7.scotts Turning A Lemon Into Lemonade PDF

“My momma always said, "Life was like a box of chocolates.
You never know what you're gonna get."”
Forrest Gump, American Philosopher
It was a cold and blustery Saturday morning in Marysville, Ohio, in late November 1986
when Tadd Seitz, president and CEO of O.M. Scott & Sons, sat with his executive team staring at a
pile of debt covenants from the sale of their company to a New York management buyout firm the
day before.
In a few hours the annual Ohio State-Michigan football game would kickoff. The Ohio State
Buckeyes were 7-0 in seasonal conference play and assured of at least a co-championship of the Big
Ten Conference. The Michigan Wolverines, their archrivals, were 6-1 in conference play and had to
win to claim a share of the crown and a trip to the Rose Bowl. Ohio State was ranked as the seventh
best team in the country, right behind Michigan. The rabid “Buckeye” managers at Scott would
never miss this game unless their lives were threatened. With that thought in mind Tadd turned to
his long-time secretary and remarked, “Better order lunch for us Harriet. We’ll then see about
dinner. And ask if any of our employees want some great tickets to the game today in Columbus,
because no one here is going.”
ITT, their former corporate parent, had decided to divest a slew of businesses including Scott. ITT
sold Scott through a sealed bid auction using the investment bank of Lazard Frères to handle the
sale. The winner of the bake-off auction would own the business. Although bidding was open to all
types of potential buyers, seven of the eight bidders were buyout firms. Scott managers did not
participate in the buyout negotiations, and therefore, had no opportunity to extract promises with
potential purchasers prior to the sale. Each of the bidders spent about one day at Scott’s
headquarters in Marysville, Ohio, and received information on the performance of the unit directly
from ITT.
Prior to Martin Dubilier’s and Hank Timnick’s visit -- two principals of the buyout firm of Clayton &
Dubilier (C&D) -- Scott managers initially felt that they preferred C&D to the other potential buyers
because of their reputation for working well with operating managers. Dubilier’s and Timnick’s visit
did not go well, however, and C&D fell to the bottom of the managers’ list of prospective suitors.
C&D had acumen but the chemistry did not appear to be there.
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Berkeley Executive Program in Management (BEPM) 3.4 (Oct 30- Nov 3, 2017), University of California, Berkeley Center for Executive Education.
Any unauthorized use or reproduction of this document is strictly prohibited.
Disclaimer: This is a fictional account designed to facilitate class discussion and is not intended to reflect real events.
Some characters were invented to dramatize actual events. A final note -- Ohio State did lose to Michigan, 26-24, in the
last seconds of the game, but went on to win the Cotton Bowl.
After the bids were opened at ITT headquarters in New York City the prior day it was clear that C&D had
valued the business much higher than did the other bidders. Instead of this Saturday morning get-
together being a celebratory occasion for Scott management, it became a discussion of how Tadd’s team
was going to make the aggressive C&D projections become a reality (Exhibit 1 contrasts ITT’s projections
for Scott with C&D’s aggressive forecasts) and how to make this arranged marriage work.
The Scott executive team in the room listened to Tadd as he once again recanted the plea that he
had made Friday to Rand Araskog, chairman and CEO of ITT:
“Rand, we don’t like these guys! Martin Dubilier and Hank Timnick think they know more
about the Scott’s business than we do. Yes, they are very competent operationally and have
turned a lot of businesses around, but they want to run Scott in such an aggressive way that
we are going to lose our best people.”
“They have leveraged us so much that when the deal is finally closed, we will be starting off
within an inch of bankruptcy and unable to service debt. At the same time, we are facing a
real competitive price point threat in a shrinking do-it-yourself lawn care market. This is a
turnaround from day one, not a triumph for the managers that have worked so hard for you
all these years. Yes, we have been given a handsome equity stake, but in what? Being
handed a company that cannot service its debt in the first year is not like drawing the
winning lottery ticket.”
Tadd recalled how Araskog, a West Point graduate and a former U.S. Army officer, waited patiently.
Looking at him as he stood while his back stiffened, Araskog responded:
“Tadd, that argument and this subway token will get you downtown. We represent the
shareholders of ITT, not Scott’s managers. This offer is a lot more money than these other
bids and we are going to take it. I have known Martin from McKinsey and Hank from GE in
days past, and they are smart operators. I don’t know about all this leverage stuff, as we
focus primarily on generating GAAP 1 earnings per share and don’t over emphasize cash flow
which you will now need to address. It’s a different paradigm. Don’t sell yourself and your
team short, maybe you have a winner here and do not realize it yet.”
Background and Industry Overview
Company History: O.M. Scott & Sons was founded in 1870 by Orlando McLean Scott, a civil war
veteran, to sell farm crop seed. Scott was known for his “white-hot hatred of weeds” and his crop
seeds were considered to be 99.91% weed-free. In addition to selling weed-free crop seeds, Scott
also began to sell weed-free lawn (or grass) seed. Beginning in 1900, the company began to expand
the sale of weed-free lawn seed through the mail, and in the 1920’s, with Orlando’s sons joining the
family business, Scott introduced the first home lawn fertilizer, the first lawn spreader and the first
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Generally accepted accounting principles
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patented bluegrass seed. By 1921, Scott had seeded one-fifth of the golf courses in the United
States2.
Scott was privately held until it was purchased by ITT in 1971 amongst a wave of acquisitions. Scott
became a part of the consumer products division of the huge conglomerate, and operated as a
wholly-owned subsidiary for 14 years. ITT began a series of divestitures, prompted by a decline in
financial performance and rumors of takeover and liquidation. On November 26, 1986, ITT
announced that the managers of Scott, along with Clayton & Dubilier (C&D), a private buyout firm
with an operating improvement philosophy, agreed to purchase the stock of Scott and another ITT
subsidiary, the W. Atlee Burpee Company, a gardening seed company.
C&D secured financing for the sale. Exhibit 2 shows Scott’s balance sheet under ITT prior to the
buyout. Exhibits 3 and 4 describe the financial structure of Scott after the buyout. Bank loans and
the sale of notes and debentures raised $190.9 million. Another $20 million was contributed equity
from C&D, 61 % of the shares were held by the C&D partnership, 21% by debt holders, 17% by Scott
management and employees and 1% personally by C&D partners. Immediately following the
buyout, Scott’s capital structure consisted of 91% debt.
Industry Background: At the closing of the deal, Scott manufactured do-it-yourself (DIY) lawn-care
products such as grass seeds, fertilizers and gardening equipment. The DIY lawn-care industry
included the mixing of fertilizers, pesticides, and lawn-care chemicals, the packaging of manure,
peat and soil and the manufacture of gardening equipment such as fertilizer spreaders. DIY products
were sold in hardware and specialty shops and large retail stores like K-Mart and Sears. Hardware
and specialty stores generally sold higher-priced, brand-name products such as Scott, while retail
stores sold mainly lower-priced, ‘brandless’ products packaged under the retailer’s label.
The DIY market changed dramatically for the worse in the early 1980’s. By 1986 the market had
significantly decreased in size because of the rapid growth of professional lawn-care (PLC) firms.
Professional lawn service involved treating a lawn with four or five professionally applied chemical
coatings per year, including fertilizers and pesticides. An aging population unable to perform lawn work
and rise in double-income families with limited leisure time had spurred the brisk growth of the PLC
industry. Also, awareness of the hazards of handling toxic chemicals like herbicides and pesticides had
made customers reluctant to personally apply these chemicals to their lawns. These factors contributed
to the rapid growth of the PLC industry, from sales of $660 million in 1977 to sales of $2.2 billion by 1985.
While slightly more costly than doing it yourself, professional lawn care was still affordable to many
consumers. The average professional fee was $125-$150 per year. This compared to a cost of $75-$100
for the necessary DIY materials, plus four to six hours of work to apply the chemical treatments. The
quality of the professionally serviced lawn was likely to be superior, however, since DIY customers
frequently had only package labels for information concerning producer use, and were often
inexperienced at gardening.
In the 1980’s, the precipitous growth of PLC firms began to impinge on the DIY market. Also, Scott’s
dominance of the DIY market was challenged by the emergence of DIY firms with lower priced product
lines. Although these firms did not have Scott’s brand recognition, their products were significantly
cheaper than comparable Scott goods. In 1986 Scott controlled roughly 35% of the DIY market.
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Gale Directory of American Companies
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A New Agenda at Scott’s
As Tadd continued the Saturday meeting, he reminded his executive team that they had to move
forward:
“No need to further rehash our situation. We had better outline our approach as to how we
are going to address our new “opportunity”. We had better have a pretty clear idea of how
we are going to meet the forecasts. We have a new sheriff in town, and while we have a big
ownership stake, we are in the minority and things are going to change. Dubilier called me to
meet here today but I delayed him until Monday so we can get prepared on our own. He and
Timnick are also available by phone today to help brainstorm with us, if we would like.”
With that, Tadd passed out copies of the agenda with the six key points that he wanted to cover
with his executive team:
1. What is the performance gap that Scott’s has to close in order to meet the C&D case?
2. Organize our strategy to generate cash and formulate 120 day plan to achieve the
target.
3. Consider strategically altering our product offerings to hold our ground in the
shrinking do it yourself market in response to our lower price competitors and to consider
positioning an entry into the higher margin professional market.
4. Review the C&D suggested metrics and incentives to see if all Scott personnel will be
motivated to drive increased cash generation passionately, and then develop a successful
product repositioning maximizing our opportunity.
5. Discuss how C&D proposes to work with us. It is a very different governance
approach than our experience with ITT.
6. Conclusions and open items. I will also ask Harriet to listen to the radio and keep us
updated on the score of the Ohio State-Michigan game throughout the day.
Agenda Item One: C&D Forecast and the Performance Gap
The performance gap in the C&D forecast presented operational and strategic challenges. After the
buyout, the large repayment obligations associated with the high debt load and the constraints
imposed by the debt covenants (see Exhibit 5), left Tadd’s executive with little choice as to how to
manage Scott’s resources immediately. EBIT at Scott under ITT the prior year was about $18 million,
and the interest in year one of the buyout totaled about $21 million. But Scott managers and C&D
somehow had to continue to generate large sums of cash and to reposition itself in its market place,
despite the fact that the firm faced a shrinking DIY market and increasingly acute competition.
Simply put, C&D proposed that Scott immediately improve margins generating cash from working
capital and enhance revenues in a threatened DIY market place where Scott needed to reposition its
product offerings. C&D believed that Scott could expand its product offerings at a lower price point,
as well as create a new, more focused approach to the more profitable PLC market. The simplistic
buyout stereotype image of buyout firms being predators that accumulated cash through mass
firings and starving growth to pay off debt was not in the C&D plan at all.
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Agenda Item Two: Generate Cash Now
Focus on Improved Working Capital: Cash generation from better working capital practices was
essential. The group was charged with reducing working capital requirements by 42%, or $25
million dollars, in the first two years. A huge chunk of borrowing could be paid down and capital
freed to reinvest in the business elsewhere to strengthen revenues. Working capital represented the
clearest and most achievable objective in the team’s eyes and was first on the list to tackle. The
amount of cash required to service the debt was substantially greater than Scott’s pre-buyout cash
flow. In the first years after the buyout, interest expense was about $21 million per year. In the year
before the buyout, Scott’s EBIT (earnings before interest and taxes) was only $18.1 million Working
capital measures were critical in closing the gap.
Satisfying the Debt Covenants: After checking the first quarter football score that had Ohio State
up by seven points, Tadd asked Craig Walley, General Counsel, to give a high level run down of the
debt structure and covenant terms for the executive team. He proceeded:
“The debt agreements contained numerous restrictive covenants. These covenants, summarized
in Exhibit 5 and detailed in my memo in Exhibit 6, restricted a great number of economic and
financial activities and mandated specific levels of accounting-based performance measures.”
The debt covenants defined the conditions under which Scott would be considered in default. If the firm
defaulted, managers would be forced to negotiate with lenders to resolve the default or, if no agreement
was reached, to seek bankruptcy protection from creditors. Under all the debt contracts, if bankruptcy,
insolvency or dissolution occurred, the full amount owed would be due and payable. Any other default
under the bank credit agreement entitled banks holding two-thirds of the loans (in value terms) to
request payment. Likewise, any default under the subordinated debt contracts, entitled holders of 25% of
the senior subordinated debentures (in value terms), to request payment in full.
Scott’s lending agreement contained financial limitations and restrictions on investment and production
policy that could be relaxed only with the lenders’ approval. For example, the covenants prohibited the
issuance of additional debt other than that outstanding at the close of the deal. Similarly, the lending
agreement prohibited the payment of cash dividends.
The covenants also restricted total capital expenditures and asset dispositions to specific dollar amounts.
Changes in corporate structure were forbidden without approval. Any plan to acquire or divest assets,
merge or create a subsidiary, or liquidate, required the lenders’ consent. Hence, although Scott’s credit
agreement did not dictate production decisions, the firm was indirectly constrained to continue in the
same business activities.
With all that, Tadd called out to Harriet to check the score; the game was tied. Tadd then turned to
the group and stated “Ok… it’s time to develop our working capital game plan. I want to end up
with an overview of a 120 day plan, once we discuss the key elements, while we are all here today.”
Creating the Working Capital Committee: Again, Scott executives are charged with reducing
working capital requirements by 42%, or $25 million dollars, in two years. Prior to the buyout,
Scott’s executives never had to manage cash balances. John Wall, Assistant Treasurer, summarized
the ITT undisciplined approach to working capital:
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“Under the ITT system, we needed virtually no cash management. The ITT lock box system
swept our lock boxes into Citibank of New York. Our disbursement bank would contact ITT’s
bank and say we need $2 million today, and it automatically went into our disbursement
account.”
At this point it was decided to call Timnick and Dubilier by phone to join in on the discussion to tap
the new owners thinking about how best to achieve this goal. Getting organized with a multi-
disciplined approach, accountability and tough deadlines were essential in C&D’s mind. Dubilier
spoke:
“John you seem to have an open mind on this topic, what do you think we should do?”
Wall recommended a task force of all the key disciplines, impacting the working capital process with
no hierarchy. Dubilier chimed in:
“I like it, John. Tadd, you decide who should lead it and the pick the participants. On Monday
I would like to see a one page slide on a 120 day plan outlining the key elements. I will send
you a template from another company on an integration plan they composed which will
work fine for this purpose as a framework (See Exhibit 7). I would like to go over the plan on
Monday.”
The call was completed. Now the team began to discuss what this working capital undertaking
would look like.
Developing A Cash Management System: ITT had established a cash control system that separated
the collection of cash from cash disbursements. Receipts went into one account and were collected
regularly by ITT’s bank. Once deposited, these funds were not available to divisional managers. Cash
to fund operations came from a different source, through a different bank account. This system
allowed ITT to centrally manage cash and control divisional spending.
When Scott was a division of ITT, cash coming into Scott bore little relation to the cash Scott was
allowed to spend. In contrast, after the buyout, all of Scott’s cash was going to be available to
managers to spend. Scott now needed to establish a system to control cash so that operations were
properly funded, and to meet debt service requirements. Wall offered a point of view:
“We don’t need a system that would keep track of our investment portfolios because we
borrowed $200 million and no excess cash. We needed to find a financial system product
that we could use for our purposes. Cash forecasting is going to be critical. I mean cash
forecasting in the intermediate and long range. I don’t mean forecasting what is going to hit
the banks in the next two or three days. We could always do that, but now we track our cash
flows on a weekly basis and we do modeling on balance sheets, which allows us to do cash
forecasting a year out. Who do you think we should assign to this task? Also, any suggestion
as to how to go about searching for the right system, and what should be our decision
deadline?”
Improving Efficiencies in Operations and Inventories: Paul Yeager, Scott’s CFO continued, “In the
first two years we need to raise inventory turns from 2.08 to roughly 3.20 times per year – an
increase of over 50%.”
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Because Scott’s business is highly seasonal, inventory control had always been a management
problem. Large inventories were required to meet the spring rush of orders; however, financing
inventories was a cash drain. Scott’s production strategy under ITT exacerbated the inventory
problem. Before the buyout, Scott produced each product once a year. Slow moving products were
produced during the slow season, so that long runs of fast-moving products could be produced
during the busy season. Before the spring buying began almost an entire year’s worth of sales were
in inventory.
The old production strategy took advantage of the cost savings of long production runs, however,
under ITT, managers did not consider the trade-off between these cost savings and the opportunity
cost of funds tied up in inventory.
Wall and Yeager asked the group if they could break and talk to Dubilier in a one-on-one call right
away. When they all reconvened, Wall reported to the group:
“What we think is that the plant managers will have to figure out how they can move the
production of the slow moving items six months forward. That means the products we used
to make in May or early June would be made in November or December. Now, instead of
producing long runs of a few products, production managers have to deal with set-ups and
change-overs during the high-production period. It requires a lot more of their attention.”
Wall continued:
“Obviously we must manage inventories more effectively. This means we need to receive
materials much closer to the time that products must be produced at time of sale and
shipment. In C&D’s mind, more set-ups and change-overs will be necessary, and therefore
the production manager’s job will become much more complicated. Instead of producing a
year’s supply of one product, inventorying it, then producing another product, managers will
have to produce smaller amounts of a variety of products repeatedly throughout the year.
We need to consider plant manager incentive adequacy as their ownership stake is not as
large as many here at the table (see Exhibit 8).”
”Inventories can also be reduced by changing purchasing practices and inventory

management. Raw material suppliers must agree to deliver small quantities more often,
reducing the levels of raw materials and finished goods inventories. The bet is that by closely
tracking inventory, Scott can manage to reduce these levels without increasing the frequency
of stock-outs of either raw materials or finished goods. We have dozens of suppliers and no
dominant source that we cannot replace.”
Paul Yeager, the CFO concluded:
“How do we want to organize our negotiations with suppliers? Who should lead from Scott
and how do we best position our case?”
Tadd asked, “Anything else Paul and John?” They both turned to the group and questioned:
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“What about Joe Turlock? He will never go along with this idea. He not only runs the
Marysville plant but is in charge of the real estate acquisition of all the plants and
warehouses in our system. He thinks of himself as the “czar of warehouses”. For instance,
he believes the warehouses in Ohio in February must be full of fertilizer when there is still
snow on the ground. Will the task force have the authority to fire him if he acts out (see
Exhibit 9)?”
The room was still once again. “I am getting a headache and let’s talk later about Joe off line.” said
Tadd. “Let’s check on the Ohio State score.” Harriet shouted, “All tied up again at 17-17.”
Managing Receivables and Payables: Receivables were an important competitive factor and
retailers expected generous payment terms from Scott under ITT. Yeager then offered:
“From now on, the timing of rebate and selling programs would need to be very carefully
planned, allowing Scott to conserve working capital. We need getting suppliers to agree to
extended terms of payment, and to negotiate some substantial price cuts from major
suppliers in return for giving fewer suppliers a larger fraction of our business. What is our
best case in terms of renegotiating with suppliers to capitulate now that we are part of a
buyout and not ITT?”
Agenda Item Number Three: Strategic Repositioning
The good news was that Scott was the major brand name in the do-it-yourself lawn care market,
and has a reputation for high quality products. Ed Wandtke, a lawn industry analyst and partner of
All Green Management Consultants Inc. stated:
“O.M. Scott is ultra high price, ultra high quality. They absolutely are the market leader. They
have been for some time. No one else has the retail market recognition. Through its
promotions, Scott has gotten its name so entrenched that the name and everything
associated with it – quality, consistency, reliability – supersede the expensive price of the
product.”
The bad news was that the DIY market was shrinking because an increasing number of consumers
were contracting with professional firms to have their lawns chemically treated. You might say the
Scott name was grade “A” brand in a grade “D” market. In 1987, Scott had a 34% share of the $350
million DIY market. Industry experts report, however, that the market had been undergoing major
changes for the last five years that appear irreversible.
Scott’s position in the DIY market was challenged by the growth of private label brands that were
sold at lower prices. Although these firms, including Lebanon Chemical, Hyponex, Monsanto and
Chevron Chemical (Ortho) did not have Scott’s brand recognition, their products were significantly
cheaper than comparable Scott goods, and consumer differentiation was blurring. Couple this with
a shift in volume away from Scott’s traditional retailers – hardware and specialty stores – to mass
merchandisers, and the expression “Houston, we have a problem” comes to mind. Scott’s decision
to champion a lower price point and produce bulk private label product has to be done as a
different brand, as to not cannibalize the Scott’s brand higher margins. “We need to analyze the
potential of an acquisition or investing in our own new product entry”, said Tadd Sietz.
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Tadd also shared, “C&D was all over this strategic question in their due diligence, and believed that
a major premise of their investment thesis was to reposition our products. They believe that the
Scott brand is strong enough to enter the PLC market. They also championed offering a lower price
point brand and private label approach to compete in the traditional DIY market to offset
competitor’s challenges. While at lower margins, DIY lower-priced products is still a profitable
business that could result in lowering our overall production cost if executed well.”
Tadd had proposed to ITT for years that Scott enter the PLC market because the trends favored its
growth and offered much higher margins than do-it –yourself. ITT continually vetoed this initiative.
Now Tadd turned to the group and asked, “should we enter the professional market as a counter to
the decline in the do-it-yourself segment now, and if so, how?” “Should we think about acquiring a
low-cost producer like Hyponex (rumored to be for sale at a reasonable price), or create our own
DYI product under another brand? What are our options? Again, these look like make or buy
(acquire) decisions to me.”
Agenda Item Number Four: Incentives to Drive Results
C&D believed that a combination of elements would kick start a higher level of performance. First, the top
management team is required to pay for a substantial equity holding. The fact that they were also
personally liable for the debts incurred to finance their equity stakes would get their attention.
Additionally, salaries will be significantly raised. Equally important, a specific bonus plan will be targeted
to the key metrics of initiatives that will make the biggest difference to Scott’s success (Exhibit 10 details
the C&D thinking behind compensation, ownership and incentives).
Tadd turned to the group and asked them to read the following C&D memo (see below) in terms of the
task ahead. “The question I want you to closely consider,” he said, “is whether we have the incentives
laser focused on the right metrics sufficiently to get the working capital gains we need fast enough? Read
this memo that C&D and I drafted and tell me what you think.”
Difference Making Results & Incentives that Matter: The salaries for the top 10 managers will be
almost double those under ITT. In addition, a new bonus plan offered maximum payments of 30%
to 100% of base salary, increasing with the manager’s rank in the company. The proportion of the
maximum bonus actually paid depended on the achievement of corporate, division and individual
performance goals. For managers on the corporate staff, the bonuses were based 60% on company
and 40% on individual performance. For division managers it was based 25% on company, 50% on
division and 25% on individual performance.
Corporate and division performance goals will be specific targets set for Earnings before Interest
and Taxes (EBIT) and for Average Working Capital. EBIT will be weighted 60% and Average
Working Capital 40% in determining whether the corporate goal was met.
Individual performance targets will be set by the employee and his supervisor before the
beginning of each fiscal year. The difference between actual and targeted performance
determined the level of payment. Individual targets could be quantitative or qualitative in
nature. A typical qualitative goal will be for each manager to make progress in training a
potential replacement.
Tadd then continued:

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“This bonus plan is a big idea! For instance, an objective for an individual manager might be
to integrate the benefits package of a newly acquired company with that of Scott within a
given time period. An objective for me as president of the company will be to spend a fixed
amount of time out of Marysville, talking to retailers and salespeople. At the end of the year,
C&D will provide an evaluation of whether or not I have achieved these objectives, and
would quantify this achievement along the same 80-125 point range. This rating will then be
combined with the quantitative measures to come up with a total performance measure.”
“The weighted average of corporate, divisional and personal target achievements will then
be used to determine total bonus pay-offs. If a manager achieves an 80% weighted average
attainment of target goals, the payoff varied from about 30% of salary for them to about
10% for lower-level managers. At 125% attainment, bonuses will vary from about 100% to
about 30%. Between 80% and 125%, bonus payouts as a percentage of salary varied linearly
with target attainment. Below 80%, bonus payments were at the discretion of me as
president and our board.”
“Their idea is that for those managers who hold equity, the bonus plan, with its emphasis on
EBIT and working capital management, served to reinforce the importance of cash
generation. Those who did not hold equity, and were thus unaffected by the potential loss in
equity value which would attend a violation of the debt covenants, were still induced to
make the generation of cash a primary concern.”
The group reflected and consensus emerged that this was a handsome package overall. The concern
most shared was the hurdle rates for success were very high (see Exhibit 7).
C&D’s bonus plan contrasted sharply with the one in place under ITT, where bonuses were small
and had little annual variance. Bob Stern, vice-president of associate relations, described ITT’s bonus
plan:
“I worked in human resources at ITT for a number of years. When I was managing the staff of ITT
Europe we evaluated the ITT bonus plan. Our conclusion was that it was nothing more than a
slightly deferred compensation arrangement: all it did was defer income from one year to the
next. Bonuses varied very, very little. If you had an average year, you might get a bonus of
$10,000. If you had a terrible year you might get a bonus of $8,000, and if you had a terrific year
you might go all the way to $12,500. On a base salary of $70,000, that’s not a lot of variation.”
Agenda Item Five: Value Added Governance Contrasted to Sharing Quarterly Results
From what the team has learned so far, the style of governance that would be practiced with C&D
promised to be substantially different than in the ITT culture. ITT’s famous quarterly reviews,
established by Howard Geneen, Araskog’s predecessor as ITT chairman and CEO, are legendary.
With as many as 40 ITT executives in attendance, The Wizard of OZ, the nickname that Geneen
suffered behind his back, presided. This is where Seitz and the team presented their numbers each
quarter. Rather than spend time on big improvements, possible in innovation, repositioning the
value proposition to customers and pricing challenges, the numbers were the numbers, and the
focus of ITT governance was historical. Big rewards of praise were heaped on if you hit modest gap
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earnings targets so that the quarter-to-quarter earning’s calls with the Wall Street analysts went
smoothly.
Geneen was a former accountant, and hitting modest targets consistently was more important than
the optimization of the business model, in his view. He was a numbers guy and not an operator.
ITT’s growth came from using its highly priced stock to acquire companies with lower price earnings
ratios, and thus create an illusion of repaid growth from pro-forma combined accounting results
(with a PE of 18x when you combine with a company valued at 10x E.P.S in the equation year will
skyrocket earnings in the short term). Oz’s long term seemed to be the next quarter.
Tadd reflected on how C&D planned to work with Scott (outlined in Exhibit 11). This collaborative,
intense, forward-looking consultative approach to working with Scott managers was quite different
than ITT’s approach. Martin Dubilier explained it:
“ITT challenges managers not to rock the boat, to make budget. We challenge managers to
improve the business. Every company takes on the personality of its CEO. Our main
contribution is to improve his performance. All the rest is secondary.”
Agenda Item Number Six: Conclusions, Open Items and the Ohio State-Michigan Game Outcome
Craig Walley, General Counsel now turned to the group and said “Zombie Companies… not to
frighten us all to death but I read a very interesting article on declining industries and milking cash
until liquidation, which I believe is where C&D might be headed if we are not successful in the
strategic repositioning in the lawn care markets. It was written by business professors Porter and
Harrigan in the Harvard Business Review, entitled “End- Game Strategies for Declining Industries”
(see course Reader). I am a lawyer, so I think about those things.” Craig carefully laid out his
theory:
“If we were to cut our marketing and distribution and research and development costs by
75% in the first year of the buyout, and ran the company to milk cash out of the business for
6 years after debt service, C&D would have a handsome return for their investment. Run the
numbers and you will see that if you decline sales and expenses on a straight line basis you
have a high return, having paid off and serviced the debt at the end of year five. Is there any
chance that is what C&D has in mind here at Scott (See Exhibit 12)?”
The room went silent. You could hear a pin drop when Harriet then walked in with a smile and said
“Ohio State was behind but 26-24. The good news is that Ohio State is on the Michigan 28 yard line
with a few seconds remaining.”
On trotted the field goal kicker and the Ohio State radio announcer excitedly screamed as Harriet turned
the radio up full blast…
“The snap is down; the short kick is in the air …. It’s ….. Wide right, White misses. Michigan wins!”
At which point Wall, the astute assistant treasurer, chimed in:
“Tadd, the way things are going in the last few minutes; any chance ITT would take us back?”
11
Exhibit 1
ITT Scott Forecast with Pro Forma Buyout Impact
Income Statement Pro forma

0 1 2 3 4 5 6
(in '000s) 1986 1987 1988 1989 1990 1991 1992
Net Sales 158,100 162,843 167,728 172,760 177,943 183,281 188,780
Cost of Sales 66,595 69,814 73,167 76,657 80,292 84,075 88,013
Gross Margin 91,505 93,029 94,562 96,103 97,651 99,206 100,767
Marketing and Distribution 58,400 61,066 63,737 65,649 67,618 69,647 71,736
Selling and Admin 7,905 7,735 7,548 7,774 8,007 8,248 8,495
Research and Development 4,100 4,071 4,193 4,319 4,449 4,582 4,719
EBITDA 21,100 20,157 19,084 18,361 17,577 16,730 15,816
Depreciation 3,000 3,206 3,418 3,637 3,862 4,094 4,332
EBIT 18,100 16,951 15,666 14,724 13,715 12,636 11,483
Net Interest -18,000 -18,000 -18,000 -18,000 -18,000 -18,000 -18,000
EBT 100 -1,049 -2,334 -3,276 -4,285 -5,364 -6,517
Taxes 39 0 0 0 0 0 0
Net Profit 61 -1,049 -2,334 -3,276 -4,285 -5,364 -6,517
Note: These numbers are fictitious and illustrative for educational purposes only. They do not
reflect actual results or projections.
C&D Scott Forecast Pro Forma Year 1 of Buyout Going Forward
Income Statement
1 2 3 4 5 6
(in '000s) 1987 1988 1989 1990 1991 1992
Net Sales 161,262 174,163 188,096 206,906 227,596 250,356
Cost of Sales 68,698 72,452 78,248 85,038 92,404 101,644
Gross Margin 92,564 101,711 109,848 121,867 135,192 148,711
Marketing and Distribution 60,312 64,266 68,467 74,279 81,707 89,878
Selling and Admin 8,386 7,837 8,464 8,276 9,104 10,014
Research and Development 4,193 4,528 4,702 5,173 5,675 6,242
EBITDA 19,674 25,079 28,214 34,139 38,707 42,577
Depreciation 3,204 3,413 3,639 3,887 4,145 4,429
EBIT 16,470 21,666 24,576 30,252 34,562 38,149
Note: These numbers are fictitious and illustrative for educational purposes only. They do not
reflect actual projections. Net interest expense not shown as a separate line item in this
scenario as annual amounts will vary with how quickly Scott is able to pay down its debt.
12
Exhibit 2: O.M. Scott Balance Sheet prior to Closing – Not adjusted for buyout financing
Select Balance Sheet Information

(in '000s) 1986
Cash and cash equivalents 0
Accounts receivable 29,974
Inventories 32,017
Other current assets 1,600
Total Current Assets (WC) 63,591
Additions to PP&E
Depreciation
Net PP&E 180,000
Total Assets 243,591
Accounts payable 2,737

Accrued expenses 1,581
Automatic Sources 4,318
Revolving Credit Facility Draw 0
Bank Working Capital Loan 0
Subordinated Notes 0
Subordinated Debentures 0
Mezzanine 0
Total Debt - See Debt Schedule 52,600
Deferred income taxes 0
Total Liabilities 56,918
Shareholders' Equity 186,673
Liabilities and Net Worth 243,591
Incr./(Decr.) in deferred taxes 0

Capital expenditures 3,000
Note: These numbers are fictitious and illustrative for educational purposes only. They do not reflect
actual results.
13
Exhibit 3: Financing of Clayton & Dubilier’s Purchase of OM Scott & Sons Company from ITT
Corporation, 12/31/86. Sources and Uses of funds.
Source: O.M. Scott Company Leveraged Buyout, HBS case
Exhibit 4: Owners of the common stock of O.M. Scott after the leveraged buyout.
14
Exhibit 5: Summary of Debt Covenants of Scott Borrowings to Finance the Buyout
15
Exhibit 6: Scott General Counsel Craig Walley’s Primer on Scott Debt Covenants
Scott’s senior debt consists of floating-rate working capital loans and borrowings against a $137 million revolving credit agreement. A group of six major
banks provides this capital, as well as a standby letter of credit for up to $2 million. The loans are secured by substantially all the assets of Scott. The rate of
interest has averaged 10.25% over the post-buyout period. In addition to interest payments, the credit agreement includes a principal repayment schedule,
which requires the principal amount to be repaid by the end of calendar 1994.
Scott’s subordinated debt consists of unsecured 13% notes to mature in 1996, and unsecured 13 ½% debentures to mature in 1998. The notes are senior to
the debentures, but junior to the bank debt. The subordinated debt was originally sold to 16 financial institutions. These institutions sold the debt to the
public in February of 1988. Sinking fund payments are required for both the notes and the debentures. By maturity two-thirds of the principle amount of
the notes and three-fourths of the principle amount of the debentures will have been set aside.
The covenants in Scott’s debt agreements are summarized in Exhibit 3.They restrict certain economic and financial activities, and require certain
accounting-based measures of performance. The accounting-based covenants are defined in terms of audited figures. With the exception of priority, the
covenants of the subordinated issues are similar and are, therefore, discussed collectively.
With so much pressure on the organization to generate cash, managers may be tempted to take actions that help service the debt, but are damaging to the
value of the firm. Such actions are detrimental to all of the firm’s claimholders, including the debt holders. Debt holders are interested in the firm’s ability to
generate cash over the life of the debt agreement. Debt covenants serve as a contract which restricts managers’ ability to use value-reducing methods to
generate cash or take other actions that reduce debt holder value.
When the firm defaults, managers are forced to negotiate with lenders to resolve the default situation, or if no agreement can be reached to seek
protection from creditors under Chapter 11. Resolution of a default or Chapter 11 generally involves replacing debt claims with equity claims, leading to a
substantial dilution of the existing equity. A default is costly not only to equity holders, but to managers, putting them in danger of relinquishing decision
rights to the legal system through Chapter 11 or even losing their jobs.
Restrictive covenants can also help control potential conflicts of interest between equity holders and debt holders. In highly levered organizations such as
Scott, the benefit to equity holders of taking actions that reduce debt holder wealth, for example by paying themselves a liquidating dividend from the
proceeds of a loan or making a “lottery ticket” investment, can be large.
Scott’s bank credit agreement restricts the firm’s investment and production decisions. Managers are allowed discretion in the choice of specific projects,
but annual capital expenditures are restricted to specific dollar amounts set forth in a schedule. Scott can only dispose of assets that are worn out or
obsolete and have a value less than $500,000. No changes in the corporate structure, for example the acquisition of assets or mergers are allowed. Hence,
although Scott’s credit agreement does not dictate production decisions, the firm is indirectly required to continue in the same economic activity. Cash
dividends to stockholders are prohibited, as is the issuance of additional debt other than the debt securities outstanding at closing.
The subordinated debt covenants define restrictions on many of the same items restricted in the credit bank agreement, but the covenants are looser.
Dividends, for example, are not prohibited, but a complex set of conditions must be met in order for dividends to be allowed. Similarly, control changes are
not prohibited, but all subordinated debentures are required to be redeemed in the event of a change in control. Mandatory redemption is also required if
Scott’s net worth falls below a specified level. Asset sales are not prohibited, but the covenants require that 75% of the proceeds from the sale of a business
segment be applied to the repayment of debt in order of priority.
The overall effect of the covenants is to restrict both the source of funds for scheduled interest and principal repayments and the use of funds in excess of
this amount. Cash to pay debt obligations must come primarily from operations or the issuance of common stock. It cannot come from asset liquidation,
stock acquisition of another firm with substantial cash, or the issuance of additional debt of any kind. Excess funds can only be spent on capital goods in
accordance with the schedule, and cannot be spent on acquisitions or dividends to shareholders. Therefore, once the capital expenditure limit has been
reached, excess cash must be held, spent in the course of normal operations, or used to pay down debt ahead of schedule. Assuming the capital
expenditure limits are set appropriately, the high leverage in conjunction with the debt covenants serves to reduce the free cash flow problem in a way that
is not damaging to the long run viability of the firm’s operations.
Additional bank agreement restrictions require Scott to maintain specific levels of consolidated net worth and current ratio at all times. A required level of
adjusted operating profit and interest coverage must be attained at the end of each fiscal quarter. These restrictions can be viewed as indicators of
potential future problems. Even if Scott is currently able to service its debt obligations, the firm can still violate an accounting-based constraint. Violation of
one of these constraints constitutes a technical default and brings managers and bankers together to renegotiate the terms of the loan.
The constraints imposed by the covenants can be relaxed at the discretion of the lender, though it is not unlikely that the lender will be able to obtain better
terms in exchange. For example, if lenders can be convinced that a particular default was not the result of a financial problem, or that a new project
prohibited by the covenants would increase firm value, they have an incentive to waive the default because it increases the value of their claim.
16
Exhibit 7: Scott Draft of Working Capital Discussion - 120 Day Plan
17
Exhibit 8: Bonus Payoff Function Under the Post-Buyout Compensation Plan for Three
Levels of Management
18
Exhibit 9: Convincing or Ejecting Plant Manager Joe Turlock
From the case…
Tadd asked “Anything else Harry and John?” Both CFO Paul Yeager and Assistant Treasurer John Wall
turned to the group and questioned:
“What about Joe Turlock? He will never go along with this idea. He not only runs the Marysville plant
but is in charge of the all the plants and real estate in our system. He thinks of himself as the “czar of
warehouses”. For instance, he believes the warehouses in Ohio in February must be full of fertilizer
when there is snow on the ground. Will the task force have the authority to fire him if he acts out?”
The Joe Challenge
To say that Scott was a patriarchal company was an understatement. Firing was unheard of. An
occasional slap in the wrist if things got messed up was about as far as consequences went. By and large,
the company had been so successful for over a century that success was automatically assumed by all.
Change was a distraction. It was a very comfortable place.
Joe Turlock is very ‘dug in’ on all of his viewpoints. He had been a star in former parent ITT’s mind,
historically. He was a champion of long and even production cycles which led to consistency in the figures
he provided the anal ITT numbers staff. He was far more valuable to the conglomerate than in the Scott
senior team’s estimation of his contribution. However, he was well-liked in the plants.
He also was in charge of warehouse acquisitions. Since ITT did not closely measure the level of cumulative
investment in their performance evaluations, Turlock enjoyed corporate amnesty. As Joe often stated, “a
good warehouse is a full warehouse; why else would you build them?”
His reaction to this new production/working capital “proposal” had been obsequiously positive as he had
responded to Tadd, “Sure boss, anything you want. I guess we can let these New York money people
screw up our system and then they will see the light.” Tadd had tried to reason with him but could tell it
went in one ear and out the other, while Joe sat smiling and saying, “Sure, good as done ”, while he would
resist over time.
Additionally, Joe is one of those guys that liked to stir the pot behind the back of headquarters. He had
already been in touch with the other plant managers and suggested that they play along at first and then
go back to the old ways. Since Joe had always delivered investment capital under ITT for warehouse
facilities he was well respected amongst his peers. Joe made their job a lot easier as there was always
room for excess production. This made the plant manager’s mission much easier. He also was an expert
bowler and bought rounds of beer for the guys when he won.
Joe argued … “suppliers enjoy such great terms that anything we the plant managers want, we get.
Everyone knows that the Scott’s brand is such an icon, marketing’s job was easy and there was always an
abundance of product produced, so production would continue to be the star once the new owners
figured it out. Why all the change? This too will pass.”
The production side of Scott was ruled by complacency and Joe Turlock was the poster child for the term.
19
Exhibit 10: C&D Framework - Incentives and Compensation
There are three basic elements of compensation: 1) The bonus is linked tightly to selected metrics to
generate specific results; 2) significant ownership was spread to the different makers that would become
wealthy if successful; and 3) the salary was almost doubled to compensate the higher risk and to cover
cost of borrowings needed to purchase managers’ new Scott’s stock investment.
Bonus Incentive Plan: Historically, ITT had created a control system that allowed ITT headquarters to
manage a vast number of businesses, but that did not give Scott managers the flexibility or incentive to
use their specialized knowledge of the business to maximize the value of their division. C&D relied much
more heavily on managers’ firm-specific knowledge; hence the incumbent management team was more
valuable to the buyout firm. C&D managers were willing to pay managers more to reduce the risk of the
managers quitting and depriving Scott and C&D of this valuable knowledge.
The bonus plan was completely redesigned after the buyout. The number of managers who participated
in the plan increased, and the factors that determined the level of bonus were changed to reflect the
objectives of the buyout firm. In addition, both the plan maximum bonus and actual realizations of bonus
as a percentage of salary increased by a factor of two to three.
After the buyout, twenty-one managers would be covered by the bonus plan; only ten were eligible for
bonuses under ITT. The maximum pay-off under the new plan ranged from 33.5% to 100% of base salary,
increasing with the manager’s rank in the company. For each manager, the amount of the payoff was
based on the achievement of corporate, divisional and individual performance goals. The weights applied
to corporate, divisional and individual performance in calculating the bonus varied across managers. For
division managers, bonus payoff was based 35% on over-all company performance, 40% on divisional
performance and 25% on individual performance. Bonuses for corporate staff managers weighed
corporate performance at 50% and personal goals at 50%
At the beginning of each fiscal year, performance targets (or goals) were set and differences between
actual and targeted performance entered directly into the computation of the bonus plan pay-offs. All
corporate and divisional performance measures were quantitative measures of cash utilization, and were
scaled from 80 to 125, 100 representing the attainment of target. For example, corporate performance
was determined by dividing actual Earnings Before Interest and Taxes (EBIT) by budgeted EBIT, and
dividing actual Average Working Capital (AWC) by budgeted AWC, and weighting the EBIT ratio at 75%
and the AWC ratio at 25%. The resulting number, expressed as a percentage attainment of budget, was
used as a part of the bonus calculation of all managers in the bonus plan.
The plan was designed so that the payoff was sensitive to changes in performance. This represented a
significant change from the ITT bonus plan. As Bob Stern, Vice-President of Associate Relations,
commented:
“I worked in human resources with ITT for a number of years. When I was
Manager of Staffing of ITT Europe, we evaluated the ITT bonus plan. Our
conclusion was that the ITT bonus plan was viewed as nothing more than a
deferred compensation arrangement: all it did was defer income from one year
to the next. Bonuses varied very, very little. If you had an average year, you
might get a bonus of $10,000. If you had a terrible year you might get a bonus
of $8,000 , and if you had a terrific year you might go all the way to $12,500.
On a base salary of $70,000, that’s not a lot of variation.”
20
Exhibit 10: C&D Framework - Incentives and Compensation (continued)
Management Equity Ownership: 17% of the equity was distributed among the firm’s employees. Eight of
Scott’s top managers contributed a total of $2,812,500 to the buyout and so hold as many shares or 12%
of the shares outstanding. Tadd Seitz, president of Scott, held the largest number of shares (1,062,500 or
4.4% of the shares outstanding). The other 7 managers purchased 250,000 shares a piece (1% each of the
shares outstanding). As a group, managers borrowed a total of $2,531,250 to finance the purchase of
shares. Though the money was not borrowed from Scott, these loans were guaranteed by the company.
The purchase of equity by Scott managers represented a substantial increase in personal risk for these
managers.
The substantial equity holdings of the top management team, and the fact that they were personally
liable for the debts incurred to finance their equity stakes, lead them to focus on two distinct aspects of
running Scott. One was the need to avoid even technical default on the company’s debt, for although such
default was unlikely to lead to liquidation of the company, it very likely would have lead to a reduction in
the manager’s fractional holdings (due to dilution in a debt-for-equity conversion), and thus a significant
reduction in the wealth of the managers. Thus, the equity ownership served to bond managers to honor
the debt covenants.
A second effect of equity ownership was to dissuade managers from making decisions, which damaged
the health of the company. Since they owned a capital value claim on the firm, they had an incentive to
meet the debt obligations without making investment decisions that sacrificed long-term value. This
incentive kept the Scott managers from meeting the debt obligations by taking actions such as reducing
their investment in brand name advertising or cutting back on the maintenance of plant and equipment.
Such short-term maximizing decisions would have reduced the value of the manager’s capital value claim,
and thus reduced their wealth. The company’s high leverage combined with covenants and management
equity ownership provides managers with the incentive to generate the cash required to meet the debt
payments without bleeding the company.
Salaries: Among the first things done by Clayton & Dubilier after the buyout was to increase salaries
selectively and begin to develop a new management compensation plan. A number of managers that
were not participants in the ITT bonus plan became participants under the C&D plan. The new plan
changed the way managers were evaluated substantially, and increased the fraction of salary that a
manager could earn as a bonus. While some of these data are confidential, we are able to describe many
of the parameters of C&D’s incentive compensation plan and compare it to the ITT compensation system.
Almost immediately after the close of the sale, the base salaries of some top managers were increased.
The president’s salary increased by 42% and the salaries of other top managers increased as well. Henry
Timnick, a C&D partner who works closely with Scott, explains the decision to raise salaries:
“We increased management salaries because divisional vice presidents are not
compensated at a level comparable to a free-standing company with the same
characteristics. Divisional VP’s don’t have all the responsibilities. In addition,
the pay raise is a shot-in-the-arm psychologically for the managers. It makes
them feel they will be dealt with fairly and encourages them to deal fairly with
their people.”
C&D increased salaries to ease management’s transition from an ITT subsidiary to a free-standing
company, and because they felt that managing after the buyout was a more difficult job, requiring more
effort. C&D sets higher standards for management performance than ITT. In other words, the minimum
acceptable level of performance (below which managers would be fired) was higher under C&D than
under ITT.
21
Exhibit 11: Organizational Changes and Changes in Decision Making
The organizational changes and changes in decision-making that would need to take place at Scott after
the buyout fall broadly into two categories: 1) improved working capital management and 2) a new
approach to product markets. These changes would not forced on managers by C&D. The buyout firm
made some suggestions (rather convincingly), but the specific plans and their implementation would be
the responsibility of Scott managers. Few of the changes in managerial actions represent keenly
innovative or fundamentally new insights into management problems. As one observer noted, “it ain’t
rocket science.” These changes, however, lead to dramatic improvements in Scott’s operating
performance. Execution is the difference.
According to Scott managers, the biggest difference between working at Scott before and after the
buyout was an increase in the extent to which they could make and implement decisions without
approval from superiors. ITT maintained control over its divisions through a formal planning and reporting
structure that was very inflexible. Changing a plan required approval at a number of levels from ITT
headquarters, and a request for a change was likely to be denied. In addition, because ITT was shedding
its consumer businesses, Scott managers fund their requests for capital funds were routinely denied. After
the buyout, Seitz could pick up the phone and propose changes in the operating plan to Timnick. This, of
course, improved the company’s ability to respond quickly to changes in the market.
Purpose and Composition of the Board: The purpose of Scott’s Board of Directors was to monitor, advise
and evaluate the CEO. As Henry Timnick describes it:
“The purpose of the board is to make sure the company has a good strategy and to
monitor the CEO. The CEO cannot be evaluated by his management staff, so we do not
put the CEO’s people on the board. Scott’s CFO and the Corporate Secretary attend the
meetings, but they have no vote. The outside directors are to be picked by the CEO, we
will not put anyone on the board that the CEO doesn’t want, but we (C&D) have to
approve them. We do not view board members as extensions of ourselves, but they are
not to be cronies or local friends of the CEO. We want people with expertise that the
CEO doesn’t have. The CEO should choose outside directors who are strong in areas in
which he is weak.”
At the close of the buyout Scott’s board had five members, only one, Tadd Seitz, was a manager of the
firm. Of the remaining four, three were C&D partners; Martin Dubilier was the chairman of the board and
voted the stock of the limited partnership, Henry Timnick was the C&D partner who worked most closely
with Scott management, and the third C&D partner was a financing specialist. The outside director was
Joe Flannery, then CEO of Uniroyal. Later, Flannery left Uniroyal and became a C&D partner. He stayed on
the board, becoming an inside, rather than outside director.
Over the next few years three new directors were added; one was an academic with specific product
knowledge, one was a consumer products expert, and one, Don Sherman, was the president of Hyponex.
The academic, Jim Beard, was one of the country’s leading turf researchers. Henry Timnick described the
process of putting him on the board:
“Our objective was to find the best turf specialist and researcher in the country. We wanted
someone to keep us up with the latest developments and to scrutinize the technical aspects of
our product line. We found Jim Beard at Texas A&M. It took Jim awhile to be enthusiastic about
being on the board, and it took Tadd a while to figure out how to get the most out of Jim. After
Jim was appointed to the board, we encouraged Tadd to have Jim out on a consulting basis for a
couple of days. Now Tadd is making good use of Jim.”
22
Exhibit 11 - Organizational Changes and Changes in Decision Making (continued)
Seitz and Timnick were considering an individual with extensive experience in consumer products
businesses to be the second outside director. They chose Jack Chamberlain, who had previously run GE’s
Consumer Electronics Division, Lennox China and Avon Products. Each board member was a stockholder;
upon joining the board they were given the opportunity to purchase 50,000 shares at adjusted-book
value. All the directors chose to own some stock.
This board structure was typical for a C&D buyout. Martin Dubilier explains:
“We have tried a number of board compositions and we found this to be the most
effective. If you have too many insiders, the board becomes an operating committee.
Outsiders fortify the growth opportunities of the firm.”
The Board of Directors met quarterly. A subset of the board and the executive committee met monthly.
The executive committee was made up of Martin Dubilier, Tadd Seitz and Henry Timnick. In their
meetings they determined policy, discussed personnel matters and tested Seitz’s thinking on major issues
facing the firm. The board meetings were more formal, usually consisting of presentations by members of
the management team other than Seitz
The Operating Partner: In each of C&D’s buyouts a partner with extensive operating experience served
as the liaison between the firm’s managers and C&D. The operating partner functioned as an advisor and
consultant to the CEO, not a decision-maker. Henry Timnick was Scott’s liaison partner. Post GE he had
been CEO at Mead that was purchased through a leveraged buyout, and had since worked with several of
C&D’s other buyout firms. Timnick spent several weeks in Marysville after the buyout closed. Following
that, he was in touch with Seitz daily by telephone and continued to visit regularly.
Timnick would advise Seitz, but felt it was important that Seitz make the decisions. When he and Seitz
disagreed, Timnick told him “If you don’t believe me, go hire a consultant, then make your own decision.”
Initially, Seitz continued to check with Timnick, looking for an authorization for his decisions. Henry
Timnick explains:
“Tadd kept asking me ‘Can I do this? Can I do that?’ I told him ‘You can do whatever you
want so long as it is consistent with Scott’s overall strategy.’”
Meetings between ITT managers and Scott managers were large and quite formal with as many as 40
members of ITT’s staff present. Scott managers found the meetings to be antagonistic, with the ITT
people working to find faults and problems with the operating units’ reported performance. By meeting
the formal goals set by ITT, Scott could largely avoid interference from headquarters. Avoiding such
interference was an important objective. As Paul Yeager, CFO, describes it:
“Geneen (then CEO of ITT) said in his book that the units would ask for help from
headquarters; that the units came to look at headquarters’ staff as outside consultants
who could be relied upon to help when needed. I have worked in many ITT units, and if
he really thought that, then he was misled. If a division vice president went to
headquarters for help, in effect he was saying, ‘I can’t handle it.’ He wouldn’t be a vice
president for very long.”
23
Exhibit 12: Scott Alternative End Game: Zombie Companies…
Milk Cash Rather Than Invest For Future Exit
The poor prospects for Scott’s do-it-yourself (DIY) market suggest a look at valuable option available to
consider if you are Clayton & Dubilier. The “milk it” end game may have merit from a financial point of
view in certain distressed company situations. The idea is to cut marketing and distribution, and research
and development expenses and “milk” the brand name capital until the company no longer has enough
brand name recognition to sell its products (Scott is a high market share company in a low growth market
making it a “cash cow”). There is an article in the Reader by Michael Porter and Kathryn Harrigan entitled
“End-Game Strategies for Declining Industries” that discusses an alternative concept for certain troubled
companies. Simply run the business to generate cash and liquidate assets when sales dwindle to an
optimal point. This financial strategy can be compared to a rescue program to invest and build value.
Based on the financial information presented in Exhibit 1, one can evaluate the prospects of such a
strategy compared to the possibility of a future exit at a multiple of EBIT. The table below presents an
analysis of a liquidation strategy under which the company cuts marketing and distribution and research
and development expenses 75% in the first year after the buyout, and uses all available cash after interest
payments to retire debt. The analysis assumes that capital expenditures equal depreciation over these
five years, that the firm liquidates working capital in five years, and shows a zero terminal value in 1993.
The declining sales projections may be conservative as killing off a strong brand like Scott’s takes years.
Income Statement Pro forma

0 1 2 3 4 5 6 7
(in '000s) 1986 1987 1988 1989 1990 1991 1992 1993
Net Sales 158,100 177,600 197,100 157,680 118,260 79,234 38,825 0
Cost of Sales 66,595 74,809 83,023 66,418 49,814 33,375 16,354 0
Gross Margin 91,505 102,791 114,077 91,262 68,446 45,859 22,471 0
Marketing and Distribution 58,400 16,401 18,202 14,561 10,921 7,317 3,585 0
Selling and Admin 7,905 2,220 2,464 1,971 1,478 990 485 0
Research and Development 4,100 1,151 1,278 1,022 767 514 252 0
EBITDA 21,100 83,019 92,134 73,707 55,281 37,038 18,149 0
Depreciation 3,000 3,000 3,000 3,000 3,000 3,000 3,000 0
EBIT 18,100 80,019 89,134 70,707 52,281 34,038 15,149 0
24

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“My momma always said, "Life was like a box of chocolates.

You never know what you're gonna get."”

Forrest Gump, American Philosopher

Background and Industry Overview

Agenda Item One: C&D Forecast and the Performance Gap

”Inventories can also be reduced by changing purchasing practices and inventory

Paul Yeager, the CFO concluded:

Agenda Item Number Three: Strategic Repositioning

Agenda Item Number Four: Incentives to Drive Results

Tadd then continued:

At which point Wall, the astute assistant treasurer, chimed in:

ITT Scott Forecast with Pro Forma Buyout Impact

Income Statement Pro forma

C&D Scott Forecast Pro Forma Year 1 of Buyout Going Forward

Select Balance Sheet Information

Accounts payable 2,737

Incr./(Decr.) in deferred taxes 0

Source: O.M. Scott Company Leveraged Buyout, HBS case

Source: O.M. Scott Company Leveraged Buyout, HBS case

Source: O.M. Scott Company Leveraged Buyout, HBS case

Source: O.M. Scott Company Leveraged Buyout, HBS case

From the case…

The Joe Challenge

Income Statement Pro forma

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