UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

Commission file number 1-11593

 

The Scotts Miracle-Gro Company

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

937-644-0011

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of Common Shares (the only common equity of the registrant) held by non-affiliates of the registrant computed by reference to the price at which Common Shares were last sold as of the last business day of the registrant’s most recently completed second fiscal quarter (March 27, 2009) was approximately $1,589,973,114.

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: The number of Common Shares of the registrant outstanding as of November 20, 2009 was 66,286,021.

 

DOCUMENT INCORPORATED BY REFERENCE:

 

Portions of the definitive Proxy Statement for Registrant’s 2010 Annual Meeting of Shareholders to be held January 21, 2010, are incorporated by reference into Part III hereof.

 

 

PART I

 

 

Company Description

 

The Scotts Miracle-Gro Company, an Ohio corporation (“Scotts Miracle-Gro” and, together with its subsidiaries, the “Company”), traces its roots to two businesses launched by entrepreneurs. In 1868, Civil War veteran O.M. Scott started a seed business in Marysville, Ohio, based on the conviction that “farmers shall have clean, weed-free fields.” Beginning in 1907, The Scotts Company expanded its reach by selling grass seed to consumers and eventually exited the agricultural market. By 1988 — through innovation and acquisition — The Scotts Company had become a leading marketer of lawn fertilizer, grass seed and growing media products within the United States.

 

Separately, Horace Hagedorn and his partner Otto Stern launched Stern’s Miracle-Gro Products, Inc. in 1951 in New York. Their easy-to-use plant food quickly revolutionized the gardening category. Through innovative marketing, Miracle-Gro^® eventually became the leading plant food product in the gardening industry. In 1995, The Scotts Company and Stern’s Miracle-Gro Products, Inc. merged, marking the start of a significant evolution for the Company.

 

In the late 1990’s, the Company launched both a geographic and a category expansion. It acquired companies with industry-leading brands in France, Germany and the United Kingdom. In fiscal 1999, the Company acquired the Ortho^® brand in the United States and exclusive rights for the marketing and distribution of consumer Roundup^®* brand products within the United States and other specified countries, thereby adding industry-leading weed, insect and disease control products to its portfolio. The Company expanded into the lawn care service industry with the launch of Scotts LawnService^® in 1998. Since fiscal 2001, the Company has invested nearly $125 million in acquisitions of local and regional lawn care businesses to provide a platform for rapid expansion throughout the United States. Most recently, the Company entered the North American wild bird food category in fiscal 2006 with the acquisition of Gutwein & Co., Inc. and its Morning Song^® brand of bird food.

 

As the Company celebrates more than 100 years of selling products to consumers, we own the leading brands in nearly every category of the lawn and garden industry. A list of some of our North American leading consumer brands is as follows:

 

 

In addition, we have the following significant brands in Europe: Miracle-Gro^® plant fertilizers, Weedol^® and Pathclear^® herbicides, EverGreen^® lawn fertilizers and Levington^® growing media in the United Kingdom; KB^® and Fertiligène^® in France; Celaflor^®, Nexa Lotte^® and Substral^® in Germany and Austria; and ASEF^®, KB^® and Substral^® in Belgium, the Netherlands and Luxembourg. Roundup^® is also a significant brand in the United Kingdom, France, Germany and other European markets.

 

 

      * Roundup^® is a registered trademark of Monsanto Technology LLC, a company affiliated with Monsanto Company.

Business Segments

 

For fiscal 2009, the Company divided its business into the following segments:

 

 

This division of reportable segments is consistent with how the segments report to and are managed by senior management of the Company. Financial information about these current segments for the three years ended September 30, 2009 is presented in “NOTE 22. SEGMENT INFORMATION” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Global Consumer

 

In our Global Consumer segment, the Company manufactures and markets products that provide easy, reliable and effective assistance to homeowners who seek healthy, weed-free and pest-free lawns, gardens and indoor plants. These products incorporate many of the latest technologies available. The Global Consumer segment sells products in the following categories:

 

Lawns:  A complete line of granular lawn fertilizer and combination products, including fertilizer and crabgrass control, weed control or pest control, is sold under the Scotts^® and Turf Builder^® brand names. The Turf Builder^® line of products in the United States is designed to make it easy for do-it-yourself consumers to select and properly apply the right product in the right quantity for their lawns. A similar range of products is available in the United Kingdom under the EverGreen^® brand, in France under the Fertiligéne^® brand name and in Germany, Austria, the Nordic countries and throughout Eastern Europe under the Substral^® brand name.

 

Gardens:  A complete line of plant foods is marketed under the Miracle-Gro^® brand name in North America, the United Kingdom and selected Western European markets. In addition to our high-quality granular and liquid water-soluble plant foods, which we market as the Shake ’n Feed^® and LiquaFeed^® sub-brands under Miracle-Gro^®, we have continuous-release plant foods for extended feeding and convenience, which we market under the Osmocote^® brand. The Company also markets an extensive line of plant food products under the Substral^® brand name in Germany, Austria, the Nordic countries and throughout Eastern Europe, and under the Fertiligéne^® brand name in France.

 

Growing Media:  A complete line of growing media products for indoor and outdoor uses is marketed under the Miracle-Gro^®, Scotts^®, Hyponex^®, Earthgro^® and SuperSoil^® brand names in the United States, as well as other labels. These products include potting mix, garden soils, seeding soil, topsoil, manures, sphagnum peat and decorative barks and mulches. The addition of the Miracle-Gro^® and Scotts^® brand names plus plant food to higher quality potting mixes, garden soils and seeding soil has turned previously low-margin commodity products into value-added category leaders. The introduction of the Moisture Control^®, Organic Choice^® and Nature Scapes^® line extensions has provided further innovation and differentiation of our products in the marketplace. This same strategy is being employed in Europe, where the Miracle-Gro^® brand, as well as the Levington^®, Fertiligène^®, KB^® and Substral^® brands, are being used to market growing media products.

 

Grass Seed:  We offer a broad line of grass seed products for consumers. Our leading grass seed products are sold under the Scotts^® Turf Builder^®, EZ Seed^®, and PatchMaster^® brand names in the consumer market. Scotts EZ Seed^®, introduced in 2009, is an example of our on-going innovation. This unique lawn repair product combines Scotts^® grass seed with granular fertilizer in a proprietary growing material having superior water absorbency qualities. By retaining moisture, the growing material not only allows for better seed germination but supports less frequent watering, resulting in a higher level of consumer success. Similarly, our proprietary Water Smart^tm grass seed allows consumers to successfully grow turf while using less water.

Controls:  A broad line of weed control, indoor and outdoor pest control and plant disease control products is marketed under the Ortho^® brand name in the United States. Ortho^® products are available in aerosol, ready-to-use liquid, concentrated, granular and dust forms. Ortho^® control products include Weed-B-Gon Max^®, Bug-B-Gon Max^®, Home Defense Max^®, Ortho Max^®, GroundClear^®, RosePride^®, and Orthene^® Fire Ant Killer. In 2009, we introduced an innovative line of mouse and rat control products under the Home Defense Max^® brand by literally — we think — building a better mouse trap. In Europe, the Company markets an extensive line of control products under a variety of brand names, including Weedol^®, Pathclear^®, KB^®, Fertiligéne^®, Celaflor^® and Nexa Lotte^®.

 

Since 1999, the Company has served as Monsanto Company’s (“Monsanto”) exclusive agent for the marketing and distribution of Roundup^® non-selective herbicide products in the consumer lawn and garden market within the United States and other specified countries, including Australia, Austria, Belgium, Canada, France, Germany, the Netherlands and the United Kingdom. (See the “Roundup^® Marketing Agreement” discussion later in this Item 1 for a more detailed explanation of the Company’s agreement with Monsanto.)

 

Wild Bird Food:  We manufacture and market an assortment of wild bird food products. The Morning Song^® line of products is sold at leading mass retailers, grocery, pet and general merchandise stores. We also offer a Scotts Songbird Selections^® branded line of wild bird food which emphasizes innovative packaging and premium blends designed to attract desirable species of birds.

 

Other Consumer Products:  The Company also manufactures and markets several lines of high-quality lawn spreaders under the Scotts^® brand name — Turf Builder^® EdgeGuard^® DLX spreaders, AccuGreen^® drop spreaders and Handy Green^®II handheld spreaders. We sell a line of hose-end applicators for water-soluble plant foods such as Miracle-Gro^® products, and lines of applicators under the Ortho^® and Dial ’N Spray^® trademarks for the diluted application of control products sold in the concentrated form.

 

The Global Consumer segment also includes our Canadian consumer operations, where we believe we are the leading marketer of branded consumer lawn and garden products. In Canada, we sell a full range of lawn and garden fertilizers, control products, grass seed, spreaders, and value-added growing media products under the Scotts^®, Turf Builder^®, EcoSense^tm, Miracle-Gro^®, Ortho^®, Killex^® and Roundup^® brands.

 

Global Professional

 

The Global Professional segment sells professional products to commercial nurseries and greenhouses and specialty crop growers primarily in North America, Europe, the Middle East, Africa, Latin America, Australia, New Zealand and throughout the Far East. Our professional products include a broad line of sophisticated controlled-release fertilizers, water-soluble fertilizers, plant protection products, wetting agents, growing media and grass seed that are sold under brand names that include Osmocote^®, Sierrablen^®, Peters Professional^®, Peters Excel^®, Agroblen^®, Agrocote^®, Agroleaf^®, Rout^®, OH2^®, Scotts^® Professional Seed and Scotts^® Turf-Seed^tm.

 

Scotts LawnService^®

 

The Scotts LawnService^® segment provides residential lawn care, lawn aeration, tree and shrub care and limited pest control services in the United States. As of September 30, 2009, Scotts LawnService^® had 82 Company-operated locations and 78 independent franchises.

 

Corporate & Other

 

The Corporate & Other segment includes our unallocated corporate general and administrative expenses, as well as the remainder of the Smith & Hawken^® business, an outdoor living and garden lifestyle category brand. On July 8, 2009, the Company announced its intention to cease operating the Smith & Hawken^® business. As of November 17, 2009, all Smith & Hawken^® stores had been closed and all operational activity is expected to be substantially complete by December 31, 2009. The Company will begin reporting the Smith & Hawken^® business as a discontinued operation in the first quarter of fiscal 2010. Financial information about the Smith & Hawken^® closure process for the fiscal year ended September 30, 2009 (“fiscal 2009”) is presented in “NOTE 3.

IMPAIRMENT, RESTRUCTURING AND OTHER CHARGES” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Competitive Marketplace

 

Our major customers include home centers, mass merchandisers, warehouse clubs, large hardware chains, independent hardware stores, nurseries, garden centers, food and drug stores, commercial nurseries and greenhouses and specialty crop growers. Each of our segments participates in markets that are highly competitive and many of our competitors sell their products at prices lower than ours. The Company attributes its market leadership and continued success in the lawn and garden category to our industry-leading brands, innovative products, award-winning advertising, supply chain excellence, highly effective field sales and merchandising organization and the strength of our relationships with major retailers in our product categories.

 

In the North American Global Consumer do-it-yourself lawn and garden and pest control markets, we compete primarily against “private label” products as well as branded products. “Private label” products are those sold under a retailer-owned label or a supplier-owned label, which are sold exclusively at a specific retail chain. In late October 2008, the Company’s largest North American competitor, Spectrum Brands, announced it would cease competing in the lawn fertilizer, grass seed and growing media categories. As a result, the Company was awarded additional lawn fertilizer and growing media business by two of its retail partners.

 

The Company continues to compete with Spectrum Brands in other lawn and garden categories. We also compete with Bayer AG, Central Garden & Pet Company, Enforcer Products, Inc., Green Light Company and Lebanon Seaboard Corporation. In addition, we face competition from regional competitors who compete primarily on the basis of price for commodity growing media business.

 

Internationally, we face strong competition in the consumer do-it-yourself lawn and garden market, particularly in Europe. Our competitors in the European Union include Bayer AG, Compo GmbH, a subsidiary of K&S Aktiengesellschaft (which owns the Compo^®, Sem^® and Algoflash^® brands), Westland Horticulture and a variety of local companies.

 

In the North American Global Professional horticulture markets, we face a broad range of competition from numerous companies such as Agrium, Inc., Haifa Chemicals Ltd., Chisso Asahi Fertilizer Co. Ltd., Syngenta AG and Bayer AG. Some of these competitors have significant financial resources and research departments.

 

The international Global Professional horticulture markets in which we compete are also very competitive, particularly the markets for controlled-release and water-soluble fertilizer products. We have numerous U.S. and European competitors in these international markets, including Pursell Industries, Inc., Compo GmbH, a subsidiary of K&S Aktiengesellschaft, Norsk Hydro ASA, Haifa Chemicals Ltd. and Kemira Oyj.

 

We have the second largest market share position in the fragmented U.S. do-it-for-me lawn care service market. We compete against TruGreen-ChemLawn^®, a division of ServiceMaster, which has the leading market share in the U.S. lawn care service market and has a substantially larger share of this market than Scotts LawnService^®, as well as numerous regional and local lawn care services operations.

 

Significant Customers

 

Approximately 78% of our worldwide net sales in fiscal 2009 were made by our Global Consumer segment. Within the Global Consumer segment, approximately 33% of our net sales in fiscal 2009 were made to Home Depot, 19% to Lowe’s and 18% to Walmart. We face strong competition for the business of these significant customers. The loss of any of these customers or a substantial decrease in the volume or profitability of our business with any of these customers could have a material adverse effect on our financial condition, results of operations or cash flows.

Competitive Strengths

 

Strong Brands

 

The Company considers its industry-leading brands to be its single largest competitive advantage, though hardly its only advantage. The Company believes it has the leading market share in every major U.S. category in which its Global Consumer business competes. The Company also owns many of the leading brands in the European marketplace.

 

The Company has helped to build awareness of its brands through consistently investing in advertising and marketing. As a result, consumer awareness of the Company’s key brands — especially in the United States — rivals that of nearly any other consumer products company. The strength of the Scotts^® brand, in particular, has been a critical aspect of the success of Scotts LawnService^®.

 

Trademarks, Patents and Licenses

 

The Company considers its trademarks, patents and licenses to be key competitive advantages. We pursue a vigorous trademark protection strategy consisting of registration and maintenance of key trademarks and proactive monitoring and enforcement activities to protect against infringement. The Scotts^®, Miracle-Gro^®, Ortho^®, Scotts LawnService^®, Smith & Hawken^®, Osmocote^®, Hyponex^® and Earthgro^® brand names and logos, as well as a number of product trademarks, including Turf Builder^®, Organic Choice^®, Home Defense Max^® and Weed-B-Gon Max^®, are federally and/or internationally registered and are considered material to our business.

 

As of September 30, 2009, we held approximately 97 issued and unexpired utility and design patents in the United States covering subject matter such as fertilizer, chemical and growing media compositions and processes; grass varieties; and mechanical dispensing devices such as applicators, spreaders and sprayers. Similar patents have also been issued in foreign countries throughout the world, bringing our total worldwide patent portfolio to approximately 466 issued and unexpired utility and design patents. The issued utility patents provide protection generally extending to 20 years from the date of filing, subject to the payment of applicable governmental maintenance and annuity fees, and many of our patents will extend well into the next decade.

 

In addition, we continue to file new patent applications each year covering new, commercially significant developments conceived by our research and development associates. Currently, we have approximately 206 pending utility and design patent applications worldwide, including approximately 33 pending U.S. applications. We also hold exclusive and non-exclusive patent licenses and supply arrangements, permitting the use and sale of additional patented fertilizers, pesticides and mechanical devices.

 

During fiscal 2009, we were granted seven U.S. and 28 foreign national utility and design patents, including patents for the designs of various spraying devices, the designs of rodent traps, the designs of spreader devices and pest control compositions comprising soybean oil derivatives. We continue to pursue patent coverage of our core technologies nationally and in our Canadian, European, Asia/Pacific and South American markets.

 

No significant U.S. or foreign patents expired in fiscal 2009. However, in fiscal 2010, the Company is anticipating the expiration of several patents, including two U.S. patents for slow release coated fertilizers and one U.S. patent for carrierless granular fertilizer products.

 

Innovation

 

The Company views its commitment to innovation as a competitive advantage. We continually invest in research and development, in the laboratory and at the consumer level, to improve our products, manufacturing processes, packaging and delivery systems. The Company’s long-standing commitment to innovation is evidenced by its worldwide portfolio of patents. Spending on research and development was $56.3 million, $44.7 million and $38.8 million in fiscal 2009, fiscal 2008 and fiscal 2007, respectively, including product registration costs of $15.6 million, $9.8 million and $9.3 million, respectively. In addition to the benefits of our own research and development, we actively seek ways to leverage the research and development activities of our suppliers.

 

Our worldwide research and development headquarters is located at the Dwight G. Scott Research Center in Marysville, Ohio. We also have research and development facilities in the United Kingdom, France, the Netherlands

and Australia, as well as several research field stations located throughout the United States. In these combined locations, the Company employs 28 PhD scientists.

 

The Company’s biotechnology program is evidence of its commitment to responsible research and to developing more effective and easier-to-use products that are preferred by consumers and are better for the environment. As part of this program, the Company is currently employing technology already proven in agriculture to develop new turf varieties that could one day require less maintenance, less water and fewer chemical inputs to resist insects, weeds and disease.

 

Supply Chain and Sales Force

 

Because our Global Consumer segment sells a substantial majority of its products to a concentrated number of retail customers, it is critical to maintain strong relationships with these partners. We believe our supply chain and sales force are major competitive advantages that have allowed us to build unrivaled relationships with our key retail partners.

 

In fiscal 2009, the Company commenced a three-year plan aimed to regionalize its supply chain by co-locating fertilizer and growing media distribution centers to allow for more full truckload deliveries, thereby lowering costs. The Company has also begun to roll out a regional packaged goods filling and distribution strategy. The investments associated with our regional manufacturing and distribution should allow the Company to more efficiently supply its key retail accounts and diversify its manufacturing footprint. The Company considers its order fill rate — which measures the accuracy of shipments — to be an important measure of customer service. In fiscal 2009, the Company achieved a global order fill rate of 98.6 percent. Additionally, over the past several years, the supply chain has helped the Company improve its inventory turns, as well as those of its retail partners. The Company has made substantial investments to lower the cost structure of its supply chain operations in Europe while simultaneously improving customer service levels.

 

The Company’s U.S. sales force is another major competitive advantage. By increasing the size of the sales force over several years, the Company has taken a more proactive role in helping our retail partners merchandise the lawn and garden department and maximize the productivity of this space. In addition to working closely with retailers, our nearly 2,000 person full-time and seasonal U.S. in-store sales force also provides the Company with an opportunity to interact face-to-face with consumers at-the-shelf. By helping consumers answer their lawn and garden questions, we believe we can drive higher sales of our products.

 

In fiscal 2009, the Company also began migrating to a regionalized sales focus in the United States that resulted in the opening of offices in Florida, Texas and California. By focusing more intently on local and regional issues, the Company believes it can improve its level of intimacy with both consumers and retailers.

 

Roundup^® Marketing Agreement

 

The Company is Monsanto’s exclusive agent for the marketing and distribution of consumer Roundup^® products (with additional rights to new products containing glyphosate or other similar non-selective herbicides) in the consumer lawn and garden market within the United States and other specified countries, including Australia, Austria, Belgium, Canada, France, Germany, the Netherlands and the United Kingdom. Under the terms of the Amended and Restated Exclusive Agency and Marketing Agreement (the “Marketing Agreement”) between us and Monsanto, we are jointly responsible with Monsanto for developing global consumer and trade marketing programs for consumer Roundup^®. We have assumed responsibility for sales support, merchandising, distribution and logistics for consumer Roundup^®. Monsanto continues to own the consumer Roundup^® business and provides significant oversight of its brand. In addition, Monsanto continues to own and operate the agricultural Roundup^® business.

 

We are compensated under the Marketing Agreement based on the success of the consumer Roundup^® business in the markets covered by the Marketing Agreement. We receive a graduated commission to the extent that the earnings before interest and taxes of the consumer Roundup^® business in the included markets exceed specified thresholds. Regardless of these earnings, we are required to make a $20 million annual contribution payment against the overall expenses of the consumer Roundup^® business.

The gross commission earned under the Marketing Agreement, the contribution payments to Monsanto and the amortization of the initial marketing fee paid to Monsanto are included in the calculation of net sales in the Company’s Consolidated Statements of Operations. For fiscal 2009, fiscal 2008 and fiscal 2007, the net amount earned under the Marketing Agreement was $51.4 million, $44.3 million and $41.9 million, respectively. For further details, see “NOTE 7. MARKETING AGREEMENT” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

The Marketing Agreement has no definite term except as it relates to the European Union countries (the “EU term”). The EU term extends through September 30, 2011, with up to two additional automatic renewal periods of two years each, subject to non-renewal only upon the occurrence of certain performance defaults. Thereafter, the Marketing Agreement provides that the parties may agree to renew the EU term for an additional three years.

 

The Marketing Agreement provides Monsanto with the right to terminate the Marketing Agreement upon an event of default (as defined in the Marketing Agreement) by the Company, a change in control of Monsanto or the sale of the consumer Roundup^® business. The Marketing Agreement provides the Company with the right to terminate the Marketing Agreement in certain circumstances, including an event of default by Monsanto or the sale of the consumer Roundup^® business. Unless Monsanto terminates the Marketing Agreement due to an event of default by the Company, Monsanto is required to pay a termination fee to the Company that varies by program year. The termination fee is calculated as a percentage of the value of the Roundup^® business exceeding a certain threshold, but in no event will the termination fee be less than $16 million. If Monsanto were to terminate the Marketing Agreement due to an event of default by the Company, however, the Company would not be entitled to any termination fee, and it would lose all, or a substantial portion, of the significant source of earnings and overhead expense absorption the Marketing Agreement provides. Monsanto may also be able to terminate the Marketing Agreement within a given region, including North America, without paying a termination fee if unit volume sales to consumers in that region decline: (1) over a cumulative three-fiscal-year period; or (2) by more than 5% for each of two consecutive years.

 

Monsanto has agreed to provide us with notice of any proposed sale of the consumer Roundup^® business, allow us to participate in the sale process and negotiate in good faith with us with respect to any such proposed sale. In the event we acquire the consumer Roundup^® business in such a sale, we would receive as a credit against the purchase price the amount of the termination fee that would have been paid to us if Monsanto had exercised its right to terminate the Marketing Agreement in connection with a sale to another party. If Monsanto decides to sell the consumer Roundup^® business to another party, we must let Monsanto know whether we intend to terminate the Marketing Agreement and forfeit any right to a termination fee or whether we will agree to continue to perform under the Marketing Agreement on behalf of the purchaser.

 

Strategic Initiatives

 

Our strategic plan is focused on leveraging our key competitive advantages to extend category and share growth and reduce costs, further distancing us from the competition and increasing shareholder value. Even in a difficult economy, we continue to expand upon our strategy of strengthening our relationship with the consumer. This will allow us to leverage the cornerstone of our business — our brands — and drive higher usage of our products. We seek to raise household penetration of our products, as well as the frequency with which existing consumers use our products. We believe this can be accomplished by increasing our intimacy with our consumers and customers at a localized level, by building our portfolio of simple, significant and sustainable products through innovation and by leveraging our strong customer relationships. We are currently involved in several initiatives designed to meet this criteria:

 

 

Headquarters will support the Regions with effective programs and services to attract more consumers and enhance support to our retailers, as well as to continue to drive innovation in our products, services, programs and operations in ways designed to keep consumers engaged in lawn and garden activities and to improve business efficiency for the long-term.

 

 

“Simple” means that products must be easy for the consumer to buy, use and store. In addition, they should reduce the amount of time it takes to accomplish a task and should give the consumer improved results. “Significant” products should have strong margin potential, generate possible cost savings, present a global opportunity and be proprietary whenever possible. “Sustainable” means new products must be designed with consumer safety and environmental impacts in mind, including the development of formulations designed to replace restricted or aging active ingredients.

 

We believe this strategy resulted in the successful launch of several new products in 2009, including Turf Builder^® Water Smart^tm Grass Seed and EZ Seed^® Grass Seed. The former includes a full line of premium grass seed products that provide consumers high-performance seed wrapped in a super-absorbent coating which allows every seed to absorb up to 40% more water than ordinary seed. As a result, the seed needs to be watered less frequently, which enables consumers to more easily succeed in growing a healthy lawn. EZ Seed^® is a seed mix which includes premium grass seed, fertilizer and a proprietary growing material. Our proprietary technology absorbs water, expanding to surround the seed in a moist protective layer. The protective layer continues to care for the seed, infusing it with water and nutrients, so it builds strong roots that survive tough conditions.

 

 

In 2009, we employed more merchandisers and expert product counselors and significantly increased the number of hours we spent in the stores of our major retail partners. We accomplished this by rebalancing our sales force, shifting a portion of our full year fixed compensation to seasonal variable labor and by employing other productivity measures which allowed us to spend more time helping our retailers and consumers and less time on administrative activities.

 

We believe continued use of this strategy provides a more flexible cost structure, helping maximize the return on our investment and allows us to better meet the needs and timing of local markets. It also allows us to quickly deploy more labor in those regions where business is particularly strong and reduce spending in regions where sales may be lower than expected due to poor weather, economic concerns or other factors.

 

Our strategy also incorporates long-term initiatives to further increase the cost productivity of our U.S. supply chain model. We believe this effort, which is another form of regionalization, can result in cumulative cost savings of $50 million and reduce inventories by $100 million.

 

 

Meanwhile, growing media products are shipped direct-to-store through a network of 26 manufacturing facilities. Because these shipments go shorter distances on full trucks, they are more efficient.

Our strategy for a future model — which began in 2009 and is being rolled out over a three-year period — allows fertilizer products to be shipped into these growing media facilities, instead of to warehouses. From there, the fertilizer and growing media products are co-distributed directly to the stores. Once deployed across the entire country, nearly all fertilizer products for home center customers will be shipped through these growing media facilities, significantly improving our product distribution efficiency.

 

 

These strategic efforts not only present a significant economic benefit to the Company, but our retail partners will benefit as well, through more frequent store replenishment, improved inventory turns and reduced order lead times. As such, we believe our partners can maximize their retail point-of-sale opportunities without compromising the customer service they have come to expect.

 

Strengthening our Global Consumer Business Internationally

 

We continue to believe in the long-term growth potential of our Global Consumer business internationally. In order to maximize shareholder value in this business, we have sharpened our focus by: (i) reducing costs in the business to improve profitability and to allow for marketing investments; (ii) aligning the organization by category rather than by geography to better leverage our knowledge of the marketplace and the consumer; and (iii) better leveraging the Company’s innovation competencies. We have implemented a global supply chain to provide our smaller, international market segments with the benefits of the larger Company, such as lower packaging costs and the ability to source products from any Company-owned plant globally. The first steps of the organizational realignment have taken place, and as part of a broader corporate initiative, they will continue to evolve in fiscal 2010 and beyond. Finally, we are combining global scale with locally tailored products to streamline our technology platform in the international Global Consumer business. As an example, when the Company introduced LiquaFeed^® Plant Food to a variety of European countries in fiscal 2008, each label carried the same design and branding while the claims and instructions were displayed in the local language. At the same time, the European business doubled sales of natural products in fiscal 2008 by launching Naturen^® sub-branded products as a locally driven effort.

 

Expanding Scotts LawnService^®

 

The number of homeowners who want to maintain their lawns and gardens but do not want to do it themselves represents a significant portion of the total lawn and garden market. We recognize that our portfolio of well-known brands provides us with a unique ability to extend our business into lawn and garden services and that the strength of our brands provides us with a competitive advantage in acquiring new customers. We have spent the past several years developing our Scotts LawnService^® business model and the business has grown significantly, from revenues of $41.2 million in fiscal 2001 to revenues of $231.1 million in fiscal 2009. This growth has come from geographic expansion, acquisitions and organic growth fueled by our direct marketing programs. Although acquisition activity has been negligible in recent years, we anticipate continuing to make selective acquisitions in fiscal 2010 and beyond. We will also continue to invest in the Scotts LawnService^® business infrastructure in order to continually improve customer service throughout the organization and leverage economies of scale as we continue to grow.

 

Seasonality and Backlog

 

Our business is highly seasonal, with 70% to 75% of our annual net sales occurring in our second and third fiscal quarters combined. Our annual sales are further concentrated in our second and third fiscal quarters by

retailers who increasingly rely on our ability to deliver products “in season” when consumers buy our products, thereby reducing the retailers’ inventories.

 

We anticipate significant orders for the upcoming spring season will start to be received late in the winter and continue through the spring season. Historically, substantially all orders are received and shipped within the same fiscal year with minimal carryover of open orders at the end of the fiscal year.

 

Raw Materials

 

We purchase raw materials for our products from various sources that we presently consider to be adequate to supply the needs of each of our segments and our business as a whole. We are subject to market risk from fluctuating prices of certain raw materials, including urea, resins, fuel, grass seed and wild bird food components. Our objectives surrounding the procurement of these materials are to ensure continuous supply, to minimize costs and to improve predictability. We seek to achieve these objectives through negotiation of contracts with favorable terms directly with vendors. When appropriate, we will procure a certain percentage of our needs in advance of the season to secure pre-determined prices. We also hedge certain commodities to improve predictability and control costs.

 

Manufacturing and Distribution

 

We manufacture products for our Global Consumer business in North America at our facilities in Marysville, Ohio; Fort Madison, Iowa; Albany, Oregon and Temecula, California, as well as at a number of third-party contract packer facilities in the United States and Canada. In addition, the Company manufactures growing media products in 27 regional facilities located throughout North America. We also own four production facilities for our wild bird food operations in Indiana, South Dakota, South Carolina and Texas. The primary distribution centers for our Global Consumer business in North America are managed by the Company and strategically placed across the United States.

 

We manufacture the non-growing media products for our Global Consumer business internationally at our facilities in Howden, the United Kingdom and Bourth, France. We also utilize a number of third-party contract packers. The primary distribution centers for our Global Consumer business internationally are located in the United Kingdom, France and Germany and are managed by a logistics provider.

 

The growing media products for our international Global Consumer business are produced at our facilities in Hatfield and Sutton Bridge, both in the United Kingdom, and Hautmont, France, and at a number of third-party contract packer facilities. These growing media products are generally shipped direct without passing through a distribution center.

 

We also manufacture horticultural products for our Global Professional business at a leased fertilizer manufacturing facility in Charleston, South Carolina and a Company-owned site in Heerlen, the Netherlands. The remaining products for our Global Professional businesses are produced at other Company-owned facilities and subcontractors in the United States and Europe.

 

The majority of shipments to customers are made via common carriers or through distributors in the United States and through a network of public warehouses and distributors in Europe. We are subject to market risk from fluctuating market prices of diesel fuel, which our common carriers pass on to the Company in the form of fuel surcharges. When appropriate, the Company will hedge a portion of these indirect fuel costs to improve predictability and control costs.

 

Employees

 

As of September 30, 2009, we employed 5,715 full-time employees in the United States and an additional 1,136 full-time employees located outside the United States. During peak sales and production periods, we utilize seasonal and temporary labor.

 

None of our U.S.-based employees are members of a union. Thirty-nine of our full-time U.K.-based employees are members of the Transport and General Workers Union and have full collective bargaining rights. An undisclosed number of our full-time employees at our office in Ecully, France are members of the Confederation Francaise

Democratique du Travail and Confederation Generale du Travail, participation in which is confidential under French law. In addition, a number of union and non-union full-time employees are members of works councils at three sites in Bourth, Hautmont and Ecully, France, and a number of non-union employees are members of works councils in Ingelheim, Germany. In the Waardenburg office and in the Heerlen Plant in the Netherlands, 10 employees are members of a workers union, but we are not responsible for collective bargaining negotiations with this union. In the Netherlands, we are governed by the Works Councils Act with respect to the union. Works councils represent employees on labor and employment matters and manage social benefits.

 

We believe we have good relationships with our employees in the United States, and with both unionized and non-unionized international employees.

 

Regulatory Considerations

 

Local, state, federal and foreign laws and regulations affect the sale of our products in several ways.

 

In the United States, all products containing pesticides must comply with the Federal Insecticide, Fungicide, and Rodenticide Act of 1947, as amended (“FIFRA”), and be registered with the U.S. Environmental Protection Agency (the “U.S. EPA”) (and similar state agencies) before they can be sold or distributed. The inability to obtain or maintain such compliance, or the cancellation of any such registration, could have an adverse effect on our business, the severity of which would depend on the products involved, whether another product could be substituted and whether our competitors were similarly affected. We attempt to anticipate regulatory developments and maintain registrations of, and access to, substitute active ingredients, but there can be no assurance that we will continue to be able to avoid or minimize these risks.

 

Fertilizer and growing media products are subject to state and foreign labeling regulations. Our manufacturing operations are subject to waste, water and air quality permitting and other regulatory requirements of federal and state agencies. The Company’s wild bird food business is subject to regulation by the U.S. Food and Drug Administration and various state regulations. Our grass seed products are regulated by the Federal Seed Act and various state regulations.

 

Pursuant to the Food Quality Protection Act, the U.S. EPA is evaluating the cumulative risks from dietary and non-dietary exposures to pesticides. The pesticides in our products are typically manufactured by independent third parties and as a result of the U.S. EPA’s continuing risk assessment, a decision by the U.S. EPA or the third-party registrant may restrict our access to the pesticides. We cannot predict the outcome or the severity of the effect of these continuing evaluations.

 

The use of certain pesticide and fertilizer products is regulated by various local, state, federal and foreign environmental and public health agencies. These regulations may include requirements that only certified or professional users apply the product or that certain products be used only on certain types of locations (such as “not for use on sod farms or golf courses”), may require users to post notices on properties to which products have been or will be applied, may require notification to individuals in the vicinity that products will be applied in the future or may ban the use of certain ingredients. We believe we are operating in substantial compliance with, or taking action aimed at ensuring compliance with, these laws and regulations.

 

State, federal and foreign authorities generally require growing media facilities to obtain permits (sometimes on an annual basis) in order to harvest peat and to discharge storm water run-off or water pumped from peat deposits. The permits typically specify the condition in which the property must be left after the peat is fully harvested, with the residual use typically being natural wetland habitats combined with open water areas. We are generally required by these permits to limit our harvesting and to restore the property consistent with the intended residual use. In some locations, these facilities have been required to create water retention ponds to control the sediment content of discharged water.

 

FIFRA Compliance, the Corresponding Governmental Investigations and Similar Matters

 

In April 2008, we became aware that a former associate apparently deliberately circumvented the Company’s policies and U.S. EPA regulations under FIFRA, by failing to obtain valid registrations for certain products and/or causing certain invalid product registration forms to be submitted to regulators. Since that time, we have been

cooperating with both the U.S. EPA and the U.S. Department of Justice (the “U.S. DOJ”) in related civil and criminal investigations into our pesticide product registration issues.

 

In late April of 2008, in connection with the U.S. EPA’s investigation, we conducted a consumer-level recall of certain consumer lawn and garden products and a Scotts LawnService^® product. Subsequently, the Company and the U.S. EPA agreed upon a Compliance Review Plan for conducting a comprehensive, independent review of the Company’s product registration records. Pursuant to the Compliance Review Plan, an independent third-party firm, Quality Associates Incorporated (“QAI”), reviewed substantially all of our U.S. pesticide product registrations and associated advertisements, some of which were historical in nature and no longer related to sales of our products. The U.S. EPA investigation and the QAI review process resulted in the temporary suspension of sales and shipments of certain products. In addition, as the QAI review process or our internal review identified potential FIFRA registration issues (some of which appear unrelated to the actions of the former associate), we endeavored to stop selling or distributing the affected products until the issues could be resolved. QAI’s review of our U.S. pesticide product registrations and associated advertisements is now substantially complete. The results of the QAI review process did not materially affect, and are not expected to materially affect, our fiscal 2009 and fiscal 2010 sales, respectively.

 

In late 2008, the Company and its indirect subsidiary, EG Systems, Inc., doing business as Scotts LawnService^®, were named as defendants in a purported class action filed in the U.S. District Court for the Eastern District of Michigan relating to Scotts LawnService’s application of certain pesticide products. In the suit, Mark Baumkel, on behalf of himself and the purported classes, sought an unspecified amount of damages, plus costs and attorneys’ fees, for alleged claims involving breach of contract, unjust enrichment, tort, and violation of the State of Michigan’s consumer protection act. On September 28, 2009, the court granted the Company’s and Scotts LawnService’s motion and dismissed the suit with prejudice. Since that time, the Company and Mr. Baumkel have agreed to a confidential settlement that, among other things, precludes an appeal of the decision. The impact of the confidential settlement did not, and will not, materially affect our financial condition, results of operations or cash flows.

 

In fiscal 2008, we conducted a voluntary recall of certain of our wild bird food products due to a formulation issue. Certain wild bird food products had been treated with pest control additives to avoid insect infestation, especially at retail stores. While the pest control additives had been labeled for use on certain stored grains that can be processed for human and/or animal consumption, they were not labeled for use on wild bird food products. In October, 2008, the U.S. Food & Drug Administration concluded that the recall had been completed and that there had been proper disposition of the recalled products. The results of the wild bird food recall did not materially affect our fiscal 2009 financial condition, results of operations or cash flows.

 

For more information with respect to additional risks and uncertainties the Company may face in connection with the ongoing investigations and for a discussion of the related costs and expenses related to the matters discussed above, see “ITEM 1A. RISK FACTORS — The Ongoing Governmental Investigation Regarding Our Compliance with FIFRA Could Adversely Affect Our Financial Condition, Results of Operations or Cash Flows” in this Annual Report on Form 10-K and “NOTE 2. PRODUCT REGISTRATION AND RECALL MATTERS” to the Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Other Regulatory Matters

 

In 1997, the Ohio Environmental Protection Agency (the “Ohio EPA”) initiated an enforcement action against us with respect to alleged surface water violations and inadequate wastewater treatment capabilities at our Marysville, Ohio facility and sought corrective action under the Federal Resource Conservation and Recovery Act. The action related to discharges from on-site waste water treatment and several discontinued on-site disposal areas that date back to the early operations of the Marysville facility, which we had already been assessing and, in some cases, remediating, on a voluntary basis. We are remediating the Marysville site under the terms of a judicial consent order under the oversight of the Ohio EPA.

 

We completed negotiations with the Philadelphia District of the U.S. Army Corps of Engineers (the “Corps”) regarding the terms of site remediation and the resolution of the Corps’ civil penalty demand in connection with our prior peat harvesting operations at our Lafayette, New Jersey facility. A final consent decree was entered

into on October 18, 2004 that required us to perform five years of wetland monitoring, and the completion of additional actions if after five years, the monitoring indicates the wetlands have not developed satisfactorily. As site monitoring activities were not initiated until 2006, the five-year monitoring period will extend until December 2010.

 

At September 30, 2009, $3.2 million was accrued for these non-FIFRA compliance-related environmental actions, the majority of which is for site remediation. Most of the costs accrued as of September 30, 2009 are expected to be paid in fiscal 2010; however, payments could be delayed. During fiscal 2009, fiscal 2008 and fiscal 2007, we expensed $0.8 million, $1.4 million, and $1.5 million for non-FIFRA compliance-related environmental matters. There were no material capital expenditures during the last three fiscal years related to environmental or regulatory matters.

 

General Information

 

The Company maintains a website at http://investor.scotts.com (this uniform resource locator, or URL, is an inactive textual reference only and is not intended to incorporate our website into this Annual Report on Form 10-K). We file reports with the Securities and Exchange Commission (the “SEC”) and make available, free of charge, on or through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as well as our proxy and information statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

 

Financial Information About Geographic Areas

 

For certain information concerning our international revenues and long-lived assets, see “NOTE 22. SEGMENT INFORMATION” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

 

Cautionary Statement on Forward-Looking Statements

 

We have made and will make “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, in this Annual Report on Form 10-K, in our 2009 Annual Report to Shareholders (our “2009 Annual Report”) and in other contexts relating to matters including future growth and profitability targets and strategies designed to increase total shareholder value. Forward-looking statements also include, but are not limited to, information regarding our future economic and financial condition and results of operations, the plans and objectives of our management and our assumptions regarding our performance and these plans and objectives.

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the forward-looking statements. We desire to take advantage of the “safe harbor” provisions of that Act.

 

Forward-looking statements that we make in our 2009 Annual Report, in this Annual Report on Form 10-K and in other contexts are subject to a variety of risks and assumptions and numerous factors beyond our control. Important factors that could cause actual results to differ materially from the forward-looking statements we make include those described below. All forward-looking statements attributable to us or persons working on our behalf are expressly qualified in their entirety by the following cautionary statements.

 

The Ongoing Governmental Investigation Regarding Our Compliance with FIFRA Could Adversely Affect Our Financial Condition, Results of Operations or Cash Flows.

 

Our products that contain pesticides must comply with FIFRA and be registered with the U.S. EPA (and similar state agencies) before they can be sold or distributed. In April 2008, we became aware that a former associate

apparently deliberately circumvented Company policies and U.S. EPA regulations under FIFRA by failing to obtain valid registrations for products and/or causing invalid product registration forms to be submitted to regulators. Since that time, internal and third-party reviews have identified additional potential pesticide product registration issues (some of which appear unrelated to the actions of the former associate) and we have been cooperating with both the U.S. EPA and the U.S. DOJ in related civil and criminal investigations into the pesticide product registration issues.

 

In connection with the registration investigations and FIFRA compliance review process, we have recorded, and in the future expect to record, charges and costs for estimated retailer inventory returns, consumer returns and replacement costs, costs to rework existing products, inventory write-downs and legal and professional fees and costs associated with administration of the registration investigation and compliance review process. Because these expected future charges are based on estimates, they may increase as a result of numerous factors, many of which are beyond our control, including the number and type of legal or regulatory proceedings relating to the registration investigation and FIFRA compliance review process and regulatory or judicial orders or decrees that may require us to take certain actions in connection with the registration investigations and FIFRA compliance review process or to pay civil or criminal fines and/or penalties at the state and/or federal level.

 

The U.S. EPA and U.S. DOJ investigations continue and may result in future state, federal or private rights of action including fines and/or penalties with respect to known or potential additional product registration issues. Until the U.S. EPA and U.S. DOJ investigations are complete, we cannot reasonably determine the scope or magnitude of possible liabilities that could result from known or potential product registration issues, and no reserves for these potential liabilities have been established as of September 30, 2009. However, it is possible that such liabilities, including fines, penalties, judgments and/or litigation costs could be material and have an adverse effect on our financial condition, results of operations or cash flows.

 

There can be no assurance that the ultimate outcome of the investigations will not result in further action against us, whether administrative, civil or criminal, by the U.S. EPA, the U.S. DOJ, state regulatory agencies or private litigants, and any such action, in addition to the costs we have incurred and would continue to incur in connection therewith, could materially and adversely affect our financial condition, results of operations or cash flows. In particular, the realization of a significant fine, penalty or judgment against us could materially affect our ability to remain in compliance with the leverage ratio or other covenants of our credit facilities, potentially causing us to have to seek an amendment or waiver from our lending group, which may increase our costs of borrowing.

 

Product recalls, our inability to ship, sell or transport affected products and the on-going governmental investigation may harm our reputation and acceptance of our products by our retail customers and consumers, which may materially and adversely affect our business operations, decrease sales and increase costs.

 

Compliance With Environmental and Other Public Health Regulations Could Increase Our Costs of Doing Business or Limit Our Ability to Market All of Our Products.

 

Local, state, federal and foreign laws and regulations relating to environmental matters affect us in several ways. In the United States, all products containing pesticides must comply with FIFRA and be registered with the U.S. EPA (and similar state agencies) before they can be sold or distributed. The inability to obtain or maintain such compliance, or the cancellation of any registration, could have an adverse effect on our business, the severity of which would depend on the products involved, whether another product could be substituted and whether our competitors were similarly affected. We attempt to anticipate regulatory developments and maintain registrations of, and access to, substitute active ingredients, but there can be no assurance that we will be able to avoid or reduce these risks. In the European Union (the “EU”), the European Parliament has adopted various forms of regulation which may substantially restrict or eliminate our ability to market and sell certain of our consumer and professional pesticide products in their current form in the EU. In addition, in Canada, regulations have been adopted by several provinces that substantially restrict our ability to market and sell certain of our consumer pesticide products.

 

Under the Food Quality Protection Act, enacted by the U.S. Congress in 1996, food-use pesticides are evaluated to determine whether there is reasonable certainty that no harm will result from the cumulative effects of pesticide exposures. Under this Act, the U.S. EPA is evaluating the cumulative risks from dietary and non-dietary exposures to pesticides. The pesticides in our products, certain of which may be used on crops processed into various food products, are typically manufactured by independent third parties and continue to be evaluated by the

U.S. EPA as part of this exposure risk assessment. The U.S. EPA or the third-party registrant may decide that a pesticide we use in our products will be limited or made unavailable to us. For example, in December 2000, the U.S. EPA reached agreement with various parties, including manufacturers of the active ingredient diazinon, regarding a phased withdrawal from retailers by December 2004 of residential uses of products containing diazinon, which was also used in our lawn and garden products. We cannot predict the outcome or the severity of the effect of continuing evaluations.

 

In addition, the use of certain pesticide and fertilizer products is regulated by various local, state, federal and foreign environmental and public health agencies. These regulations may include requirements that only certified or professional users apply the product or that certain products be used only on certain types of locations, require users to post notices on properties to which products have been or will be applied, or require notification to individuals in the vicinity that products will be applied in the future or ban the use of certain ingredients. Even if we are able to comply with all such regulations and obtain all necessary registrations, we cannot provide assurance that our products, particularly pesticide products, will not cause injury to the environment or to people under all circumstances. The costs of compliance, remediation or products liability have adversely affected operating results in the past and could materially adversely affect future quarterly or annual operating results.

 

Perceptions that the products we produce and market are not safe could adversely affect us and contribute to the risk we will be subjected to legal action. We manufacture and market a number of complex chemical products, such as fertilizers, certain growing media, herbicides and pesticides. On occasion, allegations are made that some of our products have failed to perform up to expectations or have caused damage or injury to individuals or property. Based on reports of contamination at a third-party supplier’s vermiculite mine, the public may perceive that some of our products manufactured in the past using vermiculite are or may be contaminated. Public perception that our products are not safe, whether justified or not, could impair our reputation, involve us in litigation, damage our brand names and have a material adverse affect on our business.

 

The harvesting of peat for our growing media business has come under increasing regulatory and environmental scrutiny. In the United States, state regulations frequently require us to limit our harvesting and to restore the property to an agreed-upon condition. In some locations, we have been required to create water retention ponds to control the sediment content of discharged water. In the United Kingdom, our peat extraction efforts are also the subject of regulation.

 

In addition to the regulations already described, local, state, federal and foreign agencies regulate the disposal, handling and storage of waste, air and water discharges from our facilities.

 

The adequacy of our current non-FIFRA compliance related environmental reserves and future provisions is based on our operating in substantial compliance with applicable environmental and public health laws and regulations, as well as the assumptions that we have both identified all of the significant sites that must be remediated and that there are no significant conditions of potential contamination that are unknown to us.

 

If there is a significant change in the facts and circumstances surrounding these assumptions or if we are found not to be in substantial compliance with applicable environmental and public health laws and regulations, there could be a material adverse impact on future environmental capital expenditures and other environmental expenses and our financial condition, results of operations or cash flows.

 

Increases in the Prices of Certain Raw Materials Could Adversely Affect Our Results of Operations.

 

Our ability to manage our cost structure can be adversely affected by movements in commodity and other raw material prices. Market conditions may limit our ability to raise selling prices to offset increases in our raw material costs. The uniqueness of our technologies can limit our ability to locate or utilize alternative inputs for certain products. For certain inputs, new sources of supply may have to be qualified under regulatory standards, which can require additional investment and delay bringing a product to market.

The Highly Competitive Nature of Our Markets Could Adversely Affect Our Ability to Grow or Maintain Revenues.

 

Each of our segments participates in markets that are highly competitive. Many of our competitors sell their products at prices lower than ours. Our most price sensitive customers may be more likely to trade down to lower price point products in a more challenging economic environment. We compete primarily on the basis of product innovation, product quality, product performance, value, brand strength, supply chain competency, field sales support, the strength of our relationships with major retailers and advertising. Some of our competitors have significant financial resources. The strong competition that we face in all of our markets may prevent us from achieving our revenue goals, which may have a material adverse affect on our financial condition, results of operations or cash flows. Our inability to continue to innovate, including by commercializing differentiated products to meet evolving consumer needs, could have a material adverse affect.

 

Because of the Concentration of Our Sales to a Small Number of Retail Customers, the Loss of One or More of, or Significant Reduction in Orders From, Our Top Customers Could Adversely Affect Our Financial Results.

 

Global Consumer net sales represented approximately 78% of our worldwide net sales in fiscal 2009. Our top three North American retail customers together accounted for 70% of our Global Consumer segment fiscal 2009 net sales and 42% of our outstanding accounts receivable as of September 30, 2009. Home Depot, Lowe’s and Walmart represented approximately 33%, 19% and 18%, respectively, of our fiscal 2009 Global Consumer net sales. The loss of, or reduction in orders from, Home Depot, Lowe’s, Walmart or any other significant customer could have a material adverse effect on our business, financial condition, results of operations or cash flows, as could customer disputes regarding shipments, fees, merchandise condition or related matters. Our inability to collect accounts receivable from any of these customers could also have a material adverse affect on our financial condition, results of operations or cash flows.

 

We do not have long-term sales agreements with, or other contractual assurances as to future sales to, any of our major retail customers. In addition, continued consolidation in the retail industry has resulted in an increasingly concentrated retail base. To the extent such concentration continues to occur, our net sales and income from operations may be increasingly sensitive to deterioration in the financial condition of, or other adverse developments involving our relationship with, one or more of our customers.

 

Adverse Weather Conditions Could Adversely Impact Financial Results.

 

Weather conditions in North America and Europe can have a significant impact on the timing of sales in the spring selling season and overall annual sales. An abnormally wet and/or cold spring throughout North America or Europe could adversely affect both fertilizer and pesticide sales and, therefore, our financial results.

 

Our Historical Seasonality Could Impair Our Ability to Pay Obligations As They Come Due, Including Our Operating Expenses.

 

Because our products are used primarily in the spring and summer, our business is highly seasonal. For the past three fiscal years, 70% to 75% of our annual net sales have occurred in the second and third fiscal quarters combined. Our working capital needs and borrowings typically peak during the initial weeks of our third fiscal quarter because we are incurring expenditures in preparation for the spring selling season, while the majority of our revenue collections occur later in our third fiscal quarter. If cash on hand is insufficient to pay our obligations as they come due, including interest payments or operating expenses, at a time when we are unable to draw on our credit facilities, this seasonality could have a material adverse effect on our ability to conduct our business. Adverse weather conditions could heighten this risk.

 

The Amount of Our Debt Could Adversely Affect Our Ability to Obtain Financing in the Future, React to Changes in Our Business and Satisfy Our Obligations, Adversely Impacting Our Financial Condition.

 

We have a significant amount of debt. Our inability to meet restrictive financial and non-financial covenants associated with that debt, or to generate sufficient cash flow to repay maturing debt, could adversely affect our financial condition. Our debt level could:

 

 

Our ability to make payments and to refinance our indebtedness, fund planned capital expenditures and acquisitions and pay dividends will depend on our ability to generate cash in the future. This, to some extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

 

We cannot provide assurance that our business will generate sufficient cash flow from operating activities or that future borrowings will be available to us under our credit facilities in amounts sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We will need to refinance all or a portion of our indebtedness, on or before maturity. We cannot be sure that we will be able to refinance our indebtedness on commercially reasonable terms.

 

Our credit facilities contain restrictive covenants and cross default provisions and require us to maintain specified financial ratios. Our ability to comply with those covenants and satisfy those financial ratios can be affected by events beyond our control. A breach of any of these financial ratio covenants or other covenants could result in a default. Upon the occurrence of an event of default, the lenders could elect to declare the applicable outstanding indebtedness due immediately and payable and terminate all commitments to extend further credit. We cannot be sure that our lenders would waive a default or that we could pay the indebtedness in full if it were accelerated.

 

Our Significant International Operations Make Us Susceptible to Fluctuations in Currency Exchange Rates and to the Costs of International Regulation.

 

We currently operate manufacturing, sales and service facilities outside of the United States, particularly in Canada, France, the United Kingdom, Germany and the Netherlands. In fiscal 2009, international net sales, including Canada, accounted for approximately 19% of our total net sales. Accordingly, we are subject to risks associated with operating in foreign countries, including:

 

 

In addition, our operations outside the United States are subject to the risk of new and different legal and regulatory requirements in local jurisdictions, potential difficulties in staffing and managing local operations and

potentially adverse tax consequences. The costs related to our international and Canadian operations could adversely affect our results of operations, financial condition or cash flows in the future.

 

We May Not Be Able to Adequately Protect Our Intellectual Property and Other Proprietary Rights That Are Material to Our Business.

 

Our ability to compete effectively depends in part on our rights to service marks, trademarks, trade names and other intellectual property rights we own or license, particularly our registered brand names and issued patents. We have not sought to register every one of our marks either in the United States or in every country in which they are used. Furthermore, because of the differences in foreign trademark, patent and other intellectual property or proprietary rights laws, we may not receive the same protection in other countries as we would in the United States with respect to the registered brand names and issued patents we hold. If we are unable to protect our intellectual property, proprietary information and/or brand names, we could suffer a material adverse effect on our business, financial condition or results of operations.

 

Litigation may be necessary to enforce our intellectual property rights and protect our proprietary information, or to defend against claims by third parties that our products or services infringe their intellectual property rights. Any litigation or claims brought by or against us could result in substantial costs and diversion of our resources. A successful claim of trademark, patent or other intellectual property infringement against us, or any other successful challenge to the use of our intellectual property, could subject us to damages or prevent us from providing certain products or services under our recognized brand names, which could have a material adverse effect on our business, financial condition or results of operations.

 

If Monsanto Were to Terminate the Marketing Agreement for Consumer Roundup^® Products Without Being Required to Pay Any Termination Fee, We Would Lose a Substantial Source of Future Earnings and Overhead Expense Absorption.

 

If we were to commit a serious default under the Marketing Agreement with Monsanto for consumer Roundup^® products, Monsanto may have the right to terminate the Marketing Agreement. If Monsanto were to terminate the Marketing Agreement for cause, we would not be entitled to any termination fee, and we would lose all, or a substantial portion, of the significant source of earnings and overhead expense absorption the Marketing Agreement provides. Monsanto may also be able to terminate the Marketing Agreement within a given region, including North America, without paying us a termination fee if unit volume sales to consumers in that region decline: (1) over a cumulative three-fiscal-year period; or (2) by more than 5% for each of two consecutive years.

 

Hagedorn Partnership, L.P. Beneficially Owns Approximately 31% of Our Outstanding Common Shares on a Fully Diluted Basis.

 

Hagedorn Partnership, L.P. beneficially owned approximately 31% of our outstanding common shares as of November 20, 2009, and has sufficient voting power to significantly influence the election of directors and the approval of other actions requiring the approval of our shareholders.

 

 

None.

 

 

The Company owns or leases, as appropriate, numerous facilities throughout the world to support each of its respective business segments:

 

 

Further, we own a manufacturing facility in Sutton Bridge, United Kingdom; a blending and bagging facility for growing media in Hautmont, France; and a plant in Bourth, France that we use for formulating, blending and packaging plant protection products mainly for the consumer market. The headquarters for our U.K. business is in Godalming (Surrey), United Kingdom. The headquarters for our international business (which also serves as our local French operations office) is in Ecully (Lyon), France. We also have a business office in Ingelheim, Germany; a business office in Salzburg, Austria; and a sales office in Saint Niklaas, Belgium.

 

 

The Company also leases warehouse space throughout North America and continental Europe as needed.

 

We believe that our facilities are adequate to serve their intended purposes and that our property leasing arrangements are satisfactory.

 

 

As noted in the discussion in “ITEM 1. BUSINESS — Regulatory Considerations,” “ITEM 1. BUSINESS — FIFRA Compliance, the Corresponding Governmental Investigation and Similar Matters” and “ITEM 1. BUSINESS —

Other Regulatory Matters,” we are involved in several pending environmental and regulatory matters. We believe that our assessment of contingencies is reasonable and that related reserves, in the aggregate, are adequate; however, there can be no assurance that the final resolution of these matters will not have a material adverse affect on our financial condition, results of operations or cash flows.

 

FIFRA Compliance, the Corresponding Governmental Investigations and Similar Matters

 

Information with respect to the ongoing investigations and a discussion of the related costs and expenses related to such matters is hereby incorporated by reference to “NOTE 2. PRODUCT REGISTRATION AND RECALL MATTERS” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

U.S. Horticultural Supply, Inc. (F/K/A E.C. Geiger, Inc.)

 

On November 5, 2004, U.S. Horticultural Supply, Inc. (“Geiger”) filed suit against the Company in the U.S. District Court for the Eastern District of Pennsylvania. The complaint alleged that the Company conspired with another distributor, Griffin Greenhouse Supplies, Inc., to restrain trade in the horticultural products market, in violation of Section 1 of the Sherman Antitrust Act. Geiger’s damages expert quantified Geiger’s alleged damages at approximately $3.3 million, which could have been trebled under antitrust laws. Geiger also sought recovery of attorneys’ fees and costs. On January 13, 2009, the U.S. District Court granted the Company’s motion for summary judgment and entered judgment for the Company. Geiger has appealed the ruling to the U.S. Court of Appeals for the Third Circuit.

 

The Company continues to pursue the collection of funds owed to the Company by Geiger as confirmed by the Company’s April 25, 2005 judgment against Geiger.

 

Other Pending Significant Legal Proceedings

 

The Company has been named as a defendant in a number of cases alleging injuries that the lawsuits claim resulted from exposure to asbestos-containing products, apparently based on the Company’s historic use of vermiculite in certain of its products. In many of these cases, the complaints are not specific about the plaintiffs’ contacts with the Company or its products. None of the claims seek damages from the Company alone. The Company believes that the claims against it are without merit and is vigorously defending against them. It is not currently possible to reasonably estimate a probable loss, if any, associated with the cases and, accordingly, no accrual or reserves have been recorded in the Company’s consolidated financial statements. There can be no assurance that these cases, whether as a result of adverse outcomes or as a result of significant defense costs, will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

 

The Company is reviewing agreements and policies that may provide insurance coverage or indemnity as to these claims and is pursuing coverage under some of these agreements and policies, although there can be no assurance of the results of these efforts.

 

On April 27, 2007, the Company received a proposed Order On Consent from the New York State Department of Environmental Conservation (the “Proposed Order”) alleging that, during calendar year 2003, the Company and James Hagedorn, individually and as Chairman of the Board and Chief Executive Officer of the Company, unlawfully donated to a Port Washington, New York youth sports organization 40 bags of Scotts^® LawnPro^® Annual Program Step 3 Insect Control Plus Fertilizer which, while federally registered, was allegedly not registered in the state of New York. The Proposed Order requests penalties totaling $695,000. The Company has responded in writing to the New York State Department of Environmental Conservation and is awaiting a response.

 

We are involved in other lawsuits and claims which arise in the normal course of our business. In our opinion, these claims individually and in the aggregate are not expected to result in a material adverse effect on our financial condition, results of operations or cash flows.

 

 

There were no matters submitted to a vote of the security holders of Scotts Miracle-Gro during the fourth quarter of fiscal 2009.

 

SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT

 

The executive officers of Scotts Miracle-Gro, their positions and, as of November 20, 2009, their ages and years with Scotts Miracle-Gro (and its predecessors) are set forth below.

 

 

Executive officers serve at the discretion of the Board of Directors of Scotts Miracle-Gro and pursuant to employment agreements or other arrangements.

 

The business experience of each of the individuals listed above during at least the past five years is as follows:

 

Mr. Hagedorn was named Chairman of the Board of Scotts Miracle-Gro’s predecessor in January 2003 and named Chief Executive Officer of Scotts Miracle-Gro’s predecessor in May 2001. He served as President of Scotts Miracle-Gro (or its predecessor) from November 2006 until October 2008 and from May 2001 until December 2005. Mr. Hagedorn serves on Scotts Miracle-Gro’s Board of Directors, a position he has held with Scotts Miracle-Gro (or its predecessor) since 1995. He also serves as a director for Farms For City Kids Foundation, Inc., Nurse Family Partnership, The CDC Foundation, Embry-Riddle Aeronautical University, North Shore University Hospital (New York), Scotts Miracle-Gro Foundation and the Intrepid Sea-Air-Space Museum, all charitable organizations. Mr. Hagedorn is the brother of Katherine Hagedorn Littlefield, a director of Scotts Miracle-Gro.

 

Mr. Baker was named President and Chief Operating Officer of Scotts Miracle-Gro in October 2008, and continues to serve on Scotts Miracle-Gro’s Board of Directors, a role he has held with Scotts Miracle-Gro (or its predecessor) since 2004. From September 2002 until October 2008, Mr. Baker served as Chief Executive Officer of Gander Mountain Company, an outdoor retailer specializing in hunting, fishing and camping gear. He served as President of Gander Mountain Company from February 2004 until October 2008 and as a director of Gander Mountain Company from April 2004 until October 2008.

 

Dr. Kelty was named Executive Vice President of Scotts Miracle-Gro in October 2008. He served as Vice Chairman and Executive Vice President of Scotts Miracle-Gro (or its predecessor) from May 2001 until his retirement in November 2005. After his retirement, Dr. Kelty served as an hourly consultant to Scotts Miracle-Gro at various times, most recently beginning in October 2007.

Mr. Evans was named Executive Vice President and Chief Financial Officer of Scotts Miracle-Gro on September 14, 2006. From October 2005 to September 2006, he served as Senior Vice President, Finance and Global Shared Services of The Scotts Company LLC (“Scotts LLC”). From March 2005 to September 2005, he served as Senior Vice President, North America of Scotts LLC, and from October 2003 to March 2005, he served in the same capacity for Scotts LLC’s predecessor. From June 2001 to September 2003, he served as Vice President, Finance, North America Sales of Scotts LLC’s predecessor.

 

Ms. Stump was named Executive Vice President, Global Human Resources of Scotts Miracle-Gro’s predecessor in February 2003. She had previously served as Senior Vice President, Global Human Resources of Scotts Miracle-Gro’s predecessor since October 2002. From July 2001 until October 2002, Ms. Stump served as Vice President, Human Resources North America of Scotts Miracle-Gro’s predecessor. From September 2000 until July 2001, Ms. Stump served as Vice President, Human Resources Technology and Operations of Scotts Miracle-Gro’s predecessor.

 

Mr. Sanders was named Executive Vice President, North America of Scotts Miracle-Gro in September 2007. Previously, from January 2007 until September 2007, he served as Executive Vice President of Global Technologies and Operations of Scotts Miracle-Gro and was responsible for the Company’s supply chain and information systems, as well as research and development efforts. Before January 2007, he led the North American and global supply chain organizations as well as the North American sales force. In 2005, he ran the Smith & Hawken^® business on an interim basis. Prior to joining Scotts Miracle-Gro’s predecessor in 2001, he was a partner with CapGemini/Ernst & Young.

 

Mr. Lopez was named Executive Vice President, International of Scotts Miracle-Gro in October 2007. In this role, Mr. Lopez has leadership responsibility for all of the Scotts Miracle-Gro consumer businesses outside of the United States. He also heads the Scotts Miracle-Gro Global Professional and Pro Seed businesses. Recently, Mr. Lopez was also appointed to lead the Scotts Miracle-Gro global sustainability and naturals initiatives. From December 2004 until September 2007, he served as Senior Vice President, International or Scotts Miracle-Gro (or its predecessor). Mr. Lopez joined Scotts Miracle-Gro’s predecessor in 2001 as general manager of the Company’s French business.

 

Mr. Brockman was named Executive Vice President, General Counsel and Corporate Secretary of Scotts Miracle-Gro in January 2008 and named Chief Ethics & Compliance Officer in July 2009. From February 2007 until January 2008, he served as Senior Vice President, Chief Ethics & Compliance Officer and Chief Administrative Officer of Scotts LLC. He served as Chief Administrative Officer of Scotts LLC from 2006 until February 2007. From 2004 until February 2007, he served as Chief Ethics and Compliance Officer of Scotts LLC (or its predecessor). Mr. Brockman served as Vice President and Assistant General Counsel of Scotts LLC’s predecessor from 2002 until 2004.

 

PART II

 

 

The common shares of The Scotts Miracle-Gro Company (“Scotts Miracle-Gro” and, together with its subsidiaries, the “Company”) trade on the New York Stock Exchange under the symbol “SMG.” The quarterly high and low sale prices for the fiscal years ended September 30, 2009 and 2008 were as follows:

 

 

On June 22, 2005, the Company announced that its Board of Directors had approved the establishment of a quarterly cash dividend. The $0.50 per share (adjusted for the 2-for-1 stock split distributed November 9, 2005) annual dividend has been paid in quarterly increments since the fourth quarter of fiscal 2005. The payment of future dividends, if any, on the common shares will be determined by the Board of Directors of Scotts Miracle-Gro in light of conditions then existing, including the Company’s earnings, financial condition and capital requirements, restrictions in financing agreements, business conditions and other factors. Future dividend payments are currently restricted to an aggregate of $55 million annually under our existing credit facilities. See “NOTE 11. DEBT” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for further discussion regarding the restrictions on dividend payments.

 

As of November 20, 2009, there were approximately 31,000 shareholders, including holders of record and our estimate of beneficial holders.

 

The following table shows the purchases of common shares of Scotts Miracle-Gro (“Common Shares”) made by or on behalf of Scotts Miracle-Gro or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended) of Scotts Miracle-Gro for each of the three fiscal months in the quarter ended September 30, 2009:

 

 

 

 

 

Five-Year Summary(1)
For the fiscal year ended September 30,

 

 

 

 

 

 

 

 

A numeric reconciliation of net income (loss) to Adjusted EBITDA is as follows (in millions):

 

 

 

The purpose of this discussion is to provide an understanding of the financial condition and results of operations of The Scotts Miracle-Gro Company (“Scotts Miracle-Gro”) and its subsidiaries (collectively, together with Scotts Miracle-Gro, the “Company”, “we” or “us”) by focusing on changes in certain key measures from year-to-year. Management’s Discussion and Analysis (“MD&A”) is divided into the following sections:

 

 

Executive Summary

 

We are dedicated to delivering strong, consistent financial results and outstanding shareholder returns by providing products of superior quality and value in order to enhance consumers’ outdoor living environments. We are a leading manufacturer and marketer of consumer branded non-durable products for lawn and garden care and professional horticulture in North America and Europe. We are Monsanto’s exclusive agent for the marketing and distribution of consumer Roundup^® non-selective herbicide products within the United States and other contractually specified countries. We have a presence in similar consumer branded and professional horticulture products in Australia, the Far East, Latin America and South America. In the United States, we operate Scotts LawnService^®, the second largest residential lawn care service business. Our operations are divided into the following reportable segments: Global Consumer, Global Professional, Scotts LawnService^® and Corporate & Other. The Corporate & Other segment consists of the Smith & Hawken^® business and corporate general and administrative expenses. On July 8, 2009, we announced that we were commencing a process to close the Smith & Hawken^® stores. As of November 17, 2009, all Smith & Hawken^® stores had been closed with operational activity expected to be substantially complete by December 31, 2009.

 

As a leading consumer branded lawn and garden company, our marketing efforts are largely focused on providing innovative and differentiated products and on continually increasing brand and product awareness to inspire consumers and create retail demand. We have successfully applied this model for a number of years, consistently increasing our investment in research and development and investing approximately 5% of our annual net sales in advertising to support and promote our products and brands. We continually explore new and innovative ways to communicate with consumers. We believe that we receive a significant return on these expenditures and anticipate a similar level of research and development, advertising and marketing investments in the future, with the continuing objective of driving category growth and increasing market share.

 

Our sales are susceptible to global weather conditions. For instance, periods of wet weather can adversely impact sales of certain products, while increasing demand for other products. We believe that our diversified product line provides some mitigation to this risk. We also believe that our broad geographic diversification further reduces this risk.

 

 

Due to the nature of our lawn and garden business, significant portions of our products ship to our retail customers during the second and third fiscal quarters. Our annual sales are further concentrated in the second and

third fiscal quarters by retailers who increasingly rely on our ability to deliver products “in season” when consumers buy our products, thereby reducing retailers’ inventories.

 

Management focuses on a variety of key indicators and operating metrics to monitor the financial condition and performance of our business. These metrics include consumer purchases (point-of-sale data), market share, net sales (including unit volume, pricing, product mix and foreign exchange movements), organic sales growth (net sales growth excluding the impact of foreign exchange movements, product recalls, and acquisitions), gross profit margins, income from operations, net income and earnings per share. To the extent applicable, these measures are evaluated with and without impairment, restructuring and other charges, which management believes are not indicative of the ongoing earnings capabilities of our businesses. We also focus on measures to optimize cash flow and return on invested capital, including the management of working capital and capital expenditures.

 

Given our historical performance and consistent cash flows, we undertook a number of actions beginning in fiscal 2005 to return cash to our shareholders. We began paying a quarterly cash dividend of 12.5 cents per share in the fourth quarter of fiscal 2005. In fiscal 2006, we launched a five-year, $500 million share repurchase program pursuant to which we repurchased 2.0 million common shares for an aggregate purchase price of $87.9 million during fiscal 2006. In December 2006, we announced a recapitalization plan to return $750 million to our shareholders. This plan expanded and accelerated the previously announced five-year, $500 million share repurchase program (which was canceled). Pursuant to the recapitalization plan, in February 2007, we repurchased 4.5 million of our common shares for an aggregate purchase price of $245.5 million ($54.50 per share) and paid a special one-time cash dividend of $8.00 per share ($508 million in the aggregate) in early March 2007.

 

In order to fund this recapitalization, we entered into credit facilities totaling $2.15 billion and terminated our prior credit facility. Please refer to “NOTE 11. DEBT” to the Consolidated Financial Statements included in this Annual Report on Form 10-K for further information as to the credit facilities and the repayment and termination of our prior credit facility and our 65/8% senior subordinated notes.

 

Product Registration and Recall Matters

 

In April 2008, we became aware that a former associate apparently deliberately circumvented our policies and U.S. Environmental Protection Agency (“U.S. EPA”) regulations under the Federal Insecticide, Fungicide, and Rodenticide Act of 1947, as amended (“FIFRA”), by failing to obtain valid registrations for certain products and/or causing certain invalid product registration forms to be submitted to regulators. Since that time, we have been cooperating with both the U.S. EPA and the U.S. Department of Justice (the “U.S. DOJ”) in related civil and criminal investigations into our pesticide product registration issues.

 

In late April of 2008, in connection with the U.S. EPA’s investigation, we conducted a consumer-level recall of certain consumer lawn and garden products and a Scotts LawnService^® product. Subsequently, the Company and the U.S. EPA agreed upon a Compliance Review Plan for conducting a comprehensive, independent review of our product registration records. Pursuant to the Compliance Review Plan, an independent third-party firm, Quality Associates Incorporated (“QAI”), reviewed substantially all of our U.S. pesticide product registrations and associated advertising, some of which were historical in nature and no longer related to sales of our products. The U.S. EPA investigation and the QAI review process resulted in the temporary suspension of sales and shipments of certain products. In addition, as the QAI review process or our internal review identified potential FIFRA registration issues (some of which appear unrelated to the actions of the former associate), we endeavored to stop selling or distributing the affected products until the issues could be resolved. QAI’s review of our U.S. pesticide product registrations and associated advertisements is now substantially complete. The results of the QAI review process did not materially affect, and are not expected to materially affect, our fiscal 2009 and fiscal 2010 sales, respectively.

 

In late 2008, the Company, and its indirect subsidiary, EG Systems, Inc., doing business as Scotts LawnService^® were named as defendants in a purported class action filed in the U.S. District Court for the Eastern District of Michigan relating to Scotts LawnService^® application of certain pesticide products. In the suit, Mark Baumkel, on behalf of himself and the purported classes, sought an unspecified amount of damages, plus costs and attorneys’ fees, for alleged claims involving breach of contract, unjust enrichment and violation of the state of Michigan’s consumer protection act. On September 28, 2009, the court granted the Company’s and Scotts

LawnService’s motion and dismissed the suit with prejudice. Since that time, the Company and Mr. Baumkel have agreed to a confidential settlement that, among other things, precludes an appeal of the decision. The impact of the confidential settlement did not, and will not, materially affect our financial condition, results of operations or cash flows.

 

In fiscal 2008, we conducted a voluntary recall of certain of our wild bird food products due to a formulation issue. Certain wild bird food products had been treated with pest control additives to avoid insect infestation, especially at retail stores. While the pest control additives had been labeled for use on certain stored grains that can be processed for human and/or animal consumption, they were not labeled for use on wild bird food products. In October, 2008, the U.S. Food & Drug Administration concluded that the recall had been completed and that there had been proper disposition of the recalled products. The results of the wild bird food recall did not materially affect our fiscal 2009 financial condition, results of operations or cash flows.

 

As a result of these registration and recall matters, we have reversed sales associated with estimated returns of affected products, recorded charges for affected inventory and recorded other registration and recall-related costs. The effects of these adjustments were pre-tax charges of $28.6 million and $51.1 million for the years ended September 30, 2009 and 2008, respectively. We expect to incur an additional $10-$15 million in fiscal 2010 on recall and registration matters, excluding possible fines, penalties, judgments and/or litigation costs. We expect that these charges will include costs associated with the rework of certain finished goods inventories, the potential disposal of certain products and ongoing third-party professional services related to the U.S. EPA and U.S. DOJ investigations.

 

The U.S. EPA and U.S. DOJ investigations continue and may result in future state, federal or private rights of action including fines and/or penalties with respect to known or potential additional product registration issues. Until the U.S. EPA and U.S. DOJ investigations are complete, we cannot reasonably determine the scope or magnitude of possible liabilities that could result from known or potential product registration issues, and no reserves for these potential liabilities have been established as of September 30, 2009. However, it is possible that such liabilities, including fines, penalties, judgments and/or litigation costs could be material and have an adverse effect on our financial condition, results of operations or cash flows.

 

We are committed to providing our customers and consumers with products of superior quality and value to enhance their lawns, gardens and overall outdoor living environments. We believe consumers have come to trust our brands based on the superior quality and value they deliver, and that trust is highly valued. We also are committed to conducting business with the highest degree of ethical standards and in adherence to the law. While we are disappointed in these events, we believe we have made significant progress in addressing the issues and restoring customer and consumer confidence in our products.

Results of Operations

 

The following table sets forth the components of income and expense as a percentage of net sales for the three years ended September 30, 2009:

 

 

Net Sales

 

Consolidated net sales for fiscal 2009 increased 5.4% to $3.14 billion from $2.98 billion in fiscal 2008. Net sales for fiscal 2008 increased 3.8% to $2.98 billion from $2.87 billion in fiscal 2007. Organic net sales growth, which excludes the impact of changes in foreign exchange rates, product recalls and acquisitions, was 8.9% and 2.3% for fiscal 2009 and fiscal 2008, respectively, as noted in the following table:

 

 

Organic net sales in the Global Consumer segment increased 12.5% in fiscal 2009, driven by 14.8% growth in North America. We believe the North America growth was attributable to a variety of factors, including increased marketing efforts, support received from our retail partners, product innovation, new private label business and improvements to our sales force. Global Professional organic net sales declined 7.6% primarily driven by the decrease in net sales for the North America Professional business, which was negatively impacted by the significant drop in demand due to the downturn in commercial and residential construction and customer inventory build-ups in fiscal 2008 in anticipation of price increases. Organic net sales for Scotts LawnService^® declined by 6.6% due to the anticipated decrease in customer count driven by macroeconomic factors. Corporate & Other organic net sales growth, which pertains primarily to Smith & Hawken^®, increased 1.4% in fiscal 2009.

 

Global Consumer organic net sales increased approximately 1.6% for fiscal 2008 as a result of a number of factors, including the overall economic climate in the United States, as well as unfavorable early spring weather conditions. Organic net sales in our Global Professional segment grew 17.2%, driven by strong demand for the proprietary technology used in that segment and pricing actions that prompted customer inventory build-ups in

fiscal 2008 in anticipation of price increases. Despite a reduction in customer count, Scotts LawnService^® experienced organic net sales growth of 4.0% primarily due to higher selling prices. Corporate & Other organic net sales decreased 13.9%, primarily driven by declines across all channels of the Smith & Hawken^® business.

 

Gross Profit

 

As a percentage of net sales, gross profit was 34.7% of net sales for fiscal 2009 compared to 31.5% for fiscal 2008. The increase in gross profit rates was primarily driven by increased selling prices net of increased commodity costs, and cost productivity improvements. Product registration and recall matters unfavorably impacted gross profit rates by 30 and 110 basis points for fiscal 2009 and 2008, respectively. Impairment, restructuring and other charges unfavorably impacted gross profit rates by 20 and 50 basis points for fiscal 2009 and 2008, respectively.

 

As a percentage of net sales, gross profit was 31.5% of net sales for fiscal 2008 compared to 35.0% for fiscal 2007. The decrease in gross profit rates was primarily driven by increased commodity costs, which unfavorably impacted all operating segments, and the product registration and recall matters and impairment, restructuring and other charges noted above.

 

Selling, General and Administrative Expenses

 

The following table shows the major components of SG&A for the three years ended September 30, 2009:

 

 

Advertising expenses in fiscal 2009 were $141.2 million compared to $142.4 million in fiscal 2008. Excluding the impact of foreign exchange movements, advertising expense increased in fiscal 2009 by $2.4 million, or 1.7%, driven by increased spending in the North America Consumer business, substantially offset by reductions in Scotts LawnService^® and International Consumer. Advertising expenses in fiscal 2008 were $142.4 million, a decrease of $8.5 million, or 5.6%, from fiscal 2007. The decline in fiscal 2008 was 6.7% excluding foreign exchange movements. During fiscal 2009 and fiscal 2008, we shifted some spending from media to consumer promotions and other trade expense, the costs of which are netted against sales rather than classified as SG&A.

 

In fiscal 2009, other SG&A spending increased $84.7 million, or 15.5%, from fiscal 2008. Excluding the impact of foreign exchange movements, other SG&A spending increased 19.1% in fiscal 2009 primarily driven by increased variable compensation. Other increases in SG&A spending, designed to drive long-term growth, included research and development, sales force, regulatory and technology. In addition, non-revenue enhancing areas, including pension and health care costs, increased in fiscal 2009. In fiscal 2008, other SG&A spending increased $27.9 million or 5.4% from fiscal 2007. Excluding the impact of foreign exchange movements, other SG&A spending increased 3.2% in fiscal 2008 due to increased investments focused principally within the sales force, research and development and marketing areas of the North America portion of the Global Consumer segment.

 

The majority of our stock-based awards vest over three years, with the associated expense recognized ratably over the vesting period. In certain cases, such as individuals who are eligible for early retirement based on their age and years of service, the vesting period is shorter than three years. The increase in stock-based compensation expense in fiscal 2009 was primarily due to the acceleration of expense for 2009 awards granted to key employees who are approaching eligibility for early retirement, as well as an increase in the total value of equity awards granted in fiscal 2009. The decrease in stock-based compensation expense in fiscal 2008 as compared to fiscal 2007 was primarily attributable to a change in the Board of Directors equity compensation plan effective in February 2008, which resulted in the majority of associated expense being recognized ratably over the Board of Directors’ service

period, compared to previous years’ grants where the associated expense was recorded entirely in the year of the grant.

 

Amortization expense was $11.7 million in fiscal 2009, compared to $15.6 million and $15.3 million in fiscal 2008 and 2007, respectively. The decline in fiscal 2009 was driven by the reduction of amortizing intangible assets due to the impairment charges recorded in fiscal 2008, assets that became fully amortized in fiscal 2009, and foreign exchange movements.

 

Impairment, Restructuring and Other Charges

 

The breakdown of Impairment, Restructuring and Other Charges for the three years ended September 30, 2009 is as follows:

 

 

Our annual goodwill and indefinite life intangible impairment testing is performed as of the first day of our fiscal fourth quarter. We engaged an independent valuation firm to assist in our impairment assessment reviews. The impairment analysis for the fourth quarter of fiscal 2009 indicated that no charge for impairment was required. We recorded $16.8 million of SG&A-related product registration and recall costs during fiscal 2009 which primarily related to a third-party compliance review, as well as legal and consulting fees. In addition, we recorded $8.1 million of SG&A costs related to the Smith & Hawken^® closure process, primarily comprised of third-party agency fees and severance.

 

As a result of a significant decline in the market value of the Company’s common shares during the latter half of the third fiscal quarter ended June 28, 2008, the Company’s market value of invested capital was approximately 60% of the comparable impairment metric used in our fourth quarter fiscal 2007 annual impairment testing. Management determined this was an indicator of possible goodwill impairment and, therefore, interim impairment testing was performed as of June 28, 2008.

 

Our third quarter fiscal 2008 interim impairment review resulted in a non-cash charge of $123.3 million to reflect the decline in the fair value of certain goodwill and other assets evidenced by the decline in the Company’s common shares. No further adjustments to the goodwill portion of this impairment charge were required as a result of the completion of Step 2 of the goodwill impairment test in the fourth quarter of fiscal 2008. However, an additional impairment charge of $13.5 million was recorded in the fourth quarter of fiscal 2008, primarily related to leasehold improvements of Smith & Hawken^®. In total, the fiscal 2008 impairment charges were comprised of $80.8 million for goodwill, $19.0 million related to indefinite-lived tradenames and $37.0 million for long-lived assets. Of the $37.0 million impairment charge recorded for long-lived assets, $15.1 million was recorded in cost of sales. On a reportable segment basis, $64.5 million of the impairment charges were in Global Consumer and $38.4 million were in Global Professional, with the remaining $33.9 million in Corporate & Other.

 

The Company recorded $12.7 million of SG&A-related product registration and recall costs during fiscal 2008 which primarily related to third-party compliance review, legal and consulting fees.

 

Our fourth quarter fiscal 2007 impairment review resulted in a non-cash goodwill and intangible asset impairment charge of $35.3 million, of which $29.2 million related to the Smith & Hawken^® goodwill and intangibles, $2.2 million was for a goodwill impairment charge for our turfgrass biotechnology program and $3.9 million was associated with technology initiatives in our Scotts LawnService^® segment. Other charges in fiscal 2007 related to inventory write-downs and ongoing monitoring and remediation costs associated with our turfgrass biotechnology program.

Other Income, net

 

Other income, net was $2.2 million in fiscal 2009, compared to $10.4 million and $11.5 million for fiscal 2008 and fiscal 2007, respectively. The decline in fiscal 2009 was driven by decreased royalty income and the net loss on sale of assets.

 

Income from Operations

 

Income from operations in fiscal 2009 was $267.1 million compared to $98.0 million in fiscal 2008, an increase of $169.1 million. Fiscal 2009 was negatively impacted by costs related to product registration and recall matters ($28.6 million) and the Smith & Hawken^® closure process ($14.7 million) that, when excluded, result in income from operations of $310.4 million. Fiscal 2008 was negatively impacted by impairment charges ($136.8 million) and product registration and recall costs ($51.1 million) that, when excluded, result in income from operations of $285.9 million. Excluding the impairment, restructuring and other charges and product registration and recall costs, income from operations increased by $24.5 million, or 8.6%, in fiscal 2009, primarily driven by increased net sales and gross margins that were partially offset by an increase in SG&A spending.

 

Income from operations in fiscal 2008 was $98.0 million compared to $277.1 million in fiscal 2007, a decrease of $179.1 million. Fiscal 2007 was negatively impacted by impairment and other charges ($38.0 million) that, when excluded, result in income from operations of $315.1 million. Excluding impairment and other charges and product registration and recall costs, income from operations declined by $29.2 million, or 9.3%, in 2008, primarily driven by increased commodity costs which more than offset price increases passed onto our customers.

 

Interest Expense and Refinancing Activities

 

Interest expense in fiscal 2009 was $56.4 million compared to $82.2 million and $70.7 million in fiscal 2008 and fiscal 2007, respectively. The decrease in fiscal 2009 was primarily due to a decline in our borrowing rates and a reduction in average debt outstanding, as well as the favorable impact of foreign exchange rates. Weighted-average interest rates decreased by 131 basis points during fiscal 2009. Average borrowings also decreased by approximately $170 million during fiscal 2009. The increase in interest expense in fiscal 2008 was primarily attributable to an increase in average borrowings resulting from the recapitalization transactions that were consummated during the second quarter of fiscal 2007.

 

Income Taxes

 

A reconciliation of the federal corporate income tax rate and the effective tax rate on income before income taxes from continuing operations for the three years ended September 30, 2009 is summarized below:

 

 

The effective tax rate for fiscal 2009 was 27.2% compared to 168.6% in fiscal 2008 and 39.7% in fiscal 2007. The effective tax rates were higher for fiscal 2008 and fiscal 2007 due to goodwill impairment charges ($80.8 million and $26.8 million in fiscal 2008 and 2007, respectively), which are not fully deductible for tax purposes. Fiscal 2009 income tax expense includes the reduction of $18.4 million of valuation allowances recorded in prior years to fully reserve deferred tax assets that originated from impairment charges recorded for the Smith &

Hawken^® business in fiscal 2007 and fiscal 2008. In fiscal 2008, when we were attempting to sell Smith & Hawken^®, we concluded that we would not receive any future tax benefit from these deferred tax assets as a stock sale would have resulted in a non-deductible capital loss. Given our fourth quarter fiscal 2009 decision to close the Smith & Hawken^® business, we concluded that the losses generated would be deducted for tax purposes. As a result, the deferred tax asset valuation allowances recorded in fiscal 2008 associated with these impairment charges were eliminated, thereby decreasing the effective tax rate for fiscal 2009.

 

Net Income (Loss) and Earnings (Loss) per Share

 

We reported net income of $153.3 million or $2.32 per diluted share in fiscal 2009 compared to a net loss of $10.9 million or $0.17 per diluted share in fiscal 2008. In fiscal 2009, we incurred $28.6 million of costs related to product registration and recall matters, as well as Smith & Hawken^® closure related costs totaling $14.7 million. Fiscal 2008 was unfavorably impacted by $136.8 million of impairment charges, as well as $51.1 million in costs associated with product registration and recall matters. Excluding these items, the increase in fiscal 2009 net income was primarily driven by increased net sales, led by double-digit growth in the North America consumer business. In addition, gross margin rates improved due to pricing increases in excess of increased commodity costs and cost productivity improvements. The growth in net sales and gross margins was partially offset by an increase in SG&A spending. Challenging weather conditions in March 2008 negatively impacted net sales for the largest part of our business, the Global Consumer segment. Additionally, commodity costs increased significantly in fiscal 2008. Diluted weighted-average common shares outstanding increased from 64.5 million in fiscal 2008 to 66.1 million in fiscal 2009. Diluted average common shares included 1.1 million equivalent shares for fiscal 2009. We excluded 0.9 million potential common shares from the fiscal 2008 diluted loss per share calculation because their effect was anti-dilutive. The changes in diluted average common shares are primarily driven by an increase in the Company’s common share price.

 

We reported net income of $113.4 million or $1.69 per diluted share in fiscal 2007 compared to the net loss of $10.9 million or $0.17 per diluted share in fiscal 2008. Fiscal 2007 was unfavorably impacted by $35.3 million of goodwill and intangible asset impairment charges and $2.7 million of other charges, as well as costs related to refinancing of $18.3 million. Fiscal 2008 results from operations were significantly impacted by the charges noted above. Excluding these items, the reduction in fiscal 2008 net income was attributable to higher commodity costs and the negative effects on net sales of adverse early spring weather conditions. Diluted weighted-average common shares outstanding decreased from 67.0 million in fiscal 2007 to 64.5 million in fiscal 2008, due to the 4.5 million common shares repurchased as part of the recapitalization consummated during the second quarter of fiscal 2007, weighted for the period outstanding, and offset by common shares issued upon the exercise of share-based awards and the vesting of restricted stock.

 

Segment Results

 

Our operations are divided into the following segments: Global Consumer, Global Professional, Scotts LawnService^® and Corporate & Other. The Corporate & Other segment consists of Smith & Hawken^® and corporate general and administrative expenses. Segment performance is evaluated based on several factors, including income from operations before amortization, product registration and recall costs, and impairment, restructuring and other charges, which are not generally accepted accounting principles (“GAAP”) measures. Management uses this measure of operating profit to gauge segment performance because we believe this measure is the most indicative of performance trends and the overall earnings potential of each segment.

The following tables present the segment information for the three years ended September 30, 2009 (certain costs not allocated to business segments for internal management reporting purposes are not allocated for purposes of this presentation):

 

Net Sales by Segment

 

 

Income (Loss) from Operations by Segment

 

 

Global Consumer

 

Global Consumer segment net sales were $2.46 billion in fiscal 2009 compared to $2.25 billion in fiscal 2008, an increase of 9.2%. Organic net sales growth for fiscal 2009 was 12.5%, including the favorable impact of price increases of 6.7%. Foreign exchange movements decreased net sales by 3.3% for fiscal 2009. Within Global Consumer, organic net sales in North America increased 14.8% for fiscal 2009, which included the favorable impact of higher selling prices of 7.4%. Sales of our products to consumers at retail (point-of-sales) for our three largest U.S. customers increased by 15.0% for fiscal 2009, driven by higher sales in all major categories, led by growing media, lawn fertilizers, and plant foods. Organic net sales in Europe increased by 1.1% for fiscal 2009, which included the favorable impact of price increases of 3.3%. Strong growth in the United Kingdom, led by growing media and lawn fertilizer categories, and Eastern Europe was offset by declines in sales in France and Central Europe caused by inventory de-load by retailers and a slow pesticide season.

 

Global Consumer segment operating income for fiscal 2009 was $429.3 million, an increase of $84.8 million, or 24.6%, compared to fiscal 2008. Excluding the impact of foreign exchange movements, segment operating income increased by $91.7 million, or 26.6%, for fiscal 2009. The increase in operating income was primarily driven by the increase in net sales accompanied by improvement in gross margin rate of 280 basis points for fiscal 2009. The increase in gross margin rate was primarily the result of pricing and cost productivity improvements,

partially offset by commodity cost increases. The improvements in net sales and gross margin rates were partially offset by increases in SG&A spending, primarily related to higher advertising and promotional spending, higher selling and research and development costs, and increased variable compensation.

 

Global Consumer segment net sales were $2.25 billion in fiscal 2008 compared to $2.18 billion in fiscal 2007, an increase of 3.4%. Organic net sales growth for fiscal 2008 increased approximately 1.6%, which included pricing actions that increased net sales by 4.1%. Foreign exchange movements increased net sales by 1.8% for fiscal 2008. Organic net sales in North America were flat, which included the impact of price increases of 4.7%. North America point-of-sales for our three largest U.S. customers increased by 2.2% for fiscal 2008, driven by growing media products, where consumers traded up for branded, value-added solutions. Point-of-sales for our lawn products, comprised of fertilizers, grass seed, and durables, decreased by 1.1% primarily due to the late start to the lawn and garden season, resulting in reduced sales of higher priced lawn fertilizer combination products. Ortho^® point-of-sales decreased by 5.2% in fiscal 2008, while the point-of-sales in the wild bird food category increased by 16.0% primarily due to pricing. Organic net sales in Europe increased by 2.0% in 2008, driven by growth in France and Central Europe as the result of improved marketing programs and new products. This growth offset the decreased net sales in the United Kingdom where the economic environment was more challenging and competition was more aggressive.

 

Global Consumer segment operating income decreased by $34.6 million or 9.1% in fiscal 2008. The decrease in operating income was driven primarily by a decrease in gross margin rates of 160 basis points. The decrease in gross margin rates was largely the result of higher commodity costs, which more than offset price increases. SG&A spending, including media advertising, increased 3.7% in fiscal 2008 primarily related to higher selling and research and development costs.

 

Global Professional

 

Global Professional segment net sales decreased $55.7 million, or 16.0%, in fiscal 2009. Organic net sales declined 7.6%, which included increased pricing of 9.9%. Foreign exchange movements decreased net sales by 10.5%. Net sales from Humax Horticulture Limited, a privately-owned growing media company in the United Kingdom acquired by the Company on October 1, 2008 were $7.3 million in fiscal 2009, resulting in 2.1% growth. While organic net sales for the European and Emerging Markets Professional businesses increased by 1.8% and 5.7%, respectively, organic net sales for the North America Professional business, including its seed business, declined 28.3% in fiscal 2009, driven by the downturn in commercial and residential construction and customer inventory build-ups in fiscal 2008 in anticipation of price increases.

 

Global Professional segment operating income decreased $14.3 million in fiscal 2009, or $9.4 million excluding the impact of foreign exchange rates. The decline in operating income was primarily attributable to the reduction in net sales and a $9.9 million inventory write-down necessitated by the significant decline in the market pricing and demand for professional grass seed in North America.

 

Global Professional segment net sales increased $66.9 million, or 23.7%, in fiscal 2008. Organic net sales increased by 17.2% driven primarily by strong demand for our proprietary technology. Pricing actions increased net sales by 7.8%. Global Professional segment operating income increased by $2.4 million in fiscal 2008 as the strong growth in net sales was partially offset by increased commodity costs and SG&A spending, primarily related to selling costs.

 

Scotts LawnService^®

 

Compared to fiscal 2008, Scotts LawnService^® net sales decreased 6.6% to $231.1 million in fiscal 2009 primarily related to macroeconomic pressures that have reduced customer count. Despite the decline in net sales, the Scotts LawnService^® segment operating income increased $7.7 million to $19.0 million in fiscal 2009. The improved operating results were driven by more efficient marketing and sales programs, improved labor productivity, and declines in fuel and fertilizer costs.

 

Compared to fiscal 2007, Scotts LawnService^® net sales increased 7.3% to $247.4 million in fiscal 2008. The increase for fiscal 2008 was the result of organic growth of 4.0% and acquisition growth of 3.3%. Despite

macroeconomic pressures that reduced customer count, the business grew in part due to increased penetration on tree, shrub and insect services and a reduction in customer cancels due to issues with service or results. Additionally, the shift of late season lawn treatments to the first quarter of fiscal 2008 positively impacted net sales. The Scotts LawnService^® segment operating income was flat compared to fiscal 2007 as the net sales and gross margin growth were offset by an increase in SG&A spending.

 

Corporate & Other

 

Net sales for the Corporate & Other segment, which pertain primarily to Smith & Hawken^®, increased $2.2 million in fiscal 2009 primarily due to higher fourth quarter sales following our Smith & Hawken^® closure announcement. The operating loss for Corporate & Other increased by $57.6 million in fiscal 2009 primarily driven by increased variable compensation and retention costs, higher information technology spending, increased regulatory and compliance costs, and higher pension and health care costs.

 

On July 8, 2009, we announced that we intend to cease operating the Smith & Hawken^® business by the end of the calendar year. We incurred $14.7 million of pre-tax charges in fiscal 2009 related to the Smith & Hawken^® closure process, primarily related to the termination of retail site lease obligations, third-party agency fees, charges related to inventory, and severance and benefit commitments. We expect to incur approximately $20-$25 million of pre-tax charges in fiscal 2010 related to the closure process. Based on our best estimates, we expect the overall cash impact to be neutral to slightly positive driven by the liquidation of working capital and anticipated tax benefits, offsetting the related charges. As of November 17, 2009, all Smith & Hawken^® stores had been closed, and we will begin reporting the Smith & Hawken^® business as a discontinued operation in the first quarter of fiscal 2010.

 

Net sales for the Corporate & Other segment decreased $25.4 million or 13.8% in fiscal 2008, reflecting decreased net sales across all channels of Smith & Hawken^®. The operating loss for Corporate & Other decreased by $3.3 million in fiscal 2008 primarily due to lower net Corporate spending.

 

Management’s Outlook

 

We are pleased with our performance in fiscal 2009. Despite the global recession and significant declines in consumer confidence, we delivered record net sales, crossing the $3.0 billion mark for the first time in our history. Our sales results were driven primarily by strong point of sales growth in our North America consumer business. In addition, net cash provided by operating activities less capital investments, or free cash flow, amounted to $189.2 million.

 

Our strong results in fiscal 2009 have laid a foundation for another successful year in fiscal 2010. Excluding financial results of Smith & Hawken^®, we anticipate net sales growth of 3% to 5% in fiscal 2010 primarily driven by unit volume growth in our Global Consumer business. We also anticipate that gross margin rates will be flat compared to fiscal 2009 and that expenditures on SG&A will be consistent with fiscal 2009. Interest expense is expected to decline slightly in fiscal 2010. Excluding the impact of product registration and recall costs and Smith & Hawken^®, we anticipate earnings per share growth in the mid-to-high teens.

 

In the long-term, the Company remains focused on continuing to improve its free cash flow and return on invested capital, both of which the Company believes are important drivers of shareholder value. Our regular quarterly dividend will allow us to continue to return funds to shareholders while maintaining our targeted capital structure.

 

For certain information concerning our risk factors, see “ITEM 1A. RISK FACTORS,” in this Annual Report on Form 10-K.

 

Liquidity and Capital Resources

 

Operating Activities

 

Cash provided by operating activities increased by $63.7 million from $200.9 million in fiscal 2008 to $264.6 million in fiscal 2009. Net income (loss) plus non-cash impairment and other charges, stock-based compensation expense, depreciation and amortization increased by $24.6 million, from $208.7 million in fiscal

2008 to $233.3 million in fiscal 2009, primarily due to higher operating income in our Global Consumer segment. Fiscal 2009 operating cash flows were unfavorably impacted by an increase in inventory caused primarily by higher input costs and additional professional grass seed inventory resulting from a significant drop in demand. The increase in inventory was offset by increases in other current liabilities, driven by accruals for variable compensation, and in accrued taxes, driven by our higher taxable income, for which the cash outflow will not occur until fiscal 2010.

 

Cash provided by operating activities decreased by $45.7 million from $246.6 million in fiscal 2007 to $200.9 million in fiscal 2008. Net income (loss) plus non-cash impairment charges, non-cash costs related to refinancing, stock-based compensation expense, depreciation and amortization declined by $41.8 million, from $250.5 million in fiscal 2007 to $208.7 million in fiscal 2008, primarily due to product registration and recall costs of approximately $51.1 million.

 

The seasonal nature of our operations generally requires cash to fund significant increases in working capital (primarily inventory) during the first half of the year. Receivables and payables also build substantially in the second quarter of the year in line with the timing of sales to support our retailers’ spring selling season. These balances liquidate during the June through September period as the lawn and garden season unwinds. Unlike our core retail business, Scotts LawnService^® typically has its highest receivables balance in the fourth quarter because of the seasonal timing of customer applications and extra service revenues.

 

Investing Activities

 

Cash used in investing activities was $83.3 million and $59.1 million for fiscal 2009 and fiscal 2008, respectively. Capital spending, including investments in intellectual property, increased by $15.2 million from $60.2 million in fiscal 2008 to $75.4 million in fiscal 2009. The increase in capital spending in fiscal 2009 was driven primarily by expansion of North America production facilities. For the three years ended September 30, 2009, our capital spending was allocated as follows: 48% for expansion and maintenance of Global Consumer productive assets; 20% for new productive assets supporting our Global Consumer business; 5% primarily for leasehold improvements associated with new Smith & Hawken^® retail stores; 4% for expansion and upgrades of Scotts LawnService^® facilities; 14% to expand our information technology capabilities; and 9% for other corporate assets. In fiscal 2009, we acquired a growing media company in the United Kingdom for $9.3 million. There was no acquisition activity in fiscal 2008. Acquisition activity in fiscal 2007 was restricted to our Scotts LawnService^® business, approximating $18.7 million.

 

Financing Activities

 

Financing activities used cash of $194.0 million and $123.0 million in fiscal 2009 and fiscal 2008, respectively. In fiscal 2009, the cash used was primarily the result of net repayments of $178.0 million on outstanding debt and dividends paid of $33.4 million, offset by cash of $14.8 million received from the exercise of stock options. In fiscal 2008, the cash used was primarily the result of net repayments of $99.9 million on outstanding debt and dividends paid of $32.5 million, offset by cash of $9.2 million received from the exercise of stock options.

 

Financing activities in fiscal 2007 used cash of $158.8 million, which included our 2007 recapitalization. See “NOTE 5. 2007 RECAPITALIZATION” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for additional information.

 

Credit Agreements

 

Our primary sources of liquidity are cash generated by operations and borrowings under our credit agreements. In February 2007, Scotts Miracle-Gro and certain of its subsidiaries entered into the following senior secured credit facilities totaling up to $2.15 billion in the aggregate: (a) a senior secured five-year term loan facility in the principal amount of $560 million and (b) a senior secured five-year revolving loan facility in the aggregate principal amount of up to $1.59 billion. Borrowings may be made in various currencies including U.S. dollars, Euros, British pounds, Australian dollars and Canadian dollars. Under our current structure, we may request an additional $200 million in revolving credit and/or term credit commitments, subject to approval from our lenders. As of September 30, 2009, there was $1.2 billion of availability under the senior secured credit facilities. “NOTE 11. DEBT” of the Notes to

Consolidated Financial Statements included in this Annual Report on Form 10-K provides additional information pertaining to our borrowing arrangements.

 

At September 30, 2009, we had outstanding interest rate swap agreements with major financial institutions that effectively converted a portion of our variable-rate debt denominated in U.S. dollars to a fixed rate. Interest payments made between the effective date and expiration date are hedged by the swap agreements, except as noted below. The key terms of these swap agreements are shown in the table below.

 

Notional Amount				Effective Date(a)				Expiration Date				Fixed Rate
(In millions)
$	200				3/30/2007				3/30/2010				4.87	%
	200				2/14/2007				2/14/2012				5.20	%
	50				2/14/2012				2/14/2016				3.78	%
	150(b)				11/16/2009				5/16/2016				3.26	%
	50(c)				2/16/2010				5/16/2016				3.05	%

 

 

 

On April 11, 2007, we entered into a one-year Master Accounts Receivable Purchase Agreement (the “2007 MARP Agreement”). On April 9, 2008, we terminated the 2007 MARP Agreement and entered into a new Master Accounts Receivable Purchase Agreement (the “2008 MARP Agreement”). The terms of the 2008 MARP Agreement were substantially the same as the 2007 MARP Agreement. The 2008 MARP Agreement provided an interest rate that was equal to the 7-day LIBOR rate plus 85 basis points. The 2008 MARP Agreement provided for the discounted sale, on a revolving basis, of accounts receivable generated by specified account debtors, with seasonally adjusted monthly aggregate limits ranging from $10 million to $300 million. The 2008 MARP Agreement also provided for specified account debtor sublimit amounts, which provided limits on the amount of receivables owed by individual account debtors that could be sold to the banks. The 2008 MARP Agreement expired by its terms on April 8, 2009.

 

On May 1, 2009, we entered into a Master Accounts Receivable Purchase Agreement (the “2009 MARP Agreement”), with a stated termination date of May 1, 2010, or such later date as may be mutually agreed by us and our lender. The 2009 MARP Agreement provides an interest rate that is equal to the 7-day LIBOR rate plus 225 basis points. The 2009 MARP Agreement provides for the discounted sale, on an uncommitted, revolving basis, of accounts receivable generated by a specified account debtor, with aggregate limits not to exceed $80 million. Borrowings under the 2009 MARP Agreement at September 30, 2009 were $4.2 million.

 

As of September 30, 2009, we were in compliance with all debt covenants. Our senior secured credit facilities contain, among other obligations, an affirmative covenant regarding our leverage ratio, calculated as indebtedness relative to our earnings before taxes, depreciation and amortization. Under the terms of the senior secured credit facilities, the maximum leverage ratio was 3.75 as of September 30, 2009, which is scheduled to decrease to 3.50 on September 30, 2010. Management continues to monitor our compliance with the leverage ratio and other covenants contained in the senior secured credit facilities and, based upon our current operating assumptions, we expect to remain in compliance with the permissible leverage ratio throughout fiscal 2010. However, an unanticipated charge to earnings, an increase in debt or other factors could materially adversely affect our ability to remain in compliance with the financial or other covenants of our senior secured credit facilities, potentially causing us to have to seek an amendment or waiver from our lending group which would be likely to result in repricing of our senior secured credit facilities to then current market rates. Although we were in compliance with all of our debt covenants throughout fiscal 2009, please see “ITEM 1A. RISK FACTORS — The Ongoing Governmental Investigation Regarding Our Compliance with FIFRA Could Adversely Affect Our Financial Condition, Results of Operations or

Cash Flows” for a discussion of the potential negative impact of such issues on our compliance with certain covenants contained in our credit agreements.

 

Judicial and Administrative Proceedings

 

Apart from the proceedings surrounding the FIFRA compliance matters, which are discussed separately, we are party to various pending judicial and administrative proceedings arising in the ordinary course of business, including, among others, proceedings based on accidents or product liability claims and alleged violations of environmental laws. We have reviewed these pending judicial and administrative proceedings, including the probable outcomes, reasonably anticipated costs and expenses, and the availability and limits of our insurance coverage, and have established what we believe to be appropriate reserves. We do not believe that any liabilities that may result from these pending judicial and administrative proceedings are reasonably likely to have a material adverse effect on our financial condition, results of operations, or cash flows; however, there can be no assurance that future quarterly or annual operating results will not be materially affected by final resolution of these matters.

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

The following table summarizes our future cash outflows for contractual obligations as of September 30, 2009 (in millions):

 

 

Purchase obligations primarily represent commitments for materials used in the Company’s manufacturing processes, as well as commitments for warehouse services, seed and out-sourced information services which comprise the unconditional purchase obligations disclosed in “NOTE 18. COMMITMENTS” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

Other includes actuarially determined retiree benefit payments and pension funding to comply with local funding requirements. Pension funding requirements beyond fiscal 2010 are based on preliminary estimates using actuarial assumptions determined as of September 30, 2009. The above table excludes interest payments and insurance accruals as the Company is unable to estimate the timing of the payment for these items.

 

The Company has no off-balance sheet financing arrangements.

 

In our opinion, cash flows from operations and capital resources will be sufficient to meet debt service, capital expenditures and working capital needs during fiscal 2010, and thereafter for the foreseeable future. However, we cannot ensure that our business will generate sufficient cash flow from operations or that future borrowings will be available under our credit facilities in amounts sufficient to pay indebtedness or fund other liquidity needs. Actual results of operations will depend on numerous factors, many of which are beyond our control.

 

Shelf Registration Statement

 

Following the filing of this Annual Report on Form 10-K, we expect to file a universal automatic shelf registration statement on Form S-3ASR with the SEC that will permit us, from time to time, in one or more public offerings, to offer debt securities, common shares, preferred shares, warrants, purchase contracts and purchase units or combinations of the preceding securities. These securities, which may be offered in one or more offerings and in any combination, will in each case be offered pursuant to a separate prospectus supplement issued

at the time of the particular offering that will describe the specific types, amounts, prices and terms of the offered securities and the expected use of proceeds from the offering.

 

Regulatory Matters

 

We are subject to local, state, federal and foreign environmental protection laws and regulations with respect to our business operations and believe we are operating in substantial compliance with, or taking actions aimed at ensuring compliance with, such laws and regulations. Apart from the proceedings surrounding the FIFRA compliance matters, which are discussed separately, we are involved in several legal actions with various governmental agencies related to environmental matters. While it is difficult to quantify the potential financial impact of actions involving these environmental matters, particularly remediation costs at waste disposal sites and future capital expenditures for environmental control equipment, in the opinion of management, the ultimate liability arising from such environmental matters, taking into account established reserves, should not have a material adverse effect on our financial condition, results of operations or cash flows. However, there can be no assurance that the resolution of these matters will not materially affect our future quarterly or annual results of operations, financial condition or cash flows. Additional information on environmental matters affecting us is provided in “ITEM 1. BUSINESS — Regulatory Considerations,” “ITEM 1. BUSINESS — FIFRA Compliance, the Corresponding Governmental Investigations and Similar Matters,” “ITEM 1. BUSINESS — Other Regulatory Matters” and “ITEM 3. LEGAL PROCEEDINGS” of this Annual Report on Form 10-K.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. Certain accounting policies are particularly significant, including those related to revenue recognition, goodwill and intangibles, certain employee benefits, and income taxes. We believe these accounting policies, and others set forth in “NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K, should be reviewed as they are integral to understanding our results of operations and financial position. Our critical accounting policies are reviewed periodically with the Audit Committee of the Board of Directors of Scotts Miracle-Gro.

 

The preparation of financial statements requires management to use judgment and make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to customer programs and incentives, product returns, bad debts, inventories, intangible assets, income taxes, restructuring, environmental matters, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Although actual results historically have not deviated significantly from those determined using our estimates, our results of operations or financial condition could differ, perhaps materially, from these estimates under different assumptions or conditions.

 

Revenue Recognition and Promotional Allowances

 

Most of our revenue is derived from the sale of inventory, and we recognize revenue when title and risk of loss transfer, generally when products are received by the customer. Provisions for payment discounts, product returns and allowances are recorded as a reduction of sales at the time revenue is recognized based on historical trends and adjusted periodically as circumstances warrant. Similarly, reserves for uncollectible receivables due from customers are established based on management’s judgment as to the ultimate collectibility of these balances. We offer sales incentives through various programs, consisting principally of volume rebates, cooperative advertising, consumer coupons and other trade programs. The cost of these programs is recorded as a reduction of sales. The recognition of revenues, receivables and trade programs requires the use of estimates. While we believe these estimates to be reasonable based on the then current facts and circumstances, there can be no assurance that actual amounts realized will not differ materially from estimated amounts recorded.

Long-lived Assets, including Property, Plant and Equipment

 

Property, plant and equipment are stated at cost. Depreciation of property, plant and equipment is provided on the straight-line method and is based on the estimated useful economic lives of the assets. Intangible assets with finite lives, and therefore subject to amortization, include technology (e.g., patents), customer relationships and certain tradenames. These intangible assets are being amortized on the straight-line method over periods typically ranging from 3 to 25 years. The Company reviews long-lived assets whenever circumstances change such that the indicated recorded value of an asset may not be recoverable and therefore impaired.

 

Goodwill and Indefinite-lived Intangible Assets

 

We have significant investments in intangible assets and goodwill. Our annual goodwill and indefinite-lived intangible asset testing is performed as of the first day of our fiscal fourth quarter or more frequently if circumstances indicate potential impairment. The review for impairment of intangibles and goodwill is primarily based on our estimates of discounted future cash flows, which are based upon budgets and longer-range strategic plans. These budgets and plans are used for internal purposes and are also the basis for communication with outside parties about future business trends. While we believe the assumptions we use to estimate future cash flows are reasonable, there can be no assurance that the expected future cash flows will be realized. As a result, impairment charges that possibly should have been recognized in earlier periods may not be recognized until later periods if actual results deviate unfavorably from earlier estimates. An asset’s value is deemed impaired if the discounted cash flows or earnings projections generated do not substantiate the carrying value of the asset. The estimation of such amounts requires management to exercise judgment with respect to revenue and expense growth rates, changes in working capital and selection of an appropriate discount rate, as applicable. The use of different assumptions would increase or decrease discounted future operating cash flows or earnings projections and could, therefore, change impairment determinations.

 

Fair values related to our annual impairment review of indefinite-lived tradenames and goodwill were determined using discounted cash flow models involving several assumptions. Changes in our assumptions could materially impact our fair value estimates. Assumptions critical to our fair value estimates were: (i) present value factors used in determining the fair value of the reporting units and tradenames; (ii) royalty rates used in our tradename valuations; (iii) projected average revenue growth rates used in the reporting unit and tradename models; and (iv) projected long-term growth rates used in the derivation of terminal year values. These and other assumptions are impacted by economic conditions and expectations of management and will change in the future based on period specific facts and circumstances.

 

Inventories

 

Inventories are stated at the lower of cost or market, the majority of which are based on the first-in, first-out method of accounting. Reserves for excess and obsolete inventory are based on a variety of factors, including product changes and improvements, changes in active ingredient availability and regulatory acceptance, new product introductions and estimated future demand. The adequacy of our reserves could be materially affected by changes in the demand for our products or regulatory actions.

 

Contingencies

 

As described more fully in “NOTE 19. CONTINGENCIES” of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K, we are involved in significant environmental and legal matters which have a high degree of uncertainty associated with them. We continually assess the likely outcomes of these matters and the adequacy of amounts, if any, provided for their resolution. There can be no assurance that the ultimate outcomes of these matters will not differ materially from our assessment of them, nor that all matters that may currently be brought against us are known by us at this time.

 

Income Taxes

 

Our annual effective tax rate is established based on our pre-tax income (loss), statutory tax rates and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. We record income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is

recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. Valuation allowances are used to reduce deferred tax assets to the balance that is more likely than not to be realized. We must make estimates and judgments on future taxable income, considering feasible tax planning strategies and taking into account existing facts and circumstances, to determine the proper valuation allowance. When we determine that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and consolidated statement of operations reflect the change in the period such determination is made. Due to changes in facts and circumstances and the estimates and judgments that are involved in determining the proper valuation allowance, differences between actual future events and prior estimates and judgments could result in adjustments to this valuation allowance. We use an estimate of our annual effective tax rate at each interim period based on the facts and circumstances available at that time, while the actual effective tax rate is calculated at year-end.

 

Associate Benefits

 

We sponsor various post-employment benefit plans. These include pension plans, both defined contribution plans and defined benefit plans, and other post-employment benefit (“OPEB”) plans, consisting primarily of health care for retirees. For accounting purposes, the defined benefit pension and OPEB plans are dependent on a variety of assumptions to estimate the projected and accumulated benefit obligations determined by actuarial valuations. These assumptions include the following: discount rate; expected salary increases; certain employee-related factors, such as turnover, retirement age and mortality; expected return on plan assets; and health care cost trend rates. These and other assumptions affect the annual expense recognized for these plans.

 

Assumptions are reviewed annually for appropriateness and updated as necessary. We base the discount rate assumption on investment yields available at fiscal year-end on high-quality corporate bonds that could be purchased to effectively settle the pension liabilities. The salary growth assumption reflects our long-term actual experience, the near-term outlook and assumed inflation. The expected return on plan assets assumption reflects asset allocation, investment strategy and the views of investment managers regarding the market. Retirement and mortality rates are based primarily on actual and expected plan experience. The effects of actual results differing from our assumptions are accumulated and amortized over future periods.

 

Changes in the discount rate and investment returns can have a significant effect on the funded status of our pension plans and shareholders’ equity. We cannot predict these discount rates or investment returns with certainty and, therefore, cannot determine whether adjustments to our shareholders’ equity for pension-related activity in subsequent years will be significant. We also cannot predict future investment returns, and therefore cannot determine whether future pension plan funding requirements could materially and adversely affect our financial condition, results of operations or cash flows.

 

Accruals for Self-Insurance

 

We maintain insurance for certain risks, including workers’ compensation, general liability and vehicle liability, and are self-insured for employee-related health care benefits. We establish reserves for losses based on our claims experience and industry actuarial estimates of the ultimate loss amount inherent in the claims, including losses for claims incurred but not reported. Our estimate of self-insured liabilities is subject to change as new events or circumstances develop which might materially impact the ultimate cost to settle these losses.

 

Derivative Instruments

 

In the normal course of business, we are exposed to fluctuations in interest rates, the value of foreign currencies and the cost of commodities. A variety of financial instruments, including forward and swap contracts, are used to manage these exposures. Our objective in managing these exposures is to better control these elements of cost and mitigate the earnings and cash flow volatility associated with changes in the applicable rates and prices.

 

We have established policies and procedures that encompass risk-management philosophy and objectives, guidelines for derivative-instrument usage, counterparty credit approval, and the monitoring and reporting of derivative activity. We do not enter into derivative instruments for the purpose of speculation.

Other Significant Accounting Policies

 

Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed above, are also critical to understanding the consolidated financial statements. The Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K contain additional information related to our accounting policies, including recent accounting pronouncements, and should be read in conjunction with this discussion.

 

 

As part of our ongoing business, we are exposed to certain market risks, including fluctuations in interest rates, foreign currency exchange rates and commodity prices. Financial derivative and other instruments are used to manage these risks. These instruments are not used for speculative purposes.

 

Interest Rate Risk

 

The Company had variable rate debt instruments outstanding at September 30, 2009 and 2008 that are impacted by changes in interest rates. As a means of managing our interest rate risk on these debt instruments, the Company enters into interest rate swap agreements to effectively convert certain variable-rate debt obligations to fixed rates.

 

At September 30, 2009 and 2008, the Company had outstanding interest rate swap agreements with major financial institutions that effectively convert a portion of our variable-rate debt to a fixed rate. The swap agreements had a total U.S. dollar equivalent notional amount of $650.0 million and $711.4 million, respectively. The average fixed rate of swap agreements outstanding at September 30, 2009 was 4.4%.

 

The following table summarizes information about our derivative financial instruments and debt instruments that are sensitive to changes in interest rates as of September 30, 2009 and 2008. For debt instruments, the table presents principal cash flows and related weighted-average interest rates by expected maturity dates. For interest rate swap agreements, the table presents expected cash flows based on notional amounts and weighted-average interest rates by contractual maturity dates. Weighted-average variable rates are based on implied forward rates in the yield curve at September 30, 2009 and 2008. A change in our variable interest rate of 1% for a full twelve-month period would have a $6.7 million impact on interest expense assuming approximately $670 million of our average fiscal 2009 variable-rate debt had not been hedged via an interest rate swap agreement. The information is presented in U.S. dollars (in millions):

 

 

Excluded from the information provided above are $18.6 million and $20.5 million at September 30, 2009 and 2008, respectively, of miscellaneous debt instruments.

 

Other Market Risks

 

Through fiscal 2009, we had transactions that were denominated in currencies other than the currency of the country of origin. We use foreign currency swap contracts to manage the exchange rate risk associated with intercompany loans with foreign subsidiaries that are denominated in local currencies. At September 30, 2009, the notional amount of outstanding foreign currency contracts was $105.9 million with a fair value of ($3.9) million. At September 30, 2008, the notional amount of outstanding foreign currency contracts was $86.4 million with a fair value of ($0.4) million.

 

We are subject to market risk from fluctuating prices of certain raw materials, including urea, resins, fuel, grass seed and wild bird food components. Our objectives surrounding the procurement of these materials are to ensure continuous supply and to minimize costs. We seek to achieve these objectives through negotiation of contracts with favorable terms directly with vendors. In addition, we entered into arrangements to partially mitigate the effect of fluctuating direct and indirect fuel costs on our Global Consumer and Scotts LawnService^® businesses and hedged a portion of our fuel and urea needs for fiscal 2008 and fiscal 2009. We had outstanding contracts for approximately 1.3 million gallons of fuel with a fair value of $0.1 million at September 30, 2009. There were no outstanding derivatives for fuel at September 30, 2008. We also had hedging arrangements for 74,000 and 48,500 aggregate tons of urea at September 30, 2009 and 2008, respectively. The fair value of the 74,000 aggregate tons at September 30, 2009 was $0.1 million, while the fair value of the 48,500 aggregate tons at September 30, 2008 was ($8.5) million.

 

 

The financial statements and other information required by this Item are contained in the Consolidated Financial Statements, Notes to Consolidated Financial Statements and Financial Statement Schedules listed in the “Index to Consolidated Financial Statements and Financial Statement Schedules” on page 61 of this Annual Report on Form 10-K.

 

 

None.

 

 

Evaluation of Disclosure Controls and Procedures

 

With the participation of the principal executive officer and the principal financial officer of The Scotts Miracle-Gro Company (the “Registrant”), the Registrant’s management has evaluated the effectiveness of the Registrant’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)), as of the end of the fiscal year covered by this Annual Report on Form 10-K. Based upon that evaluation, the Registrant’s principal executive officer and principal financial officer have concluded that:

 

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

The “Annual Report of Management on Internal Control Over Financial Reporting” required by Item 308(a) of SEC Regulation S-K is included on page 62 of this Annual Report on Form 10-K.

 

Attestation Report of Independent Registered Public Accounting Firm

 

The “Report of Independent Registered Public Accounting Firm” required by Item 308(b) of SEC Regulation S-K is included on page 64 of this Annual Report on Form 10-K.

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in the Registrant’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the Registrant’s fiscal quarter ended September 30, 2009, that have materially affected, or are reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

 

 

On November 20, 2009, the Compensation and Organization Committee (the “Committee”) of the Board of Directors (the “Board”) of the Company approved a change to the annual compensation package of James Hagedorn, the Company’s Chairman and Chief Executive Officer. In lieu of further increasing Mr. Hagedorn’s cash-based compensation to compensate him for the prior commuting perquisite he enjoyed, the Committee has determined to provide Mr. Hagedorn with a compensatory monthly commuting allowance of $20,000, effective at the beginning of the 2010 fiscal year. For safety and security reasons, the Board-approved CEO/COO Travel Guidelines (the “Guidelines”) provide that Mr. Hagedorn may use either personal aircraft or Company-owned or leased aircraft for commuting purposes and the commuting allowance is intended to offset the annual costs associated with Mr. Hagedorn’s compliance with the Guidelines.

 

PART III

 

 

Directors, Executive Officers and Persons Nominated or Chosen to Become Directors or Executive Officers

 

The information required by Item 401 of SEC Regulation S-K concerning the directors of The Scotts Miracle-Gro Company (“Scotts Miracle-Gro” or the “Registrant”) and the nominees for re-election as directors of Scotts Miracle-Gro at the Annual Meeting of Shareholders to be held on January 21, 2010 (the “2010 Annual Meeting”) is incorporated herein by reference from the disclosure which will be included under the caption “PROPOSAL NUMBER 1 — ELECTION OF DIRECTORS” in Scotts Miracle-Gro’s definitive Proxy Statement relating to the 2010 Annual Meeting (“Scotts Miracle-Gro’s Definitive Proxy Statement”), which will be filed pursuant to SEC Regulation 14A not later than 120 days after the end of Scotts Miracle-Gro’s fiscal year ended September 30, 2009.

 

The information required by Item 401 of SEC Regulation S-K concerning the executive officers of Scotts Miracle-Gro is incorporated herein by reference from the disclosure included under the caption “SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT” in Part I of this Annual Report on Form 10-K.

 

Compliance with Section 16(a) of the Securities Exchange Act of 1934

 

The information required by Item 405 of SEC Regulation S-K is incorporated herein by reference from the disclosure which will be included under the caption “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

Procedures for Recommending Director Nominees

 

Information concerning the procedures by which shareholders of Scotts Miracle-Gro may recommend nominees to Scotts Miracle-Gro’s Board of Directors is incorporated herein by reference from the disclosures

which will be included under the captions “CORPORATE GOVERNANCE — Nominations of Directors” and “MEETINGS AND COMMITTEES OF THE BOARD — Committees of the Board — Governance and Nominating Committee” in Scotts Miracle-Gro’s Definitive Proxy Statement. These procedures have not materially changed from those described in Scotts Miracle-Gro’s definitive Proxy Statement for the 2009 Annual Meeting of Shareholders held on January 22, 2009.

 

Audit Committee

 

The information required by Items 407(d)(4) and 407(d)(5) of SEC Regulation S-K is incorporated herein by reference from the disclosure which will be included under the caption “MEETINGS AND COMMITTEES OF THE BOARD — Committees of the Board — Audit Committee” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

Committee Charters; Code of Business Conduct and Ethics; Corporate Governance Guidelines

 

The Board of Directors of the Registrant has adopted charters for each of the Audit Committee, the Governance and Nominating Committee, the Compensation and Organization Committee, the Finance Committee and the Innovation & Technology Committee as well as Corporate Governance Guidelines as contemplated by the applicable sections of the New York Stock Exchange Listed Company Manual.

 

In accordance with the requirements of Section 303A.10 of the New York Stock Exchange’s Listed Company Manual, the Board of Directors of the Registrant has adopted a Code of Business Conduct and Ethics covering the members of the Registrant’s Board of Directors and associates (employees) of the Registrant and its subsidiaries, including, without limitation, the Registrant’s principal executive officer, principal financial officer and principal accounting officer. The Registrant intends to disclose the following events, if they occur, on its Internet website located at http://investor.scotts.com within four business days following their occurrence: (A) the date and nature of any amendment to a provision of Scotts Miracle-Gro’s Code of Business Conduct and Ethics that (i) applies to the Registrant’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, (ii) relates to any element of the code of ethics definition enumerated in Item 406(b) of SEC Regulation S-K, and (iii) is not a technical, administrative or other non-substantive amendment; and (B) a description (including the nature of the waiver, the name of the person to whom the waiver was granted and the date of the waiver) of any waiver, including an implicit waiver, from a provision of the Code of Business Conduct and Ethics to the Registrant’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, that relates to one or more of the elements of the code of ethics definition set forth in Item 406(b) of SEC Regulation S-K.

 

The text of the Registrant’s Code of Business Conduct and Ethics, the Registrant’s Corporate Governance Guidelines, the Audit Committee charter, the Governance and Nominating Committee charter, the Compensation and Organization Committee charter, the Finance Committee charter and the Innovation & Technology Committee charter are posted under the “Corporate Governance” link on the Registrant’s Internet website located at http://investor.scotts.com. Interested persons and shareholders of Scotts Miracle-Gro may also obtain copies of each of these documents without charge by writing to The Scotts Miracle-Gro Company, Attention: Corporate Secretary, 14111 Scottslawn Road, Marysville, Ohio 43041. In addition, a copy of the Code of Business Conduct and Ethics, as amended on November 2, 2006, is incorporated by reference in Exhibit 14 to this Annual Report on Form 10-K.

 

 

The information required by Item 402 of SEC Regulation S-K is incorporated herein by reference from the disclosures which will be included under the captions “EXECUTIVE COMPENSATION” and “NON-EMPLOYEE DIRECTOR COMPENSATION” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

The information required by Item 407(e)(4) of SEC Regulation S-K is incorporated herein by reference from the disclosure which will be included under the caption “MEETINGS AND COMMITTEES OF THE BOARD — Compensation and Organization Committee Interlocks and Insider Participation” in Scotts Miracle-Gro’s Definitive Proxy Statement.

The information required by Item 407(e)(5) of SEC Regulation S-K is incorporated herein by reference from the disclosure which will be included under the caption “COMPENSATION COMMITTEE REPORT” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

 

Ownership of Common Shares of Scotts Miracle-Gro

 

The information required by Item 403 of SEC Regulation S-K is incorporated herein by reference from the disclosure which will be included under the caption “BENEFICIAL OWNERSHIP OF SECURITIES OF THE COMPANY” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

Equity Compensation Plan Information

 

The information required by Item 201(d) of SEC Regulation S-K is incorporated herein by reference from the disclosure which will be included under the caption “EQUITY COMPENSATION PLAN INFORMATION” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

 

Certain Relationships and Related Person Transactions

 

The information required by Item 404 of SEC Regulation S-K is incorporated herein by reference from the disclosures which will be included under the captions “PROPOSAL NUMBER 1 — ELECTION OF DIRECTORS,” “BENEFICIAL OWNERSHIP OF SECURITIES OF THE COMPANY” and “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

Director Independence

 

The information required by Item 407(a) of SEC Regulation S-K is incorporated herein by reference from the disclosures which will be included under the captions “CORPORATE GOVERNANCE — Director Independence” and “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

 

The information required by this Item 14 is incorporated herein by reference from the disclosures which will be included under the captions “PROPOSAL NUMBER 2 — RATIFICATION OF THE SELECTION OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM — Fees of the Independent Registered Public Accounting Firm” and “PROPOSAL NUMBER 2 — RATIFICATION OF THE SELECTION OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM — Pre-Approval of Services Performed by the Independent Registered Public Accounting Firm” in Scotts Miracle-Gro’s Definitive Proxy Statement.

 

PART IV

 

 

(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT

 

1 and 2. Financial Statements and Financial Statement Schedules:

 

The response to this portion of Item 15 is submitted as a separate section of this Annual Report on Form 10-K. Reference is made to the “Index to Consolidated Financial Statements and Financial Statement Schedules” on page 61 herein.

3. Exhibits:

 

The exhibits listed on the “Index to Exhibits” beginning on page 115 of this Annual Report on Form 10-K are filed with this Annual Report on Form 10-K or incorporated herein by reference as noted in the “Index to Exhibits.” The following table provides certain information concerning each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K or incorporated herein by reference.

 

MANAGEMENT CONTRACTS AND COMPENSATORY PLANS AND ARRANGEMENTS