10-Q 1 j0239401e10vq.txt SYLVAN INC. 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 29, 2003 Commission File Number 0-18339 SYLVAN INC. (Exact name of registrant as specified in its charter) NEVADA 25-1603408 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 333 MAIN STREET, P.O. BOX 249, SAXONBURG, PA 16056-0249 (Address of principal executive offices) (Zip Code) (724) 352-7520 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2). Yes No X --- --- Number of shares of common stock outstanding as of August 6, 2003...5,144,131 SYLVAN INC. AND SUBSIDIARIES INDEX

PART I - FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED BALANCE SHEETS Sylvan Inc. and Subsidiaries (In thousands)

The accompanying notes are an integral part of these financial statements. 3 CONDENSED CONSOLIDATED BALANCE SHEETS Sylvan Inc. and Subsidiaries (In thousands except share data)

The accompanying notes are an integral part of these financial statements. 4 CONDENSED CONSOLIDATED STATEMENTS OF INCOME Sylvan Inc. and Subsidiaries (Unaudited, in thousands except share data)

The accompanying notes are an integral part of these financial statements. 5 CONDENSED CONSOLIDATED STATEMENTS OF INCOME Sylvan Inc. and Subsidiaries (Unaudited, in thousands except share data)

The accompanying notes are an integral part of these financial statements. 6 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Sylvan Inc. and Subsidiaries (Unaudited, in thousands)

The accompanying notes are an integral part of these financial statements. 7 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SYLVAN INC. AND SUBSIDIARIES JUNE 29, 2003 (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: General These condensed consolidated financial statements of Sylvan Inc. are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results of operations for the interim period. These statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the company's Annual Report to Shareholders and its Form 10-K, as amended, for the year ended December 29, 2002. The condensed consolidated December 29, 2002 balance sheet was derived from the audited balance sheet included in the most recent Form 10-K, as amended. Cash The company had a French-franc denominated loan of FF16.2 million ($2.2 million) that was repaid in January 2002. Inventories Inventories at June 29, 2003 and December 29, 2002 consisted of the following:

Earnings Per Common Share Earnings per share were calculated using the weighted average number of shares outstanding during the period, including the effect of stock options outstanding. Pursuant to the company's 1990 and 1993 stock option plans, options for a total of 1,366,081 shares of the company's common stock have been granted and options for a total of 584,826 of these shares have been exercised as of June 29, 2003. 8 The following tables reconcile the number of shares utilized in the earnings per share calculations for the three months and six months ended June 29, 2003 and June 30, 2002:

Options to purchase approximately 446,000 and 487,000 shares of common stock in the three and six months ended June 29, 2003 and 298,000 shares of common stock in the three and six months ended June 30, 2002, respectively, were outstanding, but were not included in the computation of diluted earnings per share because the exercise prices of these options were greater than the average market prices of the company's common shares for the respective periods. Intangible Assets Sylvan's intangible assets, which relate solely to its Spawn Products Segment, are as follows:

The remaining useful lives of the cultures range from six to nine years and the other intangible assets range from one to four years. Amortization expense for intangible assets was $32,000 and $64,000 for the three and six months ended June 29, 2003, respectively. Estimated amortization expense for the remainder of 2003 and the five succeeding years is as follows: (in thousands) 2003 (remainder) $ 63 2004 122 2005 67 2006 67 2007 65 2008 59 9 2. LONG-TERM DEBT AND BORROWING ARRANGEMENTS: The company has a Revolving Credit Agreement with two commercial banks, dated August 6, 1998 and amended, in part, December 29, 2002. It provides for revolving credit loans on which the aggregate outstanding balance available to the company may not initially exceed $55.0 million. The maximum aggregate outstanding balance will decline over the life of the agreement as follows: Maximum Aggregate Period Beginning Outstanding Balance ---------------- ------------------- August 6, 2003 $50.0 million August 6, 2004 45.0 million Outstanding borrowings under the agreement bear interest at either the Prime Rate or LIBOR (plus an applicable margin) at the company's option. On June 29, 2003, the company had outstanding borrowings under the agreement of $35.0 million. The revolving credit loans mature on August 5, 2005. The agreement provides for the maintenance of various financial covenants and includes limitations as to incurring additional indebtedness and the granting of security interests to third parties. Obligations under the agreement are guaranteed by certain wholly owned subsidiaries of the company. The company has several additional loan obligations. The outstanding balances related to these loans totaled approximately $1.3 million as of June 29, 2003 and $1.4 million as of December 29, 2002. Interest rates on these loans vary. 3. COMPREHENSIVE INCOME: Comprehensive income consisted of the following:

10 The components of accumulated other comprehensive deficit consist of the following:

Floating-to-fixed interest rate swap agreements, designated as cash flow hedges, hedge the company's floating rate debt and will mature at various times through August 2007. The fair value of these contracts is recorded in the balance sheet, with the offset to "Accumulated Other Comprehensive Deficit," net of tax. Based on interest rates at June 29, 2003, the company expects to expense $36,000 in the next 12 months related to derivative instruments. 4. BUSINESS SEGMENT INFORMATION: Sylvan is a worldwide producer and distributor of products for the mushroom industry, specializing in spawn (the equivalent of seed for mushrooms) and spawn-related products and services, and is a major grower of fresh mushrooms in the United States. The company has two reportable business segments: Spawn Products, which includes spawn-related products, services and bioproducts; and Fresh Mushrooms. Spawn-related products include casing inoculum, nutritional supplements and disease-control agents. During the quarter and six months ended June 29, 2003, the company made no changes in the basis of segmentation or in the basis of measurement of segment profit or loss from that reported in the December 29, 2002 financial statements. 11

Reconciliation to Consolidated Financial Data:

12 5. STOCK OPTIONS: In June 1991, the shareholders approved a stock option plan (the 1990 Plan) for employees and others who perform substantial services for the company. In April 1999, the shareholders approved an amendment and restatement of the 1990 Plan to provide for an increase to 1,700,000 in the number of shares of the company's stock which are available for the granting of options. In June 1993, the shareholders approved a stock option plan (the 1993 Plan) for nonemployee directors of the company, covering 100,000 shares of common stock. The company accounts for both plans under the Accounting Principles Board Opinion No. 25, under which no compensation cost is recognized for options granted at fair market value. In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition to SFAS No. 123's fair value method of accounting for stock-based compensation. While the Statement does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of the Statement are applicable to all companies with stock-based compensation. Had compensation cost for these plans been determined in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the company's net income and earnings per share (EPS) would have been reduced to the following pro forma amounts:

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants made in 2002: risk-free interest rates of 3.17%; no expected dividend yields; expected lives of 8.0 years; expected volatility of 34%. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS SYLVAN INC. AND SUBSIDIARIES RESULTS OF OPERATIONS (Three Months Ended June 29, 2003 and June 30, 2002) CONSOLIDATED REVIEW Net Sales (in thousands) 2003 2002 % Change ---- ---- -------- Net sales $ 23,587 $ 21,388 10.3 Net sales increased 10.3% to $23.6 million, when compared with $21.4 million for the corresponding 2002 quarter. Net sales of the Fresh Mushrooms Segment increased $0.9 million, or 14.5%, while net sales of the Spawn Products Segment increased $1.3 million, or 8.3%. On average, for the second quarter of 2003, the U.S. dollar was approximately 24% weaker, when measured against the company's applicable foreign currencies, than for the second quarter of 2002. The weakening had the effect of increasing sales and operating income during the 2003 quarter, as compared with the corresponding 2002 quarter, by approximately $2.4 million and $120,000, respectively. Overseas sales, as a percentage of net sales, were 47% in both the quarter ended June 29, 2003 and the quarter ended June 30, 2002. Operating Costs and Expenses (in thousands) 2003 2002 % Change ---- ---- -------- Cost of sales $ 15,039 $ 12,554 19.8 Selling, administration, research and development 5,816 5,570 4.4 Depreciation 1,580 1,421 11.2 The company's cost of sales, expressed as a percentage of net sales, was 63.8% for the second quarter of 2003, as compared with 58.7% for the second quarter of 2002. The cost of sales percentage increased in both the Fresh Mushrooms and Spawn Products Segments, as detailed in the Business Segments presentation below. Selling, administration, research and development expenses were $5.8 million for the June 29, 2003 quarter and $5.6 million for the June 30, 2002 quarter and were 24.7% and 26.0% of net sales, respectively. During the second quarter of 2003, the company incurred costs of approximately $320,000 related to the activities of the company's special committee of independent directors that was established by the company's board in April 2003 when it received an indication of interest by a group of Sylvan Inc. senior officers and private investors to acquire shares of Sylvan's common stock. Approximately $95,000 in similar costs were incurred during the second quarter of 2002 in the course of a similar committee's evaluation of strategic plans and business alternatives that was conducted at that time. The company recorded a net periodic pension expense of $167,500 during the quarter ended June 29, 2003 from a pension plan of a former subsidiary, as compared with a net periodic pension benefit of $37,500 for the quarter ended June 30, 2002. This expense increase was related to poor plan asset performance and a decrease in the plan's discount rate assumption. Interest Expense Net interest expense for the second quarter of 2003 decreased to $401,000 from $447,000 for the second quarter of 2002. The effective borrowing rate for the second quarter of 2003 was 4.2%, as compared with 5.3% for the 14 second quarter of 2002. The company recorded interest income of $71,000 in the second quarter of 2003, as compared with $18,000 of interest expense in the second quarter of 2002, related to SFAS No. 133. The effective borrowing rates, excluding the effect of SFAS No. 133, were 4.9% for the quarter ended June 29, 2003 and 5.1% for the quarter ended June 30, 2002. During the 2003 quarter, the company had $20.0 million of variable-to-fixed interest rate swaps in place to manage interest rate risk that increased the average borrowing rate 1.6%. During 2002, $15.0 million of swaps increased the average borrowing rate 1.5%. Income Tax Expense The effective income tax rate for the second quarter of 2003 was 33%, as compared with 32% for the corresponding 2002 quarter. BUSINESS SEGMENTS Spawn Products (in thousands) 2003 2002 % Change ---- ---- -------- Sales, including intersegment $ 16,684 $ 15,401 8.3 Operating expenses 14,733 13,011 13.2 Operating income 1,951 2,390 (18.4) Net sales of spawn and spawn-related products increased 8.3%. The effect of a weaker U.S. dollar on overseas sales increased net sales on a quarter-over-quarter comparison by $2.4 million. Spawn product sales volume decreased 4.8%, with a 2.4% decrease in the Americas and a 6.3% decrease in overseas markets. Most of the volume decrease in the overseas markets resulted from a reduction in sales in the United Kingdom due to farm closures and in France due to challenging competitive conditions. Sales of disease-control agents and nutritional supplements increased 6.2% and accounted for 17.8% of Sylvan's consolidated net sales for the second quarter. The overseas U.S. dollar-equivalent selling price was 19.1% higher during the second quarter of 2003, as compared with the corresponding quarter of 2002, primarily due to the weakening of the U.S. dollar. Overseas local currency selling prices decreased approximately 3.6% due to the loss of sales in higher-priced territories. The selling price in the Americas decreased 5.8% as a result of adjustments to the pricing structure of some products in order to compete with the lower-priced spawn offerings of other suppliers. Operating expenses increased 13.2% when compared with the second quarter of 2002. The effect of a weaker U.S. dollar increased operating expenses on a quarter-over-quarter comparison by $2.3 million. Within operating expenses, cost of sales was 58.3% of net sales, as compared with 53.7% for the corresponding 2002 quarter. Spawn production in overseas markets was 15.2% lower than for the second quarter of 2002, spreading costs that are primarily fixed in nature over fewer units. Operating income, as a percentage of net sales, was 11.7% for the second quarter of 2003, as compared with 15.5% for the corresponding 2002 quarter. Operating income was positively impacted by the weakening of the U.S. dollar, with an effect of approximately $120,000. The company's Bioproducts division recorded net sales of $950,000 for the second quarter of 2003, as compared with $330,000 for the second quarter of 2002. Sales growth was experienced in both the Red Yeast Rice and dried Agaricus mushroom products. Operating income for the second quarter of 2003 was $375,000, as compared with a $75,000 operating loss for the second quarter of 2002. 15 Fresh Mushrooms (in thousands) 2003 2002 % Change ---- ---- -------- Sales $ 7,233 $ 6,316 14.5 Operating expenses 6,561 5,568 17.8 Operating income 672 748 (10.2) Net sales of fresh mushrooms increased to $7.2 million during the second quarter, as compared with $6.3 million for the corresponding quarter of 2002. The number of pounds sold increased 4.7%, while the average selling price per pound was virtually unchanged. The Fresh Mushrooms Segment's cost of sales was $5.3 million, or 73.5% of net sales, for the quarter ended June 29, 2003, as compared with $4.3 million, or 67.8%, for the 2002 second quarter. The segment's operating income for the quarter was $0.7 million, or 9.3% of net sales, and was 10.2% lower than the amount reported for the second quarter of 2002, primarily due to increased labor costs on a per pound basis. Labor costs and Workers' Compensation expense for the second quarter of 2003 were approximately $130,000 higher, when compared with the costs recorded for the corresponding 2002 quarter. The positive performance of the company's satellite farms helped minimize the adverse effect of these increased costs. Quincy sold $0.9 million of ready-to-grow mushroom compost to its satellite farms and purchased $1.9 million of high-quality mushrooms from the satellites for immediate resale to its third-party wholesaler during the second quarter of 2003. By comparison, Quincy sold $0.3 million of ready-to-grow mushroom compost to its satellite farms and purchased $0.6 million of high-quality mushrooms in the second quarter of 2002. RESULTS OF OPERATIONS (Six Months Ended June 29, 2003 and June 30, 2002) CONSOLIDATED REVIEW Net Sales (in thousands) 2003 2002 % Change ---- ---- -------- Net sales $ 45,969 $ 42,307 8.7 Net sales increased 8.7% to $46.0 million for the first six months of 2003, when compared with $42.3 million for the corresponding 2002 period. Net sales of the Fresh Mushrooms Segment increased $1.9 million, or 15.4%, while net sales of the Spawn Products Segment increased $1.7 million, or 5.7%. On average, for the first six months of 2003, the U.S. dollar was approximately 23% weaker, when measured against the company's applicable foreign currencies, than for the first six months of 2002. The weakening had the effect of increasing sales and operating income during the 2003 period, as compared with the corresponding 2002 period, by approximately $4.8 million and $380,000, respectively. Overseas sales, as a percentage of net sales, were 48% in both the six months ended June 29, 2003 and June 30, 2002. Operating Costs and Expenses (in thousands) 2003 2002 % Change ---- ---- -------- Cost of sales $ 28,830 $ 24,632 17.0 Selling, administration, research and development 11,118 10,741 3.5 Depreciation 3,137 2,815 11.4 16 The company's cost of sales, expressed as a percentage of net sales, was 62.7% for the first six months of 2003, as compared with 58.2% for the first six months of 2002. The cost of sales percentage increased in both the Fresh Mushrooms and Spawn Products Segments, as detailed in the Business Segments presentation below. Selling, administration, research and development expenses were $11.1 million for the six months ended June 29, 2003 and $10.7 million for the six months ended June 30, 2002 and were 24.2% and 25.4% of net sales, respectively. During the first six months of 2003, the company incurred costs of approximately $320,000 related to the activities of the company's special committee of independent directors. Approximately $95,000 in similar costs were incurred during the first six months of 2002 in the course of a similar committee's evaluation of strategic plans and business alternatives that was conducted at that time. The company recorded a net periodic pension expense of $335,000 during the six months ended June 29, 2003 from a pension plan of a former subsidiary, as compared with a net periodic pension benefit of $75,000 for the six months ended June 30, 2002. This expense increase was related to poor plan asset performance and a decrease in the plan's discount rate assumption. Interest Expense Net interest expense for the first six months of 2003 decreased to $823,000 from $877,000 for the second quarter of 2002. The effective borrowing rate for the first six months of 2003 was 4.3%, as compared with 5.0% for the first six months of 2002. The company recorded interest income of $107,000 in the 2003 period, as compared with $28,000 of interest income in the corresponding 2002 period, related to SFAS No. 133. The effective borrowing rates, excluding the effect of SFAS No. 133, were 4.9% for the six months ended June 29, 2003 and 5.1% for the six months ended June 30, 2002. During the 2003 period, the company had $20.0 million of variable-to-fixed interest rate swaps in place to manage interest rate risk that increased the average borrowing rate 1.5%. During the 2002 period, $15.0 million of swaps increased the average borrowing rate 1.5%. Income Tax Expense The effective income tax rate for both the first six months of 2003 and for the first six months of 2002 was 33%. BUSINESS SEGMENTS Spawn Products (in thousands) 2003 2002 % Change ---- ---- -------- Sales, including intersegment $ 32,136 $ 30,407 5.7 Operating expenses 27,948 25,450 9.8 Operating income 4,188 4,957 (15.5) Net sales of spawn and spawn-related products increased 5.7%. The effect of a weaker U.S. dollar on overseas sales increased net sales on a six-month over six-month comparison by $4.8 million. Spawn product sales volume decreased 5.9%, with a 1.8% decrease in the Americas and an 8.3% decrease in overseas markets. Most of the volume decrease in the overseas markets was associated with a reduction in sales in the United Kingdom due to farm closures and in France due to challenging competitive conditions. Sales of disease-control agents and nutritional supplements increased 4.9% and accounted for 16.3% of Sylvan's consolidated net sales for the six-month period. The overseas U.S. dollar-equivalent selling price was 20.0% higher during the first six months of 2003, as compared with the corresponding period of 2002, primarily due to the weakening of the U.S. dollar. Overseas local currency selling prices decreased approximately 2.6%. The selling price in the Americas decreased 5.1% as 17 a result of adjustments to the pricing structure of some products in order to compete with the lower-priced spawn offerings of other suppliers. Operating expenses increased 9.8% when compared with the first six months of 2002. The effect of a weaker U.S. dollar increased operating expenses on a six-month over six-month comparison by $4.4 million. Within operating expenses, cost of sales was 57.3% of net sales, as compared with 53.2% for the corresponding 2002 period. Spawn production in overseas markets was 15.8% lower than for the first six months of 2002, spreading costs that are primarily fixed in nature over fewer units. Inventory levels were also lowered in response to the lower sales volumes. Operating income, as a percentage of net sales, was 13.0% for the first six months of 2003, as compared with 16.3% for the first six months of 2002. Operating income was positively impacted by the weakening of the U.S. dollar, with an effect of approximately $380,000. The company's Bioproducts division recorded net sales of $1,300,000 for the six-month period ended June 29, 2003, as compared with $720,000 for the first six months of 2002. Sales growth was experienced in both the Red Yeast Rice and dried Agaricus mushroom products. Operating income for the first six months of 2003 was $388,000, as compared with an operating loss of $213,000 for the first six months of 2002. Fresh Mushrooms (in thousands) 2003 2002 % Change ---- ---- -------- Sales $ 14,490 $ 12,555 15.4 Operating expenses 12,965 10,990 18.0 Operating income 1,525 1,565 (2.6) Net sales of fresh mushrooms increased during the first six months of 2003 to $14.5 million, as compared with $12.6 million for the corresponding period of 2002. The number of pounds sold increased 6.5%, while the average selling price per pound was virtually unchanged. The cost of sales in the Fresh Mushrooms Segment was $10.4 million, or 71.9% of net sales, for the six months ended June 29, 2003, as compared with $8.4 million, or 67.2%, for the first six months of 2002. The segment's operating income for the first six months of 2003 was $1.5 million, or 10.5% of net sales, and was 2.6% lower than the amount reported for the first six months of 2002. Labor costs for the first six months of 2003 were approximately $160,000 higher when compared with the costs recorded for the corresponding 2002 period. The positive performance of the company's satellite farms helped minimize the adverse effect of the higher labor costs. Quincy sold $1.7 million of ready-to-grow mushroom compost to its satellite farms and purchased $3.6 million of high-quality mushrooms from the satellites for immediate resale to its third-party wholesaler during the first six months of 2003. By comparison, Quincy sold $0.6 million of ready-to-grow mushroom compost to its satellite farms and purchased $1.2 million of high-quality mushrooms in the first six months of 2002. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities for the six months ended June 29, 2003 was $3.5 million, as compared with $8.8 million for the corresponding period of 2002. During the first quarter of 2002, the company reduced "Other Current Assets" by approximately $2.2 million due to the release of cash that had been collateralized to support a loan from a European bank. This loan was repaid in the first quarter of 2002. Also during the first six months of 2002, the company increased accounts payable by approximately $1.1 million primarily related to the construction of satellite farms at Quincy. No corresponding increase occurred in the first six months of 2003. 18 Cash used by investing activities was $1.9 million for the six months ended June 29, 2003, as compared with $2.9 million used during the corresponding period of 2002. During the first six months of 2003, approximately $0.4 million was expended on growth opportunities, primarily for the satellite farms at Quincy. Total capital expenditures in 2003 are not expected to exceed $4.0 million, with additional expenditures as required for any acquisitions or new initiatives. The company routinely assesses its requirements for additional capital investments and believes that it has sufficient cash resources from current cash balances, internally generated funds and available bank credit facilities to meet its ongoing capital needs. Available credit under the company's revolving credit arrangement was $20.0 million as of June 29, 2003. Term and revolving credit decreased by $3.6 million during the six months ended June 29, 2003, as compared with a decrease of $5.7 million during the corresponding six-month period of 2002. The larger reduction in 2002 was related to the repayment of a European bank loan supported by the cash deposit mentioned earlier. No shares of Sylvan common stock were purchased during the first six months of 2003. The share purchase program was suspended due to the announcement of the receipt of the nonbinding indication of interest mentioned above and continued activity of the special committee of Sylvan's board of directors which is detailed in Item 5. RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, the FASB issued Financial Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies," relating to a guarantor's accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45 also requires enhanced disclosures in the company's interim and annual filings. The provisions of FIN 45 are effective for financial statements issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of both interim and fiscal years after December 15, 2002. The adoption of FIN 45 did not have a material impact on the company's financial statements or results of operations. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). A variable interest entity ("VIE") is one where the contractual or ownership interests in an entity change with changes in the entity's net asset value. This interpretation requires the consolidation of a VIE by the primary beneficiary, and also requires disclosure about VIEs where an enterprise has a significant variable interest, but is not the primary beneficiary. The company does not believe that this statement will have a material impact on the company's financial statements or results of operations. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except in certain instances, and for hedging relationships designated after June 30, 2003. In addition, except in those certain instances, all provisions of this Statement should be applied prospectively. The application of SFAS No. 149 is not expected to have a material effect on the company's financial statements or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." The provisions of SFAS No. 150 require issuers to classify as liabilities, or assets in some circumstances, certain classes of freestanding financial instruments that embody obligations for the issuer. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after 19 May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 is not expected to have a material effect on the company's financial statements or results of operations. CRITICAL ACCOUNTING POLICIES The preparation of the financial statements in accordance with generally accepted accounting principles requires management to make judgments, estimates, and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates, and assumptions include the accounting for derivatives, environmental matters, the testing of goodwill and other intangible assets for impairment, pensions and other postretirement benefits, and tax matters. Management uses historical experience and all available information to make these judgments and estimates, and actual results will differ from those estimates and assumptions that are used to prepare the company's financial statements. Despite these inherent limitations, management believes that Management's Discussion and Analysis (MD&A) and the financial statements and related footnotes provide a fair presentation. A discussion of the judgments and uncertainties associated with accounting for derivatives can be found in the Market Risks section of the MD&A included in the company's Form 10-K, as amended. A summary of the company's significant accounting policies is included in Note 1 to the Consolidated Financial Statements, included with the Form 10-K, as amended, filed with the Securities and Exchange Commission for the year ended December 29, 2002. Management believes that the application of these policies on a consistent basis enables the company to provide the users of the financial statements with useful and reliable information about the company's operating results and financial condition. In July 2001, the Financial Accounting Standards Board issued SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 eliminates amortization of goodwill and amortization of indefinitely lived intangible assets and provides for impairment tests to be performed at least annually. Sylvan adopted this pronouncement on December 31, 2001, which was the first day of Sylvan's 2002 fiscal year. During the quarter ended March 31, 2002, the company retained a professional services firm to complete the initial assessment to test for transitional goodwill impairment as of December 31, 2001 and a subsequent assessment as of September 29, 2002. The assessments determined that there was no goodwill impairment. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Under its provisions, all tangible long-lived assets, whether to be held and used or to be disposed of by sale or other means, will be tested for recoverability whenever events or changes in circumstances indicate the carrying amount may not be recoverable. Sylvan adopted this pronouncement on December 31, 2001. The adoption of this pronouncement did not have a material impact on the company. Other areas of significant judgments and estimates include the liabilities and expenses for pensions and other postretirement benefits. These amounts are determined using actuarial methodologies and incorporate significant assumptions, including the rate used to discount the future estimated liability and the long-term rate of return on plan assets. The rate used to discount future estimated liabilities is determined considering the rates available at year-end on debt instruments that could be used to settle the obligations. The long-term rate of return is estimated by considering historical returns and expected returns on current and projected asset allocations and is generally applied to a five-year average market value of assets. Effective October 31, 2002, Sylvan reduced the assumption for the expected long-term return on plan assets to 8.5% from 9.0%. Sylvan is a global company and records an estimated liability for income taxes based on what it determines will likely be paid in the various tax jurisdictions in which it operates. Management uses its best judgment in the determination of these amounts; however, the liabilities ultimately realized and paid are dependent on various matters and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded 20 through income in the period in which it becomes probable that the amount of the actual liability differs from the amount recorded. FORWARD-LOOKING AND CAUTIONARY STATEMENTS References are made in this report to expectations regarding capital expenditures, share repurchases, future cash availability and the future performance of the company, in general. These "forward-looking statements" are based on currently available, competitive, financial and economic data and the company's operating plans, but they are inherently uncertain. The outcome of events could prove significantly different from what is expected, depending upon such factors as the presentment of strategically attractive acquisition opportunities or new business initiatives, mushroom growing process inconsistencies, specific pricing or product initiatives of the company's spawn business competitors, competitive conditions in the mushroom market in general, changes in currency and exchange risks, a loss of a major customer, fluctuations in the values of the assets in the defined benefit plan of a former subsidiary of the company, or changes in a specific country's or region's political or economic conditions. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information presented under this item in the company's Form 10-K report, for the fiscal year ended December 29, 2002, as amended, has not changed materially. Information relating to the sensitivity to foreign currency exchange rate changes of the company's firmly committed sales transactions, in addition to what is presented in Item 2 of this filing, is omitted because it is an immaterial portion of total sales. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Sylvan's chief executive officer and chief financial officer evaluated the company's disclosure controls and procedures as of August 7, 2003, and they concluded that these controls and procedures are effective. (b) Changes in Internal Controls There are no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to August 7, 2003. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In April and May 2003, Sylvan and the six members of its board of directors, as individuals, were served with notice that they were named as defendants in a total of five lawsuits. Two were filed in the District Court of Clark County, Nevada; two in the Court of Common Pleas, Butler County, Pennsylvania; and one in the District Court of Washoe County, Nevada. The suits were putative class actions brought by and on behalf of Sylvan's shareholders alleging that the defendants breached their fiduciary duties and had conflicts of interest in connection with the board's undertaking of an assessment of the indication of interest to acquire Sylvan's shares mentioned above. As a result of the withdrawal of the indication of interest, as announced by the company on June 16, 2003, each of the plaintiff shareholders withdrew their lawsuits, but reserved the right to refile them. There are no other pending legal proceedings to which Sylvan or any of its subsidiaries is a party, or of which any of their property is subject, other than ordinary, routine litigation incidental to their respective businesses. 21 ITEM 5. OTHER INFORMATION SHAREHOLDER PROPOSALS FOR THE 2003 ANNUAL MEETING OF SHAREHOLDERS As previously announced, Sylvan postponed its 2003 annual meeting of shareholders to provide the special committee of independent directors that the company established when it received the indication of interest referenced earlier in this report with sufficient time to evaluate the indication of interest. The company will notify its shareholders when it selects a date for the 2003 annual meeting and the dates on which any shareholder proposals must be received in order to be properly brought before the meeting. 22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 31 Certifications pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 32 Certifications pursuant to 18 U.S.C. Section 1350 ------------------ (b) Reports on Form 8-K During the three-month period ended June 29, 2003, Sylvan: o Furnished a current report on May 15, 2003, containing a press release reporting earnings for the first quarter ended March 30, 2003 and providing a financial outlook; and o Filed a current report on June 16, 2003, containing a press release announcing the withdrawal of an indication of interest to acquire shares of Sylvan common stock that was submitted to the company on April 16, 2003. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 13, 2003 SYLVAN INC. ------------------- By: /s/ DONALD A. SMITH ------------------------------- Donald A. Smith Chief Financial Officer By: /s/ FRED Y. BENNITT ------------------------------- Fred Y. Bennitt Secretary/Treasurer 23 INDEX TO EXHIBITS Exhibit No. Description Page ----------- ----------- ---- 31 Rule 13a-14(a) Certification of Dennis C. Zensen 25 31 Rule 13a-14(a) Certification of Donald A. Smith 26 32 Section 1350 Certification of Dennis C. Zensen 27 32 Section 1350 Certification of Donald A. Smith 28 ------------------ 24

SYLVAN INC 10-Q