**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

----

 

#### **FORM 10-Q**

**(Mark One)**
| **ý**                                              | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                    |                                                                                          |
| **For the quarterly period  ended March 31, 2004** |
|                                                    |                                                                                          |
| **OR**                                                  |
|                                                    |                                                                                          |
| **o**                                                   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                to                **

 

**Commission File Number: 333-76055**

 

----

 

# ***UNITED INDUSTRIES CORPORATION***

(Exact name of registrant as specified in itscharter)

 
| **Delaware**                                                                                 |   | **43-1025604**                                 |
|----------------------------------------------------------------------------------------------|--------|------------------------------------------------|
| **(State or other jurisdiction of  incorporation or organization)** |   | **(I.R.S. Employer  Identification No.)** |
|                                                                                         |   |                                           |
| **2150 Schuetz Road**St. Louis,Missouri 63146                                                |
| **(Address of principal executive office, including  zip code)**                             |
|                                                                                         |   |                                           |
| **(314) 427-0780**                                                                      |
| **(Registrant’s telephone number, including area  code)**                               |

 

----

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days. Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). Yes o   No ý

 

As of May 14, 2004, the registrant had 30,121,162 Class A votingand 30,121,162 Class B nonvoting shares of common stock outstanding.

 

 

----

 

**UNITED INDUSTRIES CORPORATION**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE PERIOD ENDED MARCH 31, 2004**

** **

**TABLE OF CONTENTS**

** **
|                                                                                                 | Page                                                                                                                     |
|------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------|
|                                                                                                 |                                                                                                                     |
| **PART I. FINANCIAL INFORMATION**                                                                    | 4                                                                                                                        |
|                                                                                                 |                                                                                                                     |
| Item 1. Financial Statements (Unaudited)                                                             | 4                                                                                                                        |
|                                                                                                 |                                                                                                                     |
|                                                                                                 | Consolidated Balance Sheets as of March 31, 2004 and 2003 and  December 31, 2003                                         | 4 |
|                                                                                                 |                                                                                                                     |   |
|                                                                                                 | Consolidated Statements of Operations and  Comprehensive Income for the Three Months  Ended March 31, 2004 and 2003 | 5 |
|                                                                                                 |                                                                                                                     |   |
|                                                                                                 | Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2004 and 2003                                | 6 |
|                                                                                                 |                                                                                                                     |   |
|                                                                                                 | Notes to Consolidated Financial Statements                                                                               | 7 |
|                                                                                                 |                                                                                                                     |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations | 27                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                  | 42                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| Item 4. Controls and Procedures                                                                      | 44                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| **PART II. OTHER INFORMATION**                                                                       | 45                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| Item 1. Legal Proceedings                                                                            | 45                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| Item 6. Exhibits and Reports on Form 8-K                                                             | 45                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| SIGNATURES                                                                                           | 46                                                                                                                       |
|                                                                                                 |                                                                                                                     |
| EXHIBIT  INDEX                                                                                       | 47                                                                                                                       |

 

2

----

 

**CAUTIONARY STATEMENT REGARDINGFORWARD-LOOKING STATEMENTS**

** **

This Quarterly Report contains forward-looking statements. Thesestatements are subject to a number of risks and uncertainties, many of whichare beyond our control. All statements other than statements of historicalfacts included in this Quarterly Report, including statements regarding ourstrategy, future operations or financial position, estimated revenues,projected costs, projections, plans and objectives of management, areforward-looking statements. As may be used in this Quarterly Report, the words“will,” “should,” “believe,” “plan,” “may,” “strategies,” “goals,” “anticipate,”“indicate,” “intend,” “determine,” “estimate,” “expect,” “project” and similarexpressions are intended to identify forward-looking statements, although notall forward-looking statements contain such identifying words. Allforward-looking statements apply only as of the date they are disclosed and arebased on our expectations at that time. We do not undertake any obligation toupdate or revise publicly any forward-looking statements, whether as a resultof new information, future events or otherwise. Although we believe that ourplans, intentions and expectations reflected in or suggested by anyforward-looking statements we make in this Quarterly Report are reasonable, wecan give no assurance that such plans, intentions or expectations will beachieved. 

 

Our actual results could differ significantly from the resultsdiscussed in any forward-looking statements contained in this QuarterlyReport.  Factors that could cause orcontribute to such differences include, without limitation, the following: 

 

•                                          generaleconomic and business conditions; 

 

•                                          theloss or bankruptcy of major customers, suppliers or parties with whom we have astrategic relationship; 

 

•                                          theloss of a significant amount of products purchased by major customers; 

 

•                                          weatherconditions and/or historical seasonality; 

 

•                                          ourability to repay our indebtedness or meet other obligations; 

 

•                                          industrytrends and competition; 

 

•                                          ourability to manage rapid growth and the integration of acquisitions;

 

•                                          ourability to achieve the benefits we expect from acquisitions, including theNu-Gro Corporation transaction;

 

•                                          ourability to successfully implement our enterprise resource planning, or ERP,system;

 

•                                          publicperception regarding the safety of our products; 

 

•                                          governmentalregulations; 

 

•                                          terroristattacks or acts of war; 

 

•                                          costand availability of raw materials; 

 

•                                          changesin our business strategy or development plans; 

 

•                                          ourability to recruit and retain quality personnel; 

 

•                                          availability,terms and deployment of capital resources; and 

 

•                                          theother risks described in our filings with the SEC, including our Annual Reporton Form 10-K.

 

**TRADEMARKS**

 

Spectracide®, Spectracide Triazicide®,Spectracide Terminate®, Spectracide Pro®, Hot Shot®,Garden Safe®, SchultzTM, Rid-a-Bug®, Bag-a-Bug®,Real-Kill®, No-Pest®, Repel®, Vigoro®,Sta-Green®, Bandini®, CILÒ,WilsonÒ, PickseedÒ,So-GreenÒ, Plant-ProdÒ,GreenleafÒ, Green EarthÒ,IB NitrogenÒ,NitroformÒ,NutraleneÒ,OrganiformÒandSCUÒ are ourtrademarks and trade names. We also license certain Cutter®trademarks from Bayer A.G. and certain Peters® and PetersProfessional® trademarks from The Scotts Company. Other trademarksand trade names used in this Quarterly Report are the property of theirrespective owners. 

 

3

----

 

**PART I. FINANCIAL INFORMATION**

** **

##### **ITEM 1.  FINANCIAL STATEMENTS**

##### ** **

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Dollars in thousands, except share data)**

**(Unaudited)**

** **
|                                                                                                                                                                                                                                                                                                                                                                    |   | **March 31,**      |       | **December  31,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------|--------|
|                                                                                                                                                                                                                                                                                                                                                                    |   | **2004**           |       | **2003**          |   | **2003** |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   | **(As  Restated)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                              |   |               |       |              |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Current assets:                                                                                                                                                                                                                                                                                                                                                         |   |               |       |              |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                               |   | $                  | —     |              | $      | — |   | $ | 11,413 |   |
| Accounts receivable, less reserves of  $4,371 and $4,950  at March 31, 2004 and 2003, respectively, and $2,753 at December 31, 2003                                                                                                                                                                                                                                     |   | 146,730            |       | 139,537           |   | 29,890 |   |
| Inventories                                                                                                                                                                                                                                                                                                                                                             |   | 115,318            |       | 98,119            |   | 96,795 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                                               |   | 17,997             |       | 10,524            |   | 15,141 |   |
| Total current assets                                                                                                                                                                                                                                                                                                                                                    |   | 280,045            |       | 248,180           |   | 153,239 |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Equipment and leasehold improvements, net                                                                                                                                                                                                                                                                                                                               |   | 41,510             |       | 33,649            |   | 37,153 |   |
| Deferred tax asset                                                                                                                                                                                                                                                                                                                                                      |   | 178,970            |       | 96,739            |   | 186,562 |   |
| Goodwill                                                                                                                                                                                                                                                                                                                                                                |   | 6,221              |       | 8,868             |   | 6,221 |   |
| Intangible assets, net                                                                                                                                                                                                                                                                                                                                                  |   | 86,037             |       | 87,670            |   | 86,872 |   |
| Other assets, net                                                                                                                                                                                                                                                                                                                                                       |   | 8,997              |       | 15,163            |   | 9,897 |   |
| Total assets                                                                                                                                                                                                                                                                                                                                                            |   | $                  | 601,780    |              | $      | 490,269 |   | $ | 479,944 |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                                                                                                                                                                                                 |   |               |       |              |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Current liabilities:                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Current maturities of long-term debt and  capital lease obligations                                                                                                                                                                                                                                                                                                     |   | $                  | 3,796      |              | $      | 1,590 |   | $ | 1,349 |   |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                        |   | 60,685             |       | 59,016            |   | 29,774 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                                        |   | 58,729             |       | 66,313            |   | 39,574 |   |
| Short-term borrowings                                                                                                                                                                                                                                                                                                                                                   |   | 61,525             |       | 10,100            |   | — |   |
| Total current liabilities                                                                                                                                                                                                                                                                                                                                               |   | 184,735            |       | 137,019           |   | 70,697 |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Long-term debt, net of current maturities                                                                                                                                                                                                                                                                                                                               |   | 387,219            |       | 431,328           |   | 387,657 |   |
| Capital lease obligations, net of current  maturities                                                                                                                                                                                                                                                                                                                   |   | 3,231              |       | 3,577             |   | 3,191 |   |
| Other liabilities                                                                                                                                                                                                                                                                                                                                                       |   | 3,222              |       | 4,048             |   | 3,256 |   |
| Total liabilities                                                                                                                                                                                                                                                                                                                                                       |   | 578,407            |       | 575,972           |   | 464,801 |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Commitments and contingencies (see Notes 10  and 11)                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                    |   |               |       |              |   |   |   |
| Stockholders’  equity (deficit):                                                                                                                                                                                                                                                                                                                                   |   |               |       |              |   |   |   |
| Preferred stock (37,600 shares of $0.01 par  value Class A issued  and outstanding, 40,000 shares authorized)                                                                                                                                                                                                                                                           |   | —             |       | —            |   | — |   |
| Common stock (33.2 million shares each of  $0.01 par value Class A and  Class B issued, 30.1 million shares of each outstanding and 43.6 million  shares of each authorized at March 31, 2004; 33.2 million shares each of  $0.01 par value Class A and Class B issued and outstanding, 43.6 million  shares of each authorized at March 31, 2003 and December 31, 2003 |   | 665                |       | 664               |   | 665 |   |
| Treasury stock (3.1 million shares each of  $0.01 par value Class A and  Class B, at cost at March 31, 2004; no shares at March 31, 2003; 9,569 shares  each of $0.01 par value                                                                                                                                                                                         |   |               |       |              |   |   |   |
| Class A and Class B, at cost at December  31, 2003)                                                                                                                                                                                                                                                                                                                     |   | (24,469            | )          | —            |   | (96 | ) |
| Warrants and options                                                                                                                                                                                                                                                                                                                                                    |   | 11,745             |       | 11,745            |   | 11,745 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                                              |   | 208,272            |       | 210,480           |   | 210,908 |   |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                                     |   | (169,547           | )          | (278,346          | )      | (179,738 | ) |
| Common stock subscription receivable                                                                                                                                                                                                                                                                                                                                    |   | —             |       | (24,976           | )      | (22,534 | ) |
| Common stock repurchase option                                                                                                                                                                                                                                                                                                                                          |   | —             |       | (2,636            | )      | (2,636 | ) |
| Common stock held in grantor trusts                                                                                                                                                                                                                                                                                                                                     |   | (2,847             | )          | (2,700            | )      | (2,847 | ) |
| Loans to executive officer                                                                                                                                                                                                                                                                                                                                              |   | (267               | )          | (324              | )      | (324 | ) |
| Accumulated other comprehensive income  (loss)                                                                                                                                                                                                                                                                                                                          |   | (179               | )          | 390               |   | — |   |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                                                                                                                                               |   | 23,373             |       | (85,703           | )      | 15,143 |   |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                                                                                                                                                                                                                              |   | $                  | 601,780    |              | $      | 490,269 |   | $ | 479,944 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

4

----

 

**UNITED INDUSTRIES CORPORATION ANDSUBISIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE INCOME**

**(Dollars in thousands)**

**(Unaudited)**

** **
|                                                                                                                                          |   | **Three  Months Ended March 31,** |    |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                                                                                          |   | **2004**                          |    | **2003** |   |
|                                                                                                                                          |   |                              |    | **(As  Restated)** |   |
| **CONSOLIDATED STATEMENTS OF OPERATIONS:**                                                                                                    |   |                              |    |   |   |
|                                                                                                                                          |   |                              |    |   |   |
| Net sales                                                                                                                                     |   | $                                 | 182,703 |   | $ | 178,812 |   |
| Operating costs and expenses:                                                                                                                 |   |                              |    |   |   |
| Cost of goods sold                                                                                                                            |   | 113,408                           |    | 108,755 |   |
| Selling, general and administrative  expenses                                                                                                 |   | 39,981                            |    | 41,399 |   |
| Total operating costs and expenses                                                                                                            |   | 153,389                           |    | 150,154 |   |
| Operating income                                                                                                                              |   | 29,314                            |    | 28,658 |   |
| Interest expense                                                                                                                              |   | 9,620                             |    | 9,702 |   |
| Interest income                                                                                                                               |   | 285                               |    | 499 |   |
| Income before income tax expense                                                                                                              |   | 19,979                            |    | 19,455 |   |
| Income tax expense                                                                                                                            |   | 7,592                             |    | 8,402 |   |
| Net income                                                                                                                                    |   | 12,387                            |    | 11,053 |   |
| Preferred stock dividends                                                                                                                     |   | 2,196                             |    | 1,807 |   |
| Net income available to common stockholders                                                                                                   |   | $                                 | 10,191  |   | $ | 9,246 |   |
|                                                                                                                                          |   |                              |    |   |   |
|                                                                                                                                          |   |                              |    |   |   |
| **CONSOLIDATED STATEMENTS OF COMPREHENSIVE  INCOME:**                                                                                         |   |                              |    |   |   |
|                                                                                                                                          |   |                              |    |   |   |
| Net income                                                                                                                                    |   | $                                 | 12,387  |   | $ | 11,053 |   |
| Other comprehensive income:                                                                                                                   |   |                              |    |   |   |
| Gain (loss) on derivative hedging  instruments, net of tax of $109 and $259  for the three months ended March 31, 2004 and 2003, respectively |   | (179                              | )       | 422 |   |
| Comprehensive income                                                                                                                          |   | $                                 | 12,208  |   | $ | 11,475 |   |

** **

See accompanying notes to consolidatedfinancial statements.

 

5

----

 

**UNITED INDUSTRIES CORPORATION ANDSUBISIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

** **
|                                                                               |   | **Three  Months Ended March 31,** |   |
|------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                               |   | **2004**                          |   | **2003** |   |
|                                                                               |   |                              |   | **(As  Restated)** |   |
| Cash flows from operating activities:                                              |   |                              |   |   |   |
| Net income                                                                         |   | $                                 | 12,387 |   | $ | 11,053 |   |
| Adjustments to reconcile net income to net  cash flows  from operating activities: |   |                              |   |   |   |
| Depreciation and amortization                                                      |   | 6,239                             |   | 4,662 |   |
| Amortization and write-off of deferred  financing fees                             |   | 628                               |   | 2,309 |   |
| Deferred income tax expense                                                        |   | 7,592                             |   | 8,402 |   |
| Changes in operating assets and  liabilities:                                      |   |                              |   |   |   |
| Accounts receivable                                                                |   | (116,927                          | )      | (116,681 | ) |
| Inventories                                                                        |   | (18,523                           | )      | (10,357 | ) |
| Prepaid expenses                                                                   |   | (3,082                            | )      | 1,248 |   |
| Other assets                                                                       |   | (2,675                            | )      | (1,524 | ) |
| Accounts payable                                                                   |   | 30,911                            |   | 31,953 |   |
| Accrued expenses                                                                   |   | 2,703                             |   | 13,448 |   |
| Facilities and organizational  rationalization costs                               |   | —                            |   | (596 | ) |
| Other operating activities, net                                                    |   | (35                               | )      | 664 |   |
| Net cash flows used in operating activities                                        |   | (80,782                           | )      | (55,419 | ) |
|                                                                               |   |                              |   |   |   |
| Cash flows from investing activities:                                              |   |                              |   |   |   |
| Purchases of equipment and leasehold  improvements                                 |   | (3,534                            | )      | (1,267 | ) |
| Net cash flows used in investing activities                                        |   | (3,534                            | )      | (1,267 | ) |
|                                                                               |   |                              |   |   |   |
| Cash flows from financing activities:                                              |   |                              |   |   |   |
| Proceeds from issuance of senior  subordinated notes                               |   | —                            |   | 86,275 |   |
| Proceeds from borrowings on revolver                                               |   | 61,525                            |   | 40,000 |   |
| Payments received for common stock  subscription receivable                        |   | —                            |   | 1,250 |   |
| Payments received on loans to executive  officer                                   |   | 57                                |   | 80 |   |
| Repayment of borrowings on term debt                                               |   | (421                              | )      | (54,769 | ) |
| Repayment of borrowings on revolver                                                |   | —                            |   | (29,900 | ) |
| Payments for capital lease obligations                                             |   | (1,016                            | )      | (78 | ) |
| Payments for debt issuance costs                                                   |   | —                            |   | (2,923 | ) |
| Payment for Bayer transactions for treasury  stock                                 |   | (1,500                            | )      | — |   |
| Change in cash overdraft                                                           |   | 14,258                            |   | 6,433 |   |
| Net cash flows from financing activities                                           |   | 72,903                            |   | 46,368 |   |
| Net increase in cash and cash equivalents                                          |   | (11,413                           | )      | (10,318 | ) |
| Cash and cash equivalents, beginning of  period                                    |   | 11,413                            |   | 10,318 |   |
| Cash and cash equivalents, end of period                                           |   | $                                 | — |   | $ | — |   |
|                                                                               |   |                              |   |   |   |
| Noncash financing activities:                                                      |   |                              |   |   |   |
| Bayer transactions for treasury stock (see  Note 12)                               |   | $                                 | 22,873 |   | $ | — |   |
| Execution of capital lease for  transportation equipment                           |   | $                                 | 3,525  |   | $ | — |   |
| Preferred stock dividends accrued                                                  |   | $                                 | 2,196  |   | $ | 1,807 |   |

** **

See accompanying notes to consolidatedfinancial statements.

 

6

----

 

**UNITEDINDUSTRIES CORPORATION AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**(Dollarsin thousands, except where indicated)**

**(Unaudited)**

** **

**Note 1—Description of Business and Basisof Presentation**

** **

Under a variety of brand names, and operating as Spectrum Brands,United Industries Corporation (the Company) manufactures and markets one of thebroadest lines of products in the industry, including herbicides and indoor andoutdoor insecticides, as well as insect repellents, fertilizers, growing mediaand soils. The Company’s value brands are targeted toward consumers who wantproducts and packaging that are comparable or superior to, and at lower pricesthan, premium-priced brands, while its opening price point brands are designedfor cost-conscious consumers who want quality products. The Company’s productsare marketed to mass merchandisers, home improvement centers, hardware, groceryand drug chains, nurseries and garden centers.

 

As described in more detail in Note 14, the Company’s operations aredivided into three business segments: Lawn and Garden, Household and Contract.The Company’s lawn and garden brands include, among others, Spectracide®,Garden Safe®, Real-Kill® and No-Pest® in thecontrols category, as well as Sta-Green®, Vigoro®,SchultzTM and Bandini® brands in the lawn and garden fertilizer andgrowing media categories. The Company’s household brands include, among others,Hot Shot®, Cutter® and Repel®. The Contractsegment represents a variety of compounds and chemicals, such as cleaningsolutions and other consumer products.

 

The accompanyingconsolidated financial statements include the accounts and balances of theCompany and its wholly-owned subsidiaries. All material intercompanytransactions have been eliminated in consolidation. The accompanyingconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and the rules and regulations of the Securities andExchange Commission. Accordingly, certain information and footnote disclosurestypically included in the Company’s Annual Report on Form 10-K have beencondensed or omitted for this report. As such, this report should be read inconjunction with the consolidated financial statements and accompanying notesin the Company’s Annual Report on Form 10-K for the year ended December 31,2003. Certain amounts in the 2003 consolidated financial statements includedherein have been reclassified to conform to the 2004 presentation.

 

The accompanying consolidated financial statements are unaudited. Inthe opinion of management, such financial statements include all adjustments,which consist of only normal recurring adjustments, necessary for a fairpresentation of the results for the periods presented. Interim results are notnecessarily indicative of results for a full year. The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from such estimates and assumptions.

 

**Note 2—Definitive Agreement to AcquireThe Nu-Gro Corporation**

** **

In March 2004, the Companyand its newly-created wholly-owned subsidiary entered into a definitiveagreement to acquire all of the outstanding common shares of The Nu-GroCorporation (Nu-Gro), a lawn and garden products company incorporated under thelaws of Ontario, Canada and publicly-traded on the Toronto Stock Exchange.  Nu-Gro’s shareholders approved thetransaction on April 27, 2004 and the Company completed the acquisition onApril 30, 2004 for cash consideration of $141.4 million.  The transaction was financed with proceedsfrom the Company’s new senior credit facility (see Note 9).  The transaction will be accounted for as anacquisition, and accordingly, the results of operations of Nu-Gro will beincluded in the Company’s results of operations from the date ofacquisition.  The Company is currentlyin the process of obtaining an independent third-party valuation of assetsacquired and liabilities assumed for purchase price allocation purposes andexpects the valuation to be completed by the third quarter of 2004.  Because the acquisition occurred after March31, 2004, Nu-Gro’s results of operations are not included in the accompanyingconsolidated statement of operations for the three months ended March 31, 2004and the acquired assets and liabilities assumed are not included in theaccompanying consolidated balance sheet as of March 31, 2004.

 

7

----

 

**Note 3—Stock-Based Compensation**

** **

The Company accounts for stock options issued to employees inaccordance with Accounting Principles Board (APB) Opinion No. 25,“Accounting for Stock Issued to Employees” and applies the disclosureprovisions of Statement of Financial Accounting Standards (SFAS) No. 123,“Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure, an amendment of FASBStatement No. 123.” Under APB No. 25 and related interpretations,compensation expense is recognized using the intrinsic value method for thedifference between the exercise price of the options and the estimated fairvalue of the Company’s common stock on the date of grant.

 

SFAS No. 123 requires pro forma disclosure of the impact on earnings asif the Company determined stock-based compensation expense using the fair valuemethod.  The following table presentsnet income, as reported, stock-based compensation expense that would have beenrecorded using the fair value method and pro forma net income that would havebeen reported had the fair value method been applied:

 
|                                                                      |   | **Three  Months Ended March 31,** |   |
|---------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                      |   | **2004**                          |   | **2003** |   |
|                                                                      |   |                              |   |   |   |
| Net income, as reported                                                   |   | $                                 | 12,387 |   | $ | 11,053 |   |
| Stock-based compensation expense using the  fair value method, net of tax |   | (178                              | )      | (685 | ) |
| Pro forma net income                                                      |   | $                                 | 12,209 |   | $ | 10,368 |   |

 

**Note 4—Inventories**

 

Inventories consist of the following:

 
|                                              |   | **March 31,** |    | **December  31,** |   |
|---------------------------------------------------|--------|---------------|---------|-------------------|--------|
|                                              |   | **2004**      |    | **2003**          |   | **2003** |   |
|                                              |   |          |    |              |   |   |   |
| Raw materials                                     |   | $             | 37,195  |              | $      | 31,307 |   | $ | 34,619 |   |
| Finished goods                                    |   | 83,030        |    | 72,252            |   | 67,794 |   |
| Allowance for obsolete and slow-moving  inventory |   | (4,907        | )       | (5,440            | )      | (5,618 | ) |
| Total inventories                                 |   | $             | 115,318 |              | $      | 98,119 |   | $ | 96,795 |   |

 

8

----

 

**Note 5—Equipment and LeaseholdImprovements**

** **

Equipment and leasehold improvements consist of the following:

 
|                                                  |   | **March 31,** |   | **December  31,** |   |
|-------------------------------------------------------|--------|---------------|--------|-------------------|--------|
|                                                  |   | **2004**      |   | **2003**          |   | **2003** |   |
|                                                  |   |          |   |              |   |   |   |
| Machinery and equipment                               |   | $             | 39,532 |              | $      | 38,670 |   | $ | 39,024 |   |
| Office furniture, equipment and capitalized  software |   | 31,881        |   | 24,891            |   | 30,183 |   |
| Transportation equipment                              |   | 10,128        |   | 6,283             |   | 6,418 |   |
| Leasehold improvements                                |   | 3,248         |   | 3,907             |   | 3,157 |   |
| Land and buildings.                                   |   | 915           |   | 72                |   | 114 |   |
|                                                  |   | 85,704        |   | 73,823            |   | 78,896 |   |
| Accumulated depreciation and amortization             |   | (44,194       | )      | (40,174           | )      | (41,743 | ) |
| Total equipment and leasehold improvements,  net      |   | $             | 41,510 |              | $      | 33,649 |   | $ | 37,153 |   |

 

For the three months ended March 31, 2004 and 2003 and the yearended December 31, 2003, depreciation expense was $2.5 million,$1.8 million and $7.4 million, respectively. In February 2004, the Companyexecuted a capital lease agreement for the use of transportation equipment for$3.5 million.  As of March 31, 2004 and2003 and December 31, 2003, the cost of transportation equipment heldunder capital lease was $8.8 million, $5.3 million and $5.3 million,respectively, and related accumulated amortization was $4.7 million,$3.5 million and $4.4 million, respectively.

 

On April 15, 2004, the Company closed an agreement that was executed inMarch 2004 to sell the aircraft it replaced in February 2004.  The carrying value of the aircraft sold was$1.2 million and proceeds from the sale were $2.8 million.  Accordingly, after related expenses of $0.1million, the Company recorded a $1.5 million gain on sale which will beincluded in operating income in the Company’s consolidated statement ofoperations for the second quarter ending June 30, 2004.

 

**Note 6—Goodwill and Intangible Assets**

** **

Intangible assets consist of the following:

 
|                         |   |                               |   | **March 31,  2004**        |    | **March 31,  2003**           |   | **December  31, 2003**   |   |
|------------------------------|--------|------------------------------------|--------|----------------------------|---------|-------------------------------|--------|--------------------------|--------|
|                         |   | **Amortization  Period  in Years** |   | **Gross  Carrying  Value** |    | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Gross  Carrying  Value** |   | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Gross  Carrying  Value** |   | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   |
|                         |   |                               |   |                       |    |                          |   |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intangible assets:           |   |                               |   |                       |    |                          |   |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Trade names                  |   | 5-40                               |   | $                          | 61,548  |                          | $      | (4,583                   | )      | $ | 56,965 |   | $ | 65,968 |   | $ | (3,470 | ) | $ | 62,498 |   | $ | 61,548 |   | $ | (2,958 | ) | $ | 58,590 |   |
| Customer relationships       |   | 5-10                               |   | 31,196                     |    | (10,024                       | )      | 21,172                   |   | 22,651 |   | (2,878 | ) | 19,773 |   | 31,196 |   | (8,566 | ) | 22,630 |   |
| Supply agreements            |   | 3-10                               |   | 8,601                      |    | (950                          | )      | 7,651                    |   | 5,694 |   | (846 | ) | 4,848 |   | 5,694 |   | (380 | ) | 5,314 |   |
| Other intangible assets      |   | 25                                 |   | 604                        |    | (355                          | )      | 249                      |   | 551 |   | — |   | 551 |   | 604 |   | (266 | ) | 338 |   |
| Total intangible assets, net |   |                               |   | $                          | 101,949 |                          | $      | (15,912                  | )      | $ | 86,037 |   | $ | 94,864 |   | $ | (7,194 | ) | $ | 87,670 |   | $ | 99,042 |   | $ | (12,170 | ) | $ | 86,872 |   |

 

Intangible assets include trade names, customer relationships, supplyagreements and other intangible assets, which are valued upon acquisitionthrough independent third-party appraisals, where material, or using othervaluation methods. Intangible assets are amortized using the straight-linemethod over periods ranging from five to forty years, or in the case ofthe supply agreements, over the period in which their economic benefits are expected to beutilized, or three to ten years. The table above reflectsreclassifications of approximately $4.4 million from trade names to customerrelationships and approximately $4.1 million from goodwill to customerrelationships due to the final independent third-party valuation reportsreceived in the second and third quarters of 2003.

 

9

----

 

***Restatement***

*** ***

The Company had initially reflected the guidance outlined in EITF02-17, “Recognition of Customer Relationship Intangible Assets Acquired in aBusiness Combination” as of the date it finalized the allocation of thepurchase price of Schultz Company, in the first quarter of 2003, and beganamortizing the customer relationship intangible asset over its remaining usefullife.  In March 2004, the Companydetermined that the effect of the application of EITF 02-17 should have beenapplied from the date of acquisition and, as such should have resulted in a$2.4 million noncash charge for the additional amortization related to thefinal valuation of the $24.6 million customer relationship intangibleasset.  Accordingly, in the fourthquarter of 2003, the Company restated the March 31, 2003 quarterly financialinformation to include the noncash adjustment which increased first quarter2003 selling, general and administrative expenses by $2.4 million and decreasedincome before income tax expense and net income by $2.4 million, as theintangible assets are not deductible for tax purposes.  Operating income and net income as originally reported of $31,058 and$13,453, respectively, were higher than the respective restated first quarteramounts of $28,658 and $11,053 due to the additional amortization expensedescribed above.

 

No amounts were recorded for goodwill during the three months endedMarch 31, 2004 or 2003.  Goodwill bysegment was $4.2 million for the Lawn and Garden segment, $1.9 million for theHousehold segment and $0.1 million for the Contract segment as of March 31,2004 and December 31, 2003.  Goodwill bysegment was $6.2 million for the Lawn and Garden segment, $2.5 million for theHousehold segment and $0.2 million for the Contract segment as of March 31,2003.

 

###### ***Customer Agreement***

###### *** ***

On February 12, 2004, the Company and its largest customer executed alicensing, manufacturing and supply agreement (the Agreement).  Under the Agreement, the Company willlicense certain of its trademarks and be the exclusive manufacturer andsupplier for certain products branded with such trademarks from January 1,2004, the effective date of the Agreement, through December 31, 2008 or suchlater date as is specified in the Agreement. Provided the customer achieves certain required minimum purchase volumesand other conditions during such period, and the manufacturing and supplyportion of the Agreement is extended for an additional three-year period asspecified in the Agreement, the Company will assign the trademarks to thecustomer not earlier than May 1, 2009, but otherwise within thirty days afterthe date upon which such required minimum purchase volumes are achieved.  The carrying value of such trademarks as ofDecember 31, 2003 was approximately $16.0 million.  If the customer fails to achieve the required minimum purchasevolumes or meet other certain conditions, assignment may occur at a later date,if certain conditions are met.  Inaddition, as a result of executing the Agreement, the Company has modified thetrademarks’ initial amortization period of forty years and will recordamortization in a manner consistent with projected sales activity over fiveyears, because the Company believes the customer will achieve all requiredconditions by May 2009.  The modificationof the amortization period will result in additional annual amortizationexpense of approximately $2.7 million in the year ended December 31, 2004.

 

For the three months ended March 31, 2004 and 2003 and the yearended December 31, 2003, aggregate amortization expense related to intangibleassets was $3.7 million, $2.8 million and $9.3 million, respectively.The following table presents estimated amortization expense for intangibleassets during each of the next five years:

 
| **Year**          |   | **Amount** |   |
|-------------------|--------|------------|--------|
|              |   |       |   |
| Remainder of 2004 |   | $          | 8,340  |   |
| 2005              |   | 11,642     |   |
| 2006              |   | 11,760     |   |
| 2007              |   | 8,128      |   |
| 2008              |   | 5,591      |   |
|                   |        |            |        |  |

 

10

----

 

**Note 7—Other Assets**

 

Other assets consist of the following:

 
|                         |   | **March 31,** |   | **December  31,** |   |
|------------------------------|--------|---------------|--------|-------------------|--------|
|                         |   | **2004**      |   | **2003**          |   | **2003** |   |
|                         |   |          |   |              |   |   |   |
| Deferred financing fees      |   | $             | 23,841 |              | $      | 24,434 |   | $ | 23,841 |   |
| Accumulated amortization     |   | (15,656       | )      | (11,438           | )      | (14,948 | ) |
| Deferred financing fees, net |   | 8,185         |   | 12,996            |   | 8,893 |   |
| Other                        |   | 812           |   | 2,167             |   | 1,004 |   |
| Total other assets, net      |   | $             | 8,997  |              | $      | 15,163 |   | $ | 9,897 |   |

 

**Note 8—Accrued Expenses**

 

Accrued expenses consist of the following:

 
|                       |   | **March 31,** |   | **December  31,** |   |
|----------------------------|--------|---------------|--------|-------------------|--------|
|                       |   | **2004**      |   | **2003**          |   | **2003** |   |
|                       |   |          |   |              |   |   |   |
| Advertising and promotion  |   | $             | 13,734 |              | $      | 23,339 |   | $ | 9,605 |   |
| Facilities rationalization |   | —        |   | 1,081             |   | — |   |
| Interest                   |   | 912           |   | 8,522             |   | 6,219 |   |
| Cash overdraft             |   | 14,258        |   | 8,031             |   | — |   |
| Noncompete agreement       |   | 350           |   | 350               |   | 350 |   |
| Preferred stock dividends  |   | 19,307        |   | 11,299            |   | 17,111 |   |
| Salaries and benefits      |   | 3,106         |   | 3,878             |   | 3,644 |   |
| Severance costs            |   | 360           |   | 1,741             |   | 201 |   |
| Freight                    |   | 4,866         |   | 5,103             |   | 1,152 |   |
| Other                      |   | 1,836         |   | 2,969             |   | 1,292 |   |
| Total accrued expenses     |   | $             | 58,729 |              | $      | 66,313 |   | $ | 39,574 |   |

 

**Note 9—Long-Term Debt**

 

Long-term debt, excluding capital lease obligations, consists of thefollowing: 

 
|                                                                                                                     |   | **March 31,** |    | **December  31,** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|---------------|---------|-------------------|--------|
|                                                                                                                     |   | **2004**      |    | **2003**          |   | **2003** |   |
| Senior Credit Facility:                                                                                                  |   |          |    |              |   |   |   |
| Term Loan B                                                                                                              |   | $             | 151,970 |              | $      | 196,069 |   | $ | 152,368 |   |
| Revolving Credit Facility                                                                                                |   | 61,525        |    | 10,100            |   | — |   |
| Senior Subordinated Notes:                                                                                               |   |          |    |              |   |   |   |
| 97/8% Series B Senior Subordinated  Notes                                                                                |   | 3,100         |    | 150,000           |   | 3,100 |   |
| 97/8% Series C Senior Subordinated Notes,  including unamortized  premium of $1.3 million                                |   | —        |    | 86,275            |   | — |   |
| 97/8% Series D Senior Subordinated  Notes, including unamortized  premium of $1.0 million and $1.1 million, respectively |   | 232,945       |    | —            |   | 232,985 |   |
| Total long-term debt                                                                                                     |   | 449,540       |    | 442,444           |   | 388,453 |   |
| Less current maturities                                                                                                  |   | (62,321       | )       | (11,116           | )      | (796 | ) |
| Total long-term debt, net of current  maturities                                                                         |   | $             | 387,219 |              | $      | 431,328 |   | $ | 387,657 |   |

 

11

----

 

***SeniorCredit Facility in Effect as of March 31, 2004***

*** ***

The seniorcredit facility, as amended as of March 14, 2003, in effect as of March 31,2004 (the Prior Senior Credit Facility), with Bank of America, N.A., MorganStanley Senior Funding, Inc. and Canadian Imperial Bank of Commerce wasterminated and all obligations outstanding thereunder were repaid on April 30,2004.  The Prior Senior Credit Facilityconsisted of (1) a $90.0 million revolving credit facility;(2) a $75.0 million term loan facility (Term Loan A), which wasrepaid in full during the year ended December 31, 2003; and (3) a$240.0 million term loan facility (Term Loan B).

 

The PriorSenior Credit Facility agreement contained affirmative, negative and financialcovenants.  Affirmative and negativecovenants placed restrictions on, among other things, levels of investments,indebtedness, insurance, capital expenditures and dividend payments.  The financial covenants required themaintenance of certain financial ratios at defined levels. As of and during thethree months ended March 31, 2004 and 2003 and year ended December 31,2003, the Company was in compliance with all covenants.  Under the Prior Senior Credit Facilityagreement, interest rates on the revolving credit facility and Term Loan Branged from 1.50% to 4.00% plus LIBOR, or other base rate as provided in thePrior Senior Credit Facility agreement, depending on certain financialratios.  LIBOR was 1.11% as of March 31,2004, 1.29% as of March 31, 2003 and 1.16% as of December 31, 2003.  The interest rate applicable to TermLoan B was 5.09% as of March 31, 2004, 5.31% as of March 31, 2003 and5.12% as of December 31, 2003. Unused commitments under the revolving credit facility were subject to a0.5% annual commitment fee.

 

The PriorSenior Credit Facility agreement allowed the Company to make prepayments inwhole or in part at any time without premium or penalty. During the threemonths ended March 31, 2004, the Company made principal payments of$0.4 million on Term Loan B, which primarily represented optionalprincipal prepayments.  During the threemonths ended March 31, 2003, the Company made principal payments of$28.3 million to fully repay Term Loan A and $25.9 million onTerm Loan B, which primarily represented optional principal prepayments.  During the year ended December 31, 2003,the Company made principal payments of $28.3 million to fully repay TermLoan A and $69.6 million on Term Loan B, which primarilyrepresented optional principal prepayments. The optional principal prepayments were made from operating cash flowsand allowed the Company to remain several quarterly payments ahead of theregular payment schedule.  In connectionwith these prepayments, the Company recorded write-offs totaling $1.3 millionin previously deferred financing fees which were included in interest expensein the consolidated statement of operations for the three months ended March31, 2003.

 

The PriorSenior Credit Facility was secured by substantially all of the Company’sproperties and assets and by substantially all of the properties and assets ofthe Company’s current domestic subsidiaries. The carrying amount of the Company’s obligations under the Prior SeniorCredit Facility approximated fair value because the interest rates were basedon floating interest rates identified by reference to market rates.

 

***New Senior Credit Facility***

*** ***

In conjunction with theclosing of the acquisition of Nu-Gro, on April 30, 2004, the Company enteredinto a new $510.0 million senior credit facility (the New Senior CreditFacility) with Bank of America, N.A., Banc of America Securities LLC, CitigroupGlobal Markets, Inc., Citicorp North America, Inc. and certain other lenders torefinance the indebtedness under its Prior Senior Credit Facility at more favorable rates, to provide fundsfor the Nu-Gro acquisition, to repurchase all of its outstanding preferredstock, along with accrued but unpaid dividends thereon, and for general workingcapital purposes.  The New Senior CreditFacility consists of (1) a $125.0 million US dollar denominatedrevolving credit facility; (2) a $335.0 million US dollar denominatedterm loan facility; and (3) a Canadian dollar denominated term loanfacility valued at US $50.0 million. Subject to the terms of the New Senior Credit Facility agreement, therevolving loan portion of the New Senior Credit Facility matures on April 30,2010, and the term loan obligations under the New Senior Credit Facility matureon April 30, 2011.  The term loanobligations are to be repaid in 28 consecutive quarterly installmentscommencing on June 30, 2004, with a final installment due on March 31,2011.  All of the loan obligations aresubject to mandatory prepayment upon certain events, including sales of certainassets, issuances of indebtedness or equity or from excess cash flow.  The New Senior Credit Facility agreementalso allows the Company to make voluntary prepayments, in whole or in part, atany time without premium or penalty.

 

12

----

 

The NewSenior Credit Facility agreement contains affirmative, negative andfinancial covenants that are more favorable than those of the Prior Senior Credit Facility.  The negative covenants place restrictionson, among other things, levels of investments, indebtedness, capitalexpenditures and dividend payments that the Company may make or incur.  The financial covenants require themaintenance of certain financial ratios at defined levels.  Under the New Senior Credit Facility agreement, interest rates on the newrevolving credit facility can range from 1.75% to 2.50% plus LIBOR, or from0.75% to 1.50% plus a base rate, subject to adjustment and depending on certainfinancial ratios.  As of April 30, 2004,the term loans were subject to interest rates equal to 2.50% plus LIBOR or 1.50%plus a base rate, as provided in the NewSenior Credit Facility agreement. Unused commitments under the new revolving credit facility are subjectto a 0.5% annual commitment fee.  The New Senior Credit Facility is securedby substantially all of the Company’s properties and assets and substantiallyall of the properties and assets of the Company’s current and future domesticsubsidiaries.

 

In connection with theclosing of the Nu-Gro acquisition, Bank of America, N.A., Canada Branch,separately loaned the Company Cdn $110.0 million for structuring purposes,which loan was repaid on April 30, 2004.

 

***Senior SubordinatedNotes***

*** ***

In November 1999, the Company issued $150.0 million inaggregate principal amount of 97/8% Series B seniorsubordinated notes (the Series B Notes) due April 1, 2009. Interestaccrued at a rate of 97/8% per annum, payablesemi-annually on April 1 and October 1. As described in more detailbelow, as of March 31, 2004, $3.1 million of the Series B Notes wereoutstanding (see Note 16).  On April 14,2004, the Company repurchased all of the outstanding Series B Notes, togetherwith accrued interest and repurchase premium of 4.938%, for $3.3 million.

 

In March 2003, the Company issued $85.0 million in aggregateprincipal amount of 97/8% Series C seniorsubordinated notes (the Series C Notes) due April 1, 2009.  Interest accrued at a rate of 97/8%per annum, payable semi-annually on April 1 and October 1.  As described in more detail below, as ofMarch 31, 2004, there were no Series C Notes outstanding.

 

In May 2003, the Company registered $235.0 million in aggregateprincipal amount of 97/8% Series D seniorsubordinated notes (the Series D Notes and collectively with the Series BNotes and Series C Notes, the Senior Subordinated Notes), with termssubstantially similar to the Series B Notes and Series C Notes, withthe U.S. Securities and Exchange Commission and offered to exchange theSeries D Notes for up to 100% of the Series B Notes and Series CNotes.  The exchange offering closed inJuly 2003, resulting in $85.0 million, or 100%, of the Series CNotes being exchanged and $146.9 million, or 98%, of the Series BNotes being exchanged.  As of March 31,2004, $3.1 million of the Series B Notes and $232.9 million of the Series D Noteswere outstanding.

 

The fair value of the Senior Subordinated Notes was $245.6 million,$243.2 million and $242.1 million as of March 31, 2004 and 2003 andDecember 31, 2003, respectively, based on their quoted market price on suchdates. In accordance with the indentures that govern them, the Senior SubordinatedNotes are unconditionally and jointly and severally guaranteed by the Company’swholly-owned subsidiaries (see Note 15).

 

The Company’s agreements that govern the New Senior Credit Facility andthe Senior Subordinated Notes contain a number of significant covenants thatcould restrict or limit the Company’s ability to:

 

•                                          incurmore debt;

•                                          paydividends, subject to financial ratios and other conditions;

•                                          makeother distributions;

•                                          issuestock of subsidiaries;

•                                          makeinvestments;

•                                          repurchasestock;

•                                          createsubsidiaries;

•                                          createliens;

•                                          enterinto transactions with affiliates;

•                                          mergeor consolidate; and

•                                          transferand sell assets.

 

13

----

 

Theability to comply with these provisions may be affected by events beyond theCompany’s control. The breach of any of these covenants will result in adefault under the applicable debt agreement or instrument and could triggeracceleration of repayment under the applicable agreements. Any default undersuch agreements might adversely affect the Company’s growth, financialcondition, results of operations and the ability to make payments onindebtedness or meet other obligations. As of and during the three months ended March 31, 2004 and 2003 andyear ended December 31, 2003, the Company was in compliance with all covenantsunder the Prior Senior Credit Facility and the Senior Subordinated Notes ineffect as of such dates.

 

Asof April 30, 2004, after giving effect to the refinancing previously described,aggregate future principal payments of long-term debt, excluding capital leaseobligation, are as follows:

 
| **Year**                                          |   | **Amount** |    |
|---------------------------------------------------|--------|------------|---------|
|                                              |   |       |    |
| Remainder 2004                                    |   | $          | 3,209   |   |
| 2005                                              |   | 4,278      |    |
| 2006                                              |   | 4,278      |    |
| 2007                                              |   | 4,278      |    |
| 2008                                              |   | 4,278      |    |
| Thereafter                                        |   | 642,475    |    |
|                                              |   | 662,796    |    |
| Unamortized premium on Senior Subordinated  Notes |   | 1,045      |    |
|                                              |   | $          | 663,841 |   |

 

**Note 10—Contingencies**

 

In the normal course of business, the Company is a party to certainguarantees and financial instruments with off-balance sheet risk, such asstandby letters of credit and indemnifications, which are not reflected in theaccompanying consolidated balance sheets. As of March 31, 2004 and 2003and December 31, 2003, the Company had $3.2 million, $2.2 million and $2.7million, respectively, in standby letters of credit pledged as collateral tosupport the lease of its primary distribution facility in St. Louis, a U.S.customs bond, certain product purchases, various workers’ compensationobligations and transportation equipment. These agreements mature at various dates through November 2004 and maybe renewed as circumstances warrant. Such financial instruments are valuedbased on the amount of exposure under the instruments and the likelihood ofperformance being required. In the Company’s past experience, no claims havebeen made against these financial instruments nor does management expect anylosses to result from them.  As aresult, the Company determined such agreements do not have significant valueand has not recorded any related amounts in its accompanying consolidated financialstatements.

 

The Company is the lessee under a number of equipment and propertyleases. It is common in such commercial lease agreements for the Company toagree to indemnify the lessor for the value of the property or equipment leasedshould it be damaged during the course of the Company’s operations. The Companyexpects that any losses that may occur with respect to the leased propertywould be covered by insurance, subject to deductible amounts. As a result, theCompany determined such indemnifications do not have significant value and hasnot recorded any related amounts in its accompanying consolidated financialstatements.

 

The Company has entered into certain commitments to purchase granularurea during its peak production season in 2004. See Note 11 for informationregarding these commitments.

 

The Company is involved from time to time in routine legal matters andother claims incidental to its business. When it appears probable inmanagement’s judgment that the Company will incur monetary damages or othercosts in connection with such claims and proceedings, and such costs can bereasonably estimated, liabilities are recorded in the consolidated financialstatements and charges are recorded to results of operations. Managementbelieves that it is remote the resolution of such routine matters and otherincidental claims, taking into account established reserves and insurance, willhave a material adverse impact on the Company’s consolidated financialposition, results of operations or liquidity.

 

14

----

 

**Note 11—Accounting for DerivativeInstruments and Hedging Activities**

 

In the normal course of business, the Company is exposed tofluctuations in interest rates and raw materials prices. The Company hasestablished policies and procedures that govern the management of theseexposures through the use of derivative hedging instruments, including swapagreements. The Company’s objective in managing its exposure to suchfluctuations is to decrease the volatility of earnings and cash flowsassociated with changes in interest rates and certain raw materials prices. Toachieve this objective, the Company periodically enters into swap agreementswith values that change in the opposite direction of anticipated cash flows.Derivative instruments related to forecasted transactions are considered tohedge future cash flows, and the effective portion of any gains or losses isincluded in accumulated other comprehensive income until earnings are affectedby the variability of cash flows. Any remaining gain or loss is recognizedcurrently in results of operations.

 

The Company formally documents, designates and assesses theeffectiveness of any transactions that receive hedge accounting treatment. Thecash flows of derivative hedging instruments the Company enters into aregenerally expected to be highly effective in achieving offsetting cash flowsattributable to fluctuations in the cash flows of the hedged risk. Changes inthe fair value of agreements designated as derivative hedging instruments arereported as either an asset or liability in the accompanying consolidatedbalance sheets with the associated unrealized gains or losses reflected inaccumulated other comprehensive income. As of March 31, 2004, the Company hadthree derivative instruments, with maturity dates through April 2004,designated as hedges against the purchase of granular urea for an aggregatecontract value upon the date of execution of $2.9 million.  Such derivative hedging instruments had anunrealized loss of $0.2 million as of March 31, 2004 which is included inaccumulated other comprehensive income in the accompanying consolidated balancesheet as of such date.  As of March 31,2003, the Company had one derivative instrument, with a maturity date in April2003, designated as a hedge against the purchase of granular urea for acontract value upon the date of execution of $0.7 million.  Such derivative hedging instrument had anunrealized gain of $0.4 million as of March 31, 2003 which is included inaccumulated other comprehensive income in the accompanying consolidated balancesheet as of such date. Although derivative hedging instruments were usedthroughout 2003, no such instruments were outstanding as of December 31, 2003.  The amounts recorded in accumulated othercomprehensive income were subsequently reclassified into cost of goods sold inthe same period in which the underlying hedged transactions affectedearnings.  As such, net gains onderivative hedging instruments for raw materials purchases reclassified intocost of goods sold in the same period in which the underlying hedgedtransactions affected earnings were $0.2 million for the three months endedMarch 31, 2003 and $1.4 million for the year ended December 31, 2003.  No such amounts were reclassified into costof goods sold during the three months ended March 31, 2004.

 

If it becomes probable that a forecasted transaction will not occur,any gains or losses in accumulated other comprehensive income will berecognized in results of operations. The Company has not incurred any gains orlosses for hedge ineffectiveness or due to excluding a portion of the valuefrom measuring effectiveness. The Company has not generally entered intoderivatives or other hedging arrangements for trading or speculative purposesbut may consider doing so in the future if strategic circumstances warrant, andits bank covenants and bond indentures permit, such transactions.

 

 

As of March 31, 2004, the Company had five purchase commitments, withexpected purchase dates through April 2004, for the purchase of granular ureafor an aggregate purchase price of $2.2 million.  As of March 31, 2003, the Company had one purchase commitment,with an expected purchase date in April 2003, for the purchase of granular ureafor $0.7 million. As of March 31, 2004, the Company’s outstanding derivativehedging instruments and purchase commitments effectively fixed 57% of itsremaining 2004 urea purchases.  Whilemanagement expects its derivative hedging instruments and purchase commitmentsto manage the Company’s exposure to such price fluctuations, no

 

15

----

 

assurance can be provided that such instruments will be effective infully mitigating exposure to these risks, nor can assurance be provided thatthe Company will be successful in passing on pricing increases to itscustomers.

 

**Note 12—Stockholders’ Equity**

 

***Bayer Transactions***

*** ***

On June 14, 2002, the Company consummated a transaction with BayerCorporation and Bayer Advanced, L.L.C. (together referred to herein asBayer) which allows the Company to gain access to certain Bayer activeingredient technologies through a Supply Agreement and to perform certainmerchandising services for Bayer through an In-Store Service Agreement.  In consideration for the Supply and In-StoreService Agreements, and in exchange for the promissory notes previously issuedto Bayer by U.S. Fertilizer, the Company issued to Bayer 3,072,000 shares ofClass A voting common stock valued at $15.4 million and 3,072,000shares of Class B nonvoting common stock valued at $15.4 million(collectively representing approximately 9.3% of the Company’s fully-dilutedcommon stock) and recorded $0.4 million of related issuance costs. TheCompany reserved for the entire face value of the promissory notes due fromU.S. Fertilizer, as the Company did not believe the notes were collectible andan independent third party valuation did not ascribe any significant value tothem. The independent third party valuation also indicated that value should beascribed to the repurchase option which is reflected in stockholders’ equity inthe accompanying consolidated balance sheets as of March 31, 2003 and December31, 2003.

 

Under the terms of the agreements, Bayer was required to make paymentsto the Company which total $5.0 million annually through June 15,2009, the present value of which equaled the value assigned to the common stocksubscription receivable as of June 14, 2002, which has been reflected instockholders’ equity in the accompanying consolidated balance sheets as ofMarch 31, 2003 and December 31, 2003. The common stock subscription receivablewas to be repaid by Bayer in 28 quarterly installments of $1.25 million,the first of which was received at closing on June 17, 2002. Thedifference between the value ascribed to the common stock subscriptionreceivable and the installment payments received has been recorded as interestincome in the accompanying consolidated statements of operations for the threemonths ended March 31, 2004 and 2003 and year ended December 31, 2003.

 

The value of the Supply Agreement has been and is being amortized tocost of goods sold over the period in which its economic benefits are expectedto be utilized which was initially anticipated to be over a three to five-yearperiod. The Company has been amortizing the obligation associated with theIn-Store Service Agreement to revenues over the seven-year life of theagreement, the period in which its obligations were originally expected to befulfilled. However, in December 2002, the Company and Bayer amended theIn-Store Service Agreement to reduce the scope of services provided byapproximately 80%. As a result, the Company reduced its obligation under theIn-Store Service Agreement accordingly and reclassified $3.6 million toadditional paid-in capital to reflect the increase in value of the In-StoreService Agreement.

 

The In-Store Service Agreement provided the Company with the right toterminate and, effective after any such termination, the right to repurchaseall of its common stock issued to Bayer at a price based on equations includedin a related agreement (the Exchange Agreement). Under the terms of theExchange Agreement, the Company was provided the right to offset Bayer’spayment obligations against the repurchase price.  Upon exercise of such repurchase option, Bayer had and continuesto have the right to terminate the Supply Agreement. Because Bayer is both acompetitor and a supplier, the Company has continually reevaluated the value ofits stockholder relationship with Bayer.

 

On October 22, 2003, the Company gave notice to Bayer regarding thetermination of the In-Store Service Agreement, as amended.  Upon termination, which became effective onDecember 21, 2003, the Company was relieved of its obligation to performmerchandising services for Bayer. Accordingly, the remaining liability of $0.7 million on the date oftermination was fully written off and recorded in selling, general andadministrative expenses in the accompanying consolidated statement ofoperations for the year ended December 31, 2003.

 

16

----

 

Based on theindependent third party valuation as of June 14, 2002, the original transactiondate, the Company assigned a fair value of $30.7 million to the transactioncomponents recorded in connection with the common stock issued to Bayer. Thefollowing table presents the values of these components as of March 31, 2004and 2003 and December 31, 2003:

 
|                                 |   | **March 31,** |   | **December  31,** |   |
|--------------------------------------|--------|---------------|--------|-------------------|--------|
| **Description**                      |   | **2004**      |   | **2003**          |   | **2003** |   |
|                                 |   |          |   |              |   |   |   |
| Common stock subscription receivable |   | $             | — |              | $      | 24,976 |   | $ | 22,534 |   |
| Supply Agreement                     |   | 4,779         |   | 5,694             |   | 5,314 |   |
| Repurchase option                    |   | —        |   | 2,636             |   | 2,636 |   |
| In-Store Service Agreement           |   | —        |   | (845              | )      | — |   |
|                                 |   | $             | 4,779  |              | $      | 32,461 |   | $ | 30,484 |   |

 

Following the termination of the In-Store Service Agreement, onDecember 22, 2003, the Company exercised its option to repurchase alloutstanding common stock previously issued to Bayer.  Bayer disputed the Company’s interpretation of the Exchange Agreementas to the calculation of the repurchase price. As a result, the Company and Bayer entered negotiations to determine anagreed upon repurchase price based on equations included in the ExchangeAgreement and other factors.  TheCompany commenced an arbitration proceeding against Bayer to resolve thedispute on January 30, 2004.  However,the Company and Bayer reached a negotiated settlement of the dispute onFebruary 23, 2004, pursuant to which Bayer agreed to deliver all of its sharesof the Company’s common stock to the Company in exchange for a cash payment of$1.5 million, cancellation of $22.5 million in remaining payments required tobe made in connection with the common stock subscription receivable andforgiveness of interest related to such payments of $0.3 million.

 

The Companyrecorded treasury stock of $24.4 million, based on the consideration given toBayer, reduced the common stock subscription receivable by $22.5 million, theremaining balance on the date of repurchase, and reversed the common stockrepurchase option of $2.6 million as a result of its exercise and recorded acorresponding amount to additional paid-in capital. As a result of thistransaction, both parties agreed that the Exchange Agreement and In-StoreService Agreement are fully terminated, with the exception of certainprovisions contained therein that expressly survive termination, and that theSupply Agreement shall remain in full force and effect according to itsterms.  Under the terms of the SupplyAgreement, any remaining balance at January 30, 2009 is unconditionally andimmediately payable to the Company by Bayer regardless of whether or not theCompany purchases ingredients under the Supply Agreement.  As of March 31, 2004, the remaining balanceof the Supply Agreement was $4.8 million.

 

***Repurchase of Preferred Stock***

*** ***

Inconjunction with its refinancing on April 30, 2004, the Company repurchased all37,600 shares of its outstanding Class A nonvoting preferred stock for $57.5million, including all accrued and unpaid dividends thereon.

 

**Note 13—Fair Value of FinancialInstruments**

 

The Company has estimated the fair value of its financial instrumentsas of March 31, 2004 and 2003 and December 31, 2003 using available marketinformation or other appropriate valuation methods. Considerable judgment,however, is required in interpreting data to develop estimates of fair value.Accordingly, the estimates presented in the accompanying consolidated financialstatements are not necessarily indicative of the amounts the Company wouldrealize in a current market exchange.

 

The carrying amounts of cash, accounts receivable, accounts payable andother current assets and liabilities approximate fair value because of theshort maturity of such instruments. The Company’s Senior Credit Facility bearsinterest at current market rates and, thus, carrying value approximates fairvalue as of March 31, 2004 and 2003 and December 31, 2003. The Company isexposed to interest rate volatility with respect to the variable interest ratesof the Senior Credit Facility. The estimated fair values of the Company’sSenior Subordinated Notes of $245.6 million, $243.2 million, and$242.1 million, respectively, as of March 31, 2004 and 2003 and December 31,2003 are based on quoted market prices.

 

17

----

 

**Note 14—Segment Information**

 

As of March 31, 2004, the Company reported its operating results usingthree reportable segments: Lawn and Garden, Household and Contract. Segmentswere established primarily by brand and product type which represents the basisupon which management, including the Chief Executive Officer who is the chiefoperating decision-maker of the Company, reviews and assesses the Company’sfinancial performance. The Lawn and Garden segment primarily consists of dry,granular lawn fertilizers, lawn fertilizer combination and lawn controlproducts, herbicides, water-soluble and controlled-release garden and indoorplant foods, plant care products, potting soils and other growing mediaproducts and insecticide products. Products are marketed to mass merchandisers,home improvement centers, hardware, grocery and drug chains, nurseries andgarden centers. This segment includes, among others, the Company’s Spectracide,Garden Safe, Schultz, Vigoro, Sta-Green, Real-Kill and No-Pest brands.

 

The Household segment represents household insecticides and insectrepellents that allow consumers to repel insects and maintain a pest-freehousehold. The Household segment includes the Company’s Hot Shot, Cutter andRepel brands, as well as a number of private label and other products.

 

The Contract segment includes a variety of compounds and chemicals,such as cleaning solutions and other consumer products.

 

The table below presents selected financial segment information inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information,” for the three months ended March 31, 2004 and 2003.The accounting policies of the reportable segments are the same as thosedescribed in the summary of significant accounting policies in Note 2 tothe consolidated financial statements included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2003, as applicable. The segmentfinancial information presented includes comparative periods prepared on abasis consistent with the current year presentation.

 
|                                          |   | **Three  Months Ended March 31,** |    |
|-----------------------------------------------|--------|-----------------------------------|---------|
|                                          |   | **2004**                          |    | **2003** |   |
| Net sales:                                    |   |                              |    |   |   |
| Lawn and Garden                               |   | $                                 | 150,507 |   | $ | 145,614 |   |
| Household                                     |   | 31,225                            |    | 27,567 |   |
| Contract                                      |   | 971                               |    | 5,631 |   |
| Total net sales                               |   | 182,703                           |    | 178,812 |   |
| Operating costs and expenses:                 |   |                              |    |   |   |
| Cost of goods sold                            |   | 113,408                           |    | 108,755 |   |
| Selling, general and administrative  expenses |   | 39,981                            |    | 41,399 |   |
| Total operating costs and expenses            |   | 153,389                           |    | 150,154 |   |
| Operating income (loss) by segment:           |   |                              |    |   |   |
| Lawn and Garden                               |   | 20,448                            |    | 22,073 |   |
| Household                                     |   | 9,048                             |    | 6,626 |   |
| Contract                                      |   | (182                              | )       | (41 | ) |
| Total operating income                        |   | 29,314                            |    | 28,658 |   |
| Interest expense                              |   | 9,620                             |    | 9,702 |   |
| Interest income                               |   | 285                               |    | 499 |   |
| Income before income tax expense              |   | 19,979                            |    | 19,455 |   |
| Income tax expense                            |   | 7,592                             |    | 8,402 |   |
| Net income                                    |   | $                                 | 12,387  |   | $ | 11,053 |   |
|                                          |   |                              |    |   |   |
| Operating margin:                             |   |                              |    |   |   |
| Lawn and Garden                               |   | 13.6                              | %       | 15.2 | % |
| Household                                     |   | 29.0                              | %       | 24.0 | % |
| Contract                                      |   | -18.7                             | %       | -0.7 | % |
| Total operating margin                        |   | 16.0                              | %       | 16.0 | % |

 

18

----

 

Operating income represents earnings before interest expense, interestincome and income tax expense. Operating income is the measure of profitabilityused by management to assess the Company’s financial performance. Operatingmargin represents operating income as a percentage of net sales.

 

The majority of the Company’s sales are conducted with customers in theUnited States. For each of the periods presented herein, the Company’sinternational sales comprised less than 2% of total annual net sales. Inaddition, no single item comprised more than 10% of the Company’s net sales.For the three months ended March 31, 2004, the Company’s three largestcustomers were responsible for 32%, 23% and 15% of net sales.  For the three months ended March 31, 2003,the Company’s three largest customers were responsible for 33%, 20% and 15% ofnet sales.

 

As the Company’s assets support production across all segments, theyare managed on an entity-wide basis at the corporate level and are not recordedor analyzed by segment. As of March 31, 2004, substantially all of theCompany’s assets were located in the United States.

 

**Note 15—Financial Information forSubsidiary Guarantors**

** **

The Company’s Senior Subordinated Notes are unconditionally and jointlyand severally guaranteed by all of the Company’s existing subsidiaries. TheCompany’s subsidiaries are 100% owned by the Company. The consolidatingfinancial information which follows is presented as of and for the three monthsended March 31, 2004 and 2003 and has been prepared in accordance with therequirements for presentation of such information. The Company believes thatseparate financial statements concerning each guarantor subsidiary would not bematerial to investors and that the information presented herein providessufficient detail to determine the nature of the aggregate financial position,results of operations and cash flows of the guarantor subsidiaries.

 

The Company’s investment in subsidiaries is accounted for using theequity method of accounting. Earnings of the subsidiaries are reflected in therespective investment accounts of the parent company accordingly. Theinvestments in subsidiaries and all intercompany balances and transactions havebeen eliminated. Various assumptions and estimates were used to establish thefinancial statements of such subsidiaries for the information presented herein.

 

19

----

 

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESBALANCE SHEETAS OF MARCH 31, 2004(Unaudited)**

 
|                                                                |   | **Subsidiary  Parent** |    | **Guarantors** |   | **Eliminations** |   | **Consolidated** |     |
|---------------------------------------------------------------------|--------|------------------------|---------|----------------|--------|------------------|--------|------------------|----------|
| **ASSETS**                                                          |   |                   |    |           |   |             |   |             |     |
|                                                                |   |                   |    |           |   |             |   |             |     |
| Current assets:                                                     |   |                   |    |           |   |             |   |             |     |
| Cash and cash equivalents                                           |   | $                      | (240    | )              | $      | 240              |   | $                | —   |   | $ | — |   |
| Accounts receivable, net                                            |   | 123,267                |    | 23,463         |   | —           |   | 146,730          |     |
| Inventories                                                         |   | 81,532                 |    | 33,786         |   | —           |   | 115,318          |     |
| Prepaid expenses and other current assets                           |   | 17,420                 |    | 577            |   | —           |   | 17,997           |     |
| Total current assets                                                |   | 221,979                |    | 58,066         |   | —           |   | 280,045          |     |
|                                                                |   |                   |    |           |   |             |   |             |     |
| Equipment and leasehold improvements, net                           |   | 35,804                 |    | 5,706          |   | —           |   | 41,510           |     |
| Investment in subsidiaries                                          |   | 35,093                 |    | —         |   | (35,093          | )      | —           |     |
| Intercompany assets                                                 |   | 68,838                 |    | 12,890         |   | (81,728          | )      | —           |     |
| Deferred tax asset                                                  |   | 166,974                |    | 11,996         |   | —           |   | 178,970          |     |
| Goodwill                                                            |   | —                 |    | 6,221          |   | —           |   | 6,221            |     |
| Intangible assets, net                                              |   | 47,458                 |    | 38,579         |   | —           |   | 86,037           |     |
| Other assets, net                                                   |   | 8,506                  |    | 491            |   | —           |   | 8,997            |     |
| Total assets                                                        |   | $                      | 584,652 |           | $      | 133,949          |   | $                | (116,821 | ) | $ | 601,780 |   |
|                                                                |   |                   |    |           |   |             |   |             |     |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                       |   |                   |    |           |   |             |   |             |     |
|                                                                |   |                   |    |           |   |             |   |             |     |
| Current liabilities:                                                |   |                   |    |           |   |             |   |             |     |
| Current maturities of long-term debt  and capital lease obligations |   | $                      | 3,796   |           | $      | —           |   | $                | —   |   | $ | 3,796 |   |
| Accounts payable                                                    |   | 42,245                 |    | 18,440         |   | —           |   | 60,685           |     |
| Accrued expenses                                                    |   | 47,151                 |    | 11,578         |   | —           |   | 58,729           |     |
| Short-term borrowings                                               |   | 61,525                 |    | —         |   | —           |   | 61,525           |     |
| Total current liabilities                                           |   | 154,717                |    | 30,018         |   | —           |   | 184,735          |     |
|                                                                |   |                   |    |           |   |             |   |             |     |
| Long-term debt, net of current maturities                           |   | 387,219                |    | —         |   | —           |   | 387,219          |     |
| Capital lease obligations, net of current  maturities               |   | 3,231                  |    | —         |   | —           |   | 3,231            |     |
| Other liabilities                                                   |   | 3,222                  |    | —         |   | —           |   | 3,222            |     |
| Intercompany liabilities                                            |   | 12,890                 |    | 68,838         |   | (81,728          | )      | —           |     |
| Total liabilities                                                   |   | 561,279                |    | 98,856         |   | (81,728          | )      | 578,407          |     |
|                                                                |   |                   |    |           |   |             |   |             |     |
| Commitments and contingencies                                       |   |                   |    |           |   |             |   |             |     |
| Stockholders’ equity:                                          |   |                   |    |           |   |             |   |             |     |
| Preferred stock                                                     |   | —                 |    | —         |   | —           |   | —           |     |
| Common stock                                                        |   | 665                    |    | —         |   | —           |   | 665              |     |
| Treasury stock                                                      |   | (24,469                | )       | —         |   | —           |   | (24,469          | )        |
| Warrants and options                                                |   | 11,745                 |    | —         |   | —           |   | 11,745           |     |
| Investment from parent                                              |   | —                 |    | 27,925         |   | (27,925          | )      | —           |     |
| Additional paid-in capital                                          |   | 208,272                |    | —         |   | —           |   | 208,272          |     |
| Accumulated deficit                                                 |   | (169,547               | )       | 7,168          |   | (7,168           | )      | (169,547         | )        |
| Common stock held in grantor trusts                                 |   | (2,847                 | )       | —         |   | —           |   | (2,847           | )        |
| Loans to executive officer                                          |   | (267                   | )       | —         |   | —           |   | (267             | )        |
| Accumulated other comprehensive income  (loss)                      |   | (179                   | )       | —         |   | —           |   | (179             | )        |
| Total stockholders’ equity                                     |   | 23,373                 |    | 35,093         |   | (35,093          | )      | 23,373           |     |
| Total liabilities and stockholders’ equity                     |   | $                      | 584,652 |           | $      | 133,949          |   | $                | (116,821 | ) | $ | 601,780 |   |

 

20

----

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESBALANCE SHEETAS OF MARCH 31, 2003(Unaudited) (As Restated)**

 
|                                                               |   | **Parent** |    | **Subsidiary  Guarantors** |   | **Eliminations** |   | **Consolidated** |    |
|--------------------------------------------------------------------|--------|------------|---------|----------------------------|--------|------------------|--------|------------------|---------|
| **ASSETS**                                                         |   |       |    |                       |   |             |   |             |    |
|                                                               |   |       |    |                       |   |             |   |             |    |
| Current assets:                                                    |   |       |    |                       |   |             |   |             |    |
| Cash and cash equivalents                                          |   | $          | —  |                       | $      | —           |   | $                | —  |   | $ | — |   |
| Accounts receivable, net                                           |   | 136,978    |    | 2,559                      |   | —           |   | 139,537          |    |
| Inventories                                                        |   | 60,177     |    | 37,942                     |   | —           |   | 98,119           |    |
| Prepaid expenses and other current assets                          |   | 9,561      |    | 963                        |   | —           |   | 10,524           |    |
| Total current assets                                               |   | 206,716    |    | 41,464                     |   | —           |   | 248,180          |    |
|                                                               |   |       |    |                       |   |             |   |             |    |
| Equipment and leasehold improvements, net                          |   | 26,511     |    | 7,128                      |   | —           |   | 33,649           |    |
| Investment in subsidiaries                                         |   | 22,634     |    | —                     |   | (22,634          | )      | —           |    |
| Intercompany assets                                                |   | 47,608     |    | —                     |   | (47,608          | )      | —           |    |
| Deferred tax asset                                                 |   | 96,313     |    | 426                        |   | —           |   | 96,739           |    |
| Goodwill                                                           |   | 8,868      |    | —                     |   | —           |   | 8,868            |    |
| Intangible assets, net                                             |   | 38,587     |    | 49,083                     |   | —           |   | 87,670           |    |
| Other assets, net                                                  |   | 8,860      |    | 6,313                      |   | —           |   | 15,163           |    |
| Total assets                                                       |   | $          | 456,097 |                       | $      | 104,414          |   | $                | (70,242 | ) | $ | 490,269 |   |
|                                                               |   |       |    |                       |   |             |   |             |    |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**            |   |       |    |                       |   |             |   |             |    |
|                                                               |   |       |    |                       |   |             |   |             |    |
| Current liabilities:                                               |   |       |    |                       |   |             |   |             |    |
| Current maturities of long-term debt  and capital lease obligation |   | $          | 11,690  |                       | $      | —           |   | $                | —  |   | $ | 11,690 |   |
| Accounts payable.                                                  |   | 30,393     |    | 28,623                     |   | —           |   | 59,016           |    |
| Accrued expenses                                                   |   | 61,691     |    | 4,622                      |   | —           |   | 66,313           |    |
| Total current liabilities                                          |   | 103,774    |    | 33,245                     |   | —           |   | 137,019          |    |
|                                                               |   |       |    |                       |   |             |   |             |    |
| Long-term debt, net of current maturities                          |   | 431,328    |    | —                     |   | —           |   | 431,328          |    |
| Capital lease obligation, net of current  maturities               |   | 3,577      |    | —                     |   | —           |   | 3,577            |    |
| Other liabilities                                                  |   | 3,121      |    | 927                        |   | —           |   | 4,048            |    |
| Intercompany liabilities                                           |   | —     |    | 47,608                     |   | (47,608          | )      | —           |    |
| Total liabilities                                                  |   | 541,800    |    | 81,780                     |   | (47,608          | )      | 575,972          |    |
|                                                               |   |       |    |                       |   |             |   |             |    |
| Commitments and contingencies                                      |   |       |    |                       |   |             |   |             |    |
| Stockholders’ equity (deficit):                               |   |       |    |                       |   |             |   |             |    |
| Preferred stock                                                    |   | —     |    | —                     |   | —           |   | —           |    |
| Common stock                                                       |   | 664        |    | —                     |   | —           |   | 664              |    |
| Warrants and options                                               |   | 11,745     |    | —                     |   | —           |   | 11,745           |    |
| Investment from parent                                             |   | —     |    | 26,891                     |   | (26,891          | )      | —           |    |
| Additional paid-in capital                                         |   | 210,480    |    | —                     |   | —           |   | 210,480          |    |
| Accumulated deficit                                                |   | (278,346   | )       | (4,257                     | )      | 4,257            |   | (278,346         | )       |
| Common stock subscription receivable                               |   | (24,976    | )       | —                     |   | —           |   | (24,976          | )       |
| Common stock repurchase option                                     |   | (2,636     | )       | —                     |   | —           |   | (2,636           | )       |
| Common stock held in grantor trust                                 |   | (2,700     | )       | —                     |   | —           |   | (2,700           | )       |
| Loans to executive officer                                         |   | (324       | )       | —                     |   | —           |   | (324             | )       |
| Accumulated other comprehensive income                             |   | 390        |    | —                     |   | —           |   | 390              |    |
| Total stockholders’ equity (deficit)                          |   | (85,703    | )       | 22,634                     |   | (22,634          | )      | (85,703          | )       |
| Total liabilities and stockholders’ equity  (deficit)         |   | $          | 456,097 |                       | $      | 104,414          |   | $                | (70,242 | ) | $ | 490,269 |   |

 

21

----

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESBALANCE SHEETAS OF DECEMBER 31, 2003**

 
|                                                               |   | **Parent** |    | **Subsidiary  Guarantors** |   | **Eliminations** |   | **Consolidated** |     |
|--------------------------------------------------------------------|--------|------------|---------|----------------------------|--------|------------------|--------|------------------|----------|
| **ASSETS**                                                         |   |       |    |                       |   |             |   |             |     |
|                                                               |   |       |    |                       |   |             |   |             |     |
| Current assets:                                                    |   |       |    |                       |   |             |   |             |     |
| Cash and cash equivalents                                          |   | $          | 11,132  |                       | $      | 281              |   | $                | —   |   | $ | 11,413 |   |
| Accounts receivable, net                                           |   | 25,548     |    | 4,342                      |   | —           |   | 29,890           |     |
| Inventories                                                        |   | 56,677     |    | 40,118                     |   | —           |   | 96,795           |     |
| Prepaid expenses and other current assets                          |   | 14,989     |    | 152                        |   | —           |   | 15,141           |     |
| Total current assets                                               |   | 108,346    |    | 44,893                     |   | —           |   | 153,239          |     |
|                                                               |   |       |    |                       |   |             |   |             |     |
| Equipment and leasehold improvements, net                          |   | 32,641     |    | 4,512                      |   | —           |   | 37,153           |     |
| Investment in subsidiaries                                         |   | 18,950     |    | —                     |   | (18,950          | )      | —           |     |
| Intercompany assets                                                |   | 82,982     |    | 10,768                     |   | (93,750          | )      | —           |     |
| Deferred tax asset                                                 |   | 186,542    |    | 20                         |   | —           |   | 186,562          |     |
| Goodwill                                                           |   | —     |    | 6,221                      |   | —           |   | 6,221            |     |
| Intangible assets, net                                             |   | 46,554     |    | 40,318                     |   | —           |   | 86,872           |     |
| Other assets, net                                                  |   | 5,059      |    | 4,838                      |   | —           |   | 9,897            |     |
| Total assets                                                       |   | $          | 481,074 |                       | $      | 111,570          |   | $                | (112,700 | ) | $ | 479,944 |   |
|                                                               |   |       |    |                       |   |             |   |             |     |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                      |   |       |    |                       |   |             |   |             |     |
|                                                               |   |       |    |                       |   |             |   |             |     |
| Current liabilities:                                               |   |       |    |                       |   |             |   |             |     |
| Current maturities of long-term debt  and capital lease obligation |   | $          | 1,349   |                       | $      | —           |   | $                | —   |   | $ | 1,349 |   |
| Accounts payable                                                   |   | 23,024     |    | 6,750                      |   | —           |   | 29,774           |     |
| Accrued expenses                                                   |   | 36,686     |    | 2,888                      |   | —           |   | 39,574           |     |
| Total current liabilities                                          |   | 61,059     |    | 9,638                      |   | —           |   | 70,697           |     |
|                                                               |   |       |    |                       |   |             |   |             |     |
| Long-term debt, net of current maturities                          |   | 387,657    |    | —                     |   | —           |   | 387,657          |     |
| Capital lease obligation, net of current  maturities               |   | 3,191      |    | —                     |   | —           |   | 3,191            |     |
| Other liabilities                                                  |   | 3,256      |    | —                     |   | —           |   | 3,256            |     |
| Intercompany liabilities                                           |   | 10,768     |    | 82,982                     |   | (93,750          | )      | —           |     |
| Total liabilities                                                  |   | 465,931    |    | 92,620                     |   | (93,750          | )      | 464,801          |     |
|                                                               |   |       |    |                       |   |             |   |             |     |
| Commitments and contingencies                                      |   |       |    |                       |   |             |   |             |     |
| Stockholders’ equity:                                         |   |       |    |                       |   |             |   |             |     |
| Preferred stock                                                    |   | —     |    | —                     |   | —           |   | —           |     |
| Common stock                                                       |   | 665        |    | —                     |   | —           |   | 665              |     |
| Treasury stock                                                     |   | (96        | )       | —                     |   | —           |   | (96              | )        |
| Warrants and options                                               |   | 11,745     |    | —                     |   | —           |   | 11,745           |     |
| Investment from parent                                             |   | —     |    | 27,925                     |   | (27,925          | )      | —           |     |
| Additional paid-in capital                                         |   | 210,908    |    | —                     |   | —           |   | 210,908          |     |
| Accumulated deficit                                                |   | (179,738   | )       | (8,975                     | )      | 8,975            |   | (179,738         | )        |
| Common stock subscription receivable                               |   | (22,534    | )       | —                     |   | —           |   | (22,534          | )        |
| Common stock repurchase option                                     |   | (2,636     | )       | —                     |   | —           |   | (2,636           | )        |
| Common stock held in grantor trusts                                |   | (2,847     | )       | —                     |   | —           |   | (2,847           | )        |
| Loans to executive officer                                         |   | (324       | )       | —                     |   | —           |   | (324             | )        |
| Total stockholders’ equity                                    |   | 15,143     |    | 18,950                     |   | (18,950          | )      | 15,143           |     |
| Total liabilities and stockholders’ equity                    |   | $          | 481,074 |                       | $      | 111,570          |   | $                | (112,700 | ) | $ | 479,944 |   |

 

22

----

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESSTATEMENT OF OPERATIONSFOR THE THREE MONTHS ENDED MARCH 31, 2004**

**(Unaudited)**

 
|                                          |   | **Parent** |    | **Subsidiary  Guarantors** |   | **Eliminations** |   | **Consolidated** |    |
|-----------------------------------------------|--------|------------|---------|----------------------------|--------|------------------|--------|------------------|---------|
|                                          |   |       |    |                       |   |             |   |             |    |
| Net sales                                     |   | $          | 153,034 |                       | $      | 101,425          |   | $                | (71,756 | ) | $ | 182,703 |   |
| Operating costs and expenses:                 |   |       |    |                       |   |             |   |             |    |
| Cost of goods sold                            |   | 93,569     |    | 73,823                     |   | (53,984          | )      | 113,408          |    |
| Selling, general and administrative  expenses |   | 56,189     |    | 1,564                      |   | (17,772          | )      | 39,981           |    |
| Total operating costs and expenses            |   | 149,758    |    | 75,387                     |   | (71,756          | )      | 153,389          |    |
| Operating income                              |   | 3,276      |    | 26,038                     |   | —           |   | 29,314           |    |
| Interest expense                              |   | 9,620      |    | —                     |   | —           |   | 9,620            |    |
| Interest income                               |   | 285        |    | —                     |   | —           |   | 285              |    |
| Income before income tax expense (benefit)    |   | (6,059     | )       | 26,038                     |   | —           |   | 19,979           |    |
| Income tax expense (benefit)                  |   | (2,303     | )       | 9,895                      |   | —           |   | 7,592            |    |
| Equity (income) loss in subsidiaries          |   | (16,143    | )       | —                     |   | 16,143           |   | —           |    |
| Net income                                    |   | $          | 12,387  |                       | $      | 16,143           |   | $                | (16,143 | ) | $ | 12,387 |   |

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESSTATEMENT OF OPERATIONSFOR THE THREE MONTHS ENDED MARCH 31, 2003**

**(Unaudited) (As Restated)**

 
|                                               |   | **Parent** |    | **Subsidiary  Guarantors** |   | **Eliminations** |   | **Consolidated** |    |
|----------------------------------------------------|--------|------------|---------|----------------------------|--------|------------------|--------|------------------|---------|
|                                               |   |       |    |                       |   |             |   |             |    |
| Net sales                                          |   | $          | 143,029 |                       | $      | 83,999           |   | $                | (48,216 | ) | $ | 178,812 |   |
| Operating costs and expenses:                      |   |       |    |                       |   |             |   |             |    |
| Cost of goods sold                                 |   | 78,352     |    | 74,979                     |   | (44,576          | )      | 108,755          |    |
| Selling, general and administrative  expenses      |   | 33,260     |    | 11,779                     |   | (3,640           | )      | 41,399           |    |
| Total operating costs and expenses                 |   | 111,612    |    | 86,758                     |   | (48,216          | )      | 150,154          |    |
| Operating income (loss)                            |   | 31,417     |    | (2,759                     | )      | —           |   | 28,658           |    |
| Interest expense                                   |   | 9,565      |    | 137                        |   | —           |   | 9,702            |    |
| Interest income                                    |   | 499        |    | —                     |   | —           |   | 499              |    |
| Income (loss) before income tax expense  (benefit) |   | 22,351     |    | (2,896                     | )      | —           |   | 19,455           |    |
| Income tax expense (benefit)                       |   | 8,581      |    | (179                       | )      | —           |   | 8,402            |    |
| Equity (income) loss in subsidiaries               |   | 2,717      |    | —                     |   | (2,717           | )      | —           |    |
| Net income (loss)                                  |   | $          | 11,053  |                       | $      | (2,717           | )      | $                | 2,717   |   | $ | 11,053 |   |

 

23

----

 

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESSTATEMENT OF CASH FLOWSFOR THE THREE MONTHS ENDED MARCH 31, 2004(Unaudited)**

 
|                                                                                        |   | **Parent** |   | **Subsidiary  Guarantors** |   | **Eliminations** |   | **Consolidated** |    |
|---------------------------------------------------------------------------------------------|--------|------------|--------|----------------------------|--------|------------------|--------|------------------|---------|
|                                                                                        |   |       |   |                       |   |             |   |             |    |
| Cash flows from operating activities:                                                       |   |       |   |                       |   |             |   |             |    |
| Net income                                                                                  |   | $          | 12,387 |                       | $      | 16,143           |   | $                | (16,143 | ) | $ | 12,387 |   |
| Adjustments to reconcile net income to net  cash flows from (used in) operating activities: |   |       |   |                       |   |             |   |             |    |
| Depreciation and amortization                                                               |   | 4,087      |   | 2,152                      |   | —           |   | 6,239            |    |
| Amortization and write-off of deferred  financing fees                                      |   | 628        |   | —                     |   | —           |   | 628              |    |
| Deferred income tax expense (benefit)                                                       |   | 19,568     |   | (11,976                    | )      | —           |   | 7,592            |    |
| Equity (income) loss in subsidiaries                                                        |   | (16,143    | )      | —                     |   | 16,143           |   | —           |    |
| Changes in operating assets and  liabilities:                                               |   |       |   |                       |   |             |   |             |    |
| Accounts receivable                                                                         |   | (26,050    | )      | (19,121                    | )      | (71,756          | )      | (116,927         | )       |
| Inventories                                                                                 |   | (78,839    | )      | 6,332                      |   | 53,984           |   | (18,523          | )       |
| Prepaid expenses                                                                            |   | (2,657     | )      | (425                       | )      | —           |   | (3,082           | )       |
| Other assets                                                                                |   | (2,675     | )      | —                     |   | —           |   | (2,675           | )  |
| Accounts payable                                                                            |   | 19,221     |   | 11,690                     |   | —           |   | 30,911           |    |
| Accrued expenses                                                                            |   | (5,987     | )      | 8,690                      |   | —           |   | 2,703            |    |
| Other operating activities, net                                                             |   | (17,807    | )      | —                     |   | 17,772           |   | (35              | )       |
| Net cash flows from (used in) operating  activities                                         |   | (94,267    | )      | 13,485                     |   | —           |   | (80,783          | )       |
|                                                                                        |   |       |   |                       |   |             |   |             |    |
| Cash flows from investing activities:                                                       |   |       |   |                       |   |             |   |             |    |
| Purchases of equipment and leasehold  improvements                                          |   | (3,534     | )      | —                     |   | —           |   | (3,534           | )       |
| Net cash flows used in investing activities                                                 |   | (3,534     | )      | —                     |   | —           |   | (3,534           | )       |
|                                                                                        |   |       |   |                       |   |             |   |             |    |
| Cash flows from financing activities:                                                       |   |       |   |                       |   |             |   |             |    |
| Proceeds from borrowings on revolver                                                        |   | 61,525     |   | —                     |   | —           |   | 61,525           |    |
| Payments received on loans to executive  officer                                            |   | 57         |   | —                     |   | —           |   | 57               |    |
| Repayment of borrowings on term debt                                                        |   | (421       | )      | —                     |   | —           |   | (421             | )       |
| Payments for capital lease obligation                                                       |   | (1,016     | )      | —                     |   | —           |   | (1,016           | )       |
| Payments for treasury stock                                                                 |   | (1,500     | )      | —                     |   | —           |   | (1,500           | )       |
| Change in cash overdraft                                                                    |   | 14,258     |   | —                     |   | —           |   | 14,258           |    |
| Other financing and intercompany activities                                                 |   | 13,526     |   | (13,526                    | )      | —           |   | —           |    |
| Net cash flows from (used in) financing  activities                                         |   | 86,429     |   | (13,526                    | )      | —           |   | 72,903           |    |
|                                                                                        |   |       |   |                       |   |             |   |             |    |
| Net decrease in cash and cash equivalents                                                   |   | (11,372    | )      | (41                        | )      | —           |   | (11,413          | )       |
| Cash and cash equivalents, beginning of  period                                             |   | 11,132     |   | 281                        |   | —           |   | 11,413           |    |
| Cash and cash equivalents, end of period                                                    |   | $          | (240   | )                          | $      | 240              |   | $                | —  |   | $ | — |   |

 

24

----

 

**UNITED INDUSTRIES CORPORATION ANDSUBSIDIARIESSTATEMENT OF CASH FLOWSFOR THE THREE MONTHS ENDED MARCH 31, 2003(Unaudited) (As Restated)**

 
|                                                                                               |   | **Parent** |   | **Subsidiary  Guarantors** |   | **Eliminations** |   | **Consolidated** |   |
|----------------------------------------------------------------------------------------------------|--------|------------|--------|----------------------------|--------|------------------|--------|------------------|--------|
|                                                                                               |   |       |   |                       |   |             |   |             |   |
| Cash flows from operating activities:                                                              |   |       |   |                       |   |             |   |             |   |
| Net income (loss)                                                                                  |   | $          | 11,053 |                       | $      | (2,717           | )      | $                | 2,717  |   | $ | 11,053 |   |
| Adjustments to reconcile net income (loss)  to net cash flows from (used in) operating activities: |   |       |   |                       |   |             |   |             |   |
| Depreciation and amortization                                                                      |   | 1,759      |   | 2,903                      |   | —           |   | 4,662            |   |
| Amortization of deferred financing fees                                                            |   | 2,309      |   | —                     |   | —           |   | 2,309            |   |
| Deferred income tax expense                                                                        |   | 8,402      |   | —                     |   | —           |   | 8,402            |   |
| Equity (income) loss in subsidiaries                                                               |   | 2,717      |   | —                     |   | (2,717           | )      | —           |   |
| Changes in operating assets and  liabilities:                                                      |   |       |   |                       |   |             |   |             |   |   |
| Accounts receivable                                                                                |   | (70,735    | )      | 2,270                      |   | (48,216          | )      | (116,681         | )      |
| Inventories                                                                                        |   | (57,075    | )      | 2,142                      |   | 44,576           |   | (10,357          | )      |
| Prepaid expenses                                                                                   |   | 405        |   | 843                        |   | —           |   | 1,248            |   |
| Other assets                                                                                       |   | (1,524     | )      | —                     |   | —           |   | (1,524           | )      |
| Accounts payable                                                                                   |   | 26,484     |   | 5,469                      |   | —           |   | 31,953           |   |
| Accrued expenses                                                                                   |   | 7,281      |   | 6,167                      |   | —           |   | 13,448           |   |
| Facilities and organizational  rationalization costs                                               |   | (596       | )      | —                     |   | —           |   | (596             | )      |
| Other operating activities, net                                                                    |   | (2,976     | )      | —                     |   | 3,640            |   | 664              |   |
| Net cash flows from (used in) operating  activities                                                |   | (72,496    | )      | 17,077                     |   | —           |   | (55,419          | )      |
|                                                                                               |   |       |   |                       |   |             |   |             |   |
| Cash flows from investing activities:                                                              |   |       |   |                       |   |             |   |             |   |   |
| Purchases of equipment and leasehold  improvements                                                 |   | (1,165     | )      | (102                       | )      | —           |   | (1,267           | )      |
| Net cash flows used in investing activities                                                        |   | (1,165     | )      | (102                       | )      | —           |   | (1,267           | )      |
|                                                                                               |   |       |   |                       |   |             |   |             |   |
| Cash flows from financing activities:                                                              |   |       |   |                       |   |             |   |             |   |   |
| Proceeds from additional term debt                                                                 |   | 126,275    |   | —                     |   | —           |   | 126,275          |   |
| Repayment of borrowings on term debt                                                               |   | (84,747    | )      | —                     |   | —           |   | (84,747          | )      |
| Other financing and intercompany activities                                                        |   | 21,942     |   | (17,102                    | )      | —           |   | 4,840            |   |
| Net cash flows from financing activities                                                           |   | 63,470     |   | (17,102                    | )      | —           |   | 46,368           |   |
|                                                                                               |   |       |   |                       |   |             |   |             |   |
| Net increase (decrease) in cash and cash  equivalents                                              |   | (10,191    | )      | (127                       | )      | —           |   | (10,318          | )      |
| Cash and cash equivalents, beginning of period                                                     |   | 10,191     |   | 127                        |   | —           |   | 10,318           |   |
| Cash and cash equivalents, end of period                                                           |   | $          | — |                       | $      | —           |   | $                | — |   | $ | — |   |

 

25

----

 

**Note 16—SubsequentEvents**

 

# ***Repurchase of SeriesB Notes***

 

As describedin Note 9, on April 14, 2004, the Company repurchased the remaining Series BNotes outstanding, together with accrued interest and repurchase premium of4.938%, for a total cost of $3.3 million.

 

***Sale of Aircraft***

 

As described in Note 5, onApril 15, 2004, the Company completed the sale of its aircraft for $2.8million.

 

***Closing of Nu-Gro Acquisition, Refinancingand Preferred Stock Repurchase***

###### * *

###### *As described in Notes 2 and 9, onApril 30, 2004, the Company completed the acquisition of Nu-Gro, therefinancing of its Prior Senior Credit Facility and the repurchase of all37,600 shares of its outstanding Class A nonvoting preferred stock.*

 

26

----

 
| **ITEM 2.** |   | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS.** |
|-------------|--------|--------------------------------------------------------------------------------------------------|

 

 

The discussionand analysis of our consolidated financial condition and results of operationsincluded herein should be read in conjunction with our historical financialinformation included in the consolidated financial statements and the relatednotes thereto included elsewhere in this Quarterly Report. Future results coulddiffer materially from those discussed below for many reasons, including therisks described under the heading “Certain Trends and Uncertainties” in thissection and elsewhere in this Quarterly Report and in our Annual Report on Form10-K for the year ended December 31, 2003.

 

**Overviewand Management Report**

 

Operating asSpectrum Brands, we are majority owned by UIC Holdings, L.L.C. and are theleading manufacturer and marketer of value-oriented products for the consumerlawn and garden care and insect control markets in the United States. Under avariety of brand names, we manufacture and market one of the broadest lines ofproducts in the industry, including herbicides and indoor and outdoorinsecticides, as well as insect repellents, fertilizers, growing media andsoils. Our value brands are targeted toward consumers who want products andpackaging that are comparable or superior to, and at lower prices than,premium-priced brands, while our opening price point brands are designed forcost-conscious consumers who want quality products. Our products are marketedto mass merchandisers, home improvement centers, hardware, grocery and drugchains, nurseries and garden centers. Our three largest customers are The HomeDepot, Lowe’s and Wal*Mart, which are leading retailers in our larger segments.

 

We compete inthe $2.9 billion consumer lawn and garden and $1.0 billion insect controlretail markets and are benefiting from a shifting of consumer preferencestoward value-oriented products. We believe a key growth factor in the lawn andgarden retail market is the aging of the United States population, as consumersover the age of forty-five represent the largest segment of lawn and garden careproduct users and typically have more leisure time and higher levels ofdiscretionary income than the general population. We also believe the growth inthe home improvement center and mass merchandiser channels has increased thepopularity of do-it-yourself activities, including lawn and garden projects.

 

As of March31, 2004, we report our operating results using three reportable segments, asfollows:

 

•                  ***Lawn and Garden****(82% of first quarter 2004 net sales).*This segment primarily consists of dry granular lawn fertilizers, lawnfertilizer combination with lawn control products, herbicides, water-solubleand controlled-release garden and indoor plant foods, plant care products,potting soils and other growing media products and insecticide products. This segmentincludes, among others, our Spectracide, Garden Safe, Schultz, Vigoro,Sta-Green, Real-Kill and No-Pest brands.

 

•                  ***Household****(17% of first quarter 2004 net sales).*This segment represents household insecticides and insect repellents that allowconsumers to repel insects and maintain pest-free households. This segmentincludes our Hot Shot, Cutter and Repel brands, as well as a number of privatelabel and other products.

 

•                  ***Contract****(1% of first quarter 2004 net sales).* Thissegment includes a variety of compounds and chemicals, such as cleaningsolutions and other consumer products.

 

We believethat our historical financial condition and results of operations are notnecessarily accurate indicators of future results because of variability in ourproduct listings at customers, our historical lack of long-term supplycontracts with most of our customers and because of certain significant pastevents. Those events include merger, acquisition, strategic and equity and debtfinancing transactions over the last several years.  Furthermore, our sales are seasonal in nature and are susceptibleto weather conditions that vary from year to year.  For example, we experienced a late winter and cool, wet springconditions that delayed the start of the lawn and garden season in 2003,whereas the weather in the first quarter of 2004 was generally more mild anddry throughout North America.

 

27

----

 

**CriticalAccounting Policies**

 

While all ofthe significant accounting policies described in the notes to our consolidatedfinancial statements are important, some of these policies may be viewed asbeing critical. Such policies are those that are both most important to theportrayal of our financial condition and require our most difficult, subjectiveor complex estimates and assumptions that affect the reported amounts of assetsand liabilities and the disclosure of contingent assets and liabilities at thedate of our consolidated financial statements and the reported amounts of revenuesand expenses during the reporting period. We base our estimates and assumptionson historical experience and various other factors that we believe to bereasonable under the circumstances. Actual results could differ from theseestimates and assumptions. We believe our most critical accounting policies areas follows.

 

***Revenue Recognition.***  We recognize revenue when title and risk ofloss transfer to the customer.  Netsales represent gross sales less any applicable customer discounts from listprice, customer sales returns and promotion expense through cooperativeprograms with our customers. The provision for customer returns is based onhistorical sales returns and analysis of credit memo and other relevantinformation. If the historical or other data used to develop these estimates donot properly reflect future returns, net sales may require adjustment. Salesreductions related to returns were $2.7 million for the three months endedMarch 31, 2004 and $2.0 million for the three months ended March 31, 2003. Theincrease in 2004 was driven primarily by higher sales and the mix of productssold during the first quarter of 2004. Amounts included in the accounts receivable reserves for product returnswere $2.6 million as of March 31, 2004 and 2003 and $1.4 million as of December31, 2003.

 

***Inventories.***  We report inventories at the lower of costor market. Cost is determined using a standard costing system that approximatesthe first-in, first-out method and includes raw materials, direct labor and overhead.  An allowance for obsolete or slow-movinginventory is recorded based on our analysis of inventory levels and futuresales forecasts.  In the event that ourestimates of future usage and sales differ from actual results, the allowancefor obsolete or slow-moving inventory may require adjustment.  The allowance for obsolete or slow-movinginventory declined $0.5 million for the three months ended March 31, 2004compared to the three months ended March 31, 2003.  The allowance for obsolete or slow-moving inventory was $4.9million as of March 31, 2004, $5.4 million as of March 31, 2003 and $5.6million as of December 31, 2003.

 

***Promotion Expense.***  We advertise and promote our productsthrough national and regional media. Products are also advertised and promotedthrough cooperative programs with retailers. Advertising and promotion costsare expensed as incurred, although costs incurred during interim periods aregenerally expensed ratably in relation to revenues. Management develops anestimate of the amount of costs that have been incurred by the retailers underour cooperative programs based on an analysis of specific programs offered tothem and historical information. Actual costs incurred may differ significantlyfrom our estimates if factors such as the level of participation and success ofthe retailers’ programs or other conditions differ from our expectations.Promotion expense, including cooperative programs with customers, is recordedas a reduction of gross sales.  Inaddition, advertising costs are incurred irrespective of promotions. Such costsare included in selling, general and administrative expenses in ourconsolidated statements of operations.

 

***Income Taxes.***  We account for income taxes under the assetand liability method. Under this method, deferred tax assets and liabilitiesare recognized for the future tax consequences attributable to differencesbetween the financial reporting basis and the tax basis of assets andliabilities at enacted tax rates expected to be in effect when such amounts arerecovered or settled. Judgment is required to determine the amount of anyvaluation allowance to apply against deferred tax assets. We will establish avaluation allowance if we determine that it is more likely than not that someportion or all of our deferred tax assets will not be realized and include anychanges to such valuation allowance in our consolidated statements ofoperations as income tax expense or benefit, as appropriate.

 

28

----

 

We expect our effectiveincome tax rate to be 38% throughout the remainder of 2004.  In addition, because of the tax-deductiblegoodwill and net operating loss carryforwards, most of our income tax expenseis deferred, and no significant cash payments for income taxes are expected forthe next several years.

 

Although webelieve it is more likely than not that we will utilize our deferred taxassets, we can provide no assurance of this, as our ability to utilize suchassets is contingent upon our ability to generate sufficient taxable income inthe future. We will continue to assess the realizability of the deferred taxassets based upon actual and forecasted operating results. If we conclude it isnot more likely than not that we will realize the benefit of our deferred taxassets, we may have to establish a valuation allowance and, accordingly, recorda charge to income tax expense.

 

***Goodwill, Intangibleand Other Long-Lived Assets.***  We have acquired intangible assets or madeacquisitions in the past that resulted in the recording of goodwill orintangible assets.  Under generallyaccepted accounting principles in effect prior to 2002, goodwill and intangibleassets were amortized over their estimated useful lives, and were testedperiodically to determine if they were recoverable from their cash flows on anundiscounted basis over their useful lives.

 

Beginning in2002, goodwill is no longer amortized and is subject to impairment testing atleast annually. We evaluate the recoverability of long-lived assets, includinggoodwill and intangible assets, for impairment when events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Such events or changes in circumstances could include such factorsas changes in technological advances, fluctuations in the fair value of suchassets or adverse changes in customer relationships or vendors.  Recoverability is evaluated by brand andproduct type, which represent the reporting unit components within ouroperating segments. If a review of goodwill using current market rates,discounted cash flows and other methods, or if a review of other intangibleassets using current market rates, undiscounted cash flows and other methods,indicates that the carrying value is not recoverable, the carrying value ofsuch asset is reduced to estimated fair value. No impairments existed as ofMarch 31, 2004 and 2003 and December 31, 2003. While we believe that ourestimates of future cash flows are reasonable, different assumptions regardingsuch cash flows could materially affect our evaluations. Therefore, impairmentlosses could be recorded in the future.

 

**RecentEvents**

 

***Acquisition of TheNu-Gro Corporation***.  InMarch 2004, we and a newly-created wholly-owned subsidiary of ours entered intoa definitive agreement to acquire all of the outstanding common shares of TheNu-Gro Corporation, a lawn and garden products company incorporated under thelaws of Ontario, Canada and publicly-traded on the Toronto Stock Exchange.  Nu-Gro’s shareholders approved thetransaction on April 27, 2004 and we completed the acquisition on April 30,2004 for cash consideration of $141.4 million. The transaction was financed with proceeds from our new senior creditfacility described further below.  Wewill account for the transaction as an acquisition, and accordingly, theresults of operations of Nu-Gro will be included in our results of operationsfrom the date of acquisition.  We arecurrently in the process of obtaining an independent third-party valuation ofassets acquired and liabilities assumed for purchase price allocation purposesand expect the valuation to be completed by the third quarter of 2004.  Because the acquisition occurred after March31, 2004, Nu-Gro’s results of operations are not included in our consolidatedstatement of operations for the three months ended March 31, 2004 and theacquired assets and liabilities assumed are not included in our consolidatedbalance sheet as of March 31, 2004, included elsewhere in this QuarterlyReport.  The Nu-Gro acquisition willbroaden our North American presence, provide us with a diverse portfolio ofadvanced fertilizer technologies and vertically integrate our fertilizeroperations.

 

***New Senior CreditFacility.***  In conjunction with the closing of theacquisition of Nu-Gro, on April 30, 2004, we entered into a new $510.0 millionsenior credit facility (referred to herein as the new senior creditfacility) with Bank of America, N.A.,Banc of America Securities LLC, Citigroup Global Markets, Inc., Citicorp NorthAmerica, Inc. and certain other lenders to refinance the indebtedness under ourprior senior credit facility at more favorable rates, to provide funds for theNu-Gro acquisition, to repurchase all of our outstanding preferred stock, alongwith accrued but unpaid dividends thereon, and for general working capitalpurposes.  The new senior creditfacility consists of (1) a $125.0 million US dollar denominatedrevolving credit facility; (2) a $335.0 million US dollar denominatedterm loan facility; and (3) a Canadian dollar denominated term loanfacility valued at US $50.0 million. Subject to the terms of the new senior credit facility agreement, therevolving loan portion of the new senior credit facility matures on April 30,2010, and the term loan obligations under the new senior credit facility matureon April 30, 2011.  The term loanobligations are to be repaid in 28 consecutive quarterly installmentscommencing on June 30, 2004, with a final

 

29

----

 

installment due on March 31, 2011.  All of the loan obligations are subject tomandatory prepayment upon certain events, including sales of certain assets,issuances of indebtedness or equity or from excess cash flow.  The new senior credit facility agreementalso allows us to make voluntary prepayments, in whole or in part, at any timewithout premium or penalty.

 

The new seniorcredit facility agreement contains affirmative, negative and financialcovenants that are more favorable than those of the prior senior credit facility.  The negative covenants place restrictionson, among other things, levels of investments, indebtedness, capitalexpenditures and dividend payments that we may make or incur.  The financial covenants require themaintenance of certain financial ratios at defined levels.  Under the new senior credit facilityagreement, interest rates on the new revolving credit facility can range from1.75% to 2.50% plus LIBOR, or from 0.75% to 1.50% plus a base rate, subject toadjustment and depending on certain financial ratios.  As of April 30, 2004, the term loans were subject to interestrates equal to 2.50% plus LIBOR or 1.50% plus a base rate, as provided in thenew senior credit facility agreement. Unused commitments under the new revolving credit facility are subjectto a 0.5% annual commitment fee.  Thenew senior credit facility is secured by substantially all of our propertiesand assets and substantially all of the properties and assets of our currentand future domestic subsidiaries.

 

In connection with theclosing of the Nu-Gro acquisition, Bank of America, N.A., Canada Branch,separately loaned us Cdn $110.0 million for structuring purposes, which loanwas repaid on April 30, 2004.

 

***Repurchaseof Preferred Stock.***  In conjunction with ourrefinancing, on April 30, 2004, we repurchased all 37,600 shares of ouroutstanding Class A nonvoting preferred stock for $57.5 million, including allaccrued and unpaid dividends thereon.

 

***Customer Agreement***.  On February 12, 2004, our largest customerand we executed a licensing, manufacturing and supply agreement.  Under the agreement, we will license certainof our trademarks and be the exclusive manufacturer and supplier for certainproducts branded with such trademarks from January 1, 2004, the effective dateof the agreement, through December 31, 2008 or such later date as is specifiedin the agreement.  Provided the customerachieves certain required minimum purchase volumes and other conditions duringsuch period, and the manufacturing and supply portion of the agreement isextended for an additional three-year period as specified in the agreement, wewill assign the trademarks to the customer not earlier than May 1, 2009, butotherwise within thirty days after the date upon which such required minimumpurchase volumes are achieved.  Thecarrying value of such trademarks as of March 31, 2004 was approximately $16.0million.  If the customer fails toachieve the required minimum purchase volumes or meet other certain conditions,assignment may occur at a later date, if certain conditions are met.  In addition, as a result of executing theagreement, we have modified the trademarks’ initial amortization period offorty years and will record amortization in a manner consistent with projectedsales activity over five years, because we believe the customer will achieveall required conditions by May 2009. The modification of the amortization period will result in additionalannual amortization expense of approximately $2.7 million in the year endedDecember 31, 2004.

 

***BayerTransactions. ***OnJune 14, 2002, we consummated a transaction with Bayer Corporation and BayerAdvanced, L.L.C. (together referred to herein as Bayer) which allows us to gainaccess to certain Bayer active ingredient technologies through a Supply Agreementand to perform certain merchandising services for Bayer through an In-StoreService Agreement.  In consideration forthe Supply and In-Store Service Agreements, and in exchange for the promissorynotes previously issued to Bayer by U.S. Fertilizer, we issued to Bayer3,072,000 shares of Class A voting common stock valued at $15.4 million and3,072,000 shares of Class B nonvoting common stock valued at $15.4 million(collectively representing approximately 9.3% of our fully-diluted commonstock) and recorded $0.4 million of related issuance costs. We reserved for theentire face value of the promissory notes due from U.S. Fertilizer, as we didnot believe the notes were collectible and an independent third party valuationdid not ascribe any significant value to them. The independent third partyvaluation also indicated that value should be ascribed to the repurchase optionwhich is reflected in stockholders’ equity in the consolidated balance sheetsas of March 31, 2003 and December 31, 2003 included elsewhere in this QuarterlyReport.

 

Under theterms of the agreements, Bayer was required to make payments to us which total$5.0 million annually through June 15, 2009, the present value of which equaledthe value assigned to the common stock subscription receivable as of June 14,2002, which has been reflected in stockholders’ equity in the consolidatedbalance sheets as of March 31, 2003 and December 31, 2003 included elsewhere inthis Quarterly Report. The common stock subscription receivable was to be repaidby Bayer in 28 quarterly installments of $1.25 million, the first of which wasreceived at closing on June 17, 2002.

 

30

----

 

The difference between thevalue ascribed to the common stock subscription receivable and the installmentpayments received has been recorded as interest income in our consolidatedstatements of operations for the three months ended March 31, 2004 and 2003 andyear ended December 31, 2003.

 

The value ofthe Supply Agreement has been and is being amortized to cost of goods sold overthe period in which its economic benefits are expected to be utilized which wasinitially anticipated to be over a three to five-year period. We have beenamortizing the obligation associated with the In-Store Service Agreement torevenues over the seven-year life of the agreement, the period in which itsobligations were originally expected to be fulfilled. However, in December2002, we and Bayer amended the In-Store Service Agreement to reduce the scope ofservices provided by approximately 80%. As a result, we reduced our obligationunder the In-Store Service Agreement accordingly and reclassified $3.6 millionto additional paid-in capital to reflect the increase in value of the In-StoreService Agreement.

 

The In-StoreService Agreement provided us with the right to terminate and, effective afterany such termination, the right to repurchase all of our common stock issued toBayer at a price based on equations included in a related agreement (theExchange Agreement). Under the terms of the Exchange Agreement, we wereprovided the right to offset Bayer’s payment obligations against the repurchaseprice.  Upon exercise of such repurchaseoption, Bayer had and continues to have the right to terminate the SupplyAgreement. Because Bayer is both a competitor and a supplier, we havecontinually reevaluated the value of our stockholder relationship with Bayer.

 

On October 22,2003, we gave notice to Bayer regarding the termination of the In-Store ServiceAgreement, as amended.  Upontermination, which became effective on December 21, 2003, we were relieved ofour obligation to perform merchandising services for Bayer.  Accordingly, the remaining liability of $0.7million on the date of termination was fully written off and recorded inselling, general and administrative expenses in the consolidated statement ofoperations for the year ended December 31, 2003 included elsewhere in thisQuarterly Report.

 

Based on theindependent third party valuation as of June 14, 2002, the original transactiondate, we assigned a fair value of $30.7 million to the transaction componentsrecorded in connection with the common stock issued to Bayer. The followingtable presents the values of these components as of March 31, 2004 and 2003 andDecember 31, 2003:

 
|                                 |   | **March 31,** |   | **December  31,** |   |
|--------------------------------------|--------|---------------|--------|-------------------|--------|
| **Description**                      |   | **2004**      |   | **2003**          |   | **2003** |   |
|                                 |   |          |   |              |   |   |   |
| Common stock subscription receivable |   | $             | — |              | $      | 24,976 |   | $ | 22,534 |   |
| Supply Agreement                     |   | 4,779         |   | 5,694             |   | 5,314 |   |
| Repurchase option                    |   | —        |   | 2,636             |   | 2,636 |   |
| In-Store Service Agreement           |   | —        |   | (845              | )      | — |   |
|                                 |   | $             | 4,779  |              | $      | 32,461 |   | $ | 30,484 |   |

 

Following thetermination of the In-Store Service Agreement, on December 22, 2003, weexercised our option to repurchase all outstanding common stock previouslyissued to Bayer.  Bayer disputed ourinterpretation of the Exchange Agreement as to the calculation of therepurchase price.  As a result, we andBayer entered negotiations to determine an agreed upon repurchase price basedon equations included in the Exchange Agreement and other factors.  We commenced an arbitration proceedingagainst Bayer to resolve the dispute on January 30, 2004.  However, we reached a negotiated settlementof the dispute with Bayer on February 23, 2004, pursuant to which Bayer agreedto deliver all of its shares of our common stock to us in exchange for a cashpayment of $1.5 million, cancellation of $22.5 million in remaining paymentsrequired to be made in connection with the common stock subscription receivableand forgiveness of interest related to such payments of $0.3 million.

 

We recordedtreasury stock of $24.4 million, based on the consideration given to Bayer, andreduced the common stock subscription receivable by $22.5 million, theremaining balance on the date of repurchase. We also reversed the common stock repurchase option of $2.6 million as aresult of its exercise and recorded a corresponding amount to additionalpaid-in capital. As a result of this transaction, we and Bayer agreed that theExchange Agreement and In-Store Service Agreement are fully terminated, withthe exception of certain provisions contained therein that expressly survivetermination, and that the Supply Agreement shall remain in full force andeffect according to its terms.  Under theterms of

 

31

----

 

the Supply Agreement, anyremaining balance at January 30, 2009 is unconditionally and immediatelypayable to us by Bayer regardless of whether or not we purchase any ingredientsunder the Supply Agreement.  As of March31, 2004, the remaining balance of the Supply Agreement was $4.8 million.

 

**Results of Operations**

 

All prior yearresults and discussion which follow reflect the segments previously describedelsewhere in this Quarterly Report.  Thefollowing table presents amounts and the percentages of net sales that items inthe accompanying consolidated statements of operations constitute for theperiods presented:

 
|                                          |   | **Three  Months Ended March 31,** |    |
|-----------------------------------------------|--------|-----------------------------------|---------|
|                                          |   | **2004**                          |    | **2003** |   |
|                                          |   |                              |    |   |   | **(As  Restated)** |   |
| Net sales by segment:                         |   |                              |    |   |   |   |   |   |   |
|                                          |   |                              |    |   |   |   |   |   |   |
| Lawn and Garden                               |   | $                                 | 150,507 |   | 82.4 | % | $ | 145,614 |   | 81.4 | % |
| Household                                     |   | 31,225                            |    | 17.1 | % | 27,567 |   | 15.4 | % |
| Contract                                      |   | 971                               |    | 0.5 | % | 5,631 |   | 3.2 | % |
| Total net sales                               |   | 182,703                           |    | 100.0 | % | 178,812 |   | 100.0 | % |
| Operating costs and expenses:                 |   |                              |    |   |   |   |   |   |   |
| Cost of goods sold                            |   | 113,408                           |    | 62.0 | % | 108,755 |   | 60.8 | % |
| Selling, general and administrative  expenses |   | 39,981                            |    | 21.9 | % | 41,399 |   | 23.2 | % |
| Total operating costs and expenses            |   | 153,389                           |    | 83.9 | % | 150,154 |   | 84.0 | % |
| Operating income (loss) by segment:           |   |                              |    |   |   |   |   |   |   |
| Lawn and Garden                               |   | 20,448                            |    | 11.2 | % | 22,073 |   | 12.3 | % |
| Household                                     |   | 9,048                             |    | 4.9 | % | 6,626 |   | 3.7 | % |
| Contract                                      |   | (182                              | )       | 0.0 | % | (41 | ) | 0.0 | % |
| Total operating income                        |   | 29,314                            |    | 16.1 | % | 28,658 |   | 16.0 | % |
| Interest expense                              |   | 9,620                             |    | 5.3 | % | 9,702 |   | 5.4 | % |
| Interest income                               |   | 285                               |    | 0.2 | % | 499 |   | 0.3 | % |
| Income before income tax expense              |   | 19,979                            |    | 11.0 | % | 19,455 |   | 10.9 | % |
| Income tax expense                            |   | 7,592                             |    | 4.2 | % | 8,402 |   | 4.7 | % |
| Net income                                    |   | $                                 | 12,387  |   | 6.8 | % | $ | 11,053 |   | 6.2 | % |

 

**ThreeMonths Ended March 31, 2004 Compared to the Three Months Ended March 31,2003**

 

***Net Sales.***  Net sales represent gross sales less anyapplicable customer discounts from list price, customer sales returns andpromotion expense through cooperative programs with our customers. Net salesincreased $3.9 million, or 2.2%, to $182.7 million for the threemonths ended March 31, 2004 from $178.8 million for the three months endedMarch 31, 2003. The increase, related to our Lawn and Garden and Householdsegments, as well as the change in our sales mix by segment, were primarily dueto stronger sales of fertilizer and indoor insecticide products compared to2003. This increase was partially offset by the cessation of sales of charcoaland non-core WPC products in the Contract segment in the second quarter of 2003and a decline in sales of other lawn and garden products during the threemonths ended March 31, 2004.

 

Net sales inthe Lawn and Garden segment increased $4.9 million, or 3.4%, to$150.5 million for the three months ended March 31, 2004 from$145.6 million for the three months ended March 31, 2003. Net sales ofthis segment increased primarily due to an increase in sales of fertilizer,partially offset by a decline in sales of outdoor insecticides and othergrowing media products. Net sales in the Household segment increased $3.6million, or 13.0%, to $31.2 million for the three months ended March 31,2004 from $27.6 million for the three months ended March 31, 2003. Netsales of this segment increased primarily due to an increase in sales of indoorinsecticide products and insect repellent products. Net sales in the Contractsegment decreased $4.6 million, or 82.1%, to $1.0 million for thethree months ended March 31, 2004 from $5.6 million for the three monthsended March 31, 2003. Net sales of this segment decreased primarily due to thecessation of sales of charcoal and non-core WPC products in the second quarterof 2003.

 

***Gross Profit.***  Gross profit decreased $0.8 million, or1.1%, to $69.3 million for the three months ended March 31, 2004 from$70.1 million for the three months ended March 31, 2003. The decrease ingross profit was primarily due to increased sales volume of certain fertilizerproducts which generally have lower margins than our other products, which waspartially due to increasing costs of granular urea used to produce fertilizer.For the year ended December 31, 2004, we expect

 

32

----

 

the net increase in granularurea costs versus customer price realization to be approximately $4.0million.  As a percentage of net sales,gross profit decreased to 38.0% for the three months ended March 31, 2004 from39.2% for the three months ended March 31, 2003. The decrease in gross profitas a percentage of net sales was primarily due to increased raw materialsprices on certain products, including granular urea costs for fertilizerproducts, partially offset by increased sales of insecticide products in ourLawn and Garden segment and repellent products in our Household segment and ourcontinuing ability to achieve operational efficiencies from the merger andacquisition transactions we consummated in 2002.

 

***Selling, General andAdministrative Expenses.***  Selling, general and administrative expenses include all costsassociated with the selling and distribution of products, product registrationsand administrative functions such as finance, information systems and humanresources. Selling, general and administrative expenses decreased$1.4 million, or 3.4%, to $40.0 million for the three months endedMarch 31, 2004 from $41.4 million for the three months ended March 31,2003. The decrease was primarily due to decreased media and advertisingspending, various operational efficiencies we continued to achieve from themerger and acquisition transactions we consummated in 2002 and a $2.4 millionadjustment to increase amortization expense during the three months ended March31, 2003 as a result of the final valuation received relative to our SchultzCompany merger in May 2002.  As apercentage of net sales, selling, general and administrative expenses decreasedto 21.9% for the three months ended March 31, 2004 from 23.2% for the threemonths ended March 31, 2003.  Thedecrease was due to the decline in expenses previously described.

 

***Operating Income.***  As a result of the factors previouslydescribed, operating income increased $0.6 million, or 2.1%, to$29.3 million for the three months ended March 31, 2004 from$28.7 million for the three months ended March 31, 2003. As a percentageof net sales, operating income increased to 16.1% for the three months ended March31, 2004 from 16.0% for the three months ended March 31, 2003.

 

Operatingincome in the Lawn and Garden segment decreased $1.7 million, or 7.7%, to$20.4 million for the three months ended March 31, 2004 from$22.1 million for the three months ended March 31, 2003. Operating incomeof this segment decreased primarily due to stronger sales of certain fertilizerproducts, which generally have lower margins than our other products, coupledwith a slight decline in sales of certain other lawn and garden products.  Operating income in the Household segmentincreased $2.4 million, or 36.4%, to $9.0 million for the threemonths ended March 31, 2004 from $6.6 million for the three months endedMarch 31, 2003. Operating income of this segment increased primarily due toincreased sales of insecticide products, offset partially by a slight declinein sales of repellent products. Operating loss in the Contract segmentincreased to $0.2 million for the three months ended March 31, 2004 fromless than $0.1 million for the three months ended March 31, 2003.Operating loss of this segment increased primarily due to increased operatingcosts and the cessation of sales of charcoal and non-core products acquired inour acquisition of WPC Brands in December 2002.

 

***Interest Expense.***  Interest expense decreased$0.1 million, or 1.0%, to $9.6 million for the three months endedMarch 31, 2004 from $9.7 million for the three months ended March 31,2003. The decrease in interest expense was primarily due to write-offs ofpreviously deferred financing fees totaling $1.8 million in 2003 recordedin connection with our repayment of a portion of the obligations outstandingunder our senior credit facility then in effect and a general decline ininterest rates in 2004 compared to 2003, partially offset by an increase in ouraverage debt outstanding during 2004 compared to 2003.

 

***Net Income.***  Net income increased $1.3 million, or 12.6%,to $12.4 million for the three months ended March 31, 2004 from $11.1 millionfor the three months ended March 31, 2003 due to the factors previouslydescribed.

 

33

----

 

**Liquidityand Capital Resources**

 

Our principalliquidity requirements are for working capital, capital expenditures and debtservice under our senior credit facility and our senior subordinated notes.

 

We believethat cash flows from operations, together with available borrowings under ourrevolving credit facility, will be adequate to meet the anticipatedrequirements for working capital, capital expenditures and scheduled principaland interest payments for the foreseeable future. In addition to the Nu-Groacquisition described in more detail under the heading “Recent Events” in thissection, we are regularly engaged in acquisition discussions with a number ofother sellers although we cannot guarantee that any acquisitions will beconsummated. If we do consummate any acquisitions such transactions could bematerial to our business and require us to incur additional debt under ourrevolving credit facility or otherwise.

 

We cannotensure that sufficient cash flows will be generated from operations to repayour senior subordinated notes and amounts outstanding under our senior creditfacility at maturity without requiring additional financing. Our ability tomeet debt service and clean-down obligations and reduce debt will be dependenton our future performance, which in turn, will be subject to general economicand weather conditions and to financial, business and other factors, includingfactors beyond our control. Because a portion of our debt bears interest atfloating rates, our financial condition is and will continue to be affected bychanges in prevailing interest rates.

 

***OperatingActivities.*** Operating activities used net cash of $80.8 million for the three monthsended March 31, 2004 compared to $55.4 million for the three months ended March31, 2003. The increase in net cash used in operating activities was primarilydue to increased inventories which used $7.5 million more cash in 2004 than in2003 due to our efforts to fulfill demand associated with increased sales andprojections for better weather conditions for the second quarter of 2004compared to first and second quarter of 2003. The increase in net cash used inoperating activities was also due to a decline in accrued expense whichprovided $10.7 million less cash in 2004 than in 2003 due primarily to lowercosts accrued for advertising and promotion, interest and other accrued items,partially offset by higher costs accrued for preferred stock dividends. Inaddition, the seasonal nature of our operations generally requires cash to fundsignificant increases in working capital, primarily accounts receivable andinventories, during the first half of the year. Accounts receivable and accountspayable generally build substantially in the first half of the year, in linewith increasing sales as the season begins. These balances generally declineover the latter part of the year as the lawn and garden season winds down.

 

***InvestingActivities.*** Investing activities used net cash flows of $3.5 million for thethree months ended March 31, 2004 compared to $1.3 million for the threemonths ended March 31, 2003. The increase in net cash flows used in investingactivities was due to a $2.2 million increase in capital expenditures in 2004compared to 2003.  Capital expendituresrelate primarily to the construction of additional capacity for production anddistribution, the development and implementation of our enterprise resourceplanning, or ERP, system and the enhancement of certain of our existingfacilities. Cash used for capital expenditures was $3.5 million for the threemonths March 31, 2004 and $1.3 million for the three months March 31,2003. The increase in capital expenditures from 2003 to 2004 was primarilyrelated to increased construction costs to expand our production anddistribution capacity.  We expect tospend approximately $17.1 million on capital expenditures in 2004, exclusive ofcapital leases, including $3.2 million on our ERP system.

 

***FinancingActivities.*** Financing activities provided net cash flows of $72.9 million forthe three months ended March 31, 2004 compared to providing net cash flows of$46.4 million for the three months ended March 31, 2003. The increase in netcash flows provided by financing activities was primarily due to borrowings,net of repayments, of $61.2 million in 2004 compared to borrowings, net ofrepayments, of $41.7 million in 2003. The increase was also due to higher cash overdrafts of $7.8 million in2004 compared to 2003, driven by outstanding checks at the end of eachperiod.  These increases were partiallyoffset by declines in cash flows of other financing activities.

 

Historically,we have utilized internally generated funds and borrowings under creditfacilities to meet ongoing working capital and capital expenditurerequirements. As a result of increased borrowings over the past several years,we have significantly increased cash requirements for debt service relating toour senior subordinated notes and senior credit facility. We had totallong-term debt, excluding capital lease obligations, of $449.5 million asof March 31, 2004, $442.4 million as of March 31, 2003 and $388.5 millionas of December 31, 2003. We will rely on internally generated funds and,to the extent necessary, borrowings under our revolving credit facility to meetliquidity needs. We had unused availability under our revolving credit facilitythen in effect of $86.8 million as of March 31, 2004, $87.8 million as of March31, 2003 and

 

34

----

 

$87.9 million as ofDecember 31, 2003.  As of April 30,2004, after giving effect to the refinancing, the Nu-Gro acquisition and therepurchase of our outstanding preferred stock, including accrued but unpaiddividends, we had unused availability under the revolving portion of our newsenior credit facility of $47.0 million.

 

Long-term debt, excludingcapital lease obligations, totaled $449.5 million as of March 31, 2004,$442.4 million as of March 31, 2003 and $388.5 million as ofDecember 31, 2003. This debt was comprised of senior subordinated notes,including related premiums, of $236.0 million as of March 31, 2004,$236.3 million as of March 31, 2003 and $236.1 million as ofDecember 31, 2003 and borrowings under our senior credit facility then ineffect of $152.0 million as of March 31, 2004, $206.2 million as ofMarch 31, 2003 and $152.4 million as of December 31, 2003. Theweighted average rate on borrowings under our senior credit facility then ineffect was 5.02% as of March 31, 2004, 5.27% as of March 31, 2003 and 5.12% asof December 31, 2003. The weighted average rate on the senior subordinatednotes was 9.875% as of the end of each of these periods, resulting in a blendedweighted average rate of 7.57% as of March 31, 2004, 7.72% as of March 31, 2003and 8.01% as of December 31, 2003. The fair value of our total fixed-ratedebt was $245.6 million as of March 31, 2004, $243.2 million as ofMarch 31, 2003 and $242.1 million as of December 31, 2003. The fair valueof our total variable-rate debt, including current maturities and short-termborrowings, approximated the carrying value of $213.5 million as of March31, 2004, $206.2 million as of March 31, 2003 and $152.4 million asof December 31, 2003. The fair values of our fixed-rate debt and variable-ratedebt are based on quoted market prices.

 

*Senior Credit Facility in Effect as of March31, 2004*.  Oursenior credit facility, as amended as of March 14, 2003, in effect as of March31, 2004, with Bank of America, N.A., Morgan Stanley Senior Funding, Inc.and Canadian Imperial Bank of Commerce was terminated and all obligationsoutstanding thereunder were repaid on April 30, 2004.  The prior senior credit facility consisted of (1) a$90.0 million revolving credit facility; (2) a $75.0 millionterm loan facility (Term Loan A), which was repaid in full during the yearended December 31, 2003; and (3) a $240.0 million term loan facility(Term Loan B).

 

The priorsenior credit facility agreement contained affirmative, negative and financialcovenants.  Affirmative and negativecovenants placed restrictions on, among other things, levels of investments,indebtedness, insurance, capital expenditures and dividend payments.  The financial covenants required themaintenance of certain financial ratios at defined levels. As of and during thethree months ended March 31, 2004 and 2003 and year ended December 31,2003, we were in compliance with all covenants.  Under the prior senior credit facility agreement, interest rateson the revolving credit facility and Term Loan B ranged from 1.50% to4.00% plus LIBOR, or other base rate as provided in the prior senior creditfacility agreement, depending on certain financial ratios.  LIBOR was 1.11% as of March 31, 2004, 1.29%as of March 31, 2003 and 1.16% as of December 31, 2003.  The interest rate applicable to TermLoan B was 5.09% as of March 31, 2004, 5.31% as of March 31, 2003 and5.12% as of December 31, 2003. Unused commitments under the revolving credit facility were subject to a0.5% annual commitment fee.

 

The priorsenior credit facility agreement allowed us to make prepayments in whole or inpart at any time without premium or penalty. During the three months endedMarch 31, 2004, we made principal payments of $0.4 million on TermLoan B, which primarily represented optional principal prepayments.  During the three months ended March 31,2003, we made principal payments of $28.3 million to fully repay TermLoan A and $25.9 million on Term Loan B, which primarilyrepresented optional principal prepayments. During the year ended December 31, 2003, we made principal paymentsof $28.3 million to fully repay Term Loan A and $69.6 million onTerm Loan B, which primarily represented optional principal prepayments.  The optional principal prepayments were madefrom operating cash flows and allowed us to remain several quarterly paymentsahead of the regular payment schedule. In connection with these prepayments, we recorded write-offs totaling$1.3 million in previously deferred financing fees which were included ininterest expense in our consolidated statement of operations for the threemonths ended March 31, 2003.

 

The priorsenior credit facility was secured by substantially all of our properties andassets and by substantially all of the properties and assets of our currentdomestic subsidiaries.  The carryingamount of our obligations under the prior senior credit facility approximatedfair value because the interest rates were based on floating interest ratesidentified by reference to market rates.

 

*New SeniorCredit Facility.* In conjunction with the closingof the acquisition of Nu-Gro, on April 30, 2004, we entered into a new $510.0million senior credit facility with Bank of

 

35

----

 

America, N.A., Banc of America SecuritiesLLC, Citigroup Global Markets, Inc., Citicorp North America, Inc. and certainother lenders to refinance the indebtedness under our prior seniorcredit facility at morefavorable rates, to provide funds for the Nu-Gro acquisition, to repurchase allof our outstanding preferred stock, along with accrued but unpaid dividendsthereon, and for general working capital purposes.  The new senior credit facility consists of (1) a$125.0 million US dollar denominated revolving credit facility; (2) a$335.0 million US dollar denominated term loan facility; and (3) aCanadian dollar denominated term loan facility valued at US$50.0 million.  Subject to theterms of the new senior credit facility agreement, the revolving loan portionof the new senior credit facility matures on April 30, 2010, and the term loanobligations under the new senior credit facility mature on April 30, 2011.  The term loan obligations are to be repaidin 28 consecutive quarterly installments commencing on June 30, 2004, with afinal installment due on March 31, 2011. All of the loan obligations are subject to mandatory prepayment uponcertain events, including sales of certain assets, issuances of indebtedness orequity or from excess cash flow.  Thenew senior credit facility agreement also allows us to make voluntaryprepayments, in whole or in part, at any time without premium or penalty.

 

The new seniorcredit facility agreement contains affirmative, negative and financialcovenants that are more favorable than those of the prior senior creditfacility.  The negative covenants placerestrictions on, among other things, levels of investments, indebtedness,capital expenditures and dividend payments that we may make or incur.  The financial covenants require themaintenance of certain financial ratios at defined levels.  Under the new senior credit facilityagreement, interest rates on the new revolving credit facility can range from1.75% to 2.50% plus LIBOR, or from 0.75% to 1.50% plus a base rate, subject toadjustment and depending on certain financial ratios.  As of April 30, 2004, the term loans were subject to interestrates equal to 2.50% plus LIBOR or 1.50% plus a base rate, as provided in thenew senior credit facility agreement. Unused commitments under the new revolving credit facility are subjectto a 0.5% annual commitment fee. The new senior credit facility is secured bysubstantially all of our properties and assets and substantially all of theproperties and assets of our current and future domestic subsidiaries.

 

In connection with theclosing of the Nu-Gro acquisition, Bank of America, N.A., Canada Branch,separately loaned us Cdn $110.0 million for structuring purposes, which loanwas repaid on April 30, 2004.

 

*97/8% Series BSenior Subordinated Notes.*  In November 1999, we issued $150.0 million in aggregateprincipal amount of 97/8% Series B seniorsubordinated notes due April 1, 2009 (the Series B Notes).  Interest accrued on the Series B Notesat a rate of 97/8% per annum, payable semi-annually onApril 1 and October 1. As described in more detail below, as of March31, 2004, $3.1 million of the Series B Notes were outstanding.  On April 14, 2004, we repurchased all of theoutstanding Series B Notes, along with accrued interest and repurchase premiumof 4.938%, for $3.3 million.

 

*97/8% Series CSenior Subordinated Notes.*  In March 2003, we issued $85.0 million in aggregateprincipal amount of 97/8% Series C seniorsubordinated notes due April 1, 2009 (the Series C Notes).  Interest accrued at a rate of 97/8%per annum, payable semi-annually on April 1 and October 1.  As described in more detail below, as ofMarch 31, 2004, there were no Series C Notes outstanding.

 

*97/8% Series DSenior Subordinated Notes.*  In May 2003, we registered $235.0 million in aggregateprincipal amount of 97/8% Series D seniorsubordinated notes (the Series D Notes and collectively with the Series BNotes and Series C Notes, the senior subordinated notes), with termssubstantially similar to the Series B Notes and Series C Notes, withthe U.S. Securities and Exchange Commission and offered to exchange theSeries D Notes for up to 100% of the Series B Notes and Series CNotes. The exchange offering closed in July 2003, resulting in $85.0 million,or 100%, of the Series C Notes being exchanged and $146.9 million, or98%, of the Series B Notes being exchanged.  As of March 31, 2004, $3.1 million of the Series B Notes and$232.9 million of the Series D Notes were outstanding.

 

Thefair value of the senior subordinated notes was $245.6 million as of March 31,2004, $243.2 million as of March 31, 2003 and $242.1 million as ofDecember 31, 2003, based on their quoted market price on such dates.  In accordance with the indentures thatgovern the senior subordinated notes, they are unconditionally and jointly andseverally guaranteed by our wholly-owned subsidiaries.

 

36

----

 

Our agreementsthat govern the new senior credit facility and the senior subordinated notescontain a number of significant covenants that could restrict or limit ourability to:

 

•                                          incurmore debt;

•                                          paydividends, subject to financial ratios and other conditions;

•                                          makeother distributions;

•                                          issuestock of subsidiaries;

•                                          makeinvestments;

•                                          repurchasestock;

•                                          createsubsidiaries;

•                                          createliens;

•                                          enterinto transactions with affiliates;

•                                          mergeor consolidate; and

•                                          transferand sell assets.

 

The ability tocomply with these provisions may be affected by events beyond our control. Thebreach of any of these covenants will result in a default under the applicabledebt agreement or instrument and could trigger acceleration of repayment underthe applicable agreements. Any default under such agreements might adverselyaffect our growth, financial condition, results of operations and the abilityto make payments on indebtedness or meet other obligations.  As of and during the three months endedMarch 31, 2004 and 2003 and year ended December 31, 2003, we were incompliance with all covenants under the prior senior credit facility and thesenior subordinated notes in effect as of such dates.

 

*Common Stock Transactions.*  In connection with our transaction withBayer in June 2002, we issued 3,072,000 shares of Class A votingcommon stock valued at $15.4 million and 3,072,000 shares of Class Bnonvoting common stock valued at $15.4 million and recorded$0.4 million of related issuance costs. We repurchased these shares in February 2004.  See more detail included under the heading “Recent Events” inthis section.

 

*Repurchase of Preferred Stock.*  In conjunction with our refinancing on April30, 2004, we repurchased all 37,600 shares of outstanding Class A nonvotingpreferred stock for $57.5 million, including all accrued and unpaid dividendsthereon.

 

**ContractualObligations**

 

The followingtable presents the aggregate amount of future cash outflows of our contractualobligations as of March 31, 2004, except as otherwise noted, excluding futureamounts due for interest on outstanding indebtedness:

 
|                                          |   | **Obligations  due in:** |      |
|-----------------------------------------------|--------|--------------------------|-----------|
| **Contractual Obligations**                   |   | **Total**                |      | **Less Than  1 Year** |   | **1 - 3  Years** |   | **4 - 5  Years** |   | **After 5  Years** |   |
|                                          |   |                     |      |   |   |   |   |   |   |   |   |
| Senior credit facility (1)                    |   | $                        | 662,796   |   | $ | 3,209 |   | $ | 12,834 |   | $ | 8,556 |   | $ | 638,197 |   |
| 97/8% Series B senior subordinated notes      |   | 3,100                    |      | — |   | — |   | — |   | 3,100 |   |
| 97/8% Series D senior subordinated notes  (2) |   | 231,900                  |      | — |   | — |   | — |   | 231,900 |   |
| Capital leases                                |   | 7,426                    |      | 6 |   | 4,594 |   | 914 |   | 1,912 |   |
| Operating leases                              |   | 61,257                   |      | 6,516 |   | 22,688 |   | 12,792 |   | 19,261 |   |
| Purchase obligations (3)                      |   | 44,245                   |      | 37,255 |   | 6,990 |   | — |   | — |   |
| Professional services agreement (4)           |   | 4,313                    |      | 563 |   | 2,250 |   | 1,500 |   | — |   |
| Total contractual obligations                 |   | $                        | 1,015,037 |   | $ | 47,549 |   | $ | 49,356 |   | $ | 23,762 |   | $ | 894,370 |   |

 

----

(1)          Representsamounts due under our new senior credit facility dated as of April 30, 2004.

(2)          Excludes$1.0 million of unamortized premium.

(3)          Represents unconditionalpurchase obligations for goods and services not presented elsewhere in thetable.

(4)          Includesmonthly payments of $62,500 for management and other consulting servicesprovided under a professional services agreement by affiliates of Thomas H. LeePartners, L.P., which indirectly owns UIC Holdings, L.L.C., ourmajority owner. The professional services agreement automatically extends forsuccessive one-year periods beginning January 20 of each year, unlessnotice is given as provided in the agreement.

 

37

----

 

We leaseseveral of our operating facilities from Rex Realty, Inc., a company ownedby certain of our stockholders and operated by a former executive and pastmember of our Board of Directors. The operating leases expire at various datesthrough December 31, 2010. We have options to terminate the leases on anannual basis by giving advance notice of at least one year.  We lease a portion of our operatingfacilities from the same company under a sublease agreement expiring onDecember 31, 2005 with minimum annual rentals of $0.7 million. Wehave two five-year options to renew this lease, beginning January 1, 2006.Management believes that the terms of these leases approximate fair value. Rentexpense under these leases was $0.3 million for the three months ended March31, 2004, $0.3 million for the three months ended March 31, 2003 and $1.2million for the year ended December 31, 2003.

 

We areobligated under additional operating leases for other operations and the use ofwarehouse space. The leases expire at various dates through January 31,2015. Five of the leases provide for as many as five options to renew for fiveyears each. Aggregate rent expense under these leases was $1.7 million forthe three months ended March 31, 2004, $1.8 million for the three monthsended March 31, 2003 and $7.2 million for the year ended December 31, 2003.

 

**Guaranteesand Off-Balance Sheet Risk**

 

In the normalcourse of business, we are a party to certain guarantees and financialinstruments with off-balance sheet risk, such as standby letters of credit andindemnifications, which are not reflected in our consolidated balancesheets.  We had $3.2 million as of March31, 2004, $2.2 million as of March 31, 2003 and $2.7 million as of December 31,2003 in standby letters of credit pledged as collateral to support the lease ofour primary distribution facility in St. Louis, a U.S. customs bond, certainproduct purchases, various workers’ compensation obligations and transportationequipment. These agreements mature at various dates through November 2004 andmay be renewed as circumstances warrant. Such financial instruments are valuedbased on the amount of exposure under the instruments and the likelihood ofperformance being required. In our past experience, no claims have been madeagainst these financial instruments nor do we expect any losses to result fromthem. As a result, we determined such agreements do not have significant valueand have not recorded any related amounts in our consolidated financialstatements.

 

We are thelessee under a number of equipment and property leases, as describedpreviously. It is common in such commercial lease transactions for us to agreeto indemnify the lessor for the value of the property or equipment leasedshould it be damaged during the course of our operations. We expect that anylosses that may occur with respect to the leased property would be covered byinsurance, subject to deductible amounts. As a result, we determined suchindemnifications do not have significant value and have not recorded anyrelated amounts in our consolidated financial statements.

 

We haveentered into certain commitments to purchase granular urea during our peakproduction season in 2004. See Note 11 of “Notes to Consolidated FinancialStatements,” included elsewhere in this Quarterly Report for informationregarding these commitments.

 

# ***Certain Trends andUncertainties***

 

***Seasonality andDependence Upon Weather Conditions*.**  Our business is highly seasonal because ourproducts are used primarily in the spring and summer seasons. For the pastthree years, approximately 71% of our net sales have occurred in the first andsecond quarters, resulting in higher net revenues and results of operationsduring those quarters. Our working capital needs, and correspondingly ourborrowings, begin to peak at the beginning of the second quarter. If cash onhand is insufficient to cover payments due on our senior subordinated notes andwe are unable to draw on our senior credit facility or obtain other financing,this seasonality could adversely affect our ability to make interest payments.

 

In addition,weather conditions in North America have a significant impact on the timing ofsales in the spring selling season and our overall annual sales.  Periods of dry, hot weather can decreaseinsecticide sales, while periods of cold, wet weather can slow sales ofherbicides and fertilizers.  Inaddition, an abnormally cold spring throughout North America could adverselyaffect both fertilizer and pesticide sales and therefore our financialresults.  If weather conditions duringthe first and second quarters are not conducive to lawn and gardeningactivities, they may have an adverse effect our consolidated financialposition, results of operations or cash flows. For example, we experienced a late winter and cool, wet springconditions in the first quarter of 2003 that delayed the start of the lawn andgarden season, whereas the weather in the first quarter of 2004 was generallymore mild and dry throughout North America.

 

38

----

 

***Competition andIndustry Trends*.** Each of our segments operates in highly competitive markets and competesagainst a number of national and regional brands. We believe the principalfactors by which we compete are product quality and performance, value, brandstrength and marketing. In some instances, we compete against companies withfewer regulatory burdens, easier access to financing, greater personnelresources, greater brand name recognition or larger research and developmentdepartments. Increasing consolidation in the consumer lawn and garden careindustry may provide additional benefits to certain of our competitors, eitherthrough access to financing, resources or efficiencies of scale.

 

Our principalnational competitors for our Lawn and Garden and Household segments include:The Scotts Company, which markets lawn and garden products under the Scotts®,Ortho®, Roundup®, Miracle-Gro® and Hyponex®brand names; S.C. Johnson & Son, Inc., which marketsinsecticide and repellent products under the Raid® and OFF!®brand names; Central Garden & Pet Company, which markets insecticideand garden products under the AMDRO®, IMAGE® andPennington Seed® brand names; The Clorox Company, which marketsproducts under the Combat® brand name; and Bayer A.G., which marketslawn and garden products under the Bayer AdvancedTM brand name. In our Contractsegment, we compete against a diverse group of companies.

 

With thegrowing trend towards retail trade consolidation, we are increasingly dependentupon key retailers whose bargaining strength is growing. Our top threecustomers, The Home Depot, Lowe’s and Wal*Mart, together accounted forapproximately 70% of our first quarter 2004 net sales and approximately 58% ofour outstanding accounts receivable as of March 31, 2004.  To the extent such concentration continuesto occur, our net sales and operating income may be increasingly sensitive to adeterioration in the financial condition of, or other adverse developmentsinvolving our relationships with, one or more of our retailer customers. Ourbusiness has been, and may continue to be, negatively affected by changes inthe policies and practices of our retailer customers, such as de-stocking andother inventory management initiatives, limitations on access to shelf space,pricing and credit term demands and other conditions. In addition, as a resultof the desire of retailers to more closely manage inventory levels, there is agrowing trend among them to make purchases on a “just-in-time” basis. Thisrequires us to shorten our lead-time for production in certain cases and moreclosely anticipate demand, which could in the future require the carrying ofadditional inventories and increase our working capital and related financingrequirements.

 

***Annual Product LineReviews*.** Each year, we undertake a series of meetings with a number of our retailersto review business activities for the following year.  Discussions at these meetings address details including, but notlimited to, product lines we wish to sell, product lines they intend topurchase, advertising and promotion programs, retail service activities andcustomer satisfaction.  While we striveto present creative and compelling products, plans and promotions in order toexpand our presence at these retailers and increase our share of the markets inwhich we compete, each year we encounter intense competition from ourcompetitors.  If we are unsuccessful inrepeating or increasing our current year product offerings, it could adverselyaffect our consolidated financial position, results of operations or cashflows.

 

As wecompleted all of our annual product line reviews in 2003 for the 2004 season,individual retailers provided  bothpositive and negative indications regarding certain elements of ourprograms.  One large retailer indicatedit would not be selling certain types of our products at its stores due to anarrangement with another vendor. However, the same retailer would add a number of our other SKUs to its2004 offerings, which are expected to result in the recovery of a significantportion of the lost sales but at lower margins.  Conversely, other large retailers indicated their interest inincreasing the number of our products and advertising and merchandising supportfor those products in their 2004 offerings which are anticipated to more thanoffset the lost sales previously described.

 

***Acquisition Strategy*.**  We have completed a number of acquisitionsand strategic transactions since 2001 and intend to grow through theacquisition of additional businesses. In addition to the Nu-Gro acquisitiondescribed in more detail under the heading “Recent Events” in this section, weare regularly engaged in acquisition discussions with a number of other sellersand anticipate that one or more potential acquisition opportunities, includingthose that could be material, may become available in the near future. If andwhen appropriate acquisition opportunities become available, we intend topursue them actively. Further, acquisitions involve a number of special risks,including but not limited to:

 

•                  failure of theacquired business to achieve expected results;

•                  diversion ofmanagement’s attention;

 

39

----

 

•                  failure toretain key personnel or customers of the acquired business;

•                  additionalfinancing that, if available, could increase leverage;

•                  successorliability, including with respect to environmental matters;

•                  the high costand expenses of completing acquisitions and risks associated with unanticipatedevents or liabilities; and

•                  failure tosuccessfully integrate our acquired businesses into our internal controlstructure.

 

These riskscould have a material adverse effect on our business and our consolidatedfinancial position, results of operations and cash flows.

 

We expect toface competition for acquisition candidates, which may limit the number ofopportunities and may lead to higher acquisition prices. We cannot assure youthat we will be able to identify, acquire or manage profitably additionalbusinesses or to integrate successfully any acquired businesses into ourexisting business without substantial costs, delays or other operations orfinancial difficulties. In future acquisitions, we also could incur additionalindebtedness or pay consideration in excess of fair value, which could have amaterial adverse effect on our business and our consolidated financialposition, results of operations and cash flows.

 

***Substantial Indebtedness.***  We have a significant amount of debt. As of March 31, 2004, ourtotal debt, excluding capital lease obligations, was $449.5 million. As ofApril 30, 2004, after giving effect to the refinancing, the Nu-Gro acquisitionand the repurchase of our outstanding preferred stock, including accrued butunpaid dividends thereon, we had unused availability under the revolvingportion of our new senior credit facility of $47.0 million.  Our substantial indebtedness, including anyindebtedness under our new senior credit facility, could have importantconsequences.

 

For example,it could:

 

•                  make it moredifficult for us to satisfy our obligations under outstanding indebtedness andotherwise;

•                  increase ourvulnerability to general adverse economic and industry conditions, includinginterest rate increases because a substantial portion of our borrowings are andwill continue to be at variable rates of interest;

•                  require us todedicate a substantial portion of cash flows from operating activities topayments on obligations under outstanding indebtedness and otherwise, whichwould reduce the cash flows available to fund working capital, capitalexpenditures, advertising, research and development efforts and other generalcorporate expenses;

•                  limit ourflexibility in planning for, or reacting to, changes in our business, theindustry in which we operate and the economy at large;

•                  place us at acompetitive disadvantage compared to our competitors that have proportionatelyless debt; and

•                  limit ourability to borrow additional funds in the future, if needed, on reasonableterms.

 

Our ability tomake payments on and to refinance any future indebtedness and to fund plannedcapital expenditures and acquisitions will depend on our ability to generatecash in the future. This, to some extent, is subject to general economic,weather, financial, competitive, legislative, regulatory and other factors thatare beyond our control.

 

We cannot provide assurancethat our business will generate sufficient cash flow from operating activitiesor that future borrowings will be available to us under our senior creditfacility in amounts sufficient to enable us to pay our indebtedness or to fundour other liquidity needs. We may need to refinance all or a portion of ourindebtedness, on or before existing maturity dates. We cannot assure you thatwe would be able to refinance any of our indebtedness on commerciallyreasonable terms or at all.

 

40

----

 

***Environmental and Regulatory Considerations*****.** Local,state, federal and foreign laws and regulations relating to environmental,health and safety matters affect us in several ways. In the United States, allproducts containing pesticides must be registered with the United StatesEnvironmental Protection Agency, or EPA, and, in many cases, similar stateagencies before they can be manufactured or sold. The inability to obtain, orthe cancellation of, any registration could have an adverse effect on ourbusiness. The severity of the effect would depend on which products wereinvolved, whether another product could be substituted and whether ourcompetitors were similarly affected. We attempt to anticipate regulatorydevelopments and maintain registrations of, and access to, substitutechemicals. We may not always be able to avoid these risks.

 

The Food Quality ProtectionAct establishes a standard for food-use pesticides, which is that a reasonablecertainty of no harm will result from the cumulative effect of pesticideexposures. Under the Act, the EPA is evaluating the cumulative effects fromdietary and non-dietary exposures to pesticides. The pesticides in our productscontinue to be evaluated by the EPA as part of this exposure. It is possiblethat the EPA or a third party active ingredient registrant may decide that apesticide we use in our products will be limited or made unavailable to us. Forexample, in 2000, Dow AgroSciences L.L.C., an active ingredient registrant,voluntarily agreed to a withdrawal of virtually all residential uses ofDursban, an active ingredient we used in our lawn and garden products. This hada material effect on our financial position, results of operations and cashflows in 2001. We cannot predict the outcome or the severity of the effect ofthe EPA’s continuing evaluations of active ingredients used in our products.

 

In addition to theregulations already described, local, state, federal and foreign agenciesregulate the disposal, handling and storage of hazardous substances andhazardous waste, air and water discharges from our facilities and theremediation of contamination. If we do not fully comply with environmentalregulations, or if a release of hazardous substances occurs at or from one ofour facilities, we may be subject to penalties and/or held liable for the costsof remedying the condition.

 

We do not anticipateincurring material capital expenditures for environmental control facilitiesduring 2004. We currently estimate that the costs associated with compliancewith environmental, health and safety regulations could total approximately$0.2 million annually for the next several years. The adequacy of ouranticipated future expenditures is based on our operating in substantialcompliance with applicable environmental and public health laws and regulationsand the assumption that there are not significant conditions of potentialcontamination that are unknown to us. If there is a significant change in thefacts and circumstances surrounding this assumption, or if we are found not tobe in substantial compliance with applicable environmental public health lawsand regulations, it could have a material impact on future environmentalcapital expenditures and other environmental expenses and our consolidatedfinancial position, results of operations or cash flows.

 

As of March31, 2004 and 2003 and December 31, 2003, we believe we were substantially incompliance with applicable environmental and regulatory requirements.

 

***Information SystemsImplementation*.** With the rapid growth we have experienced in the past and expect toexperience in the future, we are aware of the potential that such growth maystrain our ability to manage our business and strain our operational and financialresources and accounting controls. Accordingly, we have invested substantialtime, money and resources in implementing an enterprise resource planning, orERP, system to accommodate and assist in managing such growth. As we believe isthe case in most system changes, the development and implementation of thesesystems will likely necessitate some changes in operating policies andprocedures and the related internal control over financial reporting and theirmethod of application. However, throughout this process, while we haveexperienced some common and customary operational issues expected in any ERPimplementation the size of ours, there have been no significant changes thathave materially adversely affected, or are reasonably likely to materiallyadversely affect, our financial resources and accounting controls. If theimplementation of the ERP system is not successful or does not result in thebenefits we anticipate, it could adversely affect our consolidated financialposition, results of operations or cash flows.

 

***Retail ServicePersonnel*.** In previous years, we have utilized an in-store sales force tofacilitate, among other things, regionally appropriate, real time marketing andpromotional decisions, helping us to maximize store-level sales andprofitability for categories which have a high degree of sensitivity to localweather patterns.  As our largerretailers are moving toward centralized planning, purchasing and inventorymanagement strategies, we have reorganized certain of

 

41

----

 

our activities and in-storepersonnel to create retail service teams to accommodate these industrychanges.  The reorganization did notresult in significant costs to our business and represents a shift to using moreseasonal and temporary employees and outsourced personnel during our peakseason.  Our centralized customerfocused platform teams will continue to facilitate regionally appropriatemarketing and promotional efforts, while at the store-level, our retail serviceteams will focus on executing corporate merchandising strategies along withdirect in-store consumer selling for each retailer.  We believe these changes will enhance our customer service levelsat certain of our retailers as they represent a change to our retail servicemodel.

 

**ITEM 3.****                             QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

**InterestRates and Raw Materials Prices**

 

In the normalcourse of business, we are exposed to fluctuations in interest rates and rawmaterials prices.  During the first halfof each year, the price of granular urea, a critical raw material componentused in the production of fertilizer, tends to increase significantly incorrelation with natural gas prices. The costs of granular urea have generally,but not always, declined during the second half of the year.  We have established policies and proceduresthat govern the management of these exposures through the use of derivativehedging instruments, including swap agreements. Our objective in managing ourexposure to such fluctuations is to decrease the volatility of earnings andcash flows associated with changes in interest rates and certain raw materialsprices. To achieve this objective, we periodically enter into swap agreementswith values that change in the opposite direction of anticipated cash flows.Derivative instruments related to forecasted transactions are considered tohedge future cash flows, and the effective portion of any gains or losses isincluded in accumulated other comprehensive income until earnings are affectedby the variability of cash flows. Any remaining gain or loss is recognizedcurrently in results of operations.

 

We formallydocument, designate and assess the effectiveness of any transactions thatreceive hedge accounting treatment. The cash flows of derivative hedginginstruments we enter into are generally expected to be highly effective inachieving offsetting cash flows attributable to fluctuations in the cash flowsof the hedged risk. Changes in the fair value of agreements designated asderivative hedging instruments are reported as either an asset or liability inthe accompanying consolidated balance sheets with the associated unrealizedgains or losses reflected in accumulated other comprehensive income.  As of March 31, 2004, we had threederivative instruments, with maturity dates through April 2004, designated ashedges against the purchase of granular urea for an aggregate contract valueupon the date of execution of $2.9 million. Such derivative hedging instruments had an unrealized loss of $0.2million as of March 31, 2004 which is included in accumulated othercomprehensive income in the accompanying consolidated balance sheet as of suchdate.  As of March 31, 2003, we had onederivative instrument, with a maturity date in April 2003, designated as ahedge against the purchase of granular urea for a contract value upon the dateof execution of $0.7 million.  Suchderivative hedging instrument had an unrealized gain of $0.4 million as ofMarch 31, 2003 which is included in accumulated other comprehensive income inthe accompanying consolidated balance sheet as of such date.  Although derivative hedging instruments wereused throughout 2003, no such instruments were outstanding as of December 31,2003.  The amounts recorded inaccumulated other comprehensive income are subsequently reclassified into costof goods sold in the same period in which the underlying hedged transactionsaffect earnings.  As such, net gains onderivative hedging instruments for raw materials purchases reclassified intocost of goods sold in the same period in which the underlying hedgedtransactions affected earnings were $0.2 million for the three months endedMarch 31, 2003 and $1.4 million for the year ended December 31, 2003.  No such amounts were reclassified into costsof goods sold during the three months ended March 31, 2004.

 

If it becomesprobable that a forecasted transaction will not occur, any gains or losses inaccumulated other comprehensive income will be recognized in results of operations.We have not incurred any gains or losses for hedge ineffectiveness or due toexcluding a portion of the value from measuring effectiveness. We have notgenerally entered into derivatives or other hedging arrangements for trading orspeculative purposes but may consider doing so in the future if strategiccircumstances warrant, and our bank covenants and bond indentures permit, suchtransactions.

 

 

 

42

----

 

As of March31, 2004, we had five purchase commitments, with expected purchase datesthrough April 2004, for the purchase of granular urea for an aggregate purchaseprice of $2.2 million.  As of March 31,2003, we had one purchase commitment, with an expected purchase date in April2003, for the purchase of granular urea of $0.7 million. As of March 31, 2004,our outstanding derivative hedging instruments and purchase commitmentseffectively fixed 57% of our remaining 2004 urea purchases.  While we expect these derivative hedginginstruments and purchase commitments to manage our exposure to such pricefluctuations, no assurance can be provided that such instruments will beeffective in fully mitigating exposure to these risks, nor can assurance beprovided that we will be successful in passing on pricing increases to ourcustomers.

 

**MarketRisk Sensitive Instruments**

 

As describedfurther under the heading, “Liquidity and Capital Resources,” of Part I, Item2, “Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” much of our debt is variable-rate debt and is subject tofluctuation in interest rates.

 

The followingtable summarizes information about our debt instruments, excluding unamortizedpremium of $1.0 million on fixed rate debt, as of March 31, 2004, that aresensitive to changes in interest rates. The table presents future principalcash flows and related weighted-average interest rates by expected maturitydates, which are based on implied forward rates in the yield curve at March 31,2004 (dollars in thousands):

 
| **Description**       |   | **Remainder  of 2004** |   | **2005** |   | **2006** |   | **2007** |   | **2008** |   | **There-  After** |   | **Total** |   | **Fair  Value** |   |
|-----------------------|--------|------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|-------------------|--------|-----------|--------|-----------------|--------|
|                  |   |                   |   |     |   |     |   |     |   |     |   |              |   |      |   |            |   |
| Long-term debt:       |   |                   |   |     |   |     |   |     |   |     |   |              |   |      |   |            |   |
| Fixed-rate debt       |   | $                      | — |     | $      | —   |   | $        | — |     | $      | —            |   | $         | — |            | $      | 235,000 |   | $ | 235,000 |   | $ | 245,575 |   |
| Average interest rate |   | —                 |   | —   |   | —   |   | —   |   | —   |   | 9.875             | %      | 9.875     | %      |            |   |
| Variable-rate debt    |   | $                      | 61,921 |     | $      | 113,780  |   | $        | 37,794 |     | $      | —            |   | $         | — |            | $      | — |   | $ | 213,495 |   | $ | 213,495 |   |

 

An increase inour weighted average variable borrowing rates of 1% would have resulted in anincrease to annual interest expense of approximately $1.8 million for the threemonths ended March 31, 2004 and $2.3 million for the three months ended March31, 2003.

 

**ExchangeRate Risk**

 

The functionalcurrency for substantially all of our operations is the US dollar.  We are exposed to the impact of foreignexchange rate risk, primarily through the Canadian operations we acquired inour acquisition of Nu-Gro, where the functional currency is the Canadiandollar.  The recent weakening of the USdollar compared to the Canadian dollar positively impacted our purchase priceof Nu-Gro and the net sales and operating income of its subsidiaries since thedate of acquisition.  We are alsosubject to foreign exchange transaction exposure when our Canadian businesspurchases inventory in US dollars.  Wedo not currently enter into foreign exchange forward contracts to mitigateforeign exchange rate risk.

 

##### **Inflation Risk**

 

We manageinflation risks through a continuing review of our product selling prices andproduction costs.  We do not believethat inflation risks are material to our consolidated financial position,results of operations or cash flows.

 

43

----

 

**ITEM4.****                             CONTROLSAND PROCEDURES.**

 

**Evaluationof Disclosure Controls and Procedures**

 

Our chiefexecutive officer and our chief financial officer, after evaluating theeffectiveness of our disclosure controls and procedures (as defined in theSecurities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of theend of the period covered by this report, have concluded that as of such date,our disclosure controls and procedures are effective in bringing to theirattention on a timely basis material information relating to us and ourconsolidated subsidiaries required to be included in our periodic filings underthe Exchange Act.

 

**InternalControl Over Financial Reporting**

 

Since 2001, wehave been in the process of developing an enterprise resource planning, or ERP,system on a company-wide basis. As we believe is the case in most systemchanges, the development and eventual implementation of these systems hasnecessitated some changes in operating policies and procedures and the relatedinternal controls and their method of application. We believe that throughoutthis process, we have maintained internal accounting control systems that areadequate to provide reasonable assurance that assets are safeguarded from lossor unauthorized use, and which produce adequate records for preparation offinancial information.  Accordingly,there were no changes in our internal control over financial reporting thatoccurred during the most recent fiscal quarter that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

44

----

 

#### **PART II. OTHER INFORMATION**

 

**ITEM1.****                             LEGALPROCEEDINGS.**

 

We areinvolved from time to time in routine legal matters and other claims incidentalto the business.  When it appearsprobably in management’s judgment that we will incur monetary damages or othercosts in connection with such claims and proceedings, and such costs can bereasonably estimated, liabilities are recorded in the consolidated financialstatements and charges are recorded against earnings.  We believe that the resolution of such routine matters and otherincidental claims, taking into account established reserves and insurance, willnot have a material adverse impact on our consolidated financial position orresults of operations.

 

**ITEM 6.****                             EXHIBITSAND REPORTS ON FORM 8-K.**

 

a.                                       TheExhibit Index begins on page 47.

 

b.                                      Reportson Form 8-K.

 

On February11, 2004, we furnished a Current Report on Form 8-K under Item 12 to announceour earnings for the quarter and year ended December 31, 2003.

 

On February12, 2004, we furnished a Current Report on Form 8-K under Item 12 to discloseresponses to participant questions on our quarterly conference call to discussearnings for the quarter and year ended December 31, 2003.

 

On March 12,2004, we filed a Current Report on Form 8-K under Item 5 to announce ourexecution of a definitive agreement to acquire The Nu-Gro Corporation and ourplans to refinance our existing senior credit facility with a new senior creditfacility.

 

On April 30,2004, we filed a Current Report on Form 8-K under Item 2 to announce ourclosing of the Nu-Gro acquisition, the closing of the refinancing of our newsenior credit facility and the repurchase of all of our outstanding shares ofClass A nonvoting preferred stock.

 

On May 14,2004, we furnished a Current Report on Form 8-K under Item 12 to announceour earnings for the quarter ended March 31, 2004.

 

45

----

 

**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                 | UNITED  INDUSTRIES CORPORATION |                                                                                                                             |
|----------------------|--------------------------------|----------------------------------------------------------------------------------------------------------------------------------|
|                 | Registrant                     |
|                 |                           |
|                 | By:                            | /s/ Daniel J. Johnston                                                                                                           |   |
|                 |                           | Daniel J.  Johnston                                                                                                              |
|                 |                           | Executive  Vice President, Chief Financial Officer  and Director (Principal Financial Officer and  Principal Accounting Officer) |
| Dated: May  14, 2004 |                           |                                                                                                                             |
|                      |                                |                                                                                                                                  |  |  |

 

46

----

 

**EXHIBITINDEX**

 
| **Exhibit  Number** |   | **Exhibit  Description** |
|---------------------|--------|--------------------------|
|                |   |                     |
| 3.1                 |   |                     | Amended and Restated  Certificate of Incorporation of the Company, dated January 13, 1999.(1) |
| 3.2                 |   |                     | Certificate of Amendment  to the Amended and Restated Certificate of Incorporation of the Company,  dated January 20, 1999.(1) |
| 3.3                 |   |                     | Certificate of Amendment  to the Amended and Restated Certificate of Incorporation of the Company,  dated January 20, 1999.(2) |
| 3.4                 |   |                     | Certificate of Amendment  to the Amended and Restated Certificate of Incorporation of the Company,  dated January 20, 1999.(3) |
| 3.5                 |   |                     | Certificate of Amendment  to the Amended and Restated Certificate of Incorporation of the Company,  dated January 20, 1999.(3) |
| 3.6                 |   |                     | By-laws of the Company.(1) |
| 10.49               |   |                     | Credit  Agreement, dated as of April 30, 2004 among the Company, Bank of America,  N.A., Banc of America Securities LLC, Citigroup Global Markets Inc.,  Citigroup Global Markets Inc., and Other Lenders Party Hereto (as defined  therein).*† |
| 10.50               |   |                     | Trademark License and  Manufacturing and Supply Agreement by and between United Industries  Corporation and Home Depot U.S.A., Inc. effective as of January 1, 2004.*(4) |
| 31.1                |   |                     | Rule 13a-14(a)/Rule  15d-14(a) Certification of Chief Executive Officer.* |
| 31.2                |   |                     | Rule 13a-14(a)/Rule  15d-14(a) Certification of Chief Financial Officer.* |
| 32.1                |   |                     | Section 1350  Certifications (furnished to, but not “filed” with, the U.S. Securities and  Exchange Commission).* |

 

----

(1)          Previouslyfiled as an Exhibit to the Registrant’s Registration Statement on Form S-4 (No.333-76055) filed on April 9, 1999 and incorporated by reference herein.

 

(2)          Previouslyfiled as an Exhibit to the Registrant’s Form 10-K filed on March 30, 2000 andincorporated by reference herein.

 

(3)          Previouslyfiled as an Exhibit to the Registrant’s Form 10-Q filed on November 12, 2002and incorporated by reference herein.

 

(4)          Confidentialtreatment has been requested for portions of this exhibit.

 

*                 Filed orfurnished herewith.

 

†                  The Company agrees to furnish to theCommission a copy of any omitted schedule or exhibit to such agreement uponrequest by the Commission.

 

47

----