Scotts faces new shareholder lawsuit alleging mismanagement

A new shareholder lawsuit against Scotts Miracle-Gro (NYSE: SMG) was filed last week in federal district court in the Southern District of Ohio, the Eastern Division, essentially following the same complaint filed in June by the Florida Hialeah Employees’ Retirement System.

Rachel Scott filed a shareholder derivative complaint against the company and its executives including CEO James Hagedorn and his brother Chris Hagedorn among others. The complaint alleges “unjust enrichment, abuse of control, gross mismanagement, and a waste of corporate assets.”

The case was filed in Ohio since the company was founded there in 1868 by Orlando Scott. The company merged in 1995 with New York-based Stern’s Miracle-Gro, which established the Hagedorn leadership. Similar to the Hialeah complaint, this complaint targets the date range of Nov. 3, 2021, through Aug. 1, 2023.

Allegations

The new complaint highlights the company’s debt which featured multiple restrictive covenants and cross-default provisions that required Scotts to retain specific financial ratios. The complaint states, “If Scotts breached any of the covenants, the breach could trigger a default, thereby allowing lenders to declare all outstanding indebtedness immediately due and payable.”

Scotts had to maintain a debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio under 6.25. The shareholders claim that in order to maintain compliance with the EBITDA ratio covenant, Scotts was incentivized to flood its sales networks with inventory.

“At the beginning of the Relevant Period, the Company had approximately $2.3 billion of debt. BY the end of the Relevant Period, Scotts’ the debt had skyrocketed to $3.1 billion,” says the complaint.

The shareholder case states that in 2020 and 2021, Scotts missed millions of dollars in sales because of insufficient inventory to meet increasing demand. The company responded by overcompensating and buying too much inventory. Then when it realized it had too much inventory, the complaint alleges that the directors of the company flooded the market with even more inventory, selling too much product to end users.

The shareholders suggest that Scotts marked these sales to its distributors as revenue to maintain the earnings-to-debt ratios needed to satisfy its debt covenants. The filing also notes that the company was touting its record sales to shareholders.

However, by June 2022, Scotts was changing its tune and saying refill orders were falling and the company would need to slash its earnings guidance. The company announced it needed to take on more debt for restructuring charges and was amending its debt covenants. As the company continued to disclose to shareholders its precarious financial situation, the value of the shares continued to fall.

Share buyback

This shareholder complaint highlights the company was buying back its shares at inflated prices. The complaint stated, “Between October 2021 and July 2023, approximately 1,042,462 shares of Scott’s common stock were repurchased, costing the Company over $160.5 million. As the Company’s stock was actually worth only $57.86 per share, the price at which it was trading when markets closed on August 2, 2023, the Company overpaid for repurchases of its own stock by over $100.2 million in total.”

It also alleges that the Hagedorn Partnership engaged in insider sales with artificially inflated prices that earned it proceeds of over $5 million.

Scotts slips

Last month, Scotts gave investors more bad news when it lowered its guidance for fiscal year 2024. The company estimated that the adjusted EBITDA earnings of $530 million to $540 million would be below its earlier forecast of $575 million. Scotts also said at the time that it planned to trim its debt by at least $350 million and boost its full-year gross margin by a minimum of 250 basis points.

The company, however, could benefit from its investment in Riv Capital, which agreed to be acquired by Florida-based Cansortium. Riv shareholders and the Hawthorn Collective Inc. will own 48% of Cansortium stock. In May, Cansortium reported that its revenues had been rising and the company continued to upgrade its facilities and expand its stores in Florida.