AEROGROW INTERNATIONAL, INC. The discussion contained herein is for the three and six months endedSeptember 30, 2020 andSeptember 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 endedSeptember 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. 20
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OnAugust 3, 2020 , the Company entered into a Working Capital Term Loan Agreement in the principal amount of up to$7.5 million withScotts Miracle-Gro . The proceeds will be made available as needed in increments of$500,000 , and the Company may pay down and reborrow during the Term Loan, not to exceed$7.5 million with a due date ofJune 30, 2021 . The Term Loan Agreement is secured by a lien on the assets of the Company. Interest will be charged at the stated rate of 10% per annum and will be paid, in cash, quarterly in arrears at the end of each September, December, March and June. The funding provides general working capital and is being used to acquire inventory in advance of the Company's peak selling season for our retail and its direct-to-consumer sales channels. See Note 3 "Notes Payable, Long Term Debt and Current Portion - Long Term Debt" to our condensed financial statements. As reported in a Current Report on Form 8-K filed with theSEC onOctober 8, 2020 , the Company entered a non-binding Letter of Intent ("LOI") withThe Scotts Miracle-Gro , datedOctober 2, 2020 , setting forth the terms for a transaction in which Scotts would acquire all of the outstanding shares of Common Stock it does not currently own, subject to the satisfaction of various customary conditions. The LOI provides that the transaction would be structured as a merger pursuant to which the shareholders ofAeroGrow other than Scotts would receive consideration of$3.00 per share in cash. As reported in a Current Report on Form 8-K filed with theSEC onNovember 12, 2020 ,AeroGrow International, Inc. , aNevada corporation (the "Company"), entered into an Agreement and Plan of Merger (the "Merger Agreement") withSMG Growing Media, Inc. , anOhio corporation ("Parent"),AGI Acquisition Sub, Inc. , aNevada corporation and direct, wholly-owned subsidiary of Parent ("Merger Sub" and, together with Parent, the "Purchaser Parties"), and, solely for the purposes stated in Section 6.4 of the Merger Agreement,The Scotts Miracle-Gro Company , anOhio corporation ("Scotts Miracle-Gro"), relating to the proposed acquisition of the Company by Parent. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Merger Sub will be merged with and into the Company (the "Merger") with the Company continuing as the surviving corporation in the Merger, and, at the effective time of the Merger (the "Effective Time") each share of common stock of the Company, par value$0.001 per share (the "Common Stock") (other than Excluded Shares and Dissenting Shares (each as defined in the Merger Agreement)), issued and outstanding immediately prior to the Effective Time will be automatically converted into the right to receive$3.00 in cash, without interest thereon and subject to any required withholding of taxes (the "Merger Consideration"), and will be cancelled. Results of Operations
Three Months Ended
Summary Overview
Sales results during the first six months of our fiscal year (April-September), are historically variable and can be impacted by load-in timing before the holiday season, which fluctuates year to year, however, for the current year our sales growth is driven primarily by continued strength of the business, customer acceptance and knowledge of the category, and growing demand for our product and sales to a new accountBestBuy . For the three months endedSeptember 30, 2020 , total revenue was$14.3 million , an increase of 223.5%, or$9.9 million , relative to the same period in the prior year. The increase was due to continued sales into the online channels, including Amazon.com, Kohls.com, Canadian Tire andBestBuy , as well as increased interest in indoor gardening, at-home meal preparation and access to healthy, safe and fresh food. Additionally, sales in our direct-to-consumer channel increased 210.2%, or$3.4 million , primarily due to continued momentum from our general advertising and marketing campaign, and an increase in our established user base. In addition to our continued momentum from prior periods, as we saw amplified demand in the indoor gardening market from customers seeking healthy, fresh food. For the three months endedSeptember 30, 2020 , total dollar sales of AeroGarden units increased by 269.2% from the prior year period due to increased sales in the retail and direct-to-consumer channels and earlier ordering for programs with existing customers, in advance of the peak holiday season. Seed pod kit and accessory sales increased by 106.3% over prior year period as our established base of AeroGardeners continues to grow. AeroGarden sales, net of allowances, represented 76.3% of total revenue, as compared to 62.8% in the prior year period. This percentage increase, on a product line basis, was attributable to timing of sales to retail accounts, as discussed above. Seed pod kit and accessory sales increased$1.7 million or 106.3%. As a percent of total sales, seed pod kit and accessory sales decreased to 23.7% from 37.2%, primarily due to a large increase in the purchase of an AeroGarden. 21
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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. During the three months endedSeptember 30, 2020 , we incurred$1.6 million in advertising expenditures, a$1.2 million or 278.7% year-over-year increase compared to the prior year period. This was primarily due to an increase in our direct-to-consumer pay-per-click and retail marketing campaigns and expanded digital marketing. The advertising expenditures were divided as follows:
? Direct-to-consumer advertising increased
during the three months ended
an increase in spending from pay-per-click and digital display advertising
campaigns such as Google Ads and Facebook. Efficiency, as measured by
dollars of direct-to-consumer sales generated per dollar of related
advertising expense, decreased to
30, 2020, as compared to $17.50 for the same period in Fiscal 2020.
? Retail advertising increased $518,000 from $339,000 to $857,000 for the
three months ended
as the Company continued to invest in driving product awareness through: (i)
platforms made available by our retailers; (ii) various promotional programs
to increase product awareness with our housewares channel of retail
accounts, including catalogues and email campaigns; and (iii) web-based
advertising programs (e.g. including online retail catalogues, website
banner ads, email blasts, targeted search campaigns, etc.).
Our gross profit percentage for the three months ended September 30, 2020 was
41.3%, up from 33.1% in the prior year period due to higher demand during the
COVID pandemic, and increased sales prices, , fewer planned discount programs in
our sales channels due to lower inventory levels, and supply chain efficiencies
that were not in place in the prior year.
In aggregate, our total operating expenses increased 80.8% or
? A
on our company-wide incentive that scales as our growth increases and an
increase in headcount; ? A$174,000 increase in legal and consulting expenses, as the Company
considers and analyzes strategic alternatives proposed by
and ? A$78,000 increase in bad debt and depreciation expense.
These increases were partially offset by:
? A
office related expenses, such as repairs and maintenance, telephone, courier
fees, and new product testing and development; and
? A
Due to the increased order volume driven by better marketing and earlier load-in orders, and decreased operating expenses as a percentage of revenue, we generated an operating income of$1.3 million for the three months endedSeptember 30, 2020 , as compared to operating loss of$1.1 million in the prior year period. Other expense for the three months endedSeptember 30, 2020 andSeptember 30, 2019 totaled to a net other expense of$53,000 in both periods. The net other expense is primarily attributable to foreign exchange losses and interest expense on the outstanding loan. The net income for the three months endedSeptember 30, 2020 increased to$1.3 million , as compared to a loss of$1.1 million in the prior year. The increase in net income resulted from increases in overall sales in retail accounts, primarily due to more pre-holiday load-in sales to retailers, increased direct-to-consumer sales, along with increased gross margins, and decreased operating expenses as a percentage of revenue. 22
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The following table sets forth, as a total percentage of sales, our financial results for the three months endedSeptember 30, 2020 and the three months endedSeptember 30, 2019 : Three Months Ended September 30, 2020 2019 Net revenue Direct-to-consumer 35.3 % 36.8 % Retail 64.3 % 61.6 % International 0.4 % 1.6 % Total net revenue 100.0 % 100.0 % Cost of revenue 58.7 % 66.9 % Gross profit percentage 41.3 % 33.1 % Operating expenses Research and development 2.1 % 6.3 % Sales and marketing 20.2 % 30.9 % General and administrative 9.8 % 20.2 % Total operating expenses 32.1 % 57.4 % Profit (loss) income from operations 9.2 % (24.3 )% Revenue For the three months endedSeptember 30, 2020 , revenue totaled$14.3 million , a year-over-year increase of 223.5% or$9.9 million , from the three months endedSeptember 30, 2019 . Three Months Ended September 30, (in thousands) Net Revenue 2020 2019 Direct-to-consumer$ 5,051 $ 1,628 Retail 9,205 2,725 International 54 70 Total$ 14,310 $ 4,423 Direct-to-consumer sales for the three months endedSeptember 30, 2020 totaled$5.1 million , up$3.4 million or 210.2% 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. We continued 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 endedSeptember 30, 2020 totaled$9.2 million , up$6.5 million from the prior year period, principally reflecting organic growth in our existing retail accounts, namely Amazon.com, Kohl's and Canadian Tire, earlier program load-in sales with Woot!, and sales to one new account, Best Buy, in advance of the peak holiday season. International sales totaled$54,000 , down from$70,000 in the prior year period. 23
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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 September 30,
(in thousands)
2020 2019
Product revenue
AeroGardens $ 12,565 $ 3,403
Seed pod kits and accessories 3,393 1,644
Discounts, allowances and other (1,648 ) (624 )
Total $ 14,310 $ 4,423
% of total revenue
AeroGardens 87.8 % 76.9 %
Seed pod kits and accessories 23.7 % 37.2 %
Discounts, allowances and other (11.5 )% (14.1 )%
Total 100.0 % 100.0 %
AeroGarden sales increased $9.2 million , or 269.2%, from the prior year period,
reflecting: (i) increased retail channel sales as the AeroGarden gained customer
acceptance from new and existing customers, primarily Amazon.com, Kohl's, Woot!
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, from $1.6
million to $3.4 million , principally reflects the overall increase in our
established base of AeroGardens and sales to retail customers at
brick-and-mortar stores. For the three months ended September 30, 2020 , sales of
seed pod kits and accessories represented 23.7% of total revenue, as compared to
37.2% in the prior year period, as a result of the significant increase in the
AeroGarden retail sales in the current year. Other revenue, which is comprised
primarily of grow club revenue, shipping revenue, accruals and deductions,
decreased as a percent of the total to (11.5)% from (14.1)% in the prior year
period, due to lower estimated returns and select and more effective use of
discounts for in-store retail accounts.
Cost of Revenue
Cost of revenue for the three months endedSeptember 30, 2020 totaled$8.4 million , an increase of$5.4 million from the three months endedSeptember 30, 2019 , due to increased sales volume. Cost of revenue includes product costs for purchased and manufactured products, freight costs for inbound freight 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 58.7% of revenue as compared to 66.9% for the quarter endedSeptember 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. In the prior year, we generated a disproportionate amount of sales related to specific deals, such as Amazon's Prime Day, which typically have compressed margins, one-time fees related to establishing a new warehouse location, and additional warehouse fees for product preparation, which did not occur in the current period.
Gross Profit
Our gross profit varies based upon the factors affecting 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 for the product that we charge to the retailer or international distributor. Media costs associated with direct sales are included in sales and marketing expenses. As a result, international sales generally have lower gross margins and retailer margins will fluctuate with changes in programs designed to drive sales. The gross profit percentage for the quarter endedSeptember 30, 2020 was 41.3% as compared to 33.1% for the quarter endedSeptember 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 experienced several supply chain and warehouse issues that caused friction and increased costs. 24
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Table of Contents Research and Development
Research and development costs for the quarter ended
The
increase reflects a
Sales and Marketing
Sales and marketing costs for the three months endedSeptember 30, 2020 totaled$2.9 million , as compared to$1.4 million for the three months endedSeptember 30, 2019 , an increase of 111.0%, or$1.5 million . Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and sales order processing for our products, and consisted of the following: Three Months Ended September 30, (in thousands) 2020 2019 Advertising$ 1,636 $ 432 Personnel 972 494 Sales commissions 12 14 Trade shows - 1 Market research 13 94 Travel 2 90 Media production and promotional products 18 22 Quality control and processing fees 69 50 Other 166 172$ 2,888 $ 1,369
Advertising expense is principally comprised of the costs of development,
production, printing and postage for catalogue mailing, web media costs for
search and affiliate web marketing programs, and developing and employing other
forms of advertising. Each of these are key components of our integrated
marketing strategy that aims to build consumer awareness and demand for our
products in the retailer and direct-to-consumer sales channels. Advertising
expense totaled
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 endedSeptember 30, 2020 , personnel costs for sales and marketing were$972,000 , up$477,000 or 96.6% from the three months endedSeptember 30, 2019 . The increase reflected the company-wide incentive program estimate, which is based on a comparison of current year and prior year sales, the creation of new retail support roles and a related increase in employee benefits for those employees. Personnel expenses include all related payroll expenses, including incentive programs, salaries, bonuses and employee benefits.
Other marketing expenses decreased year-over-year principally because of decreases in travel and fewer market research programs.
General and Administrative
General and administrative costs for the three months endedSeptember 30, 2020 totaled$1.4 million , as compared to$893,000 for the three months endedSeptember 30, 2019 , an increase of 57.4%, or$513,000 . The increase was primarily attributable to increased salaries and wages attributable to a company-wide incentive program that scales with sales growth, consulting and legal fees and IT services as we expand our web based experience and bad debt and depreciation expenses, partially offset by decreases in travel expenses and general office categories including repairs and maintenance.
Operating Income and Loss
Our operating income for the three months endedSeptember 30, 2020 was$1.3 million , an increase of$2.4 million from the operating loss of$1.1 million for the three months endedSeptember 30, 2019 . The increased income reflected higher sales in all channels and gross margins, as discussed in greater detail above. 25
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Table of Contents Net Income and Loss For the three months endedSeptember 30, 2020 , we recorded a net income of$1.3 million as compared to a net loss of$1.1 million for the three months endedSeptember 30, 2019 . 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. 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 September 30, 2020
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 5,051 $ 9,259 $ - $ 14,310
Cost of revenue 3,059 5,344 - 8,403
Gross profit 1,992 3,915 - 5,907
Gross profit percentage 39.4 % 42.3 % - 41.3 %
Sales and marketing (1) 783 891 159 1,833
Segment profit 1,209 3,024 (159 ) 28.5
Segment profit percentage 23.9 % 32.7 % - 28.5 %
(1) Sales and marketing expense includes advertising, trade shows, media
production and promotional products and other as discussed in the sales and
marketing section.
Three Months Ended September 30, 2019
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 1,628 $ 2,795 $ - $ 4,423
Cost of revenue 920 2,038 - 2,958
Gross profit 708 757 - 1,465
Gross profit percentage 43.5 % 27.1 % - 33.1 %
Sales and marketing (1) 110 463 147 720
Segment profit 598 294 (147 ) 745
Segment profit percentage 36.7 % 10.5 % - 16.8 %
(1) Sales and marketing expense includes advertising, trade shows, media production and promotional products and other as discussed in the sales and marketing section.
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Six Months Ended
Summary Overview
Sales results during the first six months of our fiscal year (April-September), are historically variable and can be impacted by the timing of load-in sales in advance of the peak holiday season, which fluctuates year to year. In certain years there are also differences due to timing of load-in of holiday stock sales at many retail accounts as these customers will take load-in orders as early or later as they had in the prior year. Retail sales results in advance of the holiday peak season have historically fluctuated between the first six months of our fiscal year (April-September) and the first nine months of the year (April-December). However, for the current year our sales growth is driven primarily by continued strength of the business, customer acceptance and knowledge, growing demand for our product, increased interest during the pandemic in indoor gardening, at-home meal preparation and access to fresh, safe food sources, and sales to a new accountBestBuy . For the six months endedSeptember 30, 2020 , total revenue was$30.7 million , up 245.3%, or$21.8 million , relative to the same period in the prior year. The increase was primarily due to continued sales into the existing online channels, including Amazon.com, Kohls.com, HomeDepot.com, Woot!, sales to new accounts, including BestBuy.com, as well as increased enthusiasm about indoor gardening and healthy, safe and fresh food. In addition to the increase in retail sales, sales in our direct-to-consumer channels increased by 299.6%, or$10.6 million , primarily due to more visibility and continued momentum from our general advertising and marketing campaign, increased user base and our increased visibility, continued momentum from prior periods, and amplified demand in the indoor gardening market from customers seeking healthy, fresh food. For the six months endedSeptember 30, 2020 , total sales of AeroGarden units increased by 244.1% from the prior year period and seed pod kit and accessory sales increased by 208.5% over prior year period. AeroGarden sales, net of allowances, represented 66.6% of total revenue, as compared to 62.6% in the prior year period. This percentage increase, on a product line basis, was attributable to a growth in existing customer accounts, and to a lesser extent the timing of load-in programs in advance of the peak holiday season, as discussed above. Total dollar sales of seed pod kits and accessories increased by$6.9 million or 208.5%. As a percentage of total sales, seed pod kit and accessory sales decreased from 37.4% in the prior year period to 33.4%, primarily as a result of the increase in the amount of AeroGarden sales. During the six months endedSeptember 30, 2020 , we spent$3.0 million in advertising expenditures, a year-over-year increase of$2.0 million , or 214.1%, compared to the same period endedSeptember 30, 2019 . These expenditures were divided as follows:
? Direct-to-consumer advertising increased
the six months ended
specific pay-per-click advertising geared toward the direct-to-consumer
customer base and direct advertising campaigns. Efficiency, as measured by
dollars of direct-to-consumer sales per dollar of related advertising
expense decreased to
compared to $18.80 for the same period in Fiscal 2020.
? Retail advertising increased to $1.2 million for the six months ended
September 30, 2020 from $756,000 for the six months ended September 30 ,2019, as we invested in: (i) platforms made available by our retailers; (ii)
various promotional programs to increase product awareness with our retail
housewares channel, including catalogues and email campaigns; and (iii)
web-based advertising programs (e.g. inclusion in online retail catalogues,
website banner ads, email blasts, targeted search campaigns, etc.).
Our gross profit for the six months ended September 30, 2020 , was 43.2%, up from
32.8% in the prior year period. The increase in the gross profit percentage is
due to increased demand and sales volume to higher margin customers, fewer
planned discount programs in our sales channels due to lower inventory levels,
economies of scales and supply chain efficiencies that were not in place in the
prior year. The prior year included several one-time fees related to set up of a
new warehouse to serve select retail customers.
In aggregate, our total operating expenses increased 83.9%, or
? a
? a
company-wide incentive program that scales as our growth increases and an
increase in headcount to support higher sales volume;
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? a
consideration and analysis of strategic alternatives posed by Scotts
Miracle-Gro; and
? a
These increases were partially offset by a$247,000 decrease in company-wide travel. Our operating income increased$6.1 million to$4.0 million for the six months endedSeptember 30, 2020 , from an operating loss of$2.1 million in the prior year period, primarily as a result of increased sales with existing customers, sales to new customers, decreased operating expenses as a percentage of revenue and increased margins. Other expense for the six months endedSeptember 30, 2020 totaled to a net other expense of$73,000 , as compared to net other expense of$59,000 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 loans. In the prior year period, net other expense was primarily attributable to interest expense, offset by foreign exchange gains. The net income for the six months endedSeptember 30, 2020 was$3.9 million , as compared to the$2.2 million loss in the prior year. The increased net income is due to increases in overall sales, for both retail accounts direct-to-consumer sales, along with increased gross margins, and decreased operating expenses as a percentage of revenue. The following table sets forth, as a total percentage of sales, our financial results for the six months endedSeptember 30, 2020 , and the six months endedSeptember 30, 2019 : Six Months Ended September 30, 2020 2019 Net revenue Direct-to-consumer 45.9 % 39.7 % Retail 53.3 % 58.1 % International 0.8 % 2.2 % Total net revenue 100.0 % 100.0 % Cost of revenue 56.8 % 67.2 % Gross profit 43.2 % 32.8 % Operating expenses Research and development 1.9 % 5.5 % Sales and marketing 18.6 % 31.1 % General and administrative 9.7 % 20.1 % Total operating expenses 30.2 % 56.7 %
Income (loss) income from operations 13.0 % (23.9 )%
Revenue For the six months endedSeptember 30, 2020 , revenue totaled$30.7 million , a year-over-year increase of 245.3% or$21.8 million , from the six months endedSeptember 30, 2019 . Six Months Ended September 30, (in thousands) Net Revenue 2020 2019 Direct-to-consumer$ 14,107 $ 3,530 Retail 16,385 5,168 International 229 200 Total$ 30,721 $ 8,898 28
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Direct-to-consumer sales for the six months endedSeptember 30, 2020 , totaled 14.1 million, up$10.6 million or 299.6%, 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. We continued driving direct-to-consumer awareness during our non-peak season through our focus on advertising that drives increased direct-to-consumer awareness, better promotional scheduling, 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 six months endedSeptember 30, 2020 , totaled$16.4 million , up$11.2 million , or 217.0%, from the prior year period, principally reflecting: (i) organic growth in our existing retail accounts, namely Amazon.com, Kohl's and Canadian Tire; (ii) earlier program load-in with Woot!; and (iii) sales to one new account, Best Buy, all of which began in advance of the peak holiday season. Historically, load-in sales in advance of the peak holiday season to both online and brick-and-mortar stores vary between this quarter and the next quarter.
International sales for the six months ended
Our products consist of AeroGardens, and seed pod kits and accessories. A
summary of the sales of these two product categories for the six months ended
Six Months Ended
September 30,
2020 2019
Product revenue (in thousands) (in thousands)
AeroGardens $ 23,429 $ 6,809
Seed pod kits and accessories 10,259 3,325
Discounts, allowances and other (2,967 ) (1,236 )
Total $ 30,721 $ 8,898
% of total revenue
AeroGardens 76.3 % 76.5 %
Seed pod kits and accessories 33.4 % 37.4 %
Discounts, allowances and other (9.7 )% (13.9 )%
Total 100.0 % 100.0 %
AeroGarden sales increased $16.6 million , or 244.1%, from the prior year period,
reflecting an increase in the organic growth from existing customers, demand of
customers seeking healthy, safe gardening items and sales of AeroGardens in our
direct-to-consumer channel. The increase in seed pod kit and accessory sales,
which increased by $6.9 million , or 208.5%, principally reflects the continued
focus on acquiring new AeroGarden customers, who have historically purchased
seed pod kits and accessories after purchasing and using new AeroGardens. For
the six months ended September 30, 2020 , sales of seed pod kits and accessories
represented 33.4% of total revenue, as compared to 37.4% in the prior year
period. The percentage decrease is due to the relatively larger increase in
AeroGarden purchases. Other revenue, which is comprised primarily of grow club
revenue, shipping revenue, accruals and deductions, decreased as a percent of
the total to (9.7)% from (13.9)% in the prior year period due to lower retail
sales estimated returns, deductions for sales allowances and future discounts
for in-store retail accounts.
Cost of Revenue
Cost of revenue for the six months ended September 30, 2020 totaled $17.5
million , an increase of $11.5 million , from the six months ended September 30,
2019 , due to increased sales volume. Cost of revenue includes product costs for
purchased and manufactured products, freight costs for inbound freight 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 56.8% of revenue as compared to 67.2% for the prior year period.
Gross Profit
Our gross profit varies based upon the factors affecting 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 for the product that we charge to the
retailer or international distributor. Media costs associated with direct sales
are included in sales and marketing expenses. As a result, retail and
international sales generally have lower gross profits than direct-to-consumer
sales. The gross profit for the six months ended September 30, 2020 , was 43.2%
as compared to 32.8% for the six months ended September 30, 2019 . The increase
in our gross profit percentage was primarily due to changes in customer demand
and product mix within both the retail and direct-to-consumer channels, driving
sales without as much discounting, higher overall sales volume and economies of
scale in our supply chain.
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Table of Contents Research and Development Research and development costs for the six months endedSeptember 30, 2020 , totaled$595,000 , an increase of 22.3%, or$108,000 , from the six months endedSeptember 30, 2019 . The increase reflects increases in personnel expenses for new employees and a company-wide incentive program that scales with growth in sales, partially offset by decreases in travel, new product testing and certifications. Sales and Marketing Sales and marketing costs for the six months endedSeptember 30, 2020 , totaled$5.7 million , as compared to$2.8 million for the six months endedSeptember 30, 2019 , an increase of 105.7%, or$2.9 million . Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and sales order processing for our products, and consisted of the following: Six Months Ended September 30, (in thousands) 2020 2019 Advertising$ 2,967 $ 944 Personnel 2,029 985 Sales commissions 60 23 Trade shows - 1 Market research 105 145 Travel 4 156
Media production and promotional products 19 29 Quality control and processing fees
139 82
Other 380 407
$ 5,703 $ 2,772
Advertising expense totaled $3.0 million for the six months ended September 30,
2020 , a year-over-year increase of 214.1%, or $2.0 million , primarily due to
increased spending on general brand awareness advertising and marketing,
promotional programs within our retail channel, email campaigns, and pay-per
click advertising.
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 six months ended September 30, 2020 ,
personnel costs for sales and marketing were $2.0 million , up from $985,000 for
the six months ended September 30, 2019 , an increase of 106.0%. The increase
primarily reflected the company-wide incentive program that scales with growth
in sales, the creation of new retail support roles and a related increase in
employee benefits for those employees. Personnel expenses include all related
payroll expenses, including incentive programs, bonuses and employee benefits.
Other marketing expenses decreased year-over-year due to decreased travel and fewer market research and retailer marketing programs.
General and Administrative
General and administrative costs for the six months endedSeptember 30, 2020 , totaled$3.0 million , as compared to$1.8 million for the six months endedSeptember 30, 2019 , an increase of 66.7%, or$1.2 million . The increase is attributable to increases in: (i) salaries and wages including the company-wide incentive program that scales with sales growth; (ii) consulting and legal fees associated with consideration and analysis of strategic alternatives intended to maximize shareholder value; (iii) IT services as we expand our web based experience; and (iv) bad debt and depreciation expense. These increases were partially offset by decreases in a Company-wide travel.
Operating Income and Loss
Operating income for the six months endedSeptember 30, 2020 was$4.0 million , an increase of$6.1 million from the operating loss of$2.1 million for the six months endedSeptember 30, 2019 . The increase in operating income was attributable to increase sales in the retail and direct-to-consumer sales channels, increased gross margin and economies of scale, which resulted in a reduction in operating expenses as a percentage of revenue.
Net Income and Loss
The net income for the six months ended
30
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Table of Contents Segment Results
We report our segment information in the same way that management assesses the business and makes decision regarding the allocations of resources
Six Months Ended September 30, 2020
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 14,107 $ 16,614 $ - $ 30,721
Cost of revenue 7,913 9,544 - 17,457
Gross profit 6,194 7,070 - 13,264
Gross profit percentage 43.9 % 42.6 % - 43.2 %
Sales and marketing (1) 1,857 1,242 372 3,471
Segment profit 4,337 5,828 (372 ) 1,395
Segment profit percentage 30.7 % 35.1 % - 31.9 %
(1) Sales and marketing includes advertising, trade shows, media production and promotional products and other as discussed in the sales and marketing section.
Six Months Ended September 30, 2019
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 3,530 $ 5,368 $ - $ 8,898
Cost of revenue 2,309 3,668 - 5,977
Gross profit 1,221 1,700 - 2,921
Gross profit percentage 34.6 % 31.7 % - 32.8 %
Sales and marketing (1) 142 1,065 319 1,526
Segment profit 1,079 635 (319 ) 1,395
Segment profit percentage 30.6 % 11.8 % - 15.7 %
(1) Sales and marketing 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, the net cash used by operating activities totaled$5.9 million for the six months endedSeptember 30, 2020 , as compared to cash used of$4.7 million in the prior year period. Non-cash items, comprising depreciation, amortization, bad debt allowances, accretion of debt associated with sale of intellectual property and inventory allowances, totaled to a net gain of$740,000 for the six months endedSeptember 30, 2020 , as compared to a net gain of$331,000 in the prior year period. The increase reflected charges arising from all non-cash expense categories. Changes in current assets used net cash of$13.7 million during the six months endedSeptember 30, 2020 , principally from increases in inventory, prepaid and deposit balances as we ramp up for our peak sales season, which historically begins in the second and third fiscal quarter. As ofSeptember 30, 2020 , the total inventory balance was$12.8 million , representing approximately 128 days of sales activity, and 140 days of sales activity, at the average daily rate of product cost expensed during the twelve months and three months endedSeptember 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. Current operating liabilities increased$3.1 million during the six months endedSeptember 30, 2020 , principally because of an increase in accounts payable. Accounts payable as ofSeptember 30, 2020 , totaled$6.6 million , representing approximately 45 days of daily expense activity, and 47 days of daily expense activity, at the average daily rate of expenses incurred during the twelve months and three months endedSeptember 30, 2020 , respectively. 31
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Net investment activity used$1.2 million of cash in the current year period, principally due to purchases of equipment as we change supply manufacturers and introduce new products. Net financing activity provided net cash of$2.0 million during the six months endedSeptember 30, 2020 , principally due to the Term Loan and payments on the capital lease. Cash As ofSeptember 30, 2020 , we had a cash balance of$3.8 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. The decrease in cash is primarily attributable to the purchase of inventory in the current quarter to meet peak season sales demand, particularly current period load-in sales with new and expanded brick-and-mortar retail customers. Borrowing Agreements As ofSeptember 30, 2020 andMarch 31, 2020 , we have$2.9 million and$900,000 , respectively, of outstanding long-term debt. We have entered into a Working Capital Term Loan Agreement in the principal amount of up to$7.5 million and Real Estate Term Loan Agreement in the principal amount of up to$1.5 million withScotts Miracle-Gro . As ofSeptember 30, 2020 andMarch 31, 2020 , the outstanding balance of our note payable and debt, including accrued interest, was as follows: September 30, March 31, 2020 2020 (in thousands) (in thousands) Notes payable and debt-related party $ 2,915 $
915
Total debt 2,915
915
Less current portion - long term debt 2,015 15 Long term debt $ 900 $ 900
After
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.
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Table of Contents
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$3.8 million ($15,000 of which is restricted as collateral for our various corporate obligations) as ofSeptember 30, 2020 ; ? our cash of$2.8 million ($15,000 of which is restricted as collateral for our various corporate obligations) as ofNovember 9, 2020 ; ? the continued support of, and extensions of credit by, our suppliers and
lenders, including, but not limited to, the Working Capital Term Loan of up
to
amount as of September 30, 2020 and November 9, 2020 , respectively;
? 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.
On August 3, 2020 , the Company entered into a Working Capital Term Loan
Agreement in the principal amount of up to $7.5 million with Scotts
Miracle-Gro . The proceeds will be made available as needed in increments of
$500,000 , the Company may pay down and reborrow during the Term Loan, not to
exceed $7.5 million with a due date of June 30, 2021 . The Term Loan Agreement is
secured by a lien on the assets of the Company and interest is charged at the
stated rate of 10% per annum to be paid quarterly in arrears in cash, at the end
of each September, December, March and June. The funds provide general working
capital and is being used for the purpose of acquiring inventory to support
anticipated growth as the Company expands its retail and its direct-to-consumer
sales channels. We have borrowed an aggregate $3.5 million as of November 9,
2020 and can reborrow amounts repaid against the $7.5 million loan in order to
purchase inventory during our peak selling season. See Note 3 "Notes Payable,
Long Term Debt and Current Portion - Long Term Debt" to our condensed financial
statements.
On June 20, 2019 , the Company entered into a Real Estate Term Loan Agreement in
the principal amount of up to $1.5 million with Scotts Miracle-Gro . The funding
provides capital to fund real estate related lease obligations. The proceeds
will be made available as needed in increments of $100,000 not to exceed $1.5
million with a due date of March 31, 2022 . Interest will be charged at the
stated rate of 10% and will be paid quarterly in arrears on each of April 30 ,
July 31 , October 31 and January 31 . As of September 30, 2020 , the Company had
borrowed $900,000 under the Real Estate Term Loan. See Note 3 "Notes Payable,
Long Term Debt and Current Portion - Long Term Debt" to our condensed financial
statements.
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 customers;
? uncertainty regarding the impact of macroeconomic conditions, including the
COVID pandemic, on consumer spending;
? uncertainty regarding the capital markets and our access to sufficientcapital to support our current and projected scale of operations; ? the seasonality of our business, in which we have historically experienced
higher sales volume during the fall and winter months (September through
March);
? a continued, uninterrupted supply of product from our third-party
manufacturing suppliers in China ;
? the success of our relationship with
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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