1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 29, 1997 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 31-1199481 - ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 14111 Scottslawn Road Marysville, Ohio 43041 ---------------------------------------- (Address of principal executive offices) (Zip Code) (937) 644-0011 ---------------------------------------------------- (Registrant's telephone number, including area code) No change -------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. 18,597,147 Outstanding at May 7, 1997 - ----------------------------------- ------------------------------------- Common Shares, voting, no par value Page 1 of 34 pages Exhibit Index at page 23
2 THE SCOTTS COMPANY AND SUBSIDIARIES INDEX <TABLE> <CAPTION> PAGE NO. -------- <S> <C> <C> Part I. Financial Information: Item 1. Financial Statements Consolidated Statements of Operations - Three month and six month periods ended March 29, 1997 and March 30, 1996 3 Consolidated Statements of Cash Flows - Six month periods ended March 29, 1997 and March 30, 1996 4 Consolidated Balance Sheets - March 29, 1997, March 30, 1996 and September 30, 1996 5 Notes to Consolidated Financial Statements 6-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-20 Part II. Other Information Item 1. Legal Proceedings 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 6. Exhibits and Reports on Form 8-K 21 Signatures 22 Exhibit Index 23 </TABLE> Page 2
3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS THE SCOTTS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (in millions except per share amounts) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED --------------------------- ------------------------ March 29 March 30 March 29 March 30 1997 1996 1997 1996 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net sales $346.2 $251.2 $446.4 $369.2 Cost of sales 207.8 163.5 275.4 244.7 ------ ------ ------ ------ Gross profit 138.4 87.7 171.0 124.5 Selling, general and administrative 40.1 34.3 66.7 63.4 Advertising and promotion 35.0 21.7 43.5 31.0 Amortization of goodwill and other intangibles 2.7 2.2 4.9 4.4 Other expenses, net 3.2 2.4 3.5 4.6 ------ ------ ------ ------ Income from operations 57.4 27.1 52.4 21.1 Interest expense 8.3 8.1 13.9 14.7 ------ ------ ------ ------ Income before income taxes 49.1 19.0 38.5 6.4 Income taxes 21.2 8.4 16.6 2.9 ------ ------ ------ ------ Net income 27.9 10.6 21.9 3.5 Preferred stock dividends 2.4 2.4 4.9 4.9 ------ ------ ------ ------ Income (loss) applicable to common shareholders $ 25.5 $ 8.2 $ 17.0 $ (1.4) ====== ====== ====== ====== Income (loss) per common share (note 8) $ .95 $ .36 $ .75 $ (.08) ====== ======= ====== ====== Common shares used in per common share computation 29.3 29.4 29.2 18.8 ====== ======= ====== ====== </TABLE> See Notes to Consolidated Financial Statements Page 3
4 THE SCOTTS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in millions) <TABLE> <CAPTION> SIX MONTHS ENDED -------------------------- March 29 March 30 1997 1996 -------- -------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 21.9 $ 3.5 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 14.8 14.3 Equity in income of unconsolidated business (.1) (.4) Postretirement benefits .1 .1 Net increase in certain components of working capital (177.6) (162.8) Net increase in other assets and liabilities and other adjustments 2.3 2.0 ------ ------ Net cash used in operating activities (138.6) (143.3) ----- ------ CASH FLOWS FROM INVESTING ACTIVITIES Investment in property, plant and equipment, net (4.1) (8.3) Acquisition of Miracle Holdings Limited (47.1) - ------ ------ Net cash used in investing activities (51.2) (8.3) ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES Payments on term and other debt (.3) (.3) Revolving lines of credit and bank line of credit, net 200.5 153.3 Issuance of Common Shares .4 5.1 Deferred financing costs incurred (.2) - Dividends on preferred stock (4.9) (4.9) ------- ------ Net cash provided by financing activities 195.5 153.2 ----- ------ Effect of exchange rate changes on cash (4.3) (.2) ------- ------ Net increase in cash 1.4 1.5 Cash at beginning of period 10.6 7.0 ------ ------ Cash at end of period $ 12.0 $ 8.5 ====== ====== SUPPLEMENTAL CASH FLOW INFORMATION Interest paid, net of amount capitalized $ 11.0 $ 12.2 Income taxes paid $ 1.9 $ 2.6 Business acquired: Fair value of assets acquired $103.5 Liabilities assumed 45.3 Net cost for acquisition 58.2 </TABLE> See Notes to Consolidated Financial Statements Page 4
5 THE SCOTTS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) (in millions) <TABLE> <CAPTION> ASSETS March 29 March 30 September 30 1997 1996 1996 --------- ------- ------- <S> <C> <C> <C> Current Assets: Cash $ 12.0 $ 8.5 $ 10.6 Accounts receivable, less allowances of $6.2, $3.9, and $4.1, respectively 349.7 315.4 110.4 Inventories 188.3 187.4 148.8 Prepaid and other assets 22.4 21.9 22.1 --------- ------- ------- Total current assets 572.4 533.2 291.9 --------- ------- ------- Property, plant and equipment, net 134.8 147.4 139.5 Trademarks 85.9 88.1 87.0 Other intangibles 17.2 22.1 19.5 Goodwill 251.7 181.6 180.2 Other assets 2.1 15.8 13.6 --------- ------- ------- Total Assets $ 1,064.1 $ 988.2 $ 731.7 ========= ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Revolving credit line $ 128.5 $ 100.9 $ 2.0 Current portion of term debt .1 .2 .2 Accounts payable 85.0 78.6 46.3 Accrued liabilities 77.0 46.7 42.6 Accrued taxes 37.5 21.1 19.7 --------- ------- ------- Total current liabilities 328.1 247.5 110.8 --------- ------- ------- Term debt, less current portion 324.4 324.5 223.1 Postretirement benefits other than pensions 27.2 27.3 27.2 Other liabilities 6.0 5.1 6.3 --------- ------- ------- Total Liabilities 685.7 604.4 367.4 --------- ------- ------- Commitments and Contingencies Shareholders' Equity: Class A Convertible Preferred Stock, no par value 177.3 177.3 177.3 Common Shares, $.01 stated value, issued 21.1 shares in 1997 and 1996 .2 .2 .2 Capital in excess of par value 207.6 207.7 207.7 Retained earnings 37.4 31.3 20.4 Cumulative foreign currency translation adjustments (1.1) 3.4 2.2 Treasury stock, 2.5 shares on March 29, 1997 and September 30, 1996, and 2.1 shares on March 30, 1996, at cost (43.0) (36.1) (43.4) --------- ------- ------- Total Shareholders' Equity 378.3 383.8 364.3 --------- ------- ------- Total Liabilities and Shareholders' Equity $ 1,064.1 $ 988.2 $ 731.7 ========= ======= ======= </TABLE> See Notes to Consolidated Financial Statements Page 5
6 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. ORGANIZATION AND BASIS OF PRESENTATION -------------------------------------- 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 United Kingdom, continental Europe, Southeast Asia, the Middle East, Africa, Australia, New Zealand, and several Latin American countries. The Company's business is highly seasonal with approximately 70% of sales occurring in the second and third fiscal quarters. BASIS OF PRESENTATION --------------------- The consolidated financial statements include the accounts of The Scotts Company ("Scotts") and its wholly-owned subsidiaries, Hyponex Corporation ("Hyponex"), Republic Tool and Manufacturing Corp. ("Republic"), Scotts-Sierra Horticultural Products Company ("Sierra"), Scotts' Miracle-Gro Products, Inc. ("Miracle-Gro"), and Miracle Holdings Limited ("Miracle Holdings") (collectively, the "Company"). All material intercompany transactions have been eliminated. The consolidated balance sheets as of March 29, 1997 and March 30, 1996, the related consolidated statements of operations for the three and six month periods ended March 29, 1997 and March 30, 1996 and the related consolidated statements of cash flows for the six month periods ended March 29, 1997 and March 30, 1996 are unaudited; however, in the opinion of management, such financial statements contain all adjustments necessary for the fair presentation of the Company's financial position and results of operations. Interim results reflect all normal recurring adjustments and are not necessarily indicative of results for a full year. The interim financial statements and notes are presented as specified by Regulation S-X of the Securities and Exchange Commission, and should be read in conjunction with the financial statements and accompanying notes in Scotts' fiscal 1996 Annual Report on Form 10-K. 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, marketing 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. RECLASSIFICATION ---------------- Certain reclassifications have been made to the prior years' financial statements to conform to fiscal 1997 classifications. ADVERTISING COSTS ----------------- In the quarter ended March 29, 1997, the Company changed its method of accounting for advertising expenses in interim periods. The newly adopted method assigns anticipated advertising costs to interim periods based on projected sales of advertised product Page 6
7 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements categories and has been applied retroactive to the beginning of fiscal 1997 (October 1, 1996). This change impacts interim periods only; all current year advertising costs will be expensed within the fiscal year. Management believes this method of interim accounting for advertising costs provides better matching of revenues and expenses in interim periods, and is consistent with companies in the consumer packaged goods industry. This change in interim accounting had the effect of increasing advertising expense for the first and second quarters of fiscal 1997, and for the six months ended March 29, 1997 by $3.3 million, $4.6 million and $7.9 million, respectively. Net income for the first and second quarters of fiscal 1997, and for the six months ended March 29, 1997 decreased by $1.9 million or $.10 per share, $2.6 million or $.09 per share and $4.5 million or $.15 per share, respectively. 2. ACQUISITIONS ------------ Effective January 3, 1997, the Company acquired the approximately two-thirds interest in Miracle Holdings which the Company did not already own. Miracle Holdings owns Miracle Garden Care Limited, a manufacturer and distributor of lawn and garden products in the United Kingdom. The following pro forma results of operations give effect to the Miracle Holdings acquisition as if it had occurred on October 1, 1995. <TABLE> <CAPTION> (in millions, except per share amounts) SIX MONTHS ENDED -------------------------------------- March 29 March 30 1997 1996 ------- -------- <S> <C> <C> Net sales $ 457.2 $ 399.5 ======= ======== Net income $ 22.5 $ 4.6 ======= ======== Income (loss) per common share $ 0.77 $ (0.02) ======= ======= </TABLE> Pro forma primary net income per common share for the six months ended is calculated using the weighted average common shares outstanding at March 29, 1997 of 29.2 million and at March 30, 1996 of 18.8 million. The pro forma information provided does not purport to be indicative of actual results of operations if the Miracle Holdings Limited acquisition had occurred as of October 1, 1995, and is not intended to be indicative of future results or trends. 3. INVENTORIES ----------- (in millions) Inventories, net of provisions of $10.2, $6.9 and $8.7, consisted of: <TABLE> <CAPTION> March 29 March 30 September 30 1997 1996 1996 ---- ---- ---- <S> <C> <C> <C> Finished Goods $ 128.5 $ 122.8 $ 96.7 Raw Materials 59.8 64.6 52.1 -------- -------- -------- $ 188.3 $ 187.4 $ 148.8 ======== ======== ======== </TABLE> Page 7
8 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements 4. LONG-TERM DEBT -------------- (in millions) <TABLE> <CAPTION> March 29 March 30 September 30 1997 1996 1996 -------- -------- --------- <S> <C> <C> <C> Revolving Credit Line $ 353.5 $ 326.1 $ 125.7 9 7/8% Senior Subordinated Notes $100 million face amount due 2004 99.4 99.3 99.4 Capital lease obligations and other .1 .2 .2 -------- -------- --------- 453.0 425.6 225.3 Less current portions 128.6 101.1 2.2 -------- -------- --------- $ 324.4 $ 324.5 $ 223.1 ======== ======== ======== </TABLE> Maturities of term debt for the next five calendar years are as follows: <TABLE> <S> <C> 1997 128.6 1998 0 1999 0 2000 225.0 2001 0 Thereafter 100.0 </TABLE> On December 23, 1996, the Company entered into an amendment to the Fourth Amended and Restated Credit Agreement with Chase Manhattan Bank and various participating banks. The amendment provides, on an unsecured basis, up to $425 million to the Company, which represents an increase of $50 million to the revolving credit facility, and establishes a $100 million sub-tranche to be available in U. K. Pounds Sterling. 5. FOREIGN EXCHANGE INSTRUMENTS ---------------------------- The Company enters into forward foreign exchange contracts and purchases currency options to hedge its exposure to fluctuations in foreign currency exchange rates. These contracts generally involve the exchange of one currency for a second currency at some future date. Counterparties to these contracts are major financial institutions. Gains and losses on these contracts generally offset gains and losses on the assets, liabilities and transactions being hedged. Effective in the second quarter of 1997, the Company significantly reduced this program. Realized and unrealized foreign exchange gains and losses are recognized and offset foreign exchange gains or losses on the underlying exposures. Unrealized gains and losses that are designated and effective as hedges on such transactions are deferred and recognized in income in the same period as the hedged transactions. At March 29, 1997, the Company's European operations had foreign exchange risk in various European currencies tied to the Dutch Guilder. These currencies are the Belgian Franc, German Mark, Spanish Peseta, Italian Lire, French Franc, British Pound, Australian Dollar and U. S. Dollar. The Company's U. S. operations had foreign exchange rate risk in the Canadian Dollar, the Dutch Guilder and the British Pound which are tied to the U. S. Dollar. As of March 29, 1997, the Company had outstanding forward foreign exchange contracts with a contract value of approximately $2.4 million. These contracts have maturity dates ranging from June 10, 1997 to June 24, 1997. Page 8
9 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements 6. ACCOUNTING ISSUES ----------------- In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation," effective for financial statements for fiscal years beginning after December 15, 1995. SFAS No. 123 provides for, but does not require, a fair value method of accounting for stock-based compensation arrangements rather than the intrinsic value method previously required. Alternatively, entities that retain the intrinsic value method are required to disclose in the notes to the financial statements pro forma net income and earnings per share information as if the fair value method had been applied. The Company does not intend to adopt the fair value method of SFAS No. 123; therefore, this standard will not have a material effect on the Company's consolidated financial statements. 7. OTHER EXPENSES, NET ------------------- Other expenses, net consisted of the following: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------------- -------------------------- March 29 March 30 March 29 March 30 1997 1996 1997 1996 -------- -------- -------- -------- <S> <C> <C> <C> <C> Foreign currency $ - $ (0.2) $ 0.3 $ 0.1 Royalty (income) expense (1.1) (0.2) (1.1) (0.3) Asset valuation charges 4.2 0.5 4.3 0.8 Restructuring/severance - 2.7 - 4.5 Equity in income of unconsolidated businesses - 0.3 0.1 0.4 Other, net 0.1 (0.7) (0.1) (0.9) ------ ------ ------ ------ Total $ 3.2 $ 2.4 $ 3.5 $ 4.6 ====== ====== ====== ====== </TABLE> Page 9
10 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements 8. NET INCOME (LOSS) PER COMMON SHARE ---------------------------------- Net income (loss) per common share is based on the weighted average number of common shares and common share equivalents (stock options, Class A Convertible Preferred Stock and warrants) outstanding each period. The following table presents information necessary to calculate income (loss) per common share. <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ---------------------- ------------------ March 29 March 30 March 29 March 30 1997 1996 1997 1996 -------- -------- -------- ------ (in millions except per share amounts) <S> <C> <C> <C> <C> Net income $ 27.9 $ 10.6 $ 21.9 $ 3.5 Class A Convertible Preferred Stock dividend NA NA NA 4.9 ---- ---- ---- --- Income (loss) used in net income (loss) per common share calculation $ 27.9 $ 10.6 $ 21.9 $(1.4) ==== ==== ==== === Weighted average common shares outstanding during the period 18.6 18.9 18.6 18.8 Assuming conversion of Class A Convertible Preferred Stock 10.3 10.3 10.3 NA Assuming exercise of warrants - - - - Assuming exercise of options using the Treasury Stock Method 0.4 0.2 0.3 NA ----- ----- ----- ----- Weighted average number of common shares outstanding as adjusted 29.3 29.4 29.2 18.8 ==== ==== ==== ==== Income (loss) per common share $ .95 $ .36 $ .75 $ (.08) ===== ===== ===== ===== </TABLE> The shares of Class A Convertible Preferred Stock and stock options were not considered in the earnings per share computation for the six months ended March 30, 1996 because they were antidilutive for such period. Fully diluted net income (loss) per common share is considered to be the same as primary net income (loss) per common share. Page 10
11 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"). FAS 128 establishes standards for computing and presenting earnings per share ("EPS"). FAS 128 replaces the presentation of primary EPS with a presentation of basic EPS which excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. This statement also requires dual presentation of basic EPS and diluted EPS on the face of the income statement for all periods presented. FAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. The Company plans to adopt FAS 128 in the first quarter of 1998 for the year ended September 30, 1998. If FAS 128 had been adopted at March 29, 1997, basic and diluted earnings (loss) per share would be: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ---------------------- ------------------ March 29 March 30 March 29 March 30 1997 1996 1997 1996 -------- -------- -------- ------ <S> <C> <C> <C> <C> Basic earnings (loss) per share $ 1.37 $ .43 $ .92 $ (.08) ===== ===== ===== ===== Diluted earnings (loss) per share $ .95 $ .36 $ .75 $ (.08) ===== ===== ===== ===== </TABLE> 9. CONTINGENCIES ------------- Management continually evaluates the Company's contingencies, including various lawsuits and claims which arise in the normal course of business. 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. In September 1991, the Company was identified by the Ohio Environmental Protection Agency (the "Ohio EPA") as a Potentially Responsible Party ("PRP") with respect to a site in Union County, Ohio (the "Hershberger site") that has allegedly been contaminated by hazardous substances whose transportation, treatment or disposal the Company allegedly arranged. Pursuant to a consent order with the Ohio EPA, the Company, together with four other PRP's identified to date, investigated the extent of contamination in the Hershberger site. The results of the investigation were that the site presents a low degree of risk and that the chemical compounds which contribute to the risk are not compounds used by the Company. However, as a result of the joint and several liability of PRP's, the Company may choose to participate in voluntary remediation efforts which might occur at the site. Management does not believe any such obligations would have a material adverse effect on the Company's results of operations or financial condition. In July 1990, the Philadelphia District of the Army Corps of Engineers directed that peat harvesting operations be discontinued at Hyponex's Lafayette, New Jersey facility, and the Company complied. In May 1992, the Department of Justice in the U. S. District Court for the District of New Jersey, filed suit seeking a permanent injunction against such harvesting at that facility and civil penalties. The Philadelphia District of the Corps has taken the position that peat harvesting activities there require a permit under Section 404 of the Clean Water Act. 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. 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 adversely affected by continued closure of this peat harvesting operation. Page 11
12 THE SCOTTS COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements On January 30, 1996, the United States Environmental Protection Agency (the "U. S. EPA") served a Complaint and Notice of Opportunity for Hearing upon Sierra's wholly-owned subsidiary, Scotts-Sierra Crop Protection Company ("Crop Protection"). The Complaint alleged labeling violations under the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA") during 1992 and 1993 and proposed penalties totaling $785,000, the maximum allowable under FIFRA according to management's calculations. On February 11, 1997, the U.S. EPA's Motion for Accelerated Decision was granted on the issue of liability, with the amount of the civil penalty to be a resolved at hearing. Based upon Crop Protection's good faith compliance actions and FIFRA's provisions for "gravity-based" penalty reductions, management believes Crop Protection's maximum liability in this action to be $200,000. The Company does not believe that the outcome of this proceeding will have a material adverse effect on its financial condition or results of operations. The Company has been assessing and, as necessary, addressing certain environmental issues regarding the wastewater treatment plants currently operating at its Marysville facility. Specifically, it has been considering whether to upgrade the existing treatment plants or to attempt to tie the facility's wastewater into the City of Marysville's municipal treatment system. Additionally, the Company has been assessing, under Ohio's new Voluntary Action Program, the possible remediation of several discontinued on-site waste disposal areas dating back to the early operations of its Marysville facility. On February 11, 1997, the Company was informed that the Ohio EPA was referring certain matters relating to the Company's wastewater treatment plants and on-site disposal areas to the Ohio Attorney General's office. Representatives from the Ohio EPA, the Ohio Attorney General's office and the Company have had one meeting subsequent to February 11 to discuss these issues. Although the Company has not yet been informed as to the specific nature of any issues or the expected remedial response, all parties have expressed an interest in reaching an amicable resolution. The Company expects that a consent order will be negotiated with the Ohio EPA. The Company does not believe that any proceedings which may result from the Ohio EPA's referral of these matters to the Ohio Attorney General will be material to the business or financial condition of the Company but is unable, at this early stage, to predict the outcome of these issues. Page 12
13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the consolidated results of operations, cash flows and financial position of the Company should be read in conjunction with the Consolidated Financial Statements of the Company included elsewhere in this report. The Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1996 includes additional information about the Company, its operations, and its financial position, and should be read in conjunction with this quarterly report on Form 10-Q. RESULTS OF OPERATIONS Before reviewing the details of the Company's second quarter and first six months results, the reader should keep in mind the following matters. In the quarter ended March 29, 1997, the Company changed its method of accounting for advertising expenses in interim periods. The newly adopted method assigns anticipated advertising costs to interim periods based on projected sales of advertised product categories and has been applied retroactive to the beginning of fiscal 1997 (October 1, 1996). This change impacts interim periods only; all current year advertising costs will be expensed within the fiscal year. Management believes this method of interim accounting for advertising costs provides better matching of revenues and expenses in interim periods, and is consistent with companies in the consumer packaged goods industry. This change in interim accounting had the effect of increasing advertising expense for the first and second quarters of fiscal 1997, and for the six months ended March 29, 1997 by $3.3 million, $4.6 million and $7.9 million, respectively. Net income for the first and second quarters of fiscal 1997, and for the six months ended March 29, 1997 decreased by $1.9 million or $0.10 per share, $2.6 million or $.09 per share and $4.5 million or $0.15 per share, respectively. Effective with the second quarter of fiscal 1997, The Scotts Company has made several changes in its financial statement presentation. First, the Company has reformatted its statement of operations as follows: (1) Distribution expense is included in cost of sales; (2) Selling, general and administrative expenses are combined (include research and development); and (3) Advertising and promotion expenses are shown separately. Second, the business unit net sales breakdowns have been updated to include Canadian net sales as part of the North American business units in which they are managed. Canadian net sales had previously been disclosed as part of International. Annual Canadian net sales have been approximately $10.0 million or less historically. Page 13
14 THREE MONTHS ENDED MARCH 29, 1997 VERSUS THE THREE MONTHS ENDED MARCH 30, 1996 - ------------------------------------------------------------------------------ The following table sets forth the components of income and expense for the second quarter and first six months of fiscal 1997 and 1996 on a percentage-of-net sales basis: <TABLE> <CAPTION> Three Months Ended Six Months Ended ------------------ Period to ---------------- Period to March 29 March 30 Period March 29 March 30 Period 1997 1996 % Change 1997 1996 % Change ------- -------- -------- ------- ------- -------- <S> <C> <C> <C> <C> <C> <C> Net sales 100.0% 100.0% 37.8% 100.0% 100.0% 20.9% Cost of sales 60.0 65.1 27.1 61.7 66.3 12.5 ------ ------ ------ ------ Gross profit 40.0 34.9 57.8 38.3 33.7 37.3 Selling, general and administrative 11.6 13.7 16.9 14.9 17.2 5.2 Advertising and promotion 10.1 8.6 61.3 9.7 8.4 40.3 Amortization of goodwill and other intangibles 0.8 0.9 22.7 1.1 1.2 11.4 Other (income) expense 0.9 1.0 33.3 0.8 1.3 (23.9) ------- -------- ------- ------- Income from operations 16.6 10.8 111.8 11.7 5.7 148.3 Interest expense 2.4 3.2 2.5 3.1 4.0 (5.4) ------- ------- ------- ------- Income before taxes 14.2 7.6 158.4 8.6 1.7 501.6 Income taxes 6.1 3.3 152.4 3.7 0.8 472.4 ------- ------- ------- ------- Net income 8.1 4.2 163.2% 4.9 0.9 525.7% Preferred stock dividends 0.7 1.0 NM 1.1 1.3 NM ------- -------- ------- ------- Income (loss) applicable to common shareholders 7.4% 3.3% NM 3.8% (0.4)% NM ======= ======= ======= ======== </TABLE> The following table sets forth the sales by business unit for the second quarter and first six months of fiscal 1997 and 1996 (in millions). <TABLE> <CAPTION> % CHANGE V. % CHANGE V. ----------- ----------- Q2 1996 1996 First Half 1996 1996 1997 ACTUAL AS ADJUSTED 1997 ACTUAL AS ADJUSTED ---- ------ ------------ ---------- ------ ----------- (1) (1) <S> <C> <C> <C> <C> <C> <C> Consumer Lawns $ 152.5 63.1% 9.5% $ 185.9 30.6% 8.5% Consumer Gardens 55.5 18.1 66.3 11.6 Organics 56.2 1.1 70.6 (0.8) ------ ------ Domestic consumer 264.2 34.7 9.2 322.8 18.2 6.9 ----- ----- Professional 41.6 13.0 68.2 6.6 International 40.4 120.8 55.4 72.1 ------ ------ Consolidated $ 346.2 37.8% 16.6% $ 446.4 20.9% 12.1% ===== ===== </TABLE> (1)Reflects net sales adjustments of $45.8 million for the second quarter of 1996 and $29.0 million for the first six months of 1996 for the 1995 Consumer Lawns early purchase program that encouraged retailers to build their inventories well in advance of the second and third quarter of 1996. Page 14
15 THREE MONTHS ENDED MARCH 29, 1997 VERSUS THE THREE MONTHS ENDED MARCH 30, 1996 Net sales for the three months ended March 29, 1997 totaled $346.2 million, an increase of $95.0 million or 37.8%. Management estimates that approximately $45.8 million (19.9%) of this increase was due to the 1995 Consumer Lawns retailer early purchase program that had the effect of depressing sales in the second and third quarters of fiscal 1996. The January 3, 1997 acquisition of the remaining two-thirds interest in Miracle Garden Care Limited ("MGC") increased second quarter sales by $21.3 million or 8.4%. The remaining 9.5% increase in second quarter 1997 sales was primarily attributable to sales volumes in Consumer Gardens, Professional, Consumer Lawns, and International. Consumer Lawns Group net sales increased $59.0 million or 63.1% to $152.5 million, primarily as a result of volume increases. Management estimates that approximately $45.8 million (53.6%) of this quarterly sales increase is attributable to the discontinuance of the 1995 early purchase program that encouraged retailers to build their inventories well in advance of the second and third quarters of 1996. After adjusting for this program change, management estimates that the Consumer Lawns Group quarterly net sales increase was 9.5%. Consumer Gardens Group net sales increased $8.5 million or 18.1% to $55.5 million. Consumer Gardens Group net sales increased primarily as a result of volume, including the inclusion of grass seed into the Group's distribution network starting in fiscal 1997. Organics Business Group net sales increased $0.6 million or 1.1% to $56.2 million, in line with this group's focus on profitability, not revenues. Professional Business Group net sales increased $4.8 million or 13.0% to $41.6 million, as this Group's customers move more to just-in-time inventory management. International Business Group net sales increased $22.1 million or 120.8% to $40.4 million. MGC contributed $21.3 million of this net sales increase. Excluding the impact of MGC, International Business Group net sales increased $0.8 million or 4.4%, with a volume increase of approximately 17.5% largely offset by unfavorable exchange rate movements that resulted in a 13.1% quarter-to-quarter reduction in International net sales after translation to U.S. dollars. Cost of sales were 60.0% of net sales for the three months ended March 29, 1997, a 5.1 percentage point decrease compared to 65.1% in the same period of the prior year. This improvement is attributable to the discontinuance of promotional programs to drive out-of-season sales, the discontinuance of lower margin professional and consumer products, and manufacturing and distribution efficiencies. Operating expenses increased $20.4 million or 33.7% to $81.0 million. Operating expenses were 23.4% of net sales compared to 24.1% in the prior year. Selling, general and administrative expenses increased $5.8 million or 16.9% to $40.1 million. This increase reflects the inclusion of MGC for the first time, and higher salesforce and general management incentives in the current year, partially offset by cost savings generated by restructuring efforts in 1996. As a percentage of net sales, selling, general and administrative expenses decreased from 13.7% to 11.6%. Advertising and promotion expenses increased by $13.3 million or 61.3% to $35.0 million. As a percentage of net sales, advertising and promotion expenses increased to 10.1% from 8.6%. Approximately $4.5 million (20.7%) of this increase is attributable to the change in interim accounting for advertising, as previously discussed. Exclusive of the change in interim accounting for advertising, overall higher investment in media spending on brand building increased this expense by approximately $2.7 million (12.4%). Trade promotions related to the significant increase in second quarter consumer sales increased approximately $3.0 million (13.8%). The inclusion of MGC accounted for the remaining $3.0 million increase in advertising and promotion expense for the quarter. Amortization of goodwill and other intangibles increased as a result of the inclusion of MGC. Page 15
16 Other expense, net for the second quarter of 1997 includes approximately $4.2 million of charges related to various productive assets which are pending sale or whose values are impaired as a result of changes in management's plans and business conditions. These charges were partially offset by royalty income from new and ongoing agreements that license the use of the Scotts(R) logo. The second quarter of 1996 included $2.7 million in severance charges and $0.5 million asset valuation adjustments. Primarily as a result of higher sales volumes, improved manufacturing and distribution efficiencies, and other cost improvements, income from operations increased by $30.3 million or 111.8% to $57.4 million. Income from operations increased to 16.6% from 10.8% on a percentage of sales basis. Interest expense increased $0.2 million or 2.5%. Excluding the impact of MGC related borrowings, interest expense decreased by approximately $1.3 million or 16.1%, principally due to a $71.9 million reduction in average borrowings for the second quarter compared to the same period last year. MGC related interest expense was approximately $1.5 million for the quarter, reflecting both acquisition debt and seasonal working capital requirements. The Company's effective tax rate was 43.2% compared to 44.2% in the prior year. During the second quarter of fiscal 1997, the Company reported net income of $27.9 million or $0.95 per common share compared with prior year net income of $10.6 million or $0.36 per common share. The quarterly improvement reflects the positive impact of the change in retailer selling programs for the Consumer Lawns group. Other favorable factors influencing this quarters' results of operations include sales volume increases, improved manufacturing and distribution efficiencies, ongoing cost control efforts, lower average borrowings and the full consolidation of MGC's results. These positive factors were partially offset by the change in interim accounting for advertising and the higher investment in brand building the Company is making during fiscal 1997. SIX MONTHS ENDED MARCH 29, 1997 VERSUS SIX MONTHS ENDED MARCH 30, 1996 Net sales for the six months ended March 29, 1997 totaled $446.4 million, an increase of $77.2 million or 20.9%. Management estimates that approximately $29.0 million (8.3%) of this increase was due to the 1995 Consumer Lawns retailer early purchase program that had the effect of depressing sales in the second and third quarters of 1996. The January 3, 1997 acquisition of the remaining two-thirds interest in MGC increased net sales of the first six months by $21.3 million or 5.8%. The remaining 6.8% increase in net sales for the first six months of fiscal 1997 was primarily attributable to volume gains in Consumer Gardens, Consumer Lawns, Professional and International. Consumer Lawns Group net sales increased $43.5 million or 30.6% to $185.9 million, primarily as a result of volume increases. Management estimates that approximately $29.0 million (22.1%) of this six months sales increase is attributable to the discontinuance of the 1995 early purchase program. After adjusting for this program change, management estimates that the Consumer Lawns Group six month's net sales increase was 8.5%. Consumer Gardens Group net sales increased $6.9 million or 11.6% to $66.3 million. Gardens group net sales increased primarily as a result of volume, including the inclusion of grass seed into their distribution network starting in fiscal 1997. Organics Business Group net sales decreased $0.6 million or 0.8% to $70.6 million, in line with this Group's focus on profitability, not revenues. Professional Business Group net sales increased $4.2 million or 6.6% to $68.2 million, as this Group's customers move more to just-in-time inventory management. International Business Group net sales increased $23.2 million or 72.1% to $55.4 million. MGC contributed $21.3 million of this net sales increase. Excluding the impact of MGC, International Business Group net sales increased $1.9 million or 5.9%, with sales volumes up approximately 15.9%, largely offset by unfavorable exchange rate movements that resulted in a 10.0% year-to-date reduction in International sales after translation to U.S. dollars. Page 16
17 Cost of sales were 61.7% of net sales for the six months ended March 29, 1997, a 4.6 percentage point decrease compared to 66.3% in the same period of the prior year. This improvement is attributable to the discontinuance of promotional programs to drive out-of-season sales, the discontinuance of lower margin professional and consumer products, and manufacturing and distribution efficiencies. Operating expenses increased $15.2 million or 14.7% to $118.6 million. Operating expenses were 26.6% of net sales compared to 28.0% in the prior year. Selling, general and administrative expenses increased $3.3 million or 5.2% to $66.7 million. This increase reflects the inclusion of MGC for the first time, and higher salesforce and general management incentives in the current year, partially offset by cost savings generated by restructuring efforts in 1996. As a percentage of sales, selling, general and administrative expenses decreased from 17.2% to 14.9%. Advertising and promotion expenses increased by $12.5 million or 40.3% to $43.5 million. As a percentage of net sales, advertising and promotion expenses increased to 9.7% from 8.4%. Approximately $7.8 million (25.2%) of this increase is attributable to the change in interim accounting for advertising, as previously discussed. Exclusive of the change in interim accounting for advertising, overall higher investment in media spending on brand building increased this expense by approximately $2.4 million (7.7%). The inclusion of MGC increased year-to-date advertising and promotion expenses by $3.0 million. Trade promotions decreased $0.7 million reflecting the Company's move toward "pull" advertising and away from "push" retailer promotions. The Company believes retailer promotions and cooperative advertising are an integral part of the consumer lawn and garden business, but to a lesser extent than that practiced in prior years. Amortization of goodwill and other intangibles increased as a result of the inclusion of MGC. Other expense, net for the first six months of 1997 includes approximately $4.3 million of charges related to various productive assets which are pending sale or whose values are impaired as a result of changes in management plans and business conditions. These charges were partially offset by royalty income from new and ongoing agreements that license the use of the Scotts(R) logo. The first six months of fiscal 1996 included $4.5 million of severance charges and $0.8 million of asset valuation adjustments. Primarily as a result of higher sales volumes, improved manufacturing and distribution efficiencies, and other cost improvements, income from operations increased by $31.3 million or 148.3% to $52.4 million. Income from operations increased to 11.7% from 5.7% on a percentage of sales basis. Interest expense decreased $0.8 million or 5.4% for the six months ended March 29, 1997. Excluding MGC related borrowings, interest expense decreased by approximately $2.3 million or 15.7%, principally due to a $66.9 million reduction in average borrowings for the first six months compared to the same period last year. MGC related interest expense was approximately $1.5 million, reflecting both acquisition debt and seasonal working capital requirements. The Company's effective tax rate was 43.2% compared to 45.3% in the prior year. During the first six months of fiscal 1997, the Company reported net income of $21.9 million or $0.75 per common share compared with prior year net income of $3.5 million or a loss of $0.08 per common share, after considering preferred stock dividends. The year-to-date improvement reflects the positive impact of the change in retailer selling programs for the Consumer Lawns Group. Other favorable factors influencing year-to-date results of operations include sales volume increases, improved manufacturing and distribution efficiencies, ongoing cost control efforts, lower average borrowings and full consolidation of MGC's results. These positive factors were partially offset by the change in interim accounting for advertising and the higher investment in brand building the Company is making during fiscal 1997. Page 17
18 LIQUIDITY AND CAPITAL RESOURCES Cash used in operating activities totaled $138.6 million for the six month period ended March 29, 1997 compared to $143.3 million in the prior year. The seasonal nature of the Company's operations results in a significant increase in working capital (primarily inventory and accounts receivable) during the first and second fiscal quarters. The third fiscal quarter is a significant period for collecting accounts receivable. The lower level of cash used in operating activities for the first six months of 1997 is principally due to higher net income and better working capital management, partially offset by the seasonal working capital needs of MGC. Cash used in investing activities totaled $51.2 million compared to $8.3 million in the prior year. This increase is attributable to the acquisition of the remaining two-thirds interest in MGC for approximately $47.1 million effective January 3, 1997. The Company estimates that fiscal 1997 capital investments will be $20 million to $25 million compared to $18.2 million in the prior year. These capital investments will be financed with cash provided by operations and utilization of available credit facilities. The largest project will be an approximately $9.0 million expansion of the Marysville distribution facility, estimated to generate annual distribution expense savings of at least $1.5 million beginning in fiscal 1998. The Company's Fourth Amended and Restated Credit Agreement (the "Credit Agreement") restricts annual capital investments to $50 million. Financing activities provided $195.5 million for the six month period ended March 29, 1997 compared to $153.2 million in the prior year. Financing activities are principally supported by the Company's Credit Agreement. The higher level of incremental borrowings in the first six months of fiscal 1997 compared to the prior year is a result of the MGC transaction, partially offset by lower working capital requirements and year-to-date capital investment. Total debt increased by $227.7 million compared with debt at September 30, 1996 and increased by $27.4 million compared with total debt at March 30, 1996. The increase as compared to September 30, 1996 was to support increased working capital, capital expenditures, and the MGC acquisition. The increase compared to March 30, 1996 is attributable to positive cash flow generated in fiscal 1996 and lower working capital requirements in fiscal 1997, offset by the borrowings associated with the MGC acquisition and MGC's seasonal borrowing requirements. Shareholders' equity as of March 29, 1997 was $378.3 million, a $14.0 million increase compared to September 30, 1996 and a $5.5 million decrease compared to March 30, 1996. The increase compared to September 30, 1996 was due to the net income of $21.9 million, Convertible Preferred Stock dividends of $4.9 million, an unfavorable change in the cumulative foreign currency adjustment of $3.3 million and net treasury stock activity of $0.4 million. The decrease compared to March 30, 1996 was due to the net income for the twelve month period ended March 29, 1997 of $15.9 million offset by Convertible Preferred Stock dividends of $9.8 million, net treasury stock purchases of $7.0 million and an unfavorable change in the cumulative foreign currency adjustment of $4.5 million. The primary sources of liquidity for the Company are funds generated by operations and borrowings under the Company's Credit Agreement. The Credit Agreement was amended in December 1996. The most recent amendment provides for an increase in the available line-of-credit from $375 million to $425 million, and provides that up to the equivalent of $100 million of the available credit may be borrowed in U.K. Pounds Sterling. The Company has foreign exchange rate risk related to International operations and cash flows. The Company enters into forward foreign exchange contracts and purchases currency options to hedge its exposure to fluctuations in foreign currency exchange rates. These contracts generally involve the exchange of one currency for a second currency at some future date. Counterparties to these contracts are major financial institutions. Gains and losses on these contracts generally offset gains and losses on the assets, liabilities and transactions being hedged. Effective in the second quarter of 1997, the Company significantly reduced this program. Realized and unrealized foreign exchange gains and losses are recognized and offset foreign exchange gains or losses on the underlying exposures. Unrealized gains and losses that are designated and effective as hedges on such transactions are deferred and recognized in income in the same period as the hedged transactions. Page 18
19 As of March 29, 1997, the Company's European operations had foreign exchange risk in various European currencies tied to the Dutch Guilder. These currencies include the Belgian Franc, German Mark, Spanish Peseta, French Franc, British Pound, Italian Lire, and the Australian Dollar and U.S. Dollar. The Company's U.S. operations had foreign exchange rate risk in the Canadian Dollar, Dutch Guilder and the British Pound which are tied to the U.S. Dollar. As of March 29, 1997, there were outstanding forward foreign exchange contracts with a value of approximately $2.4 million. These contracts had maturity dates ranging from June 10, 1997 to June 24, 1997. 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 the 1997 fiscal year. INFLATION The Company is subject to the effect of changing prices. The Company has, however, generally been able to pass along inflationary increases in its costs by increasing the prices of its products. 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 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 9 to the Company's Consolidated Financial Statements and in the Annual Report on Form 10-K to the Securities and Exchange Commission for the year ended September 30, 1996 under the "Business" and "Legal Proceedings" sections. ACCOUNTING ISSUES In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation", effective for financial statements for fiscal years beginning after December 15, 1995. SFAS No. 123 provides for, but does not require, a fair value method of accounting for stock-based compensation arrangements rather than the intrinsic value method previously required. Alternatively, entities that retain the intrinsic value method are required to disclose in the notes to the financial statements pro forma net income and earnings per share information as if the fair value method had been applied. The Company does not intend to adopt the fair value method of SFAS No. 123; therefore, this standard will not have a material effect on the Company's consolidated financial statements. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128"). FAS 128 establishes standards for computing and presenting earnings per share ("EPS"). FAS 128 replaces the presentation of primary EPS with a presentation of basic EPS which excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. This statement also requires dual presentation of basic EPS and diluted EPS on the face of the income statement for all periods presented. FAS 128 is effective for financial statements issued for periods ending after December 15, 1997, Page 19
20 including interim periods. The Company plans to adopt FAS 128 in the first quarter of 1998 for the year ended September 30, 1998. If FAS 128 had been adopted at March 29, 1997, basic and diluted earnings (loss) per share would be: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ---------------------- ------------------ MARCH 29 MARCH 30 MARCH 29 MARCH 30 1997 1996 1997 1996 -------- --------- -------- -------- <S> <C> <C> <C> <C> Basic earnings (loss) per share $ 1.37 $ .43 $ .92 $ (.08) ====== ======= ======= ======= Diluted earnings (loss) per share $ .95 $ .36 $ .75 $ (.08) ====== ======= ======= ======= </TABLE> RECENT DEVELOPMENTS On January 3, 1997, the Company acquired the approximately two-thirds interest in Miracle Holdings Limited ("Miracle Holdings") which the Company did not already own. Miracle Holdings owns MGC Limited, a manufacturer and distributor of lawn and garden products in the United Kingdom. OUTLOOK FOR THE REMAINDER OF 1997 Looking forward to the remaining six months of fiscal 1997, management expects a continuation of the return to profitability demonstrated in the first six months of the year. The primary factors contributing to 1997's improvement over 1996 include the discontinuance of the Consumer Lawns Group's retailer early purchase program; alignment of the business groups to provide better focus on, and accountability for, performance; and the positive impacts of fiscal 1996 restructuring efforts. However, these changes, along with inherent risks of a seasonal business, present several challenges for 1997. As noted in previous reports, the Consumer Lawns Business Group's marketing strategy has been refocused on consumer directed, "pull" advertising and less on retailer directed, "push" promotional programs heavily relied upon in recent years. Management believes results for the first six months of fiscal 1997 indicate general marketplace acceptance of this strategy. However, weather conditions in North America and in Northern Europe have a significant impact on the quarterly timing of sales of the Company's products, especially in the spring selling season. After adjustment for the 1995 early purchase program, the Company has historically generated 66% to 68% of its annual revenues in its second and third fiscal quarters. Management expects this relationship to become slightly more pronounced with the change in the consumer lawns marketing and promotional programs, and the trend in both its consumer and professional markets toward "just-in-time" product purchasing. Management expects 1997 gross profit margins to continue to show improvement over 1996 as a result of the recovery of the relatively higher margin consumer lawns business, higher volumes increasing manufacturing distribution efficiencies, and the discontinuance of certain lower margin products. In the last quarter of 1997, the Company plans to change over to plastic packaging for its key consumer lawns products and update the technology of one of its key manufacturing lines. These planned changes, along with the general direction toward simplifying its product lines, may put temporary downward pressure on gross profit margins during the transition period as new processes start up and old products are phased out. The Company expects a lower effective tax rate in 1997 in the range of 42% to 44%, principally as a result of the anticipated return to profitability. The Company has made and will make certain forward-looking statements in this quarterly report and in other contexts regarding future economic performance and finances, plans and objectives of management, among others. In some cases, information regarding certain important factors that could cause actual results to differ materially from any such forward-looking statement appear together with such statement. Furthermore, the following factors, in addition to other possible factors not listed, could affect the company's actual results and cause such results to differ materially from those expressed in forward-looking statements. These factors include weather conditions in North America and in Northern Europe which have a significant impact on timing of sales in the spring selling season and overall annual sales; continued marketplace acceptance of the Company's Consumer Lawns and Gardens Group's "pull" advertising marketing strategies, especially in the Consumer Lawn's Group which refocused its general marketing strategy beginning in fiscal 1996; competition among lawn and garden product producers supplying the consumer and professional markets, both domestically and internationally; competition between retail outlets selling lawn and garden products produced by the Company; public perceptions regarding the safety of products produced and supplied by the Company; continued changes in economic conditions; risks inherent to international development; and other factors set forth in the Company's letters to shareholders and analysts, press releases and filings with the Securities and Exchange Commission. Page 20
21 Part II - OTHER INFORMATION Item 1. Legal Proceedings On January 16, 1997, Pursell and the Company settled two lawsuits pursuant to a confidential Settlement Agreement and Release (the "Settlement Agreement"). Under the terms of the Settlement Agreement, both actions have been dismissed with prejudice. Full and complete releases were exchanged by the parties, and the Company granted to Pursell a fully paid-up, non-exclusive license under the Company's Poly-S patents. The Company has been assessing and, as necessary, addressing certain environmental issues regarding the wastewater treatment plants currently operating at its Marysville facility. Specifically, it has been considering whether to upgrade the existing treatment plants or to attempt to tie the facility's wastewater into the City of Marysville's municipal treatment system. Additionally, the Company has been assessing, under Ohio's new Voluntary Action Program, the possible remediation of several discontinued on-site waste disposal areas dating back to the early operations of its Marysville facility. On February 11, 1997, the Company was informed that the Ohio EPA was referring certain matters relating to the Company's wastewater treatment plants and on-site disposal areas to the Ohio Attorney General's office. Representatives from the Ohio EPA, the Ohio Attorney General's office and the Company have had one meeting subsequent to February 11 to discuss these issues. Although the Company has not yet been informed as to the specific nature of any issues or the expected remedial response, all parties have expressed an interest in reaching an amicable resolution. The Company expects that a consent order will be negotiated with the Ohio EPA. The Company does not believe that any proceedings which may result from the Ohio EPA's referral of these matters to the Ohio Attorney General will be material to the business or financial condition of the Company but is unable, at this early stage, to predict the outcome of these issues. Item 4 - Submission of Matters to a Vote of Security Holders The Annual Meeting of Shareholders of the Company (the "Annual Meeting") was held in Columbus, Ohio on March 12, 1997. The result of the vote of the shareholders for each of the matters submitted to the shareholders at the Annual Meeting is as follows: A. The proposal to elect four directors for terms of three years each: <TABLE> <CAPTION> NOMINEE VOTES FOR WITHHELD NOT VOTED ------- --------- -------- --------- <S> <C> <C> <C> James B Beard 25,855,642 227,565 John Kenlon 25,854,492 228,715 John M. Sullivan 25,852,492 230,715 L. Jack Van Fossen 25,833,084 250,123 </TABLE> Each of the nominees was elected. The other Directors whose terms of office continue after the Annual Meeting are John S. Chamberlin, Joseph P. Flannery, Horace Hagedorn, Donald A. Sherman, Charles M. Berger, James Hagedorn, Karen G. Mills, and Tadd C. Seitz. B. The proposal to increase the number of common shares available under The Scotts Company 1996 Stock Option Plan to 3,000,000 common shares: <TABLE> <CAPTION> FOR AGAINST ABSTAIN BROKER NON VOTES --- ------- ------- ---------------- <S> <C> <C> <C> <C> 21,446,166 1,554,806 279,126 2,803,109 </TABLE> The proposal was approved. Item 6. Exhibits and Reports on Form 8-K (a) See Exhibit Index at page 23 for a list of the exhibits included herewith. (b) On January 28, 1997, Scotts filed a Form 8-K to report under "Item 5 Other Events" the acquisition of the approximately two-thirds interest in Miracle Holdings Limited which the Company did not already own. No financial statements were required to be filed. Page 21
22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE SCOTTS COMPANY Date ____________________________ /S/JEAN H. MORDO ------------------------------ Executive Vice President Chief Financial Officer Principal Accounting Officer Page 22
23 THE SCOTTS COMPANY QUARTERLY REPORT ON FORM 10-Q FOR FISCAL QUARTER ENDED March 29, 1997 EXHIBIT INDEX <TABLE> <CAPTION> Exhibit Page NUMBER DESCRIPTION NUMBER ------ ----------- ------ <S> <C> <C> 10(a) The Scotts Company 1996 24-32 Stock Option Plan (as amended through March 12, 1997) 18 Letter regarding change in accounting principles 33 27 Financial Data Schedule 34 </TABLE> Page 23