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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 JANUARY 1, 2005
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
THE SCOTTS COMPANY
(Exact Name of Registrant as Specified in Its Charter)
OHIO
(State or Other Jurisdiction of 31-1414921
Incorporation or Organization) (I.R.S. Employer Identification No.)
14111 SCOTTSLAWN ROAD, MARYSVILLE, OHIO 43041
(Address of Principal Executive Offices) (Zip Code)
(937) 644-0011
(Registrant's Telephone Number, Including Area Code)
NO CHANGE
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate 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.
33,264,474 OUTSTANDING AT FEBRUARY 4, 2005
Common Shares, voting, no par value
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THE SCOTTS COMPANY AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Condensed, Consolidated Statements of Operations - Three month
periods ended January 1, 2005 and December 27, 2003.................................. 3
Condensed, Consolidated Statements of Cash Flows - Three month
periods ended January 1, 2005 and December 27, 2003.................................. 4
Condensed, Consolidated Balance Sheets - January 1, 2005,
December 27, 2003 and September 30, 2004............................................. 5
Notes to Condensed, Consolidated Financial Statements................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations... 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk.............................. 33
Item 4. Controls and Procedures................................................................. 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................................... 34
Item 4. Submission of Matters to a Vote of Security Holders..................................... 35
Item 6. Exhibits................................................................................ 35
Signatures.......................................................................................... 36
Index to Exhibits................................................................................... 37
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
-------------------------
JANUARY 1, DECEMBER 27,
2005 2003
---------- ------------
Net sales ........................................................ $ 244.0 $ 181.4
Cost of sales .................................................... 175.8 133.0
Restructuring and other charges .................................. -- 0.5
------- -------
Gross profit ............................................... 68.2 47.9
Gross commission earned from marketing agreement ................. -- --
Amortization of deferred marketing fee ........................... 0.8 0.8
Contribution expenses under marketing agreement .................. 6.3 6.3
------- -------
Net expense from marketing agreement ............................. 7.1 7.1
Operating expenses:
Selling, general and administrative ........................... 96.1 77.7
Selling, general and administrative - lawn service business ... 13.9 11.4
Stock-based compensation ...................................... 2.3 1.3
Restructuring and other charges ............................... 0.2 0.5
------- -------
112.5 90.9
Advertising ................................................... 14.7 8.3
Amortization of intangibles ................................... 2.6 2.4
Impairment of intangible assets ............................... 22.0 --
Other income, net ............................................. (0.2) (1.8)
------- -------
Loss from operations ....................................... (90.5) (59.0)
Costs related to refinancing ..................................... -- 43.7
Interest expense ................................................. 10.4 11.9
------- -------
Loss before income taxes ................................... (100.9) (114.6)
Income taxes (benefit) ........................................... (38.4) (43.9)
------- -------
Net loss from continuing operations ........................ (62.5) (70.7)
Net loss from discontinued operations ...................... (0.2) --
------- -------
Net loss ................................................... $ (62.7) $ (70.7)
======= =======
BASIC LOSS PER COMMON SHARE:
Weighted-average common shares outstanding during the period ..... 33.0 32.0
Basic loss per common share:
Net loss from continuing operations ........................ $ (1.89) $ (2.21)
Net loss from discontinued operations ...................... (0.01) --
------- -------
Basic loss per share ....................................... $ (1.90) $ (2.21)
======= =======
DILUTED LOSS PER COMMON SHARE:
Weighted-average common shares outstanding during the period ..... 33.0 32.0
Diluted loss per common share:
Net loss from continuing operations ........................ $ (1.89) $ (2.21)
Net loss from discontinued operations ...................... (0.01) --
------- -------
Diluted loss per share ..................................... $ (1.90) $ (2.21)
======= =======
See notes to condensed, consolidated financial statements
3
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
THREE MONTHS ENDED
-------------------------
JANUARY 1, DECEMBER 27,
2005 2003
---------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ........................................................... $ (62.7) $ (70.7)
Adjustments to reconcile net loss to net cash used in
operating activities:
Loss on impairment of intangible assets ......................... 22.0 --
Write-off of deferred costs on retired debt ..................... -- 19.4
Stock-based compensation expense ................................ 2.3 1.3
Depreciation .................................................... 12.5 10.2
Amortization .................................................... 3.4 3.2
Deferred taxes .................................................. (9.5) 1.8
Changes in assets and liabilities, net of acquired businesses:
Accounts receivable .......................................... 56.6 61.4
Inventories .................................................. (181.2) (166.3)
Prepaid and other current assets ............................. (1.4) 1.0
Accounts payable ............................................. 50.0 32.4
Accrued taxes and liabilities ................................ (62.1) (83.2)
Restructuring reserves ....................................... (1.9) (1.8)
Other assets ................................................. (4.8) (0.5)
Other liabilities ............................................ 7.8 3.5
Other, net ...................................................... (1.7) 0.3
------- -------
Net cash used in operating activities ........................ (170.7) (188.0)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Redemption of available for sale securities ..................... 57.2 --
Investment in property, plant and equipment ..................... (5.0) (4.0)
Investment in acquired businesses, net of cash acquired ......... (70.3) (0.6)
------- -------
Net cash used in investing activities ........................ (18.1) (4.6)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving and bank lines of credit ............. 132.9 104.3
Repayments under revolving and bank lines of credit ............. (14.2) (12.6)
Proceeds from issuance of term loans - New Credit Agreement ..... -- 500.0
Repayments of term loans ........................................ (1.0) (326.5)
Issuance of 6 5/8% Senior Subordinated Notes .................... -- 200.0
Redemption of 8 5/8% Senior Subordinated Notes .................. -- (379.9)
Financing fees, net ............................................. (0.4) (10.9)
Payments on seller notes ........................................ (1.9) (1.9)
Cash received from the exercise of stock options ................ 11.8 7.1
------- -------
Net cash provided by financing activities .................... 127.2 79.6
Effect of exchange rate changes on cash ............................ (24.9) (16.6)
------- -------
Net decrease in cash ............................................... (86.5) (129.6)
Cash and cash equivalents at beginning of period ................... 115.6 155.9
------- -------
Cash and cash equivalents at end of period ......................... $ 29.1 $ 26.3
======= =======
See notes to condensed, consolidated financial statements
4
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
UNAUDITED
-------------------------
JANUARY 1, DECEMBER 27, SEPTEMBER 30,
2005 2003 2004
---------- ------------ -------------
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 29.1 $ 26.3 $ 115.6
Investments ........................................................... -- -- 57.2
Accounts receivable, less allowances of $27.8,
$28.2 and $29.0, respectively ...................................... 245.7 229.1 292.4
Inventories, net ...................................................... 501.2 442.4 290.1
Current deferred tax asset ............................................ 24.8 60.7 24.9
Prepaid and other assets .............................................. 55.0 32.3 50.1
-------- -------- --------
Total current assets ............................................... 855.8 790.8 830.3
Property, plant and equipment, net of accumulated depreciation
of $315.3, $284.1 and $301.4, respectively ......................... 343.8 333.8 328.0
Goodwill .............................................................. 450.2 412.5 417.9
Intangible assets, net ................................................ 435.1 436.2 431.0
Other assets .......................................................... 46.2 42.0 40.6
-------- -------- --------
Total assets ....................................................... $2,131.1 $2,015.3 $2,047.8
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ............................................... $ 20.5 $ 30.8 $ 22.1
Accounts payable ...................................................... 196.7 181.4 130.3
Accrued liabilities ................................................... 239.8 190.7 261.9
Accrued taxes ......................................................... (5.3) (24.8) 19.3
-------- -------- --------
Total current liabilities .......................................... 451.7 378.1 433.6
Long-term debt ........................................................... 727.2 810.1 608.5
Other liabilities ........................................................ 124.3 160.7 131.1
-------- -------- --------
Total liabilities .................................................. 1,303.2 1,348.9 1,173.2
Commitments and contingencies (notes 3, 8 and 10)
Shareholders' equity:
Common Shares, no par value per share, $.01 stated value
per share, 33.2, 32.3, 32.8 shares issued, respectively ............ 0.3 0.3 0.3
Deferred compensation - stock awards .................................. (21.5) (19.2) (10.4)
Capital in excess of stated value ..................................... 468.4 418.9 443.0
Retained earnings ..................................................... 436.7 327.9 499.5
Accumulated other comprehensive loss .................................. (56.0) (61.5) (57.8)
-------- -------- --------
Total shareholders' equity ......................................... 827.9 666.4 874.6
-------- -------- --------
Total liabilities and shareholders' equity ......................... $2,131.1 $2,015.3 $2,047.8
======== ======== ========
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 and franchise the Scotts LawnService(R) business
which provides lawn and tree and shrub fertilization, insect control and
other related services in the United States. Effective October 2, 2004,
Scotts acquired Smith & Hawken(R), a leading brand in the outdoor living
and gardening lifestyle category. Smith & Hawken(R) products are sold in
the United States through its 59 retail stores as well as through catalog
and internet sales.
ORGANIZATION AND BASIS OF PRESENTATION
The Company's condensed, consolidated financial statements are unaudited;
however, in the opinion of management, these financial statements 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 and 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 2004 Annual Report on
Form 10-K.
REVENUE RECOGNITION
Revenue is recognized when products are shipped and when title and risk of
loss transfer to the customer. Provisions for estimated returns and
allowances are recorded at the time revenue is recognized based on
historical rates of returns and are periodically adjusted for known changes
in return levels. Scotts LawnService(R) revenues are recognized at the time
service is provided to the customer.
Under the terms of the Marketing Agreement between The Scotts Company and
Monsanto, the Company in its role as exclusive agent performs certain
functions, such as sales support, merchandising, distribution and logistics
on behalf of Monsanto, and incurs certain costs in support of the consumer
Roundup(R) business. The actual costs incurred by Scotts on behalf of
Roundup(R) are recovered from Monsanto through the terms of the Agency
Agreement and are treated solely as a recovery of incurred costs. Revenue
is not recognized in the Company's consolidated financial statements for
the recovery of these costs since the services rendered are solely in
support of the agency arrangement and not a part of any principal line of
business.
PROMOTIONAL ALLOWANCES
The Company promotes its branded products through cooperative advertising
programs with retailers. Retailers also are offered in-store promotional
allowances and rebates based on sales volumes. Certain products are
promoted with direct consumer rebate programs and special purchasing
incentives. Promotion costs (including allowances and rebates) incurred
during the year are expensed to interim periods in relation to revenues and
are recorded as a reduction of net sales. Accruals for expected payouts
under these programs are included as accrued marketing and promotion in the
accrued liabilities line in the Condensed, Consolidated Balance Sheets.
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.
6
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 January 1, 2005, December 27, 2003 and September 30, 2004 are
$0.7 million, $0.9 million and $1.6 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 historically had a six month vesting period.
In the first quarter of fiscal 2005, the Company granted 50,500 restricted
stock rights and 456,300 non qualified stock options to officers and other
key employees. 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 Company changed its fair value option pricing model from the
Black-Scholes model to a binomial model for all options granted on or
after October 1, 2004. The fair value of stock options granted prior to
October 1, 2004, was determined using the Black-Scholes model. The Company
believes that the binomial model considers characteristics of fair value
option pricing that are not available under the Black-Scholes model.
Similar to the Black-Scholes model, the binomial model takes into account
variables such as volatility and risk-free interest rate. However, in
addition, the binomial model considers the contractual term of the option,
the probability that the option will be exercised prior to the end of its
contractual life, and the probability of termination or retirement of the
option holder in computing the value of the option.
The value of all stock-based compensation grants during fiscal 2004 using
the Black-Scholes model was $11.0 million and thus far in fiscal 2005 using
a binomial model was $9.6 million. The assumptions used in the fair value
determinations were similar for both the fiscal 2005 and 2004 grants. In
addition, the fair value of the restricted stock rights granted thus far
in fiscal 2005 was $3.3 million.
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
loss and net loss per share for the three months ended December 27, 2003,
as follows (dollars in millions, except per share data):
Net loss ............................................................. $(70.7)
Stock-based compensation expense included in reported net loss,
net of tax ........................................................ 0.8
Total stock-based employee compensation expense determined
under fair value based method for all awards, net of tax .......... (1.3)
------
Net loss as adjusted ................................................. $(71.2)
======
Net loss per share:
Basic ............................................................. $(2.21)
Diluted ........................................................... $(2.21)
Net loss per share, as adjusted:
Basic ............................................................. $(2.23)
Diluted ........................................................... $(2.23)
The pro forma amounts shown above are not necessarily representative of the
impact on net income/loss in future periods.
In December 2004, the Financial Accounting Standards Board (FASB) replaced
SFAS No. 123 "Accounting for Stock-Based Compensation" with revised SFAS
No. 123, "Share-Based Payment." As the Company previously adopted the
provisions of SFAS No. 123 for awards granted beginning in fiscal 2003, its
accounting for share-based payments (including grants of employee stock
options) is substantially in accordance with revised SFAS 123. Therefore,
the adoption of revised SFAS 123, as required for the fourth quarter of
fiscal 2005, is not expected to have a significant effect on the Company's
results of operations. Companies 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).
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
7
in circumstances indicate that the carrying amount of an asset may not be
recoverable from its estimated undiscounted 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. The Company performed its annual impairment
analysis during the first quarter of fiscal 2005 and determined that
intangibles associated with our consumer business in the United Kingdom are
impaired. The reduction in the value of the business has resulted primarily
from the decline in the profitability of its growing media business and
unfavorable category mix trends. Although management is developing
strategies to significantly improve the profitability of the U.K. business,
we believe an impairment charge against the book value is appropriate.
Accordingly, an estimated impairment charge of $22 million has been
recorded for the first quarter of fiscal 2005. No impairment charge was
recorded for the first quarter of fiscal 2004.
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 and stock appreciation rights where the exercise price was less
than the average market price of the common shares. Because of the first
quarter loss, common stock equivalents were not included in the calculation
of diluted loss per share because to do so would have been anti-dilutive.
These common stock equivalents equate to 0.9 million and 0.8 million shares
of common stock for the periods ended January 1, 2005 and December 27,
2003, respectively.
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
A reclassification was made to the prior periods' statement of operations
to reclassify $1.1 million of selling, general and administrative costs -
lawn service business to cost of sales to conform to fiscal 2005
classifications.
2. DETAIL OF INVENTORIES, NET
Inventories, net of provisions for slow moving and obsolete inventory of
$20.1 million, $21.3 million, and $21.3 million, respectively, consisted
of:
JANUARY 1, DECEMBER 27, SEPTEMBER 30,
2005 2003 2004
---------- ------------ -------------
($ MILLIONS)
INVENTORIES, NET
Finished goods ..................... $366.7 $318.0 $186.6
Work-in-process .................... 38.9 39.9 30.7
Raw materials ...................... 95.6 84.5 72.8
------ ------ ------
Total .............................. $501.2 $442.4 $290.1
====== ====== ======
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
8
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 was 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 a significant portion of the
deferred amount is never paid, even if the agreement is not terminated
prior to 2018, unless significant earnings targets are exceeded.
The express terms of the agreement permit the Company to terminate the
agreement only upon material breach, material fraud or material willful
misconduct by Monsanto, as such terms are defined in the agreement, or upon
the sale of the Roundup(R) business by Monsanto. In such instances, the
agreement permits the Company to avoid payment of any deferred contribution
and related per annum charge. The Company's basis for not recording a
financial liability to Monsanto for the deferred portions of the annual
contribution and per annum charge is based on our assessment and
consultations with our legal counsel and the Company's former 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 January 1, 2005, contribution
payments and related per annum charges of approximately $46.3 million had
been deferred under the agreement. This amount is considered a contingent
obligation and has not been reflected in the financial statements as of and
for the period then ended.
Monsanto has disclosed that it is accruing the $20 million fixed
contribution fee per year beginning in the fourth quarter of Monsanto's
fiscal year 1998, plus interest on the deferred portion.
The agreement has no definite term except as it relates to the European
Union Countries. With respect to the European Union Countries, the initial
term of the Marketing Agreement extends through September 30, 2005 and may
be renewed at the option of both parties for three successive terms ending
on September 30, 2008, 2015, and 2018, with a separate determination being
made by the parties at least six months prior to the expiration of each
such term as to whether to commence a subsequent renewal term. If Monsanto
does not agree to the renewal term as with respect to the European
Countries, the commission structure will be recalculated in a manner likely
to be favorable to Scotts. 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 Consumer 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 Consumer 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. If Monsanto terminates the Marketing Agreement upon a change of
control of Monsanto or the sale of the Consumer Roundup(R) business prior
to September 30, 2008, we will be entitled to a termination fee in excess
of $100 million. If we terminate the agreement upon an uncured material
breach , material fraud or
9
material willful misconduct by Monsanto, we will be entitled to receive a
termination fee in excess of $100 million if the termination occurs prior
to September 30, 2008. The termination fee declines over time from $100
million to a minimum of $16 million for terminations between September 30,
2008 and September 30, 2018.
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 $33
million to Monsanto. The Company has deferred 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 2005 CHARGES
During the first quarter of fiscal 2005, the Company recorded $0.2 million
of restructuring and other charges. These charges, related to our Global
Business Information Services restructuring and were included in selling,
general and administrative costs.
FISCAL 2004 CHARGES
During the first quarter of fiscal 2004, the Company recorded $1.0 million
of restructuring and other charges. 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 $0.5 million and $0.5 million,
respectively.
The following is a rollforward from September 30, 2004 of the cash portion
of the restructuring and other charges. The accrued charges are included in
accrued liabilities on the Condensed, Consolidated Balance Sheets.
SEPTEMBER 30, JANUARY 1,
2004 2005
DESCRIPTION TYPE CLASSIFICATION BALANCE PAYMENT ACCRUAL BALANCE
- --------------------- ---- -------------- ------------- ------- ------- ----------
($ MILLIONS)
Severance ........... Cash SG&A $4.7 $(2.1) $0.2 $2.8
Other related costs . Cash SG&A 0.6 -- -- 0.6
---- ----- ---- ----
Total cash ....... $5.3 $(2.1) $0.2 $3.4
==== ===== ==== ====
5. LONG-TERM DEBT
JANUARY 1, DECEMBER 27, SEPTEMBER 30,
2005 2003 2004
---------- ------------ -------------
($ MILLIONS)
New Credit Agreement:
Revolving loans .......................... $119.5 $ 79.1 $ --
Term loans ............................... 398.0 500.0 399.0
Senior Subordinated Notes:
8 5/8% Notes ............................. -- 13.2 --
6 5/8% Notes ............................. 200.0 200.0 200.0
Notes due to sellers ........................ 11.3 20.1 13.2
Foreign bank borrowings and term loans ...... 11.2 18.9 10.8
Other ....................................... 7.7 9.6 7.6
------ ------ ------
747.7 840.9 630.6
Less current portions ....................... 20.5 30.8 22.1
------ ------ ------
$727.2 $810.1 $608.5
====== ====== ======
10
Future principal payments on our short and long-term debt are as follows
(in millions):
Less than one year..................................................... $ 20.5
One to three years..................................................... 149.9
Four to five years..................................................... 430.4
After five years....................................................... 146.9
------
$747.7
======
6. STATEMENT OF COMPREHENSIVE INCOME
The components of other comprehensive loss and total comprehensive loss for
the three months ended January 1, 2005 and December 27, 2003 are as follows
(in millions):
THREE MONTHS ENDED
--------------------------
JANUARY 1, DECEMBER 27,
2005 2003
---------- ------------
Net loss........................................... $(62.7) $(70.7)
Other comprehensive income (expense):
Change in valuation of derivative instruments... 0.8 0.1
Foreign currency translation adjustments........ 0.9 (0.8)
------ ------
Comprehensive loss.............................. $(61.0) $(71.4)
====== ======
7. RETIREMENT AND RETIREE MEDICAL PLANS COST INFORMATION
The following summarizes the net periodic benefit cost for the various
plans sponsored by the Company (in millions):
THREE MONTHS ENDED
--------------------------
JANUARY 1, DECEMBER 27,
2005 2003
---------- ------------
Curtailed defined benefit plan ..................... $0.9 $1.1
International benefit plans ........................ 0.9 1.2
Retiree medical plan ............................... 0.8 0.6
8. CONTINGENCIES
Management continually evaluates the Company's contingencies, including
various lawsuits and claims which arise in the normal course of business,
product and general liabilities, 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 discharges from on-site wastewater treatment and several
discontinued on-site disposal areas. The wastewater discharges were
re-directed to the City of Marysville system in 1998. The on-site disposal
areas date back to the early operations of the Marysville facility and are
areas that we had already been assessing and, in some cases, restoring, 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 restore the site such that we eliminate exposure to waste
materials historically disposed at the Marysville site. We have continued
our restoration activities with the knowledge and oversight of the Ohio
EPA. We completed an updated evaluation of our expected liability related
to this matter based on the fine paid and restoration actions that we have
taken and expect to take in the future. As a result, we accrued an
additional $3.0 million in the third quarter of fiscal 2002 to increase our
reserve based on the then latest estimates.
11
On October 18, 2004, an agreed judicial Consent Decree was entered by the
court as a result of not obtaining a permit from the Philadelphia District
of the U.S. Army Corps of Engineers for prior peat harvesting operations at
our Lafayette, New Jersey facility. The Consent Decree requires minor
mitigation efforts and annual monitoring through 2009 as well as payment of
a $50,000 civil penalty.
We are also addressing remediation concerns raised by the Environment
Agency of the United Kingdom with respect to emissions to air and
groundwater at our Bramford (Suffolk), United Kingdom facility. We have
reserved for our estimates of probable losses to be incurred in connection
with each of these matters.
At January 1, 2005, $4.9 million was accrued for the environmental and
regulatory matters described herein, the majority of which is for site
restoration. Most of the costs accrued as of the end of the current fiscal
quarter, are expected to be paid in fiscal 2005 and 2006; however, payments
could be made for a period thereafter.
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
restored;
- 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
historical wastes can be left in place rather than having to be
removed and only specific stream segments will require
remediation/restoration 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 fiscal 2004 and 2003, we have expensed approximately $3.3 million
and $1.5 million for environmental matters. We expect spending on
environmental matters in fiscal 2005 will not vary materially from amounts
spent in fiscal 2004.
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 in those matters is reasonable and that related
reserves, in the aggregate, are adequate; however, there can be no
assurance that the final resolution of those matters will not have a
material adverse affect on our results of operations, financial position
and cash flows.
Pending material legal proceedings with material developments during the
first quarter of fiscal 2005 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.
12
AgrEvo is requesting 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 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 Company's counterclaim is now part of the underlying
litigation. Recently, Monsanto settled with AgrEvo. The terms of that
settlement are not known. A trial date has been set for April 4, 2005.
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.
U.S. HORTICULTURAL SUPPLY, INC. (F/K/A E.C. GEIGER, INC.)
On February 7, 2003, U.S. Horticultural Supply, Inc. ("Geiger") filed suit
against The Scotts Company in the U.S. District Court for the Eastern
District of Pennsylvania. Geiger alleged claims of breach of contract,
promissory estoppel, and a violation of federal antitrust laws, and seeks
an unspecified amount of damages. Geiger's promissory estoppel claims have
been dismissed. The parties have concluded discovery on the antitrust and
breach of contract claims. No trial date has been set.
On November 5, 2004, Geiger filed another suit against The Scotts Company
in the U.S. District Court for the Eastern District of Pennsylvania. This
complaint alleges that The Scotts Company conspired with another
distributor, Griffin Greenhouse Supplies, Inc., to restrain trade in the
horticultural products market, in violation of Sections 1 and 57 of the
Sherman Antitrust Act. The Scotts Company moved to dismiss the suit on
December 2, 2004, and the court has scheduled oral argument on the motion
for March 18, 2005.
The Scotts Company believes that all of Geiger's claims are without merit
and intends to vigorously defend against them. If any of 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 this matter.
9. SMITH & HAWKEN ACQUISITION
Effective October 2, 2004, Scotts acquired all outstanding shares of Smith
& Hawken(R), a leading brand in the outdoor living and gardening lifestyle
category, for a total cost of $74.9 million. Of the total purchase price,
$72.0 million was paid in cash (including $13.0 million paid to retire debt
at acquisition), while other purchase obligations of $2.9 million were
assumed. Final purchase accounting allocations are expected to be completed
by the end of the second quarter of fiscal 2005. Likewise, the allocation
of the purchase price to assets acquired and liabilities assumed, based on
their estimated fair values at the date of acquisition, is also pending.
Smith & Hawken(R) products are sold primarily through 59 retail stores
around the United States as well as through catalog and internet sales.
Smith & Hawken(R) competes in several categories, including garden tools,
gardening containers, pottery, live goods and high-end outdoor furniture.
On a pro forma basis, net sales for the three months ended December 27,
2003, would have been $222.4 million (an increase of $41.0 million) had the
acquisition of Smith & Hawken occurred as of October 1, 2003. There would
be minimal or no pro forma impact on the reported net loss or net loss per
share.
10. OPERATING LEASE FACILITY
Subsequent to January 1, 2005, the Company began to take delivery on the
first of approximately 200 vehicles that will be used in our Scotts
LawnService(R) operations. These vehicles will be leased in an operating
lease transaction under the terms of a master lease facility. The master
lease agreement provides that the Company pays certain taxes, insurance,
and maintenance on the vehicles. The vehicles will be leased for four years
from delivery, with a three-year renewal option and an option to
13
purchase. The Company will have a maximum contingent obligation that will
approximate $6 million in the aggregate for all vehicles under this master
lease facility based on the provisions of a residual value guarantee.
11. SEGMENT INFORMATION
For fiscal 2005, the Company is divided into the following segments - North
America, Scotts LawnService(R), International, and Other/Corporate. The
North America segment primarily consists of the Lawns, Gardening Products,
Ortho(R), Canada and the North American Professional business group. 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, liquid 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, warehouse clubs, distributors, nurseries, garden centers and
specialty crop growers in the United States, Canada, Latin America, South
America, Australia, and Asia-Pacific.
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 operated locations, Scotts LawnService(R) also offers tree and
shrub fertilization, disease and insect control treatments and, in our
larger branches, we also offer an exterior barrier pest control service.
The International segment provides products similar to those described
above for the North America segment to consumers outside of the United
States, Canada, Latin America, South America, Australia, and Asia-Pacific.
The Other/Corporate segment consists of the recently acquired Smith &
Hawken(R) business and corporate, general, and administrative expenses.
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). Reclassifications were made to properly allocate $26.3
million of goodwill from International to North America and to properly
allocate $109.2 million of assets from North America to SLS, International,
and the Other/Corporate segments.
SCOTTS OTHER/
NORTH AMERICA LAWNSERVICE(R) INTERNATIONAL CORPORATE TOTAL
------------- -------------- ------------- --------- ---------
(IN MILLIONS, EXCEPT OPERATING PERCENTAGES)
Net sales:
Q1 2005 ............. $ 113.0 $ 20.9 $ 68.4 $ 41.7 $ 244.0
Q1 2004 ............. $ 104.0 $ 18.5 $ 58.9 -- $ 181.4
Operating loss:
Q1 2005 ............. $ (29.9) $ (8.2) $(27.9) $(21.9) $ (87.9)
Q1 2004 ............. $ (30.1) $ (6.5) $ (2.4) $(17.6) $ (56.6)
Operating margin:
Q1 2005 ............. (26.5%) (39.2%) (40.8%) (52.5%) (36.0%)
Q1 2004 ............. (28.9%) (35.1%) (4.1%) nm (31.2%)
Goodwill:
Q1 2005 ............. $ 201.7 $100.8 $124.6 $ 23.1 $ 450.2
Q1 2004 ............. $ 203.3 $ 91.9 $117.3 $ -- $ 412.5
Total assets:
Q1 2005 ............. $1,199.6 $122.6 $581.5 $227.4 $2,131.1
Q1 2004 ............. $1,217.8 $115.0 $508.5 $174.0 $2,015.3
nm Not meaningful.
Operating loss from operations represents earnings before amortization of
intangible assets, interest and taxes, since this is the measure of
profitability used by management. Accordingly, the Other/Corporate
operating loss for the three months ended January 1, 2005 and December 27,
2003 includes amortization of certain intangible assets, unallocated
corporate general and administrative expenses, restructuring charges and
certain "other" income (expense) items not allocated to the reportable
segments.
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.
14
12. DISCONTINUED OPERATIONS
On September 30, 2004, the Company consummated the sale of the intangibles
comprising its U.S. professional growing media business. The results of
operations of the component are being reported as discontinued operations
in the accompanying Condensed, Consolidated Statements of Operations. The
detail comprising the discontinued operations for the three-month period
ended December 27, 2003, is as follows (in millions).
Net sales .................................. $4.8
Cost of sales .............................. 4.5
----
Gross profit ............................ 0.3
Selling, general and administrative ........ 0.3
----
Income from discontinued operations
before income taxes .................. --
Income taxes ............................... --
----
Net income from discontinued operations . $ --
====
During the first quarter of fiscal 2005, an additional net loss of $0.2
million was recorded for this discontinued operation relating to facility
shutdown costs.
13. SUBSEQUENT EVENT - RESTRUCTURING MERGER
At the Annual Meeting of Shareholders of the Company held on January 27,
2005, a proposal was approved regarding the restructuring of Scotts'
corporate structure into a holding company structure by merging Scotts into
a newly-created, wholly-owned, second-tier limited liability company
subsidiary, The Scotts Company LLC (the "Restructuring Merger"). Scotts
intends to consummate the Restructuring Merger and implement the
restructuring of the corporate structure in fiscal year ending September
30, 2005. Upon the effective date of the Restructuring Merger, each of
Scotts' common shares will be automatically converted into one common share
of a newly-created holding company, "The Scotts Miracle-Gro Company"
("Scotts Miracle-Gro") an Ohio Corporation, as successor to Scotts. The
rights of Scotts Miracle-Gro's shareholders after completion of the
Restructuring Merger will be the same as the rights of Scotts' shareholders
prior to the Restructuring Merger. The Restructuring Merger will constitute
a reorganization within the meaning of Section 368(a) of the Internal
Revenue Code of 1986, as amended, for United States federal income tax
purposes and neither Scotts nor Scotts Miracle-Gro will recognize any gain
or loss as a result of the Restructuring Merger or the related common share
exchange. In addition, no gain or loss will be recognized for United States
federal income tax purposes by shareholders of Scotts who exchange their
common shares of Scotts solely for common shares of Scotts Miracle-Gro.
The consolidated assets and liabilities of Scotts Miracle-Gro and its
subsidiaries (including The Scotts Company LLC) immediately after the
Restructuring Merger will be the same as the consolidated assets and
liabilities of Scotts and its subsidiaries immediately before the
Restructuring Merger. The Restructuring Merger will result in Scotts
Miracle-Gro becoming the owner of all of the outstanding membership
interests of The Scotts Company LLC. This change in ownership will have no
accounting effect on Scotts Miracle-Gro, or The Scotts Company LLC, as
successor to Scotts.
14. 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 consolidating Statements of
Operations, Statements of Cash Flows and Balance Sheets for the three-month
periods ended January 1, 2005 and December 27, 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.
15
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED JANUARY 1, 2005 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------ ---------- ---------- ------------ ------------
Net sales ................................. $ 62.9 $103.8 $ 77.3 $-- $244.0
Cost of sales ............................. 38.7 86.2 50.9 -- 175.8
Restructuring and other charges ........... -- -- -- -- --
------ ------ ------ ------ ------
Gross profit .............................. 24.2 17.6 26.4 -- 68.2
Gross commission earned from marketing
agreement .............................. (1.2) -- 1.2 -- --
Amortization of deferred marketing fee .... 0.8 -- -- -- 0.8
Contribution expenses under marketing .....
agreement .............................. 6.3 -- -- -- 6.3
------ ------ ------ ------ ------
Net expense from marketing agreement ... (8.3) -- 1.2 -- (7.1)
Operating expenses:
Advertising ............................ 5.2 5.8 3.7 -- 14.7
Selling, general and administrative .... 63.1 23.1 26.1 -- 112.3
Restructuring and other charges ........ 0.3 -- (0.1) -- 0.2
Amortization of intangible assets ...... 0.1 1.3 1.2 -- 2.6
Equity loss in subsidiaries ............... 27.0 -- -- (27.0) --
Intracompany allocations .................. (6.9) 2.8 4.1 -- --
Impairment of intangible assets ........... -- -- 22.0 -- 22.0
Other income, net ......................... 0.4 (0.8) 0.2 -- (0.2)
------ ------ ------ ------ ------
Income (loss) from operations ............. (73.3) (14.6) (29.6) 27.0 (90.5)
Interest expense (income) ................. 11.0 (2.3) 1.7 -- 10.4
------ ------ ------ ------ ------
Income (loss) before income taxes ......... (84.3) (12.3) (31.3) 27.0 (100.9)
Income tax benefit ........................ (21.8) (4.7) (11.9) -- (38.4)
------ ------ ------ ------ ------
Net income (loss) from continuing
operations ............................. (62.5) (7.6) (19.4) 27.0 (62.5)
Net loss from discontinued operations ..... (0.2) -- -- -- (0.2)
------ ------ ------ ------ ------
Net income (loss) ......................... $(62.7) $ (7.6) $(19.4) $ 27.0 $(62.7)
====== ====== ====== ====== ======
16
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED JANUARY 1, 2005 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .................................. $ (62.7) $ (7.6) $(19.4) $ 27.0 $ (62.7)
Adjustments to reconcile net loss to
net cash used in operating activities:
Loss on impairment of intangible assets ......... -- -- 22.0 -- 22.0
Stock-based compensation expense ................ 2.3 -- -- -- 2.3
Depreciation .................................... 8.9 1.6 2.0 -- 12.5
Amortization .................................... 0.9 1.3 1.2 -- 3.4
Deferred taxes .................................. 0.5 -- (10.0) -- (9.5)
Equity loss in subsidiaries ..................... 27.0 -- -- (27.0) --
Net change in certain components
of working capital .............................. (78.2) (18.2) (43.6) -- (140.0)
Net changes in other assets and
liabilities and other adjustments ............... -- 0.5 0.8 -- 1.3
------- ------ ------ ------ -------
Net cash used in operating activities .............. (101.3) (22.4) (47.0) -- (170.7)
------- ------ ------ ------ -------
CASH FLOWS FROM INVESTING ACTIVITIES
Redemption of available for sale securities ........ 57.2 -- -- 57.2
Investment in property, plant and equipment ........ (3.3) (1.0) (0.7) -- (5.0)
Investment in acquired businesses,
net of cash acquired ............................ -- (70.3) -- -- (70.3)
------- ------ ------ ------ -------
Net cash provided by (used in) investing
activities ...................................... 53.9 (71.3) (0.7) -- (18.1)
------- ------ ------ ------ -------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving
and bank lines of credit ........................ 14.5 -- 118.4 -- 132.9
Repayments under revolving and bank lines of
credit .......................................... -- -- (14.2) -- (14.2)
Gross repayments under term loans .................. (1.0) -- -- -- (1.0)
Financing fees ..................................... (0.3) -- (0.1) -- (0.4)
Payments on seller notes ........................... -- (1.9) -- -- (1.9)
Cash received from the exercise of
stock options ................................... 11.8 -- -- -- 11.8
Intracompany financing ............................. (55.7) 95.0 (39.3) -- --
------- ------ ------ ------ -------
Net cash provided by (used in) financing
activities ...................................... (30.7) 93.1 64.8 -- 127.2
Effect of exchange rate changes on cash ............ -- -- (24.9) -- (24.9)
------- ------ ------ ------ -------
Net decrease in cash ............................... (78.1) (0.6) (7.8) -- (86.5)
Cash and cash equivalents, beginning of period ... 82.4 1.3 31.9 -- 115.6
------- ------ ------ ------ -------
Cash and cash equivalents, end of period ........... $ 4.3 $ 0.7 $ 24.1 $ -- $ 29.1
======= ====== ====== ====== =======
17
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING BALANCE SHEET
AS OF JANUARY 1, 2005 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- ---------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ................. $ 4.3 $ 0.7 $ 24.1 $ -- $ 29.1
Accounts receivable, net .................. 18.3 114.2 113.2 -- 245.7
Inventories, net .......................... 257.6 103.6 140.0 -- 501.2
Current deferred tax asset ................ 22.7 0.4 1.7 -- 24.8
Prepaid and other assets .................. 22.3 5.7 27.0 -- 55.0
-------- -------- ------ --------- --------
Total current assets ................... 325.2 224.6 306.0 -- 855.8
Property, plant and equipment, net ........... 185.0 112.5 46.3 -- 343.8
Goodwill ..................................... 18.8 294.4 137.0 -- 450.2
Intangible assets, net ....................... 6.1 294.8 134.2 -- 435.1
Other assets ................................. 46.0 -- 0.2 -- 46.2
Investment in affiliates ..................... 1,222.8 -- -- (1,222.8) --
Intracompany assets .......................... -- 325.4 -- (325.4) --
-------- -------- ------ --------- --------
Total assets ........................... $1,803.9 $1,251.7 $623.7 $(1,548.2) $2,131.1
======== ======== ====== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ................... $ 5.0 $ 4.1 $ 11.4 $ -- $ 20.5
Accounts payable .......................... 98.1 37.9 60.7 -- 196.7
Accrued liabilities ....................... 100.8 26.9 112.1 -- 239.8
Accrued taxes ............................. (6.9) 0.6 1.0 -- (5.3)
-------- -------- ------ --------- --------
Total current liabilities .............. 197.0 69.5 185.2 -- 451.7
Long-term debt ............................... 618.0 4.1 105.1 -- 727.2
Other liabilities ............................ 113.3 (3.6) 14.6 -- 124.3
Intracompany liabilities ..................... 19.1 -- 306.3 (325.4) --
-------- -------- ------ --------- --------
Total liabilities ...................... 947.4 70.0 611.2 (325.4) 1,303.2
-------- -------- ------ --------- --------
Shareholders' equity:
Investment from parent .................... -- 569.4 55.7 (625.1) --
Common shares ............................. 0.3 -- -- -- 0.3
Deferred compensation-stock awards ........ (21.5) -- -- -- (21.5)
Capital in excess of stated value ......... 468.4 -- -- -- 468.4
Retained earnings ......................... 436.7 614.1 (16.4) (597.7) 436.7
Accumulated other comprehensive loss ...... (27.4) (1.8) (26.8) -- (56.0)
-------- -------- ------ --------- --------
Total shareholders' equity ................... 856.5 1,181.7 12.5 (1,222.8) 827.9
-------- -------- ------ --------- --------
Total liabilities and shareholders' equity ... $1,803.9 $1,251.7 $623.7 $(1,548.2) $2,131.1
======== ======== ====== ========= ========
18
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 27, 2003 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- ---------- ------------ ------------
Net sales ........................................ $ 60.6 $ 54.4 $66.4 $ -- $ 181.4
Cost of sales .................................... 36.7 55.9 40.4 -- 133.0
Restructuring and other charges .................. 0.3 -- 0.2 -- 0.5
------- ------ ----- ------ -------
Gross profit ..................................... 23.6 (1.5) 25.8 -- 47.9
Gross commission earned from marketing
agreement ........................................
Amortization of deferred marketing fee ........... 0.8 0.8
Contribution expense under marketing agreement ... 6.3 -- -- -- 6.3
------- ------ ----- ------ -------
Net expense from marketing agreement .......... 7.1 -- -- -- 7.1
Operating expenses:
Advertising ................................... 4.1 1.1 3.1 -- 8.3
Selling, general and administrative ........... 56.3 9.3 24.8 -- 90.4
Restructuring and other charges ............... -- 0.1 0.4 -- 0.5
Amortization of intangible assets ............. 0.1 1.1 1.2 -- 2.4
Equity loss in subsidiaries ...................... 15.1 -- -- (15.1) --
Intracompany allocations ......................... (7.6) 6.2 1.4 -- --
Other income, net ................................ (0.3) (0.8) (0.7) -- (1.8)
------- ------ ----- ------ -------
Income (loss) from operations .................... (51.2) (18.5) (4.4) 15.1 (59.0)
Costs related to refinancing ..................... 43.7 -- -- -- 43.7
Interest expense ................................. 10.4 -- 1.5 -- 11.9
------- ------ ----- ------ -------
Income (loss) before income taxes ................ (105.3) (18.5) (5.9) 15.1 (114.6)
Income tax benefit ............................... (34.6) (7.1) (2.2) -- (43.9)
------- ------ ----- ------ -------
Net income (loss) from continuing operations...... (70.7) (11.4) (3.7) 15.1 (70.7)
Net income from discontinued operations .......... -- -- -- -- --
Net income (loss) ................................ $ (70.7) $(11.4) $(3.7) $ 15.1 $ (70.7)
======= ====== ===== ====== =======
19
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTH PERIOD ENDED DECEMBER 27, 2003 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .................................... $ (70.7) $(11.4) $ (3.7) $ 15.1 $ (70.7)
Adjustments to reconcile net loss to
net cash used in operating activities:
Write-off of deferred costs on retired debt ....... 19.4 -- -- -- 19.4
Stock-based compensation expense .................. 1.3 -- -- -- 1.3
Depreciation ...................................... 6.6 2.8 0.8 -- 10.2
Amortization ...................................... 0.9 1.1 1.2 -- 3.2
Deferred Taxes .................................... 1.8 -- -- -- 1.8
Equity loss in subsidiaries ....................... 15.1 -- -- (15.1) --
Net change in certain components
of working capital ................................ (83.6) (27.9) (45.0) -- (156.5)
Net changes in other assets and
liabilities and other adjustments ................. (17.6) -- 20.9 -- 3.3
------- ------ ------ ------ -------
Net cash used in operating activities ................ (126.8) (35.4) (25.8) -- (188.0)
------- ------ ------ ------ -------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment .......... (0.8) (2.5) (0.7) -- (4.0)
Investment in acquired businesses,
net of cash acquired .............................. (0.3) (0.3) -- -- (0.6)
------- ------ ------ ------ -------
Net cash used in investing activities ................ (1.1) (2.8) (0.7) -- (4.6)
------- ------ ------ ------ -------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving
and bank lines of credit .......................... -- -- 104.3 -- 104.3
Repayments under revolving and bank lines of credit... -- -- (12.6) -- (12.6)
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 ........................... (379.9) -- -- -- (379.9)
Financing fees ....................................... (10.9) -- -- -- (10.9)
Payments on seller notes ............................. -- (1.9) -- -- (1.9)
Cash received from the exercise of
stock options ..................................... 7.1 -- -- -- 7.1
Intracompany financing ............................... (66.3) 39.7 26.6 -- --
------- ------ ------ ------ -------
Net cash provided by financing activities ............ 9.5 37.8 32.3 -- 79.6
Effect of exchange rate changes on cash .............. -- -- (16.6) -- (16.6)
------- ------ ------ ------ -------
Net increase (decrease) in cash ...................... (118.4) (0.4) (10.8) -- (129.6)
Cash and cash equivalents, beginning of period ....... 132.1 1.2 22.6 -- 155.9
------- ------ ------ ------ -------
Cash and cash equivalents, end of period ............. $ 13.7 $ 0.8 $ 11.8 $ -- $ 26.3
======= ====== ====== ====== =======
20
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 27, 2003 (IN MILLIONS)
(UNAUDITED)
SUBSIDIARY NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- ---------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 13.7 $ 0.8 $ 11.8 $ -- $ 26.3
Accounts receivable, net ........................ 28.2 90.8 110.1 -- 229.1
Inventories, net ................................ 247.7 78.9 115.8 -- 442.4
Current deferred tax asset ...................... 58.8 0.4 1.5 -- 60.7
Prepaid and other assets ........................ 16.7 1.9 13.7 -- 32.3
-------- -------- ------ --------- --------
Total current assets ......................... 365.1 172.8 252.9 -- 790.8
Property, plant and equipment, net ................. 201.3 90.0 42.5 -- 333.8
Goodwill ........................................... 20.5 294.7 97.3 -- 412.5
Intangible assets, net ............................. 5.9 280.8 149.5 -- 436.2
Other assets ....................................... 42.0 1.5 (1.5) -- 42.0
Investment in affiliates ........................... 1,024.9 -- -- (1,024.9) --
Intracompany assets ................................ 12.8 220.1 -- (232.9) --
-------- -------- ------ --------- --------
Total assets ................................. $1,672.5 $1,059.9 $540.7 $(1,257.8) $2,015.3
======== ======== ====== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of debt ......................... $ 1.8 $ 9.8 $ 19.2 $ -- $ 30.8
Accounts payable ................................ 89.2 28.1 64.1 -- 181.4
Accrued liabilities ............................. 77.9 16.3 96.5 -- 190.7
Accrued taxes ................................... (25.2) 1.0 (0.6) -- (24.8)
-------- -------- ------ --------- --------
Total current liabilities .................... 143.7 55.2 179.2 -- 378.1
Long-term debt ..................................... 720.1 8.0 82.0 -- 810.1
Other liabilities .................................. 142.3 -- 18.4 -- 160.7
Intracompany liabilities ........................... -- -- 232.9 (232.9) --
-------- -------- ------ --------- --------
Total liabilities ............................ 1,006.1 63.2 512.5 (232.9) 1,348.9
-------- -------- ------ --------- --------
Shareholders' equity:
Investment from parent .......................... -- 491.5 0.4 (491.9) --
Common shares ................................... 0.3 -- -- -- 0.3
Deferred compensation-stock awards .............. (19.2) -- -- -- (19.2)
Capital in excess of stated value ............... 418.9 -- -- -- 418.9
Retained earnings ............................... 327.9 503.4 0.9 (504.3) 327.9
Accumulated other comprehensive income (loss) ... (61.5) 1.8 26.9 (28.7) (61.5)
-------- -------- ------ --------- --------
Total shareholders' equity ......................... 666.4 996.7 28.2 (1,024.9) 666.4
-------- -------- ------ --------- --------
Total liabilities and shareholders' equity ......... $1,672.5 $1,059.9 $540.7 $(1,257.8) $2,015.3
======== ======== ====== ========= ========
21
THE SCOTTS COMPANY
CONDENSED, CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 30, 2004
(IN MILLIONS)
Subsidiary Non-
Parent Guarantors Guarantors Eliminations Consolidated
-------- ---------- ---------- ------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents .......... $ 82.4 $ 1.3 $ 31.9 $ -- $ 115.6
Investments ........................ 57.2 -- -- -- 57.2
Accounts receivable, net ........... 88.7 120.0 83.7 -- 292.4
Inventories, net ................... 132.8 57.5 99.8 -- 290.1
Current deferred tax asset ......... 23.2 0.2 1.5 -- 24.9
Prepaid and other assets ........... 19.5 5.5 25.1 -- 50.1
-------- -------- ------ --------- --------
Total current assets ............ 403.8 184.5 242.0 -- 830.3
Property, plant and equipment, net .... 191.2 92.8 44.0 -- 328.0
Goodwill .............................. 18.8 244.6 154.5 -- 417.9
Intangible assets, net ................ 5.7 279.1 146.2 -- 431.0
Other assets .......................... 46.0 -- (5.4) -- 40.6
Investment in affiliates .............. 1,176.0 -- -- (1,176.0) --
Intracompany assets ................... -- 394.9 -- (394.9) --
-------- -------- ------ --------- --------
Total assets .................... $1,841.5 $1,195.9 $581.3 $(1,570.9) $2,047.8
======== ======== ====== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of debt ............ $ 5.0 $ 6.2 $ 10.9 $ -- $ 22.1
Accounts payable ................... 61.6 16.2 52.5 -- 130.3
Accrued liabilities ................ 133.3 29.8 98.8 -- 261.9
Accrued taxes ...................... 18.3 0.8 0.2 -- 19.3
-------- -------- ------ --------- --------
Total current liabilities ....... 218.2 53.0 162.4 -- 433.6
Long-term debt ........................ 604.8 3.6 0.1 -- 608.5
Other liabilities ..................... 113.9 1.5 15.7 -- 131.1
Intracompany liabilities .............. 30.0 -- 364.9 (394.9) --
-------- -------- ------ --------- --------
Total liabilities ............... 966.9 58.1 543.1 (394.9) 1,173.2
Shareholders' Equity:
Investment from parent ............. -- 517.8 62.5 (580.3) --
Common shares ...................... 0.3 -- -- -- 0.3
Deferred compensation -- stock
awards .......................... (10.4) -- -- -- (10.4)
Capital in excess stated value ..... 443.0 -- 443.0
Retained earnings .................. 499.5 621.8 3.0 (624.8) 499.5
Accumulated other comprehensive
income (loss) ...................... (57.8) (1.8) (27.3) 29.1 (57.8)
-------- -------- ------ --------- --------
Total shareholders' equity ...... 874.6 1,137.8 38.2 (1,176.0) 874.6
-------- -------- ------ --------- --------
Total liabilities and shareholders'
equity ............................. $1,841.5 $1,195.9 $581.3 $(1,570.9) $2,047.8
======== ======== ====== ========= ========
22
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 Canada, 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
2005, our operations are divided into the following segments: North America,
Scotts LawnService(R), International, and Other/Corporate. The Other/Corporate
segment consists of the recently acquired Smith & Hawken(R) business and
corporate, general, and administrative expenses.
As a leading consumer branded lawn and garden company, we focus our
consumer marketing efforts, including advertising and consumer research, on
creating consumer demand to pull products through the retail distribution
channels. In the past three years, we have spent approximately 5% of our 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 2005, we expect to increase advertising to
support new product launches under the Ortho(R), Miracle-Gro(R) and Scotts(R)
brands.
Our sales are susceptible to global weather conditions. For instance,
periods of wet weather can adversely impact sales of certain products while
increasing demand for other 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 two 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 2004 net sales by quarter were
8.9%, 35.5%, 37.7%, and 17.9%, respectively. The addition of our Smith & Hawken
acquisition is not expected to significantly alter the percentage of net sales
by quarter in fiscal 2005.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following discussion and analysis of the consolidated results of
operations and financial position should be read in conjunction with our
Condensed, Consolidated Financial Statements included elsewhere in this
Quarterly Report on Form 10-Q. Our Annual Report on Form 10-K for the fiscal
year ended September 30, 2004 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:
- 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
23
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, 2004, 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.
RESULTS OF OPERATIONS
The following table sets forth net sales by business segment for the three
months ended January 1, 2005 and December 27, 2003:
FOR THE
THREE MONTHS ENDED
-------------------------
JANUARY 1, DECEMBER 27,
2005 2003
---------- ------------
(UNAUDITED)
($ MILLIONS)
North America ...................................... $113.0 $104.0
Scotts LawnService(R) .............................. 20.9 18.5
International ...................................... 68.4 58.9
Other/Corporate .................................... 41.7 --
------ ------
Consolidated .................................... $244.0 $181.4
====== ======
24
The following table sets forth the components of income and expense as a
percentage of net sales for the three months ended January 1, 2005 and December
27, 2003:
FOR THE
THREE MONTHS ENDED
-------------------------
JANUARY 1, DECEMBER 27,
2005 2003
---------- ------------
(UNAUDITED)
Net sales .......................................................... 100.0% 100.0%
Cost of sales ...................................................... 72.0 73.3
Restructuring and other charges .................................... -- 0.3
----- -----
Gross profit ....................................................... 28.0 26.4
Net expense from marketing agreement ............................... (2.9) (3.9)
Operating expenses:
Selling, general and administrative ............................. 39.4 42.8
Selling, general and administrative - lawn service business ..... 5.7 6.3
Stock-based compensation ........................................ 0.9 0.7
Restructuring and other charges ................................. 0.1 0.3
----- -----
46.1 50.1
Advertising ..................................................... 6.0 4.6
Amortization of intangibles ..................................... 1.1 1.3
Impairment of intangible assets ................................. 9.0 --
Other expense (income), net ..................................... (0.1) (1.0)
----- -----
Loss from operations ............................................... (37.1) (32.5)
Costs related to refinancing ....................................... -- 24.1
Interest expense ................................................... 4.3 6.6
----- -----
Loss before income taxes ........................................... (41.4) (63.2)
Income tax benefit ................................................. (15.7) (24.2)
----- -----
Net loss from continuing operations ................................ (25.6) (39.0)
Net loss from discontinued operations .............................. (0.1) --
----- -----
Net loss ........................................................... (25.7) (39.0)
===== =====
THREE MONTHS ENDED JANUARY 1, 2005 COMPARED TO THREE MONTHS ENDED DECEMBER 27,
2003
Net sales for the three months ended January 1, 2005 were $244.0 million,
an increase of 34.5% from net sales of $181.4 million for the three months ended
December 27, 2003. Excluding the effect of exchange rates, net sales for the
first quarter of fiscal 2005 were $237.5 million, an increase of 31.0% compared
to the first quarter of fiscal 2004. This strong performance was due to a
combination of organic growth in North America and International and the
acquisition of Smith & Hawken(R), acquired on October 2, 2004, which added $41.7
million of sales in the first fiscal quarter of 2005. Net sales in the first
quarter of the fiscal year represent only 10.0% of the expected net sales for
the full year and thus are likely not representative of results for the full
year. Price increases are not material to the discussion of net sales in total
or by reportable segment, with the exception of the Scotts LawnService(R)
segment as discussed below, for either fiscal period presented.
North America segment net sales were $113.0 million in the first quarter of
fiscal 2005, an increase of 8.7% from net sales of $104.0 million for the first
quarter of fiscal 2004. This increase was driven largely by strong sales growth
across most product lines, in particular Growing Media and Ortho(R), which
continue to benefit from new product introductions that have gained broad
retailer and consumer acceptance.
Scotts LawnService(R) revenues increased 13.0% from $18.5 million in the
first quarter of fiscal 2004 to $20.9 million in the first quarter of fiscal
2005. The majority of this increase was due to higher customer counts (which
increased from 298,000 at the end of the first quarter 2004 to 320,000 at the
end of the first fiscal quarter of 2005), from continued strong organic growth
and improved customer retention, and the effects of 2004 price increases on
certain customer segments.
Net sales for the International segment in the first quarter of fiscal 2005
were $68.4 million, an increase of $9.5 million, or 16.1%, versus the first
quarter of fiscal 2004. Excluding the effect of exchange rates, net sales
increased by $3.6 million or 6.2%. This increase in net sales was largely due to
the phasing of preseason orders, especially in the United Kingdom, which
benefited
25
from generally strong sell through of retail inventory due to generally milder
and dryer fall weather conditions versus the prior year.
Gross profit was $68.2 million in the first quarter of fiscal 2005, an
increase of $20.3 million from gross profit of $47.9 million in the first
quarter of fiscal 2004. As a percentage of net sales, gross profit was 28.0% of
sales in the first quarter of fiscal 2005 compared to 26.4% in the first quarter
of fiscal 2004. Excluding the effect of restructuring and other charges, gross
profit was 28.0% of sales in the first quarter of fiscal 2005 compared to 26.7%
in the first quarter of fiscal 2004. This improvement in gross profit in the
first quarter of fiscal 2005 was due primarily to the impact of Smith &
Hawken(R), which enjoys higher gross profit margins in the first quarter of the
fiscal year than our core North American lawn and garden consumables businesses.
Gross profit also benefited from high margin North America product launches,
primarily in the Ortho(R) business, and reduced North America warehousing costs.
Gross profit in the International business declined from 40.0% to 33.8% of net
sales, due primarily to the elimination of low cost growing media resulting from
the sale of company-owned peat bogs in the United Kingdom, the restructuring of
a growing media supply contract in the International Professional Business, and
increased excess and obsolete inventory charges in the United Kingdom, France
and Central Europe.
The net expense from the marketing agreement was $7.1 million in the first
quarters of fiscal 2005 and fiscal 2004. We do not recognize commission income
under the marketing agreement until minimum earnings thresholds in the agreement
are achieved, which typically occurs in the second fiscal quarter of the year.
Advertising expenses in the first quarter of fiscal 2005 were $14.7
million, an increase of 77.1% from $8.3 million in the first quarter of fiscal
2004. This sizeable increase was largely due to the acquisition of Smith &
Hawken(R), which accounted for $4.4 million of the increase in advertising
expenditures within the quarter. Excluding Smith & Hawken(R) and the impact of
foreign exchange, core advertising expenditures increased $1.6 million or 19.6%,
primarily attributable to a change in the first quarter sales mix of advertised
products. As a percentage of net sales, advertising expenses were 6.0% in the
first quarter of fiscal 2005 compared to 4.6% in the first quarter of fiscal
2004.
Selling, general and administrative expenses ("SG&A"), excluding Scotts
LawnService(R) SG&A expenses, stock based compensation and restructuring and
other charges, were $96.1 million in the first quarter of fiscal 2005, compared
to $77.7 million for the first quarter of fiscal 2004. Of this $18.4 million
increase, $9.0 million was attributable to the acquisition of Smith & Hawken(R).
SG&A expenses for the quarter were also impacted by the adverse impact of
changing foreign currency exchange rates, increased litigation spending,
incremental North American selling expenses (due to increased home center
account support) and higher auditing and Sarbanes-Oxley compliance fees.
SG&A expenses in the Scotts LawnService(R) business increased from $11.4
million in the first quarter of fiscal 2004 to $13.9 million in the first
quarter of fiscal 2005, reflecting higher customer counts and an increase in the
number of operating locations in the past year.
Expenses attributable to stock-based compensation increased from $1.3
million in the first quarter of fiscal 2004 to $2.3 million in the first quarter
of fiscal 2005, reflecting amortization of grants issued in fiscal 2005 coupled
with amortization associated with grants issued in fiscal 2004 and 2003. For the
full year, charges for stock-based compensation are expected to increase by
approximately $4.0 - $5.0 million for fiscal 2005 compared to fiscal 2004,
reflecting the third-and final year phase-in of Scotts' implementation of stock
based compensation expense.
SG&A related to restructuring activities decreased from $0.5 million in
fiscal 2004's first quarter to $0.2 million in the first quarter of fiscal 2005.
The Company performed its annual impairment analysis during the first
quarter of fiscal 2005 and determined that intangibles associated with our
consumer business in the United Kingdom are impaired. The reduction in the value
of the business has resulted primarily from the decline in the profitability of
its growing media business and unfavorable category mix trends. Although
management is developing strategies to significantly improve the profitability
of the U.K. business, we believe an impairment charge against the book value is
appropriate. Accordingly, an estimated impairment charge of $22 million has been
recorded for the first quarter of fiscal 2005. No impairment charge was recorded
for the first quarter of fiscal 2004.
Other income was $0.2 million for the first quarter of fiscal 2005,
compared to $1.8 million in the first quarter of fiscal 2004, due primarily to
the phase-out of cost subsidies related to the earlier mentioned sale of peat
bogs in the United Kingdom, for which a portion of this cost benefit has
historically been recorded in other income.
26
For segment reporting purposes, earnings before interest, taxes and
amortization of intangible assets ("EBITA") is the measure used by management to
assess earnings performance. Segment performance for the first quarter of fiscal
2005 compared to the first quarter of fiscal 2004 was as follows:
- North America's loss from operations declined from $30.1 million in
fiscal 2004 to $29.9 million in fiscal 2005, as improved gross profit
margins, previously described above, were more than offset by higher
advertising expenditures (due to sales mix) and investments in
consumer market research, selling and research and development costs.
- Scotts LawnService(R) reported higher net sales in the first quarter
of fiscal 2005, but the loss from operations increased to $8.2 million
compared to $6.5 million in the comparable period last year. 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 loss from operations increased from $2.4 million in
2004 to $27.9 million in 2005. If the effect of the $22.0 million
impairment charge is excluded, the loss increased to $5.9 million due
primarily to a decline in gross profit margin (as a percentage of
sales), described above, that more than offset organic growth
(excluding the impact of exchange rates) in net sales.
Interest expense for the first quarter of fiscal 2005 was $10.4 million,
compared to $11.9 million for the first quarter of fiscal 2004. The decrease in
interest expense was due to a $118.7 million reduction in average borrowings as
compared to the prior year, along with a slight decrease in our weighted average
interest rate as a result of the refinancing of our former Credit Agreement,
including the tendering of $400 million 8 5/8% Senior Subordinated Notes, in
November 2003, that were replaced by our 6 5/8% Notes. There were no refinancing
costs in the first fiscal quarter of 2005. This compares favorably to the $43.7
million in expense recorded in the first quarter of 2004, when the Company
substantially completed its debt refinancing.
The income tax benefit was calculated assuming an effective tax rate of
38.0% for the first quarter of fiscal 2005, versus 38.3% for the comparable
quarter in fiscal 2004. 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 the effective tax rate 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.
The Company reported a loss of $62.7 million for the first three months of
fiscal 2005, compared to a loss of $70.7 million for the first three months of
fiscal 2004. Average shares outstanding increased from 32.0 million at December
27, 2003 to 33.0 million at January 1, 2005 due to shares issued for option
exercises. Common stock equivalents are not included in the shares used for
first quarter earnings per share calculations due to their anti-dilutive effect
in periods with net losses.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operating activities was $170.7 million and $188.0 million for
the three months ended January 1, 2005 and December 27, 2003, respectively. The
large use of cash in the first fiscal quarter is due to the seasonal nature of
our operations. The first quarter is the low point for net sales while at the
same time we are building inventories in preparation for the spring selling
season that gets underway in our second fiscal quarter.
Cash used in investing activities was $18.1 million and $4.6 million for
the three months ended January 1, 2005 and December 27, 2003, respectively. Our
acquisition of Smith & Hawken(R) on October 2, 2004 required a cash outlay of
approximately $70.0 million financed in large part through the redemption of
$57.2 million of investments. Other capital spending of $5.0 million was done in
the normal course of business and was comparable to the $4.0 million spent in
the first quarter of fiscal 2004.
Financing activities provided cash of $127.2 million and $79.6 million for
the three months ended January 1, 2005 and December 27, 2003, respectively. The
higher financing needs in the first quarter of fiscal 2005 were due to the
approximate $70 million cash outlay for the Smith & Hawken(R) acquisition. The
alternative use of these funds would have been to finance the deficiency in our
cash flows from operating activities that instead were funded through higher
borrowings. 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.
27
Our primary sources of liquidity are cash generated by operations and
borrowings under our credit agreements. Our Credit Agreement consists of a $700
million multi-currency revolving credit commitment and a $400 million term loan
facility. At January 1, 2005, we were in compliance with all of our debt
covenants.
We have not paid dividends on our common shares in the past However, given
our rapidly improving financial condition and levels of cash generated by the
business, we are currently evaluating various capital structure strategies and
the use of capital for cash generated in the future. These uses may include
continued debt repayment, funding of selective acquisitions to support future
growth, payment of dividends and share repurchases. 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 and capital requirements, restrictions in financing agreements,
business conditions and other factors.
All of our off-balance sheet financing is in the form of operating leases
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, 2004.
Subsequent to the end of our fiscal quarter ended January 1, 2005, we began to
take delivery on the first of approximately 200 new vehicles that will be used
in our Scotts LawnService(R) operations. These vehicles will be financed under
the terms of an operating lease agreement as disclosed in Note 10 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, 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 2005 and
thereafter for the foreseeable future. However, we cannot insure 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.
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 8 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 2004 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
28
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, 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 Second Amended and Restated Credit Agreement("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 but, to a lesser degree,
overall annual sales. An abnormally cold or wet spring throughout North America
and/or Europe could adversely affect sales and therefore our financial results.
29
- - 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, 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, herbicides and
pesticides. There is a portion of the population that perceives all
chemical products as potentially hazardous. This perception,
regardless of its merits, enhances the risk that the Company will be
subjected to product liability claims that allege harm from exposure
to our products. Product liability claims are brought against the
Company from time to time.
- The Company has been named a defendant in product liability lawsuits
and may be named a defendant in additional product liability suits
apparently based on allegations regarding the Company's past use, in
some of its products, of vermiculite supplied to the Company, some of
which has been reported to have contained impurities.
- 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 8 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 updated 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 73% of our worldwide net
sales. Our top three North American retail customers together accounted for 67%
of our North American fiscal 2004 net sales and 71% of our outstanding accounts
30
receivable as of September 30, 2004. Home Depot, Wal-Mart and Lowe's represented
approximately 36%, 18% and 13%, respectively, of our fiscal 2004 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 in the near term
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.
In addition, with respect to the European Union Countries, the initial term
of the Marketing Agreement extends through September 30, 2005, and may be
renewed at the option of both parties for three successive terms ending on
September 30, 2008, 2015, and 2018. With a separate determination being made by
both parties at least six months prior to the expiration of each term. While the
commission structure is likely to be recalculated in a manner favorable to
Scotts should Monsanto not agree to the renewal term, there is no assurance that
the change in terms would be sufficient to offset the loss of earnings from the
European Roundup business and overhead absorption the Marketing Agreement
provides.
- - THE HAGEDORN PARTNERSHIP, L.P. BENEFICIALLY OWNS APPROXIMATELY 32% OF OUR
OUTSTANDING COMMON SHARES ON A FULLY DILUTED BASIS.
The Hagedorn Partnership, L.P. beneficially owns approximately 32% 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
31
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 of no harm will result from the cumulative effect of pesticide
exposures. Under this act, the U.S. EPA is evaluating the cumulative risks from
dietary and non-dietary exposures to pesticides. The pesticides in our products,
certain of which may be used on crops processed into various food products,
continue to be evaluated by the U.S. EPA as part of this exposure risk
assessment. It is possible that the U.S. EPA or a third party active ingredient
registrant may decide that a pesticide we use in our products will be limited or
made unavailable to us. For example, in June 2000, DowAgroSciences, an active
ingredient registrant, voluntarily agreed to a gradual phase-out of residential
uses of chlorpyrifos, an active ingredient 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 the United Kingdom, our peat extraction efforts are also the subject
of legislation.
In addition to the regulations already described, local, state, federal and
foreign agencies regulate the disposal, handling and storage of waste, air and
water discharges from our facilities. In June 1997, the Ohio Environmental
Protection Agency ("Ohio EPA") initiated an enforcement action against us with
respect to alleged surface water violations and inadequate treatment
capabilities at our Marysville facility and is seeking corrective action under
the Resource Conservation Recovery Act. We have met with the Ohio EPA and the
Ohio Attorney General's office to negotiate an amicable resolution of these
issues. On December 3, 2001, an agreed judicial Consent Order was submitted to
the Union County Common Pleas Court and was entered by the court on January 25,
2002.
During fiscal 2004 and 2003, we have expensed approximately $3.3 million
and $1.5 million for environmental matters, respectively. Expenses related to
environmental matters in fiscal 2005 are not expected to be significant.
The adequacy of these estimated future expenditures is based on our
operating in substantial compliance with applicable environmental and public
health laws and regulations and several significant assumptions:
- that we have identified all of the significant sites that must be
remediated;
- that there are no significant conditions of potential contamination
that are unknown to us; and
- that with respect to the agreed judicial Consent Order in Ohio, that
potentially contaminated soil can be remediated in place rather than
having to be removed and only specific stream segments will require
remediation as opposed to the entire stream.
If there is a significant change in the facts and circumstances surrounding
these assumptions or if we are found not to be in substantial compliance with
applicable environmental and public health laws and regulations, it could have a
material impact on future environmental capital expenditures and other
environmental expenses and our results of operations, financial position and
cash flows.
32
- - 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 2004, 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
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2004.
ITEM 4. CONTROLS AND PROCEDURES
With the participation of the Company's principal executive officer and
principal financial officer, the Company's management has evaluated the
effectiveness of the Company'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 fiscal quarter covered by this Quarterly
Report on Form 10-Q. Based upon that evaluation, the Company's principal
executive officer and principal financial officer have concluded that:
(A) information required to be disclosed by the Company in this
Quarterly Report on Form 10-Q and the other reports that the
Company files or submits under the Exchange Act would be
accumulated and communicated to the Company'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 Company in this
Quarterly Report on Form 10-Q and the other reports that the
Company files or submits under the Exchange Act would be recorded,
processed, summarized, and reported within the time periods specified
in the SEC's rules and forms; and
(C) the Company's disclosure controls and procedures are effective as
of the end of the fiscal quarter covered by this Quarterly Report on
Form 10-Q to ensure that material information relating to the
Company and its consolidated subsidiaries is made known to them,
particularly during the period in which the Company's periodic
reports, including this Quarterly Report on Form 10-Q, are being
prepared.
In addition, there were no changes in the Company's internal control
over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act)
that occurred during the Company's fiscal quarter ended January 1, 2005, that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
33
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Pending material legal proceedings with material developments during the
first quarter of fiscal 2005 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 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 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 Company's counterclaim is now part
of the underlying litigation. Recently, Monsanto settled with AgrEvo. The
terms of that settlement are not known. A trial date has been set for April
4, 2005.
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.
U.S. HORTICULTURAL SUPPLY, INC. (F/K/A E.C. GEIGER, INC.)
On February 7, 2003, U.S. Horticultural Supply Inc. ("Geiger") filed
suit against The Scotts Company in the U.S. District Court for the Eastern
District of Pennsylvania. Geiger alleged claims of breach of contract,
promissory estoppel, and a violation of federal antitrust laws, and seeks
an unspecified amount of damages. Geiger's promissory estoppel claims have
been dismissed. The parties have concluded discovery on the antitrust and
breach of contract claims. No trial date has been set.
On November 5, 2004, Geiger filed another suit against The Scotts
Company in the U.S. District Court for the Eastern District of
Pennsylvania. This complaint alleges that The Scotts Company conspired with
another distributor, Griffin Greenhouse Supplies, Inc., to restrain trade
in the horticultural products market, in violation of Sections 1 and 57 of
the Sherman Antitrust Act. The Scotts Company moved to dismiss the suit on
December 2, 2004, and the court has scheduled oral argument on the motion
for March 18, 2005.
The Scotts Company believes that all of Geiger's claims are without
merit and intends to vigorously defend against them. If any of 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 this matter.
34
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of The Scotts Company (the "Annual
Meeting") was held in Marysville, Ohio on January 27, 2005.
The result of the vote of the shareholders in the election of four
directors, for terms of three years each, is as follows:
VOTES
NOMINEE VOTES FOR WITHHELD
- ------------------------------------------------------- ---------- ---------
James Hagedorn ........................................ 28,772,560 1,260,982
Karen G. Mills ........................................ 28,756,789 1,276,753
Stephanie M. Shern .................................... 28,194,005 1,839,537
John Walker, Ph.D ..................................... 29,779,060 254,482
Each of the nominees was elected. The other directors whose terms of office
continue after the Annual Meeting are Mark R. Baker, Lynn J. Beasley, Gordon F.
Brunner, Arnold W. Donald, Joseph P. Flannery, Katherine Hagedorn Littlefield,
Patrick J. Norton and John M. Sullivan.
The Scotts Company Employee Stock Purchase Plan was approved. The result of the
vote was:
VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTES
- ---------- ------------- ----------- ----------------
26,945,868 272,057 22,800 2,792,817
The proposal to approve the restructuring of The Scotts Company's corporate
structure into a holding company structure by merging The Scotts Company into a
newly-created, wholly-owned, second-tier limited liability company subsidiary,
The Scotts Company LLC, pursuant to the agreement and plan of merger attached to
the Proxy Statement/Prospectus sent or given to shareholders in connection with
the Annual Meeting (the "Restructuring Merger") was approved and the related
agreement and plan of merger adopted, by The Scotts Company's shareholders. The
result of the vote was:
VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTES
- ---------- ------------- ----------- ----------------
26,855,494 345,746 39,485 2,792,817
ITEM 6. EXHIBITS
See Index to Exhibits at page 37 for a list of the exhibits included
herewith.
35
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: February 10, 2005
Executive Vice President and Chief
Financial Officer,
(Principal Financial and Principal
Accounting Officer)
(Duly Authorized Officer)
36
THE SCOTTS COMPANY
ANNUAL REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDED JANUARY 1, 2005
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
37