**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

| **ý** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|
|       | **For the Fiscal year ended December 31, 2001**                                           |

 

**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 000-23483**

 

**COLOR SPOT NURSERIES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                                       |   | **68-0363266**                       |
|------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)                     |   | (I.R.S. Employer Identification No.) |
|                                                                               |   |                                 |
| **3478 Buskirk Avenue****Pleasant Hill, California**                               |   | **94523**                            |
| (Address of principal executive offices)                                           |   | (Zip Code)                           |
|                                                                               |   |                                 |
| Registrant’s telephone number, including area code:  **(925)  934-4443** |

 

Securities registered pursuantto Section 12(b) of the Act:

 
| **Title of Each Class** |   | **Name of Each Exchange on Which Registered** |
|-------------------------|--------|-----------------------------------------------|
| None                    |   | None                                          |

 

Securities registered pursuantto Section 12(g) of the Act:

 

| **13% Series A Cumulative Preferred Stock and  Warrants to purchase Common Stock** |
|------------------------------------------------------------------------------------|
| (Title of Class)                                                                   |

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports, and (2)has been subject to such filing requirements for the past 90 days. Yes  ý  No  o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.  o

 

The aggregatemarket value of the Registrant’s voting stock held as of March 15, 2002 bynon-affiliates of the Registrant was $19,177. This calculation assumes thatcertain parties may be affiliates of the Registrant and that, therefore,958,865 shares of voting stock are held by non-affiliates. As of March 15,2002, the Registrant had 7,186,008 shares of its common stock outstanding.

 

 

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

None.

 

**FORWARD-LOOKING STATEMENTS**

 

*Certain statementsunder the captions “Items 1 and 2. Business and Properties,” “Item 5. Marketfor the Registrant’s Common Equity and Related Stockholder Matters,” “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and “Item 7A. Quantitative and Qualitative Disclosures About MarketRisk,” and elsewhere throughout this Annual Report on Form 10-K (“AnnualReport”) of Color Spot Nurseries, Inc. which are not historical in nature areforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934.Forward-looking statements deal with the current intentions, beliefs andexpectations of management with respect to the Company’s business and aretypically identified by phrases such as “the Company plans,” “managementbelieves” and other phrases of similar meaning. These statements involve knownand unknown risks and other factors which may cause the Company’s actualresults, levels of activity, performance or achievements to differ, perhapsmaterially, from anticipated results. These risks and uncertainties include,among others:*

 

•              the Company’s substantial leverageand debt service;

 

•              restrictions imposed by debtcovenants;

 

•              the uncertainty of additionalfinancing to fund future operating and capital needs;

 

•              weather and general agriculturalrisks;

 

•              seasonality and the variability ofquarterly results;

 

•              the concentration of sales to keycustomers, such as Home Depot;

 

•              regulatory constraints and changesin laws or regulations concerning the gardening industry;

 

•              labor laws and changes in theminimum wage;

 

•              the short operating history undercurrent management;

 

•              sensitivity to price increases ofraw materials, fuel and utilities;

 

•              the Company’s dependence on leasedfacilities;

 

•              lack of a market for the Company’ssecurities; and

 

•                                          other factors as may be identified from timeto time in the Company’s filings with the Securities and Exchange Commission orin the Company’s press releases.

 

*For a discussion of these factors and others, please see “Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperation — Certain Business Considerations” of this Annual Report. Readers arecautioned not to place undue reliance on forward-looking statements made in, orincorporated by reference into, this Annual Report or other filings with theSecurities and Exchange Commission, any document or statement referring to thisAnnual Report or the Company’s press releases.*

 

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**COLOR SPOT NURSERIES,INC.**

 

**INDEX TO FORM 10-K**

 
| PART I   |           |
|----------|----------------|
|     | Items 1 and 2. | Business and Properties |
|     | Item 3.        | Legal Proceedings |
|     | Item 4.        | Submission of Matters to a Vote of Security  Holders |
|     |           |   |
| PART II  |           |   |
|     | Item 5.        | Market for Registrant’s Common Equity and  Related Stockholder Matters |
|     | Item 6.        | Selected Consolidated Financial Data |
|     | Item 7.        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|     | Item 7A.       | Quantitative and Qualitative Disclosures  About Market Risk. |
|     | Item 8.        | Financial Statements and Supplementary Data |
|     | Item 9.        | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure |
|     |           |   |
| PART III |           |   |
|     | Item 10.       | Directors and Executive Officers of the  Registrant |
|     | Item 11.       | Executive Compensation |
|     | Item 12.       | Security Ownership of Certain Beneficial  Owners and Management |
|     | Item 13.       | Certain Relationships and Related  Transactions |
|     |           |   |
| PART IV  |           |   |
|     | Item 14.       | Exhibits, Financial Statement Schedules and  Reports on Form 8-K |

 

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**COLOR SPOT NURSERIES,INC.**

 

**ANNUAL REPORT ON FORM10–K**

 

**FOR THE FISCAL YEARENDED DECEMBER 31, 2001**

 

**PART I**

 

**Items 1 and 2.   Business and Properties**

 

**Overview**

 

Color SpotNurseries, Inc. (the “Company”) was incorporated under the laws of the State ofDelaware on August 17, 1995, and along with its consolidated subsidiaries, isone of the largest wholesale nurseries in the United States, based on revenueand greenhouse square footage. The Company provides a wide assortment of highquality plants as well as extensive merchandising services primarily to leadinghome centers and mass merchants and to independent garden centers andcommercial landscapers. Currently, the Company distributes products to over 1,400retail and 1,200 commercial customers, representing over 2,000 locations,primarily in the western and southwestern regions of the United States.

 

The Companybelieves it is one of the few wholesale nurseries that has the scale anddistribution capabilities necessary to provide large volumes of high qualityproduct to its retail customers on a multi-regional basis. The Companycurrently produces over 1,000 varieties of live plants, including beddingplants, shrubs, flowering potted plants, ground cover and fresh cut Christmastrees. Through its sales force of approximately three hundred sales andmerchandising personnel, the Company also provides retail customers with abroad array of value-added services, such as in-store merchandising, productdisplay and maintenance, promotional planning and product reordering. TheCompany believes that providing these services differentiates it from itscompetitors and establishes it as a preferred supplier in the industry. TheCompany operates 13 nursery production facilities located in California, Texas,Arizona and Washington, as well as Christmas tree growing fields in Oregon,Michigan, North Carolina and Tennessee.

 

During 2000,the Company elected to change its fiscal year end from June 30th to December31st. Previously, the fiscal year ran from July 1st through June 30th. ThisAnnual Report covers the period from January 1, 2001 through December 31, 2001(“2001”), and is the first fiscal year to correspond with the calendar year. ATransition Report was filed that covered the period from July 1, 2000 throughDecember 31, 2000 (the “Transition Period”). The Company’s business is highly seasonal with the majority of its salesoccurring in the first half of the calendar year. Therefore, the results forthe Transition Period exclude the Company’s peak selling period. Prior to thetwelve months ended December 31, 2001, the most recent results and analysis fora 12 month reporting period, which includes the Company’s peak selling season,is fiscal year 2000, covering the period from July 1, 1999 through June30, 2000.  The Company also temporarilyclosed four production facilities during the Transition Period in order toimprove financial performance and reduce excess capacity.

 

The Companyhad been in default on various financial covenants on its prior loan agreementwith Fleet Capital Corporation and certain other lenders (“Fleet”) at varioustimes since June 30, 2000, as well as out of compliance with debt covenants ofprior credit facilities in previous periods. As a result of the defaults and pending expiration of the prior loanagreement, the Company entered into discussions with Fleet regarding a newcredit facility.  In the second quarterof 2001, Fleet informed the Company that it would use the subordination provisionsin the prior loan agreement to block the Company’s payment of interest due onthe Company’s 10.5% Senior Subordinated Notes (the “Old Notes”). Thus, theCompany also entered into negotiations with holders of a majority of the OldNotes in an attempt to renegotiate the terms of the Old Notes. Thesenegotiations eventually led to a complete restructuring of the Company’sdebt.  All of the restructuringtransactions were consummated on November 20, 2001.  (See Item 7.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations —November 2001 Restructuring of Company Debt.)

 

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The Company issubject to significant risks in its current operations (See Item 7 Management’sDiscussion and Analysis of Financial Condition and Results of Operations).

 

**Industry**

 

Gardening isone of the most popular leisure activities in the United States. According tothe 1998-1999 National Gardening Survey conducted by the Gallup Organization,Inc., 65% of the approximately 103 million U.S. households participated in someform of gardening in 1998. Management****believes that the popularity of gardeningis likely to increase in coming years. According to the National GardeningSurvey, the demographic group that spends the most money per capita ongardening is individuals age 50 and older. This group will be the fastestgrowing demographic group through the year 2010, according to the U.S. Census.

 

In recentyears, the live plant market has demonstrated consistent growth. The live plantretail distribution channel has consolidated significantly over the last 10years, with sales shifting from local independent nurseries to large homecenters and mass merchants, such as Home Depot, Lowe’s, Wal-Mart, Rite Aid,Costco and Target.  Moreover, therelatively low price of most live plants encourages impulse buying by consumersand makes these products relatively resistant to economic downturns. Retailconsolidation has altered the nature of the wholesale demand for live plants.Given the sophistication, size and geographic diversity of the national chains,retail customers prefer suppliers that can meet demanding delivery schedules,fulfill large volume requirements and provide a variety of value-addedservices.

 

Despite thisretail consolidation, the wholesale nursery industry is still highly fragmentedand is characterized by a large number of local independent nurseries.  Management believes that the Company is wellpositioned as a large branded and professionally managed company to consolidatethe wholesale industry.

 

**Business Strategy**

 

The Company’slong-term goals are to continue to enhance its leadership position in thewholesale nursery industry in its established markets and to become the marketshare leader in targeted new regions nationwide. The Company’s businessstrategy is designed to meet the increasing demands of retail customers andconsumers, both of which are critical to its success. The business strategyincludes the following four key elements:

 

*OfferBroad Selection of High Quality Products*

* *

The Companyprovides retail customers and consumers with a broad selection of high qualitylive plants. Through frequent deliveries, careful pre-delivery screening andregular plant maintenance, the Company is able to provide consistently freshand attractive products. The Company’s products include over 1,000 varieties oflive plants, including bedding plants, shrubs, flowering potted plants, groundcover and fresh cut Christmas trees. In addition, the Company continually seeksto develop new products through proprietary retail product lines and creative,easy-to-use packaging. Management believes the Company is one of the fewwholesale nurseries that can consistently provide the large volumes of highquality products desired by home centers, mass merchants and premiumindependent garden centers.

 

*Provide Superior Customer Service*

 

The Companybelieves that its value-added services differentiate it from its competitorsand establish the Company as a preferred supplier to high-volume retailcustomers. The Company services its retail customers through a sales force ofapproximately three hundred sales and merchandising personnel, which managementbelieves is the largest service force in the wholesale nursery industry. TheCompany’s service philosophy encourages its sales merchandisers to functioneffectively as garden center employees, working closely with retail storepersonnel to anticipate changing customer demands and to react to local growingconditions. Services include in-store merchandising, product display, plantmaintenance, promotional planning and product reordering. Due to the perishablenature of its products,

 

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management believes theseservices are critical to maintaining attractive and fresh product displays andretail sales growth.

 

*Capitalize on Large-Scale and Multi-RegionalCapabilities*

 

Managementbelieves that home centers and mass merchants prefer to buy from largewholesale nurseries that are able to consistently deliver high quality productsto a broad geographic area. The Company is one of the largest wholesalenurseries in the United States and one of the few nurseries that has the scaleand distribution capabilities to support home centers and mass merchants on amulti-regional basis. The Company’s production facilities are located indiverse geographic regions to attempt to increase distribution efficiency,better serve customers and minimize the effects of adverse weather conditions.

 

*Continue**toStrengthen Relationships with Large Retail Customers*

 

The Companyhas long-standing relationships with many leading home centers and other massmerchants in the United States. Management believes the Company is the largestsupplier of live plants for Home Depot, Wal-Mart and Rite Aid in the westernUnited States. The Company is involved in its retail customers’ sales andinventory planning processes, allowing it to plan its production capacity moreeffectively to meet its retail customers’ demands. In addition, the Companyworks with a number of its high-volume retail customers to develop proprietaryproducts, new packaging and sales and promotional programs.

 

**Growth Strategy**

 

Contingentupon improvements in its financial performance, the Company’s long-term growthstrategy is to expand its presence in its existing markets and continue toenter new geographic markets.  Animportant aspect of the Company’s growth strategy is to increase itspenetration in targeted markets thereby enabling it to better serve high-volumeretail customers, enhancing its brand name recognition and increasing operatingefficiencies. The Company’s growth strategy includes the following three keyelements:

 

*Existing and New Customer Growth*

 

The Companyplans to increase sales by growing with its existing high-volume retailcustomers and seeking new relationships with other high-volume retailers andpremium independent garden centers. The Company strives to increase the numberof stores it serves for current retail customers both through serving a largerpercentage of its retail customers’ established stores and its retailcustomers’ new stores as those retailers expand.

 

*Acquisitions*

 

Although theCompany temporarily closed four production facilities during the TransitionPeriod in order to improve financial performance and reduce excess capacity,and management does not anticipate any acquisitions during the next 12 months,the Company’s long-term goal may involve pursuing new acquisitions. The Companyseeks acquisitions that will establish a platform in a new geographic area or“fill-ins” of its product lines and production capacities in existing markets.Between October 1996 and September 1997, the Company completed 13 acquisitions,adding 13 production facilities, over 1,800 growing acres of productioncapacity and over 8.4 million square feet of greenhouse space.

 

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*Product Line Expansion*

 

The Companyactively seeks new product opportunities, while simultaneously streamlining existingproduct offerings to focus on high-volume items.  By offering a greater variety of products overall, managementbelieves the Company’s retail customers are able to reduce their number of liveplant suppliers. Since June 30, 1996, the Company has expanded its product lineinto new areas of the wholesale nursery industry, including shrubs, floweringpotted plants and ground cover. In 1997, the Company also entered into thefresh cut Christmas tree business in order to utilize available sales channels andto reduce the impact of seasonality by increasing sales and profitabilityduring the winter months.

 

**Properties and Facilities**

 

The Companycurrently operates 13 production facilities in four states comprisingapproximately 1,900 acres of growing fields and over 11 million square feet ofgreenhouse space. Each production facility consists primarily of growingfields, greenhouses, warehouse space and distribution areas. The Company leasesapproximately 60% of its acreage and approximately 80% of its greenhousespace.  Management believes that most ofits leases can be extended on acceptable terms. The profile of the Company’sproduction facilities is as follows:

 

| **LOCATION**            |   | **OWNED/LEASED** |   | **PRODUCT LINE**        |   |
|-------------------------|--------|------------------|--------|-------------------------|--------|
| WESTERN:                |   |             |   |                    |   |
| Carson, CA              |   | Leased           |   | Bedding Plants          |   |
| Chino, CA               |   | Leased           |   | Shrubs                  |   |
| Fallbrook, CA           |   | Leased           |   | Bedding Plants          |   |
| Lodi, CA                |   | Leased           |   | Bedding Plants / Shrubs |   |
| Richmond, CA            |   | Leased           |   | Bedding Plants          |   |
| Salinas, CA             |   | Leased           |   | Bedding Plants          |   |
| San Juan Capistrano, CA |   | Leased           |   | Shrubs                  |   |
| Phoenix, AZ             |   | Leased           |   | Bedding Plants / Shrubs |   |
| Mt. Vernon, WA          |   | Leased           |   | Bedding Plants          |   |
|                    |   |             |   |                    |   |
| SOUTHWESTERN:           |   |             |   |                    |   |
| Huntsville, TX          |   | Leased           |   | Bedding Plants          |   |
| San Antonio, TX         |   | Owned            |   | Bedding Plants / Shrubs |   |
| Waller, TX              |   | Leased           |   | Bedding Plants          |   |
| Walnut Springs, TX      |   | Owned            |   | Bedding Plants          |   |
|                    |   |             |   |                    |   |
| NON-OPERATIONAL:        |   |             |   |                    |   |
| Watsonville, CA         |   | Leased           |   | Not Applicable          |   |
| Sunol, CA               |   | Leased           |   | Not Applicable          |   |
| Waco, TX                |   | Owned            |   | Not Applicable          |   |

 

During theTransition Period, the Company removed excess production capacity bytemporarily closing four facilities. The inventory at these facilities was soldor transferred to other facilities. Three of the four closed facilities may bereopened if business growth warrants. The Company continues to own one of the closed facilities and continuesto lease two others.  One of thefacilities, the Company no longer leases.

 

As hasoccurred in the past, the Company periodically evaluates its facilities and mayclose or dispose of facilities if it is in the best interests of the Company. 

 

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The followingtable sets forth changes in the number of production facilities in 2001, theTransition Period and the four prior fiscal years:

 
|                                              |   | **Transition  Period Ended** |   | **Fiscal  Year** |   |
|---------------------------------------------------|--------|------------------------------|--------|------------------|--------|
|                                              |   | **2001**                     |   | **12/31/2000**   |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
| Production facilities at beginning of the  period |   | 13                           |   | 17               |   | 17 |   | 19 |   | 13 |   | 6 |   |
|                                              |   |                         |   |             |   |   |   |   |   |   |   |   |   |
| Production facilities acquired/(closed)           |   | 0                            |   | (4               | )      | 0 |   | (2 | ) | 6 |   | 7 |   |
|                                              |   |                         |   |             |   |   |   |   |   |   |   |   |   |
| Production facilities at end of the period        |   | 13                           |   | 13               |   | 17 |   | 17 |   | 19 |   | 13 |   |

 

In addition tothe production facilities for bedding plants and shrubs, the Company alsoleases several growing fields for Christmas trees in Oregon, Michigan, NorthCarolina and Tennessee.

 

**Products**

 

The Company iscommitted to providing its retail customers and consumers with a broadselection of high quality live plant products. The Company’s products includeover 1,000 varieties of plants, including a wide selection of bedding plants,shrubs, flowering potted plants, ground cover and fresh-cut Christmas trees.Most of the Company’s products are sold under the Color Spot brand name andinclude easy-to-read labels containing growing instructions and a color pictureof a mature plant. Products are sold in various containers and sizes, rangingfrom flats and packs containing numerous small plants to single containerscontaining one plant. The Company constantly strives for product innovations,such as new packaging and “premium” potted flowers. In addition, the Company worksclosely with its large retail customers to develop proprietary brandedproducts.

 

The Company’s business ishighly seasonal, with the majority of its sales occurring in the first half ofthe calendar year for most products other than Christmas trees and certainwinter products. 

 

**Customers**

 

During 2001,the Company sold products to over 1,400 retail customers  and 1,200 commercial customers in more than2,000 locations. In order to promote efficiency and improve profitability, theCompany will continue to reduce low-volume purchasers from its customer base.The Company sells a majority of its products to large national retailers andhas long-standing relationships with many of these retail customers. The retailcustomer base includes home centers, mass merchants, drug stores, premiumindependent nursery chains and, to a lesser extent, grocery stores. Sales tonational retail chains have increased significantly as these retail customerscontinue to gain market share. 

 

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The followingtable sets forth a selected list of customers for each major category of retailcustomers:

 
| **Home  Centers**       |   | **Mass Merchants** |   | **Drug & Grocery Chains** |   | **Independent Nurseries** |   |
|-------------------------|--------|--------------------|--------|-------------------------------|--------|---------------------------|--------|
| Home Depot              |   | Wal-Mart           |   | Albertson’s              |   | Cornelius  Nurseries      |   |
| Lowe’s             |   | K-Mart             |   | H.E.B.                        |   | Star Nursery              |   |
| Orchard Supply Hardware |   |               |   | Rite-Aid  Drug Stores         |   |                      |   |
|                    |   |               |   | Safeway                       |   |                      |   |
|                    |   |               |   | Longs Drug Stores             |   |                      |   |

 

Managementbelieves that the Company’s ability to consistently provide high qualityproducts and value-added services on a multi-regional basis providessignificant competitive advantages in serving the retail channel. The Company’sproducts typically account for over half of the bedding plant sales in storesit supplies. In each region, the Company’s goal is to serve every storeoperated by each of its retail customers. During 2001, the top eight retailcustomers accounted for approximately 84% of net sales and sales to Home Depotrepresented approximately 45% of net sales. During the Transition Period (which does not include the peak sellingperiod), the top eight customers accounted for approximately 77% of net salesand sales to Home Depot represented approximately 41% of net sales.

 

The Company****alsoserves commercial customers, such as landscapers, golf courses, office parksand hotels. Approximately 3.3% of 2001 net sales and less than 1% of net salesfor the Transition Period were derived from sales to commercial customers.

 

K-MartCorporation announced on January 22, 2002 that it filed voluntary petitions forreorganization under Chapter 11 of the U.S. Bankruptcy Code, in order toaggressively address the financial and operational challenges impacting itsperformance. In its filing, K-Mart indicated that it plans to reorganize on afast-track basis and has targeted emergence from Chapter 11 in 2003.  During fiscal year 2001, sales to K-Martaccounted for approximately nine percent of the Company’s total net sales.  On January 22, 2002, the Company’spre-petition accounts receivable from K-Mart totaled $0.7 million (for which a100% reserve has been provided), which represented  the lowest exposure level of the year and therefore allowed theCompany to proceed into its peak revenue season without significant disruption oreconomic exposure.  Product shipments toK-Mart resumed in February 2002, after having been suspended in January2002.  The Company also received awaiver from Fleet allowing up to a maximum of $3.0 million of post-petitionaccounts receivable from K-Mart to be allowed in the computation of itsborrowing base.

 

**Sales and Services**

 

The Company****offersa broad range of value-added services to help its retail customers maximizelive plant sales and profitability. Management believes that a well-maintainedproduct display increases sales volume and encourages impulse buying by retailconsumers. The average shelf life for a majority of the products is two tothree weeks following delivery. Live plant products, like fresh produce in asupermarket, are unlikely to sell if they are not fresh and merchandisedcorrectly. Due to the perishable nature of the Company’s products, managementbelieves that services provided to retail customers are critical to maintainingattractive and fresh product displays. The Company****services its retailcustomers through a sales force of approximately three hundred sales andmerchandising personnel. Each sales representative generally covers eight toten stores**,**although sales representatives covering large volume stores may be assigned asfew as one to three locations. Sales merchandisers typically providemerchandising services to each of their stores four to seven times per week,which may include:

 

**•**              design and layout of the gardenshop area;

 

**•**              design and construction of displaytables and end caps;

 

**•**              creation of point-of-purchasesigns;

 

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**•**              implementation of Color Spotpromotional and marketing programs;

 

**•**              maintenance of clean and freshproduct displays;

 

**•**              reordering and restockingmerchandise;

 

**•**              maintenance of prominent floorspace; and

 

**•**              assisting consumers with productand planting information.

 

Managementbelieves that its sales merchandisers can provide many of these services moreeffectively than retail customers because sales merchandisers focus exclusivelyon live plants. Furthermore, the Company’s sales merchandisers receive ongoingtraining and are compensated on a commission basis as a percentage of netsales. Retail consumers often rely on the Company’s employees to answerquestions and give advice about selecting and planting live plants.

 

In addition toproviding merchandising services at the store level, the Company plays animportant role in assisting retail customers with their sales and inventoryplanning. Typically, the Company’s senior sales executives will meetperiodically with the retail customer’s senior representative to plan sales ofthe Company’s products based on that retail customer’s anticipated store growthand general product needs. In addition, the Company’s sales executives meetfrequently with regional and corporate buyers to more specifically planseasonal product needs and sales forecasts and to incorporate its promotionalevents and pricing strategies into their plans. At the store level, theCompany’s local sales and merchandising personnel work with in-store personnelto execute sales plans and continually monitor sales and inventory.

 

**Competition**

 

The wholesalenursery industry is highly competitive. Competition is based principally onproduct quality, breadth of product offerings, customer service and price.****Managementbelieves the Company has differentiated itself from its competitors through thebreadth of its product offerings, multi-regional capabilities and thevalue-added services it provides to its retail customers. The wholesale nurseryindustry is highly fragmented with over 10,000 small and regional nurseriesnationwide. Historically, the 10 largest wholesale nurseries in the UnitedStates have accounted for slightly less than one-tenth of total wholesaleproduction. The Company competes directly with a large number of western andsouthwestern producers. On a multi-regional basis, the Company also competeswith Hines Nurseries, primarily in bedding plants and shrubs, and with MonroviaNursery Company, primarily in shrubs. The fresh cut Christmas tree market isalso highly fragmented and, on a regional basis, the Company competes in thismarket with Holiday Tree Farms and The Kirk Company.

 

**Employees**

 

As of March 1,2002**,**theCompany****had1,684 full-time employees. During the peak growing season, which runs fromFebruary through June, the Company employs a substantial number of seasonalemployees. Total employment generally will peak at over 3,500 employees in May.All of the Company’s seasonal employees are paid on an hourly basis. None ofthe employees are covered by a collective bargaining agreement. Management****believesits relationship with its employees is good.

 

**Government Regulation**

 

The Company issubject to federal, state and local health and safety laws and regulations regardingthe production, storage and transportation of certain of its products and thedisposal of its waste. Certain of the Company’s operations and activities, suchas water runoff from its production facilities and the use of certainpesticides are subject to regulation by the EPA and similar state and localagencies. These agencies may regulate or prohibit the use of such

 

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products, procedures oroperations, thereby affecting its operations and profitability. In addition,the Company must comply with a broad range of environmental laws andregulations. More stringent health, safety and environmental laws andregulations may be enacted in the future and such changes could have a materialadverse effect on the Company.

 

The Companyuses reclamation water as one of the sources of water supply for a few of itsproduction facilities. The use and pricing of reclamation water, includingavailability of subsidized water rates, is governed by federal reclamation lawsand regulations. Changes in the law could have a material adverse effect on theCompany.

 

**Trademarks and Trade Names**

 

The Company isthe registered owner of the COLOR SPOT® trademark in the United States. Amajority of its products are sold under the trademark. The Company is also theregistered owner of various other trademarks that are used by certainfacilities.

 

**Item3.   Legal Proceedings**

 

In May 2001,Campbell Tree & Land, Co. (“Campbell”) filed an action against the Company,entitled Campbell Tree & Land v. Color Spot Nurseries, Inc., Color SpotChristmas Trees, Inc., Case number 01-C-0555, in the U.S. District Court forthe Eastern District of Wisconsin. The dispute underlying this litigation arosefrom the sale of tree inventory by Campbell to the Company during the fall of2000, while the parties were negotiating a Purchase and Marketing Agreement.The Purchase and Marketing Agreement was never finalized or executed becausethe parties never agreed upon the terms, although the Company paid over $1million to Campbell for the inventory. Campbell is claiming that because thePurchase and Marketing Agreement was never finalized, higher prices applied tothe inventory and the Company owes Campbell an additional $985,000. Althoughthe Company has had settlement discussions with Campbell representatives, theCompany now intends to vigorously defend its position. However, the Companycannot reasonably predict the outcome of the case nor estimate the financialloss that may result from any unfavorable outcome. The Company believes,however, that an unfavorable outcome of this matter could have amaterial adverse effect on the Company’s financial position, results ofoperations or cash flows.

 

The Company isfrom time to time subject to various other legal proceedings incidental to itsbusiness. Management believes that the ultimate resolution of other currentproceedings will not have a material adverse effect on its financial positionor results of operations, taken as a whole.  

 

**Item 4.  Submission of Matters to a Vote of Security Holders**

 

By writtenconsent, the common stockholders and holders of Series A Cumulative PreferredStock (“Series A Preferred Stock”) approved the Amendment to the Certificate ofDesignation for the Series A Preferred Stock, as reported in the Company’sQuarterly Report on Form 10-Q for the quarter ended September 29, 2001.

 

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**PARTII**

 

**Item 5.  Market for Registrant’s Common Equity and Related Stockholder Matters.**

 

**Common Stock**

 

There is noestablished trading market for the Company’s common stock**. **At March 15, 2002, the number of holders of record of thecommon stock was 47.

 

The Companyhas not declared or paid dividends on its common stock during 2001,  the Transition Period or the last two fiscalyears. The Company does not anticipate paying dividends on its common stock inthe foreseeable future. The Company’s credit facilities and corollaryagreements prohibit the payment of cash dividends on common stock without thelender’s consent. Any future credit facilities are also likely to prohibit thepayment of dividends. Future declaration or payment of dividends, if any, willbe at the discretion of management and the Board of Directors and will dependon the Company’s financial condition at the time of consideration, results ofoperations, capital requirements and other factors deemed relevant bymanagement and the Board of Directors. (See Item 7.  Management’sDiscussion and Analysis of Financial Condition and Results of Operation —Liquidity and Capital Resources and — Certain Business Considerations.)

 

On December31, 2001, The Company issued an additional 237,410 shares of its common stock,of which, 52,440 shares were issued as a result of the exercise of certainstock options and 184,970 were issued to existing holders of the Company’sSeries A Preferred Stock as an inducement to amend certain provisions of theSeries A Preferred Stock.  (See Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations — November 2001 Restructuringof Company Debt.)  Also, as part of theinducement, 1,016,681 shares of common stock were transferred to the holders ofthe Series A Preferred Stock from existing common stock holders.

 

**Warrants**

 

In December1997, the Company issued 825,000 warrants to purchase common stock at $.01 pershare, subject to certain adjustments. As of March 15, 2002, none of thewarrants have been exercised. The warrants are exercisable prior to December15, 2008. In the absence of an exercise, the warrants will automatically bedeemed to have been exercised on December 15, 2008 on a cash-less basis.Although the shares reserved for issuance upon the exercise of the warrantswere registered under the Securities Act of 1933, as amended, there is noestablished trading market for the warrants.

 

**Preferred Stock**

 

In December1997, the Company****issued 40,000 shares of Series A Preferred Stock. Althoughthe issuance of Series A Preferred Stock was registered under the SecuritiesAct of 1933, there is no established trading market for the Series A PreferredStock. Through December 2005, 13% dividends on the Series A Preferred Stockhave been and are expected to be paid in additional shares of Series APreferred Stock. Thereafter, dividends are to be paid in cash. In addition, theCompany’s credit facilities and corollary agreements associated with the 10 1⁄2%Senior Subordinated Notes due 2007 and the Series A Preferred Stock andwarrants****restrictthe payment of cash dividends on the Series A Preferred Stock (other than forpayment of dividends associated with fractional shares). Future declaration orpayment of dividends, if any, will be at the discretion of management and theBoard of Directors and will depend on the Company’s current financial conditionat the time of consideration, results of operations, capital requirements andother factors deemed relevant by management and the Board of Directors.  (See Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operation — Liquidity andCapital Resources and — Certain Business Considerations.)

 

In November2001, the Company****issued 634,450 shares of Series B Preferred Stock and 57,328shares of B-1 Preferred Stock.  There isno established trading market for the Series B or B-1 Preferred Stock. ThroughJune 2003,

 

9

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13% dividends on the Series BPreferred Stock and 12% dividends on the Series B-1 Preferred Stock have beenand are expected to be paid in additional shares of Series B or B-1 PreferredStock. Thereafter, dividends are to be paid in cash.  In addition, the Company’s credit facilities and other agreementsrestrict the payment of cash dividends on the Series B and B-1 Preferred Stock(other than for payment of dividends associated with fractional shares).  Future declaration or payment of dividends,if any, will be at the discretion of management and the Board of Directors andwill depend on the Company’s current financial condition at the time ofconsideration, results of operations, capital requirements and other factorsdeemed relevant by management and the Board of Directors.  (See Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operation — Liquidity andCapital Resources and — Certain Business Considerations.)

 

**Recent Sales of Unregistered Securities**

 

During  2001, the Company issued stock options topurchase 340,000 shares of common stock under the 1997 Stock Option Plan, withexercise prices ranging from $3.00 to $0.02 per share.  The options were issued in reliance upon theexemption from registration provided by Section 4(2) of the Securities Act of1933.

 

On November20, 2001, the Company exchanged its $100 million principal amount of itsexisting 10 1⁄2% Senior Subordinated Notes plus accrued interest subsequent toJune 16, 2001 for 634,450 shares of Series B Preferred Stock and $52.9 millionprincipal amount of new 13% Senior Subordinated Notes.  Simultaneously, the Company exchanged itsapproximately $10.4 million 8% Subordinated Convertible Note for 57,328 sharesof Series B-1 Preferred Stock and approximately $4.7 million principal amountof a new 8% Subordinated Convertible Note. (See Item 7. Management’s Discussion and Analysis of Financial Conditionand Results of Operations — November 2001 Restructuring of Company Debt.)  The new 13% Senior Subordinated Notes andthe new 8% Subordinated Convertible Notes were issued in reliance upon theexemption from registration provided by Section 4(2) of the Securities Act of1933.

 

**Item  6.   Selected Consolidated Financial Data.**

 

The financialinformation presented below as of December 31, 2001 and 2000, and June 30,2000, 1999, 1998, and 1997, as well as for the twelve months ended December 31,2001, the six months ended December 31, 2000, and the fiscal years ended June30, 2000, 1999, 1998, and 1997, is derived from the audited financialstatements, some appearing elsewhere in this Form 10-K. The financialinformation as of December 31, 1999, for the twelve month period ended December31, 2000 and the six month period ended December 31, 1999 is unaudited.

 

 

10

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|                                                                                                                   |   | **Year  Ended** |    | **12 Months   Ended** |   | **Six Months Ended** |   | **Fiscal Year Ended** |    |
|------------------------------------------------------------------------------------------------------------------------|--------|-----------------|---------|-----------------------|--------|----------------------|--------|-----------------------|---------|
| **Color  Spot Nurseries, Inc.**                                                                                        |   | **12/31/01**    |    | **12/31/00**          |   | **12/31/00**         |   | **12/31/99**          |    | **6/30/00** |   | **6/30/99** |   | **6/30/98(2)** |   | **6/30/97  (1)** |   |
|                                                                                                                   |   |            |    | **(unaudited)**       |   |                 |   | **(unaudited)**       |    |   |   |   |   |   |   |   |   |
| **Statement of Operations Data:**                                                                                      |   |            |    |                  |   |                 |   |                  |    |   |   |   |   |   |   |   |   |
| Net sales                                                                                                              |   | $               | 191,225 |                  | $      | 209,584              |   | $                     | 74,482  |   | $ | 75,785 |   | $ | 210,887 |   | $ | 206,076 |   | $ | 187,731 |   | $ | 113,400 |   |
| Gross profit                                                                                                           |   | 76,437          |    | 73,286                |   | 21,748               |   | 28,458                |    | 79,996 |   | 88,283 |   | 51,517 |   | 49,374 |   |
| Sales, marketing and delivery expenses                                                                                 |   | 45,952          |    | 51,656                |   | 20,578               |   | 19,284                |    | 50,362 |   | 46,252 |   | 50,033 |   | 31,168 |   |
| General and administrative expenses                                                                                    |   | 22,131          |    | 18,273                |   | 9,615                |   | 12,182                |    | 20,840 |   | 25,610 |   | 13,338 |   | 7,300 |   |
| Amortization of intangible assets                                                                                      |   | 1,471           |    | 1,637                 |   | 779                  |   | 861                   |    | 1,719 |   | 1,727 |   | 2,308 |   | 990 |   |
| Restructuring costs and other                                                                                          |   | 3,328           |    | —                |   | —               |   | —                |    | — |   | — |   | 2,400 |   | — |   |
| Income (loss) from operations                                                                                          |   | 3,555           |    | 1,720                 |   | (9,224               | )      | (3,869                | )       | 7,075 |   | 14,694 |   | (16,562 | ) | 9,916 |   |
| Interest expense                                                                                                       |   | 14,866          |    | 16,846                |   | 8,542                |   | 7,658                 |    | 15,962 |   | 16,464 |   | 13,405 |   | 4,179 |   |
| Other expense (income), net                                                                                            |   | 246             |    | (1,092                | )      | 265                  |   | 97                    |    | (1,260 | ) | 355 |   | (285 | ) | (148 | ) |
| Income tax provision (benefit)                                                                                         |   | 12,993          |    | (2,133                | )      | (5,934               | )      | (4,592                | )       | (791 | ) | (727 | ) | (10,514 | ) | 2,830 |   |
| Income before extraordinary gain (loss)                                                                                |   | (24,550         | )       | (11,901               | )      | (12,097              | )      | (7,032                | )       | (6,836 | ) | (1,398 | ) | (19,168 | ) | 3,055 |   |
| Cumulative effect of change in accounting principle                                                                    |   | —          |    | —                |   | —               |   | —                |    | — |   | (1,718 | ) | — |   | — |   |
| Extraordinary loss                                                                                                     |   | —          |    | —                |   | —               |   | —                |    | — |   | (1,018 | ) | (2,792 | ) | (215 | ) |
| Net income (loss)                                                                                                      |   | $               | (24,550 | )                     | $      | (11,901              | )      | $                     | (12,097 | ) | $ | (7,032 | ) | $ | (6,836 | ) | $ | (4,134 | ) | $ | (21,960 | ) | $ | 2,840 |   |
| Per share amounts(3)                                                                                                   |   |            |    |                  |   |                 |   |                  |    |   |   |   |   |   |   |   |   |
| Income (loss) before cumulative effect of change in accounting  principles and extraordinary loss — basic         |   | $               | (5.01   | )                     | $      | (2.92                | )      | $                     | (2.36   | ) | $ | (1.57 | ) | $ | (2.13 | ) | $ | (1.22 | ) | $ | (3.25 | ) | $ | 0.49 |   |
| Income (loss) before cumulative effect of change in accounting principles  and extraordinary loss — basic diluted |   | $               | (5.01   | )                     | $      | (2.92                | )      | $                     | (2.36   | ) | $ | (1.57 | ) | $ | (2.13 | ) | $ | (1.22 | ) | $ | (3.25 | ) | $ | 0.45 |   |
| Dividends per share                                                                                                    |   | —          |    | —                |   | —               |   | —                |    | — |   | — |   | — |   | $ | 0.22 |   |
| **Operating Data:**                                                                                                    |   |            |    |                  |   |                 |   |                  |    |   |   |   |   |   |   |   |   |
| EBITDA(4)                                                                                                              |   | $               | 15,656  |                  | $      | 9,454                |   | $                     | (5,413  | ) | $ | 31 |   | $ | 14,898 |   | $ | 21,899 |   | $ | (10,585 | ) | $ | 13,357 |   |
| Cash flows from operating activities                                                                                   |   | 2,375           |    | 1,111                 |   | (16,271              | )      | (9,411                | )       | 7,971 |   | 15,216 |   | (25,865 | ) | (4,093 | ) |
| Cash flows from investing activities                                                                                   |   | (4,711          | )       | (6,520                | )      | (3,032               | )      | (661                  | )       | (4,149 | ) | (2,176 | ) | (54,047 | ) | (58,234 | ) |
| Cash flows from financing activities                                                                                   |   | 3,936           |    | 5,685                 |   | 18,415               |   | 9,250                 |    | (3,480 | ) | (13,864 | ) | 79,394 |   | 64,388 |   |
| Depreciation and amortization                                                                                          |   | 8,767           |    | 7,734                 |   | 3,811                |   | 3,900                 |    | 7,823 |   | 7,205 |   | 5,977 |   | 3,441 |   |
| Capital expenditures                                                                                                   |   | 5,142           |    | 8,460                 |   | 3,032                |   | 661                   |    | 6,089 |   | 2,176 |   | 13,508 |   | 6,181 |   |
| Ratio of earnings to fixed charges(5)                                                                                  |   | —          |    | —                |   | —               |   | —                |    | — |   | — |   | — |   | 2.10 |   |
| Number of production facilities(6)                                                                                     |   | 13              |    | 13                    |   | 13                   |   | 17                    |    | 17 |   | 17 |   | 19 |   | 13 |   |
| **Balance Sheet Data (end of period):**                                                                                |   |            |    |                  |   |                 |   |                  |    |   |   |   |   |   |   |   |   |
| Working capital(7)                                                                                                     |   | $               | 2,023   |                  | $      | (15,744              | )      | $                     | (15,744 | ) | $ | 21,354 |   | $ | 16,289 |   | $ | 20,184 |   | $ | 26,809 |   | $ | 14,161 |   |
| Total assets                                                                                                           |   | 168,182         |    | 194,703               |   | 194,703              |   | 194,872               |    | 185,789 |   | 181,754 |   | 210,350 |   | 133,417 |   |
| Long-term debt, excluding current portion                                                                              |   | 80,246          |    | 110,768               |   | 110,768              |   | 132,408               |    | 124,690 |   | 123,413 |   | 135,044 |   | 83,408 |   |
| Stockholders' equity (deficit)                                                                                         |   | $               | (84,027 | )                     | $      | (49,236              | )      | $                     | (49,236 | ) | $ | (29,250 | ) | $ | (32,984 | ) | $ | (18,489 | ) | $ | (7,491 | ) | $ | 4,075 |   |

 

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(1)                                 Includesthe financial results of NAB Nursery and B&C Growers from October 1996,Sunrise Growers from November 1996, Sunnyside Plants from January 1997, LoneStar Growers Co. from February 1997, Signature Trees from March 1997 and Hi–CNursery from April 1997.

(2)                                 Includesthe financial results of Plants, Inc., Peters’ Wholesale Greenhouses, Inc. andWolfe Greenhouses, LLC from July 1997, Cracon, Inc. and Summersun GreenhouseCo. from August 1997 and Oda Nursery, Inc. from September 1997.

(3)                                 Pershare amounts exclude extraordinary loss which would decrease the basic dilutedshare amounts by $0.15, $0.40 and $0.03 for the fiscal years ended June 30,1999, 1998 and 1997, respectively.

(4)                                 EBITDArepresents income before interest expense, depreciation and amortizationexpense, the provision for income taxes, other (income) expense, restructuringcosts, changes in accounting principles and extraordinary items. While EBITDAis not intended to represent cash flow from operations as defined by GAAP andshould not be considered as an indicator of operating performance or analternative to cash flow (as measured by GAAP) as a measure of liquidity, it isincluded herein to provide additional information with respect to the abilityof the Company to meet its future debt service, capital expenditure and workingcapital requirements. Other companies may define EBITDA differently, and as aresult, those measures may not be comparable to its EBITDA. (See Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations.)  EBITDA for the fiscal yearended June 30, 1998 includes $2,400,000 of non-recurring charges.

(5)                                 Forpurposes of computing a ratio of earnings to fixed charges, “earnings” consistof income (loss) before provision for income taxes plus fixed charges. “Fixed charges”consist of interest on all indebtedness, amortization of deferred debtfinancing costs and one-third of rental expenses (the portion deemedrepresentative of the interest factor). Earnings were insufficient to coverfixed charges by $11,557, $14,034, $18,031, $11,624, $7,627, $2,125 and $29,682for the year ended

 

11

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December 31, 2001 and 2000, the six months ended December 31, 2000 and1999 and the years ended June 30, 2000, 1999 and 1998, respectively.

(6)                                 Facilitiesinclude owned and leased properties as of the end of each period, excludingChristmas tree fields.

(7)                                 Dueto certain provisions within the Company’s revolving credit facility, theoutstanding balance on its revolving loan was classified as current at December31, 2001 and 2000, whereas it was classified as long-term in earlier periods.

 

**Item  7.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

The following discussion of the results of operations and financialcondition of the Company should be read in conjunction with the ConsolidatedFinancial Statements and the Notes included elsewhere in this Annual Report onForm 10-K. This Annual Report on Form 10-K contains forward-looking statements.Discussions containing such forward-looking statements may be found in thematerial set forth below and under Items 1 and 2. “Business and Properties,” aswell as in this Annual Report on Form 10-K generally. Prospective investors arecautioned that any such forward-looking statements are not guarantees of futureperformance and involve risks and uncertainties. Actual events or results maydiffer materially from those discussed in the forward-looking statements as aresult of various factors, including, without limitation the risk factors setforth in this Item 7 under the heading “Certain Business Considerations.”

 

**Overview**

 

The Company isone of the largest wholesale nurseries in the United States, based on revenueand greenhouse square footage. The Company sells a wideassortment of high quality bedding plants, shrubs, flowering potted plants,ground cover and Christmas trees and provides extensive merchandising servicesprimarily to leading home centers and mass merchants.

 

Beginning in1998, and from time-to-time thereafter, the Company has experienced financialdifficulties.  As a result, in severalperiods, the Company violated its debt covenants and has taken certain chargesrelating to restructuring its operations, debt and equity. During this periodthere has been significant management turnover.  In November 2001, the Company substantially restructured its debt(see Notes 9, 11 and 12).  Terms of thenew debt and equity arrangements are restrictive and include numerous financialand non-financial covenants.  TheCompany is highly leveraged, has significant debt service obligations,including maturity of its line of credit on September 15, 2003, and has otherbusiness risks which, because of its leverage position, may be difficult tomanage.  Key business risks include, butare not limited to, customer concentration, reliance on key vendors, weatherand general agricultural risks, governmental regulations, sensitivity to labor,utility or raw material price increases, competition, litigation and dependenceon leased facilities.

 

Theaccompanying financial statements were prepared contemplating the realizationof all recorded assets and the satisfaction of liabilities in the normal courseof business.  Ultimately,  the Company must generate sufficient cash flowto meet its obligations as they come due, comply with the terms of its debt andequity facilities, including meeting its financial covenants, and ultimatelyattain profitability and achieve other business objectives or there will be amaterial adverse impact on its business, financial position and results ofoperations.  No assurance can beprovided that the Company will be able to attain profitability or achieve itsbusiness objectives or that assets will be realizable at their carrying values.

 

During 2000,management elected to change the Company’s fiscal year end from June 30th toDecember 31st. Previously, the fiscal year ran from July 1st through June 30th. A Transition Report was filed that covered the TransitionPeriod from July 1, 2000 to December 31, 2000. Beginning with 2001, the fiscalyear corresponds with the calendar year. The Company’sbusiness is highly seasonal with the majority of its sales occurring in thefirst half of the calendar year and operating losses historically occurring inthe third and fourth calendar quarters. Therefore, theresults for the Transition Period excluded the peak selling period for amajority of the Company’s products. Prior to 2001, themost recent audited results for a 12-month reporting period, which include thepeak season, are fiscal year 2000 (covering the period from July 1, 1999through June 30, 2000).

 

Although theCompany has attempted to reduce the effects of seasonality with sales that arecounter-seasonal to 

 

12

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its historic products with theacquisition of Christmas tree operations, sales remain highly seasonal. The percent of sales from the Christmas trees business, washigh during the Transition Period due to the exclusion of the Company’s peakseason from the Transition Period. The percentage distribution of net sales in2001, the Transition Period and the last two fiscal years by product categorywas as follows:

 
|                     |   |     |   | **Transition  Period  Ended  December 31, 2000** |     | **Fiscal  Year  Ended June 30,** |     |
|--------------------------|--------|----------|--------|--------------------------------------------------|----------|----------------------------------|----------|
|                     |   | **2001** |   |                                             | **2000** |                             | **1999** |   |
| Bedding  Plants          |   | 71       | %      | 54                                               | %        | 66                               | %        | 63 | % |
| Flowering  Potted Plants |   | 1        | %      | 5                                                | %        | 8                                | %        | 9 | % |
| Shrubs                   |   | 18       | %      | 13                                               | %        | 16                               | %        | 16 | % |
| Ground Cover             |   | 4        | %      | 1                                                | %        | 2                                | %        | 4 | % |
| Christmas  Trees         |   | 6        | %      | 27                                               | %        | 8                                | %        | 8 | % |
|                     |   | 100      | %      | 100                                              | %        | 100                              | %        | 100 | % |

 

In fiscal1999, the Company attempted to improve operating results and strengthen itsfinancial position by implementing a more conservative sales and productionplan and adjusting its production process to better match customer demand. As a result of these efforts, and favorable weather patterns,fiscal 1999 sales increased to $206.1 million and operating income improved by$31.3 million over the prior year, to $16.5 million.

 

In fiscal2000, sales increased to $210.9 million and the  Company generated income from operations of $7.1 million. However,operating income decreased by $7.6 million compared to fiscal 1999. Performanceduring the year was impacted by a combination of under-performing facilities,inefficiencies driven by changes in the level and mix of the production planand cost structure expansions related to further decentralization. Theinefficiencies were evident in materials and labor impacting gross margins andthe impact of further decentralization resulted in duplicative costs inselling, general and administrative functions. The decentralization of certainfunctions led to inexperienced decision making and untimely adjustments to theproduction plan that ultimately resulted in overproduction. As a result, excessproduct was sold at discounted sales prices or written off during the fourthquarter of fiscal 2000 that resulted in decreased margins and a decrease inworking capital of $3.9 million from the prior fiscal year. Gross profitdeclined to approximately 38% of net sales for the fiscal year ended June 30,2000, down from approximately 43% of net sales during the prior fiscal year.

 

The Companytemporarily closed four production facilities during the Transition Period inorder to improve financial performance and reduce excess capacity.   During the Transition Period, sales decreasedslightly and operating income declined compared to the comparable six months inthe prior year due to a combination of factors, including poor weatherconditions, costs of closing certain facilities, higher fuel costs and lossesresulting from the use of a contaminated growth retardant chemical.

 

In 2001, salesdeclined to $191.2 million and the Company generated income from operations of$3.6 million (including $3.3 million of restructuring costs).  Gross profit improved to 40.0% from 35.0%for the twelve months ended December 31, 2000 and from 37.9% for the twelvemonths ended June 30, 2000 and sales, marketing and delivery expenses declinedto $46.0 million.  In 2001, the Companyimproved operating profits (before restructuring costs) through reducing salesto low volume customers and to customers in less profitable outlying marketsand through cost containment activities.

 

The Company’sdesignation as an agricultural company provides favorable tax treatment sinceagricultural companies are generally permitted to calculate taxable income on acash basis. While the financial statements include taxexpense in certain years, the Company has historically not paid incometaxes.  The Company has generatedsignificant net operating losses since its inception and accumulate a large netoperating loss carry-forward. At December 31, 2001 theCompany has available federal and state net operating loss carryforwards ofapproximately $95.0 million and $39.1

 

13

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million, respectively. Thefederal net operating loss carryforwards expire beginning on June 30, 2011 andthe state net operating loss carryforwards expire beginning on June 30, 2001and are substantially expired by June 30, 2003.  These net operating losses may be substantially limited in use inany given year, subject to Section 382 of the Internal Revenue Code of 1986, asamended (“IRS Code”), as a result of an ownership change. In addition,significant taxable income must be generated in order to realize these recordedbenefits.  The Company provided avaluation allowance against the state and federal net deferred tax asset infiscal 2000 and 2001 as a result of uncertainties relating to the realizabilityof the related assets.

 

**Critical Accounting Policies**

 

In response tothe Securities and Exchange Commission’s Release No. 33-8040, “CautionaryAdvice Regarding Disclosure About Critical Accounting Policies,” the Companyidentified the most critical accounting principles upon which its financialstatus depends.  The Company determinedthe critical principles by considering accounting policies that involve themost complex or subjective decisions or assessments.  The most critical accounting policies were determined to be thoserelated to revenue recognition, bad debt reserves, inventory valuation andreserves, valuation allowances on deferred taxes, self-insurance reserves andimpairment of fixed assets and goodwill. We state these accounting policies in the notes to the consolidatedfinancial statements and at relevant sections in this discussion and analysis.

 

The Company’sdiscussion and analysis of its financial condition and results of operationsare based upon the Company’s consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires theCompany to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent liabilities. On an on-going basis, the Company evaluates itsestimates, including those related   toproduct returns, customer rebates, bad debts, inventory reserves,self-insurance reserves and contingencies. The Company bases its estimates on historical experience and forecastsas well as on various other assumptions that are believed to be reasonableunder the circumstances. Actual results may differ from these estimates underdifferent assumptions or conditions. The Company records estimated reductionsto revenue for customer volume-based incentives which may occasionally vary ona percentage basis depending upon certain volume levels. If market conditionswere to change such that actual sales were significantly different than forecastedsales, actual amounts due may differ significantly from estimated amounts, TheCompany records estimates of expected product returns based upon historicalexperience as well as an on-going review of current market conditions.  The Company maintains allowances fordoubtful accounts for estimated losses resulting from the inability of itscustomers to make required payments. The Company bases its estimates uponon-going review of the financial condition of it customers as well as upon theage of its receivables.  If thefinancial condition of the Company’s customers were to deteriorate, resultingin an impairment of their ability to make payments, additional allowances maybe required. The Company records reserves against its inventory for itsestimated unmarketable inventory. Amounts are estimated based upon the relationship of end of periodinventory levels to projected future sales over the next 13 weeks. If actualmarket conditions are less favorable than those projected by management,additional inventory reserves may be required. The Company records a valuationallowance to reduce its deferred tax assets to the amount that is more likelythan not to be realized. The Company has considered past performance as well asfuture taxable income in assessing the need for the valuation allowance. In theevent the Company were to determine that it would be able to realize itsdeferred tax assets in the future in excess of its net recorded amount, anadjustment to the deferred tax asset would increase income in the period suchdetermination was made. The Company records a reserve for its self-insurancepolicies in an amount equal to the expected ultimate costs less stop-lossrepayment of all claims incurred and expected to be incurred during the period.  The actual claims experience may differsignificantly from such estimates.  TheCompany carries significant balances in its financial statements for fixedassets and goodwill.  The Company iscurrently evaluating the impact of recent accounting pronouncements upon thecarrying value of assets.  At this time,the Company cannot reasonably estimate the impact on their consolidatedfinancial statements of such pronouncements; however, the effect may bematerial.  See Note 2 to Notes toConsolidated Financial Statements - "Recent AccountingPronouncements."

 

Thisdiscussion and analysis should be read in conjunction with our consolidatedfinancial statements and related notes included elsewhere in this Annual Reporton Form 10-K.

 

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**Results of Operations**

 

The followingtable sets forth for the periods indicated certain consolidated incomestatement items as a percentage of net sales:

 
|                                                                                                       |   | **Year Ended  December 31,** |   | **Six Months  Ended  December 31,** |    | **Fiscal Year  Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|-------------------------------------|---------|----------------------------------|--------|
|                                                                                                       |   | **2001**                     |   | **2000**                            |    | **2000**                         |   | **1999** |   | **2000** |   | **1999** |   |
|                                                                                                       |   |                         |   | **(unaudited)**                     |    |                             |   | **(unaudited)** |   |   |   |   |   |
| Net sales                                                                                                  |   | 100.0                        | %      | 100.0                               | %       | 100.0                            | %      | 100.0 | % | 100.0 | % | 100.0 | % |
| Cost of sales                                                                                              |   | 60.0                         |   | 65.0                                |    | 70.8                             |   | 62.4 |   | 62.1 |   | 57.2 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Gross profit                                                                                               |   | 40.0                         |   | 35.0                                |    | 29.2                             |   | 37.6 |   | 37.9 |   | 42.8 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Sales, marketing and delivery expenses                                                                     |   | 24.0                         |   | 24.6                                |    | 27.6                             |   | 25.4 |   | 23.9 |   | 22.5 |   |
| General and administrative expenses                                                                        |   | 11.6                         |   | 8.7                                 |    | 12.9                             |   | 16.1 |   | 9.9 |   | 12.4 |   |
| Amortization of intangible assets                                                                          |   | 0.8                          |   | 0.8                                 |    | 1.0                              |   | 1.1 |   | 0.8 |   | 0.8 |   |
| Restructuring costs                                                                                        |   | 1.7                          |   | 0.0                                 |    | 0.0                              |   | 0.0 |   | 0.0 |   | 0.0 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Income (loss) from operations                                                                              |   | 1.9                          |   | 0.8                                 |    | (12.4                            | )      | (5.1 | ) | 3.3 |   | 7.1 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Interest expense                                                                                           |   | 7.8                          |   | 8.0                                 |    | 11.5                             |   | 10.1 |   | 7.6 |   | 8.0 |   |
| Other expense (income), net                                                                                |   | 0.1                          |   | (0.5                                | )  | 0.4                              |   | 0.1 |   | (0.6 | ) | 0.1 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Loss before income taxes, cumulativeeffect of change in accounting  principle  and extraordinary loss |   | (6.0                         | )      | (6.7                                | )       | (24.2                            | )      | (15.3 | ) | (3.7 | ) | (1.0 | ) |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Income tax benefit (provision)                                                                             |   | (6.8                         | )      | 1.0                                 |    | 8.0                              |   | 6.1 |   | 0.4 |   | 0.3 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Loss before cumulative effect ofchange in accounting principle and extraordinary loss                      |   | (12.8                        | )      | (5.7                                | )       | (16.2                            | )      | (9.3 | ) | (3.3 | ) | (0.7 | ) |
| Cumulative effect of change inaccounting principle                                                         |   | 0.0                          |   | 0.0                                 |    | 0.0                              |   | 0.0 |   | 0.0 |   | 0.8 |   |
| Extraordinary loss                                                                                         |   | 0.0                          |   | 0.0                                 |    | 0.0                              |   | 0.0 |   | 0.0 |   | 0.5 |   |
|                                                                                                       |   |                         |   |                                |    |                             |   |   |   |   |   |   |   |
| Net loss                                                                                                   |   | (12.8                        | )%     | (5.7                                | )%      | (16.2                            | )%     | (9.3 | )% | (3.3 | )% | (2.0 | )% |

 

The Companychanged its fiscal year end from June 30 to December 31, effective December 31,2000. The Company’s audited financial statements cover the six months endedDecember 31, 2000, and the year ended June 30, 2000.  Financial information for the year ended December 31, 2000, isunaudited and is presented for comparative purposes only.

 

YEAR ENDED DECEMBER 31, 2001(“2001”) AS COMPARED TO TWELVE MONTHS ENDED DECEMBER 31, 2000 (“PRIOR TWELVEMONTH PERIOD”)

 

NET SALES. Net sales decreased $18.4 million, or 8.8%, to $191.2 millionduring 2001 from $209.6 million  in thePrior Twelve Month Period. This decrease was primarily due to the Company’s strategicobjective to reduce sales  to low volumecustomers and to customers in less profitable outlying markets.  Sales were also impacted by the Company’sdecision to temporarily close four production facilities during the PriorTwelve Month Period in order to improve financial performance and reduce excesscapacity.  In addition, mature storesales for the Company’s larger accounts 

 

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declined in 2001 compared tothe Prior Twelve Month Period reflecting the general economic slowdown in itsretail markets.  Lastly, the Companyalso exited its floral business during the Prior Twelve Month Period to focusits efforts upon its core products.

 

GROSS PROFIT. Gross profit increased $3.2 million to $76.4 million during2001 from $73.3 million in the Prior Twelve Month Period and gross profit as apercentage of net sales increased to 40.0% during 2001 from 35.0% in the PriorTwelve Month Period. The increase in gross profit wasprimarily the result of improved pricing strategies, tighter costs controls andreduced excess production partially offset by higher utility costs.

 

OPERATINGEXPENSES. Sales, marketing and delivery expenses decreased$5.7 million to $46.0 million during 2001 from $51.7 million during the PriorTwelve Month Period.  Asa percentage of net sales, sales, marketing and delivery expenses decreased0.6% to 24.0% during 2001 from 24.6% during the Prior Twelve Month Period.General and Administrative expenses increased $3.9 million, or 21.1%, to $22.1million during 2001 from $18.3 million during the Prior Twelve Month Period.  This increase isprimarily the result of a large reversal of management bonuses recorded duringthe Prior Twelve Month Period which were accrued during the prior calendar yearas well as higher bad debt expense in 2001 due to the K-Mart bankruptcy filingand higher costs for consultants and outside professionals in 2001.  Amortization ofintangible assets decreased slightly during 2001 as certain assets became fullyamortized.

 

INTERESTEXPENSE. Interest expense decreased $1.9 million to $14.9million during 2001 from $16.8 million during the Prior Twelve Month Period dueto lower interest rates and the partial year impact of the Company’s debtrestructuring partially offset by higher average levels of borrowing prior tothe restructuring.

 

OTHER INCOMEAND EXPENSE. Other income and expense was a net expense of$0.2 million in 2001 due primarily to a loss recognized on the disposal ofcertain assets and was a net gain of $1.1 million in the Prior Twelve MonthPeriod due primarily to a gain recognized on the disposal of certain assets.

 

TAXES.  The Company provided avaluation allowance against the net federal deferred tax asset of $10.6 millionin 2001 as a result of uncertainties relating to the realizability of therelated assets.  At December 31, 2001the Company has available federal and state net operating loss carryforwards ofapproximately $95.0 million and $39.1 million, respectively. The federal netoperating loss carryforwards expire beginning on June 30, 2011 and the statenet operating loss carryforwards begin to expire on June 30, 2001 and will besubstantially expired by June 30, 2003. These net operating losses may be significantly limited in use in anygiven year, subject to IRS Code Section 382 as a result of an ownershipchange.  In addition, significanttaxable income must be generated in order to realize these recordedbenefits.  **The**effectivetax benefit or provision has increased to a provision of 112.4% in 2001compared to a benefit of 15.2% in the Prior Twelve Month Period as a result ofa valuation allowance recorded against all federal net deferred tax assetsduring the fourth quarter of 2001.  Asof December 31, 2001, all of the Company’s net deferred tax assets are fullyreserved for.  The effective tax benefitdecreased to 15.2% in the Prior Twelve Month Period, primarily as a result of a$2.0 million valuation allowance recorded against the California deferred taxasset related to state net operating loss carry-forwards as a result of theuncertainty of its realization.

 

SIX MONTHS ENDED DECEMBER 31,2000 (“TRANSITION PERIOD”) AS COMPARED TO THE SIX MONTHS ENDED DECEMBER 31,1999 (“PRIOR SIX MONTH PERIOD”)

 

NET SALES. Net sales decreased $1.3 million, or 1.7%, to $74.5 millionduring the Transition Period from $75.8 million in the Prior Six Month Period. This decrease was primarily the result of lower sales in theCompany’s Southwest division due to poor weather conditions, crop losses due toa contaminated growth retardant chemical and lower sales in the facilities thatwere closed during the Transition Period, partially offset by higher sales inthe Company’s Christmas Tree division.

 

GROSS PROFIT. Gross profit decreased $6.7 million to $21.7 million duringthe Transition Period from $28.5 million in the Prior Six Month Period. Gross profit as a percentage of net sales decreased to 29.2%during the Transition Period from 37.6% in the Prior Six Month Period. The decrease in gross profit was primarily due to TransitionPeriod 

 

16

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activities related to closedfacilities, including decreased sales, closeout sale discounts and write-offsof unsaleable product. In addition, the impact ofdecreased sales in the Company’s Southwest division and the impact of decreasedsales and crop losses throughout the Company as a result of a contaminatedgrowth retardant chemical led to lower gross profit.

 

OPERATINGEXPENSES. Sales, marketing and delivery expenses increased$1.3 million to $20.6 million during the Transition Period from $19.3 millionin the Prior Six Month Period. As a percentage of netsales, sales, marketing and delivery expenses increased to 27.6% from 25.4% inthe Prior Six Month Period. This increase as a percentageof net sales was primarily due to higher distribution costs resulting fromgreater product movement required during winding down activities at thefacilities that were closed during the Transition Period, logisticalinefficiencies resulting from efforts to sell excess product carried over fromfiscal year 2000 and higher fuel costs. General andAdministrative expenses decreased $2.6 million, or 21.1%, to $9.6 million duringthe Transition Period from $12.2 million in the Prior Six Month Period. As a percent of net sales, general and administrative expensesdecreased to 12.9% during the Transition Period from 16.1% in the Prior SixMonth Period. This decrease is primarily the result of management’s electionnot to pay bonuses to employees during the Transition Period. Amortizationof intangible assets decreased slightly during the Transition Period as certainassets became fully amortized.

 

INTERESTEXPENSE. Interest expense increased $0.9 million to $8.5million during the Transition Period from $7.7 million in the Prior Six MonthPeriod due to higher average levels of borrowing throughout the TransitionPeriod.

 

OTHER INCOMEAND EXPENSE. Other expenses increased by $0.2 million to$0.3 million primarily due to losses recognized on the disposal of certainassets during the Transition Period.

 

TAXES. **The effective** tax benefit decreased to 32.9% in theTransition Period from a provision rate of 39.5% in the Prior Six Month Periodprimarily as a result of a valuation allowance recorded against state netoperating losses beginning at the end of fiscal 2000. Thestate net operating loss carryforwards expire beginning on June 30, 2001. Although the Company has not provided a valuation allowanceagainst the federal net operating loss carryforwards, the realizability of therelated assets is periodically evaluated. The federal net operating losscarryforwards expire beginning on June 30, 2011.

 

FISCAL YEAR ENDED JUNE 30, 2000(“FISCAL 2000”) AS COMPARED TO FISCAL YEAR ENDED JUNE 30, 1999 (“FISCAL1999”)

 

NET SALES. Net sales increased $4.8 million, or 2.3%, to $210.9 millionin fiscal 2000 from $206.1 million in fiscal 1999. This increase was primarilythe result of increased sales to the top eight customers, offset by fewer salesto low volume customers.

 

GROSS PROFIT. Gross profit decreased $8.3 million to $80.0 million in fiscal2000 from $88.3 million in fiscal 1999. Gross profit as a percentage of netsales decreased to 37.9% in fiscal 2000 from 42.8% in fiscal 1999. The decreasein gross profit percentage was the result of a combination of under-performingfacilities, over-production, labor and material inefficiencies driven bychanges in the level and mix of the production plan and cost structureexpansions related to further decentralization. The inefficiencies were evidentin materials and labor. The decentralization of certain functions led toinexperienced decision making and untimely adjustments to the production planthat ultimately resulted in overproduction. As a result, excess product wassold at discounted sales prices during the fourth quarter of fiscal 2000 thatresulted in decreased margins. The inefficiencies resulted in a decline ingross margin to approximately 40% for fiscal year 2000, down from 45%during  fiscal 1999. The timing of theavailability of the products did not match customer demand, causing increasedwrite-offs of excess inventory.

 

OPERATINGEXPENSES. Sales, marketing and delivery expenses increased$4.1 million to $50.4 million in fiscal 2000 from $46.3 million in fiscal 1999. As a percentage of net sales, sales, marketing and deliveryexpenses increased to 23.9% in fiscal 2000 from 22.5% in fiscal 1999. Thisincrease as a percentage of net sales was primarily due 

 

17

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to additional fieldmerchandisers, poor distribution management and higher fuel costs. General andadministrative expenses decreased $4.8 million, or 1.9%, to $20.8 million infiscal 2000 from $25.6 million in fiscal 1999. As a percentage of net sales,general and administrative expenses decreased to 9.9% in fiscal 2000 from 12.4%in fiscal 1999. This decrease is primarily the result of no bonuses accruedunder the employee bonus plan due to bonus targets were not achieved, lessemployee severance and relocation and a decrease in other consulting costswhich were incurred in fiscal 1999 associated with the new management team’songoing review of operations. Amortization of intangible assets was unchangedat $1.7 million in fiscal 2000 and 1999.

 

INTERESTEXPENSE. Interest expense decreased $0.5 million to $16.0million in fiscal 2000 from $16.5 million in fiscal 1999 due to lower averagelevels of borrowing during most of fiscal 2000.

 

OTHER INCOMEAND EXPENSE: Other income and expense increased $1.6 million to $1.3 million,primarily due to a gain on the sale of property owned at one facility duringfiscal year 2000.

 

TAXES. **The**effective tax benefit decreased to 10.4% infiscal 2000 from a provision rate of 34.2% in fiscal 1999, primarily as aresult of a $2.0 million valuation allowance recorded against the deferred taxasset related to state net operating loss carry-forwards as a result of theuncertainty of their realization.

 

**Liquidity and Capital Resources**

 

The Company’soperating activities provided cash of $2.4 million during 2001 compared to $1.1million,  $8.0 million and $15.2 duringthe Prior Twelve Month Period,  fiscal2000 and 1999, respectively.  Thereduction from fiscal 1999 to fiscal 2000 is primarily attributable to loweroperating performance.  The reductionfrom fiscal 2000 to 2001 is primarily attributable to the significant reductionof accounts payable and certain accrued liabilities during 2000 partiallyoffset by improved operating performance (before restructuring costs).  The increase in 2001 over the Prior TwelveMonth Period is due to improved operating performance.  The significant amount of cash used inoperations of $16.3 million and $9.4 million reflected in the six monthTransition Period and the Prior Six Month Period, respectively, is due to thesignificant seasonality of the business as winter sales are low and productionactivities are high in preparation for spring. The increased use of cash duringthe Transition Period compared to the Prior Six Month Period is primarily aresult of larger operating losses due to a combination of factors, includingpoor weather conditions, costs of closing certain facilities, higher fuel costsand losses resulting from the use of a contaminated growth retardant chemical. The Company invested $5.1 million, $3.0 million, $0.7 million,$6.1 million and $2.2 million in capital expenditures during 2001, theTransition Period, the Prior Six Month Period, and in fiscal 2000 and fiscal1999, respectively. Significant investments were made inthe Company’s computer systems during the Transition Period and fiscal 2000 toimprove its ability to plan for and monitor its production activities and trackperformance. The Company also continues to invest in thenecessary production equipment and facility infrastructure repairs andimprovements as well as required capital projects to meet environmentalrequirements.

 

The Companyfunds its operations primarily from cash provided by operating activities, ifany, and through borrowings under its revolving credit facility (see theAmended Loan Agreement below).  Theavailability of a revolving credit facility is critical to the Company’sability to continue as a going concern. As further described below, the Company’s Amended Loan Agreement hasvarious covenants that the company must attain and the lender has the abilityto stop advancing funds to the Company in the event of a material adversechange.  Company’s management currentlybelieves that it will be in compliance with the various covenants under theAmended Loan Agreement during 2002, although no assurance can be given to thiseffect.  The Amended Loan Agreementexpires on September 15, 2003.   Ifmaturity of the Amended Loan Agreement is not extended by September 15, 2003,or a replacement facility is not obtained, the Company will not be able tocontinue in its present form if at all.

 

Although therecan be no assurance that this will be the case, the Company believes that fundsavailable through the Amended Loan Agreement (as defined below) combined withfunds provided by operating activities will be adequate to fund the Company’soperations, capital requirements and debt service requirements for at least thenext twelve months.

 

18

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**November2001 Restructuring of Company Debt**

 

The Companyhad been in default on various financial covenants on its prior loan agreementwith Fleet at various times since June 30, 2000.  The Company had been in default on previous loan agreements andhad obtained waivers of default in certain periods.  The Company also was not in compliance with its financialcovenants as of September 29, 2001, however, it received a waiver of thisviolation in connection with the restructuring.  As a result of the defaults and pending expiration of the priorloan agreement, the Company entered into discussions with Fleet regarding a newcredit facility.  In the second quarterof 2001, Fleet informed the Company that it would use the subordinationprovisions in the prior loan agreement to block the Company’s payment ofinterest due on the Company’s 10.5% Senior Subordinated Notes (the “OldNotes”). Thus, the Company also entered into negotiations with holders of amajority of the Old Notes to renegotiate the terms of the Old Notes. Thesenegotiations eventually led to a complete restructuring of the Company’s debt,which included the prior loan agreement with Fleet, a new $12 million note fromCatalyst Equity Fund L.P., the Old Notes and the 8% Subordinate ConvertibleNote issued to Heller Equity Capital Corporation.  Each of these transactions was consummated on November 20,2001.  (See Note 9 — Notes to ConsolidatedFinancial Statements — for a detailed description of the restructuring.)

 

As a result ofaggregate restructuring, the Company was able to significantly reduce its debtlevels as well as significantly lower its future interest payments in the nearterm, which will eventually be replaced by dividend payments. The total costsassociated with the restructuring were $7.9 million of which the Companyexpensed $3.3 million, capitalized $3.2 million as loan fees and recorded $1.4million as a reduction to its carrying value of new preferred stock.

 

**Termsof the Amended Loan Agreement**

 

As part of therestructuring on November 20, 2001, the Company amended its prior loanagreement with Fleet (“Amended Loan Agreement”).  The Amended Loan Agreement, which expires on September 15, 2003,provides the Company with up to $55.0 million of credit and is subject tocertain borrowing base limitations based on a percentage of eligible inventoryand eligible accounts receivable. The Amended Loan Agreement includes aseasonal advance provision that allows the Company to borrow additional fundsabove the borrowing base limitations during the seven-month period beginning onOctober 1st and ending on April 30th. The Company isentitled to seasonal advances of up to $10 million from October 1, 2001 throughApril 30, 2002, and up to $8 million from October 1, 2002 through April 30,2003. These seasonal maximums are subject to decrease, depending on the valueof the Company’s real estate, machinery and equipment.  The Amended Loan Agreement also includes a$5.0 million letter of credit facility, but the total amount available underthe Amended Loan Agreement will be reduced by the face amount of anyoutstanding letters of credit.  AtDecember 31, 2001, the Company had borrowed $35.8 million under the AmendedLoan Agreement and had $2.8 million remaining credit availability.

 

Borrowingsunder the Amended Loan Agreement bear interest, at the Company’s option, at theprime rate plus 1.0% or the London interbank offer rate (“LIBOR”) plus 3.0%.Seasonal advances under the Amended Loan Agreement bear interest, at the Company’soption, at prime rate plus 1.5% or LIBOR plus 3.5%.

 

The AmendedLoan Agreement contains various covenants, including, without limitation,covenants prohibiting or limiting the Company’s ability to incur additionalindebtedness, grant liens, make guarantees, enter into mergers or acquisitions,make capital expenditures and pay dividends and other distributions. TheAmended Loan Agreement also contains financial covenants and informationreporting requirements, as well as a provision that allows the lenders torefuse to advance funds if there has been a material adverse change in theCompany’s business.  (See Note 9 — Notesto Consolidated Financial Statements.)

 

**Certain Business Considerations**

 

The followingare some of the factors that could affect the Company’s future results. Theyshould be considered in connection with evaluating forward-looking statementscontained in this Annual Report on Form 10-K and otherwise made by the Companyor on its behalf, because these factors could cause actual results andconditions to differ materially 

 

19

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from those projected inforward-looking statements.

 

*Substantial Leverage and Debt Service*

* *

The Company ishighly leveraged and may incur additional indebtedness in the future, subjectto certain limitations contained in the instruments governing its indebtednessand capital stock. Accordingly, the Company will continueto have significant debt service obligations. TheCompany’s debt service obligations will have important consequences to holdersof its debt and equity securities, including the following:

 

•                  a substantialportion of the Company’s cash flow from operations will be dedicated to thepayment of principal and interest on its indebtedness, thereby reducing thefunds available to the Company for operations, acquisitions, future businessopportunities and other purposes and increasing its vulnerability to adversegeneral economic and industry conditions;

 

•                  the Company’sleveraged position may increase its vulnerability to competitive pressures;

 

•                  the financialcovenants and other restrictions contained in the Amended Loan Agreement, theIndenture and the Certificate of Designation for the Series A and B and B-1Preferred Stock will require the Company to meet certain financial tests andwill restrict its ability to borrow additional funds, to dispose of assets orto pay cash dividends on, or repurchase, preferred or common stock; and

 

•                  funds availablefor working capital, capital expenditures, acquisitions and general corporatepurposes may be substantially limited or non-existent.

 

The Company’sability to make scheduled principal and interest payments or to refinance itsindebtedness to pay dividends and make redemption payments on its preferredstock and to pay dividends on the common stock depends on future performance,which to a certain extent is subject to economic, financial, competitive andother factors beyond its control in addition to normal business risks.

 

*Future Capital Needs; Uncertainty of Financingor Additional Financing*

 

There can beno assurance that borrowings under the Amended Loan Agreement and funds fromoperations will be sufficient to meet the Company’s anticipated workingcapital, capital expenditure and acquisition financing requirements or that amaterial adverse change will not occur which would allow the lenders to refuseto advance funds to the Company. The Company may need to raise additional funds through theissuance of public or private debt or equity securities in order to takeadvantage of unanticipated opportunities, including acquisitions ofcomplementary businesses, or otherwise respond to unanticipated competitivepressures or a material adverse change.  There can be no assurance that additional financing willbe available on terms favorable to the Company, or at all.

 

*Restrictions Imposed by Amended LoanAgreement and Effect of Default*

 

The AmendedLoan Agreement restricts, among other things, the Company’s ability to incuradditional indebtedness, incur liens, pay or declare dividends, enter into anytransaction not in the usual course of business, guarantee or otherwise becomein any way liable with respect to the obligations of another party or entity,merge or consolidate with another person or sell or transfer any collateral(except for the sale of inventory in the ordinary course of its business). A breach of any of these covenants could result in a defaultunder the Amended Loan Agreement. Upon the occurrence of an Event of Default(as defined in the Amended Loan Agreement), the lenders could elect to declareall amounts outstanding under the Amended Loan Agreement, together with accruedinterest, to be immediately due and payable. If the Company were unable to paythose amounts, the lenders could proceed against the collateral granted to themto secure that indebtedness. If the Amended Loan Agreement indebtedness were tobe accelerated, there can be no assurance that its assets would be sufficientto repay the indebtedness in full and other indebtedness. Substantially all of 

 

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the Company’s assets have beenpledged as security under the Amended Loan Agreement. The restrictionsdescribed above, in combination with the Company’s leveraged nature, may limitits ability to obtain financing in the future or may otherwise restrictcorporate activities. In addition, it may also limitassets available to other debt and equity holders and trade creditors.

 

*Encumbrances on Assets to Secure the AmendedLoan Agreement*

* *

The Company’sobligations under the Amended Loan Agreement are secured by substantially allof its assets. If the Company becomes insolvent or isliquidated, or if payment under the Amended Loan Agreement is accelerated, thelenders under the Amended Loan Agreement will be entitled to exercise theremedies available to a secured lender under applicable law.  Consequently, assets available toother debt and equity holders and trade creditors may be limited.

 

*Dependence**onAcquisitions for Future Growth*

* *

Contingentupon improvement in its financial performance, the Company intends to pursuethe acquisition of other companies. (See Items 1 and 2. Business andProperties—“Growth Strategy.”) Acquisitions involve a number of risks,including effects on the reported operating results, the diversion ofmanagement’s attention, the dependence on hiring, training and retaining keypersonnel and risks associated with unanticipated problems or legalliabilities, some or all of which could have a material adverse effect on the Company.Historically, the Company has financed acquisitions by incurring additionaldebt and the issuance of stock. (See above “Substantial Leverage and Debt Service.”) The Companycompleted one acquisition in fiscal 1996, seven acquisitions in fiscal 1997 andsix acquisitions in fiscal 1998. Management anticipatesthat one or more potential acquisition opportunities, including those thatwould be material, may become available in the near future.However, any acquisition would require the approval of the Company’slenders.  No assurance can begiven that an acquisition by the Company will occur, or, if an acquisition doesoccur, that it will not have a material adverse effect on the Company, that anysuch acquisition will be successful in enhancing the Company’s business or thatany such acquisition can be successfully integrated into the Company’s business.  (See above, — FutureCapital Needs; Uncertainty of Additional Financing.)

 

*Weather; General Agricultural Risks*

* *

Inclementweather or production difficulties occurring at a time of peak production orsales (in the first half of the calendar year), particularly on weekends duringthe peak gardening season, could cause declines in net sales and operatingincome that could have a material adverse effect on the Company. Inthe event of severe weather conditions, the Company does not have sufficientfacilities to preserve and protect all of its products. Duringfiscal 1998, the severe weather phenomenon known as “El Nino” materially andadversely impacted the demand for the Company’s products.   If a similar weather phenomenon shouldoccur in future years, it could have a significant material adverse effect onthe Company’s operations.  Managementintends to expand into new markets that typically have greater weathervariability than its historic markets. The Company’s failure to adequatelymanage this variability could have a material adverse effect on the Company. The Company’s operations may also be materially affected bydisease, pests or other natural hazards.  Agricultural production is highlydependent upon the availability of water. The loss ofaccess to water at any of the facilities would have a material adverse effecton the Company. Given the perishable nature of theCompany’s products, if sales do not materialize as expected, the Company couldexperience a significant decline in profitability.

 

*Seasonality**;Variability of Quarterly Results and Certain Charges*

* *

The Company’sbusiness is highly seasonal. In 2001, approximately 65.7%of net sales occurred in January through June of the year. The Company hashistorically reported operating losses in the third and fourth calendarquarters. The Company has experienced and expects to continue to experiencevariability in net sales, operating income and net income on a quarterly basis.Factors that may contribute to this variability include:

 

•                                          weatherconditions during peak growing and gardening seasons;

 

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•                  shifts in demandfor live plant products;

 

•                  changes inproduct mix, service levels and pricing by the Company and its competitors;

 

•                  the effect ofacquisitions;

 

•                  the economicstability of the retail customers; and

 

•                  the Company’srelationship with each of its retail customers.

 

*Customer Concentration; Dependence on HomeDepot*

 

The Company ishighly dependent on the purchases of its top eight retail customers, whichtogether accounted for 84 %, 78%, 77%, 75% and 70% of net sales in 2001, thetwelve months ended December 31, 2000, the six months ended December 31, 2000,fiscal 2000 and fiscal 1999, respectively. The Company’s largest customer, HomeDepot, accounted for approximately 45%, 42%, 41%, 41% and 37% of its net salesin 2001, the twelve months ended December 31, 2000, the six months ended December31, 2000, fiscal 2000 and fiscal 1999, respectively. Management expects that asmall number of customers will continue to account for a substantial portion ofthe Company’s net sales for the foreseeable future. The Company does not havelong-term contracts with any of its retail customers, and there can be noassurance that they will continue to purchase its products. The loss of orsignificant adverse change in, the Company’s relationship with Home Depot orany other major customer could have a material adverse effect on the Company.The loss of, or reduction in orders from, any significant retail customers,losses arising from retail customers’ disputes regarding shipments, fees,merchandise condition or related matters, or the Company’s inability to collectaccounts receivable from any major retail customer could have a materialadverse effect on the Company. In addition, there can be no assurance thatrevenue from customers that have accounted for significant revenue in pastperiods, individually or as a group, will continue, or if continued, will reachor exceed historical levels in any period.

 

*Dependence on Economic Stability of K-Mart*

 

During fiscalyear 2001, sales to K-Mart accounted for approximately nine percent of theCompany’s total net sales. In January 2002, K-Mart and certain of itssubsidiaries filed voluntary petitions for relief under Chapter 11 of theUnited State Bankruptcy Code in the United States Bankruptcy Court for theNorthern District of Illinois, and in March 2002, announced that it intends toclose 284 under-performing stores located in 40 states, as part of its initialChapter 11 financial objectives review. Although certain of theprojected store closures are located within the Company’s target market,to date the Company has not experienced a decline in sales to K-Mart. Moreover,K-Mart has requested additional product for certain stores and assured theCompany that it will continue to pay on a 30-day cycle. However, if K-Mart isforced to close additional stores as a result of its bankruptcy reorganization,the loss of, or reduction in orders, or the Company’s inability to collectaccounts receivables from K-Mart, could have a material adverse effect on theCompany, its business and operations.

 

*Governmental Regulations; Minimum Wage*

* *

The Company issubject to certain federal, state and local health, safety and environmentallaws and regulations regarding the production, storage and transportation ofcertain of its products and the disposal of its waste. Certain of the Company’soperations and activities, such as water runoff from its production facilitiesand the use of certain pesticides, are subject to regulation by the UnitedStates Environmental Protection Agency (the “EPA”) and similar state and localagencies. These agencies may regulate or prohibit the use of such products,procedures or operations, thereby affecting the Company’s operations andprofitability. In addition, the Company must comply with a broad range ofenvironmental laws and regulations. Additional or more stringent environmentallaws and regulations may be enacted in the future and such changes could have amaterial adverse effect on the Company. The Company uses reclamation water asone of the 

 

22

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sources of water for a few ofits production facilities. The use and pricing of reclamation water, includingavailability of subsidized water rates, is governed by federal reclamation lawsand regulations. Changes in the law could have a material adverse effect on theCompany.

 

In addition,the Company is subject to the Fair Labor Standards Act as well as variousfederal, state and local regulations that govern such matters as minimum wagerequirements, overtime and working conditions. A large number of the Company’semployees are paid at or just above the federal minimum wage level and,accordingly, changes in laws, regulations or ordinances could have a materialadverse effect on the Company by increasing its costs.

 

*Short Operating History under CurrentManagement*

* *

The Companyhas recently added a new executive team. David J. Barrett was appointed Chief Executive Officer on May 5, 2001,after joining the Company in January 2001 as its Chief Operating Officer. Priorto joining the Company, Mr. Barrett held the position of President and ChiefExecutive Officer of Scovill Fasteners Inc. Charles A. Ferer was appointed Chief Financial Officer on March 26,2001. Previously, Mr. Ferer held the position of Chief Financial Officer at OldNavy, a division of Gap Inc.  Accordingly,the Company, under its current management team, has only a limited operatinghistory upon which investors may evaluate its performance. There can be noassurance that the Company will be able to achieve or sustain revenue growth orprofitability.

 

*Comparability of Operating Results*

 

In fiscal1999, the Company incurred (i) a $2.6 million non-cash pre-tax extraordinarycharge to write-off organization costs in early-adopting Statement of Position98-5 “Reporting on Costs of Start-Up Activities” (“SOP 98-5”), which wasaccounted for as a change in accounting principle, (ii) a $1.5 million non-cashpre-tax extraordinary charge related to the write-off of unamortized financingcosts associated with the terminated credit facilities in connection with therefinancing in the second fiscal quarter, and (iii) a $3.7 million pre-taxspecial charge during the first fiscal quarter related to the closure orleasehold modification at certain facilities, employee severance and relocationand consulting costs associated with the management team’s review of itsoperations.

 

Due to theforegoing factors and other environmental considerations in its business (forexample, weather patterns), the Company believes that period-to-periodcomparisons of its operating results cannot be relied upon as indicators offuture performance. In the event that the Company’s operating results in anyfuture period fall below the expectations of securities analysts and investors,the trading price of the Company’s debt and equity securities would likely bematerially and adversely affected.

 

*Sensitivity**to PriceIncreases of Certain Raw Materials*

* *

The Companyand its competitors are vulnerable to price increases for raw materials. For2001, raw material costs accounted for approximately 26.3% of net sales. TheCompany does not have long-term contracts with the majority of its raw materialsuppliers. Increases in the cost of raw materials essential to its operations,including seed, plastic, chemicals and fertilizer, would increase its costs ofproduction. Significant increases in the price of petrochemicals or a scarcityof raw materials essential to plant propagation could have a material adverseeffect on the Company. There can be no assurance that any such price increasescan be passed on to the Company’s customers in the form of higher prices forits products.

 

*Control by Significant Stockholders andManagement*

* *

KCSNAcquisition Company, L.P. owns 56.7%****of the outstanding common stock.  Certain holders of the Company’s Series APreferred Stock own 16.7% of the outstanding common stock.  In addition, officers and directors own10.2% of the outstanding common stock. Heller Equity Capital Corporation (“Heller”) owns 2.1% of theoutstanding common stock and is the holder of an 8.0% Subordinated ConvertibleNote (the “New Heller Note”), which is convertible into approximately 3.3% ofthe outstanding common stock.  KCSN,Heller and the management 

 

23

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stockholders are parties to aStockholders Agreement, which provides that the parties to the StockholdersAgreement shall consent to any merger, consolidation or sale of all orsubstantially all of the Company’s assets involving an independent third partyand approved by a majority of KCSN’s shares and vote their shares to electcertain specified persons as directors. Subject to the terms of the Stockholders Agreement and the Certificateof Designation, KCSN is able to elect all of the Company’s directors and candetermine the outcome of corporate actions requiring stockholder approval,including adopting amendments to the Certificate of Incorporation  and approving or disapproving mergers orsales of all or substantially all of the Company’s assets.

 

*Change of Control*

* *

The Indentureand Certificate of Designations for the Company’s preferred stock provide thatupon the occurrence of a change of control****the Company must make an offer to purchaseall or any part of the New Notes at a price in cash equal to 101% of theaggregate principal amount thereof plus accrued and unpaid interest, if any, tothe date of purchase and all or any part of the Series A Preferred Stock at aprice in cash equal to 101% of the aggregate liquidation preference thereofplus accrued and unpaid dividends to the date of purchase. The Amended LoanAgreement prohibits the Company from repurchasing any New Notes or preferredstock. The Amended Loan Agreement also provides that certain change of controlevents with respect to the Company would constitute a default thereunder. Any futurecredit agreements or other agreements relating to Senior Debt to which theCompany becomes a party may contain similar restrictions and provisions. In theevent a Change of Control occurs at a time when the Company is prohibited frompurchasing the New Notes or preferred stock, or if the Company is required tomake an Asset Sale Offer (as defined) pursuant to the terms of the New Notes,the Company could seek the consent of its lenders to purchase the New Notes orpreferred stock or could attempt to refinance the borrowings that contain suchprohibition. If the Company does not obtain such consent or refinance suchborrowings, the Company would remain prohibited from purchasing the New Notesor preferred stock. In such case, the Company’s failure to purchase tenderedNew Notes would constitute an Event of Default under the Indenture. If, as aresult thereof, a default occurs with respect to any Senior Debt, thesubordination provisions in the Indenture would likely restrict payments to theholders of the New Notes. The Indenture will provide that the Company may notoffer to repurchase any preferred stock upon the occurrence of a Change ofControl until the Company has completed its offer to purchase the New Notes.There can be no assurance that the Company will have sufficient funds torepurchase the New Notes or the preferred stock after a Change of Control. Theprovisions relating to a Change of Control included in the Indenture and theCertificate of Designation may increase the difficulty of a potential acquirerobtaining control of the Company.

 

*Dependence on Leased Facilities*

* *

The Companyleases approximately 60% of its growing acreage and approximately 80% of itsgreenhouse space. These leases expire at varying times over the next 15 yearsand certain leases are month-to-month. Although management believes that theCompany can extend most of its leases on acceptable terms, failure to do sowould require the Company to establish new production facilities. No assurancecan be given that any such leases can be extended on acceptable terms or, ifnot so extended, that suitable replacement production facilities can beestablished. Failure to extend the terms of any of these leases could have amaterial adverse effect on the Company.

 

*Competition*

* *

The wholesalenursery industry is highly competitive. Competition is based principally onproduct quality, breadth of product offerings, customer service and price. Thewholesale nursery industry is highly fragmented with over 10,000 small andregional nurseries nationwide. Historically, the 100 largest wholesalenurseries in the United States accounted for less than 20% of total wholesaleproduction. The Company currently competes directly with a large number ofwestern and southwestern wholesale nursery companies. On a multi-regionalbasis, the Company competes with Hines Nurseries primarily in bedding plantsand shrubs and Monrovia Nursery Company primarily in shrubs. The fresh cutChristmas tree market is also highly fragmented and, on a regional basis, theCompany competes in this market with Holiday Tree Farms and The Kirk Company.

 

24

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*Lack of Market for Common Stock and PreferredStock*

 

At December13, 2001, the Company has 7,186,008 shares of common stock, 66,468 shares ofSeries A Preferred Stock, 639,948 shares of Series B Preferred Stock and 57,787shares of Series B-1 Preferred stock issued and outstanding.  All of the issued common stock, Series B andSeries B-1 Preferred Stock are “restricted securities” under the Securities Actof 1933, as amended (the “Securities Act”), subject to restrictions on thetiming, manner and volume of sales of such shares.  The Company has registered all of the issued and outstanding sharesof Series A Preferred Stock and 825,000 shares of common stock issuable uponexercise of the Company’s warrants. There is currently no public market for the Company’s common stock orits preferred stock and the Company cannot guarantee that a market will beavailable for the sale of common stock or preferred stock. The Company cannotpredict if future sales of its securities, or the availability of the Company’ssecurities for sale, will adversely affect the market price of the Company’ssecurities or its ability to raise capital by offering equity securities.  The Company has no present plan to list theCommon Stock or the Series A Preferred Stock on a national securities exchangeor to include the common stock for quotation through an inter-dealer quotationsystem.

 

*Lack of Prior Market for the New Notes*

* *

There iscurrently no public market for the New Notes and the Company has no presentplan to list the new Notes on a national securities exchange or to include theNew Notes for quotation through an inter-dealer quotation system. There can beno assurance that such a market will develop or, if such a market develops, asto the liquidity of such market.

 

**Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.**

 

The Company’sliabilities consist primarily of a revolving line of credit, seniorsubordinated notes and other notes and accounts payable. The Company has alsoissued preferred stock and redeemable common stock. Such liabilities andstockholders’ equity have varying levels of sensitivity to changes in marketinterest rates. Interest rate risk results when, due to different maturitydates and re-pricing intervals, interest rate indices for interest-bearingliabilities increase relative to income earning assets, thereby creating a riskof decreased net earnings and cash flow.  The Company does not have any derivative financial instruments asof December 31, 2001.

 

25

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The followingtable provides information about the Company’s market sensitive liabilities,categorized by maturity, and constitutes a “forward-looking statement.”  For more information, please refer toAppendix A “Financial Statements and Notes to Consolidated FinancialStatements.”

 
| **Long-term Liabilities**  |     | **December  31, 2001  Expected Maturities** |     |
|----------------------------|----------|---------------------------------------------|----------|
|                       | **2002** |                                        | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **Thereafter** |   | **Total** |   |
|                       |     | **(dollars in millions)**                   |     |
| Fixed Rate:                |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Series A Preferred Stock   |     | —                                      |     | — |   | — |   | — |   | $ | 14.4 |   | $ | 143.3 |   | $ | 157.7 |   |
| Average Interest Rate      |     | 13                                          | %        | 13 | % | 13 | % | 13 | % | 13 | % | 13 | % |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Series B Preferred Stock   |     | —                                      |     | $ | 5.0 |   | $ | 10.1 |   | $ | 87.6 |   | — |   | — |   | $ | 102.7 |   |
| Average Interest Rate      |     | 13                                          | %        | 13 | % | 13 | % | 13 | % | — |   | — |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Series B-1 Preferred Stock |     | —                                      |     | — |   | — |   | 9.3 |   | — |   | — |   | $ | 9.3 |   |
| Average Interest Rate      |     | 12                                          | %        | 12 | % | 12 | % | 12 | % | — |   | — |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Catalyst Note              |     | $                                           | 1.8      |   | $ | 13.4 |   | — |   | — |   | — |   | — |   | $ | 15.2 |   |
| Average Interest Rate      |     | 15                                          | %        | 15 | % | — |   | — |   | — |   | — |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| New Notes                  |     | $                                           | 5.9      |   | $ | 6.5 |   | $ | 7.1 |   | $ | 61.6 |   | — |   | — |   | $ | 81.1 |   |
| Average Interest Rate      |     | 13                                          | %        | 13 | % | 13 | % | 13 | % | — |   | — |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| New Heller Note            |     | —                                      |     | — |   | — |   | 6.5 |   | — |   | — |   | $ | 6.5 |   |
| Average Interest Rate      |     | 8.0                                         | %        | 8.0 | % | 8.0 | % | 8.0 | % | — |   | — |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Acquisition Note           |     | $                                           | 0.1      |   | $ | 0.1 |   | $ | 1.1 |   | — |   | — |   | — |   | $ | 1.3 |   |
| Average Interest Rate      |     | 9.0                                         | %        | 9.0 | % | 9.0 | % | — |   | — |   | — |   |   |   |
|                       |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Variable Rate:             |     |                                        |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Amended Loan Agreement(1)  |     | —                                      |     | $ | 55.0 |   |   |   |   |   |   |   |   |   | $ | 55.0 |   |
|                            |          |                                             |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)  The Credit Agreementexpires on September 15, 2003. See also “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”

 

Most of the Company’s debt issubject to acceleration upon various events of default.

 

 

**Item 8.  Financial Statements and Supplementary Data**

 

See AppendixA.

 

**Item 9.  Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure**

 

None.

 

26

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**PART III**

 

**Item 10.  Directors and Executive Officers of the Registrant**

 

The followingtable sets forth current information concerning each of the Company’sdirectors, executive officers and key employees. All directors shall serveuntil their successors are duly elected and qualified, subject, however, toprior death, resignation, retirement, disqualification or removal from office.Officers are appointed by and serve at the discretion of the Board ofDirectors.

 
| **Name**                   |   | **Age** |   | **Position**                                                     |   | **Officer or  Director Since** |
|----------------------------|--------|---------|--------|------------------------------------------------------------------|--------|--------------------------------|
| David J. Barrett(1)        |   | 52      |   | President, Chief Executive Officer                               |   | May 2001                       |
| Charles A. Ferer           |   | 39      |   | Executive  Vice President, Chief Financial Officer and Secretary |   | March 2001                     |
| Michael F. Vukelich(1)     |   | 51      |   | Chairman of  the Board                                           |   | July 1996                      |
| Marion Antonini(1)         |   | 71      |   | Vice  Chairman of the Board                                      |   | September  1998                |
| Samuel P. Frieder(1)(2)(3) |   | 37      |   | Director                                                         |   | December  1996                 |
| James A. Kohlberg          |   | 43      |   | Director                                                         |   | December  1996                 |
| Gary E. Mariani(2)         |   | 57      |   | Director                                                         |   | November  1995                 |
| John S. Eastburn, Jr.(1)   |   | 42      |   | Director                                                         |   | November  2000                 |
| Jeffrey Serota             |   | 36      |   | Director                                                         |   | November  2000                 |

 

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(1)           Member of Executive Committee.

(2)           Member of Audit Committee.

(3)           Member of Compensation Committee

 

*Mr. Barrett* wasappointed Chief Executive Officer on May 5, 2001, after serving as ChiefOperating Officer since January 2001. From 1994 to 2000 Mr. Barrett was President and Chief Executive Officerof Scovill Fasteners, Inc. From 1991 to 1994, he was Executive Vice Presidentof Operations at Scovill.

 

*Mr. Ferer* wasappointed Chief Financial Officer on March 26, 2001.  Previously, Mr. Ferer held the position of Chief Financial Officerat Old Navy, a division of Gap Inc.

 

*Mr.Vukelich* has been the Chairman of the Boardsince September 1995. From September 1995 through June 1999, Mr. Vukelich wasalso the Chief Executive Officer of the Company. From 1992 through August 1995,Mr. Vukelich was President and Chief Executive Officer of M.F. Vukelich Co. Heis the founder of Color Spot America, a predecessor of the Company, and wasPresident and Chief Executive Officer of Color Spot America from its inceptionin 1983 to 1991. Mr. Vukelich has 28 years of experience in the nurserybusiness.

 

*Mr.Antonini* joined Printing Arts America, Inc. inAugust 1999 as its Chief Executive Officer and has been a Principal at Kohlbergsince March 1998. Prior to that time, Mr. Antonini was Chief Executive Officerof Welbilt.

 

*Mr. Frieder* joinedKohlberg in 1989 and was named a Principal in 1995. Mr. Frieder is also amember of the board of directors of Holley Performance Products, Inc. and KatyIndustries, Inc.

 

27

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*Mr. Kohlberg* hasbeen a co-founding and Managing Principal of Kohlberg since 1987. Mr. Kohlbergis also a member of the board of directors of Holley Performance Products, Inc.and Katy Industries, Inc.

 

*Mr. Mariani* has beenChief Executive Officer of WinnDevon Art Group, Inc., an art publisher, since1994. From 1992 through 1993, Mr. Mariani was Chief Executive Officer of TheGarden Counsel, a national nursery association. Prior to that time, Mr. Marianiwas the President of the Nursery Product Division of Weyerhaeuser Company.

 

*Mr. Eastburn* joinedKohlberg in 1997 and was named a principal in 2002.

 

*Mr. Serota* is aPrincipal of Ares Management, L.P., a Los Angeles based money managementfirm.  Prior to joining Ares Management,L.P. in 1997, Mr. Serota was a Vice President at Bear, Stearns, & Co.

 

**Directors’ Meetings and Committees**

** **

The entireBoard of Directors met four times in 2001, two times during the six-monthtransition period ended December 31, 2000 and four times during the fiscal yearended June 30, 2000. The Board of Directors has appointed an Audit Committee, aCompensation Committee and an Executive Committee.

 

*Audit Committee.*The primary responsibilities of the Audit Committee are to recommend anindependent public accountant to audit the Company’s annual financialstatements and to review internal and external audits, internal accountingcontrols, annual financial statements and, at its discretion, compliance withcorporate policies and codes of conduct. The Audit Committee is comprised ofoutside directors. The current members of the Audit Committee are Messrs.Frieder and Mariani. The Audit Committee met two times in 2001, twice duringthe six-month transition period ended December 31, 2000 and three times in thefiscal year ended June 30, 2000.

 

*Compensation Committee*.The Compensation Committee determines officers’ salaries and bonuses andadministers the grant of stock options and other awards pursuant to the 1996Stock Option Incentive Plan, 1997 Stock Option Plan and Special Stock OptionPlan. The Compensation Committee is comprised of outside directors. The currentmembers of the Compensation Committee are Messrs. Frieder and Antonini. TheCompensation Committee did not meet in 2001 , during the six month transitionperiod ended December 31, 2000 or during fiscal 2000.

 

*Executive Committee*.The primary responsibilities of the Executive Committee are to deal withday-to-day issues prior to meetings of the full Board of Directors. TheExecutive Committee met ten times in 2001, four times during the six-monthtransition period ended December 31 2000 and four times in the fiscal yearended June 30, 2000. The current members of the Executive Committee are Messrs.Barrett, Vukelich, Antonini, Frieder, and Eastburn.

 

28

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**Item 11.  Executive Compensation**

 

**Summary Compensation**

 

The followingtable sets forth a summary of certain information regarding compensation theCompany paid or accrued to the Chief Executive Officers, each of the four othermost highly compensated executive officers whose total annual salary and bonusexceeded $100,000 during the year ended December 31, 2001 (collectively, the“Named Executive Officers”).

 
|                                       |   | **Annual  Compensation** |   | **Long-Term  Compensation** |    |
|--------------------------------------------|--------|--------------------------|--------|-----------------------------|---------|
| **Name and Principal Position**            |   | **Year****(2)**          |   | **Salary**                  |    | **Bonus** |   | **Other Annual  Compensation****(1)** |   | **Securities  Underlying  Options** |   | **All Other  Compensation** |   |
| Michael F. Vukelich, Chairman of the       |   | F1999                    |   | $                           | 192,308 |   | $ | — |   | $ |  5,800 |   | — |   | — |   |
| Board                                      |   | F2000                    |   | 200,000                     |    | 400,000 |   | 16,113 |   | — |   | — |   |
|                                       |   | C2000                    |   | 191,538                     |    | — |   | 18,662 |   | — |   | — |   |
|                                       |   | 2001                     |   | 200,000                     |    | — |   | 10,200 |   | — |   | — |   |
|                                       |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| Richard E. Parker, former Chief Executive  |   | F1999               |   | 12,000                 |    | — |   | 450  |   | — |   | — |   |
| Officer and Director                       |   | F2000                    |   | 260,000                     |    | — |   | 102,461 |   | — |   | — |   |
|                                       |   | C2000                    |   | 256,000                     |    | — |   | 119,275 |   | — |   | — |   |
|                                       |   | 2001                     |   | 117,586                     |    | — |   | 253,647 |   | — |   | — |   |
|                                       |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| David J Barrett, Chief Executive Officer   |   | 2001                     |   | 278,236                     |    | — |   | 56,809 |   | — |   | — |   |
|                                       |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| Charles A. Ferer, Chief Financial Officer  |   | 2001                     |   | 180,769                     |    | 100,000 |   | 53,896 |   | — |   | — |   |
|                                       |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| Joseph Beiser, Southern Division President |   | 2000                     |   | 28,846                      |    | 25,000 |   | — |   | — |   | — |   |
|                                       |   | 2001                     |   | 186,465                     |    | — |   | 60,992 |   | — |   | — |   |
|                                       |   |                     |   |                        |    |   |   |   |   |   |   |   |   |
| Don Grimm, Northern Division President     |   | 2000                     |   | 33,146                      |    | — |   | — |   | — |   | — |   |
|                                       |   | 2001                     |   | $                           | 175,000 |   | $ | 25,000 |   | $ | — |   | — |   | — |   |

 

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(1)  Represents carallowance, relocation, severance and loan forgiveness.

(2)  “F” indicates a12-month fiscal period ending in June of the indicated year. “C” indicates acalendar year.

 

29

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OPTION GRANTS DURING 2001.  The following table sets forth certaininformation regarding options granted during 2001 to the Named ExecutiveOfficers.

 
|                |                                | **Individual  Grants**                                       |        |                                                            |   |                                 |   | **Potential  Realized   Value at Assumed   Annual Rates of   Stock Price** |   |
|---------------------|-------------------------------------|--------------------------------------------------------------|-------------|-----------------------------------------------------------------|--------|--------------------------------------|--------|----------------------------------------------------------------------------|--------|
| **Name**            |                                | **Number of  Securities   Underlying   Options Granted (#)** |        | **% of Total  Options   Granted to Employees   in Fiscal Year** |   | **Exercise  or  Base Price  ($/Sh)** |   | **Expiration  Date**                                                       |   |   |   |
|                | **Appreciation  for   Option Term** |                                                         |
|                | **5% ($)**                          |                                                         | **10% ($)** |                                                            |
| Michael F. Vukelich |                                | —                                                       |        | 0.0                                                             | %      | —                               |   | —                                                                     |   | — |   | — |   |
| Richard E. Parker   |                                | —                                                       |        | 0.0                                                             | %      | —                               |   | —                                                                     |   | — |   | — |   |
| David J. Barrett    |                                | 225,000                                                      |        | 66.2                                                            | %      | 0.02                                 |   | 05/05/11                                                                   |   | 2,820 |   | 7,172 |   |
| Charles A. Ferer    |                                | 75,000                                                       |        | 22.1                                                            | %      | 0.02                                 |   | 03/26/11                                                                   |   | 943 |   | 2,391 |   |
| Joseph Beiser       |                                | 10,000                                                       |        | 2.9                                                             | %      | 0.02                                 |   | 06/04/11                                                                   |   | 126 |   | 319 |   |
| Don Grimm           |                                | —                                                       |        | 0.0                                                             | %      | —                               |   | —                                                                     |   | — |   | — |   |

 

AGGREGATE OPTION EXERCISES IN2001 AND YEAR-END OPTION VALUES. The following table sets forth certaininformation regarding options exercised and the number and value of unexercisedoptions held by the Named Executive Officers at December 31, 2001.

 
|                |            |                                |              |                |            |                                                                               |              |
|---------------------|-----------------|-------------------------------------|-------------------|---------------------|-----------------|------------------------------------------------------------------------------------|-------------------|
| **Name**            |            | **Shares   Acquired on   Exercise** |              | **Value  Realized** |            | **Number of  Securities   Underlying Outstanding   Options at  December 31, 2001** |              | **Value of  Unexercised   In-the-Money Options at   December 31, 2001****(1)** |   |
|                | **Exercisable** |                                | **Unexercisable** |                | **Exercisable** |                                                                               | **Unexercisable** |   |
| Michael F. Vukelich |            | 0                                   |              | 0                   |            | 602,609                                                                            |              | 0 |   | 0 |   | 0 |   |
| Richard E. Parker   |            | 0                                   |              | 0                   |            | 0                                                                                  |              | 0 |   | 0 |   | 0 |   |
| David J. Barrett    |            | 0                                   |              | 0                   |            | 18,750                                                                             |              | 281,250 |   | 0 |   | 0 |   |
| Charles A. Ferer    |            | 0                                   |              | 0                   |            | 0                                                                                  |              | 75,000 |   | 0 |   | 0 |   |
| Joseph Beiser       |            | 0                                   |              | 0                   |            | 2,500                                                                              |              | 17,500 |   | 0 |   | 0 |   |
| Don Grimm           |            | 0                                   |              | 0                   |            | 2,500                                                                              |              | 7,500 |   | 0 |   | 0 |   |

 

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(1) Represents the value of the shares of common stock subject tooutstanding options, based on a fair market value of $3.00 share, less theaggregate option exercise price.

 

**Employment Agreements**

 

The Companyentered into an employment agreement with Michael F. Vukelich, the Chairman ofthe Board, with the latest amendment, effective November 1, 2000.  The agreement expires December 31, 2002 andwill be automatically renewed for successive one-year periods unless Mr.Vukelich or the Company gives 60 days notice of non-renewal. As of July 1,2000, Mr. Vukelich is paid an annual base salary of $200,000, which isincreased annually based on increases in the consumer price index, and iseligible to participate in the annual bonus program pursuant to the terms ofthe agreement. The employment agreement continues in effect an option topurchase 395,609 shares of our common stock for $1.45 per share and providesthat the Company grant Mr. Vukelich an option to purchase 207,000 shares of ourcommon stock at $7.17 per share, which options were granted in fiscal 1997. Theagreement terminates upon the earlier to occur of (i) the Company’s non-renewalor Mr. Vukelich’s non-renewal, (ii) death or disability, (iii) terminationfor Cause (as defined in the agreement) or (iv) termination without Cause. Inthe event that the employment agreement is 

 

30

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terminated without cause, theCompany is obligated to pay Mr. Vukelich his base salary through the remainingterm of the employment agreement plus his pro rata portion of the bonus paid toMr. Vukelich in the year prior to termination. In the event of Mr. Vukelich’sdeath or disability, the Company is obligated to continue to pay to Mr.Vukelich or his estate his base salary for one year following his termination.The employment agreement entitles Mr. Vukelich to be nominated to a seat on theBoard of Directors so long as he owns 10% of the common stock.

 

As part of theemployment agreement, Mr. Vukelich has agreed not to compete with the Companyin certain specified counties and states for the longer of one year followingtermination or one year following the receipt of any severance from theCompany; provided that Mr. Vukelich may elect to waive the payment ofseverance, in which event the non-competition covenant expires one yearfollowing termination.

 

The Companyentered into an employment agreement with David J. Barrett, the Chief ExecutiveOfficer, effective May 5, 2001.  Underthe terms of the agreement, Mr. Barrett is paid an annual base salary of$275,000 and is eligible to participate in the Company’s bonus program asestablished by the Board of Directors. If Mr. Barrett is terminated withoutCause (as defined in the agreement), he is entitled, under certain conditions,to receive an amount equal to one year’s base salary, payable over thefollowing twelve month period.  Mr.Barrett was awarded options to purchase 275,000 shares of common stock at $0.02per share.  Such options vest in equalannual installments over a four-year period. The Company also loaned Mr.Barrett $250,000 on an interest free basis, which is deemed to be repaid on amonthly basis at the rate of $50,000 per annum, subject to Mr. Barrett’scontinued employment with the Company.

 

The Companyentered into an employment agreement with Richard E. Parker, the ChiefExecutive Officer, effective June 10, 1999.  Mr. Parker resigned effective May 4, 2001. Under the terms of theagreement, Mr. Parker was paid an annual base salary of $260,000, and waseligible to participate in the Company’s bonus program as established by theBoard of Directors. Mr. Parker was awarded options to purchase 150,000 sharesof common stock at $4.00 per share. Such options were to vest in equal annual installments over a four-yearperiod. However, Mr. Parker’s options expired upon his resignation. The Companyalso loaned Mr. Parker $250,000 on an interest free basis, which is deemedto be repaid on a monthly basis at the rate of $50,000 per annum, subject toMr. Parker’s continued employment with the Company. The loan was repaidpursuant to the terms of the employment agreement.

 

The Companyentered into an employment agreement with Charles A. Ferer, the Chief FinancialOfficer, effective March 26, 2001. Under the terms of the agreement, Mr. Fereris paid an annual base salary of $250,000 and is eligible to participate in theCompany’s bonus program as established by the Board of Directors.  Mr. Ferer is entitled to receive aguaranteed bonus of $100,000 upon completion of the Company’s 2001 fiscalyear.  If Mr. Ferer is terminatedwithout Cause (as defined in the agreement), he is entitled, to receive anamount equal to one year’s base salary, payable over the following twelve monthperiod. Mr. Ferer was awarded options to purchase 75,000 shares of common stockat $0.02 per share.  Such options vestin equal annual installments over a four-year period. The Company also loanedMr. Ferer $250,000 on an interest free basis, which is deemed to be repaid on amonthly basis at the rate of $50,000 per annum, subject to Mr. Ferer’scontinued employment with the Company.

 

The Companyentered into an employment agreement with Joseph Beiser, the Southern DivisionPresident, effective June 4, 2001. Under the terms of the agreement, Mr. Beiseris paid an annual base salary of $170,000 and is eligible to participate in theCompany’s bonus program as established by the Board of Directors. If Mr. Beiseris terminated without Cause (as defined in the agreement), he is entitled, toreceive an amount equal to one year’s base salary, payable over the followingtwelve month period. Mr. Beiser was awarded options to purchase 10,000 sharesof common stock at $0.02 per share. Such options vest in equal annual installments over a four-year period.The Company also loaned Mr. Beiser $75,000 on an interest free basis, which isdeemed to be repaid on a monthly basis at the rate of $15,000 per annum,subject to Mr. Beiser’s continued employment with the Company.

 

The Companyentered into an employment agreement with Don Grimm, the Northern DivisionPresident, effective October 16, 2000. Under the terms of the agreement, Mr.Grimm is paid an annual base salary of $175,000 and is eligible to participatein the Company’s bonus program as established by the Board of Directors. If Mr.Grimm is terminated without Cause (as defined in the agreement), he isentitled, to receive an amount equal to one year’s base

 

31

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salary, payable over thefollowing twelve month period. Mr. Grimm was awarded options to purchase 10,000shares of common stock at $3.00 per share. Such options vest in equal annual installments over a four-year period.

 

**Stock Option Plans**

* *

*1996 Stock Option Incentive Plan*.In July 1996, the Board of Directors authorized, and the stockholders approved,a stock option plan, effective September 7, 1995, for directors, officers,employees and consultants of the company and its subsidiaries (the “1996 OptionPlan”). Options to purchase a total of 1,171,419 shares of common stock at$1.45 per share were granted under the 1996 Option Plan. As of December 31,2001, options to purchase 569,417 shares have been exercised, and 395,609nonqualified stock options (“NQOs”) are outstanding under the 1996 Option Plan.No further options will be granted under the 1996 Stock Option Plan.

 

*1997 StockOption Plan*. The 1997 Stock Option Plan (the “1997Stock Option Plan”) was adopted by the Board of Directors and approved by thestockholders on December 31, 1996 to attract, retain and provide incentive tocompany executives and key employees. Options granted under the 1997 StockOption Plan may be either incentive stock options (“ISOs”) as defined inSection 422 of the Internal Revenue Code of 1986, as amended, or NQOs. A totalof 1,300,000 shares of common stock have been reserved for issuance under the1997 Stock Option Plan.

 

The 1997 StockOption Plan is administered by the Compensation Committee of the Board ofDirectors, which has the authority to determine the terms of the optionsgranted. Each option has a term specified in its option agreement, provided,however, that no term can exceed ten years from the date of grant. Each optionis exercisable upon the fulfillment of certain conditions, including agreementby the optionee to be bound by the Stockholders Agreement. In the case of anISO granted to an optionee who, at the time the option is granted, owns stockrepresenting more than 10% of the voting power of all outstanding classes ofthe Company’s stock (a “10% Optionee”), the term of the option cannot exceedfive years from the date of grant. No option granted under the 1997 StockOption Plan may be transferred by the optionee other than by will or the lawsof descent and distribution and each option may be exercised, during thelifetime of the optionee, only by such optionee. In the event that anoptionee’s employment terminates for any reason other than for cause, anyoptions held which have not yet vested will expire and become unexercisable.All of the optionee’s options that have vested shall expire and becomeunexercisable on the earlier of the expiration date stated in the optionagreement or the date 90 days after the termination of the optionee’semployment. If an optionee is terminated for cause prior to the later ofJanuary 1, 2000 or the third anniversary of the date the optionee commencesemployment, all options held by the optionee (whether or not vested) shallexpire on the date of termination. The number of shares under each option andthe price of any shares under such option may be adjusted in a mannerconsistent with any capital adjustment resulting from a stock dividend, stocksplit, recapitalization, reorganization or a combination or other change in theshares of common stock.

 

The exerciseprice for all ISOs granted under the 1997 Stock Option Plan must be no lessthan 100% of the fair value per share on the date of grant. With respect to a10% Optionee, the exercise price of any option granted must be no less than110% of the fair market value on the date of grant. Each option is designatedin the written option agreement as either an ISO or NQO. However, to the extentthat the aggregate fair market value of shares subject to an optionee’s ISO,which become exercisable for the first time during any year, exceeds $100,000,the excess options shall be treated as NQOs.

 

As of December31, 2001, under the 1997 Stock Option Plan, there were 330,000 stock optionsoutstanding with an exercise price of $0.02 per share, 185,000 stock optionsoutstanding with an exercise price of $3.00 per share, 207,000 stock optionsoutstanding with an exercise price of $7.17 per share, 167,328 stock optionsoutstanding with an exercise price of $7.19 per share and 119,800 stock optionsoutstanding with an exercise price of $10.00 per share. The 1997 Stock OptionPlan will expire in 2007 unless terminated at an earlier date by the Board ofDirectors.

 

*Special Stock Option Plan*.In February 1997, the Board of Directors authorized, and the stockholdersapproved, a stock option plan for employees of Lone Star Growers, L.P., awholly owned subsidiary of the Company (the “Special Option Plan”). Options topurchase a total of 139,383 shares of common stock at $1.43 per share wereissued under the 

 

32

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Special Option Plan. As ofDecember 31, 2001, there were 48,990 stock options outstanding. The purpose ofthe Special Option Plan was to provide incentives to employees of Lone StarGrowers, L.P. in connection with the acquisition of Lone Star Growers Co., thepredecessor to Lone Star Growers, L.P., by the Company. No further awards willbe made under the Special Option Plan. The Special Option Plan is otherwiseidentical to the 1997 Stock Option Plan.

 

**Item 12.  Security Ownership of Certain Beneficial Owners and Management****.**

 

The followingtable sets forth certain information with respect to the beneficial ownershipof the Company’s common stock as of March 15, 2002, by: (i) all persons knownby the Company to be the beneficial owners of five percent or more of thecommon stock; (ii) each director, (iii) each of the Named Executive Officers,and (iv) all executive officers as a group. Unless otherwise indicated, theaddress of each of the persons named below is in care of Color Spot Nurseries,Inc., 3478 Buskirk Avenue, Pleasant Hill, California 94523.

 
| **Name**                                             |   | **Shares  Beneficially Owned(1)** |   | **Percentage  Ownership(2)** |   |
|------------------------------------------------------|--------|-----------------------------------|--------|------------------------------|--------|
| KCSN Acquisition Company,  L.P.(3)                   |   | 4,078,059                         |   | 56.7                         | %      |
| Heller Equity Capital Corporation(4)                 |   | 391,038                           |   | 5.3                          |   |
| TCW related entities(5)                              |   | 600,825                           |   | 8.4                          |   |
| Michael F. Vukelich(6)                               |   | 1,271,976                         |   | 16.3                         |   |
| John S. Eastburn Jr.(7)                              |   | 0                                 |   | 0                            |   |
| Samuel P. Frieder(7)                                 |   | 0                                 |   | 0                            |   |
| James A. Kohlberg(7)                                 |   | 0                                 |   | 0                            |   |
| Marion Antonini(7)(8)                                |   | 37,500                            |   | *                            |   |
| Gary E. Mariani(9)                                   |   | 75,279                            |   | 1.0                          |   |
| Jeffrey Serota(10)                                   |   | 0                                 |   | 0                            |   |
| Charles A. Ferer(11)                                 |   | 18,750                            |   | *                            |   |
| David J. Barrett(12)                                 |   | 75,000                            |   | 1.0                          |   |
| Total Officers and Directors as a Group (9  persons) |   | 1,478,505                         |   | 18.6                         | %      |

 

----

*                                         Lessthan 1%

(1)                                  Beneficialownership is determined in accordance with the rules of the Securities andExchange Commission, based on factors including voting and investment powerwith respect to shares, subject to applicable community property laws. Sharesof common stock subject to options or warrants currently exercisable within 60days of the date hereof are deemed outstanding for the purpose of computing thepercentage ownership of the person holding such options or warrants, but arenot deemed outstanding for computing the percentage ownership of any otherperson.

(2)                                  Assumingexercise of warrants and options held by the named party.

(3)                                  Theaddress of KCSN is 111 Radio Circle, Mt. Kisco, NY 10549. KCSN is an affiliateof Kohlberg. The ultimate general partner of KCSN is a corporation owned 100%by James A. Kohlberg.

(4)                                  Includes239,413 shares issuable upon conversion of the Heller Note. The address ofHeller Equity Capital Corporation is 500 West Monroe Street, Chicago, IL 60661.

(5)                                  Consistsof  540,743 shares beneficially owned byTCW/Crescent Mezzanine, LLC and 60,082 shares beneficially owned by The TCWGroup, Inc.  The TCW-related parties areeach a party to a stockholders agreement. The number of shares beneficially owned by TCW/Crescent Mezzanine, LLCincludes 123,770 shares owned by TCW/Crescent Mezzanine Trust, 10,815 sharesowned by TCW/Crescent Mezzanine Investment Partners, L.P. and 406,158 sharesowned by TCW/Crescent Mezzanine Partners, L.P. The business, property and affairs of TCW/Crescent Mezzanine, LLC aremanaged exclusively by its board of directors, which consists of the followingindividuals: Mark L. Attanasio, Robert D. Beyer, Jean-Marc Chapus, Jack D.Furst, Thomas O. Hicks, William C. Sonneborn and Marc I. Stern.  The address of TCW/Crescent Mezzanine, LLCis 11100 Santa Monica Blvd, Suite 2000, Los Angeles, California 90025.  The number of shares beneficially owned byThe TCW Group, Inc. includes 60,082 shares owned by TCW Shared Opportunity FundII, L.P.   The TCW Group, Inc. may bedeemed to be controlled by Société Générale Asset Management, S.A., a companyincorporated under the laws of France. Société Générale Asset Management, S.A. is owned by Société Générale,S.A., a company incorporated under the laws of France.  The address of The TCW Group,Inc. is 865South Figueroa Street, Suite 1800, Los Angeles, California 90017.

(6)                                  Includesoptions to purchase 602,609 shares of common stock, which are presentlyexercisable and 68,095 shares owned by M.F. Vukelich Co., of which Mr. Vukelichis director and controlling shareholder. Excludes shares held by Karla D.Vukelich.

(7)                                  Excludes4,078,059 shares held by KCSN. Such person disclaims beneficial ownership ofsuch shares.

(8)                                  Includesoptions to purchase 37,500 shares of common stock which are presentlyexercisable.

 

33

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(9)                                  Includesoptions to purchase 10,350 shares of common stock which are presentlyexercisable.

(10)                            Excludes300,413 shares held by Ares Management L.P. Such person disclaims beneficial ownership of such shares.

(11)                            Includesoptions to purchase 18,750 shares of common stock which are presentlyexercisable.

(12)                            Includesoptions to purchase 75,000 shares of common stock which are presentlyexercisable.

 

**Item 13.  Certain Relationships and Related Transactions**

 

In November 2001, the Company entered into the Amended Loan Agreementwith Fleet Capital Corporation in which two existing Series A PreferredStockholders of the Company, TCW/Crescent Mezzanine, L.L.C. and certainaffiliated entities (“TCW”) and Ares Leveraged Investment Fund, L.P. andcertain affiliated entities (“Ares”), agreed to participate in the debtrestructuring and modifications to the Series A Preferred Stock in exchange forthe right to acquire (i) in the aggregate, such number of shares of theCompany’s common stock as will give TCW and Ares together a 34% interest in theissued and outstanding common stock in consideration of its $15.0 millionparticipation in the Company’s $55.0 million Amended Loan Agreement and (ii) anadditional 15% of the issued and outstanding common stock in consideration ofthe modifications to the Series A Preferred Stock.  (For additional information, see Note 9 Notes to FinancialStatements.)  In December 2001, theCompany and certain of its common stockholders transferred a total of 1,201,651shares of common stock to TCW, Ares and the remaining Series A PreferredStockholders, of which TCW received 600,825 shares of common stock.  The Company and its stockholders have notyet transferred the remaining 34% interest to which the Series A PreferredStockholders are entitled.

 

The Companypurchased a portion of its Christmas tree operations from a member ofmanagement during fiscal years 1998, 1999, and 2000 and in the transitional sixmonth period ended December 31, 2000. The Company did not purchase Christmas trees from this member ofmanagement in 2001.  The Company made apayment of $0.2 million to this member of management during 2001.

 

During thethird quarter of 2001, the Company entered into a contract with HR Synergy, tobecome the Company’s new broker / provider of the Company’s various healthbenefit programs.  HR Synergy is ownedby Mr. Mike Simmons, the Company’s Vice President of Human Resources.  The contemplated transaction was disclosedand approved in advance by Mr. Dave Barrett and Mr. John Eastburn.  Mr. Mike Simmons will not benefit from thisarrangement, as all brokerage commissions normally payable have been deductedfrom premiums billed to the Company. During 2001, the Company paid $400 to HR Synergy directly. The Companywill pay premiums and administrative fees of approximately $0.3 milliondirectly to insurance companies in fiscal 2002 related to 2002 policies placedthrough HR Synergy.

 

All futuretransactions among the Company and its officers, directors and principalstockholders and their affiliates will be approved by a majority of the Boardof Directors, including a majority of the independent and disinteresteddirectors.

 

34

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**PART IV**

 

**Item  14.  Exhibits****, Financial Statement Schedules andReports on Form 8–K.**

 

(a) Index to ConsolidatedFinancial Statements, Financial Statement Schedules and Exhibits

 

(1) Financial Statements:

 

The followingconsolidated financial statements of the Company are included in Appendix A.

 

Report ofIndependent Public Accountants

 

ConsolidatedBalance Sheets —

December 31,2001 and 2000

 

ConsolidatedStatements of Operations —

Year endedDecember 31, 2001

Twelve monthsended December 31, 2000

Six MonthsEnded December 31, 2000 and 1999

Years endedJune 30, 2000 and 1999

 

ConsolidatedStatements of Shareholders’ Equity —

Year endedDecember 31, 2001

Six monthsended December 31 2000

Years endedJune 30, 2000 and 1999

 

ConsolidatedStatements of Cash Flows —

Year endedDecember 31, 2001

Twelve monthsended December 31, 2000

Six Monthsended December 31, 2000 and 1999

Years endedJune 30, 2000 and 1999

 

Notes toConsolidated Financial Statements

 

(2) FinancialStatement Schedules:

 

The followingfinancial statement schedule is included in Appendix B.

 

II — Valuationand Qualifying Accounts —

Year endedDecember 31, 2001

Six Monthsended December 31, 2000

Years endedJune 30, 2000 and 1999

 

Inasmuch asRegistrant is primarily a holding company and all subsidiaries are whollyowned, only consolidated statements are being filed. Schedules other than thoselisted above are omitted because of the absence of the conditions under whichthey are required or because the information is included in the financialstatements or notes to the financial statements.

 

(b)           Reports on Form 8-K: One report on Form 8-K was filed bythe Registrant on October 23, 2001, announcing that the Registrant had reachedan agreement with Fleet Capital Corporation to amend its Loan and SecurityAgreement whereby, among other things, the maturity date was extended toNovember 15, 2001.  Further, theRegistrant announced

 

35

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that its offer to exchange SeriesB Preferred Stock and new senior subordinated notes in exchange for itsoutstanding senior subordinated notes, as previously announced in theRegistrant’s Quarterly Report on Form 10-Q for the six months ended June 30,2001, was extended to 12:00 midnight, New York City Time, on November 5, 2001.

 

(c)           Exhibits:  SeeExhibit Index below.

 
| **Exhibit****Number** |   | **Description  of Document**                                                                                                                                                                                                                                                                                                          |
|-----------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                   |   | Form of  Amended and Restated Certificate of Incorporation of the Registrant,  incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the quarterly period ended December 25, 1997 (SEC File No. 000-23483), as  previously filed with the Securities and Exchange Commission.                            |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 3.2                   |   | Amendment to  Certificate of Incorporation, incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended March 25, 1999  (SEC File No. 000-23483), as previously filed with the Securities and  Exchange Commission.                                                                 |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 3.3                   |   | Amended and  Restated Bylaws, incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission.                                                                                                                         |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 3.4                   |   | Form of  Certificate of Designation of the 13% Series A Cumulative Preferred Stock,  incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the quarterly period ended December 25, 1997 (SEC File No. 000-23483), as  previously filed with the Securities and Exchange Commission.                      |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.1                   |   | Form of  Preferred Stock Certificate, incorporated by reference to the Company’s  Registration Statement on Form S-1 (SEC File No. 333-37335) and amendments  thereto, as previously filed with the Securities and Exchange Commission.                                                                                          |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.2                   |   | Indenture  (including Form of Note), incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the quarterly period ended December 25, 1997 (SEC  File No. 000-23483), as previously filed with the Securities and Exchange  Commission.                                                                     |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.3                   |   | Warrant  Agreement (including Form of Warrant), incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended December 25,  1997 (SEC File No. 000-23483), as previously filed with the Securities and  Exchange Commission.                                                          |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.4                   |   | Certificate  of Amendment to the Certificate of Designation for 13% Series A Cumulative  Preferred Stock, as previously filed as Exhibit 4.2 to the Form 10-Q for the  quarter ended September 29, 2001 and incorporated herein by reference.                                                                                         |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.5                   |   | Certificate  of Designation for 13% Series B Cumulative Preferred Stock, as previously  filed as Exhibit 4.3 to the Form 10-Q for the quarter ended September 29,  2001 and incorporated herein by reference.                                                                                                                         |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.6                   |   | Certificate  of Designation for 12% Series B-1 Cumulative Preferred Stock, as previously  filed as Exhibit 4.4 to the Form 10-Q for the quarter ended September 29,  2001 and incorporated herein by reference.                                                                                                                       |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 4.7                   |   | Indenture  for 13% Senior Subordinated Notes due 2005, as previously filed as Exhibit  4.1 to the Form 10-Q for the quarter ended September 29, 2001 and  incorporated herein by reference.                                                                                                                                           |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.1                  |   | Amendment  No. 2 to Second Amended and Restated Credit Agreement dated as of December  24, 1997, incorporated by reference to the Company’s Current Report on Form  8-K (SEC File No. 000-23483), as previously filed with the Securities and  Exchange Commission on August 14, 1998.                                           |
|                  |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.2                  |   | First  Amendment and Waiver to Second Amended And Restated Credit Agreement dated as  of December 24, 1997, incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the quarterly period ended March 26, 1998 (SEC File  No. 000-23483), as previously filed with the Securities and Exchange  Commission. |

 

36

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| 10.3   |   | Second  Amended and Restated Credit Agreement dated as of December 24, 1997,  incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the quarterly period ended December 25, 1997 (SEC File No. 000-23483), as  previously filed with the Securities and Exchange Commission.                                                                                                                                                                                         |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4   |   | Amended and  Restated Credit Agreement dated as of February 20, 1997, incorporated by  reference to the Company’s Registration Statement on Form S-1 (SEC File No.  333-37335), as previously filed with the Securities and Exchange Commission.                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.5   |   | Re-capitalization  and Stock Purchase Agreement among the Registrant, Heller Equity Capital  Corporation (“Heller”), M.F. Vukelich Co., Michael F. Vukelich, Jerry  Halamuda, Gary E. Mariani, Steven J. Bookspan, Richard E. George and KCSN  Acquisition Company, L.P. dated as of December 31, 1996, incorporated by  reference to the Company’s Registration Statement on Form S-1 (SEC File No.  333-37335), as previously filed with the Securities and Exchange Commission. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6   |   | 8%  Subordinated Convertible Note issued to Heller, incorporated by reference to  the Company’s Registration Statement on Form S-1 (SEC File No. 333-37335), as  previously filed with the Securities and Exchange Commission.                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.7   |   | Put/Call  Option Agreement dated as of December 31, 1996, incorporated by reference to  the Company’s Registration Statement on Form S-1 (SEC File No. 333-37335), as  previously filed with the Securities and Exchange Commission.                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.8   |   | Stockholders  Agreement dated as of December 31, 1996, incorporated by reference to the  Company’s Registration Statement on Form S-1 (SEC File No. 333-37335), as  previously filed with the Securities and Exchange Commission.                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.9   |   | Employee  Stockholders Agreement dated as of June 1, 1997, incorporated by reference to  the Company’s Registration Statement on Form S-1 (SEC File No. 333-37335), as  previously filed with the Securities and Exchange Commission.                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.10  |   | Employment  Agreement with Michael F. Vukelich dated as of December 31, 1996,  incorporated by reference to the Company’s Registration Statement on Form S-1  (SEC File No. 333-37335), as previously filed with the Securities and  Exchange Commission.                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.11  |   | Employment  Agreement with Jerry L. Halamuda dated as of December 31, 1996, incorporated  by reference to the Company’s Registration Statement on Form S-1 (SEC File  No. 333-37335), as previously filed with the Securities and Exchange  Commission.                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.12  |   | 1996 Stock  Incentive Plan incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission.                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.13  |   | 1997 Stock  Incentive Plan incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission.                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.14  |   | Special  Stock Option Plan incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission.                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.15  |   | Form of  Stock Purchase Option incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission.                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.16  |   | Fee  Agreement dated as of December 31, 1996 between Registrant and Kohlberg  Company, LLC incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission.                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.17  |   | Merger  Agreement dated as of February 20, 1997 for the acquisition of Lone Star  Growers Co. incorporated by reference to the Company’s Registration Statement  on Form S-1 (SEC File No. 333-37335), as previously filed with the Securities  and Exchange Commission.                                                                                                                                                                                                                     |

 

37

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| 10.18   |   | Real Property  Lease between M.F. Vukelich Co. and the Registrant dated December 1, 1995,  incorporated by reference to the Company’s Registration Statement on Form S-1  (SEC File No. 333-37335), as previously filed with the Securities and  Exchange Commission.                                               |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.19   |   | Real  Property Lease between Michael F. Vukelich as Guardian for Trisha Vukelich  and the Registrant dated as of December 31, 1995, incorporated by reference  to the Company’s Registration Statement on Form S-1 (SEC File No. 333-37335),  as previously filed with the Securities and Exchange Commission.      |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.20   |   | Asset  Purchase Agreement dated as of March 14, 1997 between Color Spot Christmas  Trees, Inc. and Signature Trees, incorporated by reference to the Company’s  Registration Statement on Form S-1 (SEC File No. 333-37335), as previously  filed with the Securities and Exchange Commission.                      |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.21   |   | 9%  Subordinated Promissory Note issued to Oda Nursery, Inc. incorporated by  reference to the Company’s Registration Statement on Form S-1 (SEC File No.  333-37335), as previously filed with the Securities and Exchange Commission.                                                                             |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.22   |   | Stockholders  Repurchase Agreement dated as of December 31, 1996, incorporated by reference  to the Company’s Registration Statement on Form S-1 (SEC File No. 333-37335),  as previously filed with the Securities and Exchange Commission.                                                                        |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.23   |   | Amended and  Restated Employment Agreement dated as of July 30, 1998 with Boligala Raju,  incorporated by reference to the Company’s quarterly report on Form 10-Q for  the quarter ended March 25, 1999 (SEC File No. 000-23483), as previously  filed with the Securities and Exchange Commission.                |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.24   |   | 1998  Employees Stockholders Agreement incorporated by reference to the Company’s  Form 10-K for the year ended June 30, 1998 (SEC File No. 000-23483), as  previously filed with the Securities and Exchange Commission.                                                                                           |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.25   |   | Loan and  Security Agreement dated as of October 15, 1998, with Fleet Capital  Corporation as agent, incorporated by reference to the Company’s Form 10-K  for the year ended June 30, 1998 (SEC File No. 000-23483), as previously  filed with the Securities and Exchange Commission.                             |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.25.1 |   | Waiver and  Amendment to Debt Agreement dated as of September 28, 2000, with Fleet  Capital Corporation, incorporated by reference to the Company’s Form 10-K for  the year ended June 30, 2000 (SEC File No. 000-23483), as previously filed  with the Securities and Exchange Commission.                         |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.25.2 |   | Amendment to  Debt Agreement dated as of September 28, 2000, with Fleet Capital  Corporation, incorporated by reference to the Company's Form 10-KT for the  Transition Period ended December 31, 2000, (SEC File No. 000-23483), as  previously filed with the Securities and Exchange Commission.                      |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.26   |   | Subordination  Agreement dated as of October 15, 1998, between Heller, Fleet Capital  Corporation, as agent, and the Registrant, incorporated by reference to the  Company’s Form 10-K for the year ended June 30, 1998 (SEC File No.  000-23483), as previously filed with the Securities and Exchange Commission. |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.27   |   | Employment  Agreement with Richard E. Parker dated as of June 10, 1999, incorporated by  reference to the Company’s Form 10-K for the year ended June 30, 1999 (SEC  File No. 000-23483), as previously filed with the Securities and Exchange  Commission.                                                         |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.28   |   | Employment  Agreement with Joseph P. O’Neill dated as of June 10, 1999, incorporated by  reference to the Company’s Form 10-K for the year ended June 30, 1999 (SEC  File No. 000-23483), as previously filed with the Securities and Exchange  Commission.                                                    |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.29   |   | Amendment to  Employment Agreement with Michael F. Vukelich, dated June 10, 1999,  incorporated by reference to the Company’s Form 10-K for the year ended June  30, 1999 (SEC File No. 000-23483), as previously filed with the Securities  and Exchange Commission.                                               |
|    |   |                                                                                                                                                                                                                                                                                                                     |
| 10.30   |   | 8%  Subordinated Convertible Note due 2005 with Heller Equity Capital  Corporation, as previously filed as Exhibit 4.5 to the Form 10-Q for the  quarter ended September 29, 2001 and incorporated herein by reference.                                                                                                  |

 

 

38

----

 
| 10.31  |   | Registration  Rights Agreement dated as of November 20, 2001 among the Registrant and  certain holders of the 13% Senior Subordinated Notes and Series B Cumulative  Preferred Stock, as previously filed as Exhibit 4.6 to the Form 10-Q for the  quarter ended September 29, 2001 and incorporated herein by reference. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.32  |   | Second  Amended and Restated Stockholders Agreement dated as of November 20, 2001, as  previously filed as Exhibit 4.7 to the Form 10-Q for the quarter ended  September 29, 2001 and incorporated herein by reference.                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.33  |   | Amended and  Restated Loan and Security Agreement with Fleet Capital Corporation, as  agent, dated November 20, 2001, as previously filed as Exhibit 10.1 to the  Form 10-Q for the quarter ended September 29, 2001 and incorporated herein by  reference.                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.34  |   | Securities  Purchase Agreement with Catalyst Equity Fund, L.P. dated as of November 20,  2001, as previously filed as Exhibit 10.2 to the Form 10-Q for the quarter  ended September 29, 2001 and incorporated herein by reference.                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.35  |   | Employment  Agreement dated May 5, 2001 with David J. Barrett, as previously filed as  Exhibit 10.3 to the Form 10-Q for the quarter ended September 29, 2001 and  incorporated herein by reference.                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 10.36  |   | Employment  Agreement dated March 26, 2001 with Charles A. Ferer, as previously filed as  Exhibit 10.4 to the Form 10-Q for the quarter ended September 29, 2001 and  incorporated herein by reference.                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 11.1   |   | Computations  of Earnings Per Share — See Note 13 to the Notes to Consolidated Financial  Statements.                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 12.1   |   | Computation  of Ratio of Earnings to Fixed Charges. *                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 21.1   |   | Subsidiaries  of the Registrant incorporated by reference to the Company’s Registration  Statement on Form S-1 (SEC File No. 333-37335), as previously filed with the  Securities and Exchange Commission                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                      |
| 99     |   | Arthur  Andersen Representations*                                                                                                                                                                                                                                                                                         |

 

----

* Filed with this Annual Reporton Form 10-K.

 

39

----

 

**SIGNATURES**

 

Pursuant tothe requirements of Section 13 of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Date:  April 1, 2002 |                                             |                                                                  |
|---------------------------|--------------------------------------------------|-----------------------------------------------------------------------|
|                      |                                             |                                                                  |
|                      | COLOR SPOT NURSERIES, INC.a Delaware corporation |                                                                  |
|                      |                                             |                                                                  |
|                      | By:                                              |                                                                  | /s/ David J.  Barrett |   |   |
|                      | Name:                                            | David J.  Barrett                                                     |
|                      | Title:                                           | Chief  Executive Officer and Director*(Principal  Executive Officer)* |
|                           |                                                  |                                                                       |  |  |  |

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons of the Registrant and in the capacitiesand on the dates indicated:

 
| **NAME**                  |   | **TITLE**                                                                                   |   | **DATE**       |
|---------------------------|--------|---------------------------------------------------------------------------------------------|--------|----------------|
|                      |   |                                                                                        |   |           |
| /s/ David J. Barrett      |   | Chief  Executive Officer and Director                                                       |   | April 1,  2002 |
| David J. Barrett          |   | *(Principal Executive Officer)*                                                             |   |           |
|                      |   |                                                                                        |   |           |
| /s/ Charles A. Ferer      |   | Chief  Financial Officer *(Principal**Financial Officer and Principal  Accounting Officer)* |   | April 1,  2002 |
|    Charles A. Ferer  |   |                                                                                        |   |
|                      |   |                                                                                        |   |           |
| /s/ Michael F. Vukelich   |   | Chairman of  the Board                                                                      |   | April 1,  2002 |
| Michael F. Vukelich       |   |                                                                                        |   |           |
|                      |   |                                                                                        |   |           |
| /s/ Marion Antonini       |   | Vice  Chairman                                                                              |   | April 1,  2002 |
| Marion Antonini           |   |                                                                                        |   |           |
|                      |   |                                                                                        |   |           |
| /s/ Samuel P. Frieder     |   | Director                                                                                    |   | April 1,  2002 |
| Samuel P. Frieder         |   |                                                                                        |   |           |
|                      |   |                                                                                        |   |           |
| /s/ James A. Kohlberg     |   | Director                                                                                    |   | April 1,  2002 |
| James A. Kohlberg         |   |                                                                                        |   |           |
|                      |   |                                                                                        |   |           |
| /s/ Gary E. Mariani       |   | Director                                                                                    |   | April 1, 2002  |
| Gary E. Mariani           |   |                                                                                        |   |           |
|                      |   |                                                                                        |   |           |
| /s/ John S. Eastburn, Jr. |   | Director                                                                                    |   | April 1,  2002 |
| John S. Eastburn. Jr.     |   |                                                                                        |   |           |
|                      |   |                                                                                        |   |           |
| /s/ Jeffrey Serota        |   | Director                                                                                    |   | April 1,  2002 |
| Jeffrey Serota            |   |                                                                                        |   |           |

 

40

----

 

**REPORT OF INDEPENDENTPUBLIC ACCOUNTANTS**

 

To Color Spot Nurseries, Inc.and Subsidiaries:

 

We have audited the accompanying consolidated balance sheets of ColorSpot Nurseries, Inc. (a Delaware corporation) and Subsidiaries (the “Company”)as of December 31, 2001 and 2000 and the related consolidated statements ofoperations, stockholders’ equity (deficit) and cash flows for the year endedDecember 31, 2001, the six month period ended December 31, 2000 and for theyears ended June 30, 2000 and 1999. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conductedour audits in accordance with auditing standards generally accepted in theUnited States.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Color Spot Nurseries, Inc. and Subsidiaries at December 31, 2001 and 2000 andthe consolidated results of their operations and their cash flows for the yearended December 31, 2001, the six month period ended December 31, 2000 and forthe years ended June 30, 2000 and 1999 in conformity with accounting principlesgenerally accepted in the United States.

 

As explained in Note 8 to the financial statements, effective July 1,1998, the Company changed its method of accounting for organization costs in accordance with the AICPA’s Statement ofPosition 98-5, “Reporting on Costs of Start-up Activities”.

 
|                      | /s/ Arthur Andersen LLP |
|---------------------------|-------------------------|
|                      |                    |
| San Francisco, California |                    |
| March 2, 2002             |                    |

 

F-1

----

 

**COLOR SPOT NURSERIES, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

** **

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

 
|                                                                                                                               |   | **December  31,** |    | **December  31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-------------------|--------|
|                                                                                                                               |   | **2001**          |    | **2000**          |   |
|                                                                                                                               |   |              |    |              |   |
| **ASSETS**                                                                                                                         |
| CURRENT ASSETS:                                                                                                                    |   |              |    |              |   |
| Cash                                                                                                                               |   | $                 | 2,474   |              | $      | 874 |   |
| Accounts receivable, net of allowances of $1,610 and $1,935,  respectively                                                         |   | 10,955            |    | 13,940            |   |
| Receivables from employees                                                                                                         |   | 1,335             |    | 1,910             |   |
| Inventories, net                                                                                                                   |   | 48,637            |    | 45,980            |   |
| Prepaid expenses and other                                                                                                         |   | 1,558             |    | 699               |   |
| Total current assets                                                                                                               |   | 64,959            |    | 63,403            |   |
|                                                                                                                               |   |              |    |              |   |
| CHRISTMAS TREE INVENTORIES                                                                                                         |   | 8,760             |    | 8,309             |   |
| PROPERTY, PLANT AND EQUIPMENT, net                                                                                                 |   | 47,499            |    | 49,665            |   |
| ASSETS HELD FOR SALE                                                                                                               |   | —            |    | 612               |   |
| INTANGIBLE ASSETS, net                                                                                                             |   | 46,325            |    | 45,332            |   |
| DEFERRED INCOME TAXES                                                                                                              |   | —            |    | 26,387            |   |
| NOTES RECEIVABLE AND  OTHER  ASSETS                                                                                           |   | 639               |    | 995               |   |
| Total assets                                                                                                                       |   | $                 | 168,182 |              | $      | 194,703 |   |
|                                                                                                                               |   |              |    |              |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                            |
| CURRENT LIABILITIES:                                                                                                               |   |              |    |              |   |
| Accounts payable                                                                                                                   |   | $                 | 6,313   |              | $      | 5,737 |   |
| Bank overdrafts                                                                                                                    |   | 5,314             |    | 4,822             |   |
| Accrued liabilities                                                                                                                |   | 14,544            |    | 18,424            |   |
| Dividends payable to stockholders                                                                                                  |   | 738               |    | 317               |   |
| Deferred income taxes                                                                                                              |   | —            |    | 13,392            |   |
| Current maturities of long-term debt                                                                                               |   | 36,027            |    | 36,455            |   |
| Total current liabilities                                                                                                          |   | 62,936            |    | 79,147            |   |
|                                                                                                                               |   |              |    |              |   |
| LONG-TERM DEBT                                                                                                                     |   | 80,246            |    | 110,768           |   |
| OTHER LONG-TERM LIABILITIES                                                                                                        |   | 600               |    | —            |   |
| Total liabilities                                                                                                                  |   | 143,782           |    | 189,915           |   |
|                                                                                                                               |   |              |    |              |   |
| REDEEMABLE PREFERRED STOCK (See Note 12)                                                                                           |   | 108,405           |    | 50,641            |   |
| REDEEMABLE COMMON STOCK, $0.001 par value, 1,080,510 and 1,143,339  shares issued and outstanding, respectively               |   | 22                |    | 3,383             |   |
| STOCKHOLDERS’ EQUITY (DEFICIT):                                                                                               |   |              |    |              |   |
| Common stock, $0.001 par value, 50,000,000 shares authorized,  6,105,498and 5,805,258 shares issued  and outstanding, respectively |   | 12                |    | 12                |   |
| Additional paid-in capital                                                                                                         |   | 51,846            |    | 51,822            |   |
| Treasury stock, 5,989,238 and 6,226,649 shares, respectively                                                                       |   | (45,651           | )       | (45,651           | )      |
| Warrants, 825,000 exercisable at $0.01 per share                                                                                   |   | 8,250             |    | 8,250             |   |
| Accumulated deficit                                                                                                                |   | (98,484           | )       | (63,669           | )      |
| Total stockholders’ deficit                                                                                                   |   | (84,027           | )       | (49,236           | )      |
| Total liabilities and stockholders' deficit                                                                                        |   | 168,182           |    | 194,703           |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-2

----

 

 

**COLOR SPOT NURSERIES, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(in thousands, exceptper share data)**

 
|                                                                                     |   | **Years  Ended  December 31,** |    | **Six Months  Ended  December 31,** |   | **Fiscal  Years Ended  June 30** |   |            |
|------------------------------------------------------------------------------------------|--------|--------------------------------|---------|-------------------------------------|--------|----------------------------------|--------|-----------------|
|                                                                                     |   | **2001**                       |    | **2000**                            |   | **2000**                         |   | **1999**        |   | **2000** |   | **1999** |   |   |
|                                                                                     |   |                           |    | **(Unaudited)**                     |   |                             |   | **(Unaudited)** |   |   |   |   |   |   |
| NET SALES                                                                                |   | $                              | 191,225 |                                | $      | 209,584                          |   | $               | 74,482 |   | $ | 75,785 |   | $ | 210,887 |   | $ | 206,076 |   |   |
| COST OF SALES                                                                            |   | 114,788                        |    | 136,298                             |   | 52,734                           |   | 47,327          |   | 130,891 |   | 117,793 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Gross profit                                                                             |   | 76,437                         |    | 73,286                              |   | 21,748                           |   | 28,458          |   | 79,996 |   | 88,283 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| SALES, MARKETING AND DELIVERY EXPENSES                                                   |   | 45,952                         |    | 51,656                              |   | 20,578                           |   | 19,284          |   | 50,362 |   | 46,252 |   |   |
| GENERAL AND ADMINISTRATIVE EXPENSES                                                      |   | 22,131                         |    | 18,273                              |   | 9,615                            |   | 12,182          |   | 20,840 |   | 25,610 |   |   |
| AMORTIZATION OF INTANGIBLE ASSETS                                                        |   | 1,471                          |    | 1,637                               |   | 779                              |   | 861             |   | 1,719 |   | 1,727 |   |   |
| RESTRUCTURING COSTS                                                                      |   | 3,328                          |    | —                              |   | —                           |   | —          |   | — |   | — |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Income (loss) from operations                                                            |   | 3,555                          |    | 1,720                               |   | (9,224                           | )      | (3,869          | ) | 7,075 |   | 14,694 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| INTEREST EXPENSE                                                                         |   | 14,866                         |    | 16,846                              |   | 8,542                            |   | 7,658           |   | 15,962 |   | 16,464 |   |   |
| OTHER EXPENSE (INCOME), net                                                              |   | 246                            |    | (1,092                              | )      | 265                              |   | 97              |   | (1,260 | ) | 355 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Loss before income taxes                                                                 |   | (11,557                        | )       | (14,034                             | )      | (18,031                          | )      | (11,624         | ) | (7,627 | ) | (2,125 | ) |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| INCOME TAX BENEFIT (PROVISION)                                                           |   | (12,993                        | )       | 2,133                               |   | 5,934                            |   | 4,592           |   | 791 |   | 727 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Loss before cumulative effect of change in  accounting principle and extraordinary loss  |   | (24,550                        | )       | (11,901                             | )      | (12,097                          | )      | (7,032          | ) | (6,836 | ) | (1,398 | ) |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| CUMMULATIVE EFFECT OF CHANGE IN ACCOUNTING  PRINCIPLE, net of tax benefit                |   | —                         |    | —                              |   | —                           |   | —          |   | — |   | 1,718 |   |   |
| EXTRAORDINARY LOSS, net of tax benefit                                                   |   | —                         |    | —                              |   | —                           |   | —          |   | — |   | 1,018 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Net loss                                                                                 |   | (24,550                        | )       | (11,901                             | )      | (12,097                          | )      | (7,032          | ) | (6,836 | ) | (4,134 | ) |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| STOCK DIVIDENDS / ACCRETION                                                              |   | 10,265                         |    | 8,394                               |   | 4,309                            |   | 3,866           |   | 7,951 |   | 7,102 |   |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Net loss applicable to common stock                                                      |   | $                              | (34,815 | )                                   | $      | (20,295                          | )      | $               | (16,406 | ) | $ | (10,898 | ) | $ | (14,787 | ) | $ | (11,236 | ) |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Basic and diluted loss per common share:                                                 |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Loss before cummulative effect of change in  accounting principle and extraordinary loss |   | $                              | (5.01   | )                                   | $      | (2.92                            | )      | $               | (2.36 | ) | $ | (1.57 | ) | $ | (2.13 | ) | $ | (1.22 | ) |   |
| Cumulative effect of change in accounting  principle                                     |   | —                         |    | —                              |   | —                           |   | —          |   | — |   | (0.25 | ) |   |
| Extraordinary loss                                                                       |   | —                         |    | —                              |   | —                           |   | —          |   | — |   | (0.15 | ) |   |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Totals                                                                                   |   | $                              | (5.01   | )                                   | $      | (2.92                            | )      | $               | (2.36 | ) | $ | (1.57 | ) | $ | (2.13 | ) | $ | (1.62 | ) |
|                                                                                     |   |                           |    |                                |   |                             |   |            |   |   |   |   |   |   |
| Weighted average number of shares outstanding                                            |   | 6,948,597                      |    | 6,948,597                           |   | 6,948,597                        |   | 6,951,904       |   | 6,950,238 |   | 6,941,022 |   |   |
|                                                                                          |        |                                |         |                                     |        |                                  |        |                 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-3

----

 

**COLOR SPOTNURSERIES, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)**

** **

**(inthousands, except common shares)**

 
|                                                              |   | **Common********Shares** | **  ** | **Common  Stock** | ** **** ** | **Additional  Paid-In  Capital** | ** ** | **Treasury  Stock** | ** ** | **Warrants** | ** ** | **Retained  Earnings  (Accumulated********Deficit)** | **  ** | **Total  Stockholders’  Equity  (Deficit)** |   | **Comprehensive  Loss** |    |
|-------------------------------------------------------------------|--------|--------------------------|------------------|-------------------|----------------------|----------------------------------|------------|---------------------|------------|--------------|------------|------------------------------------------------------|------------------|--------------------------------------------------|--------|-------------------------|---------|
| Balance, June 30, 1998                                            |   | 5,773,518                |             | $                 | 12                   |                             | $          | 50,975              |       | $            | (45,488    | )                                                    | $                | 8,250                                            |   | $                       | (21,240 | ) | $ | (7,491 | ) | $ | (21,960 | ) |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Accretion of Series A preferred stock                             |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (833                                                 | )                | (833                                             | )      | —                  |    |
| Accretion of redeemable common stock                              |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (443                                                 | )                | (443                                             | )      | —                  |    |
| Exercise of stock options                                         |   | 37,950                   |             | —            |                 | 54                               |       | —              |       | —       |       | —                                               |             | 54                                               |   | —                  |    |
| Series A preferred stock dividends                                |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (5,826                                               | )                | (5,826                                           | )      | —                  |    |
| Other                                                             |   | —                   |             | —            |                 | 329                              |       | (145                | )          | —       |       | —                                               |             | 184                                              |   | —                  |    |
| Net loss                                                          |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (4,134                                               | )                | (4,134                                           | )      | (4,134                  | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Balance, June 30, 1999                                            |   | 5,811,468                |             | 12                |                 | 51,358                           |       | (45,633             | )          | 8,250        |       | (32,476                                              | )                | (18,489                                          | )      | (4,134                  | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Accretion of Series A preferred stock                             |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (855                                                 | )                | (855                                             | )      | —                  |    |
| Accretion of redeemable common stock                              |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (463                                                 | )                | (463                                             | )      | —                  |    |
| Series A preferred stock dividends                                |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (6,633                                               | )                | (6,633                                           | )      | —                  |    |
| Other                                                             |   | (6,210                   | )                | —            |                 | 310                              |       | (18                 | )          | —       |       | —                                               |             | 292                                              |   | —                  |    |
| Net loss                                                          |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (6,836                                               | )                | (6,836                                           | )      | (6,836                  | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Balance, June 30, 2000                                            |   | 5,805,258                |             | 12                |                 | 51,668                           |       | (45,651             | )          | 8,250        |       | (47,263                                              | )                | (32,984                                          | )      | (6,836                  | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Accretion of Series A preferred stock                             |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (433                                                 | )                | (433                                             | )      | —                  |    |
| Accretion of redeemable common stock                              |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (231                                                 | )                | (231                                             | )      | —                  |    |
| Series A preferred stock dividends                                |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (3,645                                               | )                | (3,645                                           | )      | —                  |    |
| Other                                                             |   | —                   |             | —            |                 | 154                              |       | —              |       | —       |       | —                                               |             | 154                                              |   | —                  |    |
| Net loss                                                          |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (12,097                                              | )                | (12,097                                          | )      | (12,097                 | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Balance, December 31, 2000                                        |   | 5,805,258                |             | 12                |                 | 51,822                           |       | (45,651             | )          | 8,250        |       | (63,669                                              | )                | (49,236                                          | )      | (12,097                 | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Accretion of preferred stock                                      |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (1,182                                               | )                | (1,182                                           | )      | —                  |    |
| Accretion of redeemable common stock and adjustment to fair value |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | 3,360                                                |             | 3,360                                            |   | —                  |    |
| Issuance of new stock                                             |   | 300,240                  |             | —            |                 | 24                               |       | —              |       | —       |       | —                                               |             | 24                                               |   |                    |    |
| Preferred stock dividends                                         |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (12,443                                              | )                | (12,443                                          | )      | —                  |    |
| Net loss                                                          |   | —                   |             | —            |                 | —                           |       | —              |       | —       |       | (24,550                                              | )                | (24,550                                          | )      | (24,550                 | )       |
|                                                              |   |                     |             |              |                 |                             |       |                |       |         |       |                                                 |             |                                             |   |                    |    |
| Balance, December 31, 2001                                        |   | 6,105,498                |             | $                 | 12                   |                             | $          | 51,846              |       | $            | (45,651    | )                                                    | $                | 8,250                                            |   | $                       | (98,484 | ) | $ | (84,027 | ) | $ | (24,550 | ) |

The accompanying notes are an integral part of these consolidatedfinancial statements.

F-4

----

 

**COLOR SPOT NURSERIES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOW**

**(in thousands)**

 
|                                                                             |   | **Years  Ended  December 31,** |    | **Six Months  Ended  December 31,** |    | **Fiscal  Years Ended  June 30,** |   |
|----------------------------------------------------------------------------------|--------|--------------------------------|---------|-------------------------------------|---------|-----------------------------------|--------|
|                                                                             |   | **2001**                       |    | **2000**                            |    | **2000**                          |   | **1999** |   | **2000** |   | **1999** |   |
|                                                                             |   |                           |    | **(Unaudited)**                     |    |                              |   | **(Unaudited)** |   |   |   |   |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                           |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Net loss                                                                         |   | $                              | (24,550 | )                                   | $       | (11,901                           | )      | $ | (12,097 | ) | $ | (7,032 | ) | $ | (6,836 | ) | $ | (4,134 | ) |
| Adjustments to reconcile net loss to net cash provided by operating  activities: |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Depreciation and amortization                                                    |   | 8,767                          |    | 7,734                               |    | 3,811                             |   | 3,900 |   | 7,823 |   | 7,205 |   |
| Loss (gain) on sale of fixed assets                                              |   | 190                            |    | (1,348                              | )  | 107                               |   | — |   | (1,455 | ) | — |   |
| Interest paid in kind                                                            |   | 3,670                          |    | 746                                 |    | 382                               |   | 336 |   | 700 |   | 660 |   |
| Deferred income taxes                                                            |   | 12,993                         |    | (2,156                              | )       | (5,934                            | )      | (4,592 | ) | (814 | ) | (2,141 | ) |
| Write-off of deferred financing costs                                            |   | —                         |    | —                              |    | —                            |   | — |   | — |   | 2,612 |   |
| Cumulative effect of change in accounting principle                              |   | —                         |    | —                              |    | —                            |   | — |   | — |   | 1,547 |   |
| Changes in operating assets and liabilities:                                     |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Decrease in accounts receivable                                                  |   | 2,985                          |    | 3,112                               |    | 3,899                             |   | 969 |   | 923 |   | 9,521 |   |
| Decrease (increase) in receivables from employees                                |   | 575                            |    | (300                                | )       | (300                              | )      | 325 |   | (416 | ) | (1,071 | ) |
| Decrease (increase) in inventories                                               |   | (2,657                         | )       | 838                                 |    | (6,991                            | )      | (13,743 | ) | (5,914 | ) | 9,231 |   |
| Decrease (increase) in prepaid expenses and other current assets                 |   | (859                           | )       | 611                                 |    | (270                              | )      | (587 | ) | 294 |   | 1,080 |   |
| Increase in Christmas tree inventory                                             |   | (451                           | )       | (2,846                              | )       | (1,104                            | )      | (714 | ) | (2,456 | ) | (1,142 | ) |
| Decrease (increase) in notes receivable and other assets                         |   | 356                            |    | 135                                 |    | (29                               | )      | 120 |   | 284 |   | 196 |   |
| Increase (decrease) in accounts payable                                          |   | 576                            |    | (3,147                              | )       | (5,812                            | )      | 3,696 |   | 6,361 |   | (11,117 | ) |
| Increase (decrease) in accrued liabilities                                       |   | 780                            |    | 9,633                               |    | 8,067                             |   | 7,911 |   | 9,477 |   | 2,769 |   |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Net cash provided by (used in) operating activities                              |   | 2,375                          |    | 1,111                               |    | (16,271                           | )      | (9,411 | ) | 7,971 |   | 15,216 |   |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                           |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Purchases of fixed assets                                                        |   | (5,142                         | )       | (8,460                              | )       | (3,032                            | )      | (661 | ) | (6,089 | ) | (2,176 | ) |
| Proceeds from sale of fixed assets                                               |   | 431                            |    | 1,940                               |    | —                            |   | — |   | 1,940 |   | — |   |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Net cash used in investing activities                                            |   | (4,711                         | )       | (6,520                              | )       | (3,032                            | )      | (661 | ) | (4,149 | ) | (2,176 | ) |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                           |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Net increase (decrease) in cash overdrafts                                       |   | 492                            |    | (7,614                              | )       | (3,146                            | )      | 642 |   | (3,826 | ) | 824 |   |
| Purchase of treasury stock                                                       |   | —                         |    | (18                                 | )       | (18                               | )      | (18 | ) | (18 | ) | (18 | ) |
| Purchase of treasury stock                                                       |   | —                         |    | —                              |    | —                            |   | (18 | ) | (18 | ) | (85 | ) |
| Financing and restructuring costs                                                |   | (7,949                         | )       | 25                                  |    | —                            |   | — |   | 25 |   | (2,087 | ) |
| Proceeds from issuance of long-term debt                                         |   | 12,000                         |    | —                              |    | —                            |   | — |   | — |   | — |   |
| Net borrowings under revolving line of credit                                    |   | 178                            |    | 14,043                              |    | 21,907                            |   | 9,078 |   | 1,214 |   | 19,783 |   |
| Repayments on revolving line of credit                                           |   | —                         |    | —                              |    | —                            |   | — |   | — |   | (31,338 | ) |
| Repayments of long-term debt                                                     |   | (785                           | )       | (769                                | )       | (346                              | )      | (452 | ) | (875 | ) | (961 | ) |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Net cash provided by (used in) financing activities                              |   | 3,936                          |    | 5,685                               |    | 18,415                            |   | 9,250 |   | (3,480 | ) | (13,864 | ) |
|                                                                             |   |                           |    |                                |    |                              |   | — |   |   |   | — |   |
| NET  INCREASE (DECREASE) IN CASH                                                 |   | 1,600                          |    | 276                                 |    | (888                              | )      | (822 | ) | 342 |   | (824 | ) |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| CASH  AT BEGINNING OF PERIOD                                                     |   | 874                            |    | 598                                 |    | 1,762                             |   | 1,420 |   | 1,420 |   | 2,244 |   |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| CASH  AT END OF PERIOD                                                           |   | $                              | 2,474   |                                | $       | 874                               |   | $ | 874 |   | $ | 598 |   | $ | 1,762 |   | $ | 1,420 |   |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                               |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Cash paid during the period for:                                                 |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Interest                                                                         |   | $                              | 9,671   |                                | $       | 16,865                            |   | $ | 8,380 |   | $ | 7,438 |   | $ | 15,923 |   | $ | 14,679 |   |
| Income taxes                                                                     |   | $                              | 25      |                                | $       | 63                                |   | $ | — |   | $ | 26 |   | $ | 89 |   | $ | 34 |   |
|                                                                             |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| SUPPLEMENTAL  DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:         |   |                           |    |                                |    |                              |   |   |   |   |   |   |   |
| Stock dividends / accretion                                                      |   | $                              | 10,265  |                                | $       | 8,394                             |   | $ | 4,309 |   | $ | 3,866 |   | $ | 7,951 |   | $ | 7,102 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-5

----

 

COLOR SPOT NURSERIES, INC. ANDSUBSIDIARIES

 

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

**1.      BASIS OF PRESENTATION, OPERATIONS ANDCERTAIN BUSINESS RISKS**

 

*BASIS OFPRESENTATION*

 

Theaccompanying consolidated financial include the accounts of Color SpotNurseries, Inc., a Delaware corporation, and its wholly owned subsidiaries(“the Company”) and are prepared in conformity with generally acceptedaccounting principles in the United States. Effective July 1, 2000, the Companychanged its fiscal year end from June 30 to December 31.  Accordingly, a transition report was filedfor the six month period ending December 31, 2000.  As a result of the significant seasonality in the Company’sbusiness, the six-month and twelve-month results included herein are notcomparable.

 

*OPERATIONS*

 

Color SpotNurseries is one of the largest wholesale nurseries in the United States, basedon revenue and greenhouse square footage. The Company provides a wideassortment of high quality plants, including packaged bedding plants, floweringpotted plants, groundcover, ornamental plants and shrubs, and fresh-cutChristmas trees. As of December 31, 2001, the Company operates 13 productionfacilities located in 4 states.  TheCompany also owns or leases growing fields for Christmas trees in Oregon,Michigan, North Carolina, and Tennessee. The Company sells primarily to leading home centers and mass merchants,and to independent garden centers and commercial landscapers, locatedpredominantly in California, Texas and other western states.  The Company conducts its operations throughone reportable segment.

 

##### *CERTAINBUSINESS RISKS*

 

Beginning in 1998, and from time-to-time thereafter, the Company hasexperienced financial difficulties.  Asa result, in several periods, the Company violated its debt covenants and hastaken certain charges relating to restructuring its operations, debt and equity.During this period there has been significant management turnover.  In November 2001, the Company substantiallyrestructured its debt (see Notes 9, 11, and 12).  Terms of the new debt and equity arrangements are restrictive andinclude numerous financial and non-financial covenants.  The Company is highly leveraged, hassignificant debt service obligations, including maturity of its line of crediton September 15, 2003, and has other business risks.  Key business risk include, but are not limited to, customerconcentration, reliance on key vendors, weather and general agricultural risks,governmental regulations, sensitivity to labor, utility or raw material priceincreases, competition, litigation, and dependence on leased facilities.

 

The Company’s debt service obligations have important consequences toholders of its debt and equity securities including the following: (i) asubstantial portion of its cash flow from operations will be dedicated to thepayment of principal and interest on its debt, thereby reducing the fundsavailable for operations, acquisitions, future business opportunities and otherpurposes and increasing its vulnerability to adverse general economic andindustry conditions; (ii) its leveraged position may increase its vulnerabilityto competitive pressures; (iii) the amended financial covenants and otherrestrictions contained in the instruments governing its indebtedness andcapital stock  will require the Companyto meet certain financial tests and will restrict its ability to borrowadditional funds, to dispose of assets or to pay cash dividends on, orrepurchase, preferred or common stock; and (iv) funds available for workingcapital, capital expenditures, acquisitions and general corporate purposes maybe limited.

 

The Company’s ability to make scheduled principal and interest paymentsor to refinance its indebtedness to pay dividends and make redemption paymentson its preferred stock and to pay dividends on its common stock depends onfuture performance, which to a certain extent is subject to economic,financial, competitive and other factors beyond its control.  There can be no assurance that the Companywill generate sufficient cash flow from operations in the future to service itsdebt, pay dividends, make redemption payments and fund necessary capitalexpenditures.  If unable to do so, theCompany may be 

 

F-6

----

 

required to refinance all or aportion of its existing debt, sell assets or obtain additional financing.  There can be no assurance that any suchrefinancing or that any such sale of assets or additional financing would bepossible on terms reasonably favorable to the Company, or at all.  In addition, unforeseen problems, delays,expenses and difficulties as well as changes in economic and regulatory orcompetitive conditions may lead to cost increases that could cause theCompany’s current cash flow and availability under its credit agreement withFleet Capital Corporation and certain other lenders (the “Amended LoanAgreement”) to be insufficient to meet its operating needs.

 

The AmendedLoan Agreement restricts, among other things, the Company’s ability to incuradditional indebtedness, incur liens, pay or declare dividends, enter into anytransaction not in the ordinary course of business, guarantee or otherwisebecome in any way liable with respect to the obligations of another party orentity, merge or consolidate with another person, or sell or transfer anycollateral (except for the sale of inventory in the ordinary course ofbusiness).  A breach of any of thesecovenants could result in a default. Upon the occurrence of an Event of Default (as defined in the AmendedLoan Agreement), the lenders could elect to declare all amounts outstanding,together with accrued interest, to be immediately due and payable.  If the Company was unable to pay thoseamounts the lenders could proceed against the collateral granted to them tosecure that indebtedness.  If theindebtedness under the Amended Loan Agreement were to be accelerated, there canbe no assurance that the Company’s assets would be sufficient to repay theindebtedness.  Substantially all of theCompany’s assets are pledged as security under the Amended Loan Agreement.  The restrictions described above, incombination with the Company’s leveraged nature, may limit the Company’sability to obtain financing in the future or may otherwise restrict corporateactivities.

 

The accompanying financial statements wereprepared contemplating the realization of all recorded assets, and thesatisfaction of liabilities in the normal course of business.  Ultimately, the Company must generate sufficient cash flow to meet its obligationsas they come due, comply with the terms of its debt and equity facilities,including meeting its financial covenants, and ultimately attain profitabilityand achieve other business objectives or there will be a material adverseimpact on its business, financial position and results of operations.  No assurance can be provided that theCompany will be able to attain profitability or achieve its business objectivesor that assets will be realizable at their carrying values.

 

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*PRINCIPLES OF CONSOLIDATION*

 

Theconsolidated financial statements include the accounts of Color Spot Nurseries,Inc. and its wholly owned subsidiaries. All material intercompany amounts andtransactions have been eliminated in consolidation.

 

*USE OF ESTIMATES*

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

*INVENTORIES*

 

Inventoriesare stated at the lower of cost or market. Cost is determined using the averagecost method. Christmas tree inventories are stated at average cost and areclassified as long-term assets until they are harvested. Inventory costsinclude material, labor and production costs directly associated with the 

 

F-7

----

 

growing process.  Direct costs associated with inventoryshrinkage are charged to cost of sales as a period expense. Reserves arerecorded for excess inventory.

 

*PROPERTY, PLANT AND EQUIPMENT*

 

Property,plant and equipment purchased in acquisitions are recorded at fair value asprescribed by the purchase method of accounting.  Subsequent purchases of property, plant and equipment arerecorded at cost, less accumulated depreciation. For assets held which arefinanced under capital leases, the present value of the future minimum lease paymentsis recorded at the date of acquisition as equipment, with a correspondingamount recorded as a capital lease obligation. Depreciation is computed on a straight-line basis over the followingestimated useful lives:

 
| **Asset Classification**  |   | **Estimated  Useful Life** |   |
|---------------------------|--------|----------------------------|--------|
| Land Improvements         |   | 40 years                   |   |
| Greenhouses and Buildings |   | 15 to 20  years            |   |
| Machinery and equipment   |   | 5 to 10  years             |   |
| Computer equipment        |   | 3 to 5 years               |   |
| Furniture and fixtures    |   | 5 to 10  years             |   |
| Leasehold improvements    |   | Life of  lease             |   |

 

Major renewalsand improvements that extend the useful life of an asset are capitalized;routine maintenance and repairs are expensed as incurred.  Upon sale or retirement of assets, the assetcost and related depreciation are removed from the accounts and any relatedgain or loss is reflected in the Company’s operating results.

 

*SOFTWARE*

 

The Companyadopted SOP 98-1, “Accounting for Costs of Computer Software Developed orObtained for Internal Use,” for the fiscal year ended June 30, 2000. SOP 98-1requires certain costs for computer software developed or obtained for internaluse to be capitalized.  Capitalizedsoftware is carried at cost less accumulated amortization and is amortized overthree to five years on a straight-line basis.

 

*INTANGIBLE ASSETS AND ASSET IMPAIRMENT*

 

Amortizationof intangible assets is computed on a straight-line basis over the shorter ofestimated useful lives or contract periods. The following useful lives are usedfor recognizing amortization expense:

 
| **Intangible  Category** |   | **Estimated  Useful Life** |   |
|--------------------------|--------|----------------------------|--------|
| Goodwill                 |   | 40 years                   |   |
| Noncompete agreements    |   | 5 years                    |   |
| Financing costs          |   | 2 to 3 years               |   |

 

Goodwillrepresents the excess of cost over the estimated fair value of the net assetsof acquired businesses. Periodically, if a triggering event occurs, the Companywill evaluate the remaining useful life and balance of goodwill and makeappropriate adjustments.  The Company’sprincipal considerations in determining impairment include the strategicbenefit of its particular business related to the questioned component ofgoodwill as measured by undiscounted current and expected future operatingincome levels of that particular business and expected undiscounted future cashflows.  If the carrying amount of anasset exceeds the expected future undiscounted cash flows, the Company measuresand records an impairment loss for the excess of the carrying value of theasset over its fair value.

 

F-8

----

 

Long-livedassets, certain identifiable intangible assets and goodwill will be reviewedfor impairment when expected future undiscounted cash flows are less than thecarrying value of the asset. No charges were recorded pursuant to SFAS 121,“Accounting for the Impairment of Long-Lived Assets to be Disposed of”, in theyear ended December 31, 2001, the six-month period ended December 31, 2000, orthe years ended June 30, 2000 or 1999.

 

*INSURANCE RESERVES*

 

The Company ispartially self-insured for workers compensation, auto and general liabilityinsurance.  The Company establishesreserves for the estimated ultimate losses expected to arise out of reported aswell as potential unreported claims incurred during the period.  The Company periodically reviews suchreserves and records necessary adjustments based upon claims experience.  Actual losses could differ from accruedamounts.

 

*REDEEMABLE PREFERRED STOCK AND WARRANTS*

 

TheCompany is required to redeem all outstanding shares of preferred stock at aprice equal to the liquidation preference (see Note 12), plus accrued andunpaid dividends, if any, at certain mandatory redemption dates.  The difference between the carrying amountand redemption amount is accreted over the period from the date of issuance tothe date of mandatory redemption.  As aresult of the mandatory redemption feature, redeemable preferred stock isclassified outside of stockholders’ equity. Warrants are recorded at theirestimated fair value on the date of issuance.

 

*REDEEMABLE COMMON STOCK*

 

Subject to theterms of the Amended Loan Agreement, the Company is required to repurchaseshares of common stock from certain management stockholders in the event oftheir termination due to their death or permanent disability. Such repurchasesare at fair market value as determined by the Board of Directors.  The Board of Directors will retain an independentappraisal firm to assist them in determining the fair market value of thecommon stock on a periodic basis. The difference between the carrying amount ofthe redeemable common stock and its fair value is accreted over the lifeexpectancy of the management stockholders by charging retained earnings.  As a result of the redemption feature,redeemable common stock is classified outside of stockholders’ equity(irrespective of voting rights of the stock). In 2001, redeemable common stock was decreased to $22,000 to reflect theestimated value of the Company’s common stock.

 

*FINANCIAL INSTRUMENTS*

 

The carryingamounts for cash, accounts receivables, notes receivable and accounts payableapproximate fair value due to the short-term nature of these instruments. Otherfair value disclosures are in the respective notes.

 

In order todecrease its exposure to unfavorable interest rate movements, the Company may,from time to time, purchase interest rate protection agreements to cap theinterest rates on its floating rate obligations.  If interest rates exceed the interest rate on the interest rateprotection agreement, the Company’s counterparty will pay it the differentialbetween the interest due on a floating basis and the interest due on the fixedbasis. Payments made by counterparties are recorded as a reduction of interestexpense in the period earned.  TheCompany does not have outstanding interest rate protection agreements as ofDecember 31, 2001.

 

F-9

----

 

*REVENUE RECOGNITION*

 

Revenue isrecognized upon delivery of goods to the customer. Sales returns and allowancesare estimated and recorded as a charge against revenue in the period in whichthe related sales are recognized. Provisions for returns and allowances are estimated based on historicaltrends and information from customers.

 

*SHIPPING AND HANDLING FEES AND COSTS*

 

In accordancewith EITF 00-10, “Accounting for Shipping and Handling Fees and Costs,” amountsbilled to a customer in a sales transaction related to shipping and handlingare classified as revenue.  Costsincurred by the Company for shipping and handling are classified in sales,marketing and delivery expenses. Shipping and handling costs were $25.1 million,$28.9 million, $11.9 million, $10.5 million, $27.5 million and $26.2 millionfor the year ended December 31, 2001, the twelve months ended December 31,2000, the six months ended December 31, 2000 and 1999 and for the fiscal yearsended June 30, 2000 and 1999, respectively.

 

*RESTRUCTURING COSTS*

 

Restructuring costs include amounts paid to variousfinancial advisors in connection with the Company’s debt restructuring (seeNotes 9,11 and 12) that were not directly attributable to new debt or equity.

 

*OTHER (INCOME)/EXPENSE, NET*

 

Other(income)/expense, net includes net gains and losses on the sale of assets.

 

*INCOME TAXES*

 

Income taxesare recognized utilizing the asset and liability method under which deferredincome taxes are recognized for the consequences of temporary differences byapplying currently enacted statutory rates to differences between the financialstatement carrying amounts and the tax basis of existing assets andliabilities.  A valuation allowance isprovided for deferred tax assets if their realizability is uncertain.

 

*EARNINGS PER SHARE*

 

Basic earningsper share is calculated by dividing net income by the weighted average numberof shares of common stock outstanding during the period. Diluted earnings pershare include the impact of common stock options, warrants outstanding andother convertible securities, if dilutive.

 

*BANK OVERDRAFTS*

 

Bankoverdrafts include net outstanding checks not yet presented to a bank forsettlement.

 

*STOCK DIVIDENDS / ACCRETION*

 

Stockdividends / accretion include dividends on the Company’s preferred stock,accretion to liquidation value of the preferred stock and redeemable commonstock, and adjustments to fair value on redeemable common stock.

 

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*ACCOUNTING FOR STOCK-BASEDCOMPENSATION*

 

The Companyaccounts for stock-based compensation plans in accordance with APB Opinion No.25 under which compensation cost is recorded as the difference between the fairvalue and the exercise price at the date of grant and is recorded on astraight-line basis over the vesting period of the underlying options. TheCompany has adopted the disclosure-only provision of SFAS No. 123, “Accountingfor Stock-Based Compensation”.

 

*RECENTACCOUNTING PRONOUNCEMENTS*

 

InJuly 2001, the Financial Accounting Standards Board (“FASB”) issued Statementof Accounting Standards No. 141, “Business Combinations” (“SFAS 141”) andStatement of Accounting Standards No. 142, “Accounting for Goodwill” (“SFAS142”).  SFAS 141 requires that allbusiness combinations be accounted for using the purchase method of accounting;use of the pooling-of-interests method is prohibited.  The provisions of the statement apply to all businesscombinations initiated after June 30, 2001. The Company does not expect that SFAS 141 will have a material impact onits consolidated financial statements. SFAS 142 establishes accounting standards for existing goodwill relatedto purchase business combinations. SFAS 142 requires the Company to discontinuethe periodic amortization of goodwill effective January 1, 2002.  Additionally, the Statement requires theCompany to evaluate all unamortized goodwill for possible impairment within thefirst six months of fiscal 2002 based on new valuation criteria set forth inthe Statement.  All provisions of SFAS142 must be applied for the fiscal year beginning January 1, 2002 to all of theCompany’s goodwill and other intangible assets, regardless of when those assetswere initially recognized.  At thistime, the Company cannot reasonably estimate the impact of this statement ontheir consolidated financial statements; however, the effect may be material.

 

In August2001, the FASB issued SFAS No. 143, “Accounting for Asset RetirementObligations.” SFAS No. 143 establishes accounting standards for recognition andmeasurement of an asset retirement obligation and an associated assetretirement cost and is effective for fiscal year 2003. The Company does notexpect SFAS No. 143 to have a material impact on its financial position or theresults of its operations.

 

The FASBissued SFAS 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” dated August 2001. This statement supercedes SFAS 121,” Accounting forthe Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposedof,” and the accounting and reporting provisions of APB Opinion No. 30,“Reporting Results of Operations - Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently OccurringEvents and Transactions.”  SFAS 144requires that the same accounting model be used for long-lived assets to bedisposed of by sale, whether previously held and used or newly acquired, and itbroadens the presentation of discontinued operations to include more disposaltransactions. The Company will adopt the provisions of SFAS 144 on the firstday of fiscal year 2003 and is currently evaluating the impact SFAS 144 mayhave on its financial position and results of operations.

 

**3. CONCENTRATION OF CUSTOMERS AND CREDIT RISK**

 

Financialinstruments that potentially subject the Company to concentration of creditrisk consist primarily of trade accounts receivable. The Company sellsprimarily on 10-day and 30-day terms, performs credit evaluation procedures onits customers and generally does not require collateral on its accountsreceivable because the majority of its customers are large, established retailcustomers with operations throughout the United States. A majority of theCompany’s sales are in California and Texas. The Company maintains an allowancefor potential credit losses. For the year ended December 31, 2001 and 2000, thesix months ended December 31, 2000 and for the fiscal years ended June 30,2000, and 1999, sales to the eight largest customers constituted 84%, 78%, 77%,75%, and 70% of net sales, respectively.  Sales to the Company’s largest customer constituted 45%, 42%, 41%,41%, and 37% of net sales in these respective periods. Accounts receivable 

 

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balances generally reflect thenet sales percentages for the Company’s largest customers. The loss of, orreduction in orders from, any major retail customer could have a materialadverse effect on the Company.

 

During fiscalyear 2001, sales to K-Mart accounted for approximately 9% of the Company’stotal net sales. In January 2002, K-Mart and certain of its subsidiaries filedvoluntary petitions for relief under Chapter 11 of the United State BankruptcyCode in the United States Bankruptcy Court for the Northern District ofIllinois, and in March 2002, announced that it intends to close 284under-performing stores located in 40 states, as part of its initial Chapter 11financial objectives review. Although certain of the projected storeclosures are located within the Company’s target market, to date the Companyhas not experienced a decline in consolidated sales to K-Mart. Moreover, K-Marthas requested additional product for certain stores and assured the Companythat it will continue to pay on a 30-day cycle. However, if K-Mart is forced toclose additional stores as a result of its bankruptcy reorganization, the lossof, or reduction in orders, or the Company’s inability to collect accountsreceivables from K-Mart, could have a material adverse effect on the Company,its business and operations.

 

**4. INVENTORIES**

 

Inventories atDecember 31, 2001 and 2000 consisted of the following (in thousands):

 
|                                 |   | **December  31,** |   |
|--------------------------------------|--------|-------------------|--------|
|                                 |   | **2001**          |   | **2000** | ** ** |
| Current:                             |   |              |   |   |   |
| Outdoor flowers and vegetable plants |   | $                 | 47,418 |   | $ | 44,852 |   |
| Raw materials and supplies           |   | 4,077             |   | 4,587 |   |
| Inventory reserve                    |   | (2,858            | )      | (3,459 | ) |
| Total current inventories            |   | 48,637            |   | 45,980 |   |
| Noncurrent:                          |   |              |   |   |   |
| Christmas tree inventories           |   | 8,760             |   | 8,309 |   |
| Total inventories, net               |   | $                 | 57,397 |   | $ | 54,289 |   |

 

**5. PROPERTY, PLANT AND EQUIPMENT**

 

Property,plant and equipment as of December 31, 2001 and 2000 consisted of the following(in thousands):

 
|                                     |   | **December  31,** |   |
|------------------------------------------|--------|-------------------|--------|
|                                     |   | **2001**          |   | **2000** |   |
| Land and land improvements               |   | $                 | 10,459 |   | $ | 10,353 |   |
| Greenhouses and buildings                |   | 23,523            |   | 23,389 |   |
| Furniture and fixtures and software      |   | 10,343            |   | 5,894 |   |
| Machinery and equipment                  |   | 21,214            |   | 21,061 |   |
| Leasehold improvements                   |   | 10,438            |   | 7,824 |   |
| Assets under capital leases              |   | 564               |   | 482 |   |
| Construction in progress                 |   | 368               |   | 2,774 |   |
| Total property, plant and equipment      |   | 76,909            |   | 71,777 |   |
| Less:   Accumulated depreciation    |   | (29,410           | )      | (22,112 | ) |
| Total property, plant and equipment, net |   | $                 | 47,499 |   | $ | 49,665 |   |

 

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Depreciationexpense for the year ended December 31, 2001 and 2000, the six months endedDecember 31, 2000 and 1999, and the fiscal years ended June 30, 2000 and 1999was $7.3 million, $6.2 million, $3.0 million, $3.1 million, $6.1 million and$5.5 million, respectively.  At December31, 2001 and 2000, greenhouses with an original cost of $6.9 million and $6.1million, respectively, are in service on property leased by the Company underoperating lease agreements. Construction in progress is primarily composed of upgrades or additionsto the Company’s greenhouses and watering systems and the implementation of anintegrated financial system.

 

**6. INTANGIBLE ASSETS**

 

Intangibleassets as of December 31, 2001 and 2000, consisted of the following (inthousands):

 
|                                  |   | **December  31,** |   |
|---------------------------------------|--------|-------------------|--------|
|                                  |   | **2001**          |   | **2000** |   |
| Goodwill                              |   | $                 | 47,517 |   | $ | 47,517 |   |
| Financing costs                       |   | 4,381             |   | 6,278 |   |
| Non-compete agreements                |   | 1,694             |   | 1,694 |   |
| Other                                 |   | 916               |   | 916 |   |
| Total intangible assets               |   | 54,508            |   | 56,405 |   |
| Less:   Accumulated amortization |   | (8,183            | )      | (11,073 | ) |
| Total intangible assets, net          |   | $                 | 46,325 |   | $ | 45,332 |   |

 

Amortizationexpense for the year ended December 31, 2001 and 2000, the six months endedDecember 31, 2000 and 1999 and for the fiscal years ended June 30, 2000 and1999 was $1.5 million, $1.5 million, $0.8 million, $0.8 million, $1.7 millionand $1.7 million, respectively.  InApril 1998, the AICPA issued Statement of Position 98-5 “Reporting on Costs ofStart-Up Activities” (“SOP 98-5”).  TheCompany adopted SOP 98-5 on July 1, 1998 and recognized a $2.6 millionnon-cash, pre-tax charge ($1.7 million after tax benefit), that was accountedfor as a change in accounting principle.

 

**7. NOTES RECEIVABLE**

 

Notesreceivable primarily represent amounts due from third parties relating to landand investment assets acquired and later sold in connection with certainacquisitions. The notes require monthly principal and interest payments rangingfrom $1,000 to $10,000 with interest rates ranging from 7.5% to 9.0%. Unpaidprincipal and interest are due between December 2001 and March 2007 and aresecured by the underlying assets. The carrying amount of the notes receivableapproximates fair value.

 

**8.  ACCRUED LIABILITIES**

 

Accruedliabilities as of December 31, 2001 and 2000, consisted of the following (inthousands):

 
|                           |   | **December  31,** |   |
|--------------------------------|--------|-------------------|--------|
|                           |   | **2001**          |   | **2000** |   |
| Compensation and benefits      |   | $                 | 2,068  |   | $ | 2,824 |   |
| Rebates                        |   | 734               |   | 1,454 |   |
| Raw material purchases         |   | 3,127             |   | 3,896 |   |
| Christmas tree grower payments |   | 1,719             |   | 5,412 |   |
| Utilities                      |   | 501               |   | 838 |   |
| Interest                       |   | 410               |   | 805 |   |
| Catalyst note renewal fee      |   | 600               |   | — |   |
| Insurance                      |   | 1,200             |   | — |   |
| Other                          |   | 4,185             |   | 3,195 |   |
| Total accrued liabilities      |   | $                 | 14,544 |   | $ | 18,424 |   |

 

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**9. DEBT**

 

Debt as of December 31, 2001 and 2000, consisted of the following (inthousands):

 
|                                          |   | **December  31,** |   |
|-----------------------------------------------|--------|-------------------|--------|
|                                          |   | **2001**          |   | **2000** |   |
| Old Loan Agreement                            |   | $                 | — |   | $ | 35,604 |   |
| Amended Loan Agreement                        |   | 35,782            |   | — |   |
| Catalyst Note                                 |   | 12,000            |   | — |   |
| Old Notes                                     |   | —            |   | 100,000 |   |
| New Notes, including premium of $7,863        |   | 60,805            |   | — |   |
| Old Heller Note                               |   | —            |   | 9,719 |   |
| New Heller Note, including premium of  $1,696 |   | 6,411             |   | — |   |
| Acquisition note                              |   | 1,000             |   | 1,000 |   |
| Non-compete agreements                        |   | 25                |   | 220 |   |
| Other debt                                    |   | 250               |   | 680 |   |
| Total debt                                    |   | 116,273           |   | 147,223 |   |
| Less:   current maturities               |   | (36,027           | )      | (36,455 | ) |
| Long-term portion                             |   | $                 | 80,246 |   | $ | 110,768 |   |

 

*RESTRUCTURING*

 

On November20, 2001, the Company reached an agreement with its creditors to restructureits debt. The following summarizes the background, effect and accounting of thedebt restructuring.  As a result of therestructuring, the Company’s total debt and future interest payments weresignificantly reduced and preferred stock and future dividend payments weresignificantly increased.

 

*Background of the Restructuring*

 

The Companyhad been in default on various financial covenants on its prior loan agreementwith Fleet Capital Corporation and certain other lenders (the “Old LoanAgreement”) at various times since June 30, 2000.  As a result of the defaults and pending expiration of the OldLoan Agreement, the Company entered into discussions with Fleet CapitalCorporation and certain other lenders (“Fleet”) regarding a new creditfacility.  In the second quarter of2001, Fleet informed the Company that it would use the subordination provisionsin the Old Loan Agreement to block the Company’s payment of interest due on theCompany’s 10.5% Senior Subordinated Notes (“Old Notes”). Thus, the Company alsoentered into negotiations with holders of a majority of the Old Notes in anattempt to renegotiate the terms of the Old Notes. These negotiationseventually led to a complete restructuring of the Company’s debt, which includedthe Old Loan Agreement, the Catalyst Note (as defined below), the Old Notes andthe Old Heller Note (as defined below.)Each of these transactions wasconsummated on November 20, 2001.

 

*Terms of the Amended Loan Agreement*

 

The AmendedLoan Agreement with Fleet, which expires on September 15, 2003, provides theCompany with up to $55.0 million of credit and is subject to certain borrowingbase limitations based on a percentage of eligible inventory and eligibleaccounts receivable. The Amended Loan Agreement includes a 

 

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seasonal advance provision thatallows the Company to borrow additional funds above the borrowing baselimitations during the seven-month period beginning on October 1st and endingon April 30th. The Company will be entitled to seasonal advances of up to $10million from October 1, 2001 through April 30, 2002, and up to $8 million fromOctober 1, 2002 through April 30, 2003. These seasonal maximums are subject todecrease, depending on the value of the Company’s real estate, machinery andequipment.  The Amended Loan Agreementalso includes a $5.0 million letter of credit facility, but the total amountavailable under the Amended Loan Agreement will be reduced by the face amountof any outstanding letters of credit.  At December 31, 2001, the Company had $3.4 million in establishedletters of credit of which $3.0 million were established as security for theCompany’s self-insurance programs. At December 31, 2001, the Company hadborrowed $35.8 million under the Amended Loan Agreement and had $2.8 millionremaining credit availability.

 

Borrowingsunder the Amended Loan Agreement bear interest, at the Company’s option, at theprime rate plus 1.0% or the London interbank offer rate (“LIBOR”) plus 3.0%.Seasonal advances under the Amended Loan Agreement bear interest, at theCompany’s option, at prime rate plus 1.5% or LIBOR plus 3.5%.

 

The Amended Loan Agreement contains various covenants, including,without limitations, covenants prohibiting or limiting the Company’s ability toincur additional indebtedness, grant liens, make guarantees, enter into mergersor acquisitions, make capital expenditures and pay dividends and otherdistributions. The Amended Loan Agreement also contains financial covenants andinformation reporting requirements.

 

The AmendedLoan Agreement contains various events of default, the occurrence andcontinuance of which would entitle the lenders to accelerate the maturity ofall loans and terminate their revolving credit and letter of credit commitment.Events of default include:  (i) failureto pay any principal, interest, fees or other amounts; (ii) breaches ofrepresentations and warranties; (iii) violations of covenants; (iv) bankruptcyor insolvency; (v) unsatisfied judgments in excess of certain thresholds; (vi)certain events giving rise to liability under the Employee Retirement IncomeSecurity Act; (vii) change of ownership of the Company; (viii) defaults undercertain other agreements; (ix) the occurrence of certain uninsured losses; (x)business disruption or condemnation; (xi) a challenge to the enforceability ofany loan document or obligation under the Amended Loan Agreement or theperfection or priority of any lien granted to Fleet; (xii) a revocation,attempted revocation, repudiation or default under the terms of any subsidiaryguaranty; and (xiii) the departure of either the current Chief ExecutiveOfficer or Chief Financial Officer from the Company unless replaced with anindividual satisfactory to the lenders or the departure of both the currentChief Executive Officer and Chief Financial Officer within a six month periodeven if the lenders approve of the replacements for such  individuals.  Events of default will also give the lenders the right to possessand sell the collateral security to obtain funds to satisfy outstandingobligations to the lenders. The obligations under the Amended Loan Agreementare secured by substantially all of the Company’s assets.  In addition, the lenders may refuse toadvance funds upon request if there has been a material adverse change in theCompany’s operations.

 

Certain of thelenders obtained the right to acquire up to 34% of the Company’s common stockas an inducement to enter into the Amended Loan Agreement. The exact amount ofcommon stock which may be acquired will depend on Fleet’s ability to syndicatethe loans under the Amended Loan Agreement on or before February 18, 2002. Thisobligation may be satisfied either by the Company or by the transfer of commonstock from the existing common stockholders. To date, such syndication has not occurred; however, the lenders haveagreed  to exercise this option andsyndication discussions continue.

 

*Terms of the Catalyst Note*

 

As part of therestructuring, the Company entered into a Securities Purchase Agreement withCatalyst Equity Fund L.P. (“Catalyst”), pursuant to which the Company sold toCatalyst $12.0 million in 

 

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senior subordinated securednotes (the “Catalyst Note”). The Catalyst Note is junior and subordinated tothe Amended Loan Agreement and senior to the New Notes (as defined below) andall other indebtedness of the Company. The proceeds from the Catalyst Note wereused to refinance a portion of the Company’s obligations under the Amended LoanAgreement, to pay interest due on the Old Notes and to pay expenses associatedwith restructuring the Company’s debt. The Catalyst Note is secured bysubstantially all of the Company’s assets, subject only to outstanding liensunder the Amended Loan Agreement.

 

The CatalystNote bears interest at the rate of 15% per annum, payable monthly, and alsobears a 5% annual renewal fee and a 5% fee upon repayment. Accordingly, $1.2million has been accrued for such fees as of December 31, 2001 and has beencapitalized as financing costs in the consolidated balance sheet.  The Catalyst Note is payable in full onOctober 1, 2003 and cannot be repaid prior to that date unless there is achange in control. If a change in control occurs prior to the first anniversaryof the closing of the Catalyst Note, the Catalyst Note is subject to mandatoryredemption at 110% of the principal amount (including all accrued and unpaidinterest). If a change in control occurs after the first anniversary of theclosing, the Catalyst Note is subject to mandatory redemption at 105% of theprincipal amount (including all accrued and unpaid interest).

 

The Catalyst Note contains various covenants, including, withoutlimitation, covenants prohibiting or limiting the Company’s ability to incuradditional indebtedness, grant liens, make guarantees, enter into mergers oracquisitions, make capital expenditures and pay dividends and otherdistributions. The Catalyst Note also contains financial covenants and informationreporting requirements.

 

The CatalystNote contains various events of default, the occurrence and continuance ofwhich would entitle Catalyst to accelerate the maturity of the CatalystNote.  Events of default include:  (i) failure to pay any principal, interest,fees or other amounts; (ii) breaches of representations and warranties; (iii)violations of covenants; (iv) bankruptcy or insolvency; (v) unsatisfiedjudgments in excess of certain thresholds; (vi) certain events giving rise toliability under the Employee Retirement Income Security Act; (vii) change ofownership of the Company; (viii) payment defaults under certain otheragreements; (ix) the occurrence of certain uninsured losses; (x) businessdisruption or condemnation; (xi) a challenge to the enforceability of any loandocument executed in connection with the Catalyst Note or obligation under theCatalyst Note or the perfection or priority of any lien granted to Catalyst;(xii) a default under the terms of any subsidiary guaranty; (xiii) the terminationof the Amended Loan Agreement or other agreements entered into in connectiontherewith or termination of the commitments under the Amended Loan Agreement;and (xiv) the departure of either the current Chief Executive Officer or ChiefFinancial Officer from the Company unless replaced with an individualsatisfactory to Catalyst or the departure of both the current Chief Executive Officer and Chief Financial Officerwithin a six month period even if Catalyst approves of the replacements forsuch individuals.  Events of defaultwill also give Catalyst the right to possess and sell the collateral securityto obtain funds to satisfy outstanding obligations to the lenders, subject tothe terms of the subordination agreement between Fleet and Catalyst. Theobligations under the Catalyst Note are secured by substantially all of theCompany’s assets, which security interest is subordinate to the securityinterest granted to Fleet under the Amended Loan Agreement.

 

*Exchange of Old Notes for New Senior SubordinatedNotes and Series B Preferred Stock*

 

As part of theCompany’s recapitalization, the Company exchanged the $100 million principalamount of Old Notes plus accrued interest (the “Exchange Offer”) for:

 

•                  $50 millionprincipal amount of new 13% Senior Subordinated Notes due 2005 (the “NewNotes”);

 

•                  approximately$2.9 million of additional principal amount of new 13% Senior SubordinatedNotes due 2005 equal to the interest that would have accrued on the $50 millionprincipal amount of the New Notes described above for the period from June 16,2001 to the closing date of the Exchange 

 

F-16

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Offer (as ifsuch New Notes had been outstanding on June 16, 2001) (together with the $50million principal amount of new notes described above);

 

•                  an additionalcash payment of $5.25 million equal to the sum of interest due on the tenderedOld Notes on June 15, 2001;

 

•                  600,000 sharesof 13% Series B  Preferred Stock, with aliquidation preference of $100 per share (“Series B Preferred Stock”); and

 

•                  34,450additional shares of Series B Preferred Stock equal to the dividend that wouldhave accrued on the Series B Preferred Stock described above for the periodfrom June 16, 2001 to the closing date of the Exchange Offer (as if the SeriesB Preferred Stock had been outstanding on June 16, 2001).

 

Holders of100% of Old Notes tendered their Old Notes in the Exchange Offer.

 

The New Notesrepresent the initial approximate $52.9 million aggregate principal amount (onNovember 21, 2001) of new 13% Senior Subordinated Notes due December 15, 2005issued pursuant to the Exchange Offer. Interest accrues at a rate of 13% per annum and will be payablequarterly in cash on each March 15th, June 15th, September 15th and December15th commencing on December 15, 2001, except that on or prior to June 15, 2003,interest may be paid, at the Company’s option, by (i) the cash payment ofaccrued interest at the annual rate equal to 11% and (ii) the issuance ofadditional New Notes with a principal amount equal to the interest accrued tosuch date at an annual rate equal to 2%. The New Notes are not entitled to thebenefit of any mandatory sinking fund.

 

TheNew Notes are redeemable, at the Company’s option, in whole at any time or inpart from time to time, on and after December 15, 2002 upon not less than 30nor more than 60 days’ prior written notice, at the following redemption prices(expressed as percentages of the principal amount thereof) if redeemed duringthe twelve-month period commencing on December 15th of the year set forthbelow, plus in each case, accrued and unpaid interest thereon, if any, to thedate of redemption:

 

| 2002 |   | 105.25 | % |
|------|--------|--------|---|
| 2003 |   | 103.50 | % |
| 2004 |   | 101.75 | % |

 

Notwithstanding the foregoing, in connection with arefinancing of the entire outstanding principal amount of the New Notes, withinsix months of the issue date, the New Notes are redeemable with no premium atthe principal amount thereof, plus accrued and unpaid interest thereon, if any,to the date of redemption.

 

Upon theoccurrence of a change of control of the Company, each holder of New Notes willhave the right to require the Company to repurchase such holder’s New Notes ata purchase price equal to 101% of the principal amount thereof, together withaccrued and unpaid interest, if any, to the date of repurchase. In the event ofa change of control of the Company, there can be no assurance that the Companywill have sufficient cash to fulfill such repurchase obligation.

 

The New Notesare unsecured and subordinated in right of payment to all existing and futuresenior debt of the Company, including the obligations under the Amended LoanAgreement and the Catalyst Note.  TheNew Notes will *pari passu* with any future senior subordinated indebtednessof the Company and rank senior to all other subordinated debt of the Company.The indenture for the New Notes (“New Note Indenture”) permits the Company toincur additional indebtedness, including up to $85.0 million of senior debtavailable under the Company’s credit facilities, subject to certainlimitations.

 

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TheNew Note Indenture contains covenants that will, subject to certain exceptions,limit, among other things, the ability of the Company and its subsidiaries to(i) pay dividends or make certain other restricted payments or investments;(ii) incur additional indebtedness and issue disqualified stock and preferredstock; (iii) create liens on assets; (iv) merge, consolidate, or sell all orsubstantially all of their assets; (v) enter into certain transactions withaffiliates; and (vi) create restrictions on dividends or other payments bysubsidiaries to the Company.

 

The ExchangeOffer was recorded as a Troubled Debt Restructuring in accordance with SFAS 15,“Accounting by Debtors and Creditors for Troubled Debt Restructurings”.  Accordingly, the Old Notes were reduced bythe fair value of the preferred stock issued in the exchange, and form theoriginal carrying value of the New Notes. The implied premium on the New Notesof $8.0 million will be recorded as a reduction to interest expense over theterm of the New Notes.   Restructuringfees relating to the Exchange  Offerwere $3.6 million of which $2.2 million were expensed.

 

The New Noteshave certain registration rights.

 

See Note 12for the amendments to the Series A Preferred Stock and the key terms of theSeries B Preferred Stock.

 

*Amendmentsto Series A Preferred Stock*

 

In conjunctionwith the restructuring, the Company also amended the terms of its Series A PreferredStock to provide (i) that dividends may be paid at the option of the Company bythe issuance of additional shares of Series A Preferred Stock (includingfractional shares) having an aggregate liquidation preference equal to theamount of such dividends through December 15, 2005, (ii) the holders of amajority of the outstanding shares of Series A Preferred Stock the right toelect one member of the Board of Directors of the Company (which number shallbe increased to two at such time as there have been six full quarterly unpaiddividends (whether or not consecutive) and designate one person as a non-votingobserver to all meetings of the Board of Directors, and (iii) to conform thedefinition of “change of control” to the definition contained in the Series BPreferred Stock.

 

The holders ofthe Series A Preferred Stock obtained the right to acquire 15% of the Company’scommon stock as an inducement to agree to amend the Series A PreferredStock.  Such stock was issued onDecember 31, 2001 through the issuance by the Company of an additional 184,970shares of common stock and by the transfer of 1,016,681 shares of common stockfrom the existing stockholders of the Company.

 

*Exchange of Old Heller Note for New Heller Note and Series B-1Preferred Stock*

 

The Companyalso exchanged its 8.0% Subordinated Convertible Note issued to Heller EquityCapital Corporation (the “Old Heller Note”) with an aggregate principal amountof $10.4 million on November 20, 2001, for a new 8.0% Subordinated ConvertibleNote (the “New Heller Note”) and 57,328 shares of new 12% Series B-1 CumulativePreferred Stock (the “Series B-1 Preferred Stock”). The New Heller Note is dueon December 15, 2005 and had a principal balance of $4.7 million on November20, 2001, representing 45% of the balance due on the Old Heller Note.

 

The New Heller Note accrues interest daily at the rate of 8.0% perannum and is payable on December 15, 2005. Interest is payable semi-annually incash or, at the option of the Company, interest may be capitalized and added tothe principal amount of the New Heller Note. The New Heller Note is subject tomandatory redemption prior to December 15, 2005 upon:

 

•                  a sale orissuance of capital stock of the Company which results in any person or groupof affiliated persons (other than KCSN Acquisition Company, L.P. and itsaffiliates) possessing the voting power to elect a majority of the Company’sBoard of Directors; and

 

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•                  a sale ortransfer of more than 50% of the Company’s consolidated assets or a merger orconsolidation in which the holders of the capital stock of the Company prior tosuch merger or consolidation do not have the power to elect a majority of theBoard of Directors of the surviving entity following such merger orconsolidation.

 

The New Heller Note is also subject to acceleration in the event of:(a) failure to pay principal or interest; (b) certain unremedied covenantbreaches; (c) bankruptcy or insolvency of the Company; (d) an individual final judgmentin excess of $250,000 or in the aggregate, judgments in excess of $1.0 million;(e) the acceleration of other indebtedness of $1.0 million individually or $2.5million in the aggregate prior to its stated maturity; or (f) failure by theCompany to make a mandatory redemption of the New Heller Note. The New HellerNote is subordinate to the Company’s obligations under the Amended LoanAgreement and the Catalyst Note and *pari passu* with the New Notes that areoutstanding.

 

The New HellerNote is redeemable in whole or in part by the Company upon 45 days notice toHeller. Prior to any redemption, Heller may convert the New Heller Note intothat number of shares of common stock computed by dividing the principal amountto be converted, plus capitalized interest accrued on such principal amount, bythe conversion price then in effect (currently $20.09 per share).

 

The New Hellernote was also recorded in accordance with SFAS 15.  Accordingly, preferred stock issued in the Exchange Offer wasrecorded at its estimated fair value of $3.9 million and will be accreted toits liquidation preference of $5.7 million through December 2005.  The New Heller note has a premium of $1.7million, which will be recorded as a reduction to interest expense over theterm of the New Heller Note.

 

See Note 12 for the key terms of the Series B-1 Preferred Stock.

 

TheOld Loan Agreement provided a maximum of up to $70.0 million of credit of which$55.0 million was based on a percentage of eligible inventory and eligibleaccounts receivable and $13.6 million, as amended was available, withoutlimitation, from October 1st through March 31st of each fiscal year.  Interest accrued at the Company’s option, ata variable rate equal to Prime plus 1.0% or LIBOR plus 3.0%.  In addition, to the extent that itsborrowings exceed certain borrowing base limitations during the period fromOctober 1st through March 31st, the interest rates increase by an additional0.5%.  The Old Loan Agreement wassecured by substantially all of the Company’s assets. The Old Loan Agreementwas repaid on November 20, 2001.

 

The Old Noteswere redeemable, in whole or in part, at the Company’s option, at any time onor after December 15, 2002 at specified redemption prices.  Interest accrued at 101⁄2% per annum and waspayable semiannually on each June 15th and December 15th. Unpaid principal andinterest was due on December 15, 2007. These notes were exchanged in full onNovember 21, 2001.

 

TheOld Heller Note was the predecessor note to the New Heller Note.  The holder of the note may convert all orany portion of the principal and accrued interest into non-voting common stock,provided that if converted in connection with a public offering, the shareswould be converted to voting common stock. The conversion price was $20.09 per share and was subject toadjustments.  If not converted, the noterequired full payment of principle and all accrued and unpaid interest onDecember 31, 2004.  The note boreinterest at 8%.  At December 31, 2000,the unpaid accrued interest amount of $382,000 was capitalized into theoriginal principal balance.

 

TheAcquisition note has a principal amount of $1.0 million.  Interest at the rate of 9% per annum accruesdaily and is payable monthly in arrears. The note is due on August 31, 2004.  The note is subject to mandatory redemptionon the earlier of August 31, 2004 or the nine-month anniversary of the date onwhich the Company completes an initial registered public offering of any classof common stock.

 

F-19

----

 

Non-competeagreements have resulted from various acquisitions.  The individual agreements require monthly payments ranging from$60 to $40,000, with all unpaid principal due on April 4, 2002.

 

Otherdebt consists of equipment notes, bank loans and real estate notes.  These debts have varying payment terms(monthly or at maturity).  Monthlyprincipal payments range from $170 to $15,000. One note was paid in full on December 31, 2001 in the amount of $0.5million.  Interest rates on these debtsrange from 7.73% to 13.45%, with varying maturity dates ranging through August2002.  Also included in other debt arevarious capital lease obligations that were incurred in conjunction with therental of equipment.  The leases requiremonthly principal payments ranging from $500 to $15,000.  Interest rates on the leases range from4.15% to 22.31%.  Maturity dates varyand range through September 2003.

 

Maturities of debtand capital lease obligations are as follows (in thousands):

 

|       |   | **DEBT** |    | **CAPITAL  LEASES** |   | **TOTAL** |   |
|------------|--------|----------|---------|---------------------|--------|-----------|--------|
| 2002       |   | 35,831   |    | 196                 |   | 36,027    |   |
| 2003       |   | 12,015   |    | 15                  |   | 12,030    |   |
| 2004       |   | 1,000    |    | —              |   | 1,000     |   |
| 2005       |   | 67,216   |    | —              |   | 67,216    |   |
| Thereafter |   | —   |    | —              |   | —    |   |
|       |   | $        | 116,062 |                | $      | 211       |   | $ | 116,273 |   |
|            |        |          |         |                     |        |           |        |  |  |  |

 

Thebook value of long-term debt and current maturities, approximates fair valuebecause all significant amounts outstanding at December 31, 2001, were recentlyissued and are representative of the terms and interest rates that would beavailable at December 31, 2001.

 

**10. INCOME TAXES**

 

The benefit(provision) for income taxes consists of the following (in thousands):

 
|            |   | **Year Ended****Dec 31,  2001** |   | **Six Months  Ended****Dec 31,  2000** |   | **Year Ended  Jun 30, 2000** |   | **Year Ended  Jun 30, 1999** |   |
|-----------------|--------|---------------------------------|--------|----------------------------------------|--------|------------------------------|--------|------------------------------|--------|
|            |   |                            |   |                                   |   |
| Current:        |   |                            |   |                                   |   |                         |   |                         |   |
| Federal         |   | $ —                        |   | $ —                               |   | $ —                     |   | $ —                     |   |
| State and local |   | —                          |   | —                                 |   | —                       |   | —                       |   |
| Deferred:       |   |                            |   |                                   |   |                         |   |                         |   |
| Federal         |   | (12,740                         | )      | 6,434                                  |   | 2,458                        |   | 652                          |   |
| State and local |   | (253                            | )      | (500                                   | )      | (1,667                       | )      | 75                           |   |
|            |   | $ (12,993                       | )      | $ 5,934                                |   | $ 791                        |   | $ 727                        |   |

 

Thereconciliation of income tax computed at the U.S. federal statutory tax rate tothe Company’s effective income tax rate is as follows:

 
|                                           |   | **Year Ended  Dec 30, 2001** |   | **Six Months  Ended   Dec 31, 2000** |   | **Year Ended  Jun 30, 2000** |   | **Year Ended  Jun 30, 1999** |   |
|------------------------------------------------|--------|------------------------------|--------|--------------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                                           |   |                         |   |                                 |   |
| Federal statutory income tax rate              |   | 34.0                         | %      | 34.0                                 | %      | 34.0                         | %      | 34.0                         | %      |
| State income tax rate, net of federal  benefit |   | 3.9                          | %      | 3.9                                  | %      | 4.0                          | %      | 4.2                          | %      |
| Limitation on state net operating losses       |   | —                       |   | —                               |   | —                       |   | (0.6                         | )%     |
| Debt restructuring                             |   | (23.1                        | )%     | —                               |   | —                       |   | —                       |   |
| Other                                          |   | (1.2                         | )%     | (0.4                                 | )%     | (2.6                         | )%     | (3.4                         | )%     |
| Valuation  allowance                           |   | (126.0                       | )%     | (4.6                                 | )%     | (25.0                        | )%     | —                       |   |
|                                           |   | (112.4                       | )%     | 32.9                                 | %      | 10.4                         | %      | 34.2                         | %      |

 

F-20

----

 

In accordancewith current tax regulations, the Company files tax returns on a cash basis inmost jurisdictions. As a result, the Company has accumulated significant netoperating losses since inception. In the state of California, utilization ofnet operating losses is limited to 50% of the loss generated; hence theeffective tax rate associated with the losses attributable to California arebenefited at a rate less than the statutory rate.

 

Deferred tax assets and liabilities are composed ofthe following at December 31, 2001 and 2000, (in thousands):

 
|                                    |   | **December  31,** |   |
|-----------------------------------------|--------|-------------------|--------|
|                                    |   | **2001**          |   | **2000** |   |
| Current deferred tax assets:            |   |              |   |   |   |
| Accounts payable                        |   | $                 | 2,041  |   | $ | 2,393 |   |
| Accrued liabilities and other           |   | 5,741             |   | 8,361 |   |
| Total current deferred tax assets       |   | 7,782             |   | 10,754 |   |
| Noncurrent deferred tax assets:         |   |              |   |   |   |
| Organization costs                      |   | 998               |   | 998 |   |
| Net operating loss carryforward         |   | 33,425            |   | 35,258 |   |
| Other                                   |   | 277               |   | 142 |   |
| Total noncurrent deferred tax assets    |   | 34,700            |   | 36,398 |   |
| Valuation allowance                     |   | (11,007           | )      | (2,456 | ) |
| Total deferred tax assets               |   | $                 | 31,475 |   | $ | 44,696 |   |
|                                    |   |              |   |   |   |
| Current  deferred tax liabilities:      |   |              |   |   |   |
| Receivables                             |   | $                 | 4,093  |   | $ | 5,749 |   |
| Inventory                               |   | 18,997            |   | 18,232 |   |
| Prepaids                                |   | 569               |   | 165 |   |
| Total current deferred tax liability    |   | 23,659            |   | 24,146 |   |
| Non-current deferred tax liabilities:   |   |              |   |   |   |
| Depreciation and amortization           |   | 4,772             |   | 4,382 |   |
| Tree Inventory                          |   | 1,875             |   | 2,466 |   |
| Other                                   |   | 1,169             |   | 707 |   |
| Total noncurrent deferred tax liability |   | 7,816             |   | 7,555 |   |
| Total deferred tax liabilities          |   | $                 | 31,475 |   | $ | 31,701 |   |
|                                         |        |                   |        |  |  |  |  |  |  |

 

At December 31, 2001 theCompany has available federal and state net operating loss carryforwards ofapproximately $95.0 million and $39.1 million, respectively. The federal netoperating loss carry forwards expire beginning on June 30, 2011 and the statenet operating loss carryforwards expire beginning on June 30, 2001 and aresubstantially expired by June 30, 2003. These net operating losses may be significantly limited in use in anygiven year, subject to Section 382 of the Internal Revenue Code of 

 

F-21

----

 

1986, as amended(the “Code”) as a result of an ownership change.  In addition, significant taxable income must be generated inorder to realize these recorded benefits. The Company has provided a valuation allowance against the net deferredtax asset as a result of uncertainties relating to the realizability of therelated assets.  The Company provided avaluation allowance of $10.6 million and $2.5 million during the year endedDecember 31, 2001 and the six month period ended December 31, 2000,respectively.

 

**11. COMMON STOCK AND REDEEMABLE COMMON STOCK**

 

The Companyhas 50,000,000 authorized shares of $0.001 par value common stock of which 7,186,008shares were outstanding as of December 31, 2001.  Holders of common stock are entitled to one vote per share on allactions submitted to a vote of stockholders.

 

Subject to theterms of the Amended Loan Agreement, the Company is required to repurchaseshares of common stock from certain management stockholders in the event oftheir termination due to their death or permanent disability. Such repurchasesare at fair market value as determined by the Board of Directors. The Board ofDirectors will retain an independent appraisal firm to assist them indetermining the fair market value of the common stock on a periodic basis. Thedifference between the carrying amount of the redeemable common stock and itsfair value is accreted over the life expectancy of the management stockholders(on average 21 years) by charging retained earnings. The fair value of theredeemable common stock, as estimated by management, at December 31, 2001 isapproximately $23,000.  In the event ofan initial public offering of the common stock, the requirement to repurchaseshares automatically terminates. As a result of the redemption feature,redeemable common stock is classified outside of stockholders’ equity.

 

KCSNAcquisition Corporation, L.P., Heller and all of the management stockholders(the “Stockholders”) are parties to the Stockholders Agreement which includescertain transfer restrictions, voting agreements and registration rights whichsurvive until December 31, 2006.  TheStockholders have agreed to (i) consent to any merger, consolidation or salesof all or substantially all of the Company’s assets involving an independentthird party and approved by a majority of the shares of common stock held byKCSN and (ii) vote their shares of common stock to elect two members ofmanagement, five KCSN designees and two independent designees reasonablyacceptable to KCSN as directors. Consequently, the Stockholders (assuming theconversion of the New Heller Note) will continue to have significant influenceover the Company’s policies and affairs and may be in a position to determinethe outcome of corporate actions requiring stockholder approval, includingadopting amendments to the Certificate of Incorporation, electing directors andapproving or disapproving mergers or sales of all or substantially all of itsassets.

 

**12. REDEEMABLE PREFERRED STOCK**

 

Redeemablepreferred stock as of December 31, 2001 and 2000 consisted of the following (inthousands):

 

|       |   | **December  31,** |    |
|------------|--------|-------------------|---------|
|       |   | **2001**          |    | **2000** | ** ** |
| Series A   |   | $                 | 59,501  |   | $ | 50,641 |   |
| Series B   |   | 44,869            |    | — |   |
| Series B-1 |   | 4,035             |    | — |   |
| Total      |   | $                 | 108,405 |   | $ | 50,641 |   |

 

The Company has 4,900,000shares authorized of $0.01 par value undesignated preferred stock. The board ofdirectors has authority, without any further vote or action by stockholders, toprovide for the issuance of preferred stock shares in series, to establish therelative, participating, optional or other special rights, qualifications orrestrictions of the shares of each such series and to determine the votingpowers, if any, of such shares.

 

F-22

----

 

In December1997, simultaneous with the issue of the Old Notes, the Company sold 40,000shares of 13% Series A Cumulative Preferred Stock and 825,000 warrants, eachwarrant representing the right to purchase one share of its common stock for$0.01 each.  The 13% Series A CumulativePreferred Stock and the warrants were sold for an aggregate cost of $40.0million.  Dividends on the 13% Series ACumulative Preferred Stock accrue at a rate of 13% of the liquidationpreference of $1,000 per share and are payable quarterly on March 15th, June15th, September 15th and December 15th commencing on March 15, 1998.  At the Company’s option through December 15,2005, dividends may be paid by the issuance of additional shares of 13% SeriesA Cumulative Preferred Stock having an aggregate liquidation preference equalto the amount of such dividends.  Duringthe year ended December 31, 2001, the Company issued 7,970 additional sharesand paid $12,813 in cash as dividends. During the six months ended December 31,2000, the Company issued 3,616 additional shares and paid $9,212 in cash asdividends. During the fiscal year ended June 30, 2000, the Company issued 6,584additional shares and paid $7,195 in cash as dividends. During the fiscal yearended June 30, 1999, the Company issued 5,794 additional shares and paid $6,438in cash as dividends.  Through 2005, 13%dividends are expected to continue to be paid in additional shares of Series ACumulative Preferred Stock.  Inaddition, the Company’s credit facilities and corollary agreements restrict thepayment of cash dividends on the 13% Series A Cumulative Preferred Stock (otherthan for payment of dividends associated with fractional shares).

 

On December15, 2008, the Company is required to redeem all outstanding shares of 13%Series A Cumulative Preferred Stock at a price equal to the liquidationpreference, plus accrued and unpaid dividends to date, if any.  The 13% Series A Cumulative Preferred Stockis redeemable, in whole or in part, at the Company’s option, at any time on orafter December 15, 2002 at specified redemption prices.  The liquidation preference as of December31, 2001 is $66.5 million. The 13% Series A Cumulative Preferred Stock ranksjunior to the Series B and Series B-1 Preferred Stock and senior to all otheroutstanding classes or series of capital stock with respect to dividends andliquidation rights.

 

The warrantsare exercisable on December 15, 2008. In the absence of an exercise, the warrants will be automatically deemedto have been exercised immediately on December 15, 2008 with payment of theexercise price on a cash-less basis.

 

The Companyhas 639,948 shares of 13% Series B Preferred Stock issued and outstanding onDecember 31, 2001.  The Series BPreferred Stock was issued initially on November 21, 2001 pursuant to theExchange Offer (see Note 9 “Debt.”).

 

The Series BPreferred Stock pays dividends at a rate per annum of 13% of the liquidationpreference of $100 per share (subject to increase as set forth below).Dividends will accumulate from the date of issuance and will be payablequarterly on each March 15th, June 15th, September 15th and December 15thcommencing on December 15, 2001. Upon certain events of default by the Companydescribed in the Certificate of Designation for the Series B Preferred Stock,the dividends on the Series B Preferred Stock will accrue at a rate of 18% perannum of the liquidation preference thereof until such event of default iscured. Dividends will be payable in cash, except that on or prior to June 15,2003, dividends may be paid, at the Company’s option, by the issuance ofadditional shares of Series B Preferred Stock (including fractional shares)having an aggregate liquidation preference equal to the amount of suchdividends.  On December 15, 2001, theCompany issued an additional 5,498 shares as dividends.

 

The Series BPreferred Stock ranks senior in right of payment to all other classes or seriesof capital stock of the Company as to dividends and upon liquidation,dissolution or winding up of the Company. The Company is required, subject to certain conditions, to redeem all ofthe shares of Series B Preferred Stock outstanding on December 15, 2005 at aredemption price in cash equal to the liquidation preference thereof, plusaccrued and unpaid dividends, if any, to the date of redemption.

 

F-23

----

 

TheSeries B Preferred Stock is redeemable, at the Company’s option, in whole atany time or in part from time to time, on and after December 15, 2002 at thefollowing redemption prices (expressed as percentages of the liquidationpreference thereof), in each case, together with accrued and unpaid dividends,if any, to the date of redemption, upon not less than 30 nor more than 60 days’prior written notice, if redeemed during the 12-month period commencing onDecember 15 of each of the years set forth below:

 

| 2002 |   | 105.25 | % |
|------|--------|--------|---|
| 2003 |   | 103.50 | % |
| 2004 |   | 101.75 | % |

 

In the eventof a change of control the Company will, subject to certain conditions, berequired to offer to repurchase all or any part of such holder’s Series BPreferred Stock at an offer price in cash equal to 101% of the aggregateliquidation preference thereof plus accrued and unpaid dividends, if any, thereonto the date of purchase. In the event of a change of control of the Company,there can be no assurance that the Company will have sufficient cash to fulfillsuch repurchase obligations.

 

The Series BPreferred Stock will be non-voting, except as otherwise required by law andexcept in certain circumstances described in the Certificate of Designation forthe Series B Preferred Stock, including (i) amending certain rightsof the holders of Series B Preferred Stock, (ii) the issuance of any newclass of equity securities that ranks *pari passu* with or senior to the Series BPreferred Stock, (iii) effecting a merger, consolidation, sale of all orsubstantially all of the Company’s assets, and (iv) making certain assetacquisitions. In addition, in the event (i) the Company fails to pay cashdividends on the Series B Preferred Stock when due, (ii) subject tocertain exceptions, the Company fails to pay cash interest on the New Noteswhen due, or (iii) the Company is under protection of Title 11 of theUnited States Code pursuant to a case commenced after September 15, 2003or, subject to certain conditions, pursuant to a voluntary case commenced priorto September 15, 2003, the holders of the Series B Preferred Stock shallhave the right to elect a majority of the Board of Directors, the Series BPreferred Stock shall vote with the common stock, together as a class, on allother matters on which the common stock is entitled to vote other than electionof the Company’s Board of Directors, and each share of Series B PreferredStock shall have a number of votes per share such that the Series B PreferredStock controls a majority of the votes of the combined class.

 

TheCertificate of Designation for the Series B Preferred Stock containscertain restrictive provisions that, among other things, limit the ability ofthe Company and its subsidiaries to pay dividends or make certain otherrestricted payments, incur additional indebtedness or enter into certaintransactions with affiliates.

 

The Series BPreferred Stock was recorded initially at its fair value of approximately $44.1million (after allocated restructuring costs of approximately $1.4million).  The $19.4 million differencebetween the initial carrying value and liquidation value of the Series BPreferred Stock will be accreted over the life of the security.

 

The Companyhas 57,787 shares of Series B-1 Preferred Stock issued and outstanding onDecember 31, 2001.  The Series B-1Preferred Stock was issued initially on November 21, 2001 in connection withthe restructuring and in partial exchange of the Old Heller Note (see Note 9“Debt.”).  On December 15, 2001, theCompany issued an additional 459 shares as dividends.

 

The terms ofthe newly issued Series B-1 Preferred Stock are substantially identical to thoseof the Series B Preferred Stock, which are discussed above, with the exceptionthat (a) dividends accrue at the rate of 12% of the liquidation preferenceof $100 per share per annum, (b) the Series B–1 Preferred Stock isconvertible, at the option of the holder, into the number of shares ofnon-voting common stock (voting common stock if the conversion is effected inconnection with a public offering) computed by dividing the aggregateliquidation preference of the shares to be converted by the conversion pricethen in effect 

 

F-24

----

 

(currently $20.09 per share)and (c) the holders of the Series B Preferred Stock have certainvoting rights that the holders of the Series B-1 Preferred Stock do not have.

 

**13. EARNINGS PER SHARE**

 

Options topurchase common shares were excluded from the computation of diluted earningsper share for all periods, as the shares were antidilutive given the Company’sreported net loss. The Old Heller Note and the New Heller Note (see Note 9)were excluded from the computation of diluted earnings per share for allperiods, as the conversion price was greater than the fair market value of thecommon shares in the respective periods. Redeemable common stock is considered equivalent to common stock forpurposes of calculating earnings per share. Accordingly, earnings per sharecalculations are disclosed on the consolidated statement of operations.

 

**14. STOCK OPTIONS**

 

In July 1996,the Company adopted the 1996 Stock Incentive Plan under which eligibleemployees, directors and consultants received options to purchase shares of itscommon stock at a price generally not less than the fair value of the commonstock on the date of the grant. Under the 1996 Plan, 1,171,419 options weregranted at $1.45 per share  (fair valueof the stock on the date of grant was $1.45 as determined by the Board ofDirectors, such grants occurring coincident with independent third partytransactions). All options under the 1996 Stock Incentive Plan fully vested asa result of the recapitalization on December 31, 1996, and 569,417 options weresimultaneously exercised. A total of 395,609 options remain outstanding underthe 1996 Stock Incentive Plan at December 31, 2001.

 

On January 1, 1997, the Company adopted the 1997 Stock Option Plan,under which eligible executives and key employees received options to purchaseshares of common stock at a price generally not less than the fair value of thecommon stock on the date of grant. On January 1, 1997, the Company granted841,803 options at $7.17 or $7.19 per share (the fair value of the stock on thedate of grant as determined by the Board of Directors, such grants occurringcoincident with independent third party transactions). Options granted underthe 1997 Stock Option Plan are exercisable over a maximum term of ten yearsfrom the date of grant and vest in equal annual installments over a four-yearperiod. The options immediately vest upon a change in control of the Company oran initial public offering. No options have been exercised under the 1997 StockOption Plan.  In January 1998, theCompany granted an additional 252,300 options at $10 per share.  During fiscal 2000 and fiscal 1999, theCompany granted an additional 50,000 and 540,000 options, respectively, at $3.00or $4.00 per share. During the six month period ended December 31, 2000, theCompany granted 95,000 options at $3.00 per share.  During 2001, the Company granted 340,000 options at $3.00 or$0.02 per share.  Pursuant to theCompany’s 1998 Employee Stockholders’ Agreement, the options granted afterJanuary 1, 1997 do not vest immediately upon a change in control of the Companyor an initial public offering of common stock. A total of 1,009,128 optionsremain outstanding under the 1997 Stock Option Plan at December 31, 2001.

 

In February 1997, the Company adopted the Special Stock Option Plan,under which eligible employees received options to purchase shares of commonstock at a price below the fair market value of the common stock on the date ofgrant. Under the Special Stock Option Plan, 139,383 options were granted at$1.43 per share. Options granted under the Special Stock Option Plan areexercisable over a maximum term of ten years from the date of grant and vest inequal annual installments over a four-year period. The options immediately vestupon a change in control of Color Spot or an initial public offering. TheCompany accounts for these plans in accordance with APB Opinion No. 25 underwhich compensation cost is recorded as the difference between the fair valueand the exercise price at the date of grant and is recorded on a straight-linebasis over the vesting period of the underlying options. The Company willrecognize total compensation expense of $0.8 million over the vesting period ofthe options. A total of 48,990 options remain outstanding under the SpecialStock Option Plan at December 31, 2001.

 

F-25

----

 

Activity under the three plans is summarized as follows:

 

|              |   | **Outstanding  Options** |   | **Weighted  Average  Exercise Price** |   | **Options  Exercisable** |    | **Weighted  Average  Exercise Price** |   |
|-------------------|--------|--------------------------|--------|---------------------------------------|--------|--------------------------|---------|---------------------------------------|--------|
| June 30,  1998    |   | 1,819,842                |   | 5.26                                  |   | 843,389                  |    | 2.85                                  |   |
|              |   |                     |   |                                  |   |                     |    |                                  |   |
| Granted           |   | 540,000                  |   | 3.42                                  |   |                     |    |                                  |   |
| Exercised         |   | (37,950                  | )      | 1.43                                  |   |                     |    |                                  |   |
| Forfeited         |   | (209,938                 | )      | 7.76                                  |   |                     |    |                                  |   |
| June 30, 1999     |   | 2,111,954                |   | 4.59                                  |   | 1,035,268                |    | 3.71                                  |   |
|              |   |                     |   |                                  |   |                     |    |                                  |   |
| Granted           |   | 50,000                   |   | 3.00                                  |   |                     |    |                                  |   |
| Exercised         |   | —                   |   |                                  |   |                     |    |                                  |   |
| Forfeited         |   | (566,482                 | )      | 3.77                                  |   |                     |    |                                  |   |
| June 30, 2000     |   | 1,595,472                |   | 4.59                                  |   | 1,027,072                |    | 4.28                                  |   |
|              |   |                     |   |                                  |   |                     |    |                                  |   |
| Granted           |   | 95,000                   |   | 3.00                                  |   |                     |    |                                  |   |
| Exercised         |   | —                   |   |                                  |   |                     |    |                                  |   |
| Forfeited         |   | (180,260                 | )      | 3.49                                  |   |                     |    |                                  |   |
| December 31, 2000 |   | 1,510,212                |   | 4.62                                  |   | 968,662                  |    | 4.32                                  |   |
|              |   |                     |   |                                  |   |                     |    |                                  |   |
| Granted           |   | 340,000                  |   | 0.11                                  |   |                     |    |                                  |   |
| Exercised         |   | —                   |   | —                                |   |                     |    |                                  |   |
| Forfeited         |   | (396,485                 | )      | 4.84                                  |   |                     |    |                                  |   |
| December 31, 2001 |   | 1,453,727                |   | $                                     | 3.50   |                     | 992,527 |                                  | $      | 4.51 |   |
|                   |        |                          |        |                                       |        |                          |         |                                       |        |  |  |

 

The followingsummarizes information about stock options outstanding at December 31, 2001:

 
| **Exercise Price** |   | **Options  Outstanding** |      | **Weighted  Average  Remaining Contractual Life** |      | **Weighted  Average  Fair Value of Options Granted** |   |
|--------------------|--------|--------------------------|-----------|---------------------------------------------------|-----------|------------------------------------------------------|--------|
|               |   |                     |      |
| $                  | 10.00  |                     | 119,800   |                                              | 6.0 Years |                                                 | $      | 2.62 |   |
| 7.17 or 7.19       |   | 374,328                  |      | 5.0 Years                                         |      | 1.87                                                 |   |
| 3.00 or 4.00       |   | 185,000                  |      | 7.9 Years                                         |      | 0.79                                                 |   |
| 1.45               |   | 395,609                  |      | 4.6 Years                                         |      | 0.38                                                 |   |
| 1.43               |   | 48,990                   |      | 5.1 Years                                         |      | 6.12                                                 |   |
| 0.02               |   | 330,000                  |      | 9.3 Years                                         |      | $                                                    | 0.98   |   |
| $                  | 3.51   |                     | 1,453,727 |                                              |      |                                                 |   |   |

 

F-26

----

 

Hadcompensation cost for the stock-based compensation plans been determined basedupon the fair value at grant dates for awards under those plans consistent withthe method prescribed by SFAS 123, net income would have been reduced to thepro forma amounts indicated below (in thousands):

 
|                    |   | **Year Ended  31-Dec-01** |    | **Six Months  Ended  31-Dec-00** |   | **Fiscal  Year Ended** |   |
|-------------------------|--------|---------------------------|---------|----------------------------------|--------|------------------------|--------|
|                    |   |                      |    |                             |
|                    |   |                      |    | **30-Jun-00**                    |   | **30-Jun-99**          |   |
| Net loss:               |   |                      |    |                             |   |                   |   |   |   |
| As reported             |   | $                         | (24,550 | )                                | $      | (12,097                | )      | $ | (6,836 | ) | $ | (4,134 | ) |
| Pro forma               |   | (24,660                   | )       | (12,271                          | )      | (7,431                 | )      | (5,022 | ) |
|                    |   |                      |    |                             |   |                   |   |   |   |
| Basic and diluted loss: |   |                      |    |                             |   |                   |   |   |   |
| As reported             |   | (3.53                     | )       | (1.74                            | )      | (0.98                  | )      | (0.60 | ) |
| Pro forma               |   | (3.55                     | )       | (1.77                            | )      | (1.07                  | )      | (0.72 | ) |
|                         |        |                           |         |                                  |        |                        |        |  |  |  |  |  |  |

 

Thefair value of each option granted was estimated on the date of the grant usingthe Black-Scholes option-pricing model assuming an expected life of six years,a risk-free interest rate of 5.07%, no expected dividends and zero volatility.

 

**15. RELATED-PARTY TRANSACTIONS**

 

The Companyleased certain property and equipment that was owned directly or indirectly bycertain members of management. Payments pursuant to these operating leases forthe year ended December 31, 2000 was $0.3 million, $0.2 million for thesix-month period ended December 31, 2000, $0.1 million for the six-month periodended December 31, 1999, and $0.3 million for the years ended June 30, 2000 and1999.  In October 2000, such propertyand equipment was sold by such management members to an unrelated party.

 

The Companypurchased a portion of its Christmas tree operations from a current member ofmanagement during fiscal year 1998. The Company made payments to thisindividual of $0.3 million and $0.4 million in the fiscal years ended June 30,2000 and 1999, respectively.  TheCompany did not make a payment during the six-month period ended December 31,2000.  The Company made a payment of$0.2 million during 2001.  The Companyalso recorded Christmas tree sales of $0.2 million, $0.4 million and $0.6million during the six months ended December 31, 2000 and the fiscal yearsended June 30, 2000 and 1999, respectively, to this individual.  The Company did not sell Christmas tree tothis individual in 2001.

 

During thethird quarter of 2001, the Company entered into a contract with HR Synergy, tobecome the Company’s new broker / provider of the Company’s various healthbenefit programs.  HR Synergy is ownedby a current member of management. During 2001, the Company paid $400 to HR Synergy directly. The Company willpay premiums and administrative fees of approximately $0.3 million to insurancecompanies in fiscal 2002 related to 2002 policies placed through HR Synergy.

 

**16. EMPLOYEE BENEFIT PLAN**

 

The Companyadopted a 401(k) plan for employees in September 1995. All employees who meetcertain service requirements are eligible to participate.  Matching contributions are at the Company’sdiscretion. The Company made no contributions to the 401(k) plan during theyear ended December 31, 2001, the six months ended December 31, 2000 and theyears ended June 30, 2000 and 1999.

 

**17. EXTRAORDINARY LOSS**

 

In connectionwith the refinancing in October 1998, the Company recorded a $1.0 millionnon-cash extraordinary charge, net of tax benefit, related to the write-off ofunamortized financing costs associated with the terminated credit facility.

 

F-27

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**18. COMMITMENTS AND CONTINGENT LIABILITIES**

 

OPERATING LEASES

 

The Companyleases certain nursery facilities consisting of land and improvements undernoncancellable operating leases expiring at various dates through 2019. TheCompany also leases transportation equipment under operating leases expiring invarious years through 2007. Some of the leases have five-year renewal optionsand some are subject to rental increases based on a change in the ConsumerPrice Index.

 

Total rentexpense for the year ended December 31, 2001, the six-month period endedDecember 31, 2000 and the years ended June 30, 2000 and 1999 was approximately$5.9 million, $2.8 million, $5.7 million and $5.2 million respectively.

 

At December31, 2001, future minimum rental payments on operating leases are as follows (inthousands):

 

| 2002                         |   | $     | 4,823  |   |
|------------------------------|--------|-------|--------|--------|
| 2003                         |   | 4,116 |   |
| 2004                         |   | 4,029 |   |
| 2005                         |   | 3,974 |   |
| 2006                         |   | 3,784 |   |
| Thereafter                   |   | 5,441 |   |
| Total minimum lease payments |   | $     | 26,167 |   |

 

The Companyhas contracts to purchase Christmas trees from third-party growers. Certain ofthese contracts require the Company to maintain the trees until they areharvested. At December 31, 2001, future minimum purchase commitments under thecontracts are as follows (in thousands):

 

| 2002                               |   | $     | 2,113  |   |
|------------------------------------|--------|-------|--------|--------|
| 2003                               |   | 1,299 |   |
| 2004                               |   | 1,269 |   |
| 2005                               |   | 977   |   |
| 2006                               |   | 72    |   |
| Thereafter                         |   | 90    |   |
| Total minimum purchase commitments |   | $     | 5,820  |   |

 

The Companyhas additional contracts to purchase Christmas trees whereby the amountspayable are dependent upon the number of trees harvested and the year in whichthey are harvested.  Certain of thecontracts may be canceled with proper notice.

 

CONTINGENCIES

 

In May 2001,Campbell Tree & Land, Co. (“Campbell”) filed an action against the Company,entitled Campbell Tree & Land v. Color Spot Nurseries, Inc., Color SpotChristmas Trees, Inc., Case number 01-C-0555, in the U.S. District Court forthe Eastern District of Wisconsin. The dispute underlying this litigation arosefrom the sale of tree inventory by Campbell to the Company during the fall of2000, while the parties were negotiating a Purchase and Marketing Agreement.The Purchase and Marketing Agreement was never finalized or executed becausethe parties never agreed upon the terms, although the Company paid over $1million to Campbell for the inventory. Campbell is claiming that because thePurchase and Marketing Agreement was never finalized, higher prices applied tothe inventory and the 

 

F-28

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Company owes Campbell anadditional $985,000. Although the Company has had settlement discussions withCampbell representatives, the Company now intends to vigorously defend itsposition. However, the Company cannot reasonably predict the outcome of thecase nor estimate the financial loss that may result from any unfavorableoutcome. The Company believes, however, that an unfavorable outcome of thismatter could have a material adverse effect on the Company’sfinancial position, results of operations or cash flows.

 

The Company iscurrently in dispute with one of its landlords, Coastal Nursery, for failure tomaintain the leased property in accordance with the lease.  The Company’s predecessor, Color King,entered into the lease with Coastal Nursery in the mid 1990s, which obligatesthe Company to maintain the property, including several greenhouses, supportstructures and a residence, in good repair. Coastal Nursery has threatened to terminate the lease, to bring aneviction against the Company and to do the repairs and restoration that itdeems necessary and to charge the Company for the costs of such repairs andrestoration.  To date, no legal actionhas been filed by Coastal Nursery against the Company and the parties are indiscussions about the matter.  TheCompany hopes to resolve the dispute amicably in hopes of avoidinglitigation.  However, the Company cannotreasonably predict the outcome of this matter. The Company believes that, if an outcome ultimately is determinedadverse to Color Spot, the potential loss exposure for the Company would be inthe range of $250,000 to $1.5 million. The facility associated with this leaseis currently closed.

 

The Company issubject to a 1986 administrative order from the California Water QualityControl Board ("CWQCB") which directs the Company to implementcontrols and practices to address the discharge of "tailwaters"(irrigation return flow) to a ditch which bisects the Company's property in Fallbrook,California.  To date, the Company hasmade capital improvements to the Fallbrook property to achieve compliance withthe 1986 CWQCB order.  Certain of theseimprovements have triggered the jurisdiction of other regulatory bodies,including the United States Army Corps of Engineers, the California Fish &Game Commission and a separate bureau of the CWQCB.  The Company has met with these government agencies and ispresently developing a program to address the applicable concerns of theagencies.  Although the Companyanticipates that it will be able to resolve these concerns through capitalimprovements to the Fallbrook property, the Company cannot fairly estimate thepotential expenses at this time.

 

The Company isa party to various other legal proceedings, claims and assessments arising inthe normal course of its business activities. Based upon information presentlyavailable and in light of legal and other defenses and insurance coverage,management does not expect these legal proceedings, claims and assessments,individually or in the aggregate, to have a material adverse impact on theCompany’s consolidated financial position or operations.

 

EMPLOYMENT AGREEMENTS

 

The Companyhas entered into employment agreements with certain of its executive officers.  The agreements provide for certain paymentsto each officer upon termination of employment, other than as a result ofdeath, disability in most cases or justified cause, as defined.  The aggregate estimated commitment underthese agreements was $1.3 million at December 31, 2001.  The agreements also provide for certainofficers to receive forgiveness of certain loans over a five-year period, basedon years of service.  The aggregateestimated commitment for loan forgiveness under these agreements wasapproximately $0.5 million at December 31, 2001. No amounts have been recordedin the financial statements related to these contingent obligations as ofDecember 31, 2001.

 

**19. QUARTERLY FINANCIAL DATA—(UNAUDITED)**

 

Summarizedquarterly financial information for the year ended December 31, 2001, thesix-month period ended December 31, 2000 and the years ended June 30, 2000 and1999 are as follows (in thousands, unaudited):

 
| **Quarter  Ended**                    |   | **March 30,  2001** |   | **June 30,  2001** |   | **Sept. 30,  2001** |   | **Dec. 31,  2001** |   |
|---------------------------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|
| Net sales                             |   | $                   | 42,089 |               | $      | 83,380              |   | $                  | 27,343 |   | $ | 38,413 |   |
| Gross profit                          |   | 19,647              |   | 34,448             |   | 9,768               |   | 12,574             |   |
| Operating income (loss)               |   | 3,729               |   | 11,377             |   | (3,618              | )      | (7,933             | )      |
| Net income (loss)                     |   | (725                | )      | 5,518              |   | (6,033              | )      | (23,310            | )      |
| Basic and diluted earnings per share: |   |                |   |               |   |                |   |               |   |
| Net income (loss)                     |   | (0.42               | )      | 0.48               |   | (1.19               | )      | (3.88              | )      |
|                                       |        |                     |        |                    |        |                     |        |                    |        |  |  |  |  |

 

F-29

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| **Quarter  Ended**                    |   | **Sept. 30,  2000** |   | **Dec. 31,  2000** |   |
|---------------------------------------|--------|---------------------|--------|--------------------|--------|
| Net sales                             |   | $                   | 27,682 |               | $      | 46,800 |   |
| Gross profit                          |   | 7,923               |   | 13,825             |   |
| Operating income (loss)               |   | (5,005              | )      | (4,219             | )      |
| Net income (loss)                     |   | (6,459              | )      | (5,638             | )      |
| Basic and diluted earnings per share: |   |                |   |               |   |
| Net loss                              |   | (1.24               | )      | (1.13              | )      |
|                                       |        |                     |        |                    |        |  |  |

 
| **Quarter  Ended**                    |   | **Sept. 30,  1999** |   | **Dec. 30,  1999** |   | **March 30,  2000** |   | **June 30,  2000** |   |
|---------------------------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|
| Net sales                             |   | $                   | 26,723 |               | $      | 49,062              |   | $                  | 47,451 |   | $ | 87,651 |   |
| Gross Profit                          |   | 10,397              |   | 18,061             |   | 23,165              |   | 28,373             |   |
| Operating income (loss)               |   | (3,610              | )      | (259               | )      | 6,121               |   | 4,823              |   |
| Net income (loss)                     |   | (4,442              | )      | (2,590             | )      | 1,140               |   | (944               | )      |
| Basic and diluted earnings per share: |   |                |   |               |   |                |   |               |   |
| Net loss                              |   | (0.91               | )      | (0.65              | )      | (0.12               | )      | (0.44              | )      |
|                                       |        |                     |        |                    |        |                     |        |                    |        |  |  |  |  |

 
| **Quarter  Ended**                                                                 |   | **Sept. 24,  1998** |   | **Dec. 24,  1998** |   | **March 25,  1999** |   | **June 30,  1999** |   |
|------------------------------------------------------------------------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|
| Net sales                                                                          |   | $                   | 27,706 |               | $      | 47,921              |   | $                  | 42,433 |   | $ | 88,016 |   |
| Gross profit                                                                       |   | 8,320               |   | 15,796             |   | 22,139              |   | 42,028             |   |
| Operating income (loss)                                                            |   | (9,133              | )      | (1,406             | )      | 7,522               |   | 17,711             |   |
| Cumulative effect of change in accounting  principle, Net of income taxes (Note 7) |   | (1,687              | )      | —             |   | —              |   | (31                | )      |
| Extraordinary loss, net of income taxes  (Note 17)                                 |   | —              |   | (999               | )      | —              |   | (19                | )      |
| Net income (loss)                                                                  |   | (10,421             | )      | (4,098             | )      | 1,975               |   | 8,410              |   |
| Basic and diluted earnings per share:                                              |   |                |   |               |   |                |   |               |   |
| Net income (loss) before extraordinary loss                                        |   | (1.48               | )      | (0.68              | )      | 0.04                |   | 0.89               |   |
| Cumulative effect of change in accounting  Principle                               |   | (0.24               | )      | —             |   | —              |   | (0.01              | )      |
| Extraordinary loss (Note 17)                                                       |   | —              |   | (0.15              | )      | —              |   | —             |   |
| Net income (loss)                                                                  |   | (1.72               | )      | (0.83              | )      | 0.04                |   | 0.88               |   |
|                                                                                    |        |                     |        |                    |        |                     |        |                    |        |  |  |  |  |

 

 

The Company ispartially self-insured for workers compensation, auto and general liabilityinsurance.  The Company established areserve for $1.2 million during the fourth quarter of 2001 for the estimatedultimate losses expected to arise out of reported as well as potentialunreported claims incurred as of December 31, 2001.

F-30

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ONSCHEDULE II

 

To Color Spot Nurseries, Inc. and Subsidiaries:

 

We have audited, in accordance with auditingstandards generally accepted in the United States, the consolidated financialstatements of Color Spot Nurseries, Inc. and Subsidiaries included in this Form10-K, and have issued our report thereon dated March 2, 2002.  Our audit was made for the purpose offorming an opinion on those statements taken as a whole.  Schedule II, “Valuation and QualifyingAccounts,” is the responsibility of the Company’s management and is presentedfor purposes of complying with the Securities and Exchange Commission’s rulesand is not part of the basic financial statements.  This schedule has been subjected to the auditing proceduresapplied in the audit of the basic financial statements and, in our opinion,fairly states in all material respects the financial data required to be setforth therein in relation to the basic financial statements taken as a whole.

 
|                       |   | /s/  ARTHUR ANDERSEN LLP |
|----------------------------|--------|-------------------------------|
|                       |   |                          |
| San  Francisco, California |   |                          |
| March 2,  2002             |   |                          |

 

S-1

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Schedule II

Valuation andQualifying Accounts

 
|                                           |   | **Balance at  Beginning of  Period** | ** ** | **Additions   Charged to  Costs and  Expenses** | ** ** | **Deduction  from Reserves** | ** ** | **Balance at  End  of Period** | ** ** |
|------------------------------------------------|--------|--------------------------------------|------------|-------------------------------------------------|------------|------------------------------|------------|--------------------------------|------------|
|                                           |   | **(in  thousands)**                  | ** ** |
| Valuation and qualifying accounts              |   |                                 |       |                                            |       |                         |       |                           |       |
| Deducted from the assets to which they  apply: |   |                                 |       |                                            |       |                         |       |                           |       |
|                                           |   |                                 |       |                                            |       |                         |       |                           |       |
| For the year ended December 31, 2001           |   |                                 |       |                                            |       |                         |       |                           |       |
| Allowance for uncollectible accounts           |   | $                                    | 1,935      |                                            | $          | 1,767                        |       | $                              | (2,092     | ) | $ | 1,610 |   |
|                                           |   |                                 |       |                                            |       |                         |       |                           |       |
| For the six months ended December 31, 2000     |   |                                 |       |                                            |       |                         |       |                           |       |
| Allowance for uncollectible accounts           |   | $                                    | 1,199      |                                            | $          | 908                          |       | $                              | (172       | ) | $ | 1,935 |   |
|                                           |   |                                 |       |                                            |       |                         |       |                           |       |
| For the year ended June 30, 2000               |   |                                 |       |                                            |       |                         |       |                           |       |
| Allowance for uncollectible accounts           |   | $                                    | 1,854      |                                            | $          | 715                          |       | $                              | (1,370     | ) | $ | 1,199 |   |
|                                           |   |                                 |       |                                            |       |                         |       |                           |       |
| For the year ended June 30, 1999               |   |                                 |       |                                            |       |                         |       |                           |       |
| Allowance for uncollectible accounts           |   | $                                    | 3,084      |                                            | $          | 1,337                        |       | $                              | (2,567     | ) | $ | 1,854 |   |

 

S-2

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