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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(MARK ONE)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1998
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 1-11593
THE SCOTTS COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
OHIO 31-1414921
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
14111 SCOTTSLAWN ROAD, MARYSVILLE, OHIO 43041
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 937-644-0011
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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9 7/8% Senior Subordinated Notes due August 1, New York Stock Exchange
2004
Common Shares, Without Par Value (18,305,525 New York Stock Exchange
Common Shares outstanding at December 2, 1998)
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
The aggregate market value of the common shares held by non-affiliates of the
registrant at December 2, 1998 was $651,820,209.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE PROXY STATEMENT FOR REGISTRANT'S 1999 ANNUAL MEETING OF
SHAREHOLDERS TO BE HELD FEBRUARY 23, 1999, ARE INCORPORATED BY REFERENCE INTO
PART III HEREOF.
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PART I
ITEM 1. BUSINESS
GENERAL
The Scotts Company ("Scotts"), and its wholly-owned subsidiaries, Hyponex
Corporation ("Hyponex"), Scotts-Sierra Horticultural Products Company
("Sierra"), Republic Tool & Manufacturing Corp. ("Republic"), Scotts'
Miracle-Gro Products, Inc. ("Scotts' Miracle-Gro"), Miracle Garden Care Limited
("Miracle Garden Care"), Levington Group Limited ("Levington"), and their
respective subsidiaries (collectively, the "Company"), are among the oldest and
most widely recognized marketers and manufacturers of products used to grow and
maintain landscapes: lawns, gardens and golf courses. The Company's Turf
Builder(R) (for consumer lawn care), Miracle-Gro(R) (for consumer garden care)
and Osmocote(R) (for professional horticulture) brands command market-leading
shares more than double those of the next ranked competitors, in the referenced
consumer or professional subgroup. The Company's long history of technical
innovation, its reputation for quality and service and its marketing tailored to
the needs of do-it-yourselfers and professionals have enabled the Company to
maintain leadership in its markets while delivering consistent growth in the
Company's net sales.
Do-it-yourselfers and professionals purchase through different distribution
channels and have different information and product needs. Accordingly, the
Company has historically had two business groups, Consumer and Professional, to
serve its domestic markets, as well as an International Group to serve its
markets outside of North America. In fiscal 1997, the Company reorganized into
six business groups comprised of Consumer Lawns, Consumer Gardens and Consumer
Organics (together, the "Consumer Business Group"), the Professional Business
Group, the International Business Group, and an Operations Group. During fiscal
1999, the Company re-named the Consumer Business Group, the "North American
Consumer Business Group", and the Consumer Organics Business Group, "the
Consumer Growing Media Business Group".
In early fiscal 1999, the Company added a fourth business group within the North
American Consumer Business Group, named the Consumer Pesticides Business Group,
to implement the agreement reached in September 1998 with Monsanto Company
("Monsanto"), for exclusive international agency and marketing rights to
Monsanto's consumer Roundup(R)* herbicide products. This group will also
integrate the assets of the consumer lawn and garden business of Monsanto
(Solaris Division), including its Ortho(R)* product line (the "Ortho
Acquisition"), which Scotts intends to purchase from Monsanto in the second
quarter of fiscal 1999 for approximately $300.0 million pursuant to a definitive
purchase agreement executed in November 1998. Other consumer pesticide
trademarks which will be acquired pursuant to the purchase agreement include
Weed-B-Gon(R)*, Rose Pride(R)*, Home Defense(R)* and White Swan(R)*. As part of
the agreement, Scotts will also acquire the assets of Monsanto's Green Cross(R)*
business, the leading consumer pesticides business in Canada, its Phostrogen(R)*
business in the United Kingdom and its Defender(R)* business in Australia, as
well as formulation facilities in Fort Madison, Iowa and Corwen, the United
Kingdom. The purchase price under the purchase agreement is subject to
adjustment as of the closing date.
The purchase agreement includes various customary representations and warranties
of the parties for transactions of this type and contains customary, limited
carve-outs for materiality, knowledge and disclosed information. However, the
indemnification provisions limit the Company's total exposure to assumed
liabilities, disputes with Central Garden & Pet Company (a distributor to the
Solaris Division, "Central Garden") and breaches of representation to $5.0
million in the aggregate. The Company's obligation to close under the purchase
agreement is conditioned upon, among other things: (i) receipt of all
governmental authorizations, consents and approvals; (ii) the expiration or
termination of the applicable waiting period under the Hart-Scott-Rodino
Antitrust Improvements Act of 1976, as amended; (iii) the execution of certain
ancillary agreements, including a glyphosate supply agreement (the active
ingredient in Roundup(R)), a formulation agreement and a transition services
agreement; and (iv) no material adverse change in the acquired business since
December 31, 1997. Either party may terminate the purchase agreement if the
closing has not occurred by March 31, 1999.
In September 1998, the Company entered into a long-term Exclusive Agency and
Marketing Agreement (the "Roundup Marketing Agreement") with Monsanto. Pursuant
to the Roundup Marketing Agreement, the Company became Monsanto's exclusive
agent for the marketing and distribution of consumer Roundup(R)
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*Roundup(R) is a registered trademark of Monsanto; Ortho(R), Green Cross(R),
Phostrogen(R), Defender(R), Weed-B-Gon(R), Rose Pride(R), Home Defense(R) and
White Swan(R) are registered trademarks that will be transferred to the Company
upon consummation of the Ortho Acquisition.
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The Scotts Company and Subsidiaries
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products in the consumer lawn and garden market in the United States and other
specified countries, including, among others, Australia, Austria, Canada,
France, Germany and the United Kingdom. Roundup(R) is a glyphosate-based product
and is the leading consumer herbicide brand in the United States, with a
substantial presence internationally. The Roundup Marketing Agreement does not
involve Monsanto's Roundup business for agricultural, professional turf and
horticultural markets. In addition, if Monsanto develops new products containing
glyphosate or other non-selective herbicides, the Company has certain rights to
market such products to consumers as well in the consumer lawn and garden
market.
Under the Roundup Marketing Agreement, the Company and Monsanto will jointly
develop global consumer and trade marketing programs for Roundup, and the
Company has assumed responsibility for sales support, merchandising,
distribution and logistics. Monsanto continues to own all the assets of the
consumer Roundup business and will provide significant oversight of its brand.
The Company has taken responsibility for its functions in North America with a
longer transition expected in Europe and Australia.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
During fiscal 1998, the Company operated in three principal business segments:
(1) North American Consumer Business Group, which include products of the
Consumer Lawns, Consumer Gardens and Consumer Growing Media groups, sold in the
United States and Canada; (2) Professional Business Group, including products of
the ProTurf(R) and Horticulture groups, sold in the United States and Canada;
and (3) International Business Group. For fiscal 1998, North American Consumer
Business Group, Professional Business Group and International Business Group
products accounted for 66%, 16%, and 18%, respectively, of consolidated
revenues. These businesses accounted for 71%, 11%, and 18%, respectively, of
fiscal 1998 income from operations before general corporate expenses. Financial
information on the Company's segments for the three years ended September 30,
1998, is presented in Note 18 of the Notes to Consolidated Financial Statements,
which are included elsewhere herein.
NORTH AMERICAN CONSUMER BUSINESS GROUP
Products
The Company's consumer products include: lawn fertilizers, lawn fertilizer
combination products and lawn control products, pesticides (including herbicides
and insecticides), garden tools, walk-behind and riding mowers, grass seed, lawn
spreaders and lawn and garden carts; garden and indoor plant care products; and
potting soils and other growing media products.
Consumer Lawns Products. Among the Company's most important consumer products
are lawn fertilizers, such as Scotts Turf Builder(R), and lawn fertilizer
combination products, such as Scotts Turf Builder(R) with Plus 2(TM) Weed
Control and Scotts Turf Builder(R) with Halts(R) Crabgrass Preventer. Typically,
these are patented, homogeneous, controlled-release products which provide
complete controlled feeding for consumers' lawns for up to two months without
the risk of damage to the lawn presented by less expensive controlled- and
non-controlled-release products. Some of the Company's products are specially
formulated for geographical differences and some, such as Bonus(R) S (to control
weeds in Southern grasses), are distributed to limited areas. Lawn control
products prevent or control lawn problems and contain no fertilizer component.
These control products include Scotts(R) Halts(R) Crabgrass Preventer, Scotts(R)
Lawn Fungus Control, Scotts(R) Moss Control Granules, Scotts(R) Diazinon Lawn
Insect Control and GrubEx(R) Season Long Grub Control. The Company also sells a
line of Miracle-Gro(R) lawn fertilizers, including Miracle-Gro(R) Lawn
Fertilizer and Miracle-Gro(R) Weed and Feed. The Company's lawn fertilizers,
combination products and control products are sold in dry, granular form.
Management estimates that as of September 1998, the Company's share of the U.S.
do-it-yourself consumer lawn fertilizer and combination products market was
approximately 58%.
The Company sells numerous varieties and blends of high quality grass seed, many
of them proprietary, designed for different uses and geographies. Management
estimates that the Company's share of the U.S. consumer grass seed market
(includes PatchMaster(R) products) was approximately 39% as of September 1998.
Because the Company's granular lawn care products perform best when applied
evenly and accurately, the Company sells a line of spreaders specifically
manufactured and developed for use with its products. For fiscal 1998, this line
included three sizes each of SpeedyGreen(R) rotary spreaders and AccuGreen(R)
drop spreaders, and the HandyGreen(R) II hand-held rotary spreaders, all
marketed under the Scotts(R) brand name.
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The Scotts Company and Subsidiaries
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Management estimates that the Company's share of the U.S. market for lawn
spreaders and lawn and garden carts was approximately 42% as of September 1998.
The Company has a licensing agreement in place with Union Tools, Inc. ("Union")
under which Union, in return for the payment of royalties, is granted the right
to produce and market a line of garden tools bearing the Scotts(R) trademark.
The Company also is a party to a licensing agreement with American Lawn Mower
Company ("American") under which American, in return for the payment of
royalties, is granted the right to produce and market a line of push-type walk-
behind lawn mowers bearing the Scotts(R) trademark. Also, the Company is a party
to a licensing agreement with The Home Depot and Murray, Inc. under which, in
return for the payment of royalties, The Home Depot markets a line of motorized,
walk-behind and riding lawnmowers bearing the Scotts(R) trademark, with the
mowers currently manufactured by Murray, Inc. These mowers are sold exclusively
through The Home Depot retail stores. In management's estimation, the Company
did not have a material share of the markets for these products in fiscal 1998.
Consumer Gardens Products. The Company sells a complete line of water-soluble
fertilizers under the Miracle-Gro(R) brand name. These products are primarily
used for garden fertilizer application. The Company also produces and sells a
line of boxed Scotts(R) plant foods, garden and landscape fertilizers,
Osmocote(R) controlled-release garden fertilizers, hose-end feeders and
houseplant fertilizer products.
Scotts' Miracle-Gro markets and distributes the country's leading line of
water-soluble plant foods. These products are designed to be dissolved in water,
creating a dilute nutrient solution which is poured over plants or sprayed
through an applicator and rapidly absorbed by their roots and leaves.
Miracle-Gro(R) All-Purpose Water-Soluble Plant Food is the leading product in
the Miracle-Gro(R) line. Other water-soluble plant foods in the product line
include Miracid(R) for acid loving plants, Miracle-Gro(R) for Roses,
Miracle-Gro(R) for Tomatoes and Miracle-Gro(R) for Lawns. Scotts' Miracle-Gro
also sells a line of hose-end applicators for water-soluble plant foods, through
the Miracle-Gro(R) No-Clog Garden and Lawn Feeder line, which allow consumers to
apply water-soluble fertilizers to large areas quickly and easily with no mixing
or measuring required. Scotts' Miracle-Gro also markets a line of products for
houseplant use including Liquid Miracle-Gro(R), African Violet Food, Plant Food
Spikes, Leaf Shine and Orchid Food.
Management estimates that as of September 1998, the Company's share of the
garden fertilizer segment was 52%, and its share of the indoor plant foods
market was approximately 33%.
Consumer Growing Media Products. The Company sells a complete line of growing
media products for indoor and outdoor uses under the Miracle-Gro(R) , Scotts(R),
Hyponex(R), Earthgro(R), Peters Professional(R) and other labels. These products
include retail potting soils, topsoil, humus, peat, manures, soil conditioners,
barks and mulches. These products are primarily regionally formulated to respond
to varying consumer expectations and to utilize the suitable but varying raw
materials available in different areas of the country. With the acquisition of
EarthGro, Inc. ("EarthGro") in February 1998, the Earthgro(R) and 1881 Select(R)
trademarks were acquired, as well as six additional growing media facilities
primarily serving the Northeast market area.
Management estimates that as of September 1998, it had approximately a 32%
market share of the consumer large-bag outdoor landscaping products market, and
approximately a 47% market share of the consumer potting soils market.
Market
The Company believes that it has achieved its leading position in the
do-it-yourself lawn care and garden markets on the basis of its strong marketing
and advertising programs, its sophisticated technology, the superior quality and
value of its products and the service it provides its customers. The Company
seeks to maintain and expand its market position by emphasizing these qualities
and taking advantage of the name and reputation of its many strong brands such
as Scotts(R), Miracle-Gro(R) and Hyponex(R). Through its Scotts(R), Hyponex(R),
Miracle-Gro(R) and Peters(R) labels, the Company has also focused on increasing
sales of its higher margin growing media products such as potting soils.
The Company is the market leader in the lawn, garden and growing media sections
of the growing lawn and garden market. U.S. population trends indicate that the
consumer segment age of 40 and older, who represent the largest group of lawn
and garden product users, will grow by 28% from 1996 to 2010, a growth rate more
than twice that of the total population.
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Drawing upon its strong research and development capabilities, the Company
intends to continue to develop and introduce new and innovative lawn and garden
products. The Company believes that its ability to introduce successful new
consumer products has been an important element in the Company's growth. New
consumer products in recent years include: YardAll(R) (fiscal 1995), an
extra-large lawn and garden cart; Miracle-Gro(R) Quick Start (fiscal 1996), a
liquid starter solution for newly-planted or young plants; GrubEx(R) (fiscal
1996), providing season-long lawn protection against grubs; the redesigned
HandyGreen(R) II (fiscal 1996), a hand-held rotary spreader with an arm support;
two new grass seed products, Mirage(TM) and Spring-Up(R) (fiscal 1996), grass
seed blends for rapid seeding in the Spring; Scotts(R) potting soils and a
complete line of indoor soil amendments such as vermiculite, perlite and
charcoal in resealable stand-up bags (fiscal 1997); the No-Clog-4 in 1(R), which
allows for sprinkler feeding of fertilizer for gardens and lawns (fiscal 1998);
a new line of Miracle-Gro(R) potting soil mix and soil amendment products
(fiscal 1998); and an expanded assortment of professional nursery quality
potting soil mixes for consumers under the Scotts Pro Gro(TM) and Miracle-Gro(R)
brands (fiscal 1998). In fiscal 1999, the Company plans to introduce
Miracle-Gro(R) Flower Seeding Mix, a pre-mixed combination of flower seed,
fertilizer and mulch; Miracle-Gro(R) Bloom Booster(R), a fertilizer for flowers;
and Miracle-Gro(R) Tree Spikes, a fertilizer for outdoor trees.
The Company also seeks to capitalize upon the competitive advantages stemming
from its position as the leading nationwide supplier of a full line of consumer
lawn and garden products. The Company believes that this gives it an advantage
in selling to retailers, who value the efficiency of dealing with a limited
number of suppliers. During fiscal 1998, the Company established relationships
with key retailers Wal*Mart, as manager of Wal*Mart's lawn and garden fertilizer
category, and Kmart, as co-manager with Kmart of Kmart's lawn and garden product
category. In the role of "category manager", the Company's representatives
advise retailers of advantageous product mix, merchandising, shelving and
pricing, based on consumer data. Category management has been successfully
utilized in the grocery industry, in reducing "out of stock" situations,
identifying retail trends and increasing store sales.
The Company is maintaining agreements with municipalities and waste haulers to
compost yard waste. As of December 2, 1998, the Company had 14 compost
facilities. During fiscal 1999 and 2000, the Company plans to close nine
composting sites in the United States that collect yard and compost waste on
behalf of municipalities. The economics of composting have deteriorated as
municipalities have found lower-cost alternatives to disposing of their yard
waste, resulting in substantial drops in the fees that municipalities had been
providing to the Company in return for removing yard waste. In addition, the
Company's costs to process and transport composted waste have exceeded original
industry expectations. The Company plans to close the nine facilities as their
contracts expire, which include six facilities in 1999, and three in 2000.
Marketing, Promotion and Business Strategy
Consumer Lawns products are sold by a 79-person direct sales force to
headquarters of national, regional and local retail chains. This sales force,
most of whom have college degrees and prior sales experience, also recruits and
supervises approximately 225 seasonal part-time merchandisers and in-store
weekend counselors, in connection with the Company's emphasis on in-store retail
merchandising of lawn and garden products, a strategy the Company intends to
continue for fiscal 1999. The Company also employs approximately 50 part-time
year-round employees as merchandisers. Most retail sales of the Company's lawn
products occur on weekends during the Spring and Fall. The Consumer Lawns Group
also employs distributors on a selective basis.
Consumer Gardens products are sold by a 14-person sales force to a network of
hardware and lawn and garden wholesale distributors, with certain sales made
directly to some retailers. Most retail sales of Consumer Gardens products occur
on or near weekends during Spring and early Summer. The Consumer Growing Media
Group utilizes a 22-person direct sales force to cover the headquarters of
national and regional chains, local accounts of significant size and
distributors who sell to smaller accounts. The Consumer Growing Media Group's
sales force hires and directs a network of outside merchandising service
companies to provide seasonal in-store retail merchandising and re-order support
on a national basis. Most retail sales of Consumer Growing Media landscape
products occur on weekends during late Spring, while value-added products sell
year-round.
The Consumer Lawns Group continues to support independent retailers with a
special line of products, marketed under the Lawn Pro(R) name. These products
include the 4-Step program, introduced in 1984,
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The Scotts Company and Subsidiaries
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which encourages consumers to purchase four products at one time (fertilizer
plus crabgrass preventer, fertilizer plus weed control, fertilizer plus insect
control and a special fertilizer for Fall application). The Company promotes the
4-Step program as providing consumers with all their annual lawn care needs for,
on average, less than one-third of what a lawn care service would cost. The
Company believes the Lawn Pro(R) program has helped the Company to grow its
business with independent retailers while they face increasing competition from
mass merchandisers and home improvement centers. The Consumer Growing Media
Group similarly markets a special line of growing media products under the 1881
Select(R) label, to independent retailers.
The Company supports its sales efforts with extensive advertising and
promotional programs. Because of the importance of the Spring sales season in
the marketing of consumer lawn, garden and growing media products, the Company
focuses advertising and promotional efforts on this period. Through advertising
and other promotional efforts, the Company encourages consumers to make the bulk
of their lawn, garden and growing media purchases in the early months of Spring
in order to moderate the risk to its consumer sales which may result from bad
weekend weather. The Consumer Lawns Group utilizes radio and television
advertising to build consumer product usage in the Fall, a recommended time to
plant grass seed and plants. The Consumer Lawns Group also promotes a Turf
Builder(R) annual program for home centers and mass merchandisers. This program
encourages consumers to purchase their entire year's supply of Turf Builder(R)
products in early Spring, for application in the early Spring, late Spring,
Summer and Fall. The Consumer Growing Media Group uses a consumer rebate program
for selected Hyponex(R) products to encourage early and multiple purchases in
the Spring.
The percentage of North American Consumer Business Group sales to mass
merchandisers, warehouse-type clubs, home improvement centers and large buying
groups continues to increase as a percentage of sales. The top ten accounts
(which include two buying groups of independent retailers) represented 73% of
the North American Consumer Business Group sales in fiscal 1997 and 77% in
fiscal 1998.
The fiscal 1999 marketing strategies for the Consumer Lawns Group are to
continue the efforts begun in prior years to improve the Company's relationship
with consumers and retail customers, including: carefully directed consumer
research, to increase understanding of its markets, sales trends and consumer
needs; increased media advertising, with continuation of television advertising
featuring real-life stories of people's experiences with Scotts(R) products, and
of weekend radio advertising emphasizing that "this weekend" is the best time to
apply selected Scotts(R) products; simplification of the product line;
addressing "just-in-time" customer purchasing through continued use of the
"never-out" program by which the Company builds pre-season inventory of select
high-volume products, which enhances the Company's ability to timely and
completely fill customer orders; and use of retail merchandisers to enhance
communications with consumers at the point of sale.
The Consumer Lawns Group has used Scotts(R) and Miracle-Gro(R) consumer brand
recognition to market the newly-formed "Scotts LawnService(TM)". In January
1995, Scotts entered into a licensing agreement with a lawn care service
company, Emerald Green Lawn Service ("Emerald Green"), which allows Emerald
Green to use the Scotts(R) name and logo in its marketing efforts. Emerald Green
applies Scotts(R) products exclusively. In October 1997, Scotts increased its
equity interest in Emerald Green from 28% to 64%, and announced the formation of
Scotts LawnService(TM), which provides applications of lawn and garden
fertilizer and control products, and tree and shrub pruning services. The
Company has introduced Scotts LawnService(TM) to several major markets in the
premium lawn and garden services segment. In June 1998, Scotts increased its
equity interest in Emerald Green from 64% to 84%. The business ended fiscal 1998
with Scotts LawnService(TM) in ten markets, and 21 franchised outlets marketed
as Emerald Green Lawn Service featuring Scotts(R) and Miracle-Gro(R) products.
The strategy in fiscal 1998 was to refine the operations model and measure the
equity transfer of the Scotts(R) brands into the premium lawn service segment.
The fiscal 1999 strategy will be similar with moderate expansion of the business
planned through owned or franchised locations, while applying market knowledge
learned from 1998 to better optimize opportunities in this service industry.
The fiscal 1999 marketing strategies for the Consumer Gardens Group are to
continue: conducting consumer research to determine consumer purchase decisions,
attitude and usage data; efforts to consolidate certain package sizes in the
Miracle-Gro(R), Scotts(R) ornamental and Osmocote(R) fertilizer lines;
implementation of packaging improvements; cost-reduction and quality enhancement
efforts throughout all product lines;
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The Scotts Company and Subsidiaries
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increased national network television advertising; and use of Scotts'
Miracle-Gro's sales and distribution network for Scotts(R) garden products.
The strategy for the Consumer Growing Media Group is to expand its market share
of the potting soil and specialty planting soil market, while becoming the
industry's low-cost producer of the more commodity-oriented outdoor landscaping
products such as topsoil, manures and barks/mulches. The Company expects to grow
its share of the potting and planting soil markets by: developing products and
national marketing programs which utilize its Hyponex(R), Scotts(R), Peters
Professional(R), Miracle-Gro(R), Earthgro(R) and 1881 Select(R) brand names on
high-quality potting mixes, with innovative and consumer-preferred packaging;
gaining national distribution of Miracle-Gro(R) value-added potting soils;
marketing Earthgro(R)-labeled organic landscape products nationally; expanding
the distribution of Scotts(R) and Miracle-Gro(R) potting mix products into
Canada; and conducting consumer research to better understand market needs.
An important part of the Company's sales effort is its national toll-free
Consumer Helpline, on which its lawn consultants answer questions about the
Company's products and give general lawn care advice to consumers. The Company's
lawn consultants responded to approximately 400,000 telephone and written
inquiries in fiscal 1998, which is consistent with the number of inquiries in
prior years. In September 1998, Helpline consultants answered the four millionth
call since it began in 1972.
Backing up the Company's marketing effort is its well-known Scotts No-Quibble
Guarantee(TM), instituted in 1958, which promises consumers a full refund if for
any reason they are not satisfied with the results after using the Company's
products. Refunds under this guarantee have consistently amounted to less than
0.4% of net sales for the North American Consumer Business Group on an annual
basis.
The Company has an Internet web site at www.scottscompany.com, which provides
lawn care and gardening information for consumers, and special sections for the
Professional Business Group's customers, along with corporate and investment
information. Do-it-yourself consumer topics include basic lawn care and
gardening tips, problem solving, frequently asked questions, houseplant care,
landscaping with trees and shrubs and product guides. An arrangement with the
National Gardening Association (NGA) provides access to a database of more than
5,000 gardening questions with answers by NGA's staff horticulturists. The site
also provides an e-mail link to the Company's Consumer Helpline for answers to
lawn care questions. The Professional Turf section delivers information for turf
managers, by providing the Company's complete professional product guide, a
Technical Representative/distributor locator and information aimed at turf
maintenance workers and golf course superintendents. The Professional
Horticulture section points nursery and greenhouse growers to their nearest
distributor, delivers the latest news from the Horticulture business of the
Professional Business Group of the Company and directs users to customer
service. In its first year, the site received 22 million "hits", over 9,000
e-mails to Scotts' Consumer Helpline and more than 50,000 searches of the NGA
database.
Competition
The consumer lawn and garden market is highly competitive. Consumers have a
choice of do-it-yourself lawn care or use of a lawn service. Based on a study
conducted by Hallberg, Schireson & Sur, Inc. covering the period from 1991 to
1996, management estimates that approximately 15% of all homeowners with lawns
use a lawn service. The most significant competitors for the consumer market
which uses a lawn service are lawn care service companies. Service Master, which
owns the Tru Green Company, ChemLawn(R) and Barefoot Grass(R) lawn care service
businesses, operates nationally and is significantly larger than the Company. In
the do-it-yourself lawn care and consumer gardens markets, the Company's
products compete primarily against regional products and private label products
produced by various suppliers and sold by such companies as Kmart Corporation.
These products compete across the entire range of the Company's consumer product
line. In addition, certain of the Company's consumer products compete against
branded fertilizers, pesticides and combination products marketed by such
companies as Lebanon Chemical Corp. (Greenview(R)), United Industries
Corporation (Peters(R) water-soluble fertilizers for the consumer market),
Vigoro/Pursell Industries (Vigoro(R), Sta-Green(R)) and the newly-announced
Bayer/Pursell joint venture. Competitors in Canada include Nu Gro, So Green and
IMC Vigoro.
Most competitors, with the exception of lawn care service companies, sell their
products at prices lower than those of the Company. The Company competes
primarily on the basis of its strong brand names, consumer advertising
campaigns, quality, value, service, convenience and technological innovation.
The
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The Scotts Company and Subsidiaries
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Company's competitive position is also supported by its national sales force and
its unconditional guarantee. There can be no assurance, however, that additional
competition from new or existing competitors will not erode the Company's share
of the consumer market or its profit margins.
The Company's Consumer Growing Media business faces primarily regional
competitors who are able to compete very effectively on the basis of price in
the areas near their plants where they can reach customers with a lower cost of
freight. The low cost of entry to establish a commodity organics bagging
facility and the ready availability of raw materials make it likely that the
large-bag outdoor market will remain price competitive and lower margin into the
future. Customers require short lead-times, with very high on-time and complete
fill rates. These demands, combined with the high cost of freight, require the
Consumer Growing Media business to continually evaluate production locations to
reduce costs.
Roundup's competitors include United Industries Corporation (Spectracide(R)) and
Enforcer Products, Inc. (Enforcer(R)).
Backlog
The majority of annual consumer product orders (other than Consumer Growing
Media products which are normally ordered in season on an "as needed" basis) are
received from retailers during the months of October through April and are
shipped during the months of January through April. As of November 27, 1998,
orders on hand for retailers totaled approximately $53.6 million compared to
approximately $62.9 million on the same date in fiscal 1997. All such orders are
expected to be filled in fiscal 1999.
PROFESSIONAL BUSINESS GROUP
Market
The Company sells its professional products to golf courses, commercial
nurseries and greenhouses, schools and sportsfields, multi-family housing
complexes, business and industrial sites, lawn and landscape services and
specialty crop growers. The Professional Group's two core businesses are
ProTurf(R), the professionally managed turf market, and Horticulture, the
nursery and greenhouse markets. In fiscal 1998, the Professional Business Group
served such high-profile golf courses as Augusta National (Georgia), Cypress
Point and Pebble Beach (California), Desert Mountain (Arizona), Oakmont Country
Club (Pennsylvania), Colonial Country Club (Texas) and Medinah Country Club
(Illinois). Sports complexes such as Fenway Park, Camden Yards, Wrigley Field,
Yankee Stadium and the Rose Bowl are professional customers, as are major
commercial nursery/ greenhouse operations such as Monrovia, Hines and Imperial.
Golf courses and highly visible turf areas accounted for approximately 58% of
the Company's Professional Business Group sales in fiscal 1998. During fiscal
1998, the Company sold products to approximately 49% of the over 15,700 golf
courses in North America, including 72 of Golf Digest's top 100 U.S. courses.
Management estimates, based on an independent bi-annual market survey and other
information available to the Company, that the Company's share of its target
North American golf course high value turf fertilizer and control products
market was approximately 20% in fiscal 1998.
According to the National Golf Foundation, approximately 350 new golf courses
have been constructed annually during the last three years. Management believes
that the increase in the number of courses, the concentration of the growth in
the West/South with a longer growing/maintenance season, the increasing playing
time requiring more course maintenance and the trend toward more highly
maintained courses should contribute to sales growth in the golf course market.
Horticulture sales accounted for approximately 42% of the Company's Professional
Business Group sales in fiscal 1998. The Company sold products to thousands of
nursery, greenhouse and specialty crop growers through a network of
approximately 75 horticultural distributors. The Company estimates that its
leading share of the North American horticultural market was approximately 23%
in fiscal 1998.
Management believes the increasing acceptance of controlled-release fertilizers
in horticultural/ agricultural applications due to performance advantages, labor
savings and water quality concerns should contribute to sales growth in the
horticulture market. However, competitive product technologies may also make
inroads into the horticultural and turf markets.
Products
The Company's professional products, marketed under such brand names as
ProTurf(R), Osmocote(R), Miracle-Gro(R), Peters(R), Metro-Mix(R) and
Terra-Lite(R), include a broad line of sophisticated controlled-release
fertilizers, water-soluble fertilizers, pesticide products (herbicides,
8
The Scotts Company and Subsidiaries
9
insecticides, fungicides and growth regulators), wetting agents, growing media
products, grass seed and application devices. The fertilizer lines utilize a
range of proprietary controlled-release fertilizer technologies, including
Contec(TM), Poly-S(R), Osmocote(R) and ScottKote(R), and proprietary
water-soluble fertilizer technologies, including Peters(R) and Miracle-Gro
Excel(TM). The Company applies these technologies to meet a wide range of
professional customer needs, ranging from quick-release greenhouse fertilizers
to controlled-release fairway/
greens fertilizers to extended-release nursery fertilizers that last up to a
year or more.
To secure uninterrupted supply and consistent costs of raw materials, the
Horticulture group has entered into alliances with suppliers. The Company works
closely with basic pesticide manufacturers to secure access to, and if possible,
exclusive positions on, advanced control chemistry which can be formulated on
granular carriers, including fertilizers, or formulated as a liquid application.
In fiscal 1998, Scotts signed an agreement with AgrEvo USA Company ("AgrEvo")
for the exclusive domestic distribution rights to various AgrEvo active
ingredients for the professional horticulture market. These active ingredients
will be used to create Scotts(R) branded herbicides, fungicides and
insecticides. The Company expects this product group to represent 10% to 25% of
Horticulture sales by fiscal 2002.
Application devices in the professional line include both rotary and drop action
spreaders. Over 20 proprietary grass seed varieties are also part of the
professional line. The professional horticulture line also includes an
established line of soil-less mixes in which controlled-release and control
products, and water-soluble fertilizers and wetting agents, can be incorporated
or applied, respectively, to customize potting media for nurseries and
greenhouses.
Business Strategy
The Company's Professional Business Group focuses its sales efforts on the
middle and high ends of the professional market and generally does not compete
for sales of commodity products. Demand for the Company's professional products
is primarily driven by product quality, performance and technical support. The
Company seeks to meet these needs with a range of sophisticated, specialized
products.
A primary focus of the Professional Business Group's strategy is to provide
innovative high-value new products to its professional customers. In fiscal
1998, the Contec(TM) line of methylene urea fertilizers was introduced, as well
as the Nutriblend(R) water-soluble fertilizer line. For fiscal 1999, the Group
will introduce Osmocote(R) Plus, a modification of Osmocote(R) timed-release
fertilizer for subtropic U.S. markets. The Company's fertilizer technology is
expected to lead to further new combination product introductions in fiscal 1999
and beyond.
The Company intends to take advantage of its strong position in the golf course
segment to increase sales of Sierra's products to those users, and intends to
expand the distribution of Scotts(R) nursery products in the commercial
horticultural segment in which Sierra has a strong position.
In January 1995, Scotts entered into a licensing agreement with Emerald Green,
which allows Emerald Green to use the Scotts(R) name and logo in its marketing
efforts. In fiscal 1998, Scotts increased its equity interest in Emerald Green
from 28% to 84%. See "North American Consumer Business Group--Marketing,
Promotion and Business Strategy."
Marketing and Promotion
For fiscal 1998, the Professional Business Group's sales force consisted of
approximately 100 territory managers. Many territory managers are experienced
former golf course superintendents or nursery managers and most have degrees in
agronomy, horticulture or similar disciplines. Territory managers have worked
closely with golf course and sports field superintendents, turf and nursery
managers, and other landscape professionals. In addition to marketing the
Company's products, the Company's territory managers have provided consultation,
testing services and advice regarding maintenance practices, including
individualized comprehensive programs incorporating various products for use at
specified times throughout the year. The professional grower business is served
primarily through an extensive network of distributors, all with substantial
experience in the horticulture market. Territory managers for this market spend
the majority of their time with growers.
In December 1998, the Company reorganized its Professional Business Group to
strengthen distribution and technical sales support, integrate brand management
across market segments and reduce annual operating expenses. The reorganization
will reduce the ProTurf(R) division's personnel from approximately 100 employees
to approximately 40 employees. The Group will retain a consultative field sales
force and field-based technical group to provide distributors with product
training, address questions from customers
9
The Scotts Company and Subsidiaries
10
and maintain involvement in university trial work. Working with the retained
sales force will be four well-known independent distributors. This shift to
independent distribution is expected to more than double the number of sales
representatives and result in a four-fold increase in the number of warehouses
serving the Company's professional turf and landscaping customers. The
independent distributors include Turf Partners, Inc. in the Midwest and
Northeast, BWI Companies, Inc. in the Southwest and Southeast, Wilbur Ellis
Company in the Pacific Northwest and Western Farm Services, Inc. in California.
The Professional Business Group has already been effectively and economically
distributing its nursery and greenhouse products through most of these
distributors. Alliances are expected to be formed with other distributors as
necessary.
To reach potential purchasers, the Company uses trade advertising and direct
mail and sponsors seminars throughout the country. In addition, the Company
maintains a special toll-free number for its professional customers. The
professional customer service department responded to over 45,000 telephone
inquiries in fiscal 1998.
Competition
In the professional turf and horticulture markets, the Company faces a broad
range of competition from numerous companies ranging in size from multi-
national chemical and fertilizer companies such as DowElanco Company, Uniroyal,
BASF and Chisso-Asahi, to smaller specialized companies such as Lesco, Inc. and
Lebanon Chemical Corp., to local fertilizer manufacturers and blenders. Portions
of this market are served by large agricultural fertilizer companies, while
other segments are served by specialized, research-oriented companies. In
certain areas of the country, particularly Florida, a number of companies have
begun to offer turf care services, including product application, to golf
courses. In addition, the higher margins available for sophisticated products to
treat high-value crops continue to attract large and small chemical producers
and formulators, some of which have larger financial resources and research
departments than the Company. Also, the influence of mass merchandisers, with
significant buying power, has increased the cost consciousness of horticulture
growers. While the Company believes that its reputation, turf and ornamental
market focus, expertise in product development and sales and distribution
network should enable it to continue to maintain and build its share of the
professional market, there can be no assurance that the Company's market share
or margins will not be eroded in the future by new or existing competitors.
Backlog
A large portion of professional product orders is received during the months of
August through November and is filled during the months of September through
November. As of November 27, 1998, orders on hand from professional customers
totaled approximately $13.4 million compared with $8.3 million on the same date
in 1997. All such orders are expected to be filled in fiscal 1999.
INTERNATIONAL BUSINESS GROUP
Market
The International Business Group regularly sells its products to both consumer
and professional users in over 40 countries. Management believes that growth
potential should exist in both markets. The Company has established business
entities in the markets with significant potential, which include Australia, the
United Kingdom, the Benelux countries, Germany, France, Spain and Italy.
Consumer lawn and garden products are sold under the Company's various
trademarks, including the Scotts(R) label, in Australia, the European Union, New
Zealand and South America. In addition, products bearing the Miracle-Gro(R)
trademark are marketed in the Caribbean, Australia, New Zealand, the Netherlands
and the United Kingdom. The Company's Hyponex(R) line of products is present in
Japan as a result of a long-term agreement with Hyponex Japan Corporation, Ltd.,
an unaffiliated entity.
Professional markets include both the horticulture and turf industries. The
International Business Group markets professional products in Africa, Australia,
the Caribbean, the European Union, Japan, Latin America, Mexico, the Middle
East, New Zealand, South America and Southeast Asia. Horticultural products
mainly carry the Scotts(R), Sierra(R), Peters(R) and Osmocote(R) labels. Turf
products primarily use the Scotts(R) trademark.
Consumer products are sold by an approximate 25-person sales force and
professional products are sold by an approximate 85-person sales force.
Miracle Garden Care has leading positions in the United Kingdom in a number of
lawn and garden market categories. Its major consumer brands include
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The Scotts Company and Subsidiaries
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Miracle-Gro(R), Weedol(R), Pathclear(R) and Grasshopper(R). In December 1997,
the Company acquired Levington, the leading producer of consumer and
professional lawn fertilizer and growing media in the United Kingdom. Its major
brands include Levington(R) (for growing media), Evergreen(R) (for lawn care
products), Tumbleweed(R) (for herbicides) and Tomorite(R) (a tomato fertilizer).
Management believes this acquisition has expanded the Company's potential in the
United Kingdom and Irish consumer markets. During fiscal 1998, management
integrated the sales, marketing and manufacturing operations of Miracle Garden
Care and Levington, forming a new subsidiary, The Scotts Company (UK) Limited.
In October 1998, the Company, through certain subsidiaries, acquired from
various affiliates of Rhone-Poulenc Agro ("RPA"): the shares of Rhone-Poulenc
Jardin SAS; the shares of Celaflor GmbH; the shares of Celaflor
Handelsgesellschaft m.b.H.; and the home and garden business of Rhone-Poulenc
Agro S.A. in Belgium (collectively "RPJ"), each in a privately-negotiated
transaction (collectively, the "RPJ Acquisition"). The total consideration paid
for the RPJ Acquisition was approximately 1.2 billion French Francs
(approximately $216 million). As part of the purchase price, the Company has
agreed to pay 156 million French Francs (approximately $35.6 million on a
present value basis) over a four-year period for certain access rights to
specific research and development services to be provided by RPA.
RPJ is continental Europe's largest producer of consumer lawn and garden
products. It manufactures and sells a full line of consumer lawn and garden
pesticides, fertilizers and growing media in France, Germany, the Benelux
countries, Austria, Italy and Spain. Leading brands include KB(R),
Fertiligene(R), Celaflor(R) and Nexa-Lotte(R).
Also in October 1998, the Company acquired from an agency of the Irish
government, Bord na Mona, the Shamrock(TM) trademark, a brand used to market
peat products in the United Kingdom and Ireland. As part of the agreement, the
Company has an option to supply the Shamrock(TM) brand of peat in the leading
continental European markets. The Company also acquired the rights to a ten-year
horticultural peat supply agreement with Bord na Mona as supplier, with a
renewable ten-year term at the Company's option. Under the agreement, Bord na
Mona will mix and package peat and other growing media products for the Company.
It is expected that this acquisition will secure the Company's access to high
quality peat resources for both the consumer and professional markets in the
United Kingdom and Ireland and will also enable the Company to enter the
professional horticultural compost market in mainland Europe in due course.
In December 1998, the Company completed its acquisition of Asef Holding B.V.
("ASEF"), a privately-held consumer lawn and garden products company, with
operations in the Netherlands. As part of the transaction, the Company also
acquired related assets in Belgium. ASEF, which sells fertilizers, growing media
and pesticides under the ASEF brand and through private label programs with
major retailers, had 1997 sales of approximately $17 million. ASEF has
approximately 40 employees.
Business Strategy
An increasing portion of the Company's sales and earnings is derived from
customers in foreign countries. In fiscal 1998, following the acquisition of
Miracle Garden Care, the International Business Group re-located its
headquarters office to an area outside of London in the United Kingdom. The
Company's managers also travel abroad regularly to visit its facilities,
distributors and customers. The Company's own employees manage its affairs in
Europe, Australia, Malaysia, Mexico, Brazil and the Caribbean. The International
Business Group plans to further develop its international business in both the
consumer and professional markets. The Company believes that the technology,
quality and value that are widely associated with its domestic and acquired
brands should be transferable to the global marketplace.
Management believes the International Business Group is well positioned to
obtain an increased share of the international market. The Company has a broad,
diversified product line made up of value-added fertilizers which can be
targeted to the market segments of consumer, turf, horticulture and high value
agricultural crops. Also, the Company has the capability to sell worldwide
through its extensive distributor network. However, there can be no assurance
that the Company's market share or margins will not be eroded by new or existing
competitors, or that an increased share of the international market will be
obtained.
Any significant changes in international economic conditions, expropriations,
changes in taxation and regulation by U.S. and/or foreign governments could have
a substantial effect upon the international business of the Company. Management
believes, how-
11
The Scotts Company and Subsidiaries
12
ever, that these risks are not unreasonable in view of the opportunities for
profit and growth available in foreign markets. The Company's international
earnings and cash flows are subject to variations in currency exchange rates,
which derive from sales and purchases of the Company's products made in foreign
currencies. For a discussion of how the Company manages its foreign currency
rate exposure, see "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--Liquidity and Capital Resources."
Competition
The International Business Group's consumer business faces strong competition in
the lawn and garden market, particularly in Australia and the European Union.
Competitors in Australia include Chisso-Asahi, Debco and Yates. Competitors in
the European Union include Bayer, BASF and various local companies. The Company
has historically responded to competition with superior technology, excellent
trade relationships, competitive prices, broad distribution and strong
advertising and promotional programs.
The international professional market is very competitive, particularly in the
controlled-release and water-soluble fertilizer segments. Numerous U.S. and
European companies are pursuing these segments internationally, including
Pursell Industries, Lesco, BASF, Norsk Hydro, Haifa Chemicals Israel, Kemira and
private label companies. Historically, the Company's response to competition in
the professional markets has been to adapt its technology to solve specific user
needs which are identified by developing close working relationships with key
users.
MATTERS RELATING TO THE COMPANY GENERALLY
Patents, Trademarks and Licenses
The "Scotts(R)", "Miracle-Gro(R)" and "Hyponex(R)" brand names and logos, as
well as a number of product trademarks, including "Turf Builder(R)", "Lawn
Pro(R)", "ProTurf(R)", "Osmocote(R)" and "Peters(R)", are federally and
internationally registered and are considered material to the Company's
business. The Company regularly monitors its trademark registrations, which are
generally effective for ten years, so that it can renew those nearing
expiration. In 1989, the Company assigned rights to certain Hyponex(R)
trademarks to Hyponex Japan Corporation, Ltd., an unaffiliated entity. In July
1995, Sierra granted a non-exclusive license to Peters Acquisition Corporation,
now owned by United Industries Corporation, to use the Peters(R) trademark in
the U.S. consumer market.
As of September 30, 1998, the Company held over 200 U.S. and international
patents on processes, compositions, grasses and mechanical spreaders and has
several additional patent applications pending. Patent protection generally
extends 20 years from the filing date and many of the Company's patents extend
well into the next decade. The Company also holds exclusive and non-exclusive
patent licenses from certain chemical suppliers permitting the use and sale of
patented pesticides. During fiscal 1998, the Company secured new U.S. patents
for three Kentucky Bluegrass varieties with high turf performance
characteristics and three mechanical devices covering consumer broadcast
spreader and utility carts. The Company also secured several international
patents, including one for water-soluble fertilizer technology in Europe, and
patents for Poly-S(R) technology in New Zealand and Israel.
The Company's methylene-urea product composition patent which covers Scotts Turf
Builder(R), Scotts Turf Builder(R) with Weed Control and Scotts Turf Builder(R)
with Halts(R) Crabgrass Preventer, is deemed material by the Company and is due
to expire in July 2001. The Company believes that the high entry costs of
manufacturing needed to replicate this product and the value of the Scotts(R)
brand should lessen the likelihood of product duplication by any competitor.
Glyphosate, the active ingredient in Roundup(R), is subject to a patent in the
United States that expires in September 2000. The Company cannot predict the
success of Roundup(R) after glyphosate ceases to be patented. Substantial new
competition in the United States could adversely affect the Company. Glyphosate
is no longer subject to patent in the European Union and is not subject to
patent in Canada. While sales of Roundup(R) in such countries have continued to
increase despite the lack of patent protection, sales in the United States may
decline as a result of increased competition after the U.S. patent expires.
Research and Development
The Company has a long history of innovation, and its research and development
successes can be measured in terms of sales of new products and by the Company's
patents. Most of the Company's fertilizer products, many of its grasses and many
of its mechanical devices are covered by one or more of the approximately 200
U.S. and international patents owned by the Company.
The Company maintains a premier research and development organization
headquartered in the Dwight G.
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The Scotts Company and Subsidiaries
13
Scott Research Center in Marysville, Ohio ("Scotts Research"). The Company also
operates three research field stations located in Florida, Texas and Oregon.
These field stations facilitate evaluation of products in a variety of climatic
and soil composition conditions, an integral part of the Company's product
development, quality assurance and competitive product analysis programs.
Research to develop new and improved application devices for production at
Republic's manufacturing facility in Carlsbad, California, is being transitioned
to Scotts Research. Taken together, the research and development effort
maintains a focus on superior agronomic performance for lawn, turf and
horticultural applications through products which are cost-effective and easy to
use. The knowledge and concepts used to formulate products for the professional
turf and plant protection markets are also used to provide similar results for
the do-it-yourself market.
In addition to Scotts Research, Scotts Europe BV (Netherlands) maintains a
research and development facility devoted to the Osmocote(R) controlled-release
fertilizer line produced in Heerlen, the Netherlands. Miracle Garden Care leases
a research facility and trial station in the United Kingdom for formulating
plant protection products for the consumer and professional markets. The Company
also maintains a complete research facility in Suffolk (Levington), United
Kingdom, for formulating garden and lawn fertilizers, herbicides, insecticides,
fungicides and growing media. With the RPJ Acquisition, the Company acquired a
research and development facility in Ingelheim, Germany.
Since its introduction of the first slow-release home lawn fertilizer in 1928,
the Company has used its research and development strengths to build the do-it-
yourself and professional markets. Technology continues to be a Company
hallmark. In fiscal 1992, the Company introduced Poly-S(R), a patented
proprietary controlled-release fertilizer technology. In fiscal 1993,
ScottKote(R), another controlled-release technology primarily for the nursery
market, was introduced, as well as a patented methylene urea manufacturing
process used in both the consumer and professional turf product lines. Since the
Hyponex acquisition in 1988, the Company's research and development organization
has worked to improve the quality and reduce the production cost of branded
growing media products, in particular potting soils. One of the results of this
effort was the introduction, in fiscal 1994, of a line of value-added,
premium-quality potting soils and planting mixes sold under the Scotts(R) brand,
and in fiscal 1997, a similar line under the Miracle-Gro(R) brand.
Through the acquisition of Sierra, Scotts was able to obtain patents for
technological advancements in water-soluble fertilizers. In fiscal 1996, Scotts
secured a patent on the use of urea phosphate in water-soluble fertilizers used
as the basis for the Peters Excel(R) (and Miracle-Gro Excel(TM), for fiscal
1998) brands of fertilizers, having previously obtained a solution and method
patent for such product line. Also during fiscal 1997, the Company completed
installation of a dedicated turfgrass genetic engineering laboratory in its
existing Scotts Research facility, to develop turfgrass varieties with improved
characteristics such as resistance to disease, insects and herbicides. Research
in fiscal 1997 also focused on improving the quality and durability of the
Company's consumer lawn fertilizer packaging. The Company implemented plans to
use plastic packaging for substantially all consumer lawn products shipped in
fiscal 1998. The Company's professional product line also used plastic packaging
for products shipped in fiscal 1998.
Research has also focused on durability, precision and reduced production costs
of the Republic-produced spreaders. Recently, Republic completely redesigned the
consumer line of walk-behind spreaders with quality and performance improvements
on each model.
Sierra pioneered the use of controlled-release fertilizers for the horticultural
markets with the introduction of Osmocote(R) in the 1960's. This
polymer-encapsulated technology has achieved a large share of the horticultural
markets due to its ability to meet the strict performance requirements of
professional growers. Scotts' and Sierra's research and development efforts have
been fully integrated and are focused on quality enhancement, product/process
innovation and cost reduction.
During fiscal 1997, the Company developed new products in several branded lines
including Scotts(R) professional turf products; Osmocote(R) controlled-release
fertilizer; Miracle-Gro(R) granular lawn food products; Scotts(R) spreaders; and
PatchMaster(R) flowering seed/fertilizer mix. Also during fiscal 1997, several
new growing media products were introduced under the Miracle-Gro(R) brand, which
included Miracle-Gro(R) Perlite, Miracle-Gro(R) Potting Mix, Miracle-Gro(R)
African Violet Potting Mix and Miracle-Gro(R) Seed Starter Potting Mix. In
fiscal 1998, new professional growing media products included Miracle-Gro(R)
Nutrified Peat with ScottsCoir(TM) and Miracle-Gro(R) Bale Mix with
ScottsCoir(TM). These baled products use a compressed mixture of peat and coir
(patent pending).
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The Scotts Company and Subsidiaries
14
In January 1998, Scotts acquired an 80.8% interest in Sanford Scientific, Inc.
("SSI"), a leading research company in the rapidly growing field of genetic
engineering of plants. SSI has developed and licensed a broad portfolio of genes
and genetic process technology. It holds the exclusive license to use biolistic
("gene gun") technology in the commercial development of genetically transformed
turf grasses, flowers and woody ornamental plants. Biolistic technology involves
the delivery of desirable genetic characteristics by high-velocity injection
into cells. The technology is widely used in medical research and agricultural
fields for applications ranging from immunization and cancer treatment to
creation of new agricultural crop varieties, including corn and soybeans. The
biolistic approach to genetic engineering of plants has important advantages
over other transformation technologies. For certain plant species,
transformation using the gene gun is largely considered the only commercially
viable method of inserting new gene traits into plants. In addition, SSI has
developed and licensed a broad portfolio of genes and genetic process technology
with significant commercial potential.
Gene gun technology augments the Company's genetic improvement program by
allowing researchers to create desirable varieties of plants with value-added
traits beyond the capabilities of conventional plant breeding techniques.
Targets of the Company's research effort include disease and insect resistance,
herbicide tolerance and other consumer-relevant traits, such as turf grasses
that require less mowing and flowers with novel colors and fragrances. The
Company expects that it will commercialize certain genetically transformed
plants within a few years.
Scotts acquired its interest from SSI founder and president Dr. John Sanford,
who retained a 19.2% interest and remains involved with SSI. Dr. Sanford led the
team of Cornell University scientists who invented the gene gun technology in
the 1980's, and he continues as a leading expert in the field. SSI operates an
advanced genetic research facility in Waterloo, New York, and actively
collaborates with other leading genetic scientists.
Exclusive access to this technology is a key element in the Company's program to
create value by combining the Company's brands and SSI's biolistic
transformation process with proven genes licensed from technology partners.
Consistent with this strategy, in August 1998, Scotts completed an agreement
with Rutgers University, the State University of New Jersey. Under this
agreement, Scotts will fund, through research support and future royalties, a
combined effort by Rutgers' plant biotechnology and turfgrass breeding programs
to develop improved transgenic bentgrass varieties. In return, Scotts will
receive exclusive rights to market all Rutgers' patented transgenic bentgrass
varieties developed over the next seven years, likely extending to seventeen
years. Rutgers' development program will utilize the biolistic process and other
enabling technologies under license to SSI to insert and activate genes that are
proprietary to Rutgers University. Any superior bentgrass varieties that result
from the program are expected to be commercialized in the golf course market.
Company research and development expenses were approximately $14.8 million (1.3%
of net sales) for fiscal 1998 including environmental and regulatory expenses.
This compares to $10.0 million (1.1% of net sales) and $10.6 million (1.4% of
net sales) for fiscal 1997 and 1996, respectively.
Seasonality
The Company's business is highly seasonal with approximately 72% of sales
occurring in the second and third fiscal quarters combined for the past two
fiscal years. Please also see the discussion in "North American Consumer
Business Group -- Backlog" and "Professional Business Group -- Backlog."
OPERATIONS GROUP
Production Facilities
The manufacturing plant for consumer and professional fertilizer products
marketed under the Scotts(R) label is located in Marysville, Ohio. Manufacturing
for such products is also conducted by approximately 40 contract manufacturers.
Demand for Turf Builder(R), Poly-S(R) and other products results in the Company
expanding operations (generally from October through May) of its fertilizer
processing and packaging lines from five days per week, three-shift operations
to seven days, three-shift operations when necessary to prepare for the peak
demand periods. The Company currently operates its two Turf Builder(R) lines
seven days per week, year round, and has recently installed a third Turf
Builder(R) production line to meet capacity needs for those products. Sierra(R)
controlled-release fertilizers are produced in Charleston, South Carolina,
Milpitas, California and Heerlen, the Netherlands. Expansion at each facility
has been completed to permit the blending of products which utilize both Scotts
and Sierra proprietary technology. Production schedules at Sierra's facilities
vary to meet demand. Seed blending and packaging are outsourced to
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The Scotts Company and Subsidiaries
15
various packaging companies located on the West Coast near seed growers. With
the acquisition of EarthGro, growing media products are processed and packaged
in 29 locations throughout the United States. The Company operates 14 composting
facilities where yard waste (grass clippings, leaves, and twigs) is converted to
raw materials for the Company's growing media products. Operations at these
composting facilities have been integrated with the Company's 29 growing media
facilities. The Company also utilizes approximately 43 contract production
locations for growing media products. The Company's lawn spreaders are produced
at the Republic facility in Carlsbad, California. Republic adjusts assembly
capacity from time to time, to meet demand. Both Hyponex's and Republic's
operations vary production schedules to meet demand. The majority of
Miracle-Gro(R) water-soluble fertilizers is contract-manufactured in three
facilities located in Ohio, Texas and Florida.
Granular and water-soluble fertilizers, liquid herbicides and pesticides and
growing media for the U.K. market, are produced in East Yorkshire (Howden,
Hatfield and Swinefleet) and Suffolk (Bramford), in the United Kingdom.
Bramford is the headquarters for U.K. operations and for the U.K. professional
business. The site houses a modern fertilizer granulation plant with automated
packing lines, liquid fertilizer production and bottling facilities. In
addition, there are facilities for formulating and bottling a wide range of
liquid plant protection products including herbicides, insecticides and
fungicides. Bramford produces a wide range of products for both the consumer and
professional businesses in Europe. These include the Evergreen(R) line of lawn
products, Tomorite(R) liquid tomato feed and Greenmaster(R) products for the
professional turf market. The Hatfield and Swinefleet factories contain modern
facilities for the screening and blending of peat, together with various
additives to produce a wide range of growing media. Peat to supply the
facilities is harvested on both sites and brought in from satellite sites in
Northwest England and Scotland. This facility produces the Levington(R) range of
compost for both the consumer and professional businesses. Peat from Ireland is
imported to produce the Shamrock(TM) range of growing media. Granular and
water-soluble fertilizers and pesticides are produced at Howden and growing
media is produced at Swinefleet and Hatfield.
With the RPJ Acquisition, the Company acquired the Hautmont and Bourth plants in
France. At Hautmont, growing media and fertilizers for the consumer market are
blended and bagged, and at Bourth, pesticide products for the consumer market
are formulated, blended and packaged. Production schedules at Hautmont vary from
one shift to two shifts to meet demand, while Bourth maintains two shifts
year-round.
Resin used for producing Osmocote(R) controlled-release fertilizer in the United
States is manufactured at Sierra-Sunpol Resins, Inc., a joint venture company
which is 97% owned by Sierra.
Management believes that each of its facilities is well-maintained and suitable
for its purpose. However, due to the seasonal nature of the Company's business,
the Company's plants operate at maximum capacity during the peak production
periods. Therefore, an unplanned serious production interruption could have a
substantial adverse affect on the Company's sales of the affected product lines.
Capital Expenditures
Capital expenditures totaled $41.3 million and $28.6 million for the fiscal
years ended September 30, 1998 and 1997, respectively. Of the major expenditures
in fiscal 1998, approximately $17.8 million was spent on the installation of a
third Turf Builder(R) production line, which will increase total site capacity
by approximately 25%, with expected annual savings of approximately $4 million.
The Company estimates that capital expenditures will approximate $60 million in
fiscal 1999, $50 million to $60 million for each of the following three years
and approximately $40 million per year thereafter for the foreseeable future.
Purchasing
The key ingredients in the Company's fertilizer and control products are various
commodity and specialty chemicals including vermiculite, phosphates, urea,
potash, herbicides, insecticides and fungicides. The Company obtains its raw
materials from various sources, which the Company presently considers to be
adequate. No one source is considered to be essential to any of the Company's
North American Consumer, Professional or International Business Groups, or to
its business as a whole. The Company has never experienced a significant
interruption of supply.
Raw materials for Scotts' Miracle-Gro include phosphates, urea and potash. The
Company considers its sources of supply for these materials to be adequate. All
of the products sold by Scotts' Miracle-Gro (other than those produced by
Miracle Garden
15
The Scotts Company and Subsidiaries
16
Care) are produced under contract by independent fertilizer blending and
packaging companies.
Sierra purchases granular, homogeneous fertilizer substrates to be coated and
the resins for coating. These resins are primarily supplied domestically by
Sierra-Sunpol Resins, Inc.
Sphagnum peat, bark, peat, humus, vermiculite and manure constitute Hyponex's
most significant raw materials. At current production levels, the Company
estimates Hyponex's peat reserves to be sufficient for its near-term needs in
all locations. Bark products are obtained from sawmills and other wood residue
producers and manure is obtained from a variety of sources, such as feed lots
and mushroom growers.
Raw materials for Republic include various engineered resins and metals, all of
which are available from a variety of vendors.
Distribution
The primary distribution centers for the Company's Scotts(R) products are
located near the Company's headquarters in central Ohio. The Company's expansion
of its Marysville distribution facility was completed in December 1997. The
Company's products are shipped by rail and truck. While the majority of truck
shipments is made by contract carriers, a portion is made by the Company's own
fleet of leased trucks. Inventories are also maintained in contract field or
public warehouses located in major markets.
The products of Scotts' Miracle-Gro are warehoused and shipped from five
contract packagers located throughout the United States. These contract
packagers ship full truckloads of product via common carrier to lawn and garden
distributors. Inventories of Miracle Garden Care's and Levington's products for
the European market, which are produced at the East Yorkshire (Howden) and
Suffolk (Bramford) facilities, are distributed through a public warehouse in
Daventry, the United Kingdom. Distributors are used for Miracle Garden Care's
professional products.
Most growing media products have low sales value per unit of weight, making
freight costs significant to profitability. Therefore, the Consumer Growing
Media Business Group has located all of its 29 plant/ distribution locations
near large metropolitan areas in order to minimize shipping costs and to be near
raw material sources. The Group uses its own fleet of approximately 70 trucks as
well as contract haulers to transport its products from plant/distribution
points to retail customers. Large-bag outdoor landscaping products and much of
the indoor potting soil products are shipped directly to retail stores. A
portion of the Company's indoor potting soil and additive products is shipped to
retailers' distribution centers for redistribution to their stores. In the
United Kingdom, growing media is packaged at Hatfield and Swinefleet and shipped
directly to customers in the United Kingdom. With the RPJ Acquisition, growing
media is also produced in Hautmont, France and shipped directly to customers.
Sierra's products are produced at two fertilizer and two growing media
manufacturing facilities located in the United States and one fertilizer
manufacturing facility located in Heerlen, the Netherlands. The majority of
shipments is via common carriers through distributors in the United States and a
network of public warehouses in Europe.
Fertilizers and pesticide products manufactured in Bourth, France are shipped to
customers via a central distribution center located in Blois, France.
Republic-produced, Scotts(R) branded spreaders are shipped via common carrier to
regional warehouses serving the Company's retail network. A portion of
Republic's spreader line and its private label lines is sold free-on-board (FOB)
Carlsbad with transportation arranged by the customer.
Significant Customers
The Home Depot and Kmart Corporation represented approximately 17% and 9%,
respectively, of the Company's sales in fiscal 1998 and 12% and 2% respectively,
of the Company's outstanding trade accounts receivable at September 30, 1998.
Wal*Mart sales represented 9% of the Company's fiscal 1998 sales. After
allocating buying groups' sales to that retail customer, Wal*Mart sales
represented approximately 11% of the Company's sales and 2% of the Company's
outstanding trade accounts receivable at September 30, 1998. All three customers
hold significant positions in the retail lawn and garden market. The loss of any
of these customers or a substantial decrease in the amount of their purchases
could have a material adverse effect on the Company's business.
Employees
The Company's corporate culture is a blend of the history, heritage and culture
of Scotts and companies acquired over the past ten years. The Company provides a
comprehensive benefits program to all full-time associates. As of September 30,
1998, the Company employed approximately 2,500 full-time
16
The Scotts Company and Subsidiaries
17
workers in the United States (including all subsidiaries) and an additional 530
full-time employees located outside the United States. With the RPJ Acquisition,
the Company gained an additional 416 full-time employees outside the United
States. As of September 30, 1998, full-time workers averaged approximately nine
years employment with the Company or its predecessors. During peak production
periods, the Company engages as many as 1,300 temporary workers in the United
States. In the United Kingdom, during peak periods, as many as 66 temporary
workers are engaged and European operations engage an average of 60 temporary
workers annually.
The Company's U.S. employees are not members of a union, with the exception of
20 of Sierra's employees at its Milpitas facility, who are represented by the
International Chemical Workers Union. One hundred of the Company's full-time
U.K. employees at the Hatfield, Swinefleet and Bramford manufacturing sites are
members of the Transport and General Workers Union. A number of the Company's
full-time employees at the headquarters office in Lyon, France are members of
the Confederation Generale des Cadres (CGC), Confederation Francaise
Democratique du Travail (CFDT) and Confederation Generale du Travail (CGT),
which number is confidential under French law. The average rate of union
membership among employees in France is approximately 15%. A number of union and
non-union full-time employees are members of work councils at three sites in
Bourth, Hautmont and Lyon, France, and a number of non-union employees are
members in Ingelheim, Germany. Work councils represent employees on labor and
employment matters and manage social benefits.
ENVIRONMENTAL AND REGULATORY CONSIDERATIONS
Local, state, federal and foreign laws and regulations relating to environmental
matters affect the Company in several ways. In the United States, all products
containing pesticides must be registered with the U.S. Environmental Protection
Agency (and in many cases, similar state and/or foreign agencies) before they
can be sold. The inability to obtain or the cancellation of any such
registration could have an adverse effect on the Company's business. The
severity of the effect would depend on which products were involved, whether
another product could be substituted and whether the Company's competitors were
similarly affected. The Company attempts to anticipate regulatory developments
and maintain registrations of, and access to, substitute chemicals, but there
can be no assurance that it will continue to be able to avoid or minimize these
risks. Fertilizer and growing media products (including manures) are also
subject to state and foreign labeling regulations. Grass seed is also subject to
state, federal and foreign labeling regulations.
In addition, the use of certain pesticide and fertilizer products is regulated
by various local, state, federal and foreign environmental and public health
agencies. These regulations may include requirements that only certified or
professional users apply the product or that certain products be used only on
certain types of locations (such as "not for use on sod farms or golf courses"),
may require users to post notices on properties to which products have been or
will be applied, may require notification of individuals in the vicinity that
products will be applied in the future or may ban the use of certain
ingredients. The Company believes it is operating in substantial compliance
with, or taking action aimed at ensuring compliance with, such laws and
regulations. Compliance with such regulations and the obtaining of registrations
does not assure, however, that the Company's products will not cause injury to
the environment or to people under all circumstances. 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 the Company's financial position; however, there can be no assurance
that future quarterly or annual operating results will not be materially
affected by the resolution of these matters.
State and federal authorities generally require Hyponex to obtain permits
(sometimes on an annual basis) in order to harvest peat and to discharge water
run-off or water pumped from peat deposits. The state permits typically specify
the condition in which the property must be left after the peat is fully
harvested, with the residual use typically being natural wetland habitats
combined with open water areas. Hyponex is generally required by these permits
to limit its harvesting and to restore the property consistent with the intended
residual use. In some locations, Hyponex has been required to create water
retention ponds to control the sediment content of discharged water.
Regulations and environmental concerns exist surrounding peat extraction in the
United Kingdom. Levington played a leading role in the development and
implementation of legislation concerning peat extraction. The Scotts Company
(UK) Limited believes
17
The Scotts Company and Subsidiaries
18
it complies with the legislation and regards it as the minimum standard.
Local, state, federal and foreign agencies regulate the disposal, handling and
storage of waste and air and water discharges from Company facilities. During
fiscal 1998, the Company had approximately $0.7 million in environmental capital
expenditures and $3.1 million in other environmental expenses, compared with
approximately $0.4 million in environmental capital expenditures and $1.5
million in other environmental expenses in fiscal 1997. The Company has budgeted
$0.9 million in environmental capital expenditures and $2.6 million in other
environmental expenses for fiscal 1999.
Ohio Environmental Protection Agency
The Company has assessed and addressed certain environmental issues regarding
the wastewater treatment plants which had operated at the Marysville facility.
The Company decommissioned the old wastewater treatment plants and has connected
the facility's wastewater system with the City of Marysville's municipal
treatment system. Additionally, the Company has been assessing, under Ohio's new
Voluntary Action Program ("VAP"), the possible remediation of several
discontinued on-site waste disposal areas dating back to the early operations of
its Marysville facility.
In February 1997, the Company learned that the Ohio Environmental Protection
Agency ("OEPA") was referring certain matters relating to environmental
conditions at the Company's Marysville site, including the existing wastewater
treatment plants and the discontinued on-site waste disposal areas, to the Ohio
Attorney General's Office ("OAG"). Representatives from the OEPA, the OAG and
the Company continue to meet to discuss these issues.
In June 1997, the Company received formal notice of an enforcement action and
draft Findings and Orders ("F&O") from the OEPA. The draft F&O elaborated on the
subject of the referral to the OAG alleging: potential surface water violations
relating to possible historical sediment contamination possibly impacting water
quality; inadequate treatment capabilities of the Company's existing and
currently permitted wastewater treatment plants; and that the Marysville site is
subject to corrective action under the Resource Conservation Recovery Act
("RCRA"). In late July 1997, the Company received a draft judicial consent order
from the OAG which covers many of the same issues contained in the draft F&O
including RCRA corrective action.
In accordance with the Company's past efforts to enter into Ohio's VAP, the
Company submitted to the OEPA a "Demonstration of Sufficient Evidence of VAP
Eligibility Compliance" on July 8, 1997. Among other issues contained in the VAP
submission, was a description of the Company's ongoing efforts to assess
potential environmental impacts of the discontinued on-site waste disposal areas
as well as potential remediation efforts. Pursuant to the statutes covering VAP,
an eligible participant in the program is not subject to State enforcement
actions for those environmental matters being addressed. On October 21, 1997,
the Company received a letter from the Director of the OEPA denying VAP
eligibility based upon the timeliness of and completeness of the submittal. The
Company has appealed the Director's action to the Environmental Review Appeals
Commission. No hearing date has been set and the appeal remains pending.
The Company is continuing to meet with the OAG and the OEPA in an effort to
negotiate an amicable resolution of these issues but is unable at this stage to
predict the outcome of the negotiations. The Company believes that it has viable
defenses to the State's enforcement action, including that it had been
proceeding under VAP to address certain environmental issues, and will assert
those defenses in any such action.
While the Company is unable to predict the ultimate outcome of this matter,
management believes that the probable range of outcome will not be material to
the Company. Many of the issues raised by the State are already being
investigated and addressed by the Company during the normal course of conducting
business.
Lafayette
In July 1990, the Philadelphia District of the U.S. Army Corps of Engineers
("Corps") directed that peat harvesting operations be discontinued at Hyponex's
Lafayette, New Jersey facility, based on its contention that peat harvesting and
related activities result in the "discharge of dredged or fill material into
waters of the United States" and, therefore, require a permit under Section 404
of the Clean Water Act. In May 1992, the United States filed suit in the U.S.
District Court for the District of New Jersey seeking a permanent injunction
against such harvesting, and civil penalties in an unspecified amount. If the
Corps' position is upheld, it is possible that further harvesting of peat from
this facility
18
The Scotts Company and Subsidiaries
19
would be prohibited. The Company is defending this suit and is asserting a right
to recover its economic losses resulting from the government's actions. The suit
was placed in administrative suspense during fiscal 1996 in order to allow the
Company and the government an opportunity to negotiate a settlement, and it
remains suspended while the parties develop, exchange and evaluate technical
data. In July 1997, the Company's wetlands consultant submitted to the
government a draft remediation plan. Comments were received and a revised plan
was submitted in early 1998. Further immaterial comments from the government
were received in June 1998, and final agreement is expected sometime in 1999.
Management does not believe that the outcome of this case will have a material
adverse effect on the Company's operations or its financial condition.
Furthermore, management believes the Company has sufficient raw material
supplies available such that service to customers will not be materially
adversely affected by continued closure of this peat harvesting operation.
Hershberger
In September 1991, the Company was identified by the OEPA as a Potentially
Responsible Party ("PRP") with respect to a site in Union County, Ohio (the
"Hershberger site"), because the Company allegedly arranged for the
transportation, treatment or disposal of waste that allegedly contained
hazardous substances, at the Hershberger site. Effective February 1998, the
Company and four other named PRPs executed an Administrative Order on Consent
("AOC") with the OEPA, by which the named PRPs will fund remedial action at the
Hershberger site. After construction of the leachate collection system and
reconstruction of the landfill cap, which was substantially completed in August
1998, the Company expects its obligation to consist primarily of its share of
annual operating and maintenance expenses. Management does not believe that its
obligations under the AOC will have a material adverse effect on the Company's
results of operations or financial condition.
YEAR 2000 READINESS
Please see the information contained under the caption "Year 2000 Readiness" in
"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS."
ITEM 2. PROPERTIES
The Company has fee or leasehold interests in approximately 60 facilities.
The Company owns approximately 844 acres of land, with 719 acres at its
Marysville, Ohio headquarters. Three research facilities in Apopka, Florida;
Cleveland, Texas; and Gervais, Oregon, comprise 125 acres. The Company leases
warehouse space throughout the country as needed. Republic leases its 20-acre
spreader facility in Carlsbad, California.
With the acquisition of EarthGro, the Company operates 29 growing media
facilities located nationwide in 21 states. Twenty-five are owned by the Company
and four are leased. Most facilities include production lines, warehouses,
offices and field processing areas.
The Company also operates 14 composting facilities nationwide in nine states.
Five of these sites are leased and are located in California, Indiana, Oregon
and Illinois. Six other composting sites are utilized through agreements with
the municipalities of Greensboro, North Carolina; Shreveport, Louisiana;
Spokane, Washington; Independent Hill, Virginia; Balls Ford, Virginia and
Fairfield, Connecticut. Three other sites are located at bagging facilities in
Wisconsin, California and Connecticut. The Company plans to close nine
composting sites in the United States that collect and compost yard waste on
behalf of municipalities, as their contracts expire. Six facilities will be
closed in 1999 and three in 2000.
The Company owns two Sierra manufacturing facilities in Fairfield, California
and Heerlen, the Netherlands. It leases two Sierra manufacturing facilities in
Milpitas, California and North Charleston, South Carolina. As a result of the
acquisition of Miracle Garden Care, the Company owns a manufacturing facility in
East Yorkshire (Howden), Great Britain, and a headquarters office for the
consumer market, in Suffolk (Godalming). As a result of the acquisition of
Levington, the Company owns manufacturing facilities at three sites in the
United Kingdom. As a result of the RPJ Acquisition, the Company acquired the
Hautmont plant in France, a blending and bagging facility for growing media and
fertilizers sold to the consumer market; the Bourth plant, also in France, a
facility for formulating, blending and packaging pesticide products for the
consumer market; and a sales and research and development facility in Ingelheim,
Germany. The Company leases a headquarters office in Lyon, France; and a sales
office in A Sol Bergheim, Austria.
19
The Scotts Company and Subsidiaries
20
The Company leases the land upon which Scotts' Miracle-Gro headquarters is
located in Port Washington, New York.
The Company leases property for ten lawn care service centers in Georgia,
Illinois, Indiana, Maryland, Missouri and Ohio. The Company also leases the land
upon which SSI is located in Waterloo, New York.
It is the opinion of the Company's management that its facilities are adequate
to serve their intended purposes at this time and that its property leasing
arrangements are stable. Please also see the discussion of the Company's
production facilities in "ITEM 1. BUSINESS -- Operations Group -- Production
Facilities" above.
ITEM 3. LEGAL PROCEEDINGS
As noted in the discussion of "Environmental and Regulatory Considerations" in
"ITEM 1. BUSINESS", the Company is involved in several pending environmental
matters. 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 Company is involved in other lawsuits and claims which arise in the normal
course of its business. In the opinion of management, these claims individually
and in the aggregate are not expected to result in a material adverse effect on
the Company's financial position or operations.
20
The Scotts Company and Subsidiaries
21
ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders during the
fourth quarter of the fiscal year covered by this Report.
Executive Officers of Registrant
The executive officers of Scotts, their positions and, as of December 10, 1998,
their ages and years with Scotts (and its predecessors) are set forth below.
Years with
the Company
(and its
Name Age Position(s) Held Predecessors)
---- --- ---------------- -------------
Charles M. Berger 62 Chairman of the Board, President and Chief 2
Executive Officer
James Hagedorn 43 President, Scotts North America, and a 11
Director
Jean H. Mordo 53 Executive Vice President and Chief 1
Financial Officer, and interim head of
International Business Group
John Kenlon 67 President, Consumer Gardens Group, and a 38
Director
Anthony S. Colatrella 43 Senior Vice President, Planning and 1
Corporate Development
William A. Dittman 42 Senior Vice President, Consumer Growing 6
Media Business Group
Michael P. Kelty, Ph.D. 48 Senior Vice President, Professional 19
Business Group, and interim head of
Operations Group
G. Robert Lucas 55 Senior Vice President, General Counsel and 1
Secretary
Joseph M. Petite 48 Senior Vice President, Business Process 10
Development
William R. Radon 39 Senior Vice President, Information 10 months
Technology
James L. Rogula 64 Senior Vice President, Consumer Pesticides 3
Business Group
L. Robert Stohler 57 Senior Vice President, Consumer Lawns 3
Business Group
Richard Martinez 43 Vice President, Research and Development 19
Rosemary L. Smith 51 Vice President, Human Resources 25
Executive officers serve at the discretion of the Board of Directors and in the
case of: Mr. Berger, Mr. Hagedorn, Mr. Mordo, Mr. Kenlon and Mr. Lucas, pursuant
to employment agreements.
21
The Scotts Company and Subsidiaries
22
The business experience of each of the persons listed above during the past five
years is as follows:
Mr. Berger was elected Chairman of the Board, President and Chief Executive
Officer of Scotts in August 1996. Mr. Berger came to Scotts from H. J. Heinz
Company, where he served as Chairman, President and Chief Executive Officer of
Weight Watchers International, a Heinz affiliate, from 1978 to September 1994.
From October 1994 to August 1996, he was Chairman and CEO of Heinz India Pvt.
Ltd. (Bombay). During his 32-year career at Heinz, he also held the positions of
Managing Director and CEO of Heinz-Italy (Milan), the largest Heinz profit
center in Europe; General Manager, Marketing, for all Heinz U.S. grocery
products; Marketing Director for Heinz UK (London) and Director of Corporate
Planning at Heinz World Headquarters. He is also a former director of Stern's
Miracle-Gro Products, Inc. ("Miracle-Gro Products").
Mr. Hagedorn was named President, Scotts North America, in December 1998. He was
previously Executive Vice President, U.S. Business Groups, since October 1996.
From May 1995 to October 1996, he served as Senior Vice President, Consumer
Gardens Group, of Scotts. Mr. Hagedorn has also been Executive Vice President of
Scotts' Miracle-Gro since May 1995. He was Executive Vice President of
Miracle-Gro Products from 1989 until May 1995. He was previously an officer and
an F-16 pilot in the U.S. Air Force.
Mr. Mordo was recently named interim head of the International Business Group,
as a result of Mr. Stohler's assumption of duties as head of the Consumer Lawns
Business Group. He was named Executive Vice President and Chief Financial
Officer of Scotts in January 1997. From 1992 through December 1996, he served as
Senior Vice President and Chief Financial Officer of Pratt and Whitney Aircraft,
a division of United Technologies Corporation ("UTC").
Mr. Kenlon was named President, Consumer Gardens Group, of Scotts in December
1996. He remains Chief Operating Officer and President of Scotts' Miracle-Gro,
positions held since May 1995. Mr. Kenlon was the President of Miracle-Gro
Products from 1985 until May 1995. Mr. Kenlon began his association with the
Miracle-Gro companies in 1960.
Mr. Colatrella was named Senior Vice President, Planning and Corporate
Development, of Scotts in July 1998. Before joining Scotts in February 1997 as
Vice President, Planning and Corporate Development, he was Vice President and
Chief Financial Officer of the General Electric/Pratt & Whitney Engine Alliance,
a joint venture between UTC and GE Aircraft Engines, having served in that role
since September 1996. From 1993 to September 1996, he was Director, Business
Development, at the Pratt & Whitney Aircraft Engine Division of UTC.
Mr. Dittman was named Senior Vice President, Consumer Growing Media Business
Group, of Scotts, in April 1998. From December 1996 to April 1998, he was Senior
Vice President of Sales, Marketing and Advertising of the Consumer Gardens Group
of Scotts. From 1992 to December 1996, he was Vice President of Sales,
Miracle-Gro Products, n/k/a Scotts' Miracle-Gro.
Dr. Kelty was named interim head of the Operations Group in September 1998. He
was named Senior Vice President, Professional Business Group, of Scotts in July
1995. Dr. Kelty had been Senior Vice President, Technology and Operations, of
Scotts from 1994 to July 1995. From 1988 to 1994, he served first as Director,
then as Vice President, of Research and Development of Scotts. Prior to that,
Dr. Kelty was the Director of Advanced Technology, Research of Scotts, and from
1983 to 1987, he was Director, Chemical Technology Development, of Scotts and
its predecessors.
Mr. Lucas was named Senior Vice President, General Counsel and Secretary of
Scotts in May 1997. From 1990 until the time he joined Scotts, Mr. Lucas was a
partner with the law firm Vorys, Sater, Seymour and Pease LLP ("VSSP"). From
1993 to the time he joined Scotts, he was the lead outside counsel at VSSP
representing the Company. Mr. Lucas is a director of Bob Evans Farms, Inc.
Mr. Petite was named Senior Vice President, Business Process Development, in
February 1998. He served as Senior Vice President, Consumer Growing Media
Business Group, of Scotts from December 1996 to February 1998. From July 1996 to
December 1996, he served as Vice President, Consumer Growing Media Business
Group, of Scotts. From November 1995 to July 1996, Mr. Petite served as Vice
President, Strategic Planning of Scotts. From 1989 to November 1995, he was Vice
President of Marketing, North American Consumer Business Group, of Scotts.
Mr. Radon joined Scotts in February 1998, as Senior Vice President, Information
Technology. From September 1995 to the time he joined Scotts, Mr. Radon was
22
The Scotts Company and Subsidiaries
23
Vice President, Chief Information Officer at Lamson & Sessions, a manufacturer
and distributor of plastic pipe, conduit and consumer electrical devices. From
1984 to September 1995, he was a management consultant at Ernst & Young.
Mr. Rogula was named Senior Vice President, Consumer Pesticides Business Group,
in October 1998. Prior thereto, he had been Senior Vice President, Consumer
Lawns Group, of Scotts since October 1996. He served as Senior Vice President,
North American Consumer Business Group, of Scotts from January 1995 to October
1996. From 1990 until the time he joined Scotts, he was President of The
American Candy Company, a producer of non-chocolate candies. He is also a former
director of Miracle-Gro Products.
Mr. Stohler was named Senior Vice President, Consumer Lawns Business Group, in
October 1998. Prior thereto, he had been Senior Vice President, International
Business Group, of Scotts since December 1996. From November 1995 to December
1996, he served as Vice President, International Business Group, of Scotts. From
January 1994 to October 1995, he was President of Rubbermaid Europe S.A., a
marketer of plastic housewares, toys, office supplies and janitorial and food
service products. From 1992 to January 1994, he was Vice President and Chief
Financial Officer of Synthes (USA), a marketer and manufacturer of implants and
surgical instruments for orthopedic health care.
Mr. Martinez was named Vice President, Research and Development, of Scotts in
December 1997. From October 1995 to December 1997, he was Director, Operations
Strategic Planning, and from January 1994 to October 1995, he was Director,
Chemical Technology Development, of Scotts. From 1993 to January 1994, he was
Director, Research and Development, of Scotts. Mr. Martinez has been with Scotts
since 1979.
Ms. Smith was named Vice President, Human Resources, of Scotts in October 1996.
From 1991 to October 1996, she was Director, Human Resources, and from 1986 to
1991, she was Director, Compensation & Benefits, of Scotts. Ms. Smith first
joined Scotts in 1973.
23
The Scotts Company and Subsidiaries
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER
MATTERS
The common shares of Scotts trade on the New York Stock Exchange ("NYSE") under
the symbol "SMG".
Sales Prices
-------------
High Low
---- ---
FISCAL 1997
1st quarter................... $20 1/2 $17 3/4
2nd quarter................... 24 7/8 19 1/2
3rd quarter................... 29 3/4 22 7/8
4th quarter................... 30 9/16 25 5/8
FISCAL 1998
1st quarter................... $31 1/16 $26 1/4
2nd quarter................... 35 1/2 29 7/16
3rd quarter................... 38 32 1/2
4th quarter................... 41 3/8 26 3/8
Scotts has not paid dividends on the common shares in the past and does not
presently plan to pay dividends on the common shares. It is presently
anticipated that earnings will be retained and reinvested to support the growth
of the Company's business. The payment of any future dividends on common shares
will be determined by the Board of Directors of Scotts in light of conditions
then existing, including the Company's earnings, financial condition and capital
requirements, restrictions in financing agreements, business conditions and
other factors.
As of December 2, 1998, Scotts estimates there were approximately 6,500
shareholders including holders of record and Scotts' estimate of beneficial
holders.
In a series of private placements during May 1998, Scotts issued put options
with respect to 0.3 million common shares providing the right to sell to Scotts
one Scotts common share at a fixed price. The puts mature in May 1999 and can
only be exercised at maturity. The strike price is $35.32 per share. Scotts
received a premium for the issues of $0.5 million.
24
The Scotts Company and Subsidiaries
25
...............................................................................
25
The Scotts Company and Subsidiaries
ITEM 6. SELECTED FINANCIAL
DATA
FIVE YEAR SUMMARY
For the fiscal year ended September 30, (in millions except per share amounts) 1998(4) 1997 1996(3) 1995(2)
.........................................................................................................................
OPERATING RESULTS:
Sales $1,113.0 $899.3 $750.4 $731.1
Gross profit $ 398.0 $325.7 $238.0 $232.3
Income from operations (5) $ 94.1 $ 94.8 $ 26.3 $ 60.9
Income (loss) before extraordinary items and accounting changes $ 37.0 $ 39.5 $ (2.5) $ 22.4
Income (loss) applicable to common shareholders $ 26.5 $ 29.7 $(12.3) $ 18.8
Net cash provided by operating activities $ 71.0 $121.1 $ 82.3 $ 4.4
Depreciation and amortization $ 37.8 $ 30.4 $ 29.3 $ 25.7
FINANCIAL POSITION:
Working capital $ 135.3 $146.5 $181.1 $227.0
Investment in property, plant and equipment $ 41.3 $ 28.6 $ 18.2 $ 23.6
Property, plant and equipment, net $ 197.0 $146.1 $139.5 $148.8
Total assets $1,035.2 $787.6 $731.7 $809.0
Total debt $ 372.5 $221.3 $225.3 $272.5
Total shareholders' equity $ 403.9 $389.2 $364.3 $380.8
RATIOS:
Operating margin 8.5% 10.5% 3.5% 8.3%
Current ratio 1.6 2.1 2.6 2.8
Total debt to total capitalization 48.0% 36.2% 38.2% 41.7%
Return on average shareholders' equity 9.2% 10.5% (0.7)% 8.2%
PER SHARE DATA:
Diluted earnings (loss) per common share before extraordinary items and
accounting changes $ 1.22 $ 1.35 $(0.65) $ 0.99
Diluted earnings (loss) per common share $ 1.20 $ 1.35 $(0.65) $ 0.99
Shareholders' equity $ 12.82 $12.19 $11.44 $11.92
Price to earnings, end of period 25.5 19.4 nm 22.4
Stock price at year-end $ 30.63 $26.25 $19.25 $22.13
Stock price range High $ 41.38 $30.56 $21.88 $23.88
Low $ 26.25 $17.75 $16.13 $14.75
OTHER:
EBITDA (6) $ 131.9 $125.2 $ 55.6 $ 86.6
EBITDA margin 11.9% 13.9% 7.4% 11.8%
Interest coverage (EBITDA/interest) 4.1 5.0 2.2 3.5
Average common shares outstanding 18.7 18.6 18.8 18.7
Common shares used in diluted earnings (loss) per common share calculation 30.3 29.3 18.8 22.6
Preferred stock dividends $ 9.8 $ 9.8 $ 9.8 $ 3.6
For the fiscal year ended September 30, (in millions except per share amounts) 1994(1)
.............................................................................
OPERATING RESULTS:
Sales $606.3
Gross profit $202.2
Income from operations (5) $ 59.3
Income (loss) before extraordinary items and accounting changes $ 23.9
Income (loss) applicable to common shareholders $ 22.9
Net cash provided by operating activities $ 9.9
Depreciation and amortization $ 21.9
FINANCIAL POSITION:
Working capital $140.6
Investment in property, plant and equipment $ 33.4
Property, plant and equipment, net $140.1
Total assets $528.6
Total debt $247.3
Total shareholders' equity $168.2
RATIOS:
Operating margin 9.8%
Current ratio 2.3
Total debt to total capitalization 59.5%
Return on average shareholders' equity 14.7%
PER SHARE DATA:
Diluted earnings (loss) per common share before extraordinary items and
accounting changes $ 1.27
Diluted earnings (loss) per common share $ 1.22
Shareholders' equity $ 9.01
Price to earnings, end of period 12.7
Stock price at year-end $15.50
Stock price range High $20.13
Low $15.25
OTHER:
EBITDA (6) $ 81.2
EBITDA margin 13.4%
Interest coverage (EBITDA/interest) 4.6
Average common shares outstanding 18.7
Common shares used in diluted earnings (loss) per common share calculation 18.8
Preferred stock dividends $ --
- ---------
NOTE: Prior year presentations have been changed to conform to fiscal 1998
presentation; these changes did not impact net income.
(1) Includes Scotts-Sierra Horticultural Products Company from December 1993.
(2) Includes Scotts' Miracle-Gro Products, Inc. from May 1995.
(3) Includes Miracle Holdings Limited from January 1997.
(4) Includes Levington Group Limited from December 1997 and EarthGro, Inc. from
February 1998.
(5) Operating income for fiscal 1998 and 1996 includes $20.4 million and $17.7
million of restructuring charges, respectively.
(6) EBITDA is defined as income from operations, plus depreciation and
amortization. The Company believes that EBITDA provides additional
information for determining its ability to meet debt service requirements.
EBITDA does not represent and should not be considered as an alternative to
net income or cash flow from operations as determined by generally accepted
accounting principles, and EBITDA does not necessarily indicate whether cash
flow will be sufficient to meet cash requirements.
nm Not meaningful
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a leading manufacturer and marketer of consumer branded products
for lawn and garden care, professional turf care and professional horticulture
businesses in the United States and Europe. The Company's operations are divided
into three business segments: North American Consumer, Professional and
International. The North American Consumer segment includes the Lawns, Gardens
and Growing Media business groups.
As a leading consumer branded lawn and garden company, the Company focuses on
its consumer marketing efforts, including advertising and consumer research, to
create demand to pull product through the retail distribution channels. During
fiscal 1998, the Company spent $104.4 million on advertising and promotional
activities, an increase of 17.3% over fiscal 1997 excluding the impact of fiscal
1998 acquisitions. Management believes that the Company receives a significant
return on these increased marketing expenditures. For example, sales in the
Company's Consumer Lawns business group increased 12.9% from fiscal 1997 to
fiscal 1998, which the Company believes resulted primarily from its increased
consumer-oriented marketing efforts. The Company expects that it will continue
to focus its marketing efforts toward the consumer and to increase consumer
marketing expenditures in the future to drive market share and sales growth.
The Company's sales are seasonal in nature and are susceptible to global weather
conditions, primarily in North America and Europe. For instance, periods of wet
weather can slow fertilizer sales but can create increased demand for
pesticides. Periods of dry, hot weather can have the opposite effect on
fertilizer and pesticide sales. The Company believes that its recent
acquisitions diversify both its product line risk and geographic risk to weather
conditions.
On September 30, 1998, the Company entered into a long-term Exclusive Agency and
Marketing Agreement (the "Roundup Marketing Agreement") with Monsanto for its
consumer Roundup(R) herbicide products. Under the Roundup Marketing Agreement,
the Company and Monsanto will jointly develop global consumer and trade
marketing programs for Roundup(R) and the Company has assumed responsibility for
sales support, merchandising, distribution, logistics and certain administrative
functions. In addition, the Company has signed a definitive agreement to
purchase from Monsanto the assets of its worldwide consumer lawn and garden
businesses, exclusive of the Roundup business (the "Ortho Acquisition"). These
transactions with Monsanto will further the Company's strategic objective of
significantly enhancing its position in the pesticides segment of the consumer
lawn and garden category. These businesses will make up the newly created
Consumer Pesticides business group within the North American
Consumer segment.
Management believes that the acquisitions will provide the Company with several
strategic benefits including immediate market penetration, geographic expansion,
brand leveraging opportunities and the achievement of substantial cost savings.
The Company is currently a leader in four segments of the consumer lawn and
garden category: lawn fertilizer, garden fertilizer, growing media and grass
seeds. The Ortho Acquisition (when completed) and the Roundup Marketing
Agreement will provide the Company with an immediate entry into the fifth
segment of the consumer lawn and garden category: the U.S. pesticides segment.
The addition of the U.S. pesticides product line completes the Company's product
portfolio and positions the Company as the only national company with a complete
offering of consumer products.
The addition of strong pesticide brands will complete the Company's product
portfolio of powerful branded consumer lawn and garden products that should
provide the Company with brand leveraging opportunities for revenue growth. For
example, the Company's strengthened market position should create category
management opportunities to enhance shelf positioning, consumer communication,
trade incentives and trade programs. In addition, significant synergies should
be realized from the combined businesses, including reductions in general and
administrative, sales, distribution, purchasing, research and development and
corporate overhead costs. Management expects to redirect a portion of these cost
savings into increased consumer marketing spending to support the Ortho(R)
brand.
Over the past two years, the Company has made several other acquisitions to
strengthen its global market position in the lawn and garden category. In
October 1998, the Company purchased RPJ, for an estimated purchase price of $216
million. RPJ is a leading European consumer lawn and garden business. The RPJ
Acquisition provides a significant addition to
26
The Scotts Company and Subsidiaries
27
the Company's existing European platform and strengthens its foothold in the
continental European consumer lawn and garden market. Through this acquisition,
the Company will establish a strong presence in France, Germany, Austria and the
Benelux countries. The RPJ Acquisition may also mitigate, to a certain extent,
the Company's susceptibility to weather conditions by expanding the regions in
which the Company operates. In February 1998, the Company acquired EarthGro,
Inc. ("EarthGro"), a Northeastern U.S. growing media producer. In December 1997,
the Company acquired Levington Group Limited ("Levington"), a leading producer
of consumer and professional lawn fertilizer and growing media in the United
Kingdom. In January 1997, the Company acquired the approximate two-thirds
interest in Miracle Holdings Limited ("Miracle Holdings") which the Company did
not already own. Miracle Holdings owns Miracle Garden Care Limited ("Miracle
Garden"), a manufacturer and distributor of lawn and garden products in the
United Kingdom. These acquisitions are consistent with the Company's stated
objective of becoming the world's foremost branded lawn and garden company.
The following discussion and analysis of the consolidated results of operations
and financial position of the Company should be read in conjunction with the
Consolidated Financial Statements of the Company included elsewhere in this
report. Dollars are in millions except per share data.
RESULTS OF OPERATIONS
The following table sets forth the components of income and expense as a
percentage of sales for the three years ended September 30, 1998:
Fiscal Year Ended September 30,
1998 1997 1996
...................................................................................................
Sales 100.0% 100.0% 100.0%
Cost of sales 64.2 63.8 68.3
------------------------------------
Gross profit 35.8 36.2 31.7
Advertising and promotion 9.4 9.3 9.2
Selling, general and administrative 15.0 14.5 15.5
Amortization of goodwill and other intangibles 1.2 1.1 1.2
Restructuring and other charges 1.4 - -
Other expense, net 0.4 0.7 2.3
------------------------------------
Income from operations 8.4 10.5 3.5
Interest expense 2.9 2.8 3.3
------------------------------------
Income before income taxes 5.5 7.7 0.2
Income taxes 2.2 3.3 0.5
------------------------------------
Income (loss) before extraordinary items 3.3 4.4 (0.3)
Extraordinary loss 0.1 -- --
------------------------------------
Net income (loss) 3.2 4.4 (0.3)
Preferred stock dividends 0.9 1.1 1.3
------------------------------------
Income (loss) applicable to common shareholders 2.3% 3.3% (1.6)%
====================================
The following table sets forth sales by business segment for the three years
ended September 30, 1998:
Fiscal Year Ended September 30,
1998 1997 1996
...................................................................................................
North American Consumer:
Lawns $ 369.1 $309.6 $228.2
Gardens 133.0 127.0 115.3
Growing Media 231.6 182.6 180.6
------------------------------------
Total 733.7 619.2 524.1
Professional 179.4 165.5 160.4
International 199.9 114.6 65.9
------------------------------------
Consolidated $1,113.0 $899.3 $750.4
27
The Scotts Company and Subsidiaries
28
FISCAL 1998 COMPARED TO FISCAL 1997
Sales in fiscal 1998 were $1.1 billion, an increase of 23.8% over fiscal 1997
sales of $899.3 million. On a pro forma basis, assuming that the Levington and
EarthGro acquisitions had occurred on October 1, 1996, fiscal 1998 sales would
have been $1.1 billion, an increase of $100.1 million, or 9.7%, over fiscal 1997
pro forma sales of $1.0 billion. The increase in these pro forma sales was
driven primarily by significant increases in sales in the Consumer Lawns
business group and the Professional segment as discussed below.
North American Consumer segment sales were $733.7 million in fiscal 1998, an
increase of $114.5 million, or 18.5%, over fiscal 1997 sales of $619.2 million.
Sales in the Consumer Lawns business group within this segment increased $59.5
million, or 19.2%, from fiscal 1997 to fiscal 1998, reflecting significant
volume growth year to year in the Company's Turf Builder(R) line of products
driven by continued increases in consumer-oriented marketing efforts such as
advertising and packaging improvements. Sales in the Consumer Gardens and
Consumer Growing Media business groups increased $6.0 million, or 4.7%, and
$49.0 million, or 26.8%, respectively, from fiscal 1997 to fiscal 1998. The
increase in the Consumer Growing Media business group was primarily the result
of the EarthGro acquisition made earlier in fiscal 1998. The increase in sales
for the Consumer Gardens business group was driven primarily by strong volume,
particularly in the Osmocote(R) and Miracle-Gro(R) product lines, which the
Company believes was due to increased advertising. Increases were also due to
the introduction of certain new products. On a pro forma basis, including the
EarthGro acquisition, sales in the Consumer Growing Media business group
increased 4.4% from fiscal 1997 to fiscal 1998. More importantly, the Company
made a strategic decision to emphasize sales of higher margin, value-added
products and to deemphasize sales of lower margin landscape products. Selling
price changes did not have a material impact in the North American Consumer
segment in fiscal 1998.
Professional segment sales were $179.4 million in fiscal 1998, an increase of
$13.9 million, or 8.4%, over fiscal 1997 sales of $165.5 million. This increase
in sales was primarily reflected in the ProTurf(R) business and resulted from
increased volumes as a result of emphasizing more technological support for
customers and new product introductions.
International segment sales were $199.9 million in fiscal 1998, an increase of
$85.3 million, or 74.4%, over fiscal 1997 sales of $114.6 million. After
considering the Levington acquisition, on a pro forma basis, sales in the
International segment increased 11.4% from fiscal 1997 to fiscal 1998, primarily
in the European professional business.
Gross profit increased to $398.0 million in fiscal 1998, an increase of 22.2%
over fiscal 1997 gross profit of $325.7 million. As a percentage of sales, gross
profit was 35.7% of sales for fiscal 1998, compared to 36.2% of sales for fiscal
1997. Fiscal 1998 gross profit reflects a charge of $2.9 million, or 0.3% of
fiscal 1998 sales, for restructuring and other charges as discussed below. Also
impacting fiscal 1998 gross margins were start-up costs associated with the
upgrade of certain domestic manufacturing facilities, demolition costs
associated with the removal of certain old manufacturing facilities, unplanned
outsourcing of certain production and unfavorable inventory adjustments. The
aggregate impact of these items, approximately $8.0 million, was offset by
favorable raw material pricing of approximately $8.0 million.
Advertising and promotion expenses in fiscal 1998 were $104.4 million, an
increase of $20.5 million, or 24.4%, over fiscal 1997 advertising and promotion
expenses of $83.9 million. On a pro forma basis, including the Levington and
EarthGro acquisitions, advertising and promotion expenses increased 17.3% from
fiscal 1997 to fiscal 1998. This increase reflects continued emphasis on
building consumer demand through consumer-oriented marketing efforts, and is
highlighted by 18.5% and 58.9% increases in advertising and promotion expenses
in the Consumer Lawns business group and International segment (excluding the
Levington acquisition), respectively. As a percentage of sales, advertising and
promotion increased slightly to 9.4%, compared to 9.3% for the prior year.
Selling, general and administrative (SG&A) expenses in fiscal 1998 were $167.2
million, an increase of $36.7 million, or 28.1%, over SG&A expenses in fiscal
1997 of $130.5 million. As a percentage of sales, SG&A was 15.0% for fiscal
1998, compared to 14.5% for fiscal 1997. On a pro forma basis, including the
Levington and EarthGro acquisitions, SG&A expenses increased 13.1% from fiscal
1997 to fiscal 1998. The increase in SG&A expenses was due to several factors:
the assumption of selling, marketing, research and development and
administrative functions related to acquired businesses;
28
The Scotts Company and Subsidiaries
29
information systems expenses of $1.9 million for Year 2000 compliance and $1.2
million for the enterprise system implementation efforts, as well as an increase
in information systems spending to support the new initiatives and additional
businesses; and a $2.1 million charge for costs to integrate the acquired
Levington business as discussed below.
Amortization of goodwill and other intangibles increased to $12.9 million in
fiscal 1998, compared to $10.2 million in fiscal 1997, as a result of the
Levington and EarthGro acquisitions during the year.
Restructuring and other charges in fiscal 1998 were $20.4 million, $15.4 million
of which is identified separately within operating expenses, $2.9 million of
which is included in cost of sales and $2.1 million of which is included in SG&A
charges. These charges represent primarily the costs to integrate the Company's
U.K. operations, discontinue most of the U.S. composting operations over the
next two years and divest an existing pesticides business. Costs to integrate
the U.K. businesses include charges for closing duplicate facilities,
discontinuing overlapping product lines and providing for severance related to
headcount reductions in sales, administrative and manufacturing functions. Costs
to discontinue most of the composting facilities include the write-off of
certain assets, estimated losses under contractual commitments for which no
future revenues will be realized and certain closing costs. Costs to divest the
pesticides business reflect the estimated loss on its sale. Included in the
$20.4 million restructuring charge are non-cash write-offs of $9.4 million. The
balance of $11.0 million represents cash obligations, of which $1.1 million have
been paid as of September 30, 1998.
Other expenses for fiscal 1998 were $4.0 million, compared to $6.3 million in
fiscal 1997. The decrease was primarily due to a reduction in charges provided
for the disposal of certain assets and an increase in royalty income from
licensing arrangements for certain of the Company's brand names, partially
offset by increased foreign currency losses and legal and environmental
provisions.
Income from operations for fiscal 1998 was $94.1 million, compared to $94.8
million for fiscal 1997. On a pro forma basis, including the Levington and
EarthGro acquisitions, income from operations for fiscal 1998 was $94.6 million,
compared to $102.0 million in fiscal 1997. Excluding the restructuring and other
charges of $20.4 million discussed above, income from operations in fiscal 1998
was $114.5 million, or 10.3% of sales, which was just slightly below income from
operations as a percentage of sales for fiscal 1997 of 10.5%.
Interest expense for fiscal 1998 was $32.2 million, an increase of 27.8% over
fiscal 1997 interest expense of $25.2 million. The increase in interest expense
was due to increased borrowings to fund the Levington, EarthGro and Miracle
Garden acquisitions, partially offset by lower average debt levels excluding the
acquisition borrowings.
Income tax expense was $24.9 million for fiscal 1998, a 17.3% decrease from
income tax expense for fiscal 1997. The Company's effective tax rate decreased
to 40.3% in fiscal 1998 from 43.2% in fiscal 1997 as a result of favorable tax
planning strategies.
In February 1998, the Company secured an interim revolving credit facility to
replace its then existing credit facility. Write-off of deferred financing costs
associated with the then existing credit facility resulted in an extraordinary
loss, net of income taxes, on the early extinguishment of debt of $0.7 million.
The Company reported net income of $36.3 million for fiscal 1998, or $1.20 per
common share on a diluted basis, compared to net income of $39.5 million for
fiscal 1997, or $1.35 per common share on a diluted basis. Excluding the impact
of the restructuring charges and extraordinary loss discussed above, the Company
earned net income of $1.62 per share on a diluted basis, a 20% increase over
fiscal 1997. This increase reflects the impact of strong sales volumes during
fiscal 1998 as discussed above.
FISCAL 1997 COMPARED TO FISCAL 1996
Sales in fiscal 1997 were $899.3 million, an increase of $148.9 million, or
19.8%, over fiscal 1996 sales. On a pro forma basis, assuming the remaining
two-thirds interest in Miracle Garden was acquired at the beginning of fiscal
1996, fiscal 1997 sales would have been $910.7 million, an increase of 13.3%
over fiscal 1996 pro forma sales of $803.4 million. Further adjusting for the
impact on fiscal 1996 sales of the fiscal 1995 Consumer Lawns group's retailer
early purchase program, management estimates consolidated sales would have
increased 6.4% in fiscal 1997.
North American Consumer segment sales totaled $619.2 million, an increase of
$95.1 million, or 18.1%, over fiscal 1996. After adjusting for the estimated
impact of the fiscal 1995 early purchase
29
The Scotts Company and Subsidiaries
30
program on the Consumer Lawns group's fiscal 1996 sales, management estimates
that fiscal 1997 North American Consumer segment sales increased 7.4%. This
reflects strong sales volume gains in the Consumer Gardens (15.5%) and Consumer
Lawns (8.2%) operating groups. The Consumer Growing Media group's sales were up
slightly as this group emphasized increased profitability, not sales growth, in
fiscal 1997.
Professional segment sales increased $5.1 million, or 3.2%, to $165.5 million in
fiscal 1997. Beginning late in fiscal 1996, this segment refocused its strategy
on growth in its core ProTurf(R) and Horticultural product lines, and
significantly curtailed certain initiatives that increased sales in prior years,
but had little net income contribution.
International segment sales increased to $114.6 million in fiscal 1997, up $48.7
million, or 73.9%, over fiscal 1996. Reflecting the Company's international
growth strategy, sales for this segment were 12.7% of consolidated revenues in
fiscal 1997, up from 8.8% in fiscal 1996. Including Miracle Garden on a pro
forma basis, International sales increased 6.0% from $118.9 million in fiscal
1996 to $126.0 million in fiscal 1997. The year-to-year pro forma sales
comparison for the International segment was negatively impacted by
approximately 1% as a result of unfavorable exchange rate movements.
Gross profit increased to 36.2% of sales in fiscal 1997, a 4.5% improvement
compared to 31.7% in fiscal 1996. This improvement is attributable to the
discontinuance of promotional programs that drove out-of-season sales, the
discontinuance of lower margin Professional and Consumer products and
manufacturing and distribution efficiencies.
Advertising and promotion expenses increased by $14.7 million, or 21.2%, to
$83.9 million. As a percentage-of-sales, advertising and promotion expenses
increased to 9.3% from 9.2%. Reflecting the "pull" marketing strategy of the
Lawns and Gardens groups of the North American Consumer segment, U.S. consumer
media advertising increased $5.6 million, or 22.5%, in fiscal 1997. The
inclusion of Miracle Garden ($6.4 million) in fiscal 1997, as well as higher
trade allowances and cooperative advertising, also contributed to the overall
advertising and promotional expense increase in 1997. The Company believes
retailer promotions and cooperative advertising are an integral part of the
consumer lawn and garden care business, but to a lesser extent than practiced in
prior years.
SG&A expenses increased $13.9 million or 11.9% to $130.5 million. As a
percentage-of-sales, SG&A expenses decreased from 15.5% to 14.5%. The overall
increase in this expense category reflects the inclusion of Miracle Garden ($8.0
million), higher selling and general management incentives and profit sharing
expenses, increased emphasis on in-store merchandisers and higher spending on
certain support functions.
Amortization of goodwill and other intangibles increased as a result of the
inclusion of Miracle Garden.
Other expense (income), net for fiscal 1997 included approximately $6.0 million
in charges related to the disposal of and valuation charges related to certain
assets. These charges were partially offset by higher Scotts(R) brand name
licensing royalties. During fiscal 1996, the Company recorded $4.9 million in
severance costs related to workforce reductions and $12.8 million in write-downs
and write-offs for various under-utilized or idle assets, including several
plant closings.
Primarily as a result of higher sales volumes, improved manufacturing and
distribution efficiencies and other cost improvements, income from operations
increased by $68.5 million, or 360.5%, to $96.3 million. Income from operations
increased to 10.5% from 3.5% as a percentage of sales. Excluding asset valuation
charges in both years and severance expense in fiscal 1996, income from
operations was 11.4% in fiscal 1997 compared to 6.1% in fiscal 1996.
Interest expense increased $0.2 million, or 0.8%, in fiscal 1997. Excluding
Miracle Garden related borrowings, interest expense decreased by approximately
$3.8 million, or 14.3%, primarily due to a $69.2 million reduction in average
borrowings for the year. Miracle Garden related interest expense was
approximately $4.0 million, reflecting both acquisition debt and seasonal
working capital requirements, from the January 3, 1997 effective date of the
acquisition transaction.
The Company's effective tax rate was 43.2% in fiscal 1997 compared to 302.3% in
fiscal 1996. The high effective tax rate in fiscal 1996 was attributable to the
low level of reported pre-tax income and non-tax deductible amortization of
goodwill and certain intangibles. Additional information on the effective income
tax rate is described in Note 11 to the Company's Consolidated Financial
Statements.
During fiscal 1997, the Company reported net income of $39.5 million, or $1.35
per common share, compared with a net loss of $2.5 million, or $0.65 per
30
The Scotts Company and Subsidiaries
31
common share, in fiscal 1996. The return to profitability in 1997 was
attributable to a variety of factors, including: the refocused, "pull" directed
marketing strategy of the Consumer Lawns group compared to the retailer early
purchase program that severely discounted this group's leading branded products;
sales volume increases in the Consumer Gardens group; Consumer Growing Media
group and Professional segment strategies that focused on profitable growth and
eliminated sales of marginal products and to unprofitable distribution channels;
improved weather conditions in fiscal 1997 in most key markets; improved
manufacturing and distribution efficiencies, and other cost improvements; and
lower interest expense before the impact of Miracle Garden related borrowings.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $71.0 million, $121.1 million and
$82.3 million in fiscal 1998, 1997 and 1996, respectively. The decrease in cash
provided from operations for fiscal 1998 compared to fiscal 1997 was primarily
due to increased working capital levels in fiscal 1998 to support increased
sales revenues. The fiscal 1997 improvement compared to fiscal 1996 was driven
by higher earnings and improved working capital management. The seasonal nature
of the Company's sales results in a significant increase in working capital
(primarily accounts receivable and inventory) during the first half of the
fiscal year, with the third quarter being a significant cash collection period.
Cash used in investing activities was $192.1 million, $72.5 million and $17.4
million in fiscal 1998, 1997 and 1996, respectively. The increase in cash used
in investing activities in fiscal 1998 was due to the cost of businesses
acquired during the year (or to be acquired in fiscal 1999) and an increase in
capital expenditures of $14.8 million primarily due to costs incurred to upgrade
certain manufacturing facilities to more technologically advanced production
capabilities. The fiscal 1997 increase was partially attributable to the
acquisition of the remaining two-thirds interest in Miracle Garden for
approximately $47.0 million effective January 3, 1997. The largest capital
project during fiscal 1997 was an approximate $9.0 million expansion of the
Company's Marysville distribution facility, estimated to generate annual
distribution expense savings of at least $1.5 million beginning in fiscal 1998.
The Company's new credit facilities (as described below) restrict annual capital
investments to $70.0 million.
Financing activities generated cash of $118.4 million in fiscal 1998 and used
cash of $46.2 million and $61.1 million in fiscal 1997 and 1996, respectively.
Cash generated in fiscal 1998 was generally provided by the Company's credit
facilities in order to provide funds for the acquisitions during the year. The
lower level of debt repayment in fiscal 1997 reflects the usage of higher
operating cash flows to support the additional investment in Miracle Garden and
higher net capital investments.
Total debt as of September 30, 1998 was $372.5 million, an increase of $151.2
million from a year earlier. The increase in debt year to year was primarily due
to borrowings to fund the Levington and EarthGro acquisitions.
Shareholders' equity as of September 30, 1998 was $403.9 million, a $14.7
million increase compared to September 30, 1997. This increase was primarily
attributable to net income of $36.3 million, offset by Convertible Preferred
Stock dividends of $9.8 million and net treasury stock purchases of $14.0
million.
The primary sources of liquidity for the Company are funds generated by
operations and borrowings under the Company's credit facilities. The Company
entered into a credit agreement in February 1998 which provided for an available
line of credit of $550 million, an increase of $125 million from the previous
facility, and allowed up to the equivalent of $200 million of the available
credit to be borrowed in British Pounds Sterling and $50 million of the
available credit to be borrowed in other foreign currencies.
On December 4, 1998, the Company and certain of its subsidiaries entered into
new credit facilities which provide for borrowings in the aggregate principal
amount of $1.025 billion and consist of term loan facilities in the aggregate
amount of $525 million and a revolving credit facility in the amount of $500
million.
The term loan facilities consist of three tranches. The Tranche A Term Loan
Facility consists of a 6 1/2 year term loan facility in an aggregate principal
amount of $265 million, which is divided into three sub-tranches of French
Francs, German Deutschemarks and British Pounds Sterling. The Tranche A Term
Loans are to be repaid quarterly over a 6 1/2 year period. The Tranche B Term
Loan Facility consists of a 7 1/2 year term loan facility in an aggregate
principal amount of $140 million, which is to be repaid in nominal quarterly
installments for the first 6 1/2 years and in substantial quarterly installments
in the final year. The Tranche C
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The Scotts Company and Subsidiaries
32
Term Loan Facility consists of a 8 1/2 year term loan facility in an aggregate
principal amount of $120 million, which is to be repaid in nominal quarterly
installments for the first 7 1/2 years and in substantial quarterly installments
in the final year.
The revolving credit facility consists of loans up to $500 million, which are
available on a revolving basis for a term of 6 1/2 years. A portion of the
revolving credit facility not to exceed $100 million is available for the
issuance of letters of credit. Additionally, a portion of the facility, not to
exceed $30 million, is available for swing line loans on same-day notice. A
portion of the facility, not to exceed $225 million, is available for borrowings
in optional currencies, including German Deutschemarks, British Pounds Sterling,
French Francs, Belgian Francs, Italian Lira and other specified currencies,
provided that the outstanding revolving loans in optional currencies other than
British Pounds Sterling do not exceed $120 million. The outstanding principal
amount of all revolving credit loans may not exceed $150 million for at least 30
consecutive days during any calendar year.
The Company funded the RPJ Acquisition with borrowings under the new credit
facilities. The Company expects to fund the Ortho Acquisition with proceeds from
an anticipated private debt offering to qualified institutional buyers and
certain borrowings under the new credit facilities.
Management estimates that capital expenditures will approximate $60 million in
fiscal 1999, $50 million to $60 million for each of the following three years
and approximately $40 million per year thereafter for the foreseeable future.
Included in these estimates are amounts to be spent on the Company's information
systems initiative in fiscal 1999 and fiscal 2000.
Subject to certain contingencies, including the successful completion of the
Ortho Acquisition, the Board of Directors of the Company has authorized the
repurchase of up to $100 million of the Company's common shares on the open
market or in privately negotiated transactions on or prior to September 30,
2001. As of September 30, 1998, approximately 250,000 common shares (or $8.4
million) had been repurchased under the Company's previously announced stock
repurchase program, all of which will be applied to the new repurchase program
limit. The timing and amount of any purchases under the new repurchase program
will be at the Company's discretion and will depend upon market conditions and
the Company's operating performance and liquidity. Any repurchase will also be
subject to the covenants contained in the Company's new credit facilities as
well as its other debt instruments. The repurchased shares will be held in
treasury and will thereafter be used for the exercise of employee stock options
and for other valid corporate purposes. The Company anticipates that any
repurchases would be made pro rata from the former shareholders of Stern's
Miracle-Gro Products, Inc. (the "Miracle-Gro Shareholders") upon terms no less
favorable to the Company than those obtainable in the public market. The
agreement governing the merger transactions with the Miracle-Gro Shareholders
requires that they reduce their percentage ownership in the Company to no more
than 44% on a fully diluted basis to the extent that repurchases by the Company
would cause such ownership to exceed 44%.
Gains and losses on foreign currency transaction hedges are recognized in income
and offset the foreign exchange gains and losses on the underlying transactions.
Gains and losses on foreign currency firm commitment hedges are deferred and
included in the basis of the transactions underlying the commitments. At
September 30, 1998, there were no outstanding foreign currency transaction
hedges or firm commitment hedges.
In the opinion of the Company's management, cash flows from operations and
capital resources will be sufficient to meet debt service and working capital
needs during fiscal 1999 and thereafter for the foreseeable future. However, the
Company cannot ensure that its business groups will generate sufficient cash
flow from operations, that currently anticipated cost savings and operating
improvements will be realized on schedule or at all, or that future borrowings
will be available under the new 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 the Company's control. The
Company cannot ensure that it will be able to refinance any indebtedness,
including the new credit facilities, on commercially reasonable terms, or at
all.
ENVIRONMENTAL MATTERS
The Company is subject to local, state, federal and foreign environmental
protection laws and regulations with respect to its business operations and
believes it is operating in substantial compliance with, or taking action aimed
at ensuring compliance with, such laws and regulations. The Company is involved
in several
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The Scotts Company and Subsidiaries
33
environmental related legal actions with various governmental agencies. 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 the Company's financial position; however, there can be no
assurance that future quarterly or annual operating results will not be
materially affected by the resolution of these matters. Additional information
on environmental matters affecting the Company is provided in Note 15 to the
Company's Consolidated Financial Statements and in this Annual Report on Form
10-K under "ITEM 1. BUSINESS--Environmental and Regulatory Considerations" and
"ITEM 3. LEGAL PROCEEDINGS."
YEAR 2000 READINESS
General
The Company may be impacted by the inability of its computer software
applications and other business systems (e.g., embedded microchips) to properly
identify the Year 2000 due to a commonly used programming convention of using
only two digits to identify a year. Unless modified or replaced, these systems
could fail or create erroneous results when referencing the Year 2000.
Management is assessing the extent and impact of this issue and is implementing
a readiness program to mitigate the possibility of business interruption or
other risks. The objective of the program is to have all significant business
systems Year 2000 compliant by mid-1999.
The Company has established a Year 2000 Program Office to oversee the readiness
program. The Program Office functions include regular communication with Year
2000 project managers and site visits to the Company's various businesses to
monitor remediation efforts and verify progress toward stated compliance goals.
The Program Office reports to senior management, who in turn reports regularly
to the Board of Directors regarding the Company's progress toward Year 2000
readiness.
Information Technology (IT) Systems
Currently, the mainframe computer operations at the Company's Marysville, Ohio
headquarters support all U. S. business groups with the exception of the Scotts'
Miracle-Gro administrative headquarters in New York and the Republic Tool
(spreaders) manufacturing operation in California. The Company's foreign
operations generally do not electronically interface with the U.S. headquarters.
The headquarters mainframe operations consist primarily of internally developed
systems which are being remediated, while other domestic and international
operations utilize commercial packaged software which, if not Year 2000
compliant, is being upgraded or replaced. Remediation of headquarters
applications, which is the Company's most complex and costly effort, is being
managed and executed by a project team including 15 external consultants working
full-time in conjunction with seven Company associates. The Company maintains
overall project management control while a project manager for the consultants
is responsible for daily administration of the project.
Personal computers are being made Year 2000 compliant by systematic upgrade
through lease renewals. Many other hardware/software upgrades are being executed
under ongoing maintenance and support agreements with vendors. Testing of
upgrades will be performed internally.
In support of the Company's long-range strategic plans, an enterprise-wide
application systems (ERP) project is under way to link all business groups. This
enterprise-wide system will be implemented in stages starting in 1999 and is
expected to be completed in 2000. The primary software provider for the
enterprise-wide system has represented that its software is Year 2000 compliant,
which will be verified as part of testing prior to implementation.
The Company's Year 2000 compliance efforts are being concentrated on the
currently existing systems to ensure there is adequate information systems
support until implementation of the enterprise-wide system is completed.
Non-IT Systems
Non-IT systems, comprised mainly of equipment and machinery operating and
control systems, telecommunication systems, building air management systems,
security and fire control systems, electrical and natural gas systems, are being
assessed by each business group with advice from suppliers of these
systems/services. Upgrades or replacements are being made as necessary.
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The Scotts Company and Subsidiaries
34
Third Party Suppliers
The Company relies on third party suppliers for finished goods, raw materials,
water, other utilities, transportation and a variety of other key services.
Interruption of supplier operation due to Year 2000 issues could affect Company
operations. The Company is evaluating the status of suppliers' efforts through
confirmation and follow-up procedures to determine contingency planning where
necessary.
Recent Acquisitions
The Company has recently completed the RPJ Acquisition and has entered into an
agreement with Monsanto under which it agreed to become the exclusive consumer
marketing agent for Monsanto's Roundup(R) herbicide products. Due diligence
reviews of the Year 2000 readiness status for each of these businesses have been
completed. The RPJ Acquisition has both IT and non-IT Year 2000 considerations.
The Roundup Marketing Agreement does not involve the acquisition of assets;
however, additional efforts are necessary to confirm Year 2000 readiness by the
Company's business partners. Representations have been provided in the
definitive agreement signed in conjunction with the Ortho Acquisition that the
Ortho business is Year 2000 compliant in all material respects. The Company is
in the process of compiling Year 2000 reporting from these operations and will
include site visits as part of the verification efforts. Due to the timing of
these transactions, the Company's current estimates of costs and completion
dates do not include these businesses.
State of Readiness
Each business group has substantially completed an internal inventory which is
designed to identify IT and non-IT systems that are susceptible to system
failure or processing errors as a result of Year 2000 issues.
The headquarters mainframe remediation project is more than half complete and is
scheduled for completion (including testing) in mid-1999. Plans are in place for
the upgrade or replacement and testing of IT systems at other U. S. operations
by mid-1999. Non-IT efforts are being performed concurrently and replacement and
testing is expected to be completed by mid-1999. Site visits are being planned
by the Program Office to verify progress against plans.
Year 2000 readiness plans are being executed within the International segment.
Upgrades of packaged software for the primary systems will be completed by early
1999. Completion of all IT and non-IT upgrades and testing is scheduled for
mid-1999. Site visits are being planned by the Program Office to verify progress
against plans.
A confirmation process with respect to third party suppliers is in progress.
Plans are being formulated for site visits and other testing with critical
suppliers to determine if alternative sources are needed.
Due diligence efforts to date for pending acquisitions have revealed that plans
exist by the seller to timely address material Year 2000 issues.
Costs
The Company has been tracking incremental Year 2000 costs which excludes the
costs of internally dedicated resources. The current estimate of incremental
costs for the Year 2000 efforts (excluding those related to the RPJ Acquisition,
the Roundup Marketing Agreement, other pending acquisitions and the ERP project)
is approximately $5.2 million. Of this amount, $1.9 million has been incurred to
date. These costs, with the exception of relatively small capital expenditures,
are being expensed as incurred and are being funded through operating cash
flows. A summary of the cost components follows ($ in millions):
Fiscal Fiscal
LOCATION 1998 1999 TOTAL
.
(actual) (estimate)
Headquarters mainframe $1.5 $1.5 $3.0
Other U. S. operations and
Program Office 0.1 1.1 1.2
International operations 0.3 0.7 1.0
------------------------
Total $1.9 $3.3 $5.2
------------------------
------------------------
..........................
The above costs do not include costs of Year 2000 efforts for acquisitions not
deemed material. The costs of the headquarters mainframe work represents 15% and
20% of 1998 actual and 1999 budgeted IT expenditures excluding ERP,
respectively. The Company believes that Year 2000 costs have not had and will
not have a material impact on the Company's results of operations, financial
condition or cash flows.
Risks
The principal business risks to the Company relating to completion of Year 2000
efforts are:
- Reliance on key business partners to not have disruption in the ability to
provide goods and services as a result of Year 2000 issues.
- The ability to recruit and/or retain key staff for the Year 2000 effort.
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The Scotts Company and Subsidiaries
35
- Unforeseen issues arising in connection with recent and future
acquisitions/business partnerships.
- The ability to continue to focus on Year 2000 issues by internal and
external resources.
Because the Company's Year 2000 readiness is dependent upon key business
partners also being Year 2000 ready, there can be no guarantee that the
Company's efforts will prevent a material adverse impact on its results of
operations, financial condition and cash flows. The possible consequences to the
Company of its key business partners' inability to provide goods and services as
a result of Year 2000 issues include temporary plant closings; delays in
delivery of finished products; delays in receipt of key ingredients, containers
and packaging supplies; invoice and collection errors; and inventory and supply
obsolescence. The Company believes that its readiness efforts, which include
confirmation, site visits and other testing with critical suppliers to determine
if contingency planning is needed, should reduce the likelihood of such
disruptions.
Contingency Plans
A formal contingency plan has not yet been developed. The Company will continue
to assess where alternative courses of action are needed as the IT and non-IT
readiness plans are executed. The drive for formal contingency planning will be
in the second quarter of 1999, once a significant amount of the business groups'
readiness plans have been completed.
Ongoing Process
The Company's readiness program is an ongoing process and the estimates of costs
and completion dates for various components of the program described above are
subject to change.
ENTERPRISE RESOURCE PLANNING ("ERP")
In July 1998, the Company announced a project designed to bring its information
system resources in line with the Company's current strategic objectives. The
project will include the redesign of certain key business processes in
connection with the installation of new software on a world-wide basis over the
course of the next two fiscal years. The Company estimates that the project will
cost $50.0 million, approximately 75% of which will be capitalized over a period
of four to eight years. SAP has been selected as the primary software provider
for this project.
EURO
Beginning in January 1999, a new currency called the "euro" is scheduled to be
introduced in certain Economic and Monetary Union ("EMU") countries. During
2002, all EMU countries are expected to be operating with the euro as their
single currency. Uncertainty exists as to the effects the euro currency will
have on the marketplace. Additionally, the European Commission has not yet
defined and formalized all of the final rules and regulations. The Company is
still assessing the impact the EMU formation and euro implementation will have
on its internal systems and the sale of its products. The Company expects to
take appropriate actions based on the results of such assessment. The Company
has not yet determined the cost related to addressing this issue and there can
be no assurance that this issue and its related costs will not have a materially
adverse effect on the Company's business, operating results and financial
condition.
MANAGEMENT'S OUTLOOK
Fiscal 1998 was a very strong year for the Company as it reported record sales
of $1.1 billion and achieved market share growth in every one of its major U. S.
categories. The year's performance reflected the successful continuation of its
primary growth drivers: to emphasize consumer-oriented marketing efforts to pull
demand through its distribution channels, and to make strategic acquisitions to
increase market share in global markets and within segments of the lawn and
garden category. Restructuring charges taken in fiscal 1998 reflect the costs to
integrate recent acquisitions and to exit businesses that are not strategically
aligned with the Company's core businesses. Going forward, these actions should
allow the Company to fully realize the operational synergies created by the
acquisitions and to focus resources in businesses that provide opportunities for
growth.
Looking forward, the Company maintains the following broad tenets to its
strategic plan:
(1) Promote and capitalize on the strengths of the Scotts(R), Miracle-Gro(R)
and Hyponex(R) industry-leading brands, as well as those brands acquired
and to be acquired in conjunction with the RPJ Acquisition and Ortho
Acquisition, respectively. This involves a commitment to investors and
retail partners that the Company will support these brands through
advertising and promotion unequaled in the lawn and garden consumables
market. In the Professional categories, it signifies a commitment to
customers to provide
35
The Scotts Company and Subsidiaries
36
value as an integral element in their long-term success;
(2) Commit to continuously study and improve knowledge of the market, the
consumer and the competition;
(3) Simplify product lines and business processes, to focus on those that
deliver value, evaluate marginal ones and eliminate those that lack future
prospects; and
(4) Achieve world leadership in operations, leveraging technology and know-how
to deliver outstanding customer service and quality.
Within the Company's four-year strategic plan, management has established
challenging, but realistic, financial goals, including:
(1) Sales growth of 6% to 8% in core businesses;
(2) An aggregate operating margin improvement of at least 2% over the next
four years; and
(3) Minimum compounded annual EPS growth of 15%.
FORWARD-LOOKING STATEMENTS
The Company has made and will make certain forward-looking statements in its
Annual Report, Form 10-K and in other contexts relating to future growth and
profitability targets and strategies designed to increase total shareholder
value. The Private Securities Litigation Reform Act of 1995 (the "Act") provides
a "safe harbor" for forward-looking statements to encourage companies to provide
prospective information, so long as those statements are identified as
forward-looking and are accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those discussed in the forward-looking statements. The Company
desires to take advantage of the "safe harbor" provisions of the Act.
These forward-looking statements represent challenging goals for the Company,
and the achievement thereof is subject to a variety of risks and assumptions and
numerous factors beyond the Company's control. These forward-looking statements
include, but are not limited to, information regarding the future economic
performance and financial condition of the Company, the plans and objectives of
the Company's management and the Company's assumptions regarding such
performance and plans. Therefore, it is possible that the Company's future
actual financial results may differ materially from those expressed in these
forward-looking statements due to a variety of factors, including, but not
limited to, the following:
- Effect of Weather Conditions -- Adverse weather conditions could adversely
impact financial results. Weather conditions in North America and Europe
have a significant impact on the timing of sales in the Spring selling
season and overall annual sales. Periods of wet weather can slow fertilizer
sales, while periods of dry, hot weather can decrease pesticide sales. In
particular, an abnormally cold Spring throughout the United States could
adversely affect the Company's financial results;
- Effect of Seasonality -- Historical seasonality could impair the Company's
ability to make interest payments on indebtedness. Because the Company's
products are used primarily in the Spring and Summer, the business is highly
seasonal. For the past two fiscal years, approximately 72% of sales have
occurred in the second and third fiscal quarters combined. Working capital
needs, and correspondingly borrowings, peak at the end of the first fiscal
quarter during which the Company generates fewer revenues while incurring
expenditures in preparation for the Spring selling season. If the Company is
unable to draw on the new credit facilities when an interest payment is due
on the other indebtedness, this seasonality could adversely affect the
Company's ability to make interest payments as required by other
indebtedness. Adverse weather conditions could heighten this risk;
- Continued marketplace acceptance of the Company's North American Consumer
groups' "pull" advertising marketing strategies -- Acceptance is
particularly important in the Consumer Lawns group which refocused its
general marketing strategy beginning in fiscal 1996;
- The ability to maintain profit margins on its products, to produce its
products on a timely basis and to maintain and develop additional production
capacity as necessary to meet demand;
- Competition among lawn and garden care product producers supplying the
consumer and professional markets, both in North America and Europe;
- Competition between and the recent consolidation within the retail outlets
selling lawn and garden care products produced by the Company;
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The Scotts Company and Subsidiaries
37
- Public perceptions regarding the safety of the products produced and
marketed by the Company;
- Risks Associated with International Operations -- The Company's significant
international operations make it more susceptible to fluctuations in
currency exchange rates and to the costs of international regulation. The
Company currently operates manufacturing, sales and service facilities
outside of North America and particularly in the United Kingdom, Germany and
France. International operations have increased with the acquisitions of
Levington, Miracle Garden and RPJ and will increase further through the
Roundup Marketing Agreement and the Ortho Acquisition. In fiscal 1998,
international sales accounted for approximately 18% of total sales.
Therefore, the Company is subject to risks associated with operations in
foreign countries, including fluctuations in currency exchange rates, the
imposition of limitations on conversion of foreign currencies into dollars
or remittance of dividends and other payments by foreign subsidiaries. Many
foreign countries have tended to suffer from inflation more than the United
States. In addition, by operating in a large number of countries, the
Company incurs additional costs of compliance with local regulations. The
Company has attempted to hedge some currency exchange rate risks, including
by borrowing in local currencies, but such hedges do not eliminate the risk
completely. The costs related to international operations could adversely
affect operations and financial results in the future;
- Effect of New European Currency -- The implementation of the euro currency
in certain European countries in 2002 could adversely impact the Company.
Beginning in January 1999, a new currency called the "euro" is scheduled to
be introduced in certain Economic and Monetary Union ("EMU") countries.
During 2002, all EMU countries are expected to be operating with the euro as
their single currency. Uncertainty exists as to the effects the euro
currency will have on the marketplace. Additionally, all of the final rules
and regulations have not yet been defined and finalized by the European
Commission with regard to the euro currency. The Company is still assessing
the impact the EMU formation and euro implementation will have on internal
systems and the sale of its products. The Company expects to take
appropriate actions based on the results of such assessment. However, the
Company has not yet determined the cost related to addressing this issue and
there can be no assurance that this issue and its related costs will not
have a materially adverse effect on the Company's business, operating
results and financial condition;
- Changes in economic conditions in the United States and the impact of
changes in interest rates;
- Addressing Year 2000 Issues -- The failure of the Company, or the failure of
third party suppliers or retailer customers, to address information
technology issues related to the Year 2000 could adversely affect
operations. Like other business entities, the Company must address the
ability of its computer software applications and other business systems
(e.g., embedded microchips) to properly identify the Year 2000 due to a
commonly used programming convention of using only two digits to identify a
year. Unless modified or replaced, these systems could fail or create
erroneous results when referencing the Year 2000. While the Company is
assessing the relevant issues related to the Year 2000 problem and has
implemented a readiness program to mitigate the possibility of business
interruption or other risks, the Company cannot be sure that it will have
adequately addressed the issue, particularly with respect to recent and
pending acquisitions. Moreover, the Company relies on third party suppliers
for finished goods, raw materials, water, other utilities, transportation
and a variety of other key services. If one or more of these suppliers fail
to address the Year 2000 problem adequately, such suppliers' operations
could be interrupted. Such interruption, in turn, could adversely affect the
Company's operations. In addition, the failure of retailer customers
adequately to address the Year 2000 problem could adversely affect financial
results;
- The ability to improve processes and business practices to keep pace with
the economic, competitive and technological environment, including
successful completion of the ERP project;
- Environmental Regulation -- Compliance with environmental and other public
health regulations could result in the expenditure of significant capital
resources. Local, state, federal and foreign laws and regulations relating
to environmental matters affect the Company in several ways. All products
containing pesticides must be registered with the U.S. Environmental
Protection Agency (and in many cases, similar state and/or foreign agencies)
before they can be sold. The inability to obtain or the cancellation of any
such registration could have an
37
The Scotts Company and Subsidiaries
38
adverse effect on the Company. The severity of the effect would depend on
which products were involved, whether another product could be substituted
and whether competitors were similarly affected. The Company attempts to
anticipate regulatory developments and maintain registrations of, and access
to, substitute chemicals, but may not always be able to avoid or minimize
these risks. Regulations regarding the use of certain pesticide and
fertilizer products may include requirements that only certified or
professional users apply the product or that certain products be used only
on certain types of locations (such as "not for use on sod farms or golf
courses"), may require users to post notices on properties to which products
have been or will be applied, may require notification of individuals in the
vicinity that products will be applied in the future or may ban the use of
certain ingredients. In addition, with the RPJ Acquisition and assuming the
Ortho Acquisition is consummated, the Company has acquired or will acquire
many new pesticide product lines that are subject to additional regulations.
Even if the Company is able to comply with all such regulations and obtain
all necessary registrations, the Company cannot assure that its products,
particularly pesticide products, will not cause injury to the environment or
to people under all circumstances. The costs of compliance, remediation or
products liability have adversely affected operating results in the past and
could materially affect future quarterly or annual operating results;
- Control by Significant Shareholders -- The interests of the Miracle-Gro
Shareholders could conflict with those of the other shareholders or
noteholders. The Miracle-Gro Shareholders (through the Hagedorn Partnership,
L.P.) beneficially own approximately 42% of the outstanding common shares of
the Company on a fully diluted basis. While the agreement governing the
merger transactions with the Miracle-Gro Shareholders places certain voting
restrictions on the Miracle-Gro Shareholders through May 19, 2000, the
Miracle-Gro Shareholders have the right to designate three members of the
Company's Board of Directors and have the ability to veto significant
corporate actions by the Company. In addition, after May 19, 2000, the
Miracle-Gro Shareholders will be able to vote their shares without
restriction and will be able to significantly control the election of
directors and the approval of other actions requiring the approval of the
Company's shareholders. The interests of the Miracle-Gro Shareholders could
conflict with those of the Company's other shareholders;
- Substantial Leverage -- The Company has substantial indebtedness which could
adversely affect the financial health of the Company and prevent the Company
from fulfilling its obligations under certain indebtedness. Substantial
indebtedness could have important consequences to shareholders. For example,
it could:
- make it more difficult to satisfy obligations with respect to such
indebtedness;
- increase vulnerability to general adverse economic and industry
conditions;
- limit the ability to fund future working capital, capital expenditures,
research and development costs and other general corporate requirements;
- require the Company to dedicate a substantial portion of cash flow from
operations to payments on indebtedness, thereby reducing the availability
of cash flow to fund working capital, capital expenditures, research and
development efforts and other general corporate requirements;
- limit flexibility in planning for, or reacting to, changes in the
Company's business and the industry in which it operates;
- place the Company at a competitive disadvantage compared to competitors
that have less debt; and
- limit, along with the financial and other restrictive covenants in the
Company's indebtedness, among other things, the ability to borrow
additional funds. And, failing to comply with those covenants could
result in an event of default which, if not cured or waived, could have a
material adverse effect on the Company;
- Ability to Service Debt -- To service indebtedness, the Company will require
a significant amount of cash. The Company's ability to generate cash depends
on many factors beyond its control. The ability to make payments on and to
refinance indebtedness and to fund planned capital expenditures and research
and development efforts will depend on the ability to generate cash in the
future. This, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond the Company's control. Based on the current level
38
The Scotts Company and Subsidiaries
39
of operations and anticipated cost savings and operating improvements, the
Company believes its cash flow from operations, available cash and available
borrowings under the new credit facility will be adequate to meet its future
liquidity needs for at least the next few years. The Company cannot assure,
however, that its business will generate sufficient cash flow from
operations, that currently anticipated cost savings and operating
improvements will be realized on schedule or at all or that future
borrowings will be available under the new credit facility in amounts
sufficient to enable us to pay our indebtedness, or to fund other liquidity
needs. The Company may need to refinance all or a portion of its
indebtedness, on or before maturity. The Company cannot ensure that it will
be able to refinance any of its indebtedness, on commercially reasonable
terms or at all;
- Integration Issues -- Inability to integrate the acquisitions made could
prevent the Company from maximizing synergies and could adversely affect
financial results. The Company has made several substantial acquisitions in
the past four years. The Ortho Acquisition will represent the largest. The
success of any completed acquisition depends, and the success of the Ortho
Acquisition will depend, on the ability to integrate effectively the
acquired business. The Company believes that the RPJ Acquisition provides
and the Ortho Acquisition will provide significant cost saving
opportunities. However, if the Company is not able to successfully integrate
Ortho, RPJ or other acquired businesses, the Company will not be able to
maximize such cost saving opportunities. Rather, the failure to integrate
such acquired businesses, because of difficulties in the assimilation of
operations and products, the diversion of management's attention from other
business concerns, the loss of key employees or other factors, could
materially adversely affect financial results;
- Customer Concentration -- Because of the concentration of sales to a small
number of retail customers, the loss of one or more of the Company's top 10
customers could adversely affect financial results. The Company's top 10
customers together accounted for approximately 50% of 1998 fiscal year sales
and 27% of outstanding accounts receivable as of September 30, 1998. The top
two customers, The Home Depot and Wal*Mart, represented approximately 17%
and 10%, respectively, of 1998 fiscal year sales and approximately 12% and
2%, respectively, of outstanding accounts receivable at September 30, 1998.
The loss of, or reduction in orders from, The Home Depot, Wal*Mart or any
other significant customer could have a material adverse effect on the
Company and its financial results, as could customer disputes regarding
shipments, fees, merchandise condition or related matters with, or the
inability to collect accounts receivable from, any of such customers;
- Termination of Roundup Marketing Agreement -- Monsanto has the right to
terminate the Roundup Marketing Agreement, either as a whole or within a
particular region, for certain events of default. If Monsanto terminates the
Roundup Marketing Agreement without having to pay a termination fee, the
Company would lose a substantial source of future earnings;
- Post-Patent Sales of Roundup(R) in the United States -- Glyphosate, the
active ingredient in Roundup(R), is subject to a patent in the United States
that expires in September 2000. The Company cannot predict the success of
Roundup(R) after glyphosate ceases to be patented. Substantial new
competition in the United States could adversely affect the Company.
Glyphosate is no longer subject to patent in the European Union and is not
subject to patent in Canada. While sales of Roundup(R) in such countries
have continued to increase despite the lack of patent protection, sales in
the United States may decline as a result of increased competition after the
U.S. patent expires.
ITEM 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISE
As part of its ongoing business, the Company is exposed to certain market risks,
including fluctuations in interest rates, foreign currency exchange rates,
commodity prices and its common share price. The Company uses derivative
financial and other instruments, where appropriate, to manage these risks. The
Company does not enter into transactions designed to mitigate its market risks
for trading or speculative purposes.
INTEREST RATE RISK
The Company has various debt instruments outstanding at September 30, 1998 and
anticipates issuing new debt instruments in fiscal 1999 as well. Accordingly,
the Company is impacted by changes in interest rates. As a means of managing its
interest rate risk on existing debt instruments, the Company has entered
39
The Scotts Company and Subsidiaries
40
into an interest rate swap agreement to effectively convert certain variable
rate debt obligations denominated in British Pounds Sterling to a fixed rate.
The exchange rate used to convert British Pounds Sterling to U.S. dollars at
September 30, 1998 was $1.6989:1 LBP. In order to manage its interest rate risk
on an anticipated fixed-rate debt issuance, the Company has entered into two
interest rate locks.
The following table summarizes information about the Company's derivative
financial instruments and debt instruments that are sensitive to changes in
interest rates as of September 30, 1998. For debt instruments, the table
presents principal cash flows and related weighted-average interest rates by
expected maturity dates. For interest rate swaps and locks, the table presents
expected cash flows based on notional amounts and weighted-average interest
rates by contractual maturity dates. Weighted-average variable rates are based
on implied forward rates in the yield curve at September 30, 1998. The
information is presented in U.S. dollars (in millions):
Expected maturity date
--------------------------------------------------------------------------------
FAIR
1999 2000 2001 2002 2003 THEREAFTER TOTAL VALUE
------ ------ ------ ------ ------ ---------- ------ ------
Long-term debt:
Fixed rate debt.......................... $100.0 $100.0 $106.8
Average rate........................... 9.88% 9.88%
Variable rate debt....................... $253.5 $253.5 $253.5
Average rate........................... 6.33%
Interest rate derivatives:
Interest rate swap....................... $ 0.3 $ 0.4 $ 0.4 $ 0.2 $ (1.5)
Average rate........................... 7.62% 7.62% 7.62% 7.62%
Interest rate lock....................... $ 16.7 $(16.7)
Average rate........................... 5.44%
On December 4, 1998, the Company entered into new credit facilities and
terminated its then existing credit facility. See additional discussion of the
Company's new credit facilities in "Liquidity and Capital Resources" in "ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS".
EQUITY PRICE RISK
In May 1998, the Company sold 0.3 million put options which give the holder the
option to sell one of the Company's common shares at a specified price for each
option held. The put options have a strike price of $35.32 per share and expire
in May 1999. The put options can only be exercised on their date of expiration.
At September 30, 1998, the buy-out value of these put options was $1.4 million
as estimated using an option pricing model.
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
The financial statements and other information required by this Item are
contained in the financial statements, footnotes thereto and schedules listed in
the Index to Consolidated Financial Statements and Financial Statement Schedules
on page F-1 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
40
The Scotts Company and Subsidiaries
41
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
In accordance with General Instruction G(3), the information contained under the
captions "BENEFICIAL OWNERSHIP OF SECURITIES OF THE COMPANY -- Voting
Restrictions on the Miracle-Gro Shareholders", and " -- Section 16(a) Beneficial
Ownership Reporting Compliance" and "ELECTION OF DIRECTORS" in the Registrant's
definitive Proxy Statement for the 1999 Annual Meeting of Shareholders to be
held on February 23, 1999 to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A promulgated under the Securities Exchange
Act of 1934 (the "Proxy Statement"), is incorporated herein by reference. The
information regarding executive officers required by Item 401 of Regulation S-K
is included in Part I hereof under the caption "Executive Officers of
Registrant."
ITEM 11. EXECUTIVE COMPENSATION
In accordance with General Instruction G(3), the information contained under the
captions "EXECUTIVE COMPENSATION" and "ELECTION OF DIRECTORS -- Compensation of
Directors" in the Registrant's Proxy Statement, is incorporated herein by
reference. Neither the report of the Compensation and Organization Committee of
the Registrant's Board of Directors on executive compensation nor the
performance graph included in the Registrant's Proxy Statement shall be deemed
to be incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
In accordance with General Instruction G(3), the information contained under the
caption "BENEFICIAL OWNERSHIP OF SECURITIES OF THE COMPANY" in the Registrant's
Proxy Statement, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In accordance with General Instruction G(3), the information contained under the
captions "BENEFICIAL OWNERSHIP OF SECURITIES OF THE COMPANY" and "EXECUTIVE
COMPENSATION -- Certain Relationships and Related Transactions" in the
Registrant's Proxy Statement, is incorporated herein by reference.
41
The Scotts Company and Subsidiaries
42
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
1 and 2. Financial Statements and Financial Statement Schedules:
The response to this portion of Item 14 is submitted as a separate section of
this Annual Report on Form 10-K. Reference is made to "Index to Consolidated
Financial Statements and Financial Statement Schedules" beginning at Page F-1.
3. Exhibits:
Exhibits filed with this Annual Report on Form 10-K are attached hereto. For a
list of such exhibits, see "Index to Exhibits" beginning at page E-1. The
following table provides certain information concerning executive compensation
plans and arrangements required to be filed as exhibits to this Annual Report on
Form 10-K.
EXECUTIVE COMPENSATORY PLANS AND ARRANGEMENTS
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10(a) The Scotts Company Associates' Pension Plan Incorporated herein by reference to the
as amended effective January 1, 1989 and Registrant's Annual Report on Form 10-K
December 31, 1995 (the "Pension Plan") for the fiscal year ended September 30,
1996 (File No. 1-11593) [Exhibit 10(a)]
10(b) First Amendment to the Pension Plan Incorporated herein by reference to the
Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30,
1997 (File No. 1-11593) [Exhibit 10(b)]
10(c) The Scotts Company Retirement Savings Plan *
10(d) First Amendment to The Scotts Company *
Retirement Savings Plan
10(e) Second Amendment to The Scotts Company *
Retirement Savings Plan
10(f) The O.M. Scott & Sons Company Excess Benefit Incorporated herein by reference to the
Plan, effective October 1, 1993 Annual Report on Form 10-K for the
fiscal year ended September 30, 1993, of
The Scotts Company, a Delaware
corporation which was predecessor to the
Registrant ("Scotts Delaware") (File No.
0-19768) [Exhibit 10(h)]
10(g) The Scotts Company 1992 Long Term Incentive Incorporated herein by reference to
Plan Scotts Delaware's Registration Statement
on Form S-8 filed on March 26, 1993
(Registration No. 33-60056) [Exhibit
4(f)]
10(h) The Scotts Company 1998 Executive Annual *
Incentive Plan
10(i) The Scotts Company 1996 Stock Option Plan (as *
amended through September 1, 1998)
10(j) The Scotts Company Executive Retirement Plan *
10(k) Employment Agreement, dated as of May 19, Incorporated herein by reference to the
1995, between the Registrant and James Registrant's Annual Report on Form 10-K
Hagedorn for the fiscal year ended September 30,
1995 (File No. 1-11593) [Exhibit 10(p)]
42
The Scotts Company and Subsidiaries
43
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10(l) Consulting Agreement, dated July 9, 1997, Incorporated herein by reference to the
among Scotts' Miracle-Gro Products, Inc., the Registrant's Annual Report on Form 10-K
Registrant and Horace Hagedorn for the fiscal year ended September 30,
1997 (File No. 1-11593)[Exhibit 10(1)]
10(m) Employment Agreement, dated as of May 19, Incorporated herein by reference to the
1995, among Stern's Miracle-Gro Products, Registrant's Annual Report on Form 10-K
Inc. (nka Scotts' Miracle-Gro Products, for the fiscal year ended September 30,
Inc.), the Registrant and John Kenlon 1996 (File No. 1-11593) [Exhibit 10(k)]
10(n) Employment Agreement, dated as of August 7, *
1998, between the Registrant and Charles M.
Berger, with three attached Stock Option
Agreements with the following effective
dates: September 23, 1998; October 21, 1998
and September 24, 1999
10(o) Stock Option Agreement, dated as of August 7, Incorporated herein by reference to the
1996, between the Registrant and Charles M. Registrant's Annual Report on Form 10-K
Berger for the fiscal year ended September 30,
1996 (File No. 1-11593) [Exhibit 10(m)]
10(p) Letter Agreement, dated December 23, 1996, Incorporated herein by reference to the
between the Registrant and Jean H. Mordo Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30,
1997 (File No. 1-11593) [Exhibit 10(p)]
10(q) Specimen form of Stock Option Agreement for *
Non-Qualified Stock Options
10(r) Letter Agreement, dated April 10, 1997, Incorporated herein by reference to the
between the Registrant and G. Robert Lucas Registrant's Annual Report on Form 10-K
for the fiscal year ended September 30,
1997 (File No. 1-11593) [Exhibit 10(r)]
10(s) Letter Agreement, dated December 17, 1997, *
between the Registrant and William R. Radon
10(t) Letter Agreement, dated March 30, 1998, *
between the Registrant and William A. Dittman
- ---------------
* Filed herewith.
(b) REPORTS ON FORM 8-K
The Registrant filed no Current Reports on Form 8-K for the last quarter of the
period covered by this Report.
(c) EXHIBITS
See Item 14(a)(3) above.
(d) FINANCIAL STATEMENT SCHEDULES
The response to this portion of Item 14 is submitted as a separate section of
this Annual Report on Form 10-K. See Item 14(a)(2) above.
43
The Scotts Company and Subsidiaries
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
Dated: December 21, 1998
By: /s/ CHARLES M. BERGER
---------------------------------------
Charles M. Berger, Chairman of the
Board,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons in the capacities and on the
dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ JAMES B BEARD, PH.D. Director December 21, 1998
- ------------------------------------------------
James B Beard, Ph.D.
/s/ CHARLES M. BERGER Chairman of the Board/President/Chief December 21, 1998
- ------------------------------------------------ Executive Officer
Charles M. Berger
/s/ JOSEPH P. FLANNERY Director December 21, 1998
- ------------------------------------------------
Joseph P. Flannery
/s/ HORACE HAGEDORN Vice Chairman/Director December 21, 1998
- ------------------------------------------------
Horace Hagedorn
/s/ JAMES HAGEDORN Executive Vice President/Director December 21, 1998
- ------------------------------------------------
James Hagedorn
/s/ ALBERT E. HARRIS Director December 21, 1998
- ------------------------------------------------
Albert E. Harris
/s/ JOHN KENLON Director December 21, 1998
- ------------------------------------------------
John Kenlon
/s/ KAREN GORDON MILLS Director December 21, 1998
- ------------------------------------------------
Karen Gordon Mills
/s/ JEAN H. MORDO Executive Vice President/Chief December 21, 1998
- ------------------------------------------------ Financial Officer/Principal
Jean H. Mordo Accounting Officer
/s/ PATRICK J. NORTON Director December 21, 1998
- ------------------------------------------------
Patrick J. Norton
/s/ JOHN M. SULLIVAN Director December 21, 1998
- ------------------------------------------------
John M. Sullivan
/s/ L. JACK VAN FOSSEN Director December 21, 1998
- ------------------------------------------------
L. Jack Van Fossen
/s/ JOHN WALKER, PH.D. Director December 21, 1998
- ------------------------------------------------
John Walker, Ph.D.
44
The Scotts Company and Subsidiaries
45
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
FORM 10-K
ANNUAL REPORT
-------------
Consolidated Financial Statements of The Scotts Company and
Subsidiaries:
Report of Management........................................ F-2
Report of Independent Accountants........................... F-2
Consolidated Statements of Operations for the years ended
September 30, 1998, 1997 and 1996......................... F-3
Consolidated Statements of Cash Flows for the years ended
September 30, 1998, 1997 and 1996......................... F-4
Consolidated Balance Sheets at September 30, 1998 and
1997...................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity
for the years ended September 30, 1998, 1997 and 1996..... F-6
Notes to Consolidated Financial Statements.................. F-7 to F-20
Schedules Supporting the Consolidated Financial Statements:
Report of Independent Accountants on Financial Statement
Schedules................................................. F-21
Valuation and Qualifying Accounts for the years ended
September 30, 1998, 1997 and 1996......................... F-22
Schedules other than those listed above are omitted since they are not required
or are not applicable, or the required information is shown in the Consolidated
Financial Statements or Notes thereto.
F-1
The Scotts Company and Subsidiaries
46
REPORT OF MANAGEMENT
Management of The Scotts Company is responsible for the preparation, integrity
and objectivity of the financial information presented in this Form 10-K. The
accompanying financial statements have been prepared in conformity with
generally accepted accounting principles appropriate in the circumstances and,
accordingly, include some amounts that are based on management's best judgments
and estimates.
Management is responsible for maintaining a system of accounting and internal
controls which it believes are adequate to provide reasonable assurance that
assets are safeguarded against loss from unauthorized use or disposition and
that the financial records are reliable for preparing financial statements. The
selection and training of qualified personnel, the establishment and
communication of accounting and administrative policies and procedures, and a
program of internal audits are important objectives of these control systems.
The financial statements have been audited by PricewaterhouseCoopers LLP,
independent accountants, selected by the Board of Directors. The independent
accountants conduct a review of internal accounting controls to the extent
required by generally accepted auditing standards and perform such tests and
related procedures as they deem necessary to arrive at an opinion on the
fairness of the financial statements in accordance with generally accepted
accounting principles.
The Board of Directors, through its Audit Committee consisting solely of
non-management directors, meets periodically with management, internal audit
personnel and the independent accountants to discuss internal accounting
controls and auditing and financial reporting matters. The Audit Committee
reviews with the independent accountants the scope and results of the audit
effort. Both internal audit personnel and the independent accountants have
access to the Audit Committee with or without the presence of management.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
The Scotts Company
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and changes in shareholders'
equity present fairly, in all material respects, the financial position of The
Scotts Company and Subsidiaries at September 30, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended September 30, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Columbus, Ohio
October 23, 1998
Except for Note 20
as to which the date is December 15, 1998.
F-2
The Scotts Company and Subsidiaries
47
...............................................................................
F-3
The Scotts Company and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
For the fiscal years ended September 30, 1998, 1997 and 1996 (in millions except per share amounts) 1998 1997
..........................................................................................................................
Sales $1,113.0 $899.3
Cost of sales 715.0 573.6
--------------------
Gross profit 398.0 325.7
Advertising and promotion 104.4 83.9
Selling, general and administrative 167.2 130.5
Amortization of goodwill and other intangibles 12.9 10.2
Restructuring and other charges 15.4 --
Other expense (income), net 4.0 6.3
--------------------
Income from operations 94.1 94.8
Interest expense 32.2 25.2
--------------------
Income before income taxes 61.9 69.6
Income taxes 24.9 30.1
--------------------
Income (loss) before extraordinary item 37.0 39.5
Extraordinary loss on early extinguishment of debt, net of income tax benefit 0.7 --
--------------------
Net income (loss) 36.3 39.5
Preferred stock dividends 9.8 9.8
--------------------
Income (loss) applicable to common shareholders $ 26.5 $ 29.7
Basic earnings (loss) per share:
Before extraordinary loss $ 1.46 $ 1.60
Extraordinary loss, net of tax (0.04) --
--------------------
$ 1.42 $ 1.60
Diluted earnings (loss) per share:
Before extraordinary loss $ 1.22 $ 1.35
Extraordinary loss, net of tax (0.02) --
--------------------
$ 1.20 $ 1.35
Common shares used in basic earnings (loss) per share calculation 18.7 18.6
Common shares and potential common shares used in diluted earnings (loss) per share calculation 30.3 29.3
For the fiscal years ended September 30, 1998, 1997 and 1996 (in millions except per share amounts) 1996
..................................................................................................
Sales $750.4
Cost of sales 512.4
-----------
Gross profit 238.0
Advertising and promotion 69.2
Selling, general and administrative 116.6
Amortization of goodwill and other intangibles 8.8
Restructuring and other charges 17.7
Other expense (income), net (0.6)
--------------------
Income from operations 26.3
Interest expense 25.0
--------------------
Income before income taxes 1.3
Income taxes 3.8
--------------------
Income (loss) before extraordinary item (2.5)
Extraordinary loss on early extinguishment of debt, net of income tax benefit --
--------------------
Net income (loss) (2.5)
Preferred stock dividends 9.8
--------------------
Income (loss) applicable to common shareholders $(12.3)
Basic earnings (loss) per share:
Before extraordinary loss $(0.65)
Extraordinary loss, net of tax --
--------------------
$(0.65)
Diluted earnings (loss) per share:
Before extraordinary loss $(0.65)
Extraordinary loss, net of tax --
--------------------
$(0.65)
Common shares used in basic earnings (loss) per share calculation 18.8
Common shares and potential common shares used in diluted earnings (loss) per share calculation 18.8
See Notes to Consolidated Financial Statements.
48
...............................................................................
F-4
The Scotts Company and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the fiscal years ended September 30, 1998, 1997 and 1996 (in millions) 1998 1997 1996
...........................................................................................................
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 36.3 $ 39.5 $ (2.5)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation 21.6 16.6 16.8
Amortization 16.2 13.8 12.5
Extraordinary loss 0.7 -- --
Restructuring and other charges 19.3 -- 15.1
Loss (gain) on sale of fixed assets 2.3 5.6 (0.1)
Deferred income taxes (2.4) (1.5) (5.7)
Changes in assets and liabilities, net of acquired
businesses:
Accounts receivable (8.6) 18.3 66.1
Inventories (5.7) 17.3 (4.9)
Prepaid and other current assets (2.1) 0.4 2.1
Accounts payable 8.8 1.1 (16.9)
Accrued taxes and other liabilities (14.4) 12.7 0.6
Other, net (1.0) (2.7) (0.8)
------------------------------
Net cash provided by operating activities 71.0 121.1 82.3
------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property, plant and equipment (41.3) (28.6) (18.2)
Proceeds from sale of equipment 0.6 2.7 0.8
Investments in acquired businesses, net of cash acquired (151.4) (46.6) --
------------------------------
Net cash used in investing activities (192.1) (72.5) (17.4)
------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings (repayments) under revolving and bank lines of credit 140.0 (37.3) (46.6)
Dividends on Class A Convertible Preferred Stock (7.3) (9.8) (12.2)
Repurchase of common shares (15.3) -- --
Other, net 1.0 0.9 (2.3)
------------------------------
Net cash provided by (used in) financing activities 118.4 (46.2) (61.1)
------------------------------
Effect of exchange rate changes on cash 0.3 -- (0.2)
------------------------------
Net increase (decrease) in cash (2.4) 2.4 3.6
Cash, beginning of period 13.0 10.6 7.0
------------------------------
Cash, end of period $ 10.6 $ 13.0 $ 10.6
------------------------------
------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid (net of amount capitalized) $ 31.5 $ 24.2 $ 25.5
Income taxes paid 38.6 20.5 4.4
Dividends declared not paid 2.5 -- --
Businesses acquired:
Fair value of assets acquired 195.8 115.8
Liabilities assumed and minority interest (45.9) (69.2)
Cash paid 0.4 --
Debt issued 149.5 46.6
See Notes to Consolidated Financial Statements.
49
...............................................................................
F-5
The Scotts Company and Subsidiaries
CONSOLIDATED BALANCE SHEETS
September 30, 1998 and 1997 (in millions) 1998 1997
...................................................................................
ASSETS
Current Assets:
Cash $ 10.6 $ 13.0
Accounts receivable, less allowance for uncollectible
accounts of $6.3 in 1998 and $5.7 in 1997 146.6 104.3
Inventories, net 177.7 146.1
Current deferred tax asset 20.8 19.0
Prepaid and other assets 11.5 3.4
--------------------
Total current assets 367.2 285.8
Property, plant and equipment, net 197.0 146.1
Intangible assets, net 435.1 352.2
Other assets 35.9 3.5
--------------------
Total assets $1,035.2 $787.6
--------------------
--------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Short-term debt $ 13.3 $ 1.5
Accounts payable 77.8 54.1
Accrued liabilities 124.9 57.8
Accrued taxes 15.9 25.9
--------------------
Total current liabilities 231.9 139.3
Long-term debt 359.2 219.8
Other liabilities 40.2 39.3
--------------------
Total liabilities 631.3 398.4
--------------------
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity:
Class A Convertible Preferred Stock, no par value 177.3 177.3
Common shares, no par value per share, $.01 stated value
per share, issued 21.1 shares in 1998 and 1997 0.2 0.2
Capital in excess of par value 208.7 207.8
Retained earnings 76.6 50.1
Cumulative foreign currency translation account (3.0) (4.3)
Treasury stock, 2.8 shares in 1998 and 2.4 shares in
1997, at cost (55.9) (41.9)
--------------------
Total shareholders' equity 403.9 389.2
--------------------
Total liabilities and shareholders' equity $1,035.2 $787.6
--------------------
--------------------
See Notes to Consolidated Financial Statements.
50
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Cumulative
Class A Convertible Foreign
For the fiscal years ended Preferred Stock Common Shares Capital in Treasury Stock Currency
September 30, 1998, 1997 and 1996 ------------------- --------------- Excess of Retained --------------- Translation
(in millions) Shares Amount Shares Amount Par Value Earnings Shares Amount Account
................................................................................................................................
Balance, September 30, 1995 0.2 $177.3 21.1 $0.2 $207.5 $32.7 (2.4) $(41.0) $ 4.1
Issuance of common shares held in
treasury 0.1 0.4 7.4
Purchase of common shares (0.5) (9.8)
Net loss (2.5)
Preferred Stock dividends (9.8)
Foreign currency translation (1.9)
................................................................................................................................
Balance, September 30, 1996 0.2 $177.3 21.1 $0.2 $207.6 $20.4 (2.5) $(43.4) 2.2
Issuance of common shares held in
treasury 0.2 0.1 1.5
Net income 39.5
Preferred stock dividends (9.8)
Foreign currency translation (6.5)
................................................................................................................................
Balance, September 30, 1997 0.2 $177.3 21.1 $0.2 $207.8 $50.1 (2.4) $(41.9) $(4.3)
Issuance of common shares held in
treasury 0.1 1.7
Purchase of common shares (0.5) (15.3)
Net income 36.3
Preferred Stock dividends (9.8)
Foreign currency translation 1.3
Other 0.9 (0.4)
................................................................................................................................
Balance, September 30, 1998 0.2 $177.3 21.1 $0.2 $208.7 $76.6 (2.8) $(55.9) $(3.0)
................................................................................................................................
For the fiscal years ended
September 30, 1998, 1997 and 1996
(in millions) Total
..........................................
Balance, September 30, 1995 $380.8
Issuance of common shares held in
treasury 7.5
Purchase of common shares (9.8)
Net loss (2.5)
Preferred Stock dividends (9.8)
Foreign currency translation (1.9)
.................................
Balance, September 30, 1996 $364.3
Issuance of common shares held in
treasury 1.7
Net income 39.5
Preferred stock dividends (9.8)
Foreign currency translation (6.5)
.................................
Balance, September 30, 1997 $389.2
Issuance of common shares held in
treasury 1.7
Purchase of common shares (15.3)
Net income 36.3
Preferred Stock dividends (9.8)
Foreign currency translation 1.3
Other 0.5
.................................
Balance, September 30, 1998 $403.9
.................................
See Notes to Consolidated Financial Statements.
F-6
The Scotts Company and Subsidiaries
51
NOTE 1. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Scotts Company is engaged in the manufacture and sale of lawn care and
garden products. The Company's major customers include mass merchandisers, home
improvement centers, large hardware chains, independent hardware stores,
nurseries, garden centers, food and drug stores, golf courses, professional
sports stadiums, lawn and landscape service companies, commercial nurseries and
greenhouses, and specialty crop growers. The Company's products are sold in the
United States, Canada, the European Union, the Caribbean, South America,
Southeast Asia, the Middle East, Africa, Australia, New Zealand, Mexico, Japan,
and several Latin American Countries.
ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of The Scotts Company
and its subsidiaries (collectively, the "Company"). All material intercompany
transactions have been eliminated.
REVENUE RECOGNITION
Revenue generally is recognized when products are shipped. For certain large
multi-location customers, revenue is recognized when products are shipped to
intermediate locations and ownership is acknowledged by the customer.
RESEARCH AND DEVELOPMENT
All costs associated with research and development are charged to expense as
incurred. Expense for fiscal 1998, 1997 and 1996 was $14.8 million, $10.0
million, and $10.6 million, respectively.
ADVERTISING AND PROMOTION
The Company advertises its branded products through national and regional media,
and through cooperative advertising programs with retailers. Retailers are also
offered pre-season stocking and in-store promotional allowances. Certain
products are also promoted with direct consumer rebate programs. The Company
expenses advertising and promotion costs as incurred, although costs incurred
during interim periods are generally expensed ratably in relation to revenues or
related performance measures.
EARNINGS PER COMMON SHARE
Basic earnings per common share is based on the weighted-average number of
common shares outstanding each period. Diluted earnings per common share is
based on the weighted-average number of common shares and dilutive potential
common shares (stock options, convertible preferred stock and warrants)
outstanding each period.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying disclosures. The most significant of these estimates are related to
the allowance for doubtful accounts, inventory valuation reserves, expected
useful lives assigned to property, plant and equipment and goodwill and other
intangible assets, legal and environmental accruals, post-retirement benefits,
promotional and consumer rebate liabilities, income taxes and contingencies.
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.
INVENTORIES
Inventories are principally stated at the lower of cost or market, determined by
the FIFO method; however, certain growing media inventories are accounted for by
the LIFO method. At September 30, 1998 and 1997, approximately 12% and 14% of
inventories, respectively, are valued at the lower of LIFO cost or market.
Inventories include the cost of raw materials, labor and manufacturing overhead.
The Company makes provisions for obsolete or slow-moving inventories as
necessary to properly reflect inventory value.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including significant improvements, are stated at
cost. Expenditures for maintenance and repairs are charged to operating expenses
as incurred. When properties are retired or otherwise disposed of, the cost of
the asset and the related accumulated depreciation are removed from the accounts
with the resulting gain or loss being reflected in results of operations.
F-7
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
52
Depletion of applicable land is computed on the units-of-production method.
Depreciation of other property, plant and equipment is provided on the
straight-line method and is based on the estimated useful economic lives of the
assets as follows:
Land improvements 10-25 years
Buildings 10-40 years
Machinery and equipment 3-15 years
Furniture and fixtures 6-10 years
Software 3-8 years
Interest is capitalized on all material projects, generally those over $1.0
million. The Company capitalized $0.8 million and $0.4 million of interest costs
during fiscal 1998 and 1997, respectively.
INTANGIBLE ASSETS
Goodwill arising from business acquisitions is amortized over its useful life,
which is generally 40 years, on a straight-line basis. Intangible assets also
consist of patents, trademarks and debt issuance costs. Debt issuance costs are
being amortized over the terms of the various agreements. Patents and trademarks
are being amortized on a straight-line basis over periods varying from 7 to 40
years. Accumulated amortization at September 30, 1998 and 1997 was $71.7 million
and $68.9 million, respectively.
Management periodically assesses the recoverability of goodwill, trademarks and
other intangible assets by determining whether the amortization of such assets
over the remaining lives can be recovered through projected undiscounted net
cash flows produced by such assets.
INTERNAL USE SOFTWARE
In July of fiscal 1998, the Company announced an initiative designed to enhance
its information system resources. The project includes re-design of certain key
business processes and the installation of new software on a world-wide basis
over the next two fiscal years. SAP has been chosen as the primary software
provider for this project. The Company is accounting for the costs of the
project in accordance with Statement of Position 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use". Accordingly, costs
other than reengineering are expensed or capitalized depending on whether they
are incurred in the preliminary project stage, application development stage, or
the post-implementation/operation stage. Any reengineering costs are expensed as
incurred.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid financial instruments with original
maturities of three months or less to be cash equivalents. The Company did not
have any cash equivalents as of September 30, 1998.
FOREIGN EXCHANGE INSTRUMENTS
Gains and losses on foreign currency transaction hedges are recognized in income
and offset the foreign exchange gains and losses on the underlying transactions.
Gains and losses on foreign currency firm commitment hedges are deferred and
included in the basis of the transactions underlying the commitments. At
September 30, 1998, there were no outstanding transaction hedges or firm
commitment hedges.
All assets and liabilities in the balance sheets of foreign subsidiaries whose
functional currency is other than the U.S. dollar are translated into U.S.
dollar equivalents at year-end exchange rates. Translation gains and losses are
accumulated as a separate component of shareholders' equity. Income and expense
items are translated at average monthly exchange rates. Foreign currency
transaction gains and losses are included in the determination of net income.
ENVIRONMENTAL COSTS
The Company recognizes environmental liabilities when conditions requiring
remediation are identified. The Company determines its liability on a site by
site basis and records a liability at the time when it is probable and can be
reasonably estimated. Expenditures which extend the life of the related property
or mitigate or prevent future environmental contamination are capitalized.
Environmental liabilities are not discounted or reduced for possible recoveries
from insurance carriers.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' financial
statements to conform to fiscal 1998 classifications.
NOTE 2. DETAIL OF CERTAIN FINANCIAL STATEMENT ACCOUNTS
(IN MILLIONS) 1998 1997
.
INVENTORIES, NET:
Finished Goods $121.0 $102.8
Raw Materials 55.8 42.8
---------------
FIFO Cost 176.8 145.6
LIFO Reserve 0.9 0.5
---------------
Total $177.7 $146.1
---------------
---------------
............................
F-8
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
53
Inventory balances are shown net of provisions for slow moving and obsolete
inventory, of $12.0 million and $11.8 million as of September 30, 1998 and 1997,
respectively. Inventory for 1998 is also shown net of $2.7 million non-cash
reserves associated with the 1998 restructuring program. See further discussion
in Note 4.
(IN MILLIONS) 1998 1997
.
PROPERTY, PLANT AND EQUIPMENT, NET:
Land and improvements $ 41.1 $ 27.6
Buildings 70.9 44.9
Machinery and equipment 169.7 136.8
Furniture and fixtures 17.0 11.5
Software 3.7 3.2
Construction in progress 28.8 24.5
Less: accumulated depreciation (134.2) (102.4)
---------------
Total $197.0 $146.1
---------------
---------------
......................................
Balances for 1998 are shown net of $4.4 million non-cash reserves associated
with the 1998 restructuring program. See further discussion in Note 4.
(IN MILLIONS) 1998 1997
.
INTANGIBLE ASSETS, NET:
Goodwill $268.1 $215.6
Trademarks 144.0 114.6
Other 23.0 22.0
---------------
Total $435.1 $352.2
---------------
---------------
.......................
(IN MILLIONS) 1998 1997
.
ACCRUED LIABILITIES:
Payroll and other compensation accruals $ 20.4 $ 21.2
Advertising and promotional accruals 26.5 15.6
Current restructuring reserves 7.8 --
Other 70.2 21.0
---------------
Total $124.9 $ 57.8
---------------
---------------
...........................
The current restructuring reserve consists of $2.3 million for non-cash
write-offs and $5.5 million for cash payments to be made in fiscal 1999,
primarily related to estimated losses under contractual commitments, the
elimination of 80 associate positions in the United Kingdom, and product
development costs in the United Kingdom. See further discussion in Note 4.
(IN MILLIONS) 1998 1997
.
OTHER NON-CURRENT LIABILITIES:
Accrued postretirement liabilities $ 26.0 $ 26.6
Non-current restructuring reserves 4.4 --
Environmental reserves 6.2 5.0
Other 3.6 7.7
---------------
Total $ 40.2 $ 39.3
---------------
---------------
...........................
The long term restructuring reserve consists of accruals for cash payments to be
made in fiscal 2000 primarily related to estimated losses under contractual
commitments. See further discussion in Note 4.
NOTE 3. OTHER EXPENSE (INCOME)
Other expense (income) consisted of the following for the fiscal years ended
September 30:
(IN MILLIONS) 1998 1997 1996
.
Royalty income $(3.4) $(2.0) $(1.0)
Asset valuation and write-off charges 2.3 6.0 --
Foreign currency loss 2.5 -- 1.2
Legal and environmental charges 2.7 1.1 --
Other, net (0.1) 1.2 (0.8)
---------------------
Total $ 4.0 $ 6.3 $(0.6)
---------------------
---------------------
..........................
NOTE 4. RESTRUCTURING AND OTHER CHARGES
During fiscal 1998, the Company recorded $20.4 million of restructuring and
other charges. Included in these charges are the following: (1) $6.0 million for
consolidation of the Company's two U.K. operations into one lower-cost business,
consisting primarily of property and equipment and packaging write-offs of $3.9
million and severance costs of $1.4 million; (2) $9.3 million for the closure of
nine composting operations in the United States that collect yard and compost
waste for certain municipalities, consisting of losses of $4.5 million to be
incurred under contractual commitments for which no future revenues will be
realized and inventory and fixed asset write-offs of $4.8 million; and (3) $5.1
million for the sale or closure of certain other U.S. plants and businesses. The
Company expects that these restructuring efforts will be completed during fiscal
1999, with the exception of certain losses under contractual commitments which
are expected to be incurred through fiscal 2000.
Such charges are included in the fiscal 1998 results of operations as follows
(amounts in millions):
Cost of sales $ 2.9
Selling, general and administrative 2.1
Restructuring and other charges 15.4
-----
$20.4
=====
During fiscal 1996, the Company recorded $17.7 million of unusual, non-recurring
charges as part of management's plan to reduce costs and improve operating
efficiencies. This program included the following charges: (1) $4.9 million for
severance costs; (2) $3.5 million for previously deferred packaging costs; and
(3) $9.3 million related to the write-down of various under-utilized or idle
assets, including several plant closings.
NOTE 5. ACQUISITIONS
Effective February 1998, the Company acquired all the shares of EarthGro, Inc.
("EarthGro"), a regional
F-9
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
54
growing media company located in Glastonbury, Connecticut, for approximately
$47.0 million, including deal costs and refinancing of certain assumed debt.
Effective December 1997, the Company acquired all the shares of Levington Group
Limited ("Levington"), a leading producer of consumer and professional lawn
fertilizer and growing media in the United Kingdom, for approximately $94.0
million, including deal costs and refinancing of certain assumed debt.
Effective January 1997, the Company acquired the approximate two-thirds interest
in Miracle Holdings Limited ("Miracle Holdings") which the Company did not
already own for approximately $47.0 million. Miracle Holdings owns Miracle
Garden Care Limited ("MGC"), a manufacturer and distributor of lawn and garden
products in the United Kingdom.
During fiscal 1998, the Company also invested in or acquired other entities
consistent with its long-term strategic plan. These investments include Scotts
Lawn Service, Sanford Scientific, Inc. (genetics) and the U.S. Home and Garden
Consumer Products Business of AgrEvo Environmental Health, Inc. (pesticides),
which is expected to be divested in fiscal 1999.
Each of the above acquisitions was accounted for under the purchase method of
accounting. Accordingly, the purchase prices have been allocated to the assets
acquired and liabilities assumed based on their estimated fair values at the
date of acquisition. Goodwill and identifiable intangibles associated with the
purchase of Levington were $44.0 million and $18.8 million, respectively.
Goodwill and identifiable intangibles associated with the purchase of EarthGro
were $5.2 million and $10.6 million, respectively.
The following unaudited pro forma results of operations give effect to the
Levington, EarthGro and Miracle Holdings acquisitions as if they had occurred on
October 1, 1996.
(IN MILLIONS) 1998 1997
Net sales $1,135.0 $1,034.8
Income before extraordinary loss 35.6 37.2
Net income 34.9 37.2
Basic earnings per share:
Before extraordinary loss $ 1.38 $ 1.47
After extraordinary loss 1.34 1.47
Diluted earnings per share
Before extraordinary loss $ 1.17 $ 1.27
After extraordinary loss 1.15 1.27
The pro forma information provided does not purport to be indicative of actual
results of operations if the EarthGro, Levington and Miracle Holdings
acquisitions had occurred as of October 1, 1996, and is not intended to be
indicative of future results or trends.
NOTE 6. RETIREMENT PLANS
In September 1997, in conjunction with the decision to offer a new defined
contribution retirement savings plan to domestic Company associates, management
decided to suspend benefits under its Scotts and Sierra defined benefit pension
plans. The suspension of benefits under the defined benefit plans was accounted
for as a curtailment under SFAS No. 88 ("Employers' Accounting for Settlements
and Curtailments of Defined Benefit Pension Plans and for Termination
Benefits"). The gain recognized from the reduction of the projected benefit
obligation was offset by the recognition of previously unrecognized net losses
and obligations.
The curtailed pension plans covered substantially all full-time U.S. associates
who had completed one year of eligible service and reached the age of 21. The
benefits under these plans are based on years of service and the associates'
average final compensation for the Scotts plan employees and for Sierra salaried
employees and on stated amounts for Sierra hourly employees. The Company's
funding policy, consistent with statutory requirements and tax considerations,
is based on actuarial computations using the Projected Unit Credit method.
The following table sets forth the plans' funded status and the related amounts
recognized in the Consolidated Balance Sheets:
September 30,
(IN MILLIONS) 1998 1997
Actuarial present value of accumulated and
projected benefit obligations:
Vested benefits $(49.3) $(42.5)
Nonvested benefits (7.6) (7.4)
---------------
(56.9) (49.9)
Plan assets at fair value, primarily corporate
bonds, U.S. Government bonds and cash
equivalents 58.0 53.9
---------------
Plan assets greater than projected benefit
obligations 1.1 4.0
Unrecognized items 3.7 --
---------------
Prepaid pension costs $ 4.8 $ 4.0
---------------
---------------
Pension cost includes the following components:
Fiscal year ended
September 30,
(IN MILLIONS) 1998 1997 1996
Service cost $ - $ 1.9 $ 1.8
Interest cost 3.6 4.1 3.8
Actual return on plan assets (3.7) (7.0) (4.3)
Net amortization and deferral -- 2.8 0.6
---------------------------
Net pension cost $(0.1) $ 1.8 $ 1.9
---------------------------
---------------------------
F-10
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
55
The weighted-average settlement rate used in determining the actuarial present
value of the projected benefit obligation was 6.75%, 7.25% and 8.0% as of
September 30, 1998, 1997 and 1996, respectively. Future compensation was assumed
to increase 4% annually for fiscal 1997 and 1996. The expected long-term rate of
return on plan assets was 7.0% for fiscal 1998 and 9.0% in fiscal 1997 and 1996.
The following table sets forth the funded status and the related amounts
recognized in the Consolidated Balance Sheets for defined benefit plans which
exist as of September 30, 1998 and 1997 for MGC, Levington and Scotts Europe BV
on a combined basis:
September 30,
(IN MILLIONS) 1998 1997
Actuarial present value of benefit obligation:
Accumulated benefit obligations:
Vested benefits $(46.0) $(13.8)
Nonvested benefits (0.2) --
Additional obligation for projected
compensation increase (8.9) (4.1)
------------------
Projected benefit obligation (55.1) (17.9)
Plan assets at fair value 51.2 14.7
------------------
Plan assets less than projected benefit
obligations (3.9) (3.2)
Unrecognized items (1.2) 0.3
------------------
Net pension liability $ (5.1) $ (2.9)
------------------
------------------
Pension expense for fiscal 1998 for the International plans was $3.1, consisting
of $2.8 service cost, $3.1 interest cost, $0.4 loss on plan assets, offset by
$3.2 amortization of unrecognized items.
At September 30, 1997, the Company also curtailed its non-qualified supplemental
pension plan which provides for incremental pension payments from the Company so
that total pension payments equal amounts that would have been payable from the
Company's pension plans if it were not for limitations imposed by income tax
regulations. The projected benefit obligation at September 30, 1998 and 1997 was
$1.5 million and $1.4 million, respectively. Pension expense for the plan was
$0.1 million, $0.2 million and $0.3 million in fiscal 1998, 1997 and 1996,
respectively.
NOTE 7. ASSOCIATE BENEFITS
The Company provides comprehensive major medical benefits to certain of its
retired associates and their dependents. Substantially all of the Company's
domestic associates become eligible for these benefits if they retire at age 55
or older with more than ten years of service. The plan requires certain minimum
contributions from retired associates and includes provisions to limit the
overall cost increases the Company is required to cover. The Company funds its
portion of retiree medical benefits on a pay-as-you-go basis.
Prior to October 1, 1993, the Company effected several changes in plan
provisions, primarily related to current and ultimate levels of retiree and
dependent contributions. Retirees as of October 1, 1993 are entitled to benefits
existing prior to these plan changes. These plan changes resulted in a reduction
in unrecognized prior service cost, which is being amortized over future years.
The following table sets forth the retiree medical plan status reconciled to the
amounts included in the Consolidated Balance Sheets, as of September 30, 1998
and 1997.
(IN MILLIONS) 1998 1997
Accumulated postretirement benefit obligations:
Retirees $ 7.3 $ 7.8
Fully eligible active plan participants 0.4 0.4
Other active plan participants 7.4 7.6
------------------
Total accumulated postretirement benefit
obligation 15.1 15.8
Unrecognized items 10.9 10.8
------------------
Accrued postretirement liability $ 26.0 $ 26.6
------------------
------------------
Net periodic postretirement benefit cost includes the following components:
Fiscal year ended
September 30,
(IN MILLIONS) 1998 1997 1996
Service cost $ 0.4 $ 0.3 $ 0.4
Interest cost 1.0 1.1 1.5
Net amortization (1.3) (1.2) (0.9)
---------------------------
Net periodic postretirement benefit cost $ 0.1 $ 0.2 $ 1.0
---------------------------
---------------------------
The discount rates used in determining the accumulated postretirement benefit
obligation were 6.75% and 7.25% in fiscal 1998 and 1997, respectively. For
measurement purposes, an 8.5% annual rate of increase in per capita cost of
covered retiree medical benefits was assumed for 1998 and 1997; the rate was
assumed to decrease gradually to 5.5% through the year 2003 and remain at that
level thereafter. A 1% increase in the health care cost trend rate assumptions
would increase the accumulated postretirement benefit obligation as of September
30, 1998 and 1997 by $0.7 million and $1.0 million, respectively. A 1% increase
in the same rate would not have a material effect on service or interest costs.
Effective January 1, 1998, the Scotts, Hyponex and Sierra defined contribution
profit sharing and 401(k) plans were merged and the surviving plan was expanded
and amended to serve as the sole, active retirement savings plan for
substantially all U.S. employees. Full-time employees may participate in the
plan on the first day of the month after being hired.
F-11
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
56
Temporary employees may participate after working at least 1,000 hours in their
first twelve months of employment and after reaching the age of 21. The plan
allows participants to contribute up to 15% of their compensation in the form of
pre-tax or post-tax contributions. The Company provides a matching contribution
equivalent to 100% of participants' initial 3% contribution and 50% of the
participants' remaining contribution up to 5%. Participants are immediately
vested in employee contributions, the Company's matching contributions and the
investment return on those monies. The Company also provides a 2% automatic base
contribution to employees' accounts regardless of whether employees are active
in the plan. Participants become vested in the Company's 2% base contribution
after three years of service. The Company recorded charges of $4.7 million under
the new plan in fiscal 1998. Under the terminated profit sharing and 401(k)
plans, the Company recorded charges of $2.3 million and $0.9 million in fiscal
1997 and 1996, respectively.
The Company is self-insured for certain health benefits up to $0.2 million per
occurrence per individual. The cost of such benefits is recognized as expense in
the period the claim incurred. This cost was $8.6 million, $7.9 million and $9.4
million in fiscal 1998, 1997 and 1996, respectively. The Company is self-
insured for State of Ohio workers compensation up to $0.5 million per claim.
Claims in excess of stated limits of liability and claims for workers
compensation outside of the State of Ohio are insured with commercial carriers.
NOTE 8. DEBT
September 30,
(IN MILLIONS) 1998 1997
Revolving credit line........................... $253.5 $114.7
9 7/8% Senior Subordinated Notes, $100 face
amount (net of unamortized discount)........... 99.5 99.4
Foreign term loans.............................. 9.0 5.6
Short-term bank debt............................ 0.0 1.5
Capital lease obligations and other............. 10.5 0.1
------------------
372.5 221.3
Less current portions........................... 13.3 1.5
------------------
$359.2 $219.8
------------------
------------------
Maturities of short and long-term debt, including capital leases for the next
five fiscal years and thereafter are as follows:
CAPITAL OTHER
(IN MILLIONS) LEASES DEBT
1999 $1.0 $13.3
2000 1.2 1.4
2001 1.1 1.0
2002 0.2 2.0
2003 0.1 251.5
Thereafter 0.2 100.0
On February 26, 1998, the Company replaced its existing credit facility with a
five-year, senior unsecured revolving credit facility with The Chase Manhattan
Bank ("Chase") and various participating banks. The new facility provided up to
$550 million to the Company, an increase of $125 million over the previous
facility, and established a $200 million sub-tranche available in British Pounds
Sterling and a $50 million sub-tranche available in other foreign currencies in
which the Company transacts business. Interest pursuant to the competitive
advance facility was determined by auction. Interest pursuant to the revolving
credit facility was at a floating rate initially equal, at the Company's option,
to the Alternate Base Rate, as defined, without additional margin, or the
Eurodollar Rate, as defined, plus a margin of .30% per annum, which margin was
decreased to .20% or increased up to .50% based on the unsecured debt ratings of
the Company. The new facility provided for the payment of a facility fee of .15%
per annum, which fee was be reduced to .10% or increased up to .375% based on
the unsecured debt ratings of the Company. The agreement contained certain
financial and operating covenants, including maintenance of interest coverage
and leverage ratios, as well as restrictions on capital expenditures. All other
provisions of the credit facility remained substantially the same as the
extinguished facility. Gross borrowings and gross repayments under the credit
facility were $576.1 million and $436.1 million, respectively, for the year
ended September 30, 1998.
In conjunction with the early extinguishment of the previous credit facility,
the Company recorded an extraordinary loss of $1.2 million ($0.7 million after
tax) related to the write-off of unamortized deferred financing costs.
On July 19, 1994, the Company issued $100.0 million in principal of 9 7/8%
Senior Subordinated Notes with a 10 year term. The Notes are subject to
redemption, at the option of the Company, in whole or in part at any time on or
after August 1, 1999 at a declining premium to par until 2001 and at par
thereafter and are not subject to sinking fund requirements. The fair market
value of the 9 7/8% Senior Subordinated Notes, estimated based on the quoted
market prices for same or similar issues, was approximately $106.8 million at
September 30, 1998. The Notes are subject to certain covenants limiting, among
other things, indebtedness of subsidiaries, dividends and other payment
restrictions.
The foreign term loans, which were issued on December 12, 1997, have an 8 year
term and bear interest at
F-12
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
57
1% below LIBOR. The foreign term loans can be redeemed, on demand, by the note
holder.
NOTE 9. SHAREHOLDERS' EQUITY
(IN MILLIONS) 1998 1997
.
STOCK
Class A Convertible Preferred Stock, no
par value:
Authorized 0.2 shares 0.2 shares
Issued 0.2 shares 0.2 shares
Common shares, no par value
Authorized 50.0 shares 50.0 shares
Issued 21.1 shares 21.1 shares
.................................
Class A Convertible Preferred Stock with a face amount of $195.0 million was
issued in conjunction with the 1995 Miracle-Gro merger transactions. This
Preferred Stock has a 5% dividend yield and is convertible upon shareholder
demand into 10.3 million common shares at $19.00 per common share. Additionally,
warrants to purchase 3.0 million common shares of Scotts were issued as part of
the purchase price. The warrants are exercisable upon shareholder demand for 1.0
million common shares at $21.00 per share, 1.0 million common shares at $25.00
per share and 1.0 million common shares at $29.00 per share. The exercise term
for the warrants expires September 2003. The fair value of the warrants at
issuance has been included in capital in excess of par value in the Company's
Consolidated Balance Sheets.
The Class A Convertible Preferred Stock has certain voting restrictions and
limits the preferred shareholders from acquiring additional voting securities of
the Company. The Class A Convertible Preferred Stock is subject to redemption at
any time after May 19, 2000 for $1,000 per share plus accrued unpaid dividends.
Both the Class A Convertible Preferred Stock and the warrants have limits on
transferability.
Under The Scotts Company 1992 Long Term Incentive Plan (the "Plan"), stock
options, stock appreciation rights and performance share awards were granted to
officers and other key employees of the Company. The Plan also provided for the
grant of stock options to non-employee directors of the Company. The maximum
number of common shares that may be issued upon the exercise of options granted
under the Plan is 1.7 million, plus the number of shares surrendered to exercise
options (other than director options) granted under the Plan, up to a maximum of
1.0 million surrendered shares. Vesting periods under the Plan vary and are
determined by the Compensation and Organization Committee of the Company's Board
of Directors.
Under The Scotts Company 1996 Stock Option Plan (the "1996 Plan"), stock options
may be granted to officers, other key employees and non-employee directors of
the Company. The maximum number of common shares that may be issued under the
1996 Plan is 3.0 million. Vesting periods under the 1996 Plan vary and are
determined by the Compensation and Organization Committee of the Company's Board
of Directors.
Aggregate stock option activity consists of the following:
Fiscal year ended September 30,
1998 1997 1996
NUMBER NUMBER NUMBER
OF WTD. AVG. OF WTD. AVG. OF WTD. AVG.
(IN MILLIONS) SHARES PRICE SHARES PRICE SHARES PRICE
.
Beginning balance 2.6 $18.35 1.6 $16.73 1.7 $16.51
Options granted 1.4 29.43 1.1 20.18 0.5 18.29
Options exercised (0.1) 16.60 (0.1) 12.72 (0.4) 17.17
Options canceled (0.1) 29.63 0.0 19.27 (0.2) 18.13
---- ---- ----
Ending balance 3.8 20.70 2.6 18.35 1.6 16.73
---- ---- ----
Exercisable at
September 30 1.8 18.17 1.5 17.30 1.2 16.23
..........................
The following summarizes certain information pertaining to stock options
outstanding and exercisable at September 30, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
(IN MILLIONS) WTD. AVG. WTD. AVG. WTD. AVG.
RANGE OF NO. OF REMAINING EXERCISE NO. OF EXERCISE
EXERCISE PRICES OPTIONS LIFE PRICE OPTIONS PRICE
.
$9.90 0.1 3.05 $ 9.90 0.1 $ 9.90
$15.50-$17.75 1.1 5.80 16.72 1.0 16.72
$18.00-$20.75 0.9 8.02 19.03 0.3 18.42
$21.13-$22.89 0.3 7.73 21.45 0.3 21.44
$26.25-$30.13 1.2 9.52 28.30 0.1 26.61
$31.56-$36.63 0.2 9.52 34.06 0.0 34.38
--- ------ ------
3.8 $22.14 1.8 $18.17
=== ====== ======
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which changes the measurement,
recognition and disclosure standards for stock-based compensation. The Company,
as allowable, has adopted SFAS No. 123 for disclosure purposes only.
The fair value of each option granted has been estimated on the grant date using
the Black-Scholes option-pricing model based on the following assumptions for
those granted in fiscal 1998, 1997 and 1996: (1) expected market-price
volatility of 23.23%, 22.48% and 21.85%, respectively; (2) risk-free interest
rates of 4.3%, 6.6% and 6.1%, respectively; and (3) expected life of options of
6 years. The estimated weighted-average fair values of options granted during
fiscal 1998, 1997 and 1996 are $13.0 million, $8.8 million and $3.2 million,
respectively.
Had compensation expense been recognized for fiscal 1998, 1997 and 1996 in
accordance with provisions of
F-13
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
58
SFAS No. 123, the Company would have recorded net income and earnings per share
as
(IN MILLIONS) 1998 1997 1996
.
Net income (loss) used in per share
calculation $31.3 $37.3 $(12.9)
Diluted earnings per share $1.03 $1.27 $ (.69)
............
The pro forma amounts shown above are not necessarily representative of the
impact on net income in future years as additional option grants may be made
each year.
In fiscal 1998, the Company sold 0.3 million put options which give the holder
the option to sell the Company's common shares to the Company at a strike price
of $35.32. The options can only be exercised on their expiration date in May
1999. Settlement obligations can be satisfied in cash or Company common shares
at the Company's option.
NOTE 10. EARNINGS PER COMMON SHARE
The following table presents information necessary to calculate basic and
diluted earnings per common share.
Year Ended September 30,
(IN MILLIONS) 1998 1997 1996
.
BASIC EARNINGS PER COMMON SHARE:
Net income (loss) before extraordinary
loss 37.0 39.5 (2.5)
Net income (loss) 36.3 39.5 (2.5)
Class A Convertible Preferred Stock
dividend (9.8) (9.8) (9.8)
-----------------------
Income (loss) available to common
shareholders 26.5 29.7 (12.3)
Weighted-average common shares
outstanding during the period 18.7 18.6 18.8
Basic earnings per common share
Before extraordinary item $1.46 $1.60 $(0.65)
After extraordinary item $1.42 $1.60 $(0.65)
DILUTED EARNINGS PER COMMON SHARE:
Net income (loss) used in diluted
earnings per common share calculation $36.3 $39.5 $(12.3)
Weighted-average common shares
outstanding during the period 18.7 18.6 18.8
Potential common shares:
Assuming conversion of Class A
Convertible Preferred Stock 10.3 10.3 na
Assuming exercise of options 0.7 0.3 na
Assuming exercise of warrants 0.6 0.1 na
-----------------------
Weighted-average number of common
shares outstanding and dilutive
potential common shares 30.3 29.3 18.8
Diluted earnings per common share
Before extraordinary item $1.22 $1.35 $(0.65)
After extraordinary item $1.20 $1.35 $(0.65)
-----------------------
-----------------------
................................................................................
Basic earnings per common share is computed by dividing income (loss) available
to common shareholders by the weighted average number of common shares
outstanding during the period.
Diluted earnings per share is computed by dividing net income (loss) by the
weighted-average number of common shares and dilutive potential common shares
(stock options, Class A Convertible Preferred Stock and warrants) outstanding
during each period. The potential common shares were not considered in the
earnings per share computation for the year ended September 30, 1996 because
their effect was antidilutive for the period. Consequently, the dividends
attributable to the Class A Convertible Preferred Stock were included in
determining the net loss used in the fiscal 1996 calculation.
NOTE 11. INCOME TAXES
The provision for income taxes, net of a $0.5 million tax benefit associated
with the 1998 extraordinary loss, consists of the following:
Year Ended September 30,
(IN MILLIONS) 1998 1997 1996
.
Currently payable:
Federal $22.1 $21.6 $ 4.2
State 3.9 3.4 2.5
Foreign 2.7 6.6 2.8
Deferred:
Federal (4.0) (1.3) (5.1)
State (0.3) (0.2) (0.6)
----------------------
Income tax expense $24.4 $30.1 $ 3.8
----------------------
----------------------
..................................
A reconciliation of the Federal corporate income tax rate and the effective tax
rate on income before income taxes is summarized below:
Year Ended September 30,
(IN MILLIONS) 1998 1997 1996
.
Statutory income tax rate 35.0% 35.0% 35.0%
Pension amortization 0.1 6.3
Meals and entertainment 0.9 0.4 17.6
Effect of foreign operations (1.6)
Goodwill amortization and other effects
resulting from purchase accounting 4.6 4.2 206.9
State taxes, net of federal benefit 3.8 3.0 97.6
Resolution of previous tax contingencies (0.3) (0.8) (42.0)
Equity income of affiliate (13.8)
Other (2.1) 1.3 (5.3)
---------------------
Effective income tax rate 40.3% 43.2% 302.3%
---------------------
---------------------
...........................................
The net current and non-current components of deferred income taxes recognized
in the Consolidated Balance Sheets at September 30 are:
(IN MILLIONS) 1998 1997
.
Net current asset $ 20.8 $ 19.0
Net non-current liability (included in other
liabilities) (1.2) (6.7)
---------------
Net asset $ 19.6 $ 12.3
---------------
---------------
...............
F-14
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
59
The components of the net deferred tax asset are as follows:
September 30,
(IN MILLIONS) 1998 1997
ASSETS
Inventories $ 5.9 $ 6.8
Accrued liabilities 11.7 11.0
Postretirement benefits 9.8 10.5
Foreign net operating losses 6.0 6.7
Other 11.1 5.3
------------------
Gross deferred tax assets 44.5 40.3
Valuation allowance (4.5) (6.7)
------------------
Net deferred tax assets 40.0 33.6
LIABILITIES
Property, plant and equipment (20.4) (21.3)
------------------
Net asset $ 19.6 $ 12.3
------------------
------------------
Net operating loss carryforwards in foreign jurisdictions total $6.0 million,
$4.5 million of which the Company expects not to be utilized. The remaining $1.5
million can be carried forward indefinitely. The use of these acquired
carryforwards is subject to limitations imposed by the tax laws of each
applicable country.
NOTE 12. FINANCIAL INSTRUMENTS
A description of the Company's financial instruments and the methods and
assumptions used to estimate their fair values are as follows:
LONG-TERM DEBT
The Company has issued $100.0 million in principal of 9 7/8% Senior Subordinated
Notes due 2004. The fair value of the Notes is estimated based on the quoted
market prices for the same or similar issues.
The Company has borrowings outstanding under a revolving credit facility,
including amounts borrowed in foreign currencies. The borrowings under the
credit facility are at variable rates. The carrying amounts of these borrowings
are considered to approximate their fair values.
INTEREST RATE SWAP AGREEMENT
In fiscal 1997, the Company entered into an interest rate swap agreement with a
notional amount of 20.0 million British Pounds Sterling which expires in March
2002. The Company entered into the swap agreement to effectively convert 20.0
million of British Pounds Sterling debt obligations from a variable to a fixed
rate.
The Company enters into interest rate swap agreements as a means to hedge its
interest rate exposure on debt instruments. Since the interest rate swap
agreement has been designated as a hedging instrument, its fair value is not
reflected in the Company's Consolidated Balance Sheets. Net amounts to be
received or paid under the swap agreement are reflected as adjustments to
interest expense. The fair value of the swap agreement was determined based on
the present value of the estimated future net cash flows using implied rates in
the applicable yield curve as of the valuation date.
INTEREST RATE LOCKS
In fiscal 1998, the Company entered into two contracts, each with notional
amounts of $100.0 million to lock the treasury rate component of the Company's
anticipated offering of debt securities in the first quarter of fiscal 1999. One
of the interest rate locks expired in October 1998 and was rolled over into a
new rate lock that expires in February 1999. The other rate lock also expires in
February 1999.
The Company entered into the interest rate locks to hedge its interest rate
exposure on the anticipated debt offering. Since the interest rate lock has been
designated as a hedging instrument, its fair value is not reflected in the
Company's Consolidated Balance Sheets; net amounts to be received or paid under
the interest rate locks will be reflected as an adjustment to the carrying
amount of the future debt offering. The fair value of the interest rate locks
was estimated based on the difference between the contracted interest rates and
the yield on treasury notes at September 30, 1998.
The estimated fair values of the Company's financial instruments are as follows
for the fiscal years ended September 30:
1998 1997
Carrying Fair Carrying Fair
(in millions) Amount Value Amount Value
Long-term debt $99.5 $106.8 $99.4 $107.8
Interest rate swap agreement -- (1.5) -- (1.0)
Interest rate locks -- (16.7) -- --
NOTE 13. OPERATING LEASES
The Company leases buildings, land and equipment under various noncancellable
lease agreements for periods of two to six years. The lease agreements generally
provide that the Company pay taxes, insurance and maintenance expenses related
to the leased assets. Certain lease agreements contain purchase
F-15
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
60
options. At September 30, 1998, future minimum lease payments were as follows:
(in millions)
1999 $14.4
2000 11.2
2001 8.5
2002 6.9
2003 6.2
Thereafter 1.4
-----
Total minimum lease payments $48.6
=====
The Company also leases transportation and production equipment under various
one-year operating leases, which provide for the extension of the initial term
on a monthly or annual basis. Total rental expenses for operating leases were
$13.5 million, $12.3 million and $14.0 million for fiscal 1998, 1997 and 1996,
respectively.
NOTE 14. COMMITMENTS
The Company has entered into the following purchase commitments:
SEED: The Company is obligated to make future purchases based on estimated
yields. At September 30, 1998, estimated annual seed purchase commitments were
as follows:
(in millions)
1999 $15.0
2000 18.3
2001 7.2
2002 1.8
2003 1.1
UREA: The Company is obligated to purchase 90,000 tons of urea annually. The
value to the Company based on current market prices of urea is approximately
$13.0 million. The purchase contract expires December 31, 2000.
GLUFOSINATE AMMONIUM: The Company is obligated to purchase product valued at
$12.6 million through September 2001. If the Company does not purchase product
with a value of $12.6 million, the Company is required to provide cash
settlement in an amount equal to 50% of the shortfall.
PEAT: The Company is obligated to purchase 470,000 cubic meters annually
(approximately $6.8 million based on average prices) for ten years. The contract
can be extended another ten years at the Company's option. No penalties are
applicable to the first year of the contract; however, if the Company does not
purchase required amounts after year one, the Company will be required to
provide cash settlement equal to 50% of the quantity shortfall multiplied by the
average product price.
NOTE 15. CONTINGENCIES
Management continually evaluates the Company's contingencies, including various
lawsuits and claims which arise in the normal course of business, product and
general liabilities, property losses and other fiduciary liabilities for which
the Company is self-insured. In the opinion of management, its assessment of
contingencies is reasonable and related reserves, in the aggregate, are
adequate; however, there can be no assurance that future quarterly or annual
operating results will not be materially affected by final resolution of these
matters. The following details are the more significant of the Company's
identified contingencies.
OHIO ENVIRONMENTAL PROTECTION AGENCY
The Company has assessed and addressed certain environmental issues regarding
the wastewater treatment plants which had operated at the Marysville facility.
The Company decommissioned the old wastewater treatment plants and has connected
the facility's wastewater system with the City of Marysville's municipal
treatment system. Additionally, the Company has been assessing, under Ohio's new
Voluntary Action Program ("VAP"), the possible remediation of several
discontinued on-site waste disposal areas dating back to the early operations of
its Marysville facility.
In February 1997, the Company learned that the Ohio Environmental Protection
Agency ("OEPA") was referring certain matters relating to environmental
conditions at the Company's Marysville site, including the existing wastewater
treatment plants and the discontinued on-site waste disposal areas, to the Ohio
Attorney General's Office ("OAG"). Representatives from the OEPA, the OAG and
the Company continue to meet to discuss these issues.
In June 1997, the Company received formal notice of an enforcement action and
draft Findings and Orders ("F&O") from the OEPA. The draft F&O elaborated on the
subject of the referral to the OAG alleging: potential surface water violations
relating to possible historical sediment contamination possibly impacting water
quality; inadequate treatment capabilities of the Company's existing and
currently permitted wastewater treatment plants; and that the Marysville site is
subject to corrective action under the Resource Conservation Recovery Act
("RCRA"). In late July 1997, the Company received a draft judicial consent order
from the OAG which covers many of the same issues contained in the draft F&O
including RCRA corrective action.
F-16
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
61
In accordance with the Company's past efforts to enter into Ohio's VAP, the
Company submitted to the OEPA a "Demonstration of Sufficient Evidence of VAP
Eligibility Compliance" on July 8, 1997. Among other issues contained in the VAP
submission, was a description of the Company's ongoing efforts to assess
potential environmental impacts of the discontinued on-site waste disposal areas
as well as potential remediation efforts. Pursuant to the statutes covering VAP,
an eligible participant in the program is not subject to State enforcement
actions for those environmental matters being addressed. On October 21, 1997,
the Company received a letter from the Director of the OEPA denying VAP
eligibility based upon the timeliness of and completeness of the submittal. The
Company has appealed the Director's action to the Environmental Review Appeals
Commission. No hearing date has been set and the appeal remains pending.
The Company is continuing to meet with the OAG and the OEPA in an effort to
negotiate an amicable resolution of these issues but is unable at this stage to
predict the outcome of the negotiations. The Company believes that it has viable
defenses to the State's enforcement action, including that it had been
proceeding under VAP to address certain environmental issues, and will assert
those defenses in any such action.
While the Company is unable to predict the ultimate outcome of this matter,
management believes that the probable range of outcome will not be material to
the Company. Many of the issues raised by the State are already being
investigated and addressed by the Company during the normal course of conducting
business.
LAFAYETTE
In July 1990, the Philadelphia District of the U.S. Army Corps of Engineers
("Corps") directed that peat harvesting operations be discontinued at Hyponex's
Lafayette, New Jersey facility, based on its contention that peat harvesting and
related activities result in the "discharge of dredged or fill material into
waters of the United States" and therefore require a permit under Section 404 of
the Clean Water Act. In May 1992, the United States filed suit in the U.S.
District Court for the District of New Jersey seeking a permanent injunction
against such harvesting, and civil penalties in an unspecified amount. If the
Corps' position is upheld, it is possible that further harvesting of peat from
this facility would be prohibited. The Company is defending this suit and is
asserting a right to recover its economic losses resulting from the government's
actions. The suit was placed in administrative suspense during fiscal 1996 in
order to allow the Company and the government an opportunity to negotiate a
settlement, and it remains suspended while the parties develop, exchange and
evaluate technical data. In July 1997, the Company's wetlands consultant
submitted to the government a draft remediation plan. Comments were received and
a revised plan was submitted in early 1998. Further comments from the government
were received in June 1998, and final agreement is expected sometime in 1999.
Management does not believe that the outcome of this case will have a material
adverse effect on the Company's operations or its financial condition.
Furthermore, management believes the Company has sufficient raw material
supplies available such that service to customers will not be materially
adversely affected by continued closure of this peat harvesting operation.
HERSHBERGER
In September 1991, the Company was identified by the OEPA as a Potentially
Responsible Party ("PRP") with respect to a site in Union County, Ohio (the
"Hershberger site"), because the Company allegedly arranged for the
transportation, treatment or disposal of waste that allegedly contained
hazardous substances, at the Hershberger site. Effective February 1998, the
Company and four other named PRPs executed an Administrative Order on Consent
("AOC") with the OEPA, by which the named PRPs will fund remedial action at the
Hershberger site. After construction of the leachate collection system and
reconstruction of the landfill cap, which was substantially completed in August
1998, the Company expects its obligation thereafter to consist primarily of its
share of annual operating and maintenance expenses. Management does not believe
that its obligations under the AOC will have a material adverse effect
on the Company's results of operations or
financial condition.
NOTE 16. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration of
credit risk consist principally of trade accounts receivable. The Company sells
its consumer products to a wide variety of retailers, including mass
merchandisers, home centers, independent hardware stores, nurseries, garden
outlets, warehouse clubs and local and regional chains. Professional products
are sold to golf courses, schools and sports fields, nurseries, lawn care
service companies and growers of specialty agriculture crops.
F-17
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
62
The Company's two largest customers accounted for the following % of net sales
in each respective period:
LARGEST 2(ND)LARGEST
CUSTOMER CUSTOMER
1998 16.8% 10.6%
1997 16.1% 11.9%
1996 15.1% 13.9%
No other customers represent more than 10% of net sales or receivables recorded
by the Company as of September 30, 1998.
NOTE 17. NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" and
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information". In February 1998, the FASB issued SFAS No. 132, "Employers'
Disclosure about Pensions and Other Postretirement Benefits." In August 1998,
the FASB issued SFAS No. 133, "Accounting For Derivative Instruments and Hedging
Activities." SFAS No. 130, 131 and 132 are effective for financial statements
for fiscal years beginning after December 15, 1997. SFAS NO. 133 is effective
for fiscal years beginning after June 15, 1999.
SFAS No. 130 establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains and losses). SFAS No. 130
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. Comprehensive income is defined as the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in equity during a
period except those resulting from investments by owners and distributions to
owners. The Company believes the only significant differences between
comprehensive income and currently reported income will be the impact of foreign
currency translation. The Company plans to adopt SFAS No. 130 in fiscal 1999.
SFAS No. 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. This statement
defines business segments as components of an enterprise about which separate
financial information is available and used internally for evaluating segment
performance and decision making on resource allocations. SFAS No. 131 requires
reporting a measure of segment profit or loss, certain specific revenue and
expense items, and segment assets; and other reporting about geographic and
customer matters. The Company plans to adopt SFAS No. 131 in fiscal 1999;
however, the Company believes that the business segments identified and set
forth in Note 18 are in substantial compliance with SFAS No. 131.
SFAS No. 132 revises employers' disclosures about pension and other
postretirement benefit plans. It does not change the measurement or recognition
of those plans. It standardizes the disclosure requirements for pensions and
other postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan assets
that will facilitate financial analysis, and eliminates certain disclosures that
are no longer useful. The Company plans to adopt SFAS No. 132 in fiscal 1999.
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The Company has not yet
determined the impact this statement will have on its operating results. The
Company plans to adopt SFAS No. 133 in fiscal 2000.
NOTE 18. SEGMENT INFORMATION
The Company is divided into three reportable segments -- North American
Consumer, Professional and International. The North American Consumer segment
consists of the Lawns, Gardens and Growing Media business units.
The North American Consumer segment specializes in dry, granular slow-release
lawn fertilizers, lawn fertilizer combination and lawn control products, grass
seed, spreaders, water-soluble and controlled-release garden and indoor plant
foods, plant care products, and potting soils, barks, mulches and other growing
media products. Products are marketed to mass merchandisers, home improvement
centers, large hardware chains, nurseries and gardens centers.
The Professional segment is focused on a full line of turf and horticulture
products including controlled-release and water-soluble fertilizers and plant
protection products, grass seed, spreaders, custom application services and
growing media. Products are sold to golf courses, professional baseball,
football and soccer stadiums, lawn and landscape service companies,
F-18
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
63
commercial nurseries and greenhouses and specialty crop growers.
The International segment provides a broad range of controlled-release and
water-soluble fertilizers and related products, including ornamental
horticulture, turf and landscape, and consumer lawn and garden products which
are sold to all customer groups mentioned above.
The following tables summarizes certain segment information for fiscal 1998,
1997 and 1996. The Company did not assign interest expense of $32.2 million,
$25.2 million, or $25.0 million for fiscal 1998, 1997 or 1996, respectively, to
the reportable segments.
N.A. OTHER/
(IN MILLIONS) CONSUMER PROFESSIONAL INTERNATIONAL CORPORATE TOTAL
Sales:
1998 $733.7 $179.4 $199.9 $1,113.0
1997 619.2 165.5 114.6 899.3
1996 524.1 160.4 65.9 750.4
Operating Income (Loss):
1998 $ 85.5 $ 13.9 $ 21.7 $ (27.0) $ 94.1
1997 87.1 14.6 19.4 (26.3) 94.8
1996 40.9 2.2 14.7 (31.5) 26.3
Operating Margin:
1998 11.7% 7.7% 10.9% nm 8.4%
1997 14.1 8.8 16.9 nm 10.5
1996 7.8 1.4 22.3 nm 3.5
Depreciation and Amortization:
1998 $ 11.9 $ 2.4 $ 4.0 $ 19.5 $ 37.8
1997 11.3 1.7 1.5 15.9 30.4
1996 12.4 1.7 0.4 14.8 29.3
Capital Expenditures:
1998 $ 19.6 $ 9.2 $ 5.1 $ 7.4 $ 41.3
1997 17.6 4.2 2.2 4.6 28.6
1996 10.4 2.4 1.4 4.0 18.2
Total Assets:
1998 $315.9 $119.4 $108.8 $ 491.1 $1,035.2
1997 256.1 94.3 62.6 374.6 787.6
nm Not meaningful.
Other/Corporate operating loss for the fiscal years ended September 30, 1998,
1997 and 1996 primarily includes unallocated portions of the unusual charges
described in Note 4 of $4.9 million, $7.8 million and $17.4 million,
respectively; amortization of intangibles not assigned to business segments of
$12.9 million, $10.0 million and $8.9 million, respectively; and corporate
general and administrative expense of $9.2 million, $8.5 million and $5.2
million, respectively.
Operating income for fiscal 1998 and 1996 includes $20.4 million and $17.7
million of restructuring charges, respectively.
Other/Corporate assets primarily include all intangible assets (including
goodwill) not assigned to the business segments as well as deferred tax assets.
NOTE 19. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations for
fiscal 1998 and 1997:
(IN MILLIONS) 1(ST) QTR 2(ND) QTR 3(RD) QTR 4(TH) QTR FULL YEAR
FISCAL 1998
Net sales $124.8 $430.1 $367.0 $191.1 $1,113.0
Gross profit 41.3 170.5 131.3 54.9 398.0
Net income (loss) (5.5) 32.8 24.4 (15.4) 36.3
Basic earnings per
common share (.42) 1.62 1.18 (.96) 1.42
Shares used in basic
EPS calculation 18.7 18.7 18.7 18.6 18.7
Diluted earnings per
Common share (.42) 1.08 .80 (.96) 1.20
Shares used in diluted
EPS calculation 18.7 30.4 30.6 18.6 30.3
(IN MILLIONS) 1(ST) QTR 2(ND) QTR 3(RD) QTR 4(TH) QTR FULL YEAR
FISCAL 1997
Net sales $ 99.9 $345.9 $298.5 $155.0 $899.3
Gross profit 32.3 138.1 110.2 45.1 325.7
Net income (loss) (6.0) 27.9 21.1 (3.5) 39.5
Basic earnings per
common share (.45) 1.37 1.01 (.32) 1.60
Shares used in basic
EPS calculation 18.6 18.6 18.6 18.7 18.6
Diluted earnings per
common share (.45) .95 .71 (.32) 1.35
Shares used in diluted
EPS calculation 18.6 29.3 29.9 18.7 29.3
NOTES:
Certain reclassifications have been made within interim periods.
Fiscal 1998 results of operations included $20.4 million of restructuring and
other non-recurring charges, all of which were recorded in the fourth quarter.
Fiscal 1997 results of operations included $6.0 million of asset valuation
charges, $4.2 million and $1.8 million in the second and fourth quarters,
respectively.
The Company's business is highly seasonal with approximately 72% of sales
occurring in the second and third fiscal quarters combined.
NOTE 20. SUBSEQUENT EVENTS
On November 13, 1998, the Company signed a definitive agreement with Monsanto
Company to acquire the assets of Monsanto's consumer lawn and garden businesses,
exclusive of the Roundup(R) business, for approximately $300 million. The
acquired businesses will include the Ortho(R) line of pesticides which
encompasses brands such as Weed-B-Gon(R), Rose Pride(R) and Home Defense(R). As
part of the agreement, the Company will also acquire Green Cross(R), a leading
pesticides business in Canada. The
F-19
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
64
Company expects to consummate the purchase of the non-Roundup(R) businesses in
the second quarter of fiscal 1999.
On October 7, 1998, the Company acquired RPJ, continental Europe's largest
consumer lawn and garden products company, for approximately $216 million, from
Rhone-Poulenc Agro and its affiliates.
On December 4, 1998, the Company and certain of its subsidiaries entered into
new credit facilities which provide for borrowings in the aggregate principal
amount of $1.025 billion and consist of term loan facilities in the aggregate
amount of $525 million and a revolving credit facility in the amount of $500
million.
The term loan facilities consist of three tranches. The Tranche A Term Loan
Facility consists of a 6 1/2 year term loan facility in an aggregate principal
amount of $265 million, which is divided into three sub-tranches of French
Francs, German Deutschemarks and British Pounds Sterling. The Tranche A Term
Loans are to be repaid quarterly over a 6 1/2 year period. The Tranche B Term
Loan Facility consists of a 7 1/2 year term loan facility in an aggregate
principal amount of $140 million, which is to be repaid in nominal quarterly
installments for the first 6 1/2 years and in substantial quarterly installments
in the final year. The Tranche C Term Loan Facility consists of a 8 1/2 year
term loan facility in an aggregate principal amount of $120 million, which is to
be repaid in nominal quarterly installments for the first 7 1/2 years and in
substantial quarterly installments in the final year.
The revolving credit facility provides for loans up to $500 million, which are
available on a revolving basis for a term of 6 1/2 years. A portion of the
revolving credit facility, not to exceed $40 million, is available for the
issuance of letters of credit. Additionally, a portion of the facility, not to
exceed $30 million, is available for swing line loans on same-day notice. A
portion of the facility, not to exceed $225 million, is available for borrowings
in optional currencies, including German Deutschemarks, British Pounds Sterling,
French Francs, Belgian Francs, Italian Lira and other specified currencies,
provided that the outstanding revolving loans in optional currencies other than
British Pounds Sterling do not exceed $120 million. The outstanding principal
amount of all revolving credit loans may not exceed $150 million for at least 30
consecutive days during any calendar year.
Interest rates and commitment fees pursuant to the new credit facilities vary
according to the Company's leverage ratios and also within tranches. Financial
covenants include minimum net worth, interest coverage and net leverage ratios.
Other covenants include limitations on: indebtedness, liens, mergers,
consolidations, liquidations and dissolutions, sale of assets, leases,
dividends, capital expenditures, and investments, among others.
On December 15, 1998, the Company acquired Asef Holding B.V., a privately-held
Netherlands-based lawn and garden products company, for approximately $22
million.
F-20
The Scotts Company and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
65
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES
To the Shareholders and Board of Directors of The Scotts Company
Our report on the consolidated financial statements of The Scotts Company is
included on page F-2 of this Form 10-K. In connection with our audits of such
financial statements, we have also audited the financial statement schedules
listed in the Index on page F-1 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the consolidated financial statements taken as a
whole, present fairly, in all material respects, the information required to be
included therein.
PricewaterhouseCoopers LLP
Columbus, Ohio
October 23, 1998
Except for Note 20 as to which the date is December 15, 1998.
F-21
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66
THE SCOTTS COMPANY AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
(IN MILLIONS)
Column A Column B Column C Column D Column E Column F
-------- ---------- --------- --------- ---------- ----------
Balance Additions Deductions
at charged credited Balance
beginning Reserves to and at end
Classification of period Acquired expense write-offs of period
-------------- ---------- --------- --------- ---------- ----------
Valuation and qualifying accounts deducted
from the assets to which they apply:
Inventory reserve......................... $11.8 $0.5 $4.8 $(5.1) $12.0
Allowance for doubtful Accounts........... 5.7 0.8 2.6 (2.8) 6.3
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
(IN MILLIONS)
Column A Column B Column C Column D Column E Column F
-------- ---------- --------- --------- ---------- ----------
Balance Additions Deductions
at charged credited Balance
beginning Reserves to and at end
Classification of period Acquired expense write-offs of period
-------------- ---------- --------- --------- ---------- ----------
Valuation and qualifying accounts deducted
from the assets to which they apply:
Inventory reserve......................... $8.7 $2.0 $8.5 $(7.4) $11.8
Allowance for doubtful accounts........... 4.1 0.9 1.6 (0.9) 5.7
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1996
(IN MILLIONS)
Column A Column B Column C Column D Column E Column F
-------- ---------- --------- --------- ---------- ----------
Balance Additions Deductions
at charged credited Balance
beginning Reserves to and at end
Classification of period Acquired expense write-offs of period
-------------- ---------- --------- --------- ---------- ----------
Valuation and qualifying accounts deducted
from the assets to which they apply:
Inventory reserve......................... $6.7 -- $8.0 $(6.0) $8.7
Allowance for doubtful accounts........... 3.4 -- 3.4 (2.7) 4.1
F-22
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67
THE SCOTTS COMPANY
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998
INDEX TO EXHIBITS
Exhibit No. Description Location
- ----------- ----------- --------
2(a) Amended and Restated Agreement and Plan of Merger, dated as Incorporated herein by
of May 19, 1995, among Stern's Miracle-Gro Products, Inc., reference to the Registrant's
Stern's Nurseries, Inc., Miracle-Gro Lawn Products, Inc., Current Report on Form 8-K
Miracle-Gro Products Limited, Hagedorn Partnership, L.P., filed with the Securities and
the general partners of Hagedorn Partnership, L.P., Horace Exchange Commission (the "SEC")
Hagedorn, Community Funds, Inc., and John Kenlon, The Scotts on June 2, 1995 (File No.
Company (the "Registrant"), and ZYX Corporation 0-19768) [Exhibit 2(b)]
2(b) Agreement for the Sale and Purchase of Levington Group Incorporated herein by
Limited, dated December 12, 1997, between Scotts Holdings reference to the Registrant's
Limited, as Purchaser, and Prudential Nominees Limited PAC Current Report on Form 8-K
Account; Prudential Nominees Limited PSPS Account; dated December 29, 1997 (File
Prudential Nominees Limited USV Account; Prudential Nominees No. 1-11593) [Exhibit 2]
Limited BMV Account; Prudential Nominees Limited Holborn
Account; Prutec Limited; The Sears Pension Plan by The Chase
Manhattan Bank NA; HSBC Equity Limited; Candover Investments
plc; Candover Trustees Limited; Candover Partners Limited as
General Partner of Candover 1991 Lead Investors Limited
Partner; Candover Partners Limited as General Partner of
Candover 1991 UK Limited Partnership; Candover Partners
Limited as General Partner of Candover 1991 US Limited
Partnership; 3i Group plc; NatWest Ventures Investments
Limited; Philip Parry; Mrs. L. Parry; Philip Parry and Lynne
Parry as trustees of the Parry Trust; N.W. Gibbs; Mrs. A.
Gibbs; N.W. Gibbs and A. Gibbs as trustees of the Gibbs
Trusts; P.J. Elsdon; Mrs. B. Elsdon; P.J. Elsdon and B.
Elsdon as trustees of the Elsdon Trust; and Fairmount
Trustee Services Limited as trustee for the time being of
the Levington Unapproved Pension Fund, as Sellers
2(c) Master Contract, dated September 30, 1998, by and between Incorporated herein by
Rhone-Poulenc Agro; the Registrant; Scotts Celaflor GmbH & reference to the Registrant's
Co. K.G.; "David" Sechsundfunfzigste Beteiligungs und Current Report on Form 8-K
Verwaltungsgesellschaft mbH; Rhone-Poulenc Agro Europe GmbH; dated October 22, 1998 (File
Scotts France Holdings S.A.R.L.; Scotts France S.A.R.L.; and No. 1-11593) [Exhibit 2]
Scotts Belgium 2 B.V.B.A.
2(d) Asset Purchase Agreement, dated as of November 11, 1998, *
between Monsanto Company and the Registrant
3(a) Amended Articles of Incorporation of the Registrant as filed Incorporated herein by
with the Ohio Secretary of State on September 20, 1994 reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1994 (File No. 0-19768)
[Exhibit 3(a)]
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68
Exhibit No. Description Location
- ----------- ----------- --------
3(b) Certificate of Amendment by Shareholders to the Articles of Incorporated herein by
Incorporation of the Registrant as filed with the Ohio reference to the Registrant's
Secretary of State on May 4, 1995 Quarterly Report on Form 10-Q
for the fiscal quarter ended
April 1, 1995 (File No.
0-19768) [Exhibit 4(b)]
3(c) Regulations of the Registrant (reflecting amendments adopted Incorporated herein by
by the shareholders of the Registrant on April 6, 1995) reference to the Registrant's
Quarterly Report on Form 10-Q
for the fiscal quarter ended
April 1, 1995 (File No.
0-19768) [Exhibit 4(c)]
4(a) Form of Series A Warrant Included in Exhibit 2(a) above
4(b) Form of Series B Warrant Included in Exhibit 2(a) above
4(c) Form of Series C Warrant Included in Exhibit 2(a) above
4(d) Credit Agreement, dated as of December 4, 1998, by and among Incorporated herein by
the Registrant; OM Scott International Investments Ltd., reference to the Registrant's
Miracle Garden Care Limited, Scotts Holdings Limited, Current Report on Form 8-K,
Hyponex Corporation, Scotts' Miracle-Gro Products, Inc., dated December 11, 1998 (File
Scotts-Sierra Horticultural Products Company, Republic Tool No. 1-11593) [Exhibit 4]
& Manufacturing Corp., Scotts-Sierra Investments, Inc.,
Scotts France Holdings SARL, Scotts Holding GmbH, Scotts
Celaflor GmbH & Co. KG, Scotts France SARL, Scotts Belgium 2
BVBA and The Scotts Company (UK) Ltd. as Subsidiary
Borrowers; the lenders party thereto; The Chase Manhattan
Bank as Administrative Agent; Salomon Smith Barney, Inc. as
Syndication Agent; Credit Lyonnais Chicago Branch and NBD
Bank as Co-Documentation Agents; and Chase Securities Inc.
as Lead Arranger and as Book Manager
4(e) Subordinated Indenture, dated as of June 1, 1994, among The Incorporated herein by
Scotts Company, a Delaware corporation ("Scotts Delaware"), reference to the Registration
The O.M. Scott & Sons Company ("OMS") and Chemical Bank, as Statement on Form S-3 of Scotts
trustee Delaware filed with the SEC on
June 1, 1994 (Registration No.
33-53941) [Exhibit 4(b)]
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69
Exhibit No. Description Location
- ----------- ----------- --------
4(f) First Supplemental Indenture, dated as of July 12, 1994, Incorporated herein by
among Scotts Delaware, OMS and Chemical Bank, as trustee reference to Scotts Delaware's
Current Report on Form 8-K
dated July 18, 1994 (File No.
0-19768) [Exhibit 4.1]
4(g) Second Supplemental Indenture, dated as of September 20, Incorporated herein by
1994, among the Registrant, OMS, Scotts Delaware and reference to the Registrant's
Chemical Bank, as trustee Annual Report on Form 10-K for
the fiscal year ended September
30, 1994 (File No. 0-19768)
[Exhibit 4(i)]
4(h) Third Supplemental Indenture, dated as of September 30, Incorporated herein by
1994, between the Registrant and Chemical Bank, as trustee reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1994 (File No. 0-19768)
[Exhibit 4(j)]
10(a) The Scotts Company Associates' Pension Plan as amended Incorporated herein by
effective January 1, 1989 and December 31, 1995 (the reference to the Registrant's
"Pension Plan") Annual Report on Form 10-K for
the fiscal year ended September
30, 1996 (File No. 1-11593)
[Exhibit 10(a)]
10(b) First Amendment to the Pension Plan Incorporated herein by
reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1997 (File No. 1-11593)
[Exhibit 10(b)]
10(c) The Scotts Company Retirement Savings Plan *
10(d) First Amendment to The Scotts Company Retirement Savings *
Plan
10(e) Second Amendment to The Scotts Company Retirement Savings *
Plan
10(f) The O.M. Scott & Sons Company Excess Benefit Plan, effective Incorporated herein by
October 1, 1993 reference to Scotts Delaware's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1993 (File No. 0-19768)
[Exhibit 10(h)]
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70
Exhibit No. Description Location
- ----------- ----------- --------
10(g) The Scotts Company 1992 Long Term Incentive Plan Incorporated herein by
reference to Scotts Delaware's
Registration Statement on Form
S-8 filed on March 26, 1993
(Registration No. 33-60056)
[Exhibit 4(f)]
10(h) The Scotts Company 1998 Executive Annual Incentive Plan *
10(i) The Scotts Company 1996 Stock Option Plan (as amended *
through September 1, 1998)
10(j) The Scotts Company Executive Retirement Plan *
10(k) Employment Agreement, dated as of May 19, 1995, between the Incorporated herein by
Registrant and James Hagedorn reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1995 (File No. 1-11593)
[Exhibit 10(p)]
10(l) Consulting Agreement, dated July 9, 1997, among Scotts' Incorporated herein by
Miracle-Gro Products, Inc., the Registrant and Horace reference to the Registrant's
Hagedorn Annual Report on Form 10-K for
the fiscal year ended September
30, 1997 (File No. 1-11593
[Exhibit 10(1)]
10(m) Employment Agreement, dated as of May 19, 1995, among Incorporated herein by
Stern's Miracle-Gro Products, Inc. (nka Scotts' Miracle-Gro reference to the Registrant's
Products, Inc.), the Registrant and John Kenlon Annual Report on Form 10-K for
the fiscal year ended September
30, 1996 (File No. 1-11593)
[Exhibit 10(k)]
10(n) Employment Agreement, dated as of August 7, 1998, between *
the Registrant and Charles M. Berger, and three attached
Stock Option Agreements with the following effective dates:
September 23, 1998; October 21, 1998 and September 24, 1999
10(o) Stock Option Agreement, dated as of August 7, 1996, between Incorporated herein by
the Registrant and Charles M. Berger reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1996 (File No. 1-11593)
[Exhibit 10(m)]
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71
Exhibit No. Description Location
- ----------- ----------- --------
10(p) Letter Agreement, dated December 23, 1996, between the Incorporated herein by
Registrant and Jean H. Mordo reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1997 (File No. 1-11593)
[Exhibit 10(p)]
10(q) Specimen form of Stock Option Agreement for Non-Qualified *
Stock Options
10(r) Letter Agreement, dated April 10, 1997, between the Incorporated herein by
Registrant and G. Robert Lucas reference to the Registrant's
Annual Report on Form 10-K for
the fiscal year ended September
30, 1997 (File No. 1-11593)
[Exhibit 10(r)]
10(s) Letter Agreement, dated December 17, 1997, between the *
Registrant and William R. Radon
10(t) Letter Agreement, dated March 30, 1998, between the *
Registrant and William A. Dittman
10(u) Amended and Restated Exclusive Agency and Marketing *
Agreement, dated as of September 30, 1998, between Monsanto
Company and the Registrant
10(v) Exclusive Distributor Agreement -- Horticulture, effective *
as of June 22, 1998, between the Registrant and AgrEvo USA
21 Subsidiaries of the Registrant *
23 Consent of Independent Accountants *
27 Financial Data Schedule *
- ---------------
*Filed herewith.
E-5
The Scotts Company and Subsidiaries