Item 1. BUSINESS
Introduction
Hines Horticulture, Inc., a Delaware corporation ("Hines"), produces and distributes horticultural products through its two operating divisions: (1) its nursery division, Hines Nurseries and (2) its plant-growing media division, Sun Gro Horticulture ("Sun Gro"). On June 12, 1998, Hines Horticulture became the successor to the business of Hines Holdings, Inc., a Nevada corporation ("Holdings"), as a result of the merger of Hines Holdings, Inc. into Hines, the purpose of which was to change Hines Horticulture's name and jurisdiction of incorporation. The business of Hines Nurseries is currently conducted through Hines Nurseries, Inc. ("Hines Nurseries") a wholly owned subsidiary of Hines, and through Sun Gro Horticulture Inc. ("Sun Gro- U.S.") a wholly owned subsidiary of Hines Nurseries, Sun Gro-U.S.'s wholly owned subsidiary, Sun Gro Horticulture Canada Ltd. ("Sun Gro-Canada"), and Sun Gro-Canada's direct and indirect Canadian subsidiaries. Unless otherwise specified, references to "Hines" or the "Company" refer to Hines Horticulture, Inc. and its subsidiaries.
Hines Nurseries produces approximately 4,100 varieties of ornamental shrubs and color plants through its eight nursery facilities located in California, Oregon, Pennsylvania, South Carolina and Texas. Hines Nurseries sells to more than 1,900 retail and commercial customers, representing more than 7,300 outlets throughout the United States and Canada. Sun Gro produces high quality, sphagnum peat moss and peat-based potting and growing mixes. Sphagnum peat moss is a natural, organic material that is generally considered the highest quality growing medium available due to its excellent water and nutrient retention and aeration characteristics. Sun Gro controls approximately 49,000 acres of peat bogs throughout Canada and produces its peat moss and peat-based mixes in ten facilities strategically located across Canada and the United States.
History
Ownership
Hines was founded in 1920 by James W. Hines Sr. in San Gabriel, California. Hines was a family owned business until its acquisition by the Weyerhauser Company in 1976. Hines was sold in 1990 to a private investment group and certain members of management. In August 1995, Hines was acquired by Madison Dearborn Capital Partners, L.P. ("MDCP"), a private equity investment firm and certain members of management. On June 22, 1998, Hines completed an initial public offering of 5.1 million shares of its common stock (the "Offering").
Recent Acquisitions
Hines has completed a number of recent acquisitions to expand and diversify its operations. Often they have complemented the Company's existing operations and enhanced the Company's product offerings.
The following table sets forth information with respect to these acquisitions:
On April 6, 1998, the Company acquired Lakeland Peat Moss, Ltd. and certain affiliated entities ("Lakeland"), a leading producer of sphagnum peat moss and peat-based potting and growing mixes in western Canada, with facilities in Utah and Oregon. Lakeland's products are sold primarily to retail customers and, to a lesser extent, professional customers such as greenhouse growers, vegetable farmers and golf course developers located primarily in the western United States.
On December 16, 1997, the Company acquired Bryfogle's Wholesale, Inc. and certain affiliated entities ("Bryfogle's"), a producer of color bedding plants sold primarily to home centers and mass merchandisers in Pennsylvania and surrounding states. This acquisition significantly enhanced the Company's offerings of annual bedding and holiday plants.
On October 20, 1997, the Company acquired the assets of Pacific Color Nurseries, Inc. ("Pacific Color"), a producer of color bedding plants sold primarily to home centers and mass merchandisers in California. The acquisition of Pacific Color increased the Company's offerings of annual bedding and holiday plants.
On November 27, 1996, the Company acquired Flynn Nurseries, Inc. ("Flynn"), a producer of ornamental plants, flowering color plants and perennials sold to various retail customers throughout the United States. Hines acquired Flynn, in part, because of its location in Southern California where there are ideal growing conditions and its close proximity to the Company's Irvine, California nursery.
On August 30, 1996, the Company acquired Iverson Perennial Gardens ("Iverson"), a producer of perennial flowers and plants sold primarily to home centers, mass merchandisers and other retail customers located in the southeastern, eastern and midwestern regions of the United States. The Iverson acquisition has enhanced the Company's market presence in the eastern and southeastern United States, increased penetration into the perennial plant market and provided expansion capacity at the South Carolina nursery location.
On January 27, 1995, the Company acquired Oregon Garden Products ("OGP"), a producer of ornamental, cold-tolerant, container-grown plants sold primarily to home centers, mass merchandisers and other retail customers located in the eastern and midwestern regions of the United States and flowering color plants sold primarily to retail customers located in the northwestern United States. The OGP acquisition broadened Hines Nurseries' product mix and added undeveloped acreage which provides Hines Nurseries with significant opportunities for future expansion.
In June 1993, Hines acquired Sun Gro-U.S. and its subsidiaries in order to enter the peat-products market, thereby diversifying the Company's operations and expanding its share of the market for horticultural products.
Business Overview
Hines Nurseries is one of the largest commercial nursery operations in North America, producing one of the broadest assortments of container-grown plants in the industry. Hines Nurseries sells its nursery products primarily to the retail segment which includes the premium independent garden centers, as well as the leading home centers and mass merchandisers, such as Home Depot, Lowe's, Wal-Mart, Kmart and Target. Sun Gro is also the largest North American producer and marketer of sphagnum peat moss and professional peat-based growing mixes, which it primarily sells to professional customers, including greenhouse growers, nursery growers and golf course developers. As a result of both internal expansion and acquisitions, the Company has grown sales from approximately $50 million in 1992 to almost $235 million in 1998, representing a compound annual growth rate of 29%. Unaudited pro forma net sales for 1998, after giving effect to the acquisition of Lakeland as if it had occurred on January 1, 1998, would have been approximately $241 million.
Key Growth Strategies
Expand Production. The Company is experiencing unfulfilled demand from a number of key nursery customers. Accordingly, the Company plans to continue expanding its nursery acreage and greenhouse facilities in 1999 in order to increase production of key product lines (including the color plant category), and to commercially introduce new plant varieties. By expanding production at existing facilities, the Company seeks not only to increase sales volume, but also to leverage its established operating processes and management, thereby reducing unit costs.
Increase Customer Penetration and Expand Customer Base. With its strategically-located nurseries and its emphasis on customer service, the Company has established a national customer base and distribution system for a wide variety of ornamental plants. The Company is pursuing opportunities to increase its volume with existing customers by (1) increasing sales to successful "big box" retailers and premium independent garden centers as they open additional outlets, and (2) increasing same-store sales by capitalizing on its customers' continued expansion of lawn and garden floor space with a broader variety of merchandise, particularly in the color plant category. The Company also intends to pursue new relationships with other high volume retailers and premium garden centers. Management believes that the demand for value-added peat-based mixes by professional growers is increasing and that there is a trend among professional growers to outsource the mixing of these products. Sun Gro intends to further penetrate the professional market by expanding its offerings of customized value-added mixes and technical expertise in order to capitalize on this trend.
Pursue Strategic Acquisitions. The Company believes that strategic acquisitions will continue to play an important role in expanding its geographic presence and product offerings. For example, since optimizing production and distribution of color plants such as holiday crops, annual bedding plants and perennials requires regional growing capacity, the Company will continue to seek acquisitions of additional regional color plant growers as it continues to expand its nursery network. The Company will continue to apply its proprietary operating processes to recently acquired businesses to facilitate integration and to improve operating performance. In the peat division, the Company will continue to seek acquisitions of businesses that offer operating synergies and complementary products.
Hines' Nursery Business
Hines Nurseries produces and markets approximately 4,100 varieties of ornamental, container-grown plants grown primarily for outdoor use, most of that are sold under its Hines Nurseries(TM) and Iverson(TM) trade names. Most of Hines Nurseries' varieties fall into the following categories:
Since 1993, Hines Nurseries has added numerous plant varieties to its product line. Recently, Hines Nurseries has aggressively expanded its offering of flowering color plants. Hines Nurseries has also successfully developed patio-ready type products, which it markets under the names of Patio Tropics(TM) and Festival Pots(TM). These products generally command premium prices and improved profit margins than other plants offered by the Company.
The Company sells its nursery products primarily to the retail segment which includes the premium independent garden centers, as well as the leading home centers and mass merchandisers, such as Home Depot, Lowe's, Wal-Mart, Kmart and Target. The following table sets forth the estimated percentage of Hines Nurseries' net sales by customer type for the period indicated:
The Company believes sales to home centers and mass merchandisers have increased significantly during the past several years as a result of the rapid growth of this channel of distribution. Management believes the Company enjoys competitive advantages in selling into this channel due to its ability to provide a broad assortment of consistently high quality products in large volumes, its nationwide distribution and its value-added
services such as custom labeling, bar-coding, full electronic data interchange and technical support. Management expects to participate in the overall growth of this channel to a greater extent than its competitors that do not offer such services. Hines Nurseries' top ten customers accounted for approximately 48%, 58% and 62% of Hines Nurseries' net sales in 1996, 1997 and 1998, respectively. Hines Nurseries' largest customer, Home Depot, accounted for approximately 15%, 18% and 20% of its net sales in 1996, 1997 and 1998, respectively, and approximately 10%, 12% and 14% of the Company's consolidated net sales in 1996, 1997 and 1998, respectively.
Research and Development. Hines Nurseries' product sourcing and development yield unique plant varieties, which are marketed under a trade name and patented whenever possible. The Company applies for patents on plant varieties that are significantly different from existing varieties. Differences among plant varieties may include coloration, size at maturity or hardiness in drought or cold conditions. These varieties command higher prices, provide higher unit margins and enhance the Company's reputation as a product innovator.
Sales and Marketing. Most of Hines Nurseries' facilities have separate sales forces, which include a sales manager, in-house customer service representatives, direct sales consultants and various support personnel. As of December 31, 1998, Hines Nurseries employed approximately 122 direct sales consultants, key account managers and merchandisers. National accounts are serviced through "National Account Task Teams" comprised of a senior management member and direct sales personnel from each nursery supplying the account. Hines Nurseries also markets its products through trade shows, print advertising in trade journals, direct mail promotion and catalogues.
Competition. Competition in the nursery products segment of the lawn and garden industry is based principally on breadth of product offering, consistent product quality and product availability, customer service and price. The nursery products segment is highly fragmented, comprised of approximately 30,000 primarily small and regionally based growers, with the top 100 growers accounting for approximately 22% of the industry volume in 1997. Management believes Hines Nurseries is one of only two growers able to serve every major regional market in North America; the Company's only national competitor being Monrovia Nursery Company. In each of its markets, Hines competes with regional growers such as Color Spot in the West, Clinton Nurseries in the Northeast, Zelenka Nurseries in the Midwest, Wight Nurseries in the South and many other smaller regional and local growers. Hines Nurseries' key competitive advantage is its ability to provide consistent, high quality products in large volumes, its nationwide distribution and its value-added services.
Sun Gro Peat and Peat-Based Products Business
Sun Gro harvests and produces high quality, sphagnum peat moss and peat- based potting and growing mixes. Sphagnum peat moss is partially decomposed sphagnum moss, a plant whose unique cellular structure consists of large cavities with sponge-like absorption characteristics for air and water. Because the optimal balance of air and water is essential for root development and plant growth, organic sphagnum peat moss is generally considered the highest quality growing medium available. While there are less expensive products on the market that are used for similar purposes, such as top soil, manure, bark, mulch and composts made from yard or sewage wastes, these products do not contain the superior soil aeration and water and nutrient retention characteristics of peat moss.
Sun Gro markets peat moss under its Sunshine(TM), Parkland(TM), Fairway(TM), Black Gold(TM), Lakeland Grower(TM), Alberta Rose(TM), Nature's(TM) and Gardener's Gold(TM) trade names in both the professional and retail markets in four different grades: fine, medium, coarse and super coarse. Fine grade is typically sold in the retail market, while the other grades, particularly coarse grade, are sold to professional growers. Capitalizing on its strong market position in the professional peat moss market, Sun Gro has become one of the leading North American suppliers of value-added, peat-based growing mixes used for specific professional applications such as seed germination, cutting propagation and greenhouse crop production. As a result of Sun Gro's success with this product line, higher margin professional growing mixes now constitute a greater percentage of Sun Gro's professional market sales than pure peat moss. Sun Gro's retail potting mixes use a similar blend of ingredients
as its professional growing mixes, but are specifically targeted to home gardeners. By highlighting formulations for specific plant varieties, Sun Gro has expanded its product offerings to the retail customer.
Sun Gro's peat moss and peat-related products are sold directly and by distributors throughout the United States and Canada. Sun Gro also markets its product internationally through distributors who sell to Mexico and Japan and, to a lesser extent, other countries in Asia and South America. Peat moss is sold to both the professional and retail markets, while growing mixes are sold exclusively to the professional market as potting mixes are to the retail market. Sun Gro's professional customers consist of greenhouse growers, nursery growers and golf course developers. Sun Gro's retail customers are similar to those of Hines Nurseries.
The following table sets forth the estimated percentage of Sun Gro's net sales by customer type for the period indicated:
Sun Gro's top ten customers accounted for approximately 30%, 28% and 26% of Sun Gro's net sales in 1996, 1997 and 1998, respectively. No single Sun Gro customer accounted for more than 10% of consolidated net sales in 1996, 1997 and 1998.
Research and Development. Sun Gro's research and development efforts focus on the creation and development of new value-added peat-based growing mixes for retail and professional customers. Such mixes often command higher prices and provide higher profit margins than peat alone. Differences in growing mixes may relate to differences in coarseness of peat and amounts of nutrient additives, including limestone, and other mix constituents, such as perlite, vermiculite and bark. Sun Gro's research and development efforts have resulted in the commercial introduction of approximately 35 new growing mixes and related products since 1992.
Sales and Marketing. Sun Gro sells its products on a direct basis and through a network of approximately 205 distributors located throughout North America. As of December 31, 1998, Sun Gro's direct sales force was comprised of approximately 36 employees who are highly trained in the technical applications of its products. Approximately 56% of Sun Gro's sales are conducted through the distributor network. Sun Gro's distributor network provides broad market coverage, reduces credit exposure and distributes products to smaller growers cost effectively.
Competition. Competition in the peat moss and professional growing and potting mix segment of the lawn and garden industry is based principally upon product quality, distribution, service and price. Management believes Sun Gro is one of the largest producers and marketers of plant-growing media in North America. Sun Gro's principal competition comes from Premier Canadian Enterprises, Ltd., a Canadian producer of peat moss, and The Scotts Company, which competes mostly in the retail growing mix and potting mix markets. Sun Gro's key competitive advantages are its control over high quality peat moss reserves, its strong relationships throughout its distributor network and its ability to provide significant technical support.
Financial Information on the Company's Foreign Operations and Operating Segments
See Notes 13 and 18 to the Company's consolidated financial statements, which are included as a separate section of this Report beginning on page.
Seasonality
The Company's nursery business is highly seasonal in nature, with most of its sales typically occurring in the first half of the year. Sun Gro's business is more heavily weighted towards the professional markets, which do not typically experience the large seasonal variances present in the retail peat market. The table below sets forth the Company's quarterly net sales, as a percentage of total year net sales, during the year ended December 31, 1998:
Patents and Trademarks
The Company has registered numerous trademarks, service marks and logos used in its businesses in the United States and Canada. In addition, the Company has developed and continues to develop specialty plants for which it holds patents registered with the U.S. Patent and Trademark Office. The Company currently holds 24 patents with 1 patent application pending.
Government Regulation
The Company is subject to certain United States and Canadian federal, state, local and provincial health, safety and environmental laws and regulations regarding the production, storage and transportation of certain products and the disposal of its wastes. The EPA and similar state and local agencies regulate the Company's operations and activities, including but not limited to water runoff and the use of certain pesticides in its nursery operations. With respect to its peat moss operations, the Company has various operating, monitoring and site maintenance obligations, which are prescribed by various Canadian and U.S. agencies. The Company does not anticipate that future expenditures for compliance with such environmental laws and regulations will have a material adverse effect on the Company's financial position or results of operations. The Company cannot give any assurance, however, that compliance with such laws and regulations, or compliance with other environmental laws and regulations that may be enacted in the future, will not have an adverse effect.
Hines Nurseries obtains certain irrigation water supplied to local water districts from facilities owned and operated by the United States acting through the Department of Interior Bureau of Reclamation ("reclamation water"). The use and price of reclamation water, including availability of subsidized water rates, is governed by federal reclamation laws and regulations. Hines Nurseries utilizes reclamation water as one of the water supplies for its Northern California and Oregon facilities. While the Company believes that the nursery operations are in compliance with applicable regulations and it maintains a continuous compliance program, there can be no assurance that changes in law will not reduce availability of or increase the price of, reclamation water to the Company.
Employees
As of December 31, 1998, the Company employed approximately 2,945 persons, including approximately 775 seasonal employees. Of this total, approximately 2,255 were employed by Hines Nurseries, including approximately 495 seasonal employees (seasonal employment peaked at 1,456 in April), and approximately 690 were employed by Sun Gro, including approximately 280 seasonal employees (its peak seasonal employment). As of December 31, 1998, approximately 500 of Sun Gro's employees were employed in Canada. All of Hines Nurseries' employees are non-union. The non-management employees at Sun Gro's Canadian peat processing facilities, which vary seasonally in number from approximately 200 to 300, are represented by various labor unions, with collective bargaining agreements in effect for all such facilities. Sun Gro's agreement with the United Food and Commercial Workers Union, which covers 135 employees at its Manitoba facility, expires in May 1999 and the Company expects negotiations to begin in April 1999. Sun Gro's agreements with the Brotherhood of Carpenters and Joiners of America, which cover 71 employees at Sun Gro's Lameque, New Brunswick facility and 49 employees at its Maisonnette, New Brunswick facility, expire in December 2000 and August 2001, respectively. The Company's management believes labor relations are good.
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report contains forward-looking statements. Hines desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing itself of the protections of the safe harbor with respect to all forward-looking statements. Several important factors, in addition to the specific factors discussed in connection with such forward-looking statements individually, could affect the future results of the Company and could cause those results to differ materially from those expressed in the forward-looking statements contained herein.
The Company's estimated or anticipated future results, products and service performance or other non-historical facts are forward-looking and reflect Hines' current perspective of existing trends and information. These statements involve risks and uncertainties that cannot be predicted or quantified and, consequently, actual results may differ materially from those expressed or implied by such forward-looking statements. Such risks and uncertainties include, among others, the continued ability of Hines' to access water, the impact of growing conditions, risks associated with customer concentration, future acquisitions and the ability to integrate such acquisitions in a timely and cost effective manner, the ability to manage growth, the impact of competition, the ability to obtain future financing, limitations of leverage and debt restrictions, government regulations, the successful and timely implementation of the Company's Year 2000 Compliance Program and other risks and uncertainties defined from time to time in Hines' Securities and Exchange Commission filings.
Therefore, the Company wishes to caution each reader of this report to consider carefully these factors as well as the specific factors discussed with each forward-looking statement in this report and disclosed in the Company's filings with the Securities and Exchange Commission as such factors, in some cases, have affected, and in the future (together with other factors) could affect, the ability of the Company to implement its business strategy and may cause actual results to differ materially from those contemplated by the statements expressed herein.
Item 2.
Item 2. PROPERTIES
The Company owns approximately 3,190 acres related to its nursery facilities and approximately 1,792 acres of harvestable peat bogs in Canada. In addition, the Company leases approximately 1,377 acres related to its nursery facilities (including leases from Blooming Farm, Inc., an affiliated entity) and approximately 49,000 acres of harvestable peat bogs in Canada from provincial governments and various private parties. Sun Gro has historically been able to renew its leases upon expiration. However, no assurance can be given that Sun Gro will be able to do so in the future. The Company's management believes that its owned and leased facilities are sufficient to meet its operating requirements for the foreseeable future.
The Company's facilities are identified in the table below:
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(a) The lease contains a purchase option that the Company has exercised. The Company is in negotiations regarding the purchase price, and expects to consummate the purchase of this property in 1999.
(b) The Company owns 745 acres and leases 361 acres at this nursery.
(c) The Northern California nursery consists of sites in Vacaville and Allendale, California.
(d) The San Joaquin Valley nursery consists of sites in Chowchilla and Madera, California.
(e) The Company owns 38 acres and leases 10 acres at this nursery.
(f) The Company owns 512 acres and leases 60 acres at this nursery.
(g) The Company leases all but 1,792 acres in the aggregate of these peat bogs from Canadian provincial governments and various private parties. The Company's peat processing facilities are owned by the Company but, with the exception of the Vilna peat-processing facility, these facilities are situated on land leased to the Company by Canadian provincial governments and various private parties.
Item 3.
Item 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in various disputes and litigation matters, which arise in the ordinary course of business. The litigation process is inherently uncertain and it is possible that the resolution of these disputes and lawsuits may adversely affect the Company's financial position. Management believes, however, that the ultimate resolution of such matters will not have a material adverse impact on the Company's consolidated financial position or results of operations.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 1998.
PART II
Item 5.
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As a result of the Company's initial public offering on June 22, 1998, the common stock of Hines trades on The Nasdaq National Market under the symbol "HORT". As of March 15, 1999, there were 70 registered holders of record of the Company's common stock. The following table sets forth the quarterly high and low share price for the year ended December 31, 1998:
Hines has not paid dividends on the common stock in the past and does not presently plan to pay dividends on the common stock. The payment of dividends is restricted under the terms of the Company's senior credit agreement and senior subordinated note indenture. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources."
Recent Sales of Unregistered Securities
On February 5, 1998, in a transaction exempt from Registration under Section 4(2) of the Securities Act, Hines issued to MDCP, for $2,000,000 in cash, 2,000 shares of Hines' 12% Cumulative Redeemable Senior Preferred Stock ("Senior Preferred Stock"), having an aggregate liquidation value of $2,000,000. All of Hines' Senior Preferred Stock was converted into common stock in connection with the Offering.
On March 18, 1998, in a transaction exempt from Registration under Section 4(2) of the Securities Act, Hines issued and sold to Abbott Capital 1330 Investors I, L.P. ("Abbott") (1) 4,250 shares of Senior Preferred, at a price per share of $970.21 per share, and (2) presently exercisable warrants to purchase 93,034 shares of common stock, with an exercise price of $.01 per share. Each warrant entitled the holder to purchase one share of common stock at a price of $1.36. The purchase price was paid in cash. Abbott exercised all of its warrants immediately prior to the Offering.
On April 2, 1998, in a transaction exempt from Registration under Section 4(2) of the Securities Act Hines issued and sold to Abbott (1) 250 shares of Senior Preferred Stock, at a price per share of $970.21 per share, and (2) presently exercisable warrants to purchase 5,473 shares of common stock, with an exercise price of $.01 per share. Each warrant entitled the holder to purchase one share of common stock at a price of $1.36. The purchase price was paid in cash. Abbott exercised all of its warrants immediately prior to the Offering.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial data for the years ended December 31, 1994 and December 31, 1995 have been derived from Hines' consolidated financial statements, which have been audited by Arthur Andersen LLP, independent accountants. The selected historical consolidated financial data for the years ended December 31, 1996 through December 31, 1998 have been derived from Hines' consolidated financial statements, which have been audited by PricewaterhouseCoopers LLP, independent accountants, as indicated in their report included elsewhere herein. The following selected historical consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.
NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA (dollars in thousands)
(a) From January 1, 1994 through December 31, 1998, the Company acquired the following six companies: OGP (January 27, 1995), Iverson (August 30, 1996), Flynn (November 27, 1996), Pacific Color (October 20, 1997), Bryfogle's (December 16, 1997) and Lakeland (April 6, 1998). The financial results include the operations of each acquisition since its respective acquisition date.
(b) Unusual operating expenses consist of certain severance and other restructuring costs of $830 and $1,537 in 1996 and 1997, respectively, net of a $1,194 gain from receipt of insurance proceeds on an involuntary disposal of fixed assets in 1997.
(c) After deduction of the minority interest in earnings of subsidiaries of $2,740 and $3,958 for the years ended December 31, 1994 and 1995 and accrued preferred stock dividends of $1,460, $3,775, $6,666 and $5,609 for the years ended December 31, 1995, 1996, 1997 and 1998, respectively.
(d) The financial statements for the year ended December 31, 1995 reflect purchase accounting for the exchange by certain members of management and other investors of their minority interests for stock of Hines in connection with the recapitalization of Hines on August 4, 1995. The repurchase by Hines of its own stock from shareholders (other than the continuing management shareholders) was recorded as a repurchase and retirement of treasury stock, which resulted in negative shareholders' equity. As a result of this transaction, the earnings per share amount for the year ended December 31, 1994 is not considered to be comparable to those for the years ended December 31, 1995, 1996, 1997 and 1998.
(e) Hines derives significant benefits under the U.S. federal tax code by qualifying to use the cash method of accounting and by qualifying under the "farming exception" to the uniform cost capitalization rules. As a result, the Company has generally not been required to pay significant cash income taxes and has generated net operating losses for federal income tax purposes. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview--Tax Matters."
(f) All shares and per share amounts reflect a 1.3611-for-one reverse stock split effected on June 22, 1998.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains trend analysis and other forward-looking statements that involve risks and uncertainties. Such risks and uncertainties are discussed at "Cautionary Statement for Purposes of the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995" on page 8 of the Annual report of Form 10-K.
Overview
General. Hines is one of the largest commercial nursery operations in North America, producing one of the broadest assortments of container-grown plants in the industry. The Company sells its nursery products primarily to the retail segment which includes the premium independent garden centers, as well as the leading home centers and mass merchandisers, such as Home Depot, Lowe's, Wal-Mart, Kmart and Target. The Company is also the largest North American producer and marketer of sphagnum peat moss and professional peat- based growing mixes. The Company sells its peat-based products primarily to professional customers, including greenhouse growers, nursery growers and golf course developers. The Company believes that sales of its nursery products have been positively affected by societal and demographic trends, such as greater levels of homeownership, the aging of the American population and the increasing popularity of gardening. Recent trends in the retail distribution channel, such as the expansion of large "big box" retailers and their growing emphasis on the lawn and garden category, have increased consumer exposure to lawn and garden products. Management believes these trends have favorably impacted the Company and provide excellent opportunities for improved operating performance.
Seasonality. The Company's nursery business, like that of its competitors, is highly seasonal. The Company has, and expects to continue to experience significant variability in net sales, operating income and net income on a quarterly basis.
Acquisitions. The Company has completed a number of recent acquisitions to expand and diversify its operations. In the three years ended December 31, 1998, the Company completed five acquisitions. These acquisitions have and will continue to affect the period-to-period comparability of the operating results discussed below. The Company intends to pursue strategic acquisitions from time to time that increase its production capacity, broaden or complement its existing product lines, expand its geographic presence or offer operating synergies. The Company believes that the highly fragmented nature of the nursery industry presents it with a number of opportunities to make such acquisitions, though the Company does not have current agreements to consummate any such acquisitions.
Tax Matters. The Company derives significant benefits under the U.S. federal tax code by qualifying to use the cash method of accounting for federal income tax purposes. Under the cash method, sales are included in taxable income when payments are received and expenses are deducted as they are paid. The primary benefit the Company receives is the ability to deduct the cost of inventory as it is incurred. As a result of the Company's ability to deduct its growing costs under the farming exception, the Company has generally not been required to pay cash income taxes and has generated net operating losses for federal income tax purposes. During the same period, the Company has continued to show a tax provision relating to the recording of deferred taxes. At December 31, 1998, the Company had approximately $36 million in net operating loss carryforwards for federal income tax reporting purposes.
Results of Operations
Fiscal Year Ended December 31, 1998 compared to Fiscal Year Ended December 31, 1997.
Net sales. Net sales of $235.0 million for the fiscal year ended December 31, 1998 increased $33.7 million, or 16.7%, from net sales of $201.3 million for the comparable period in 1997. The Company's sales of nursery products increased 19.1%, which included $16.2 million of sales from Pacific Color (acquired on October 20, 1997) and Bryfogle's (acquired on December 16, 1997). Excluding these acquisitions, sales from
the Company's nursery operations increased 7.4% from the comparable period in 1997. The higher sales were primarily due to increased sales in the eastern and southern regions of the country, resulting from continued expansion of existing operations. This increase was partially offset by lower sales in the western and southwestern regions of the country, particularly in California, where the historically strong seasonal demand was reduced due to excessive rainfall attributable to El Nino during the period.
Net sales of the Company's peat moss and peat-based products increased by $9.4 million, or 12.7%, from the comparable period in 1997. Fiscal year 1998 sales included $11.7 million from Lakeland, acquired on April 6, 1998. Excluding the Lakeland acquisition, sales decreased 3.1% from the comparable period in 1997. Sales of peat-based products in the western United States were negatively impacted during the first half of the year by unseasonably wet weather attributable to El Nino. The Company's strategy of emphasizing sales to professional customers was reflected in a 3.3%, or $1.8 million, increase in sales to this customer segment during the period. Likewise, the Company's strategy to move away from unprofitable and low margin customers resulted in reduced sales to retail customers of $4.1 million, or 22.0%, compared to 1997.
Gross profit. Gross profit of $119.9 million (51.1% of net sales) for the year ended December 31, 1998 increased $18.1 million, or 17.8%, from gross profit of $101.8 million (50.6% of net sales) for the comparable period in 1997. The increase was primarily attributable to higher sales and improved gross profit from the Company's peat moss operations resulting from the heightened emphasis on professional customers and pricing improvements in all professional products. As a percent of sales, gross margin improved by .5% to 51.1% of net sales as lower nursery operation gross margins were more than offset by improved margins in the peat moss operations. The gross margins of the nursery operations were depressed by the newly-acquired companies, which initially have lower margins than those of the core nursery business. However, the gross profit and operating performance of recently acquired companies have generally improved following the installation of Hines' operating systems and their integration into the Company.
Operating expenses. Operating expenses of $82.2 million (35.0% of net sales) for the fiscal year ended December 31, 1998 increased $11.4 million, or 16.1%, from $70.8 million (35.2% of net sales) for the comparable period in 1997. The increase was primarily attributable to acquisitions and the significant investment in sales and management infrastructure required to support the Company's current and future growth. Excluding the impact of acquisitions, the operating expenses of the Company's nursery operations increased 21.7% while operating expenses of the Company's peat moss operation decreased 13.6%. The increase in operating expenses of the nursery operations was due to higher selling and general and administrative expenses, related to significant investments in sales and management infrastructure required to support the Company's current and future growth. The decrease in operating expenses of the Company's peat moss operations was primarily due to the reduction in promotional and advertising programs targeted at retail customers resulting from the shift away from the lower margin retail peat business. Total operating expenses as a percentage of net sales decreased .2% to 35.0% due primarily to improved operating leverage at the Company's peat moss operation.
Operating income. Operating income of $37.8 million (16.1% of net sales) for the fiscal year ended December 31, 1998 increased $6.7 million, or 21.5%, from $31.1 million (15.5% of net sales) for the comparable period in 1997. Operating income increased primarily due to higher sales and gross profit margins, which were partially offset by higher operating expenses, as described above. The higher operating margin resulted from improved gross margin and a reduction in operating expenses as a percentage of net sales.
Interest expense. Interest expense of $19.5 million for the year ended December 31, 1998 decreased $1.2 million from $20.7 million for the comparable period in 1997. The decrease was attributable to lower borrowing levels and financing costs under the Company's revolving credit facilities during the third and fourth quarter of the year. Another contributing factor was the redemption of $42.0 million of senior subordinated notes in connection with the Company's initial public offering of common stock in June 1998.
Provision for income taxes. The Company's effective income tax rate was 39.5% and 37.8% for the years ended December 31, 1998 and 1997, respectively. The higher effective tax rate in 1998 was due to the non-deductibility of the goodwill amortization related to recent acquisitions.
Net income. Net income of $6.1 million for the year ended December 31, 1998 increased $0.3 million, or 5.2%, from $5.8 million for the comparable period in 1997. Excluding the $4.4 million extraordinary loss on the early extinguishment of debt, net income increased by $4.7 million, or 81.4%, from net income of $5.8 million for the comparable period in 1997. The increase in net income was primarily attributable to an increase in sales and gross margins, partially offset by an increase in operating expenses, as described above.
Fiscal Year Ended December 31, 1997 compared to Fiscal Year Ended December 31, 1996.
Net sales. The Company had consolidated net sales of $201.3 million in 1997, representing an increase of $37.0 million, or 22.5%, from net sales of $164.3 million in 1996. The Company's sales of nursery products increased 38.2% to $127.5 million from net sales of $92.2 million in 1996. This 1997 performance reflects increased sales volume and prices from its existing nursery operations as well as $26.3 million of sales from the acquisitions of Iverson on August 30, 1996, Flynn on November 27, 1996, Pacific Color on October 20, 1997 and Bryfogle's on December 16, 1997. Excluding these acquisitions, sales from the nursery operations increased 9.6% in 1997. This sales growth resulted primarily from higher sales to home centers and mass merchandisers as well as increased sales volume of flowering color plants. Net sales of peat moss and peat-based products increased 2.3% to $73.8 million from $72.1 million in 1996 primarily due to volume growth in the professional market. Sales of peat to the retail market also increased in 1997 as a result of higher unit sales volume, partially offset by lower retail peat prices. Peat prices in the first half of 1997 continued to be adversely affected by the unusually long peat moss harvesting season in eastern Canada in 1995, which created an excess supply of peat moss in the Company's eastern markets.
Gross profit. Gross profit of $101.8 million (50.6% of net sales) for the fiscal year ended December 31, 1997 represents an increase of $18.3 million, or 21.9%, from gross profit of $83.5 million (50.8% of net sales) in 1996. This increase was primarily attributable to the Company's 1996 and 1997 nursery acquisitions and higher sales from the Company's existing nursery operations. The slight decrease in gross margin percentage was primarily due to lower margins from these acquisitions, which are in varying stages of being integrated into the Company's existing nursery operations.
Operating expenses. Operating expenses of $70.8 million (35.2% of net sales) for the fiscal year ended December 31, 1997 represented an increase of $9.2 million, or 14.9%, from $61.6 million of operating expenses (37.5% of net sales) in 1996. Operating expenses in 1997 included $0.3 million of unusual expenses, which consisted of $1.5 million of severance and other restructuring costs (compared to $0.8 million in 1996), net of a $1.2 million gain on the involuntary disposal of fixed assets in connection with property damage covered by insurance. While the absolute increase was largely related to the Company's nursery acquisitions, the reduction as a percentage of net sales was primarily attributable to leveraging fixed costs over a larger sales base.
Operating income. Operating income of $31.1 million (15.4% of net sales) for the fiscal year ended December 31, 1997 represents an increase of $9.2 million, or 42.0%, from $21.9 million (13.3% of net sales) in 1996. The increase was primarily due to the Company's nursery acquisitions and higher sales from the Company's existing nursery operations. The improved operating margin resulted from a reduction in operating expenses as a percentage of sales more than offsetting the slight decrease in gross margins.
Interest expense. Interest expense of $20.7 million for the fiscal year ended December 31, 1997 increased $0.6 million from $20.1 million in 1996. The increase was attributable to higher borrowing levels as a result of increased capital expenditures and working capital requirements relating to the acquisitions. This increase was partially offset by lower interest rates.
Provision for income taxes. The effective income tax rate was 37.8% and 75.4% for the years ended December 31, 1997 and 1996, respectively. The decrease in the Company's effective income tax rate was due primarily to the $0.3 million increase in the valuation allowance in 1996 against certain net operating loss carryforwards and investment tax credits related to Sun Gro- Canada.
Net income. Net income of $5.8 million for 1997 represented an increase of $5.6 million from net income of $0.2 million for the comparable period in 1996. The increase was primarily due to the Company's higher sales and operating margins as discussed above.
Liquidity and Capital Resources
The Company has historically satisfied its working capital requirements through operating cash flow. Due to the highly seasonal nature of the Company's nursery operations, borrowings under its revolving credit facilities fund peak needs.
On June 22, 1998, the Company completed the issuance of 5.1 million shares of common stock through an initial public offering resulting in net proceeds to the Company (after deducting issuance costs) of approximately $50.2 million. The proceeds were used for the redemption on July 29, 1998, of $42.0 million in aggregate principal amount of senior subordinated notes and repayment, in part, of certain debt secured by a mortgage.
In conjunction with the Offering, the Company entered into a new senior credit facility (the "Senior Credit Facility") with Bankers Trust Company, Bank of America, N.T. & S.A. and Harris Trust & Savings Bank. The Senior Credit Facility amended and restated the Company's previous senior credit facilities to provide for a new $50.0 million term loan and a $200.0 million revolving credit facility, increasing the Company's total borrowing capacity by $100.0 million. The revolving credit facility is comprised of a $100.0 million working capital facility and a $100.0 million acquisition facility. The Senior Credit Facility has a five-year term. The revolving credit facility and all other obligations under the Senior Credit Facility are secured by substantially all of the assets and common stock of Hines Nurseries and Sun Gro-U.S., as well as a pledge of 65% of the common stock of Sun Gro-Canada. The principal repayment schedule for the term loan is $2.5 million in 1999, $6.25 million in 2000, $11.25 million in 2001, $18.75 million in 2002 and $11.25 million in 2003. Amounts borrowed under the acquisition facility will convert into a term loan in 2000 and will begin to amortize thereafter. The Senior Credit Facility, among other things, limits the ability of Hines and subsidiaries to pay any dividends.
In October 1995, Hines Nurseries issued $120.0 million in aggregate principal amount of 11 3/4% senior subordinated notes due 2005 (the "Senior Subordinated Notes") to refinance certain indebtedness incurred in connection with the acquisition of Hines by MDCP and certain members of management. These Senior Subordinated Notes were subsequently exchanged in a registered offering for $120.0 million of its 11 3/4% Senior Subordinated Notes due 2005, Series B. As of December 31, 1998, $78.0 million in aggregate principal amount remains outstanding. The indenture pursuant to which the Senior Subordinated Notes were issued imposes a number of restrictions on Hines Nurseries and Sun Gro-U.S. The indenture limits, among other things, their ability to incur additional indebtedness, to make certain restricted payments (including dividends to Hines), to make certain asset dispositions, to incur certain liens and to enter into certain significant transactions. In addition, breach of a material term of the indenture or any other material indebtedness that results in the acceleration of such indebtedness would trigger an event of default under the Senior Credit Facility, causing all amounts owing thereunder to become immediately due and payable. The Senior Credit Facility imposes a number of similar and certain additional restrictions (including financial covenants) on Hines Nurseries and Sun Gro-U.S and its subsidiaries.
Net cash provided by operating activities for the year ended December 31, 1998 of $16.0 million increased $13.8 million, from $2.2 million for the comparable period in 1997. The higher cash level generated was primarily due to increases in net income and accounts receivable collections compared with the prior year. The seasonal nature of the Company's operations results in a significant increase in certain components of working capital (primarily accounts receivable and inventory) during the growing and selling cycles. As a result, operating activities during the first and fourth quarters of 1998 used significant amounts of cash, totaling $27.1 million and $14.5 million, respectively. In contrast, the operating activities for the second and third quarters generated substantial cash, totaling $40.0 million and $17.6 million, respectively, as the Company shipped inventory and collected accounts receivable.
Net cash used for investment activities during the year ended December 31, 1998 increased $9.1 million to $38.8 million from $29.7 million for the comparable period in 1997. The increase was primarily due to the Company's increased purchases of fixed assets to develop additional nursery acreage, and the purchase of nursery-related structures, certain vehicles, machinery and equipment.
Net cash provided by financing activities during the year ended December 31, 1998 decreased $8.7 million to $20.8 million from $29.5 million for the comparable period in 1997. The decrease was primarily associated with the redemption of a portion of the Senior Subordinated Notes and the repayment of other debt obligations.
The Company typically draws under its revolving credit facilities in the first and fourth quarters to fund its inventory buildup of nursery products and seasonal operating expenses. Approximately 79% of the sales of Hines Nurseries occur in the first half of the year, generally allowing the Company to reduce borrowings under its revolving credit facilities in the second and third quarters. Working capital requirements for the Company's peat moss operations are less seasonal in nature, with slight inventory buildups generally occurring in the third and fourth quarters. On March 15, 1999, the Company had unused borrowing capacity of $81.0 million and $35.5 million under its acquisition revolver and working capital revolver, respectively, within the Senior Credit Facility.
As a result of the Company's ability to deduct its growing costs under the farming exception, the Company has generally not been required to pay cash income taxes in recent years and has generated net operating losses for federal income tax purposes. Even with the benefits of the farming exception, the Company may nonetheless be required to pay cash income taxes in future years after use, loss or expiration of its tax net operating loss carry forwards. Such cash income taxes could also result from increased taxable income due to, among other reasons, (1) reduction in the Company's deduction for interest expense resulting from the Company's repayment of indebtedness with the proceeds of the Offering, (2) any slowdown in, or elimination of, future growth in the Company's inventory of growing plants, or (3) limits on the Company's ability to use net operating loss carryforwards to offset all of its tax liability under the alternative minimum tax system.
The Company's capital expenditures were approximately $19.2 million for the year ended December 31, 1998. The capital expenditures for Hines Nurseries ($15.8 million) related primarily to the purchase and development of additional nursery acreage and the purchase of nursery-related structures, certain vehicles, machinery and equipment. The capital expenditures for Sun Gro ($3.4 million) related primarily to peat bog development and the purchase of peat bog harvesting and processing equipment. The Company's capital expenditures for 1999 are expected to be approximately $25.1 million.
Management believes that cash generated by operations and borrowings available under the Senior Credit Facility will be sufficient to meet the Company's anticipated working capital, capital expenditures and debt service requirements for the foreseeable future. However, as a result of its plan to pursue strategic acquisitions, the Company may require additional debt or equity financing in the future.
Year 2000 Compliance
The Company has instituted a program to determine whether its computerized information systems are able to interpret dates beyond the year 1999 (the "Year 2000 Compliance Program") and has implemented programming modifications to its main operational and financial reporting systems that will address these issues. All modified programming is currently operational and testing has been completed. The financial systems of companies recently acquired by the Company may not be entirely Year 2000 compliant. It is expected, however, that the Company will integrate the financial data of these acquired companies into the Company's main system during 1999 and will have no need to rely on any non-compliant systems.
The Company is in the early stage of evaluating non-information technology systems, which would include telephone equipment, greenhouse automation and watering systems. Upgrades or replacements are being made as necessary, and is expected to be completed by the end of 1999.
Evaluation and testing of personal computers will be performed internally. As needed, personal computers will be made Year 2000 compliant by systematic upgrades or replacements by the end of 1999.
The Company relies on third party suppliers for finished goods, raw materials, water, other utilities, transportation and a variety of other key services. The Company is evaluating the status of suppliers with a material relationship with the Company through confirmation and follow-up procedures and expects this phase to be completed by mid-1999.
The total cost of the Year 2000 Compliance Program is not expected to be material to the Company's consolidated financial position or results of operations. To date, the Company has spent approximately $.3 million on Year 2000 compliance. The Company believes that the total cost of ensuring Year 2000 compliance for its own operational and financial systems will be less than $.5 million.
Although management believes the Company has an adequate plan to be Year 2000 compliant, there can be no assurance that this program ultimately will be successful. The Company will continue to assess where alternative courses of action are needed as the information technology and non-information technology readiness plans are executed. The drive for formal contingency planning will be in the third quarter of 1999, once a significant amount of the business groups' readiness plans have been completed.
The principal business risks to the Company relating to completion of Year 2000 efforts are:
.The inability of key business partners to provide goods and services as a result of Year 2000 issues.
.Unforeseen issues arising in connection with recent and future acquisitions/business partnerships.
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 delays in delivery of finished products; delays in receipt of key ingredients, containers and packaging supplies; invoice and collection errors; and excess inventory of perishable items. The Company believes that its readiness efforts, which include confirmation and other testing with critical suppliers to determine if contingency planning is needed, should reduce the likelihood of such disruptions.
The foregoing represents a Year 2000 readiness disclosure entitled to protection as provided in the Year 2000 Information and Readiness Disclosure Act.
New Accounting Pronouncements
In 1998, Hines adopted Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. The adoption of SFAS 131 had no effect on the Company's consolidated results of operations, financial position or cash flows. SFAS 131 did however require the disclosure of segment information (refer to Note 13 to the Company's consolidated financial statements).
In March 1998, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP provides guidance on accounting for certain costs in connection with obtaining or developing computer software for internal use and requires that entities capitalize such costs once certain criteria are met. The Company is required to adopt SOP 98-1 as of January 1, 1999.
Effects of Inflation
Management believes the Company's results of operations have not been materially impacted by inflation over the past three years.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 stock price. The Company does not enter into transactions designed to mitigate its market risks for trading or speculative purposes. As of December 31, 1998, the Company had no foreign exchange contracts and options outstanding.
The Company manages its interest rate risk by balancing the amount of its fixed and variable long-term debt. For fixed rate debt, interest rate changes affect the fair market value of such debt but do not impact earnings or cash flows. Conversely, for variable rate debt, interest rate changes generally do not affect the fair market value of such debt but do impact future earnings and cash flows, assuming other factors are held constant. At December 31, 1998, Hines had fixed rate long-term debt of $78.0 million and variable rate long-term debt of $69.0 million. Holding other variables constant (such as foreign exchange rates and debt levels), a one percentage point increase in interest rates would have decreased the unrealized fair market value of the fixed rate debt at December 31, 1998 by approximately $3.9 million and would be expected to have an estimated impact on pre-tax earnings and cash flows for next year of approximately $.7 million for the variable debt.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information in response to this item is submitted as a separate section of this Report on page.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference to the Company's 1998 Proxy Statement to be filed with the Securities and Exchange Commission.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Company's 1998 Proxy Statement to be filed with the Securities and Exchange Commission.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the Company's 1998 Proxy Statement to be filed with the Securities and Exchange Commission.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Company's 1998 Proxy Statement to be filed with the Securities and Exchange Commission.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. The financial statements listed in "Index to Financial Statements."
2. The exhibits listed in "Index to Exhibits."
(b) Reports on Form 8-K:
The Registrant filed no current reports on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1998.
INDEX TO EXHIBITS
- -------- +Filed herewith. *Management contract or compensatory arrangement. (1) Incorporated by reference to Hines Holdings, Inc.'s Registration Statement on Form S-4, File No. 33-99452, filed on November 15, 1995 and amended on December 22, 1995 and January 8, 1996. (2) Incorporated by reference to Hines Holdings, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1997. (3) Incorporated by reference to Hines Holdings, Inc.'s Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (4) Incorporated by reference to Hines Horticulture, Inc.'s Registration Statement on Form S-1, File No. 333-51943, filed on May 6, 1998 and amended on May 26 1998 and June 16, 1998. (5) Incorporated by reference to Hines Horticulture, Inc.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. (6) Incorporated by reference to Hines Horticulture, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.
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 on March 24, 1999.
HINES HORTICULTURE, INC.
/s/ Claudia M. Pieropan By: _________________________________ Claudia M. Pieropan Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant in the capacities indicated on March 24, 1999.
HINES HORTICULTURE, INC.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Hines Horticulture, Inc. (formerly Hines Holdings, Inc.)
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Hines Horticulture, Inc. (formerly Hines Holdings, Inc.) and its subsidiaries at December 31, 1998 and 1997 and the results of their operations and their cash flows for the years then ended 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
Newport Beach, California February 22, 1999
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
CONSOLIDATED BALANCE SHEETS December 31, 1997 and 1998 (Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 1996, 1997 and 1998 (Dollars in thousands except per share data)
The accompanying notes are an integral part of these consolidated financial statements
HINES HORTICULTURE, INC. (Formerly Hines Holdings, Inc.)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) For the Years Ended December 31, 1996, 1997 and 1998 (Dollars in thousands except for share data)
- -------- (i) Accumulated accretion of cumulative redeemable preferred stock (in excess) less than additional paid-in capital
The accompanying notes are an integral part of these consolidated financial statements.
HINES HORTICULTURE, INC. (Formerly Hines Holdings, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1996, 1997 and 1998 (Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands)
1. Summary of Significant Accounting Policies
Description of Business
Hines Horticulture, Inc. ("Hines"), a Delaware corporation, produces and distributes horticultural products through its two operating divisions, Hines Nurseries and Sun Gro Horticulture ("Sun Gro"). On June 12, 1998, Hines succeeded to the business of Hines Holdings, Inc., a Nevada corporation, as a result of the merger of Hines Holdings, Inc. into Hines, the purpose of which was to change the Company's name and jurisdiction of incorporation. The business of Hines is currently conducted through Hines Nurseries, Inc. (formerly Hines Horticulture, Inc.) ("Hines Nurseries") and through Sun Gro Horticulture Inc. ("Sun Gro-U.S.") its wholly owned subsidiary, Sun Gro Horticulture Canada Ltd. ("Sun Gro-Canada"), and Sun Gro-Canada's direct and indirect Canadian subsidiaries. Hines, together with Hines Nurseries, Sun Gro- U.S., Sun Gro-Canada, and Sun Gro-Canada's direct and indirect Canadian subsidiaries, are hereafter collectively referred to as the "Company."
Hines Nurseries is a leading national supplier of ornamental, container- grown plants with nursery facilities located in California, Oregon, Pennsylvania, South Carolina and Texas. Hines Nurseries markets its products to retail customers throughout the United States.
Sun Gro produces, markets and distributes peat-based horticulture products for both retail and professional customers. Sun Gro markets its products in North America and various international markets with manufacturing facilities located in Canada and the United States.
Consolidation
The consolidated financial statements include the accounts of Hines and its wholly owned subsidiaries Hines Nurseries and Sun Gro, including Sun Gro's wholly owned subsidiary, Sun Gro-Canada. All material intercompany accounts and transactions have been eliminated in consolidation.
Revenue Recognition and Concentration of Credit Risk
The Company recognizes revenue, net of sales discounts and allowances, upon product shipment to the customer. The Company is subject to credit risk primarily through accounts receivables. Credit risk on accounts receivables is minimized as a result of the large and diverse nature of the Company's customer base throughout North America. The Company does not require collateral for its accounts receivable. Certain customers are granted deferred payment terms (dating). At December 31, 1997 and 1998, significant amounts of accounts receivable are subject to dating terms. The Company's largest customer accounted for approximately 10%, 12% and 14% of the Company's consolidated net sales in 1996, 1997 and 1998, respectively.
Amortization of Deferred Financing Expenses
Deferred financing expenses are being amortized using a method, which approximates the effective interest method over the term of the associated financing agreements.
Depreciation and Depletion
Fixed assets are stated at cost less accumulated depreciation. Interest is capitalized for qualifying assets during the assets' acquisition period. In 1998, $709 of interest was capitalized. No interest was capitalized in 1996 or 1997. Capitalized interest is recorded as part of the asset to which it relates and is amortized over the
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
respective asset's estimated useful life. Depreciation has been provided for on a straight-line basis over the following estimated economic useful lives:
Bog depletion is based on the volume of peat produced during the year at rates which will amortize the bog acquisition costs, as well as the initial bog clearing and development costs, over the period of production of peat from the bog.
Goodwill and Negative Goodwill
In connection with the sale of the Company in 1990, the Company recorded $6,100 of negative goodwill. Negative goodwill equals the excess of the fair market value of the acquired net assets over the acquisition purchase price after reducing the amount allocated to the fixed assets acquired to zero. The Company has amortized negative goodwill on a straight-line basis as a component of other operating expenses over the period from June 29, 1990 to December 31, 1997.
In connection with the acquisition of the interests of minority shareholders for stock in the Company, approximately $14,700 of goodwill was recorded and is being amortized over a 35-year period as a component of other operating expenses.
Goodwill recorded in connection with the Company's recent acquisitions, as discussed in Note 3, is being amortized over an estimated life of 35 years.
At each balance sheet date, the Company reviews the recoverability of goodwill by comparing projected operating income on an undiscounted basis to the net book value of the related assets. If the carrying value of goodwill exceeds projected operating income, the carrying value of goodwill is written down to undiscounted projected operating income.
Impairment of Long-Lived Assets
The Company annually evaluates its long-lived assets, including identifiable intangible assets, for potential impairment. When circumstances indicate that the carrying amount of the asset may not be recoverable, as demonstrated by the projected undiscounted cash flows, an impairment loss would be recognized based on fair value.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market. Hines' nursery stock has an average growing period of approximately eighteen months. The nursery stock is classified as a current asset based on Hines Nurseries' normal operating cycle.
Foreign Currency Translation
The Company considers the U.S. dollar to be the functional currency of Sun Gro's Canadian operations. Monetary assets and liabilities are translated at the foreign exchange rate in effect as of the balance sheet date.
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Non-monetary assets and liabilities are translated at historical rates and revenues and expenses at average exchange rates for the period. Gains or losses from changes in exchange rates are recognized in the consolidated results of operations in the year of occurence.
Income Taxes
Hines' operations are agricultural in nature. Hines reports its results for income tax purposes on the cash basis.
The Company accounts for income taxes using an asset and liability approach which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities at the applicable enacted tax rates. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Advertising
The Company expenses advertising costs at the time the advertising first takes place. Advertising expense was $1,658, $1,898 and $1,124 for the years ended December 31, 1996, 1997 and 1998, respectively.
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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings (Loss) Per Share ("EPS")
Basic earnings per share is computed by dividing net income, after deduction of preferred dividends, by the weighted average number of common shares outstanding in each year. Diluted earnings per share is computed by dividing net income, after deduction of preferred dividends, by the weighted average number of common shares outstanding plus any potential dilution that could occur if options and warrants were converted into common stock in each year.
In 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). In accordance with the implementation provisions of SFAS 128, the Company has restated earnings per share in the Consolidated Statements of Operations for the year ended December 31, 1996.
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
There is no difference between the numerators and denominators for basic and diluted earnings per share since common stock equivalents have been excluded from the earnings per share calculation for fiscal years 1996 and 1997 (in the amounts of $52 and $618, respectively) because the effect would be anti- dilutive. A reconciliation of the numerators and denominators of basic and diluted earnings per share for the year ended December 31, 1998 is as follows (in thousands, except per share amounts):
Recent Accounting Pronouncements
In 1998, Hines adopted Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's consolidated results of operations, financial position or cash flows. SFAS 131 did however require the disclosure of segment information (refer to Note 13).
In March 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP provides guidance on accounting for certain costs in connection with obtaining or developing computer software for internal use and requires that entities capitalize such costs once certain criteria are met. The Company is required to adopt SOP 98-1 as of January 1, 1999.
Reclassifications
Certain prior year amounts have been reclassified to conform to current year presentations.
2. Initial Public Offering
On June 22, 1998, the Company completed the issuance of 5.1 million shares of common stock through an initial public offering ("the Offering"), resulting in net proceeds to the Company (after deducting issuance costs) of approximately $50,200. A portion of the proceeds was used to repay in part certain borrowings secured by real property bearing interest at 11.75% per annum and maturing on June 27, 2005. The remaining proceeds were
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
used for the redemption on July 29, 1998, of $42,000 in aggregate principal amount of the 11.75% Senior Subordinated Notes due 2005, Series B (the "Senior Subordinated Notes"). The Senior Subordinated Notes were redeemed at a price of 109.139% of the aggregate principal amount thereof ($45,800 at July 29, 1998), plus accrued and unpaid interest thereon through the date of redemption. Payment of the redemption premium and the recognition of a portion of the deferred costs related to the Senior Subordinated Notes resulted in an extraordinary loss of $3,000, net of related income taxes of $2,000, in the quarter ended September 30, 1998.
Concurrent with the closing of the Offering, the Company entered into an amended and restated senior credit facility (the "Senior Credit Facility") to provide for a new $50,000 term loan and $200,000 revolving credit facility, as further discussed in Note 7. The revolving credit facility is comprised of a $100,000 working capital revolver and a $100,000 acquisition revolver. The Senior Credit Facility replaced the Company's existing senior credit facility and increased the aggregate size of the Company's borrowing facilities by $100,000. The prepayment of the previous credit facilities resulted in an extraordinary loss related to the write-off of unamortized financing costs of $1,400, net of $1,000 in related income taxes, during the three months ended June 30, 1998.
In connection with the Offering, on June 22, 1998, Hines effected a 1.3611- for-one reverse stock split with respect to its common stock which has been reflected in the accompanying financial statements for all periods presented.
Immediately prior to the Offering, (i) all of the outstanding shares of the Company's 12% Cumulative Redeemable Senior Preferred Stock, par value $.01 per share, and all of the outstanding shares of the Company's 12% Cumulative Redeemable Junior Preferred Stock, par value $.01 per share, together, in each case, with all accrued and unpaid dividends thereon through the date of the closing of the Offering, were converted into shares of common stock at the initial public offering price less underwriting discounts and commissions, (ii) a portion of the Company's outstanding 6% convertible subordinated promissory notes, which were issued in connection with certain acquisitions in the aggregate principal amount of $1,200, was converted into shares of common stock at the initial public offering price less underwriting discounts and commissions, and (iii) all of the outstanding warrants to purchase common stock were exercised in accordance with their terms. These actions, as well as the above noted stock split, are collectively referred to herein as the "Equity Recapitalization".
3. Acquisitions
Lakeland Peat Moss
On April 6, 1998, the Company acquired all of the issued and outstanding shares of capital stock of Lakeland Peat Moss, Ltd. and certain affiliated entities (collectively "Lakeland"), a producer of sphagnum peat moss in western Canada, for approximately U.S. $22,437. The acquisition was accounted for using the purchase method. The purchase price allocation is summarized as follows:
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Bryfogle's
On December 16, 1997, the Company acquired all of the issued and outstanding shares of Bryfogle's Wholesale, Inc., Bryfogle's Power Plants, and Power Plants II, Inc. (collectively "Bryfogle's") for approximately $18,981. The acquisition was accounted for using the purchase method. The purchase price allocation is summarized as follows:
Pacific Color Nurseries
On October 20, 1997, the Company acquired certain assets and assumed certain liabilities of Pacific Color Nurseries, Inc. ("PCN") for $1,705. The acquisition was accounted for using the purchase method. The purchase price allocation is summarized as follows:
Flynn Nurseries
On November 27, 1996, the Company acquired all of the issued and outstanding shares of Flynn Nurseries, Inc. ("Flynn") for $11,653. The acquisition was accounted for using the purchase method. The purchase price allocation is summarized as follows:
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Iverson Perennial Gardens
On August 30, 1996, the Company acquired certain assets and assumed certain liabilities of Iverson Perennial Gardens, Inc. ("Iverson") for $10,301. The acquisition was accounted for using the purchase method. The purchase price allocation is summarized as follows:
The consolidated financial statements reflect the operations of Iverson, Flynn, PCN, Bryfogle's, and Lakeland since the dates of their respective acquisition. The following summary of condensed unaudited pro forma results of operations for the year ended December 31, 1997 reflects the acquisitions of Bryfogle's, PCN and Lakeland as if they had occurred on January 1, 1997. The following summary of condensed unaudited pro forma results of operations for the year ended December 31, 1998 gives effect to the following transactions as if they had occurred as of January 1, 1998: (i) the acquisition of Lakeland; (ii) the Equity Recapitalization; (iii) the closing of the new Senior Credit Facility; and (iv) the Offering (in thousands, except per share data):
- -------- (a) After deduction of preferred stock dividends of $6,666 for the year ended December 31, 1997.
The pro forma results do not necessarily represent results, that would have occurred if the acquisitions had taken place as of the dates assumed, nor are they indicative of the results of future combined operations.
4. Unusual Expenses
During 1997, the Company received $1,194 of insurance proceeds from claims to replace assets that had been damaged and recorded a gain of $1,194, representing the difference between the proceeds received and the carrying amount of the damaged assets. As of December 31, 1998, the Company had acquired $1,324 of fixed assets utilizing the insurance proceeds.
In December 1996, the Company approved a restructuring plan for Sun Gro which, for the year ended December 31, 1996, resulted in an unusual charge of $830, representing severance-related payments. An additional liability of $1,537 was recognized during the year ended December 31, 1997, representing $1,100 of severance-related payments and $437 of other related restructuring charges. As of December 31, 1998, there was no remaining reserve balance.
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Inventories
Inventories consisted of the following:
6. Fixed Assets
Fixed assets consisted of the following:
7. Revolving Lines of Credit
On August 4, 1995, the Company entered into a revolving credit agreement that, as amended on December 16, 1997, provided for a line of credit equal to the lesser of $75,000 or a specified percentage of accounts receivable and inventory. Borrowings under this line were at interest rates approximating the U.S. prime rate plus 1.5 percent or the Eurodollar rate plus 2.5 percent. The line of credit was secured by substantially all of the assets and common stock of Hines Nurseries and Sun Gro-U.S., as well as a pledge of 66% of the common stock of Sun Gro-Canada. The agreement contained covenants that, among other matters, established minimum interest coverage and maximum leverage ratios and minimum earnings and maximum capital expenditure amounts. The average daily amount of the unused portion of the line of credit was subject to a commitment fee of 0.5 percent per annum.
On December 16, 1997 the Company entered into another revolving loan agreement that provided for a line of credit equal to the lesser of $10,000 or a percentage of accounts receivable and inventory balances, as stipulated in the agreement. Borrowings under this line were at interest rates approximating the U.S. prime rate plus 0.75 percent or the Eurodollar rate plus 2.25 percent. The line of credit was secured by substantially all of the assets of Hines Nurseries. The agreement contained covenants, which, among other matters, established minimum interest coverage and maximum leverage ratios and minimum earnings and maximum capital expenditure amounts. The average daily amount of the unused portion of the line of credit was subject to a commitment fee of 0.5 percent per annum.
Concurrent with the Offering, the Company entered into an amended and restated Senior Credit Facility to provide for a new $50,000 term loan and a $200,000 revolving credit facility, which replaced the Company's
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
existing senior credit facility and increased the aggregate size of the Company's borrowing facilities by $100,000. The revolving credit facility is comprised of a $100,000 working capital revolver and a $100,000 acquisition revolver.
After an initial period, the interest rate spread over the U.S. prime rate and Eurodollar rate varies depending upon the Company's quarterly leverage and interest coverage ratios as defined in the Senior Credit Facility agreement. The revolving credit facility and all other obligations under the Senior Credit Facility are secured by substantially all of the assets and common stock of Hines Nurseries and Sun Gro-U.S., as well as a pledge of 65% of the common stock of Sun Gro-Canada. The Senior Credit Facility contains covenants that, among other matters, establish minimum interest coverage and net worth and maximum leverage ratios and capital expenditure amounts. After an initial period, the average daily amount of the unused portion of the revolving credit facility is subject to a commitment fee which varies depending upon the Company's quarterly leverage ratio as defined in the Senior Credit Facility agreement. The revolving credit facility expires on June 30, 2003. Amounts borrowed under the acquisition facility will convert into a term loan on June 30, 2000 and will begin to amortize thereafter. The weighted average interest rate on borrowings outstanding under the Company's revolving lines of credit as of December 31, 1997 and 1998 was approximately 8.4% and 7.7%, respectively.
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8.Long-term Debt
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Estimated principal maturities of long-term debt outstanding at December 31, 1998 are as follows:
The Senior Subordinated Notes were issued by Hines Nurseries and are redeemable, in whole or in part, at the option of the Company, on or after October 15, 2000 at prices specified by the indenture agreement (105.875% as a percentage of the principal amount thereof in 2000 to 100.000% in 2004). Upon a change of control, each holder will have the right to require Hines Nurseries to repurchase such holder's notes at a price equal to 101 percent of the principal amount thereof plus accrued interest, if any, to the date of repurchase. The Senior Subordinated Notes are unsecured and subordinated to all existing and future senior debt and unconditionally guaranteed on a senior subordinated basis by Hines and Sun Gro-U.S.
The indenture governing the Senior Subordinated Notes imposes certain limitations on the ability of Hines and Sun Gro-U.S. to, among other things, incur additional indebtedness, pay dividends or make certain other restricted payments and consummate certain asset sales.
9. Commitments and Contingencies
Operating Leases
The Company leases certain land, office and warehouse facilities under various renewable long-term operating leases, which expire through 2010. Certain of these leases include escalation clauses based upon changes in the consumer price index and/or the fair rental value of leased land. One of the operating land leases requires the Company to pay rent equal to the greater of 2.25 percent, increasing to 3 percent by the year 2010, of the sales derived from the related land or a minimum per acre amount, as defined in the agreement. Total rent expense under these operating lease agreements for the years ended December 31, 1996, 1997 and 1998 was $1,302, $1,684 and $1,592 respectively.
As of December 31, 1998, the Company's future minimum annual payments under its non-cancelable operating leases are as follows:
Legal Matters
From time to time, the Company is involved in various disputes and litigation matters, which arise in the ordinary course of business. The litigation process is inherently uncertain and it is possible that the resolution of
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
these disputes and lawsuits may adversely affect the Company. Management believes, however, that the ultimate resolution of such matters will not have a material adverse impact on the Company's consolidated financial position or results of operations.
10. Shareholders' Equity
Stock Option Plan: On June 22, 1998, the Board adopted the 1998 Long-Term Equity Incentive Plan (the "1998 Stock Plan"). The 1998 Stock Plan provides for grants of stock options, stock appreciation rights ("SARs"), restricted stock, performance awards and any combination of the foregoing to certain directors, officers and employees of the Company and its subsidiaries. The purpose of the 1998 Stock Plan is to provide such individuals with incentives to maximize shareholder value and otherwise contribute to the success of the Company and to enable the Company to attract, retain and reward the best available persons for positions of substantial responsibility. The options are granted at the fair market value of the shares underlying the options at the date of grant, generally become exercisable over a four-year period and expire in ten years.
Approximately 2.6 million shares of common stock will be available for issuance pursuant to the 1998 Stock Plan, subject to adjustment in the event of a reorganization, stock split, merger or similar change in the corporate structure of the Company or the outstanding shares of common stock.
The Company adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") in 1998. As permitted by SFAS 123, the Company measures compensation cost in accordance with Accounting Principles Board Opinon No. 25, "Accounting for Stock Issued to Employees", and related interpretations, but provides pro forma disclosures of net income and earnings per share as if the fair value method (as defined in SFAS 123) had been applied. Had compensation cost been determined using the fair value method prescribed by SFAS 123, the Company's net loss and earnings (loss) per share would have been as follows (in thousands, except per share amounts):
The Company estimates the weighted average fair value of each stock option on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions: no dividend yield; expected volatility of approximately 50%; risk-free interest rate of 5.56% and expected life of approximately four years.
A summary of the status of the Company's stock option plan as of December 31, 1998 is presented below:
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For options outstanding as of December 31, 1998, the weighted average remaining contractual life was 9.5 years with expiration dates ranging from June 22, 2008 to October 20, 2008. The range of exercise prices was $6.875 to $11.00 for options outstanding as of December 31, 1998. The weighted average fair value of options granted during the year ended December 31, 1998 was $4.93.
11. Income Taxes
The components of income (loss) from continuing operations before provision for income taxes and the provision for income taxes consisted of the following:
The reported provision for income taxes differs from the amount computed by applying the statutory federal income tax rate of 34 percent to income before provision for income taxes as follows:
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred tax assets (liabilities) are comprised of the following:
The Company derives significant benefits by qualifying to use the cash method of accounting for federal income tax purposes. Under the cash method, sales are included in taxable income when payments are received and expenses are deducted as they are paid. The primary benefit the Company receives is the ability to deduct the cost of inventory as it is incurred. The net benefit realized by the Company thus far is represented by the "Accrual to Cash Adjustment" item above. Because the items to which this "Accrual to Cash Adjustment" relate to are comprised of current assets and current liabilities in the balance sheet (such as inventory, accounts receivable, accounts payable, etc.), this deferred tax item is also characterized as current.
At December 31, 1998, the Company had approximately $36,000 in net operating loss carryforwards for federal income tax reporting purposes. The Company's federal net operating losses begin to expire in 2005.
Included in the valuation allowance is $1,000 that relates to the deferred tax assets recorded from acquisitions. Any tax benefits subsequently recognized for these deferred tax assets will be allocated to goodwill.
At December 31, 1998, Sun Gro-Canada had capital loss carryforwards and investment tax credits of approximately Cdn. $2,908 (U.S. $1,890) and Cdn. $459 (U.S. $298), respectively. Their use is limited to future taxable earnings of Sun Gro-Canada. A full valuation allowance has been recorded against the deferred tax assets
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
associated with the capital loss carryforwards and the investment tax credits. The capital loss may be carried forward indefinitely and the investment tax credits expire as follows (Canadian dollars):
During 1998, the Canadian net operating loss carryforward of approximately Cdn. $7,000 was fully utilized and the valuation allowance related to it was released.
12. Employee Benefit Plans
Sun Gro sponsors defined contribution plans for certain salaried U.S. employees, certain salaried Canadian employees and certain hourly Canadian employees. Participants of the salaried U.S. investment plan may make voluntary contributions to the plan up to 15 percent of their compensation (as defined). Sun Gro contributes five percent of each participant's compensation (as defined) up to a maximum of $3,500 per participant depending upon Sun Gro's performance.
Participants of the salaried and hourly Canadian investment plan must contribute 3 percent of their compensation (as defined) and may make voluntary contributions to the plan up to 18 percent of their compensation (as defined). Sun Gro contributes up to 5 percent and 3 percent of each participant's compensation (as defined) with no maximum for the salaried and hourly plans, respectively.
The total expense related to these plans was $395, $284 and $0 for the years ended December 31, 1996, 1997 and 1998, respectively.
13. Segment Information
The Company operates in two business segments in the horticultural industry: nursery products and peat-based products. The Company evaluates the performance of its segments based primarily on operating income. Refer to Note 19 "Guarantor/ Non-guarantor Disclosures" for the required disclosures about the Company's segments for the three years ended December 31, 1998.
14. Supplemental Cash Flow Information
Supplemental disclosure of non-cash investing and financing activities were as follows:
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. Fair Values of Financial Instruments
The Company used the following methods and assumptions in estimating its fair value disclosures for financial instruments:
Cash
The carrying amount reported in the balance sheet for cash approximates its fair value.
Short-term and Long-term Debt
The fair value of the Senior Subordinated Notes is based on the closing price of the debt securities at December 31, 1997 and 1998. The carrying amount of the Company's other long-term debt approximates its fair value based upon borrowing rates currently available to the Company. The carrying amount of the short-term debt approximates the fair value based on the short-term maturity of the instrument.
Redeemable Preferred Stock
The fair value of the Senior Preferred Stock and Junior Preferred Stock approximates its carrying value as of December 31, 1997, as the stock was recently issued.
The carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1997 and 1998 are as follows:
17. Valuation and Qualifying Accounts
Activity with respect to the Company's allowance for doubtful accounts receivable is summarized as follows:
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
18. Geographic Information
Geographic information is summarized as follows:
Export sales from the United States totaled $6,780, $7,872 and $9,952 for the years ended December 31, 1996, 1997 and 1998, respectively.
19. Guarantor/Non-guarantor Disclosures
The Senior Subordinated Notes issued by Hines Nurseries (the issuer) have been guaranteed by Hines (the parent guarantor) and by Sun Gro-U.S. (the subsidiary guarantor). The issuer and the subsidiary guarantor are wholly owned subsidiaries of the parent guarantor and the parent and subsidiary guarantees are full, unconditional, and joint and several. Separate financial statements of Hines Nurseries and Sun Gro-U.S. are not presented and Hines Nurseries and Sun Gro-U.S. are not filing separate reports under the Exchange Act because management believes that they would not be material to investors. The Senior Subordinated Notes are not guaranteed by Sun Gro-Canada or its present or future subsidiaries.
The following condensed consolidating information shows (a) Hines on a parent company basis only as the parent guarantor (carrying its investment in its subsidiary under the equity method), (b) Hines Nurseries as the issuer (carrying its investment in its subsidiary under the equity method), (c) Sun Gro-U.S. as subsidiary guarantor (carrying its investment in Sun Gro-Canada under the equity method), (d) Sun Gro-Canada and its direct and indirect subsidiaries, as subsidiary non-guarantors, (e) eliminations necessary to arrive at the
HINES HORTICULTURE, INC. (FORMERLY HINES HOLDINGS, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
information for the parent guarantor and its direct and indirect subsidiaries on a consolidated basis and (f) the parent guarantor on a consolidated basis, as follows:
.Consolidating balance sheets as of December 31, 1997 and December 31,
.Consolidating statements of operations for the year ended December 31, 1996, 1997 and 1998; and
.Consolidating statements of cash flows for the year ended December 31, 1996, 1997 and 1998
GUARANTOR / NON-GUARANTOR DISCLOSURES
CONSOLIDATING BALANCE SHEET
As of December 31, 1997 (Dollars in thousands)
GUARANTOR / NON-GUARANTOR DISCLOSURES--(CONTINUED)
CONSOLIDATING BALANCE SHEET
As of December 31, 1998 (Dollars in thousands)
GUARANTOR / NON-GUARANTOR DISCLOSURES--(CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 1996 (Dollars in thousands)
GUARANTOR / NON-GUARANTOR DISCLOSURES--(CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 1998 (Dollars in thousands)
GUARANTOR / NON-GUARANTOR DISCLOSURES--(Continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 1996 (Dollars in thousands)
GUARANTOR / NON-GUARANTOR DISCLOSURES--(Continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 1997 (Dollars in thousands)
GUARANTOR / NON-GUARANTOR DISCLOSURES--(CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 1998 (Dollars in thousands)