AEROGROW INTERNATIONAL, INC. The discussion contained herein is for the three months endedJune 30, 2020 andJune 30, 2019 . The following discussion should be read in conjunction with the financial statements ofAeroGrow International, Inc. (the "Company," "AeroGrow ," "we," "our," or "us,") and the notes to the financial statements included in Item 1 above in this Quarterly Report on Form 10-Q for the period endedJune 30, 2020 (this "Quarterly Report"). The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including statements that include words such as "anticipates," "expects," "intends," "plans," "believes," "may," "will," or similar expressions that are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections, or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements include, but are not limited to, statements regarding our intent, belief, or current expectations regarding our strategies, plans, and objectives, our product release schedules, our ability to design, develop, manufacture, and market products, the ability of our products to achieve or maintain commercial acceptance, our ability to obtain financing and/or generate cash flow sufficient to fund our future operations, and our ability to continue as a going concern. Such statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. Factors that could cause or contribute to the differences are discussed in this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations and in Item 1A. "Risk Factors" of our Annual Report on Form 10-K for the year endedMarch 31, 2020 . Except as required by applicable law or regulation, we undertake no obligation to revise or update any forward-looking statements contained in this Quarterly Report. The information contained in this Quarterly Report is not a complete description of our business or the risks associated with an investment in our common stock. Each reader should carefully review and consider the various disclosures we made in this Quarterly Report and in our other filings with theU.S. Securities and Exchange Commission ("SEC"). OverviewAeroGrow International, Inc. was formed as aNevada corporation inMarch 2002 . The Company's principal business is developing, marketing, and distributing advanced indoor aeroponic garden systems designed and priced to appeal to the consumer gardening, cooking and small indoor appliance markets worldwide. The Company's principal activities from its formation throughMarch 2006 consisted of product research and development, market research, business planning, and raising the capital necessary to fund these activities. InDecember 2005 , the Company commenced initial production of its AeroGarden system and, inMarch 2006 , began shipping these systems to retail and catalogue customers. The Company manufactures, distributes and markets eight different models of its AeroGarden systems in multiple colors, as well as over 40 varieties of seed pod kits and a full line of accessory products through multiple channels including online retail distribution, in-store retail distribution, catalogue and direct-to-consumer sales primarily inthe United States andCanada , as well as selected countries inEurope . InApril 2013 , we entered into a Securities Purchase Agreement and strategic alliance with a wholly owned subsidiary ofThe Scotts Miracle-Gro Company (collectively with its subsidiary, "SMG" or "Scotts Miracle-Gro"). Pursuant to the Securities Purchase Agreement, we issued (i) 2.6 million shares of Series B Convertible Preferred Stock, par value$0.001 per share (the "Series B Preferred Stock); and (ii) a warrant to purchase up to 80% of the Company's common stock for an aggregate purchase price of$4.0 million . In addition, as part of the strategic alliance, we entered into several other agreements withScotts Miracle-Gro , including: (i) an Intellectual Property Sale Agreement; (ii) a Technology Licensing Agreement; (iii) a Brand License Agreement; and (iv) a Supply Chain Management Agreement. InNovember 2016 ,Scotts Miracle-Gro fully exercised the Warrant and, by its terms, the Series B Preferred Stock automatically converted into the Company's common stock.Scotts Miracle-Gro currently owns approximately 80.5% of the Company's outstanding common stock. Pursuant to the Intellectual Property Agreement, we agreed to sell all intellectual property associated with our hydroponic products (the "Hydroponic IP"), other than theAeroGrow and AeroGarden trademarks, free and clear of all encumbrances, toScotts Miracle-Gro for$500,000 .Scotts Miracle-Gro has the right to use theAeroGrow and AeroGarden trademarks in connection with the sale of products incorporating the Hydroponic IP. In addition to the total working capital infusion of approximately$4.5 million from the Securities Purchase Agreement and Intellectual Property Sale Agreement, as amended, the strategic alliance allows us to use the globally recognized and highly trusted Miracle-Gro brand name. We believe that the strategic alliance also givesScotts Miracle-Gro an entry into the burgeoning indoor gardening market, while providingAeroGrow a broad base of support in marketing, distribution, supply chain logistics, R&D, and sourcing. We have also used our strategic alliance withScotts Miracle-Gro to re-establish our presence in the retail and international sales channels. In Fiscal 2020, we amended the Brand License Agreement withScotts Miracle-Gro to allow us to remove the Miracle-Gro brand from AeroGardens, thereby eliminating the cost associated with this portion of the agreement. 18
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Table of Contents Results of Operations
Three Months Ended
Summary Overview
For the three months endedJune 30, 2020 , we generated$16.4 million of total revenue, an increase of 266.7%, or$11.9 million , relative to the same period in the prior year. Retail sales increased by 193.9% to$7.2 million primarily due to continued sales into the online channels, including Amazon.com, Kohls.com, HomeDepot.com and BestBuy.com, as well as continued enthusiasm about indoor gardening and healthy, safe and fresh food. Direct-to-consumer sales increased 376.1%, to$9.1 million , reflecting more efficient use of advertising and marketing campaigns, increased visibility and more focused sales programs. In addition to our continued momentum from prior periods, we saw amplified demand in the indoor gardening market from customers seeking healthy, fresh food during a pandemic. For the three months endedJune 30, 2020 , total dollar sales of AeroGarden units increased by 218.9% from the prior year period and seed pod kit and accessory sales increased by 308.6% over prior year period. AeroGarden sales represented 66.2% of total revenue, as compared to 76.1% in the prior year period. This percentage decrease, on a product line basis, was attributable to both direct to consumer and retail online customers purchasing additional seed pod kits and accessories. Sales of seed pod kits increased from 94,000 to 382,000 units, primarily as a result of newAeroGrow sales in the prior periods and the follow on purchases of seed pod kits and resulting increased size of our active customer database. The Company continues to spend advertising dollars in order to strategically build market awareness and enhance initiatives implemented in the prior year. For the fiscal year endingMarch 31, 2021 ("Fiscal 2021"), we intend to expand consumer awareness of the AeroGrow brand and product line. As a result, during the three months endedJune 30, 2020 , (the first quarter of Fiscal 2021), we incurred$1.3 million of advertising expenses to support our direct-to-consumer and retail channels, a$818,000 or 159.7% year-over-year increase compared to the same period in Fiscal 2020. The advertising expenditures were divided as follows: ? Retail specific advertising decreased to$317,000 from$416,000 for the three months endedJune 30, 2020 , as the Company continues to invest in driving product awareness through: (i) platforms made available by our
retailers; (ii) various promotional programs to increase product awareness
with our retail accounts, including catalogues and email campaigns; and
(iii) web-based advertising programs (e.g. including retail catalogues,
website banner ads, email blasts, targeted search campaigns, media group
and marketing service campaigns, etc.), however, due to lower levels of
inventory the Company did not spend as much driving sales through retail
specific programs.
? Direct-to-consumer advertising increased
the three months ended
specific pay-per-click advertising geared toward the direct-to-consumer
customer base and direct advertising campaigns such as Google Ads and
Facebook. Efficiency, as measured by dollars of direct-to-consumer sales
per dollar of related advertising expense, increased to
months ended
Fiscal 2020.
Our gross profit percentage for the three months ended June 30, 2020 was 44.8%,
up from 32.5% in the prior year period, primarily due to increases in sales
prices, more sales to higher margin Direct-to-consumer customers, supply chain
efficiencies that were not in place in the prior year, fewer planned discount
programs in our sales channels due to lower inventory levels, and increased
sales.
In aggregate, our total operating expenses increased 87.0%, or
? a$909,000 increase in personnel expenses primarily driven by our company-wide incentive program that scales as our growth increases and
an increase in headcount as some hiring happened during this quarter
last year;
? a
channels;
? a
web services as we launch better order processing software and prepare
for new product launches that leverage web-based platforms;
? a $171,000 increase in bad debt and depreciation expense; and
? a $156,000 increase in legal and consulting expenses related to
strategic alternatives being investigated.
These increases were partially offset by a $111,000 decrease in Company-wide
travel. As a result of efforts to drive growth and increase sales, our operating
income was $2.7 million for the three months ended June 30, 2020 , as compared to
an operating loss of $1.1 million in the prior year period.
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Net other expense for the three months endedJune 30, 2020 totaled$20,000 , as compared to net other expense of$5,000 in the prior year period. The current year other expense is attributable to an increase in foreign exchange losses and interest expense on the outstanding loan. Net income for the three months endedJune 30, 2020 was$2.6 million , as compared to the$1.1 million loss in the prior year period. The$3.7 million increase reflected increased sales revenue, decreased operating expenses as a percentage of revenue and increased margins. The following table sets forth, as a total percentage of sales, our financial results for the three months endedJune 30, 2020 and the three months endedJune 30, 2019 : Three Months Ended June 30, 2020 2019 Net revenue Direct-to-consumer 55.2 % 42.5 % Retail 43.8 % 54.6 % International 1.0 % 2.9 % Total net revenue 100.0 % 100.0 % Cost of revenue 55.2 % 67.5 % Gross profit percentage 44.8 % 32.5 % Operating expenses Research and development 1.8 % 4.7 % Sales and marketing 17.2 % 31.4 % General and administrative 9.6 % 20.0 % Total operating expenses 28.6 % 56.1 % Profit (loss) from operations 16.2 % (23.6 )% Revenue For the three months endedJune 30, 2020 , revenue totaled$16.4 million , a year-over-year increase of 266.7% or$11.9 million , from the three months endedJune 30, 2019 . Three Months Ended June 30, (in thousands) 2020 2019 Net revenue Direct-to-consumer$ 9,056 $ 1,902 Retail 7,180 2,443 International 175 130 Total$ 16,411 $ 4,475 Direct-to-consumer sales for the three months endedJune 30, 2020 totaled$9.1 million , an increase of$7.2 million , or 376.1%, from the prior year period. This increase was caused by continued momentum of growth from prior periods amplified by demand in indoor gardening of customers seeking healthy, fresh food and uncertainties in the food supply chain during COVID-19, driving direct-to-consumer awareness during our non-peak season through our focus on advertising that drives sales, follow-on direct sales to customers that have previously purchased AeroGardens, and continued momentum from general brand awareness campaigns. Sales to retailer customers for the three months endedJune 30, 2020 totaled$7.2 million , up$4.7 million , or 193.9%, principally reflecting organic growth in our existing retail accounts, namely Amazon.com, Kohl's, Canadian Tire and timing of programs with Home Depot and sales to one new account, Best Buy. International sales increased from$130,000 to$175,000 in the first quarter of Fiscal 2021 primarily due to timing of available inventory to sell in European markets as we continue to understand the trends that impact the international market. 20
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Our products consist of AeroGardens, and seed pod kits and accessories. A
summary of the sales of these two product categories for the three months ended
Three Months Ended June 30,
(in thousands)
2020 2019
Product revenue
AeroGardens $ 10,864 $ 3,406
Seed pod kits and accessories 6,866 1,681
Discounts, allowances and other (1,319 ) (612 )
Total $ 16,411 $ 4,475
% of total revenue
AeroGardens 66.2 % 76.1 %
Seed pod kits and accessories 41.8 % 37.6 %
Discounts, allowances and other (8.0 )% (13.7 )%
Total 100.0 % 100.0 %
AeroGarden sales increased $7.5 million , or 218.9%, from the prior year period,
reflecting: (i) increased retail channel sales as the AeroGarden gained customer
acceptance from new and existing customers in historically slower sales period,
primarily from Amazon.com, Kohl's, HomeDepot.com and BestBuy.com; (ii) increased
sales in Direct-to-consumer channels; and (iii) continued focus on specific
advertising, including pay-per-click and general awareness campaigns toward the
general population, which informed buyers about our products. The increase in
seed pod kit and accessory sales, which increased by $5.2 million , or 308.6%,
principally reflecting our prior focus on acquiring new AeroGarden customers,
who purchase seed pod kits and accessories after purchasing and using new
AeroGardens, and increases in light bulb sales for both LED lighting and CFL
lights. For the three months ended June 30, 2020 , sales of seed pod kits and
accessories represented 41.8% of total revenue, as compared to 37.6% in the
prior year period. Other revenue, which is comprised primarily of grow club
revenue, shipping revenue, accruals and deductions, decreased as a percent of
total revenue to (8.0)% from (13.7)% in the prior year period, primarily due to
select and more effective use of discounts for in-store retail accounts, which
generated higher retail sales.
Cost of Revenue
Cost of revenue for the three months endedJune 30, 2020 totaled$9.1 million , an increase of$6.0 million , or 199.8%, from the three months endedJune 30, 2019 . Cost of revenue includes product costs for purchased and manufactured products, inbound freight costs from manufacturers, costs related to warehousing and the shipping of products to customers, credit card processing fees for direct sales, and duties and customs applicable to imported products. As a percent of total revenue, cost of revenue represented 55.2% of revenue for the quarter endedJune 30, 2020 , as compared to 67.5% for the quarter endedJune 30, 2019 . The decrease in costs as a percent of revenue was primarily due to increases in sales prices as we offered fewer discounts, as well as realizing efficiencies and economies of scale in the supply chain..
Gross Profit
Our gross profit varies based upon the factors impacting net revenue and cost of revenue, as discussed above, as well as the mix of our revenue that comes from the retail, direct-to-consumer, and international channels. In a direct-to-consumer sale, we recognize as revenue the full consumer purchase price for the product. In retail and international sales, by comparison, we recognize as revenue the wholesale price that we charge to the retailer or international distributor. Media costs associated with direct sales are included in sales and marketing expenses. For international sales, margins are structured based on the distributor purchasing products by letter of credit or cash in advance, terms with the distributor bearing all of the marketing and distribution costs within its territory. As a result, international sales generally have lower gross profits than domestic retail sales. The gross profit percentage for the quarter endedJune 30, 2020 was 44.8% as compared to 32.5% for the quarter endedJune 30, 2019 . The increase in our gross profit was primarily attributable to the changes to our customer and product mix within both the retail and direct-to-consumer, driving sales without as much discounting, higher sales and resulting economies of scale. Additionally, in the prior year we had several supply chain and warehouse issues that caused friction and increased costs. Research and Development Research and development costs for the quarter endedJune 30, 2020 totaled$301,000 , an increase of$91,000 from the quarter endedJune 30, 2019 , primarily related to increased salaries and wages due to greater headcount and company-wide incentive program that scales with increased growth, and termination of the collaboration expense repayment partially offset by decreased travel and expenses related to new product development. 21
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Table of Contents Sales and Marketing Sales and marketing costs for the three months endedJune 30, 2020 totaled$2.8 million , up 100.6% from the prior year period. Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and sales order processing for our products, and consisted of the following: Three Months Ended June 30, (in thousands) 2020 2019 Advertising$ 1,331 $ 512 Personnel 1,057 491 Sales commissions 48 9 Travel 2 66 Media production and promotional products 1 7 Quality control and processing fees 69 33 Market research 91 50 Other 216 236$ 2,815 $ 1,404 Advertising expense is composed primarily of catalogue development, production, printing, and postage costs, web media expenses for search and affiliate web marketing programs, and the cost of developing and employing other forms of advertising. Each is a key component of our integrated marketing strategy because it helps build consumer awareness and demand for our products in the retailer and direct-to-consumer sales channels. Total advertising expense was$1.3 million for the quarter endedJune 30, 2020 , a year-over-year increase of 159.7%, or$818,000 , primarily due to increased spending on pay-per click advertising, general brand awareness and marketing, and email campaigns. Sales and marketing personnel costs include salaries, payroll taxes, employee benefits and other payroll costs for our sales, operations, customer service, graphics and marketing departments. For the three months endedJune 30, 2020 , personnel costs for sales and marketing were$1.1 million , up$567,000 or 115.5% from the three months endedJune 30, 2019 . The increase reflected the company-wide incentive program that scales as growth increases, increased employee headcount and related benefits. Other marketing expenses increased year-over-year as we continue to grow our business and increase market research and other programs, including the use of third party agencies for sales planning.
General and Administrative
General and administrative costs for the three months endedJune 30, 2020 totaled$1.6 million , as compared to$894,000 for the three months endedJune 30, 2019 , an increase of 76.0%, or$680,000 . The increase was primarily attributable to increased salaries and wages including the company-wide incentive program that scales as growth increases, consulting and legal fees associated with strategic alternatives intended to maximize shareholder value, and IT services as we expand our web based experience and bad debt and depreciation expenses. Operating Income and Loss Our operating income for the three months endedJune 30, 2020 was$2.7 million , an increase of$3.7 million from the$1.1 million operating loss for the three months endedJune 30, 2019 . The increased operating income was attributable to increased margins on our higher sales, partially offset by increases in marketing and brand awareness advertising expenses, a company-wide incentive program, and use of outside consultants.
Net Income and Loss
For the three months endedJune 30, 2020 , we recorded a net income of$2.6 million , a$3.7 million increase over the$1.1 million net loss for the three months endedJune 30, 2019 . The increase in the net income is primarily a result of increased margins on increased sales volume in the current year period, partially offset by increases in sales and marketing expenses designed to continue growing brand awareness and outside consulting fees.
Segment Results
We report our segment information in the same way that management assesses the business and makes decision regarding the allocations of resources in accordance with the Segment Reporting Topic of theFinancial Accounting Standards Board Accounting Standards Codification (ASC). Factors considered in determining our reportable segments include the nature of the business activities, the reports provided to the Company's chief operating decision maker (CODM) for operating and administrative activities, available information and information that is presented to our Board of Directors. 22
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The Company's CODM has been identified as the Chief Executive Officer because he has final authority over the performance assessment and resource allocation decisions. The CODM: (i) regularly receives discrete financial information about each reportable segment, (ii) uses all such information for performance assessment and resource allocation decisions; and (iii) evaluates the performance of and allocates resources based upon the contribution margins of each segment.
As a result, we divide our business into two reportable segments: Direct-to-Consumer and Retail. This division of reportable segments is consistent with how the segments report to and are managed by the chief operating decision maker of the Company. The Company evaluates performance based on the primary financial measure of contribution margin ("segment profit"). Segment profit reflects the income or loss from operations before corporate expenses, non-operating income, net interest expense, and income taxes.
Three Months Ended June 30, 2020
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 9,056 $ 7,355 $ - $ 16,411
Cost of revenue 4,854 4,200 - 9,054
Gross profit 4,202 3,155 - 7,357
Gross profit percentage 46.4 % 42.9 % - 44.8 %
Sales and marketing (1) 1,073 351 214 1,638
Segment profit 3,129 2,804 (214 ) 5,719
Segment profit percentage 34.6 % 38.1 % - 34.8 %
(1) Sales and marketing expense includes advertising, trade shows, media
production and promotional products and other as discussed in the sales and
marketing section.
Three Months Ended June 30, 2019
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 1,902 $ 2,573 $ - $ 4,475
Cost of revenue 1,389 1,631 - 3,020
Gross profit 513 942 - 1,455
Gross profit percentage 27.0 % 36.6 % - 32.5 %
Sales and marketing (1) 109 521 176 806
Segment profit 404 421 (176 ) 649
Segment profit percentage 21.2 % 16.4 % - 14.5 %
(1) Sales and marketing expense includes advertising, trade shows, media production and promotional products and other as discussed in the sales and marketing section.
Liquidity and Capital Resources
After adjusting the net income for non-cash items and changes in operating assets and liabilities, net cash provided by operating activities totaled$1.4 million for the three months endedJune 30, 2020 , as compared to cash used of$309,000 for the three months endedJune 30, 2019 . Non-cash items, comprising depreciation, amortization, bad debt allowances, accretion of debt association with sale of intellectual property and inventory allowances, totaled to a net gain of$444,000 for the three months endedJune 30, 2020 , as compared to a net gain of$137,000 in the prior year period. The increase reflected non-cash charges arising from all of the non-cash expenses. Changes in current assets used net cash of$3.6 million during the three months endedJune 30, 2020 , principally from increases in inventory, prepaid assets and accounts receivable, as we continue to order inventory to support the sales growth and begin to prepare for our fall sales programs. As ofJune 30, 2020 , the total inventory balance was$6.3 million , representing approximately 74 days of sales activity, and 64 days of sales activity, at the average daily rate of product cost expensed during the twelve months and three months endedJune 30, 2020 , respectively. The three months' days in inventory calculation is based on the three months of sales activity and can be greatly impacted by the seasonality of our sales, which have historically been at their highest level during the quarter endingDecember 31 . The twelve months' days in inventory calculation is based on the twelve months of sales activity and is less impacted by the seasonality of our sales. 23
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Current operating liabilities increased$1.9 million during the three months endedJune 30, 2020 , principally because of increases in accounts payable and accrued expenses. Accounts payable as ofJune 30, 2020 totaled$6.0 million , representing approximately 46 days of daily expense activity, and 40 days of daily expense activity, at the average daily rate of expenses incurred during the twelve months and three months endedJune 30, 2020 , respectively.
Net investing activity used
Cash
As ofJune 30, 2020 , we had a cash balance of$10.3 million , of which$15,000 was restricted as collateral for various corporate obligations. This compares to a cash balance of$9.1 million as ofMarch 31, 2020 , of which$15,000 was restricted. Borrowing Agreements As ofJune 30, 2020 andMarch 31, 2020 , we have$900,000 of outstanding long-term debt, respectively. See Note 3 related to the Real Estate Term Loan Agreements withScotts Miracle-Gro and Note 10 for subsequent events. As ofJune 30, 2020 andMarch 31, 2020 , the outstanding balance of our note payable and debt, including accrued interest, was as follows: June 30, March 31, 2020 2020 (in thousands) (in thousands) Notes payable and debt-related party $ 915 $
915
Total notes payable and debt 915
915
Less current portion - long term debt 15 15 Long term debt $ 900 $ 900 Cash Requirements We generally require cash to:
? fund our operations and working capital requirements;
? develop and execute our product development and market introduction plans;
? execute our sales and marketing plans;
? fund research and development efforts; and
? pay debt obligations as they come due.
At this time, we do not expect to enter into additional capital leases to finance major purchases. In addition, we do not currently have any binding commitments with third parties to obtain any material amount of equity or debt financing other than the financing arrangements described in this report.
Assessment of Future Liquidity and Results of Operations
Liquidity
To assess our ability to fund ongoing operating requirements, we developed assumptions regarding operating cash flow. Critical sources of funding, and key assumptions and areas of uncertainty include:
? our cash of
our various corporate obligations) as of
? our cash of
our various corporate obligations) as of
? continued support of, and extensions of credit by, our suppliers and lenders;
? our historical pattern of increased sales between September and March, and
lower sales volume from April through August;
? the level of spending necessary to support our planned initiatives; and
? our sales to consumers, retailers, and international distributors, and the
resulting cash flow from operations, which will depend in great measure on
the success of our direct-to-consumer sales initiatives, and the acceptance
of the product at our various retail distribution customers.
Based on these facts and assumptions, we believe our existing cash and cash
equivalents, along with the Term Loan Agreement and the cash generated by our
anticipated results from operations, will be sufficient to meet our operating
needs for the next twelve months.
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Table of Contents Results of Operations
There are several factors that could affect our future results of operations. These factors include, but are not limited to, the following:
? the effectiveness of our consumer marketing efforts in generating both
direct-to-consumer sales, and sales to consumers by our retailer customer;
? uncertainty regarding the impact of macroeconomic conditions on consumer
spending;
? uncertainty regarding the capital markets and our access to sufficient
capital to support our current and projected scale of operations;
? the seasonality of our business, in which we have historically experienced
higher sales volume in the five-month period from September through
January;
? a continued, uninterrupted supply of product from our third-party
manufacturing suppliers in China ;
? the success of
? uncertainty of appropriate exit strategies with retail customers regardless
of the contractual obligations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interest in transferred assets, and have not entered into any contracts for financial derivative such as futures, swaps, and options.
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