of the United
States, Canada, Latin America and South America.
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).
16
SCOTTS OTHER/
NORTH AMERICA LAWNSERVICE(R) INTERNATIONAL CORPORATE TOTAL
------------- -------------- ------------- --------- -----
(IN MILLIONS, EXCEPT OPERATING PERCENTATGES)
Net sales:
YTD 2004 ............ $ 660.5 $ 34.9 $ 220.0 $ -- $ 915.4
YTD 2003 ............ $ 625.6 $ 26.8 $ 204.5 $ -- $ 856.9
Q2 2004 ............. $ 557.8 $ 16.3 $ 155.1 $ -- $ 729.2
Q2 2003 ............. $ 521.0 $ 11.5 $ 143.7 $ -- $ 676.2
Operating income (loss):
YTD 2004 ............ $ 116.9 $ (19.2) $ 22.8 $ (42.1) $ 78.4
YTD 2003 ............ $ 98.7 $ (17.1) $ 20.8 $ (37.8) $ 64.6
Q2 2004 ............. $ 145.6 $ (12.7) $ 25.1 $ (23.1) $ 134.9
Q2 2003 ............. $ 128.4 $ (12.3) $ 22.5 $ (17.0) $ 121.6
Operating margin:
YTD 2004 ............ 17.7% (55.0)% 10.4% nm 8.6%
YTD 2003 ............ 15.8% (63.8)% 10.2% nm 7.5%
Q2 2004 ............. 26.1% (77.9)% 16.2% nm 18.5%
Q2 2003 ............. 24.6% (107.0)% 15.7% nm 18.0%
Goodwill:
Q2 2004 ............. $ 207.6 $ 97.5 $ 118.2 $ -- $ 423.3
Q2 2003 ............. $ 199.4 $ 77.9 $ 106.9 $ -- $ 384.2
Total assets:
Q2 2004 ............. $ 1,708.0 $ 112.7 $ 611.1 $ 109.5 $ 2,541.3
Q2 2003 ............. $ 1,661.8 $ 94.2 $ 568.9 $ 129.0 $ 2,453.9
nm Not meaningful.
Operating income reported for Scotts' three reportable segments represents
earnings before amortization of intangible assets, interest and taxes,
since this is the measure of profitability used by management.
Accordingly, the corporate operating loss for the three and six month
periods ended March 27, 2004 and March 29, 2003 includes amortization of
certain intangible assets, unallocated corporate general and
administrative expenses, North America restructuring charges and certain
"other" income (expense) items not allocated to the reportable segments.
Goodwill reported as of March 27, 2004 is $423.3 million, an increase of
$16.8 million from $406.5 million at September 30, 2003. The increases in
both the North America and Scotts LawnService(R) reported segments were
due to the purchasing of remaining minority interest shares in two
majority-owned consolidated entities, increasing goodwill by $9.0 million.
The International segment was impacted by changes in foreign exchange
rates, resulting in an increase of $6.6 million to goodwill for the six
months ended March 27, 2004.
Total assets reported for Scotts' reportable segments include the
intangible assets for the acquired businesses within those segments.
Corporate assets primarily include deferred financing and debt issuance
costs, corporate intangible assets and deferred tax assets.
13. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTORS
The 6 5/8% Senior Subordinated 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 consolidated Statements of
Operations for the three and six month periods ended March 27, 2004 and
March 29, 2003, Statements of Cash Flows for the six month periods ended
March 27, 2004 and March 29, 2003 and Balance Sheets as of March 27, 2004,
March 29, 2003 and September 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.
17
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 27, 2004 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales ................................ $ 418.7 $ 137.7 $ 172.8 $ $ 729.2
Cost of sales ............................ 257.7 76.7 104.6 439.0
Restructuring and other charges .......... 0.2 0.2
---------- ---------- ---------- ---------- ----------
Gross profit ............................. 161.0 61.0 68.0 -- 290.0
Gross commission earned from marketing
agreement ............................. 13.8 1.5 15.3
Costs associated with marketing agreement 7.1 7.1
---------- ---------- ---------- ---------- ----------
Net commission from marketing agreement 6.7 -- 1.5 -- 8.2
Operating expenses:
Advertising ........................... 28.4 1.2 10.2 39.8
Selling, general and administrative ... 81.0 13.7 30.7 125.4
Restructuring and other charges ....... 0.2 0.2
Amortization of intangible assets ..... 0.1 1.0 1.2 2.3
Equity income in subsidiaries ............ (40.7) 40.7
Intracompany allocations ................. (4.3) (4.1) 8.4
Other income, net ........................ (0.3) (0.5) (1.3) (2.1)
---------- ---------- ---------- ---------- ----------
Income (loss) from operations ............ 103.5 49.7 20.1 (40.7) 132.6
Interest expense ......................... 9.7 3.8 13.5
Costs related to refinancing ............. 0.6 0.6
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes ........ 93.2 49.7 16.3 (40.7) 118.5
Income tax expense ....................... 20.1 19.0 6.3 45.4
---------- ---------- ---------- ---------- ----------
Net income (loss) ........................ $ 73.1 $ 30.7 $ 10.0 $ (40.7) $ 73.1
========== ========== ========== ========== ==========
18
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 27, 2004 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales ................................ $ 479.4 $ 196.9 $ 239.1 $ $ 915.4
Cost of sales ............................ 294.4 136.0 145.0 575.4
Restructuring and other charges .......... 0.3 0.4 0.7
---------- ---------- ---------- ---------- ----------
Gross profit ............................. 184.7 60.9 93.7 -- 339.3
Gross commission earned from marketing
agreement ............................. 13.4 1.9 15.3
Costs associated with marketing agreement 14.2 14.2
---------- ---------- ---------- ---------- ----------
Net commission from marketing agreement (0.8) -- 1.9 -- 1.1
Operating expenses:
Advertising ........................... 32.6 2.3 13.2 48.1
Selling, general and administrative ... 137.3 24.4 55.4 217.1
Restructuring and other charges ....... 0.1 0.6 0.7
Amortization of intangible assets ..... 0.2 2.2 2.4 4.8
Equity income in subsidiaries ............ (25.7) 25.7
Intracompany allocations ................. (12.4) 2.1 10.3
Other income, net ........................ (0.6) (1.3) (2.0) (3.9)
---------- ---------- ---------- ---------- ----------
Income (loss) from operations ............ 52.5 31.1 15.7 (25.7) 73.6
Interest expense ......................... 20.2 5.2 25.4
Costs related to refinancing ............. 44.3 44.3
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes ........ (12.0) 31.1 10.5 (25.7) 3.9
Income tax expense (benefit) ............. (14.4) 11.9 4.0 1.5
---------- ---------- ---------- ---------- ----------
Net income (loss) ........................ $ 2.4 $ 19.2 $ 6.5 $ (25.7) $ 2.4
========== ========== ========== ========== ==========
19
THE SCOTTS COMPANY
STATEMENT OF CASH FLOWS
FOR THE SIX MONTH PERIOD ENDED MARCH 27, 2004 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .............................. $ 2.4 $ 19.2 $ 6.5 $ (25.7) $ 2.4
Adjustments to reconcile net loss to net cash
used in operating activities:
Costs related to refinancing ................ 44.3 44.3
Stock-based compensation expense ............ 4.4 4.4
Depreciation ................................ 13.2 5.7 2.8 21.7
Amortization ................................ 1.8 2.4 2.3 6.5
Deferred Taxes .............................. (0.1) (0.1)
Equity (income) loss in subsidiaries ........ (25.7) 25.7
Net change in certain components of working .... (317.0) (32.9) (125.4) (475.3)
capital
Net changes in other assets and liabilities and
other adjustments ............................ (15.0) (0.3) 6.9 (8.4)
---------- ---------- ---------- ---------- ----------
Net cash used in operating activities .......... (291.7) (5.9) (106.9) -- (404.5)
---------- ---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment .... (2.1) (4.6) (4.2) (10.9)
Investment in acquired businesses, net of cash
acquired ..................................... (0.3) (1.8) (3.2) (5.3)
Payments on seller notes ....................... (2.0) (6.9) (8.9)
---------- ---------- ---------- ---------- ----------
Net cash used in investing activities .......... (4.4) (13.3) (7.4) -- (25.1)
---------- ---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under revolving and bank
lines of credit .............................. 2.8 327.9 330.7
Gross borrowings under term loans .............. 500.0 500.0
Gross repayments under term loans .............. (240.5) (86.0) (326.5)
Issuance of 6 5/8% Notes ....................... 200.0 200.0
Redemption of 8 5/8% Notes ..................... (418.0) (418.0)
Financing fees ................................. (11.5) (11.5)
Cash received from the exercise of stock options 12.2 12.2
Intracompany financing ......................... 123.6 19.5 (143.1)
---------- ---------- ---------- ---------- ----------
Net cash provided by financing activities ...... 168.6 19.5 98.8 -- 286.9
Effect of exchange rate changes on cash ........ 1.0 1.0
---------- ---------- ---------- ---------- ----------
Net increase (decrease) in cash ................ (127.5) 0.3 (14.5) -- (141.7)
Cash and cash equivalents, beginning of period . 132.1 1.2 22.6 155.9
---------- ---------- ---------- ---------- ----------
Cash and cash equivalents, end of period ....... $ 4.6 $ 1.5 $ 8.1 $ -- $ 14.2
========== ========== ========== ========== ==========
20
THE SCOTTS COMPANY
BALANCE SHEET
AS OF MARCH 27, 2004 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents .................... $ 4.6 $ 1.5 $ 8.1 $ $ 14.2
Accounts receivable, net ..................... 355.1 169.9 251.0 776.0
Inventories, net ............................. 226.4 85.4 106.8 418.6
Current deferred tax asset ................... 58.8 0.5 1.4 60.7
Prepaid and other assets ..................... 28.5 5.3 12.4 46.2
---------- ---------- ---------- ---------- ----------
Total current assets ...................... 673.4 262.6 379.7 -- 1,315.7
Property, plant and equipment, net .............. 196.2 89.3 44.0 329.5
Goodwill ........................................ 21.5 274.1 127.7 423.3
Intangible assets, net .......................... 4.9 279.9 146.9 431.7
Other assets .................................... 41.2 1.5 (1.6) 41.1
Investment in affiliates ........................ 1,071.1 (1,071.1)
Intracompany assets ............................. 225.1 (225.1)
---------- ---------- ---------- ---------- ----------
Total assets .............................. $ 2,008.3 $ 1,132.5 $ 696.7 $ (1,296.2) $ 2,541.3
========== ========== ========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ...................... $ 2.5 $ 7.9 $ 17.3 $ $ 27.7
Accounts payable ............................. 130.0 46.6 102.6 279.2
Accrued liabilities .......................... 130.7 36.6 95.8 263.1
Accrued taxes ................................ 20.0 2.4 0.9 23.3
---------- ---------- ---------- ---------- ----------
Total current liabilities ................. 283.2 93.5 216.6 -- 593.3
Long-term debt .................................. 711.7 4.9 323.3 1,039.9
Other liabilities ............................... 144.3 0.7 17.3 162.3
Intracompany liabilities ........................ 123.3 101.8 (225.1)
---------- ---------- ---------- ---------- ----------
Total liabilities ......................... 1,262.5 99.1 659.0 (225.1) 1,795.5
---------- ---------- ---------- ---------- ----------
Shareholders' equity:
Investment from parent ....................... 501.2 55.6 (556.8)
Common shares, no par value per share, $.01
stated value per share ..................... 0.8 0.8
Deferred compensation-stock awards ........... (18.8) (18.8)
Capital in excess of par value ............... 426.3 426.3
Retained earnings ............................ 401.0 534.0 9.3 (543.3) 401.0
Accumulated other comprehensive expense ...... (63.5) (1.8) (27.2) 29.0 (63.5)
---------- ---------- ---------- ---------- ----------
Total shareholders' equity ................ 745.8 1,033.4 37.7 (1,071.1) 745.8
---------- ---------- ---------- ---------- ----------
Total liabilities and shareholders' equity $ 2,008.3 $ 1,132.5 $ 696.7 $ (1,296.2) $ 2,541.3
========== ========== ========== ========== ==========
21
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 ................................ $ 389.9 $ 128.8 $ 157.5 $ $ 676.2
Cost of sales ............................ 248.0 71.3 98.3 417.6
Restructuring and other charges .......... 0.4 0.3 0.7
---------- ---------- ---------- ---------- ----------
Gross profit ............................. 141.5 57.5 58.9 -- 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 from marketing agreement 3.2 -- 1.0 -- 4.2
Operating expenses:
Advertising ........................... 25.6 1.0 8.3 34.9
Selling, general and administrative ... 66.1 13.4 26.1 105.6
Restructuring and other charges ....... 1.0 0.1 1.3 2.4
Amortization of intangible assets ..... 0.1 1.0 1.0 2.1
Equity income in subsidiaries ............ (40.1) 40.1
Intracompany allocations ................. (1.8) (2.1) 3.9
Other income, net ........................ (0.2) (1.2) (1.0) (2.4)
---------- ---------- ---------- ---------- ----------
Income (loss) from operations ............ 94.0 45.3 20.3 (40.1) 119.5
Interest expense ......................... 17.9 (3.8) 4.6 18.7
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes ........ 76.1 49.1 15.7 (40.1) 100.8
Income tax expense ....................... 13.6 18.7 6.0 38.3
---------- ---------- ---------- ---------- ----------
Net income (loss) ........................ $ 62.5 $ 30.4 $ 9.7 $ (40.1) $ 62.5
========== ========== ========== ========== ==========
22
THE SCOTTS COMPANY
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 29, 2003 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales ................................ $ 449.8 $ 188.7 $ 218.4 $ $ 856.9
Cost of sales ............................ 286.9 131.3 138.4 556.6
Restructuring and other charges .......... 4.7 0.4 5.1
---------- ---------- ---------- ---------- ----------
Gross profit ............................. 158.2 57.4 79.6 -- 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 from marketing agreement (4.1) -- 1.2 -- (2.9)
Operating expenses:
Advertising ........................... 30.4 1.7 11.4 43.5
Selling, general and administrative ... 113.4 23.4 46.7 183.5
Restructuring and other charges ....... 1.3 0.3 2.7 4.3
Amortization of intangible assets ..... 0.2 1.9 2.0 4.1
Equity income in subsidiaries ............ (25.2) 25.2
Intracompany allocations ................. (10.9) 4.6 6.3
Other income, net ........................ (0.3) (1.8) (1.5) (3.6)
---------- ---------- ---------- ---------- ----------
Income (loss) from operations ............ 45.2 27.3 13.2 (25.2) 60.5
Interest expense ......................... 35.2 (7.7) 7.7 35.2
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes ........ 10.0 35.0 5.5 (25.2) 25.3
Income tax expense (benefit) ............. (5.7) 13.3 2.0 9.6
---------- ---------- ---------- ---------- ----------
Net income (loss) ........................ $ 15.7 $ 21.7 $ 3.5 $ (25.2) $ 15.7
========== ========== ========== ========== ==========
23
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 $ 21.7 $ 3.5 $ (25.2) $ 15.7
Adjustments to reconcile net loss to
net cash used in operating activities:
Stock-based compensation expense ........... 1.6 1.6
Depreciation ............................... 10.8 5.0 3.0 18.8
Amortization ............................... 1.9 1.9 2.0 5.8
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) (62.8) (121.6) (432.4)
Net changes in other assets and
liabilities and other adjustments .......... 13.0 23.0 (36.0) --
---------- ---------- ---------- ---------- ----------
Net cash used in operating activities ........ (220.3) (11.2) (149.1) -.- (380.6)
---------- ---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment .. (13.8) (14.4) (3.1) (31.3)
Investment in acquired businesses,
net of cash acquired ....................... (5.2) (5.2)
Payments on seller notes ..................... (3.8) (8.7) (14.5) (27.0)
---------- ---------- ---------- ---------- ----------
Net cash used in investing activities ........ (17.6) (28.3) (17.6) -.- (63.5)
---------- ---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under revolving
and bank lines of credit ................... 104.8 268.2 373.0
Gross repayments under term loans ............ (17.3) (8.5) (25.8)
Financing fees ............................... (0.5) (0.5)
Cash received from the exercise of stock
options .................................... 9.0 9.0
Intracompany financing ....................... 89.0 39.5 (128.5)
---------- ---------- ---------- ---------- ----------
Net cash provided by financing activities .... 185.0 39.5 131.2 -.- 355.7
Effect of exchange rate changes on cash ...... 1.0 1.0
---------- ---------- ---------- ---------- ----------
Net increase (decrease) in cash .............. (52.9) -- (34.5) -.- (87.4)
Cash and cash equivalents, beginning
of period .................................. 54.7 2.0 43.0 99.7
---------- ---------- ---------- ---------- ----------
Cash and cash equivalents, end of period ..... $ 1.8 $ 2.0 $ 8.5 $ -.- $ 12.3
========== ========== ========== ========== ==========
24
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 $ 2.0 $ 8.5 $ $ 12.3
Accounts receivable, net ............... 330.0 148.6 245.7 724.3
Inventories, net ....................... 229.8 73.8 96.6 400.2
Current deferred tax asset ............. 72.1 0.5 (0.1) 72.5
Prepaid and other assets ............... 24.2 6.0 20.6 50.8
---------- ---------- ---------- ---------- ----------
Total current assets .............. 657.9 230.9 371.3 -- 1,260.1
Property, plant and equipment, net ....... 215.6 92.2 34.8 342.6
Goodwill ................................. 16.6 280.7 86.9 384.2
Intangible assets, net ................... 4.4 281.0 134.1 419.5
Other assets ............................. 46.9 2.8 (2.2) 47.5
Investment in affiliates ................. 965.1 (965.1)
Intracompany assets ...................... 130.4 23.1 (153.5)
---------- ---------- ---------- ---------- ----------
Total assets ...................... $ 1,906.5 $ 1,018.0 $ 648.0 $ (1,118.6) $ 2,453.9
========== ========== ========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ................ $ 265.8 $ 7.9 $ 14.0 $ $ 287.7
Accounts payable ....................... 125.5 41.2 97.5 264.2
Accrued liabilities .................... 119.5 30.8 98.8 249.1
Accrued taxes .......................... 18.5 2.0 7.2 27.7
---------- ---------- ---------- ---------- ----------
Total current liabilities ......... 529.3 81.9 217.5 -- 828.7
Long-term debt ........................... 489.7 6.3 377.0 873.0
Other liabilities ........................ 114.0 0.4 17.8 132.2
Intracompany liabilities ................. 153.5 (153.5)
---------- ---------- ---------- ---------- ----------
Total liabilities ................... 1,286.5 88.6 612.3 (153.5) 1,833.9
---------- ---------- ---------- ---------- ----------
Shareholders' equity:
Investment from parent ................. 496.5 51.9 (548.4)
Common shares, no par value per share,
$.01 stated value per share .......... 0.3 0.3
Deferred compensation-stock awards ..... (10.4) (10.4)
Capital in excess of par value ......... 398.6 398.6
Retained earnings ...................... 310.5 435.5 7.2 (442.7) 310.5
Treasury stock, 1.0 shares at cost ..... (20.7) (20.7)
Accumulated other comprehensive expense (58.3) (2.6) (23.4) 26.0 (58.3)
---------- ---------- ---------- ---------- ----------
Total shareholders' equity .......... 620.0 929.4 35.7 (965.1) 620.0
---------- ---------- ---------- ---------- ----------
Total liabilities and
shareholders' equity .............. $ 1,906.5 $ 1,018.0 $ 648.0 $ (1,118.6) $ 2,453.9
========== ========== ========== ========== ==========
25
THE SCOTTS COMPANY
BALANCE SHEET
AS OF SEPTEMBER 30, 2003
(IN MILLIONS)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
--------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 132.1 $ 1.2 $ 22.6 $ $ 155.9
Accounts receivable, net 103.3 99.8 87.4 290.5
Inventories, net 143.6 50.4 82.1 276.1
Current deferred tax asset 56.8 0.4 (0.3) 56.9
Prepaid and other assets 16.2 3.2 13.8 33.2
--------------------------------------------------------------------
Total current assets 452.0 155.0 205.6 -- 812.6
Property, plant and equipment, net 206.8 90.6 40.8 338.2
Goodwill 20.5 294.3 91.7 406.5
Intangible assets, net 5.8 281.8 141.4 429.0
Other assets 44.8 1.5 (2.3) 44.0
Investment in affiliates 1,066.3 (1,066.3)
Intracompany assets 275.2 (275.2)
--------------------------------------------------------------------
Total assets $1,796.2 $ 1,098.4 $ 477.2 $ (1,341.5) $ 2,030.3
====================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of debt $ 38.9 $ 9.9 $ 6.6 $ $ 55.4
Accounts payable 70.0 27.0 52.0 149.0
Accrued liabilities 111.4 25.8 97.1 234.3
Accrued taxes 7.6 2.3 (0.4) 9.5
--------------------------------------------------------------------
Total current liabilities 227.9 65.0 155.3 -- 448.2
Long-term debt 603.8 9.7 88.7 702.2
Other liabilities 137.2 14.5 151.7
Intracompany liabilities 99.1 176.1 (275.2)
--------------------------------------------------------------------
Total liabilities 1,068.0 74.7 434.6 (275.2) 1,302.1
--------------------------------------------------------------------
Shareholders' Equity:
Investment from parent 510.7 65.3 (576.0)
Common shares, no par value per share,
$.01 stated value per share, 32.0
shares issued in 2003 0.3 0.3
Deferred compensation-stock awards (8.3) (8.3)
Capital in excess of stated value 398.4 398.4
Retained earnings 398.6 514.8 2.8 (517.6) 398.6
Accumulated other comprehensive income (60.8) (1.8) (25.5) 27.3 (60.8)
--------------------------------------------------------------------
Total shareholders' equity 728.2 1,023.7 42.6 (1,066.3) 728.2
--------------------------------------------------------------------
Total liabilities and
shareholders' equity $1,796.2 $ 1,098.4 $ 477.2 $ (1,341.5) $ 2,030.3
====================================================================
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. Also, in the United States, we operate the second largest
residential lawn service business, Scotts LawnService(R). In fiscal 2004, our
operations are divided into three reportable segments: North America, Scotts
LawnService(R) and International.
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 retail distribution channels.
In the past three years, we have spent approximately 5% of our net sales
annually on media advertising to support and promote our products and brands. We
have applied this consumer marketing focus for the past several years, and we
believe that Scotts receives a significant return on these marketing
expenditures. We expect that we will continue to focus our marketing efforts
toward the consumer and make additional investments in consumer marketing
expenditures in the future to continue to drive category growth and increased
market share. In fiscal 2004, we have increased advertising spending as we
deliver a new media message for the Ortho(R) line, increase our advertising
on selected brands in Europe and continue to have the largest share of voice
in our lawn and garden categories in North America.
Our sales are susceptible to global weather conditions. For instance,
periods of wet weather like we experienced in the spring of 2003 in the United
States adversely impacted fertilizer sales, but increased demand for certain
pesticide products. We believe that our past acquisitions have somewhat
diversified both our product line risk and geographic risk to weather
conditions.
Historically, the majority of our shipments to retailers have occurred in
the second and third fiscal quarters. However, over the past three years,
retailers have reduced their pre-season inventories by relying on vendors to
deliver products "in season" when consumers seek to buy our products. This
change in retailer purchasing patterns and the increasing importance of Scotts
LawnService(R) revenues have caused a sales shift from our second fiscal quarter
to the third and fourth fiscal quarters. Fiscal 2003 net sales by quarter were
9.5%, 35.4%, 37.2%, and 17.9%, respectively. Concurrent with this sales shift,
and because of the expansion of Scotts LawnService(R), the Company has
experienced a shift in profitability from the second to third and fourth fiscal
quarters, with the third fiscal quarter now more profitable than the second
fiscal quarter. Results for the Company's fourth fiscal quarter, historically a
loss making quarter, improved substantially in fiscal 2003. We expect the trend
towards stronger third and fourth fiscal quarter sales and profits to continue
in fiscal 2004.
In fiscal 2002, we announced the International Profit Improvement Plan to
improve the operations and profitability of our European-based consumer and
professional businesses. We have expended approximately $33 million through
March 27, 2004, of which approximately 25% have been capital expenditures,
primarily technology related. The remaining 75% of the total spending relates to
the reorganization and rationalization of our European supply chain, increased
sales force productivity and a shift to Pan-European category management of our
product portfolio. By the end of 2005, we anticipate a cumulative total of $45
million to $55 million will have been spent on various projects related to this
plan.
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46). In December 2003, the FASB modified FIN
46 to make certain technical corrections and address certain implementation
issues that had arisen. FIN 46 provides a new framework for identifying variable
interest entities (VIEs) and determining when a company should include the
assets, liabilities, noncontrolling interests, and results of activities of a
VIE in its consolidated financial statements. Reference should be made to Note
10 to the Condensed, Consolidated Financial Statements (unaudited) included in
Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information
as to the Company's assessment of FIN 46.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following discussion and analysis of the consolidated financial
position and results of operations should be read in conjunction with our
Condensed, Consolidated Financial Statements included elsewhere in this
Quarterly Report on Form 10-Q. Our Annual Report on Form 10-K for the fiscal
year ended September 30, 2003 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 Condensed, 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:
27
- - 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 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 results of operations or financial
position.
- - Reserves for product returns are based upon historical data and current
program terms and conditions with our customers. Changes in economic
conditions, regulatory actions or defective products could result in
actual returns being materially different than the amounts provided for in
our interim or annual results of operations or financial position.
- - 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, 2003, 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.
28
RESULTS OF OPERATIONS
The following table sets forth net sales by business segment for the three
and six month periods ended March 27, 2004 and March 29, 2003:
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
-------- -------- -------- --------
(UNAUDITED)
($ MILLIONS)
North America ....... $ 557.8 $ 521.0 $ 660.5 $ 625.6
Scotts LawnService(R) 16.3 11.5 34.9 26.8
International ....... 155.1 143.7 220.0 204.5
-------- -------- -------- --------
Consolidated ..... $ 729.2 $ 676.2 $ 915.4 $ 856.9
======== ======== ======== ========
The following table sets forth the components of income and expense as a
percentage of net sales for the three and six month periods ended March 27, 2004
and March 29, 2003:
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ ------------------------
MARCH 27, MARCH 29, MARCH 27, MARCH 29,
2004 2003 2004 2003
-------- -------- -------- --------
(UNAUDITED)
Net sales .................................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales ................................................ 60.2 61.7 62.8 65.0
Restructuring and other charges .............................. -- 0.2 0.1 0.6
-------- -------- -------- --------
Gross profit ................................................. 39.8 38.1 37.1 34.4
Net commission (expense) from marketing agreement ............ 1.1 0.6 0.1 (0.3)
Operating expenses:
Advertising ............................................... 5.5 5.2 5.3 5.0
Selling, general and administrative ....................... 14.7 13.5 20.2 18.5
Selling, general and administrative - lawn service business 2.1 1.9 3.0 2.7
Stock-based compensation .................................. 0.4 0.1 0.5 0.2
Restructuring and other charges ........................... -- 0.4 0.1 0.5
Amortization of intangibles ............................... 0.3 0.3 0.5 0.5
Other expense (income), net ............................... (0.3) (0.4) (0.4) (0.4)
-------- -------- -------- --------
Income from operations ....................................... 18.2 17.7 8.0 7.1
Interest expense ............................................. 1.9 2.8 2.8 4.1
Costs related to refinancing ................................. 0.1 -- 4.8 --
-------- -------- -------- --------
Income before income taxes ................................... 16.2 14.9 0.4 3.0
Income tax expense ........................................... 6.2 5.7 0.1 1.1
-------- -------- -------- --------
Net income ................................................... 10.0% 9.2% 0.3% 1.9%
======== ======== ======== ========
THREE MONTHS ENDED MARCH 27, 2004 COMPARED TO THREE MONTHS ENDED MARCH 29, 2003
Net sales for the three months ended March 27, 2004 were $729.2 million,
an increase of 7.8% from net sales of $676.2 million for the three months ended
March 29, 2003. Excluding the effect of exchange rates, sales for the second
quarter of fiscal 2004 were $707.0 million, or 4.6% above the second quarter of
fiscal 2003. Price increases are not material to the discussion of net sales in
total or by reportable segment for either fiscal period presented.
The North America segment net sales were $557.8 million in the second
quarter of fiscal 2004, an increase of 7.1% from net sales of $521.0 million for
the second quarter of fiscal 2003. Every product group within the North America
segment finished the second quarter with strong sales. This increase was driven
primarily by sales within our Lawns and Gardening Products groups as a result of
increased listings, primarily at our top three retail accounts.
Scotts LawnService(R) revenues increased 41.7% from $11.5 million in the
second quarter of fiscal 2003 to $16.3 million in the second quarter of fiscal
2004. Approximately one half of the growth reflects an increase in the number of
operating locations primarily due to acquisitions in new markets in late fiscal
2003, with the remainder of the increase due to more favorable weather
conditions and increased demand for additional services in the second quarter of
fiscal 2004.
29
Net sales for the International segment in the second quarter of fiscal
2004 were $155.1 million, an increase of $11.4 million, or 7.9%, versus the
second quarter of fiscal 2003. Excluding the effect of exchange rates, net sales
declined by 6.1%. Poor weather in most of Europe has delayed the lawn and garden
season and is the primary contributor to the sales decline. In addition, our
decision to exit a very low gross margin line within our professional business
and continued drought conditions in Australia also decreased net sales in the
International segment.
Gross profit was $290.0 million in the second quarter of fiscal 2004, an
increase of $32.1 million from gross profit of $257.9 million in the second
quarter of fiscal 2003. As a percentage of net sales, gross profit was 39.8% of
sales in the second quarter of fiscal 2004 compared to 38.1% in the second
quarter of fiscal 2003. North America gross profit margin in the second quarter
of fiscal 2004 improved primarily due to favorable product mix. The
International segment realized improved margins due to the exit of the low
margin professional line described above.
The net commission from the marketing agreement was $8.2 million in the
second quarter of fiscal 2004 and $4.2 million in the second quarter of fiscal
2003. This increase from the prior year's comparable period is driven by
increased sales volume and the favorable timing of media spending. Per the terms
of our agreement with Monsanto, we account for media expense consistently with
Monsanto's accounting policies. This results in media expense being recorded as
incurred.
Advertising expenses in the second quarter of fiscal 2004 were $39.8
million, an increase of 14.0% from $34.9 million in the second quarter of fiscal
2003. As a percentage of net sales, advertising expenses were 5.5% in the second
quarter of fiscal 2004 compared to 5.2% in the second quarter of fiscal 2003.
Selling, general and administrative expenses ("SG&A"), excluding Scotts
LawnService(R), stock-based compensation and restructuring and other charges,
increased to $107.1 million in the second quarter of fiscal 2004 from $91.3
million in the second quarter of fiscal 2003. This increase in SG&A was due
primarily to increased legal costs, severance and incentives, and increases in
worker's compensation and insurance in fiscal 2004.
SG&A in the Scotts LawnService(R) business increased from $13.1 million in
the second quarter of fiscal 2003 to $15.2 million in the second quarter of
fiscal 2004, reflecting the increased number of locations added over the past
year from acquisitions, primarily in new markets, and the resulting support of
increased customer count.
Stock-based compensation expense increased to $3.1 million in the second
quarter of fiscal 2004, compared to $1.2 million in the second quarter of fiscal
2003, primarily reflecting amortization of grants issued in fiscal 2003 coupled
with amortization associated with grants issued in fiscal 2004. The full year
charges for stock-based compensation are expected to increase by $4.0 to $5.0
million in fiscal 2004 compared to fiscal 2003.
Restructuring and other charges included in SG&A decreased from $2.4
million in fiscal 2003's second quarter to $0.2 million in fiscal 2004's second
quarter due primarily to reduced North American distribution restructuring costs
and reduced International plant closure costs.
Other income was $2.1 million for the second quarter of fiscal 2004,
compared to other income of $2.4 million in the second quarter of fiscal 2003.
For segment reporting purposes, the Company defines operating income as
earnings before interest, taxes and amortization of intangible assets ("EBITA"),
as this is the measure used by management to assess earnings performance.
Segment performance for the second quarter of fiscal 2004 compared to the second
quarter of fiscal 2003 was as follows:
- North America's operating income increased from $128.4 million in
fiscal 2003 to $145.6 million in fiscal 2004, as improved sales and
gross margins, previously described above, more than offset current
year SG&A increases in severance, incentives, selling and research
and development costs;
- Scotts LawnService(R) reported higher net sales, but a larger
operating loss, $12.7 million compared to $12.3 million. As this
highly seasonal business grows and adds fixed infrastructure costs,
it will have larger losses in the first and second quarters of the
fiscal year due to seasonally low revenues. Conversely, the second
half of the fiscal year will provide higher revenues, margins and
operating income;
- International's operating income increased to $25.1 million from
$22.5 million. Although net sales declined $8.8 million,
30
excluding the effect of exchange rates, this was more than offset by
improved gross margin, decreased SG&A spending and the favorable
impact of foreign exchange on operating income.
Interest expense for the second quarter of fiscal 2004 was $13.5 million,
compared to $18.7 million for the second quarter of fiscal 2003. The decrease in
interest expense was due to a reduction in average borrowings as compared to the
prior year coupled with a reduction in the weighted average interest rate as a
result of lower rates under our New Credit Agreement and the 6 5/8% Notes, which
replaced the 8 5/8% Notes which were tendered in October 2003.
The income tax expense was calculated assuming an effective tax rate of
38.3% for the second quarter of fiscal 2004 versus 38.0% for the comparable
quarter in fiscal 2003. The effective tax rate used for interim reporting
purposes is based on management's best estimate of factors impacting the
effective tax rate for the fiscal year. Factors affecting the estimated rate
include assumptions as to income by jurisdiction (domestic and foreign), the
availability and utilization of tax credits, the existence of elements of income
and expense that may not be taxable or deductible, as well as other items. There
can be no assurance that the effective tax rate estimated for interim financial
reporting purposes will approximate that determined at fiscal year end. The
estimated effective tax rate is subject to revision in later interim periods and
at fiscal year end as facts and circumstances change during the course of the
fiscal year. There are no material changes to the effective tax rate expected at
this time.
The Company reported net income of $73.1 million for the second quarter of
fiscal 2004, compared to $62.5 million for fiscal 2003. Average shares
outstanding for purposes of computing earnings per common share increased from
32.2 million at March 29, 2003 to 33.0 million at March 27, 2004 due to shares
issued for option and warrant exercises.
SIX MONTHS ENDED MARCH 27, 2004 COMPARED TO SIX MONTHS ENDED MARCH 29, 2003
Net sales for the six months ended March 27, 2004 were $915.4 million, an
increase of 6.8% from net sales of $856.9 million for the six months ended March
29, 2003. Excluding the effect of exchange rates, sales for the first half of
fiscal 2004 were $883.3 million, or 3.1% above the first half of fiscal 2003.
Price increases are not material to the discussion of net sales in total or by
reportable segment for either fiscal period presented.
The North America segment net sales were $660.5 million in the first half
of fiscal 2004, an increase of 5.6% from net sales of $625.6 million for the
first half of fiscal 2003. This increase was driven by the strong second quarter
sales within the North America segment.
Scotts LawnService(R) revenues increased 30.2% from $26.8 million in the
first half of fiscal 2003 to $34.9 million in the first half of fiscal 2004.
This growth reflects an increase in the number of operating locations, primarily
due to acquisitions in new markets in late fiscal 2003, coupled with favorable
weather conditions and additional services provided in the first half of fiscal
2004.
Net sales for the International segment in the first half of fiscal 2004
were $220.0 million, an increase of $15.5 million, or 7.6%, versus the first
half of fiscal 2003. Excluding the effect of exchange rates, net sales declined
by 7.0%. This decrease was partially due to first fiscal quarter shipping delays
in our consumer business due to product availability issues resulting from our
SKU rationalization initiatives. Poor weather in the second fiscal quarter
delayed the lawn and garden season in Europe. In addition, our decision to exit
a very low gross margin line within our professional business and continued
drought conditions in Australia also decreased net sales in the International
segment.
Gross profit was $339.3 million in the first half of fiscal 2004, an
increase of $44.1 million from gross profit of $295.2 million in the first half
of fiscal 2003. As a percentage of net sales, gross profit was 37.1% of sales in
the first half of fiscal 2004 compared to 34.4% in the first half of fiscal
2003. Excluding the effect of favorable exchange rates and excluding
restructuring and other charges, gross profit margin was 37.1% of sales in the
first half of fiscal 2004 compared to 35.0% in the first half of fiscal 2003.
North America gross profit margin in the first half of fiscal 2004 improved
primarily due to favorable product mix, favorable distribution expense driven by
reductions in warehousing costs and the timing of trade programs that will occur
in the second half of fiscal 2004, compared to similar programs that occurred in
the first half of fiscal 2003. The International segment realized improved
margins due to the exit of the low margin professional line described above.
The net commission from the marketing agreement was $1.1 million in the
first half of fiscal 2004 compared to net expense of $2.9 million in the first
half of fiscal 2003 driven by sales volume and the favorable timing of media
spending. Per the terms of our agreement with Monsanto, we account for media
expense consistently with Monsanto's accounting policies. This results in media
expense being recorded as incurred. The annual contribution payment remains
unchanged at $25 million for fiscal 2004.
31
Advertising expenses in the first half of fiscal 2004 were $48.1 million, an
increase of 10.6% from $43.5 million in the first half of fiscal 2003. As a
percentage of net sales, advertising expenses were 5.3% in the first half of
fiscal 2004 compared to 5.0% in the first half of fiscal 2003.
Selling, general and administrative expenses ("SG&A"), excluding Scotts
LawnService(R), stock-based compensation and restructuring and other charges,
increased to $185.1 million in the first half of fiscal 2004 from $158.8 million
in the first half of fiscal 2003. This increase in SG&A was due primarily to
increased legal costs, severance and incentives, and increases in worker's
compensation and insurance in fiscal 2004, coupled with the non-recurrence of
bad debt recoveries realized in fiscal 2003.
SG&A in the Scotts LawnService(R) business increased from $23.1 million in
the first half of fiscal 2003 to $27.6 million in the first half of fiscal 2004,
reflecting the increased number of locations added over the past year from
acquisitions, primarily in new markets and the resulting support of increased
customer count.
Stock-based compensation expense increased to $4.4 million in the first half
of fiscal 2004, compared to $1.6 million in the first half of fiscal 2003,
primarily reflecting amortization of grants issued in fiscal 2003 coupled with
amortization associated with grants issued in fiscal 2004. The full year charges
for stock-based compensation are expected to increase by $4.0 to $5.0 million in
fiscal 2004 compared to fiscal 2003.
Restructuring and other charges included in SG&A decreased from $4.3 million
in the first half of fiscal 2003 to $0.7 million in the first half of fiscal
2004 due to reduced North American distribution restructuring costs and reduced
charges related to our International Profit Improvement Plan.
Other income was $3.9 million for the first half of fiscal 2004, compared to
other income of $3.6 million in the first half of fiscal 2003.
For segment reporting purposes, the Company defines operating income as
EBITA, as this is the measure used by management to assess earnings performance.
Segment performance for the first half of fiscal 2004 compared to the first half
of fiscal 2003 was as follows:
- North America's operating income increased from $98.7 million in fiscal
2003 to $116.9 million in fiscal 2004, as improved sales and gross
margins, previously described above, more than offset current year SG&A
increases in severance, incentives, selling and research and
development costs;
- Scotts LawnService(R) reported higher net sales, but a larger operating
loss, $19.2 million compared to $17.1 million. As this highly seasonal
business grows and adds fixed infrastructure costs, it will have larger
losses in the first and second quarters of the fiscal year due to
seasonally low revenues. Conversely, the second half of the fiscal year
will provide higher revenues, margins and operating income;
- International's operating income increased to $22.8 million from $20.8
million, as the net sales decline of $14.4 million, excluding the effect
of exchange rates, was only partially offset by improved gross margin
and SG&A expense reductions.
Interest expense for the first half of fiscal 2004 was $25.4 million,
compared to $35.2 million for the first half of fiscal 2003. The decrease in
interest expense was due to a reduction in average borrowings as compared to the
prior year, coupled with a reduction in the weighted average interest rate as a
result of lower rates under our New Credit Agreement and the 6 5/8% Notes, which
replaced the 8 5/8% Notes which were tendered in October 2003.
The income tax expense was calculated assuming an effective tax rate of
38.3% for the first half of fiscal 2004 versus 38.0% for the comparable period
in fiscal 2003. The effective tax rate used for interim reporting purposes is
based on management's best estimate of factors impacting the effective tax rate
for the fiscal year. Factors affecting the estimated rate include assumptions as
to income by jurisdiction (domestic and foreign), the availability and
utilization of tax credits, the existence of elements of income and expense that
may not be taxable or deductible, as well as other items. There can be no
assurance that the effective tax rate estimated for interim financial reporting
purposes will approximate that determined at fiscal year end. The estimated
effective tax rate is subject to revision in later interim periods and at fiscal
year end as facts and circumstances change during the course of the fiscal year.
There are no material changes to the effective tax rate expected at this time.
The Company reported net income of $2.4 million for the first half of fiscal
2004, compared to $15.7 million for the first half of
32
fiscal 2003. If the effect of costs related to our refinancing are excluded, our
net income for the six months ended March 27, 2004 was $29.7 million. Average
shares outstanding for purposes of computing earnings per common share increased
from 32.1 million at March 29, 2003 to 32.9 million at March 27, 2004 due to
shares issued for option and warrant exercises.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operating activities was $404.5 million and $380.6 million for
the six months ended March 27, 2004 and March 29, 2003, respectively. We entered
fiscal 2004 with $155.9 million of cash and cash equivalents as compared to
$99.7 million in fiscal 2003. This increase in cash and cash equivalents was
largely due to cash management initiatives in the fourth quarter of fiscal 2003
that affected accounts payable and accrued liabilities. The increase in cash
used in operating activities from 2003 to 2004, is due primarily to the growth
in accounts receivable during the second fiscal quarter as a result of strong
sales within the quarter, particularly in the month of March. While the balance
in accounts receivable is higher than in the prior year, our continued
management of customer accounts has improved the quality of our accounts
receivables at March 27, 2004.
Cash used in investing activities was $25.1 million and $63.5 million for
the six months ended March 27, 2004 and March 29, 2003, respectively. Capital
expenditures were responsible for $20.4 million of the decrease between the
periods. There were no significant capital projects that commenced in the first
half of fiscal 2004. In addition, principal payments due on seller notes issued
in conjunction with prior acquisitions were $18.1 million less during the first
half of fiscal 2004 as compared to fiscal 2003.
Financing activities provided cash of $286.9 million and $355.7 million for
the six months ended March 27, 2004 and March 29, 2003, respectively. During the
first quarter of fiscal 2004, we restructured our borrowing arrangements through
the refinancing of our former Credit Agreement, the redemption of our 8 5/8%
Notes and the issuance of our 6 5/8% Notes. Our future cash outflows for the
repayment of our debt after the refinancing of our former Credit Agreement, the
redemption of our 8 5/8% Notes and the issuance of our 6 5/8% Notes is as
follows; $28.8 million in less than one year, $16.2 million in one to three
years, $331.4 million in four to five years and $698.1 million after five years,
with $6.9 million representing future interest. In the first quarter of fiscal
2003, a $24.4 million mandatory prepayment was made on term loans as required by
the level of fiscal 2002 excess cash flow, as defined in the former Credit
Agreement.
Our primary sources of liquidity are cash generated by operations and
borrowings under our credit agreements. The New Credit Agreement consists of a
$700 million multi-currency revolving credit commitment and a $500 million term
loan B facility. Note 5 to the Condensed, Consolidated Financial Statements
(unaudited) included in Part I, Item 1 of this Quarterly Report on Form 10-Q
provides additional information pertaining to the refinancing of our former
Credit Agreement, the redemption of our 8 5/8% Notes, the issuance of our 6 5/8%
Notes and our New Credit Agreement. At March 27, 2004, we were in compliance
with all of our debt covenants.
We have not paid dividends on our common shares in the past and currently
have no plans to pay dividends in the future. We anticipate that our earnings
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 our Board of Directors in light of conditions then
existing, including our earnings, financial condition, 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
that are disclosed in the notes to consolidated financial statements included in
our Annual Report on Form 10-K for the fiscal year ended September 30, 2003.
During the second quarter of fiscal 2004, we took final delivery on a used
aircraft under the terms of a synthetic operating lease agreement as disclosed
in Note 8 to the Condensed, Consolidated Financial Statements (unaudited)
included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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, reviewed the 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 2004,
and thereafter for the foreseeable future. However, we cannot ensure that our
business 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.
33
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 results of operations, financial position and cash
flows. Additional information on environmental matters affecting us is provided
in Note 9 to the Condensed, Consolidated Financial Statements (unaudited)
included in Part I, Item 1 of this Quarterly Report on Form 10-Q and in the
fiscal 2003 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 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 the 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 certain competitors
that may 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,
34
legislative, regulatory and other factors that are beyond our control.
We cannot assure you that our business will generate sufficient cash flow
from operating activities or that future borrowings will be available to us
under our New Credit Agreement 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 New Credit Agreement and the indenture governing our outstanding 6 5/8%
Notes contain restrictive covenants and cross default provisions that require us
to maintain specified financial ratios. Our ability to satisfy those financial
ratios can be affected by events beyond our control, and we cannot assure you
that we will satisfy those tests. A breach of any of these covenants could
result in a default under our New Credit Agreement and/or our outstanding 6 5/8%
Notes. Upon the occurrence of an event of default under our New Credit Agreement
and/or the 6 5/8% 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 or wet spring throughout North America and/or Europe could
adversely affect 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 and building inventories 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.
35
- 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 former 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.
- 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.
Please see Note 9 to the Condensed, Consolidated Financial Statements
(unaudited) included in Part I, Item 1 of this Quarterly Report on Form 10-Q and
the disclosures under Part II, Item 1 "Legal Proceedings" of this Quarterly
Report 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 RESULTS OF OPERATIONS,
FINANCIAL POSITION OR CASH FLOWS.
North America net sales represent approximately 74% of our worldwide net
sales for fiscal 2003. Our top three North American retail customers together
accounted for 69% of our North American fiscal 2003 net sales and 79% of our
outstanding accounts receivable as of September 30, 2003. Home Depot, Wal-Mart
and Lowe's represented approximately 37%, 19% and 13%, respectively, of our
fiscal 2003 North American net sales. The loss of, or reduction in orders from,
Home Depot, Wal-Mart and Lowe's or any other significant customer could have a
material adverse effect on our results of operations, financial position or cash
flows, 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 effect.
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 results of operations, financial position or cash flows may be increasingly
sensitive to a deterioration in the financial condition of, or other adverse
developments involving our relationship with, one or more customers.
- - 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 effect on our results of
operations, financial position or cash flows.
- - IF MONSANTO WERE TO TERMINATE THE MARKETING AGREEMENT FOR CONSUMER
ROUNDUP(R) PRODUCTS WITHOUT BEING REQUIRED TO PAY ANY TERMINATION FEE, WE
WOULD LOSE A SUBSTANTIAL SOURCE OF FUTURE EARNINGS.
If we were to commit a serious default under the marketing agreement with
Monsanto for consumer Roundup(R) products, Monsanto may have the right to
terminate the agreement. If Monsanto were to terminate the marketing agreement
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 33% OF OUR
OUTSTANDING COMMON SHARES ON A FULLY DILUTED BASIS.
36
The Hagedorn Partnership, L.P. beneficially owns approximately 33% of our
outstanding common shares 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, established the following standard for food-use pesticides: a reasonable
certainty 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 that was used in certain of our lawn
and garden products. In December 2000, the U.S. EPA reached agreement with
various parties, including manufacturers, regarding a phased withdrawal from
retailers by December 2004 of residential use products containing diazinon, an
active ingredient used in certain of 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 results of operations, financial position and cash flows in
the past and could do so again in the future.
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 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.
During the first six months of fiscal 2004, we have expended approximately
$0.9 million related to environmental matters, compared with approximately $1.5
million in environmental expenditures for all of fiscal 2003.
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
37
- 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, Belgium and
the Netherlands. In fiscal 2003, international sales accounted for approximately
20% of our total sales. Accordingly, we are subject to risks associated with
operations in foreign countries, including:
- fluctuations in currency exchange rates;
- limitations on the conversion of foreign currencies into U.S. dollars;
- limitations on the remittance of dividends and other payments by foreign
subsidiaries;
- additional costs of compliance with local regulations; and
- historically, higher rates of inflation than in the United States.
In addition, our operations outside the United States are subject to the
risk of new and different legal and regulatory requirements in local
jurisdictions, potential difficulties in staffing and managing local operations
and potentially adverse tax consequences. The costs related to our international
operations could adversely affect our results of operations, financial position
and cash flows.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks have not changed significantly from those disclosed in the
Registrant's Annual Report on Form 10-K for the fiscal year ended September 30,
2003.
ITEM 4. CONTROLS AND PROCEDURES
With the participation of the Registrant's principal executive officer and
principal financial officer, the Registrant's management has evaluated the
effectiveness of the Registrant's disclosure controls and procedures (as defined
in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act")), as of the end of the period covered by this Quarterly Report
on Form 10-Q. Based upon that evaluation, the Registrant's principal executive
officer and principal financial officer have 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;
(B) information required to be disclosed by the Registrant in this Quarterly
Report on Form 10-Q would be recorded, processed, summarized and
reported within the time period specified in the SEC's rules and forms;
and
(C) the Registrant's disclosure controls and procedures are effective as of
the end of the period covered by this Quarterly Report on Form 10-Q to
ensure that material information relating to the Registrant and its
consolidated subsidiaries is made known to them, particularly during the
period in which the Registrant's periodic reports, including this
Quarterly Report on Form 10-Q, are being prepared.
In addition, there were no changes in the Registrant's internal control over
financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that
occurred during the Registrant's fiscal quarter ended March 27, 2004 that have
materially affected, or are reasonably likely to materially affect, the
Registrant's internal control over financial reporting.
38
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
THE SCOTTS COMPANY V. AVENTIS S.A. AND STARLINK LOGISTICS, INC.
On August 9, 2002, The Scotts Company 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, The Scotts Company alleges
it is entitled to injunctive and monetary relief arising from Aventis' and
Starlink's interference with The Scotts Company's 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
The Scotts Company 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 The Scotts Company. The complaint further alleges that Aventis
directed Aventis CropScience to make a belated sham offer to The Scotts Company
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 The Scotts Company.
In this suit, The Scotts Company seeks to ensure that it is able to exercise
its right to receive a bona fide offer to acquire TechPac, and The Scotts
Company seeks to recover compensatory and punitive damages in an amount as yet
undetermined for Aventis' and Starlink's interference with The Scotts Company's
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. On April 23, 2004 the court dismissed the action without
prejudice.
THE SCOTTS COMPANY V. UNITED INDUSTRIES, SOUTHERN DISTRICT OF FLORIDA
On April 15, 2002, The Scotts Company and OMS Investments, Inc., a
subsidiary of The Scotts Company that holds various Scotts intellectual property
assets ("OMS Investments"), 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, The Scotts
Company 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 Industries had intentionally copied The
Scotts Company's trade dress, the trial court denied the motion for preliminary
injunction. The Scotts Company appealed, but the United States Court of Appeals
for the Eleventh Circuit affirmed.
On December 13, 2002, The Scotts Company filed an 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
Industries 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. Since then, the parties have exchanged drafts of a proposed
settlement agreement.
39
We do not anticipate incurring any damages relating to this action.
THE SCOTTS COMPANY V. BAYER CROPSCIENCE, LP, SOUTHERN DISTRICT OF OHIO
On May 29, 2003, The Scotts Company and OMS Investments, filed a four count
complaint against Bayer CropScience, LP ("Bayer") for acts of (1) federal unfair
competition; (2) federal dilution; (3) common law trade dress infringement and
unfair competition; and (4) copyright infringement. The complaint alleges that
Bayer's line of lawn fertilizer products infringes and dilutes The Scotts
Company's proprietary rights in the packaging of its Turf Builder(R) and
LawnPro(R) Super Turf Builder(R) line of products. The complaint seeks both
injunctive and monetary relief.
Bayer filed its answer and affirmative defenses on June 19, 2003. Bayer
asserted no counterclaims. The parties have exchanged discovery requests, but
have agreed to postpone the production of documents given that alternative
resolutions have been discussed and given that the parties have participated in
the Court's mediation process.
We do not anticipate incurring any damages relating to this action.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) See Index to Exhibits at page 42 for a list of the exhibits included
herewith.
(b) The Registrant filed a Current Report on Form 8-K dated January 8, 2004
reporting under "Item 5. Other Events" an update to Note 24, "Financial
Information for Subsidiary Guarantors and Non-Guarantors" from the Registrant's
Consolidated Financial Statements included in the Registrant's Annual Report on
Form 10-K for the fiscal year ended September 30, 2003 which displayed the
aggregation of subsidiary guarantors and non-guarantors as delineated under the
indenture governing the 8 5/8% Senior Subordinated Notes which was in effect at
September 30, 2003. The revised Note 24 "Financial Information for Subsidiary
Guarantors and Non-Guarantors" displayed the aggregation of subsidiary
guarantors and non-guarantors as delineated under the indenture governing the
new 6 5/8% Senior Subordinated Notes which came into effect subsequent to
September 30, 2003.
The Registrant filed a Current Report on Form 8-K dated April 16, 2004
reporting under "Item 5. Other Events" a change in its reportable segments
previously reported in the Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 2003. These new segments differ from those used
in the previous fiscal year due to the absorption of the Global Professional
group into the North America and International segments based on geography.
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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 10, 2004
Executive Vice President and Chief Financial Officer,
(Principal Financial and Principal Accounting Officer)
41
THE SCOTTS COMPANY
QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED MARCH 27, 2004
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
31(a) Rule 13a-14(a)/15d-14(a) Certification (Principal *
Executive Officer)
31(b) Rule 13a-14(a)/15d-14(a) Certification (Principal *
Financial Officer)
32 Section 1350 Certification (Principal Executive *
Officer and Principal Financial Officer)
- ------------------
* Filed herewith.
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