0000825542 2008-10-01 2009-09-30 0000825542 2008-09-30 0000825542 2010-07-03 0000825542 2009-09-30 0000825542 2009-06-27 0000825542 2010-04-04 2010-07-03 0000825542 2009-03-29 2009-06-27 0000825542 2008-10-01 2009-06-27 0000825542 2009-03-27 0000825542 2010-08-06 0000825542 2009-10-01 2010-07-03 iso4217:USD xbrli:shares xbrli:pure xbrli:shares iso4217:USD <!--DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Transitional//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-transitional.dtd" --> <!-- Begin Block Tagged Note 1 - us-gaap:SignificantAccountingPoliciesTextBlock--> <div align="left" style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <!-- xbrl,ns --> <!-- xbrl,nx --> <div align="left"> </div> <div align="justify" style="font-size: 10pt; margin-top: 0pt"> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><b>NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">NATURE OF OPERATIONS </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Scotts Miracle-Gro Company (&#8220;Scotts Miracle-Gro&#8221;) and its subsidiaries (collectively, together with Scotts Miracle-Gro, the &#8220;Company&#8221;) are engaged in the manufacturing, marketing and sale of consumer branded non-durable products for lawn and garden care and professional horticulture products. The Company&#8217;s primary customers include home centers, mass merchandisers, warehouse clubs, large hardware chains, independent hardware stores, nurseries, garden centers, food and drug stores, commercial nurseries and greenhouses and specialty crop growers. The Company&#8217;s products are sold primarily in North America and the European Union. The Company also operates the Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> business, which provides residential lawn care, lawn aeration, tree and shrub care and limited pest control services in the United States. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">After its acquisition in fiscal 2005, the Company operated Smith &#038; Hawken<sup style="font-size: 85%; vertical-align: text-top">&#174;(1)</sup>, an outdoor living and garden lifestyle category brand. As discussed in &#8220;NOTE 2. DISCONTINUED OPERATIONS,&#8221; on July&#160;8, 2009, Scotts Miracle-Gro announced its intention to close the Smith &#038; Hawken business by the end of calendar 2009. During the Company&#8217;s first quarter of fiscal 2010, all Smith &#038; Hawken stores were closed and substantially all operational activities of Smith &#038; Hawken were discontinued. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Due to the nature of the lawn and garden business, the majority of sales to customers occur in the Company&#8217;s second and third fiscal quarters. On a combined basis, net sales for the second and third fiscal quarters generally represent 70% to 75% of annual net sales. As a result of the seasonal nature of the Company&#8217;s business, results for the first nine months cannot be annualized to predict the results of the full fiscal year. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">ORGANIZATION AND BASIS OF PRESENTATION </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company&#8217;s condensed, consolidated financial statements are unaudited; however, in the opinion of management, these financial statements are presented in accordance with accounting principles generally accepted in the United States of America (&#8220;GAAP&#8221;). The condensed, consolidated financial statements include the accounts of Scotts Miracle-Gro and its subsidiaries. All intercompany transactions and accounts have been eliminated in consolidation. The Company&#8217;s consolidation criteria are based on majority ownership (as evidenced by a majority voting interest in the entity) and an objective evaluation and determination of effective management control. Interim results reflect all normal and recurring adjustments and are not necessarily indicative of results for a full year. The interim financial statements and notes are presented as specified by Regulation&#160;S-X of the Securities and Exchange Commission, and should be read in conjunction with the consolidated financial statements and accompanying notes in Scotts Miracle-Gro&#8217;s Annual Report on Form 10-K for the fiscal year ended September&#160;30, 2009, as updated by its Current Report on Form 8-K filed February&#160;16, 2010. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company&#8217;s Condensed, Consolidated Balance Sheet at September&#160;30, 2009 has been derived from the Company&#8217;s audited Consolidated Balance Sheet at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">USE OF ESTIMATES </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates are based on management&#8217;s best knowledge of current events and actions the Company may undertake in the future, actual results ultimately may differ from the estimates. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">REVENUE RECOGNITION </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Revenue is recognized when title and risk of loss transfer, which generally occurs when products or services are received by the customer. Provisions for estimated returns and allowances are recorded at the time revenue is recognized based on historical rates and are periodically adjusted for known changes in return levels. Shipping and handling costs are included in cost of sales. </div> <div align="left"> <div style="font-size: 3pt; margin-top: 13pt; width: 18%; border-bottom: 1px solid #000000">&#160; </div> </div> <table width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt; text-align: left"> <tr style="font-size: 6pt"> <td width="3%">&#160;</td> <td width="1%">&#160;</td> <td width="96">&#160;</td> </tr> <tr valign="top"> <td nowrap="nowrap" align="left"><sup style="font-size: 85%; vertical-align: text-top">1</sup></td> <td>&#160;</td> <td> <div style="text-align: justify">Smith &#038; Hawken<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> is a registered trademark of Target Brands, Inc. As discussed in &#8220;NOTE 2. DISCONTINUED OPERATIONS,&#8221; the Company sold the Smith &#038; Hawken brand and certain intellectual property rights related thereto on December&#160;30, 2009, and subsequently changed the name of the subsidiary entity formerly known as Smith &#038; Hawken, Ltd. to Teak 2, Ltd. References in this Quarterly Report on Form 10-Q to Smith &#038; Hawken refer to Scotts Miracle-Gro&#8217;s subsidiary entity, not the brand itself. </div></td> </tr> </table> <!-- Folio --> <!-- /Folio --> </div> <!-- PAGEBREAK --> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Under the terms of the Amended and Restated Exclusive Agency and Marketing Agreement (the &#8220;Marketing Agreement&#8221;) between the Company and Monsanto Company (&#8220;Monsanto&#8221;), the Company, in its role as exclusive agent, performs certain functions, primarily manufacturing conversion, distribution and logistics, and selling and marketing support on behalf of Monsanto in the conduct of the consumer Roundup<sup style="font-size: 85%; vertical-align: text-top">&#174;(2)</sup> business. The actual costs incurred by the Company on behalf of the consumer Roundup<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> business are recovered from Monsanto through the terms of the Marketing Agreement. The reimbursement of costs for which the Company is considered the primary obligor is included in net sales. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">PROMOTIONAL ALLOWANCES </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company promotes its branded products through, among other things, cooperative advertising programs with retailers. Retailers may also be offered in-store promotional allowances and rebates based on sales volumes. Certain products are promoted with direct consumer rebate programs and special purchasing incentives. Promotion costs (including allowances and rebates) incurred during the year are expensed to interim periods in relation to revenues and are recorded as a reduction of net sales. Accruals for expected payouts under these programs are included in the &#8220;Other current liabilities&#8221; line in the Company&#8217;s Condensed, Consolidated Balance Sheets. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">ADVERTISING </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Advertising costs incurred during the year by our Global Consumer segment are expensed to interim periods in relation to revenues. All advertising costs, except for external production costs, are expensed within the fiscal year in which such costs are incurred. External production costs for advertising programs are deferred until the period in which the advertising is first aired. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> promotes its service offerings primarily through direct mail campaigns. External costs associated with these campaigns that qualify as direct response advertising costs are deferred and recognized as advertising expense in proportion to revenues over a period not beyond the end of the subsequent calendar year. Costs that do not qualify as direct response advertising costs are expensed within the fiscal year in which such costs are incurred on a monthly basis in proportion to net sales. The costs deferred at July&#160;3, 2010, June&#160;27, 2009 and September&#160;30, 2009 were $2.3&#160;million, $4.0&#160;million and $2.1&#160;million, respectively. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">INCOME TAXES </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The effective tax rate for continuing operations for the three and nine months ended July&#160;3, 2010 was 36.9% and 37.2%, respectively, compared to 36.2% and 36.1% for the three and nine months ended June&#160;27, 2009, respectively. The increase in the effective tax rate for the nine months ended July 3, 2010 was partially due to the discrete item related to the Medicare Part&#160;D subsidy received by the Company as discussed in &#8220;NOTE 10. INCOME TAXES.&#8221; The effective tax rate used for interim reporting purposes was based on management&#8217;s best estimate of factors impacting the effective tax rate for the full fiscal year. Factors affecting the estimated effective tax rate include assumptions as to income by jurisdiction (domestic and foreign), the availability and utilization of tax credits and the existence of elements of income and expense that may not be taxable or deductible, as well as other items. The estimated effective tax rate is subject to revision at fiscal year end as facts and circumstances change during the course of the fiscal year. 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The objective is to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. The guidance applies to all transactions or other events in which an entity (the &#8220;acquirer&#8221;) obtains control of one or more businesses (the &#8220;acquiree&#8221;), including those sometimes referred to as &#8220;true mergers&#8221; or &#8220;mergers of equals&#8221; and combinations achieved without the transfer of consideration. In April&#160;2009, the FASB issued additional guidance which addresses application issues arising from contingencies in a business combination. The Company adopted the new guidance beginning October&#160;1, 2009. The Company had no acquisition activity for the nine months ended July&#160;3, 2010, and the adoption of the new guidance did not impact the Company&#8217;s financial statements and related disclosures. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Noncontrolling Interests in Consolidated Financial Statements </i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"> In December&#160;2007, the FASB issued new accounting and reporting guidance for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. 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The Company is in the process of evaluating the impact that the guidance may have on its financial statements and related disclosures. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Variable Interest Entities</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"> In June&#160;2009, the FASB issued new accounting guidance requiring an enterprise to perform an analysis to determine whether the enterprise&#8217;s variable interest or interests give it a controlling financial interest in a variable interest entity. The new guidance also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise&#8217;s involvement in a variable interest entity. The provisions are effective for the Company&#8217;s financial statements for the fiscal year beginning October&#160;1, 2010. 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During the Company&#8217;s first quarter of fiscal 2010, all Smith &#038; Hawken stores were closed and substantially all operational activities of Smith &#038; Hawken were discontinued. As a result, effective in its first quarter of fiscal 2010, the Company classified Smith &#038; Hawken as discontinued operations. Accordingly, the Company has reclassified its results of operations for the three and nine months ended June&#160;27, 2009 to reflect Smith &#038; Hawken as discontinued operations separate from the Company&#8217;s results of continuing operations. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In fiscal 2010, the Company has incurred charges related to the liquidation of the Smith &#038; Hawken business primarily associated with the termination of retail site lease obligations, third-party agency fees and severance and benefit commitments. 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PRODUCT REGISTRATION AND RECALL MATTERS</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In April&#160;2008, the Company became aware that a former associate apparently deliberately circumvented Company policies and U.S. Environmental Protection Agency (&#8220;U.S. EPA&#8221;) regulations under the Federal Insecticide, Fungicide, and Rodenticide Act of 1947, as amended (&#8220;FIFRA&#8221;), by failing to obtain valid registrations for products and/or causing invalid product registration forms to be submitted to regulators. Since that time, the Company has been cooperating with both the U.S. EPA and the U.S. Department of Justice (&#8220;U.S. DOJ&#8221;) in related civil and criminal investigations into the pesticide product registration issues. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In late April of 2008, in connection with the U.S. EPA&#8217;s investigation, the Company conducted a consumer-level recall of certain consumer lawn and garden products and a Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> product. Subsequently, the Company and the U.S. EPA agreed upon a Compliance Review Plan for conducting a comprehensive, independent review of the Company&#8217;s product registration records. Pursuant to the Compliance Review Plan, an independent third-party firm, Quality Associates Incorporated (&#8220;QAI&#8221;), reviewed substantially all of the Company&#8217;s U.S. pesticide product registrations and associated advertisements, some of which were historical in nature and no longer related to sales of the Company&#8217;s products. The U.S. EPA investigation and the QAI review process resulted in the temporary suspension of sales and shipments of certain products. In addition, as the QAI review process or the Company&#8217;s internal review identified potential FIFRA registration issues (some of which appear unrelated to the actions of the former associate), the Company endeavored to stop selling or distributing the affected products until the issues could be resolved. QAI&#8217;s review of the Company&#8217;s U.S. pesticide product registrations and associated advertisements is now substantially complete. The results of the QAI review process did not materially affect the Company&#8217;s fiscal 2009 or year-to-date fiscal 2010 sales and are not expected to materially affect the Company&#8217;s sales during the remainder of fiscal 2010. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In late 2008, Scotts Miracle-Gro and its indirect subsidiary, EG Systems, Inc., doing business as Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup>, were named as defendants in a purported class action filed in the U.S. District Court for the Eastern District of Michigan relating to the application of certain pesticide products by Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup>. In the suit, Mark Baumkel, on behalf of himself and the purported classes, sought an unspecified amount of damages, plus costs and attorneys&#8217; fees, for alleged claims involving breach of contract, unjust enrichment and violation of the State of Michigan&#8217;s consumer protection act. On September&#160;28, 2009, the court granted the motion filed by Scotts Miracle-Gro and EG Systems, Inc. and dismissed the suit with prejudice. Since that time, Scotts Miracle-Gro, EG Systems, Inc. and Mr.&#160;Baumkel have agreed to a confidential settlement that, among other things, precludes an appeal of the decision. The impact of the confidential settlement did not, and will not, materially affect the Company&#8217;s financial condition, results of operations or cash flows. </div> <!-- Folio --> <!-- /Folio --> </div> <!-- PAGEBREAK --> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In fiscal 2008, the Company conducted a voluntary recall of certain of its wild bird food products due to a formulation issue. Certain wild bird food products had been treated with pest control additives to avoid insect infestation, especially at retail stores. While the pest control additives had been labeled for use on certain stored grains that can be processed for human and/or animal consumption, they were not labeled for use on wild bird food products. In October&#160;2008, the U.S. Food &#038; Drug Administration concluded that the recall had been completed and that there had been proper disposition of the recalled products. The results of the wild bird food recall did not materially affect the Company&#8217;s fiscal 2009 financial condition, results of operations or cash flows. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">As a result of these registration and recall matters, the Company has reversed sales associated with estimated returns of affected products, recorded charges for affected inventory and recorded other registration and recall-related costs. The impacts of these adjustments were pre-tax charges of $1.5&#160;million and $6.4&#160;million for the three-month periods, and $5.8&#160;million and $22.0&#160;million for the nine-month periods ended July&#160;3, 2010 and June&#160;27, 2009, respectively. The Company expects to incur $8.0 to $10.0&#160;million in fiscal 2010 on recall and registration matters, excluding possible fines, penalties, judgments and/or litigation costs. These fiscal 2010 charges primarily consist of costs associated with the reworking of certain finished goods inventories, the disposal of certain products and ongoing third-party professional services related to the U.S. EPA and U.S. DOJ investigations. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The U.S. EPA and U.S. DOJ investigations continue and may result in future state, federal or private actions including fines and/or penalties with respect to known or potential additional product registration issues. Until the U.S. EPA and U.S. DOJ investigations are complete, the Company cannot reasonably determine the scope or magnitude of possible liabilities that could result from known or potential product registration issues, and no reserves for these potential liabilities have been established as of July&#160;3, 2010. 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The 2009 MARP Agreement, as amended by the First Amendment, provides an interest rate that approximates the 7-day LIBOR rate plus 125 basis points; the First Amendment did not otherwise modify any substantive provisions of the 2009 MARP Agreement. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company accounts for the sale of receivables under the 2009 MARP Agreement, as amended, as short-term debt and continues to carry the receivables on its Condensed, Consolidated Balance Sheet, primarily as a result of the Company&#8217;s right to repurchase receivables sold. 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With few exceptions, the Company is no longer subject to examinations by these tax authorities for fiscal years prior to 2007. The Company is currently under examination by the Internal Revenue Service and certain U.S. state and local tax authorities. In regard to the U.S. state and local audits, the tax periods under investigation are limited to fiscal years 2005 through 2008. A federal audit of the Company&#8217;s fiscal 2008 tax year also commenced during the quarter ended July&#160;3, 2010. In addition to these audits, certain other tax deficiency notices and refund claims for previous years remain unresolved. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company currently anticipates that few of its open and active audits will be resolved within the next 12&#160;months. The Company is unable to make a reasonably reliable estimate as to when or if cash settlements with taxing authorities may occur. Although audit outcomes and the timing of audit payments are subject to significant uncertainty, the Company does not anticipate that the resolution of these tax matters or any events related thereto will result in a material change to its consolidated financial position, results of operations or cash flows. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company has historically received a federal retiree drug subsidy as it offers retiree prescription drug coverage that is at a minimum as valuable as Medicare Part&#160;D coverage. The Patient Protection and Affordable Care Act (&#8220;PPACA&#8221;), which was enacted on March 23, 2010, repealed the existing rule that permitted a tax deduction for the portion of the drug coverage expense that was offset by the Medicare Part&#160;D subsidy received by the Company. This provision of PPACA was to be effective beginning with the Company&#8217;s fiscal 2012 tax year. On March&#160;30, 2010, a companion bill, the Health Care and Education Reconciliation Act of 2010 (&#8220;HCERA&#8221;), was enacted. HCERA delayed the effective date of the reduction under PPACA until the Company&#8217;s fiscal 2014 tax year. As a result of this new legislation, the Company recorded a $1.9&#160;million charge to tax expense during its second quarter of fiscal 2010 to reduce its deferred tax asset for the portion of the subsidy that will no longer be deductible when paid after fiscal 2013. </div> </div> <!--DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Transitional//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-transitional.dtd" --> <!-- Begin Block Tagged Note 11 - smg:LossContingencyDisclosureTextBlock--> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><b>NOTE 11. CONTINGENCIES</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Management regularly evaluates the Company&#8217;s contingencies, including various lawsuits and claims which arise in the normal course of business, product and general liabilities, workers&#8217; compensation, property losses and other fiduciary liabilities for which the Company is self-insured or retains a high exposure limit. Self-insurance reserves are established based on actuarial loss estimates for specific individual claims plus actuarially estimated amounts for incurred but not reported claims and adverse development factors for existing claims. Legal costs incurred in connection with the resolution of claims, lawsuits and other contingencies generally are expensed as incurred. In the opinion of management, its assessment of contingencies is reasonable and related reserves, in the aggregate, are adequate; however, there can be no assurance that final resolution of these matters will not have a material adverse effect on the Company&#8217;s financial condition, results of operations or cash flows. The following are the more significant of the Company&#8217;s identified contingencies: </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>FIFRA Compliance and the Corresponding Governmental Investigations</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">For a description of the Company&#8217;s ongoing FIFRA compliance efforts and the corresponding governmental investigations, see &#8220;NOTE 3. PRODUCT REGISTRATION AND RECALL MATTERS.&#8221; </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Other Regulatory Matters</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In 1997, the Ohio Environmental Protection Agency initiated an enforcement action against the Company with respect to alleged surface water violations and inadequate wastewater treatment capabilities at its Marysville, Ohio facility, seeking corrective action under the federal Resource Conservation and Recovery Act of 1976, as amended (&#8220;RCRA&#8221;). The action related to discharges from on-site waste water treatment and several discontinued on-site disposal areas. Pursuant to a Consent Order entered by the Union County Common Pleas Court in 2002, as of June&#160;2010 the Company has completed the required actions to restore the site and eliminate exposure to waste materials from the discontinued on-site disposal areas. The Company is obligated to perform long-term monitoring of the site for up to 25 to 30&#160;years. </div> <!-- Folio --> <!-- /Folio --> </div> <!-- PAGEBREAK --> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt">On or about March&#160;19, 2010, the U.S. EPA Region VII issued notice to the Company indicating that the U.S. EPA intended to file an administrative complaint with respect to alleged RCRA violations arising out of an October&#160;28-29, 2008 inspection of the Company&#8217;s Fort Madison, Iowa facility. The notice proposed a penalty of $466,977 and offered the Company the opportunity to negotiate a resolution of the proposed penalty before any complaint was filed. The Company made a timely response to the U.S. EPA and agreed to enter into pre-filing negotiations. Settlement discussions are underway. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">At July&#160;3, 2010, $2.5&#160;million was accrued for other regulatory matters in the &#8220;Other liabilities&#8221; line in the Condensed, Consolidated Balance Sheet. The amounts accrued are believed to be adequate to cover such known environmental exposures based on current facts and estimates of likely outcomes. However, if facts and circumstances change significantly, they could result in a material adverse effect on the Company&#8217;s financial condition, results of operations or cash flows. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Other</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company has been named as a defendant in a number of cases alleging injuries that the lawsuits claim resulted from exposure to asbestos-containing products, apparently based on the Company&#8217;s historic use of vermiculite in certain of its products. The complaints in these cases are not specific about the plaintiffs&#8217; contacts with the Company or its products. The Company in each case is one of numerous defendants and none of the claims seek damages from the Company alone. The Company believes that the claims against it are without merit and is vigorously defending against them. It is not currently possible to reasonably estimate a probable loss, if any, associated with these cases and, accordingly, no accrual or reserves have been recorded in the Company&#8217;s condensed, consolidated financial statements. The Company is reviewing agreements and policies that may provide insurance coverage or indemnity as to these claims and is pursuing coverage under some of these agreements and policies, although there can be no assurance of the results of these efforts. There can be no assurance that these cases, whether as a result of adverse outcomes or as a result of significant defense costs, will not have a material adverse effect on the Company&#8217;s financial condition, results of operations or cash flows. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">On April&#160;27, 2007, the Company received a proposed Order On Consent from the New York State Department of Environmental Conservation (the &#8220;Proposed Order&#8221;) alleging that, during calendar year 2003, the Company and James Hagedorn, individually and as Chairman of the Board and Chief Executive Officer of the Company, unlawfully donated to a Port Washington, New York youth sports organization forty bags of Scotts<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> LawnPro Annual Program Step 3 Insect Control Plus Fertilizer which, while federally registered, was allegedly not registered in the state of New York. The Proposed Order requests penalties totaling $695,000. The Company has responded in writing to the New York State Department of Environmental Conservation with respect to the Proposed Order and is awaiting a response. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company is involved in other lawsuits and claims which arise in the normal course of business. These claims individually and in the aggregate are not expected to result in a material adverse effect on the Company&#8217;s financial condition, results of operations or cash flows. </div> </div> <!--DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Transitional//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-transitional.dtd" --> <!-- Begin Block Tagged Note 12 - us-gaap:DerivativeInstrumentsAndHedgingActivitiesDisclosureTextBlock--> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><b>NOTE 12. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Derivatives and Hedging</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company is exposed to market risks, such as changes in interest rates, currency exchange rates and commodity prices. To manage the volatility related to these exposures, the Company enters into various financial transactions. The utilization of these financial transactions is governed by policies covering acceptable counterparty exposure, instrument types and other hedging practices. The Company does not hold or issue derivative financial instruments for speculative trading purposes. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company formally designates and documents qualifying instruments as hedges of underlying exposures at inception. The Company formally assesses, both at inception and at least quarterly, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposure. Fluctuations in the value of these instruments generally are offset by changes in the fair value or cash flows of the underlying exposures being hedged. This offset is driven by the high degree of effectiveness between the exposure being hedged and the hedging instrument. GAAP requires all derivative instruments to be recognized as either assets or liabilities at fair value in the Condensed, Consolidated Balance Sheets. The Company designates commodity hedges as cash flow hedges of forecasted purchases of commodities and interest rate swap agreements as cash flow hedges of interest payments on variable rate borrowings. Any ineffective portion of a change in the fair value of a qualifying instrument is immediately recognized in earnings. The amounts recorded in earnings related to ineffectiveness of derivative hedges for the three- and nine-month periods ended July&#160;3, 2010 and June&#160;27, 2009 were not significant. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Foreign Currency Swap Contracts</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company periodically uses foreign currency swap contracts to manage the exchange rate risk associated with intercompany loans with foreign subsidiaries that are denominated in local currencies. At July&#160;3, 2010, the notional amount of outstanding foreign currency swap contracts was $211.4&#160;million, with a fair value of $(5.6) million. The fair value of foreign currency swap contracts is determined based on changes in spot rates. The unrealized loss on the foreign currency swap contracts approximates the unrealized gain on the intercompany loans recognized by the Company&#8217;s lending subsidiaries. </div> <!-- Folio --> <!-- /Folio --> </div> <!-- PAGEBREAK --> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Interest Rate Swap Agreements</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company enters into interest rate swap agreements as a means to hedge its variable interest rate exposure on debt instruments. The fair values are reflected in the Company&#8217;s Condensed, Consolidated Balance Sheets. Net amounts to be received or paid under the swap agreements are reflected as adjustments to interest expense. Since the interest rate swap agreements have been designated as hedging instruments, unrealized gains or losses resulting from adjusting these swaps to fair value are recorded as elements of accumulated other comprehensive loss (&#8220;AOCI&#8221;) within the Condensed, Consolidated Balance Sheets. The fair value of the swap agreements is determined based on the present value of the estimated future net cash flows using implied rates in the applicable yield curve as of the valuation date. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">At July&#160;3, 2010 and June&#160;27, 2009, the Company had outstanding interest rate swap agreements with major financial institutions that effectively converted a portion of the Company&#8217;s variable-rate debt to a fixed rate. The swap agreements had a total U.S. dollar equivalent notional amount of $450&#160;million and $650&#160;million at July&#160;3, 2010 and June&#160;27, 2009, respectively. Refer to &#8220;NOTE 6. DEBT&#8221; for the terms of the swap agreements outstanding at July&#160;3, 2010. Included in the AOCI balance at July&#160;3, 2010 was a pre-tax loss of $11.5&#160;million related to interest rate swap agreements that is expected to be reclassified to earnings during the next 12&#160;months, consistent with the timing of the underlying hedged transactions. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><u><b><i>Commodity Hedges</i></b></u> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company had outstanding hedging arrangements at July&#160;3, 2010 designed to fix the price of a portion of its urea needs. The contracts are designated as hedges of the Company&#8217;s exposure to future cash flow fluctuations associated with the cost of urea. The objective of the hedges is to mitigate the earnings and cash flow volatility attributable to the risk of changing prices. Unrealized gains or losses in the fair value of these contracts are recorded to the AOCI component of shareholders&#8217; equity. Realized gains or losses remain as a component of AOCI until the related inventory is sold. Upon sale of the underlying inventory, the gain or loss is reclassified to cost of sales. Included in the AOCI balance at July&#160;3, 2010 was a pre-tax gain of $0.8&#160;million related to urea derivatives that is expected to be reclassified to earnings during the next 12&#160;months, consistent with the timing of the underlying hedged transactions. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Periodically, the Company also uses fuel derivatives to partially mitigate the effect of fluctuating diesel and gasoline costs on operating results. 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FAIR VALUE MEASUREMENTS</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company adopted the new accounting guidance for all financial assets and liabilities accounted for at fair value on a recurring basis effective October&#160;1, 2008. The Company adopted the new accounting guidance for all non-financial assets and liabilities accounted for at fair value on a non-recurring basis effective October&#160;1, 2009. The guidance defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. It defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or the most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. GAAP establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. 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margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><b>NOTE 14. ACQUISITIONS</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">There was no acquisition activity in the first nine months of fiscal 2010. Effective October&#160;1, 2008, the Company acquired Humax Horticulture Limited, a privately-owned growing media company in the United Kingdom, for a total cost of $9.3&#160;million. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">In May&#160;2006, the Company acquired certain brands and assets of Turf-Seed, Inc., a leading producer of quality commercial turfgrasses, for cash of $10.0&#160;million, assumed liabilities of $4.5&#160;million and contingent consideration due in the second half of fiscal 2012. The contingent consideration is largely based on the performance of the Company&#8217;s consumer and professional seed business for the twelve-month period ending in May&#160;2012. </div> </div> <!--DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Transitional//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-transitional.dtd" --> <!-- Begin Block Tagged Note 15 - us-gaap:SegmentReportingDisclosureTextBlock--> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt"><b>NOTE 15. SEGMENT INFORMATION</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Company divides its business into the following segments &#8212; Global Consumer, Global Professional, Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> and Corporate &#038; Other. 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Products are sold to commercial nurseries and greenhouses and specialty crop growers, primarily in North America and Europe. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup> segment provides lawn fertilization, disease and insect control and other related services such as core aeration, tree and shrub fertilization and limited pest control services primarily to residential consumers through Company-owned branches and franchises in the United States. </div> <!-- Folio --> <!-- /Folio --> </div> <!-- PAGEBREAK --> <div style="font-family: 'Times New Roman',Times,serif; margin-left: 0in; "> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Corporate &#038; Other segment primarily consists of corporate general and administrative expenses. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">Segment performance is evaluated based on several factors, including income from continuing operations before amortization, product registration and recall costs, and impairment, restructuring and other charges, which are not GAAP measures. Senior management of the Company uses this measure of operating profit to gauge segment performance because the Company believes this measure is the most indicative of performance trends and the overall earnings potential of each segment. 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FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTORS</b> </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The Senior Notes issued by Scotts Miracle-Gro on January&#160;14, 2010 are guaranteed by certain of its domestic subsidiaries and, therefore, the Company has disclosed condensed, consolidating financial information in accordance with SEC Regulation&#160;S-X Rule&#160;3-10, <i>Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered. </i>The following 100% directly or indirectly owned subsidiaries fully and unconditionally guarantee the Senior Notes on a joint and several basis: EG Systems, Inc., dba Scotts LawnService<sup style="font-size: 85%; vertical-align: text-top">&#174;</sup>; Gutwein &#038; Co., Inc.; Hyponex Corporation; Miracle-Gro Lawn Products, Inc.; OMS Investments, Inc.; Rod McLellan Company; Sanford Scientific, Inc.; Scotts Temecula Operations, LLC; Scotts Manufacturing Company; Scotts Products Co.; Scotts Professional Products Co.; Scotts-Sierra Crop Protection Company; Scotts-Sierra Horticultural Products Company; Scotts-Sierra Investments, Inc.; SMG Growing Media, Inc.; Swiss Farms Products, Inc.; and The Scotts Company LLC (collectively, the &#8220;Guarantors&#8221;). Teak 2, Ltd., f/k/a Smith &#038; Hawken, Ltd., was released from its guarantee under the Senior Notes on March&#160;18, 2010. Accordingly, Teak 2, Ltd. has been classified as a Non-Guarantor for all periods presented in the condensed, consolidating financial information accompanying this Note 16. </div> <div align="justify" style="font-size: 10pt; margin-top: 10pt">The following information presents condensed, consolidating Statements of Operations for the three-month and nine-month periods ended July&#160;3, 2010 and June&#160;27, 2009, condensed, consolidating Statements of Cash Flows for the nine-month periods ended July&#160;3, 2010 and June&#160;27, 2009, and condensed, consolidating Balance Sheets as of July&#160;3, 2010, June&#160;27, 2009 and September&#160;30, 2009. The condensed, consolidating financial information presents, in separate columns, financial information for: Scotts Miracle-Gro on a Parent-only basis, carrying its investment in subsidiaries under the equity method; Guarantors on a combined basis, carrying investments in subsidiaries which do not guarantee the debt (collectively, the &#8220;Non-Guarantors&#8221;) under the equity method; Non-Guarantors on a combined basis; and eliminating entries. The eliminating entries primarily reflect intercompany transactions, such as interest expense, accounts receivable and payable, short and long-term debt, and the elimination of equity investments and income in subsidiaries. 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