The Scotts Miracle-Gro Company produces various lawn, garden, and agricultural products for both consumer and professional purposes.  It is also the world’s largest marketer of branded consumer products for lawn and garden care.  Its main brands are Scotts, Miracle-Gro, and Ortho.  Scotts is the exclusive agent of Monsanto for distribution of its consumer Roundup products.  Scotts sells a vast majority of its products through third-party distributors. In 2014, Scotts formed a wholly owned subsidiary, The Hawthorne Gardening Company (“Hawthorne”), which focuses on hydroponics for the emerging cannabis growing market. The Company divides its business into three reportable segments: U.S. Consumer, Hawthorne, and Other.

According to a recently filed federal securities fraud class action complaint, The Scotts Miracle-Gro Company (NYSE: SMG) was highly leveraged, with its senior secured credit facilities containing various restrictive covenants and cross-default provisions that require the Company maintain specific financial ratios.  A breach of any of these covenants could result in a default, enabling the Company’s lenders to declare all outstanding indebtedness immediately due and payable.  A key covenant required Scotts to maintain a debt-to-EBITDA ratio under 6.25.  This dynamic created an incentive for the Company to saturate its sales channels with inventory to avoid breaching its debt covenants.  In early November 2021, Scotts held $2.3 billion of debt.  By August 1, 2023, Scotts’ debt had ballooned to $3.1 billion.

As alleged in the complaint, Scotts missed out on millions of dollars in sales in 2020 and 2021 due to a lack of inventory as it faced surging demand. In response to this strong demand, Scotts significantly increased its inventory for both its U.S. Consumer and Hawthorne segments to “ensure [it] could service the needs of [its] retail partners.” However, the Company quickly realized that it had purchased too much inventory. Rather than write down the inventory or otherwise disclose the issue to investors, Scotts executives engaged in a scheme to saturate the Company’s sales channels with more inventory than could be sold to end users. Through this scheme, Scotts booked as revenue the sales to its distributors and thereby maintained earnings to debt ratios that just barely exceeded those required by its debt covenants.

Scotts pushed product into its sales channels at a pace that outstripped demand while it repeatedly assured investors that its inventory levels were appropriate, that the Company was having peak or record selling, and that the Company was not going to breach its debt covenants. For example, throughout the Class Period, Scotts assured investors that the Company “[didn’t] have [an] inventory problem at all” and was “in a very good place,” while attributing strong sales to “selling through high-cost inventory,” which resulted in “peak selling” and “record shipments.” With regard to its debt covenants, Scotts touted that the Company beat internal targets and had “net leverage of 5.9 times debt-to-EBITDA comfortably within covenant maximum of 6.25 times.” The Company also stated it was “optimistic we will remain within the bounds of our bank covenants” and “[did] not see leverage compliance issues going forward.” The Company claimed it was “tracking to do even better” than its guidance, which the Company later stated was “really, really important for us to avoid covenant hell.”

These statements, and others, were materially false or misleading when made. In reality, by November 2021, Scotts had an oversupply of inventory that far exceeded consumer demand. Recognizing that problem, Scotts executives engaged in a scheme to saturate the Company’s sales channel with more product than those retailers could sell through to end users, a practice that required Scotts sales personnel to pressure retailers to purchase more inventory than they wanted or needed. Further, as Scotts later admitted, the Company was critically close to violating its debt covenants and would have required an “exceptional year” to remain in compliance with its covenants. Ultimately, Scotts was only able to satisfy the covenants through the channel stuffing scheme. In its fiscal fourth quarter of 2022, Scotts even changed its definition on how it calculated EBITDA in order to stay within the bounds of its debt covenants, as EBITDA was the main metric to calculate the Company’s compliance. As a result of these misrepresentations, Scotts common stock traded at artificially inflated prices.

The truth began to emerge on June 8, 2022, when Scotts admitted that replenishment orders from its U.S. retailers were more than $300 million below target in the month of May alone. The Company told investors that 2022 full-year earnings would be roughly half of its prior guidance. The Company also announced plans to take on additional debt to cover restructuring charges as it attempted to cut costs. In response to these disclosures, the price of Scotts common stock declined by $9.05 per share, or nearly 9%, from a closing price of $102.18 per share on June 7, 2022, to a closing price of $93.13 per share on June 8, 2022.

These disclosures came mere weeks after the Company promised that it was “tracking to do even better” than its guidance. Indeed, analysts were shocked by the disclosures, as reflected in a report by Truist commenting that, “[w]e have not seen anything similar occur in the 20 years we have covered [Scotts].” However, throughout the rest of the Class Period, Defendants continued to downplay the Company’s inventory and debt compliance issues.

On August 2, 2023, Scotts revealed that quarterly sales for its fiscal third quarter had declined by 6%, and that gross margins fell by 420 basis points. The Company also slashed fiscal year EBITDA guidance by a staggering 25% and announced a $20 million write down of “pandemic driven excess inventories.” The Company also disclosed that it had to modify its debt covenants to 7.00 times debt-to-EBITDA ratio, from the former ratio of 6.25 times debt-to- EBITDA ratio.

These disclosures caused the price of Scotts common stock to decline by $13.58 per share, or 19%, from a closing price of $71.44 per share on August 1, 2023, to a closing price of $57.86 per share on August 2, 2023.

Current Scotts shareholders who have Scotts shares since on or before November 3, 2021, can seek corporate reforms, the return of funds spent defending litigation back to the company, and a court approved incentive award, at no cost to them.

If you would like to learn more about this matter, you are encouraged to contact us at [email protected], or call 267-507-6085.