AEROGROW INTERNATIONAL, INC. The discussion contained herein is for the three and nine months endedDecember 31, 2020 andDecember 31, 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 endedDecember 31, 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 the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement, the failure to satisfy the closing conditions in the Merger Agreement, risks related to disruption of management's attention from our ongoing business operations due to the proposed Merger, the effect of the announcement of the proposed Merger on our ability to retain and hire key personnel and maintain relationships with our customers, suppliers, other business partners and employees, unexpected costs, liabilities or delays involving the proposed Merger, uncertainty surrounding the proposed Merger, including the timing of the consummation of the Merger, the outcome of any legal proceeding relating to the proposed Merger, other statements regarding the Merger, 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 onMarch 25, 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"). As part of the strategic alliance, we entered into several agreements withScotts Miracle-Gro , including: (i) a Securities Purchase Agreement in whichScotts Miracle-Gro invested approximately$4.0 million in the Company; (ii) a$500,000 Intellectual Property Sale Agreement; (iii) a Technology Licensing Agreement; (iv) a Brand License Agreement; and (v) a Supply Chain Management Agreement.Scotts Miracle-Gro currently owns approximately 80.5% of the Company's outstanding common stock. 19
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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. 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. ScottsMiracle-Gro Merger As reported in a Current Report on Form 8-K filed with theSEC onNovember 12, 2020 , 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 the Company's 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
For the three months endedDecember 31, 2020 , we generated$38.4 million of total net revenue, an increase of 107.1%, or$19.8 million , relative to the same period in the prior year. The current year sales growth is driven primarily by continued strength of the business, customer acceptance and knowledge, growing demand for our product, increased enthusiasm during the pandemic in indoor gardening, at-home meal preparation and access to healthy, fresh, safe food sources. Retail sales increased 76.4% to$24.0 million , primarily due to timing of load-in sales to the brick-and-mortar customers, continued strong sales with our established web/internet channels (Amazon.com, Bed, Bath & Beyond, Kohls.com,Walmart.com , etc.) and new retail accounts. Sales in our direct-to-consumer channel increased 199.8%, to$14.0 million . This increase is due to the reasons listed above, as well as the efficiency and effectiveness of our promotional programs and increases in our established user base. For the three months endedDecember 31, 2020 , total gross dollar sales of AeroGarden units increased by 98.4% from the prior year period. Seed pod kit and accessory sales increased by 90.8% or$3.2 million . AeroGarden sales, net of allowances, represented 82.6% of total revenue, as compared to 81.1% in the prior year period. Seed pod kit and accessory sales decreased as a percent of the total to 17.4% from 18.9% due to the increase in the sales of AeroGardens. This percentage decrease, on a product line basis, was attributable to the load-in of brick-and-mortar sales in the quarter, which tends initially to favor garden sales over seed pod kit or accessory sales, especially during the high demand holiday season and organic growth of the business. The decrease in sales of seed pod kits and accessories are typically dependent on prior purchases of gardens and during the peak holiday season purchases of gardens are expected. 20
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The Company continues to spend advertising dollars in order to strategically build market awareness of the AeroGrow brand, as well as the product line. During the three months endedDecember 31, 2020 , we spent$5.6 million in advertising, an increase of$2.9 million , or 105.1%, compared to the same period endedDecember 31, 2019 . This increase was primarily due to an increase in our direct-to-consumer pay-per-click and retail marketing campaigns and expanded digital advertising. Advertising expenditures included:
? Retail-specific advertising increased to
the three months ended
respectively, as the Company utilized: (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.).
? Linear TV, Online TV, Connected TV, general TV, YouTube, Facebook and other
media advertising, as the Company spent approximately
this investment as a long term commitment to increasing awareness of the
AeroGarden brand.
? Direct-to-consumer advertising increased to $1.3 million from $338,000 for
the three months ended December 31, 2020 and December 31, 2019 ,
respectively, reflecting an increase in spending for catalogues,pay-per-click campaigns, and other social media expenditures. Efficiency,
as measured by dollars of direct-to-consumer sales per dollar of related
advertising expense, decreased to
Fiscal 2020, in part due to the spillover effect of increased sales through
retail outlets.
Gross profit percentage for the three months ended December 31, 2020 was 41.1%,
up from 35.2% in the prior year period. This increase was attributable to the
following factors: (1) the introduction of new products with higher margins; (2)
improved pricing from our suppliers as compared to the prior year; and (3)
higher demand during the COVID-19 pandemic; and (4) fewer planned discount
programs in our sales channels.
In aggregate, our total operating expenses increased 108.1%, or $5.7 million ,
year-over-year, principally as a result of an increase in the activities related
to the increase in sales in the current year. The increase in gross spending was
attributable to:
? A
? A
on our company-wide incentive compensation that scales as our growth increases
and an increase in headcount;
? A
and review of Scotts
related alternatives; and
? A
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
Our operating profit was
Net other expense for the three months endedDecember 31, 2020 totaled$150,000 , as compared to net other expense of$141,000 in the prior year period. The net other expense is primarily attributable to foreign exchange losses and interest expense on the outstanding loan. Net income for the three months endedDecember 31, 2020 was$4.6 million , as compared to$1.1 million in the prior year quarter. The increase in net income is primarily a result of the overall increase in net sales and economies of scale, as discussed above. 21
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The following table sets forth, as a total percentage of sales, our financial results for the three months endedDecember 31, 2020 and the three months endedDecember 31, 2019 : Three Months Ended December 31, 2020 2019 Net revenue Direct-to-consumer 36.5 % 25.2 % Retail 62.4 % 73.3 % International 1.1 % 1.5 % Total net revenue 100.0 % 100.0 % Cost of revenue 58.9 % 64.8 % Gross profit percentage 41.1 % 35.2 % Operating expenses Research and development 1.3 % 1.7 % Sales and marketing 20.4 % 20.4 % General and administrative 7.1 % 6.6 % Total operating expenses 28.8 % 28.7 % Income (loss) from operations 12.3 % 6.5 % Revenue For the three months endedDecember 31, 2020 , revenue totaled$38.4 million , a year-over-year increase of 107.1% or$19.8 million , from the three months endedDecember 31, 2020 . Three Months Ended December 31, (in thousands) Net Revenue 2020 2019 Direct-to-consumer$ 13,988 $ 4,665 Retail 23,950 13,579 International 429 282 Total$ 38,367 $ 18,526 Direct-to-consumer sales for the three months endedDecember 31, 2020 totaled$14.0 million , up$9.3 million , or 199.8%, from the prior year period. The increase in sales through direct-to-consumer channels was due to continued momentum of growth from prior periods amplified by demand in indoor gardening of customers seeking a trustworthy food supply chain for healthy, fresh food during the COVID-19 pandemic, more effective marketing, better promotional scheduling and increased brand awareness. Sales to retailer customers for the three months endedDecember 31, 2020 totaled$24.0 million , up$10.4 million , or 76.4%, principally reflecting continued strength of the business, customer acceptance and knowledge, growing demand for our product, timing of our load-in of sales to our brick-and-mortar stores, 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 several new accounts, including Best Buy, Big Lots, Menards and Walmart, in advance of the peak holiday season. International sales totaled$429,000 , as compared to$282,000 in the prior year period, as we continue to selectively test international markets in order to understand the trends, distribution models and acceptance of our products in the international market. 22
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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 December 31,
(in thousands)
2020 2019
Product revenue
AeroGardens $ 37,397 $ 18,845
Seed pod kits and accessories 6,675 3,498
Discounts, allowances and other (5,705 ) (3,817 )
Total $ 38,367 $ 18,526
% of total revenue
AeroGardens 97.5 % 101.7 %
Seed pod kits and accessories 17.4 % 18.9 %
Discounts, allowances and other (14.9 )% (20.6 )%
Total 100.0 % 100.0 %
AeroGarden sales increased $18.6 million , or 98.4%, from the prior year period,
reflecting: (i) increased retail channel sales due to continued strength of the
business, customer acceptance and knowledge, growing demand for our product,
timing of the load-in into brick-and-mortar stores in the quarter and customer
acceptance from new and existing customers, primarily Amazon.com, Kohl's,
Canadian Tire, Costco.ca and Macy's; (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 of $3.2 million , or 90.8%, principally reflects the increase in
our established base of AeroGardens. For the three months ended December 31,
2020 , sales of seed pod kits and accessories represented 17.4% of total revenue,
as compared to 18.9% 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 (14.9)% from (20.6)% in the prior
year period, primarily due to decreases in revenue deductions for estimated
future returns and sales discounts and allowances for certain retail accounts.
At the end of each reporting period we analyze the possibility of product
returns from customers and determine if specific reserves are satisfactory or
should be adjusted and determined the customer specific reserve was appropriate.
Cost of Revenue
Cost of revenue for the three months ended December 31, 2020 totaled $22.6
million , an increase of $10.6 million , or 88.3%, from the three months ended
December 31, 2019 . Cost of revenue includes product costs for purchased and
manufactured products, duties, customs and freight costs for imported products
from manufacturers, costs related to warehousing and the shipping of products to
customers and credit card processing fees for direct sales. As a percent of
total revenue, cost of revenue represented 58.9% of revenue, as compared to
64.8% for the quarter ended December 31, 2019 . The percentage decrease was
primarily attributable to increased sales during the current quarter for
customers with a higher margin product mix, as well as efficiencies and
economies of scale in the supply chain, partially offset by higher shipping and
order fulfillment costs, as we began using additional warehouses that put us in
a better position for long-term growth.
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 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. For international sales, when we sell to a distributor, 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. We have continued to test international test markets through Amazon in various countries, so this margin model may change over time. The gross profit percentage for the quarter endedDecember 31, 2020 was 41.1%, as compared to 35.2% for the quarter endedDecember 31, 2019 . The increase in our gross profit was primarily due to the shift to retailers with higher margin products in both the retail and direct-to-consumer channels, reduced discounting, higher sales and resulting economies of scale. 23
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Table of Contents Research and Development Research and development costs for the quarter endedDecember 31, 2020 totaled$454,000 , an increase of$147,000 from the quarter endedDecember 31, 2019 . The increase was due to increased R&D headcount and related incentive compensation, which scales with growth of the Company, partially offset by decreased travel and expenses related to new product development product testing and certifications. Sales and Marketing Sales and marketing costs for the three months endedDecember 31, 2020 totaled$7.9 million , as compared to$3.8 million for the three months endedDecember 31, 2019 , an increase of 107.9%. Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and order processing for our products, and consisted of the following: Three Months Ended December 31, (in thousands) 2020 2019 Advertising$ 5,585 $ 2,723 Personnel 1,721 571 Sales commissions 175 44 Trade shows - 7 Market research 17 112 Travel 8 43 Media production and promotional products 90 35 Quality control and processing fees 102 65 Other 162 180$ 7,860 $ 3,780 Advertising expense is composed primarily of television advertising, 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. As noted above, during the three months endedDecember 31, 2020 , we spent$5.6 million in advertising expenditures to support our retail and direct-to-consumer channels, a 105.1% year-over-year increase compared to the same period in Fiscal 2020. The increase resulted from investments in driving brand product awareness through: (1) platforms made available by our retail partners, including increased spending in general TV, YouTube, Facebook and other general media advertising; and (2) pay-per click advertising, including keyword search campaigns and other web-based advertising programs. 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 endedDecember 31, 2020 , personnel costs for sales and marketing were$1.7 million , up$1.1 million , or 201.3% from the three months endedDecember 31, 2019 . The increase reflected the estimated employee incentive program expenses which are based on a comparison of current year and prior year sales. Personnel expenses include all related payroll including departmental incentive programs, including 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 endedDecember 31, 2020 totaled$2.8 million , as compared to$1.2 million for the three months endedDecember 31, 2019 , an increase of 123.7%, or$1.6 million , primarily due to increases in the company-wide incentive program that scales with increased growth , bad debt and depreciation expense attributable to increase volume, and consulting and legal fees related to the proposed ScottsMiracle-Gro Merger discussed above, partially offset by decreases in travel expenses and general office categories including repairs and maintenance. 24
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Table of Contents Operating Income Our operating income for the three months endedDecember 31, 2020 was$4.7 million , an increase of$3.5 million from a$1.2 million operating income for the three months endedDecember 31, 2019 . The increase reflected increased sales in both our retail and direct-to-consumer channels, along with fewer revenue reductions for various returns and allowances and better gross margins, partially offset by increases in operating expenses, including overall general advertising, as discussed in greater detail above.
Net Income
For the three months endedDecember 31, 2020 , we recorded net income of$4.6 million , a$3.5 million increase over the$1.1 million net income for the three months endedDecember 31, 2019 . The increase in the net income is primarily a result of increased sales volume and gross margins in the current year period, partially offset by the increase in operating expenses.
Nine Months Ended
Summary Overview
For the nine months endedDecember 31, 2020 , total revenue increased$41.7 million , or 151.9%, to$69.1 million relative to the same period in the prior year. The current year 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, fresh, safe food sources and at-home meal preparation and sales to new accounts includingBestBuy , Big Lots and Menards. Retail sales increased$21.6 million , or 115.2%, due to increased sales into existing online channels, including Amazon.com, Kohls.com, Costco.ca and the new accounts mentioned above. Sales in our direct-to-consumer channel increased 242.8%, or$19.9 million , primarily due to visibility and continued momentum from our general advertising and marketing campaign, increased user base, increased presence of other online accounts and amplified demand in the indoor gardening market from customers seeking healthy, fresh food. Sales to international distributors increased$177,000 to$658,000 in the nine months endedDecember 31, 2020 , relative to the same period in the prior year, primarily due to increased distribution in certain international markets such as Amazon.uk,France ,Germany ,Spain andItaly . For the nine months endedDecember 31, 2020 , total dollar sales of AeroGardens increased by 137.1% and seed pod kit accessories increased by 148.2%, over the prior year period. AeroGarden sales, net of allowances, represented 75.4% of total revenue, as compared to 75.1% in the prior year period. This percentage increase, on a product line basis, is relatively consistent with the prior year. Seed pod kit and accessory gross sales decreased as a percent of the total sales to 24.5% from 24.9% in the prior year period, with total dollar sales increasing by$10.1 million . During the nine months endedDecember 31, 2020 , we spent$8.6 million in advertising expenditures to support our direct-to-consumer and retail channels, a year-over-year increase of 133.2%, compared to the same period endedDecember 31, 2019 . These expenditures included the following:
? Retail-specific advertising, which increased
from
31, 2019, respectively, as the Company continues to invest in: (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. inclusion in retail catalogues,
website banner ads, email blasts, targeted search campaigns, etc.).
? Other advertising related expenses, which increased
million during the nine months ended
spending on linear, connected and online TV, YouTube, Facebook and other
media advertising. The Company views this general investment as a long term
commitment to increasing awareness of the AeroGarden brand.
? Direct-to-consumer advertising which increased to $3.0 million fromrespectively, reflecting increased spending on catalogues and increases in
pay-per-click campaigns. Efficiency, as measure by dollars of
direct-to-consumer sales per dollar of related advertising expense,
decreased to
compared to $15.58 for the same period in Fiscal 2020.
Gross profit percentage for the nine months ended December 31, 2020 was 42.0%,
as compared to 34.4% during the prior year period. This increase was
attributable changes in customer and product mix, 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. The prior year included several one-time fees related to set up of
a new warehouse to serve select customers.
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In aggregate, our total operating expenses increased 96.3%, or
? a
? a$3.6 million increase in personnel expenses primarily driven by our company-wide incentive program that scales as our growth increases and an increase in headcount to support higher sales volume; ? a$1.2 million increase in legal and consulting expenses related to the
analysis of the Scotts
alternatives;
? a $352,000 increase in bad debt and depreciation expense.
These increases were partially offset by a
Operating income increased by$9.6 million to$8.7 million for the nine months endedDecember 31, 2020 , from an operating loss of$918,000 in the prior year period, primarily as a result of continued growth in the retail and direct-to-consumer channels, our efforts to provide general awareness of our product, and increased consumer demand for healthy, safe, fresh food. Other expense for the nine months endedDecember 31, 2020 , totaled to net other expense of$222,000 , as compared to net other expense of$200,000 in the prior year period. The net other expense in the current and prior year periods are attributable to interest expense on the Term Loans and foreign exchange losses. Net income for the nine months endedDecember 31, 2020 , was$8.5 million , as compared to a$1.1 million loss in the prior year. The increased net income is attributable to the factors discussed above. The following table sets forth, as a percentage of sales, our financial results for the nine months endedDecember 31, 2020 and the nine months endedDecember 31, 2019 : Nine Months Ended December 31, 2020 2019 Net revenue Direct-to-consumer 40.6 % 29.9 % Retail 58.4 % 68.3 % International 1.0 % 1.8 % Total net revenue 100.0 % 100.0 % Cost of revenue 58.0 % 65.6 % Gross profit percentage 42.0 % 34.4 % Operating expenses Research and development 1.5 % 2.9 % Sales and marketing 19.6 % 23.8 % General and administrative 8.3 % 11.0 % Total operating expenses 29.4 % 37.7 % Income (loss) from operations 12.6 % (3.3 )% 26
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Table of Contents Revenue For the nine months endedDecember 31, 2020 , revenue totaled$69.1 million , a year-over-year increase of 151.9%, or$41.7 million , from the nine months endedDecember 31, 2019 . Nine Months Ended December 31, (in thousands) Net Revenue 2020 2019 Direct-to-consumer$ 28,095 $ 8,196 Retail 40,335 18,747 International 658 481 Total$ 69,088 $ 27,424 Direct-to-consumer sales for the nine months endedDecember 31, 2020 totaled$28.1 million , up$19.9 million , or 242.8%, 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 a trustworthy supply chain for healthy, fresh food during the COVID-19 pandemic. The increase in sales to direct-to-consumer channels is due to more effective and focused marketing to drive direct-to-consumer awareness, better promotional scheduling, follow-on direct sales to customers that have previously purchased AeroGardens, better returns on existing general advertising and brand awareness programs. Sales to retailer customers for the nine months endedDecember 31, 2020 totaled$40.3 million , up$21.6 million , or 115.2%, from the prior-year period, principally reflecting: (i) our marketing strategy of more focused and effective spending to drive sales through retailer programs and reduce product returns (ii) 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; (iii) organic growth in our existing retail accounts, namely Amazon.com, Kohl's and Canadian Tire; and (iv) sales to new accounts including, Best Buy, Big Lots and Menards, 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 nine months endedDecember 31, 2020 increased$177,000 , primarily due to increased sales testing inEurope and as we continue to expand our understanding of international market factors, distribution models and acceptance of our products. Our products consist of AeroGardens, seed pod kits and accessories. A summary of the sales of these product categories for the nine months endedDecember 31, 2020 andDecember 31, 2019 is as follows: Nine Months Ended December 31, 2020 2019 Product revenue (in thousands) (in thousands) AeroGardens$ 60,826 $ 25,654 Seed pod kits and accessories 16,934 6,823 Discounts, allowances and other (8,672 ) (5,053 ) Total$ 69,088 $ 27,424 % of total revenue AeroGardens 88.0 % 93.5 % Seed pod kits and accessories 24.5 % 24.9 % Discounts, allowances and other (12.5 )% (18.4 )% Total 100.0 % 100.0 % 27
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AeroGarden sales increased$35.2 million , or 137.1%, from the prior year period, reflecting increased sales in the retail and direct-to-consumer channel, organic growth from existing customers, demand of customers seeking healthy, safe gardening items during the COVID-19 pandemic. Sales of seed pod kits and accessories increased$10.1 million , or 148.2%, reflecting a large increase in direct-to-consumer and retail sales. Our customers have historically purchased seed pod kits and accessories after purchasing and using AeroGardens. For the nine months endedDecember 31, 2020 , sales of seed pod kits and accessories represented 24.5% of total revenue, as compared to 24.9% in the prior year period. Other revenue, which is comprised primarily of shipping revenue, accruals and deductions, decreased as a percent of the total to (12.5)% from (18.4)% in the prior year period due to fewer deductions for returns and accruals for sales allowances and future discounts for in-store retail accounts. Cost of Revenue Cost of revenue for the nine months endedDecember 31, 2020 totaled$40.1 million , an increase of$22.1 million , or 122.8%, from the nine months endedDecember 31, 2019 . Cost of revenue includes product costs for purchased and manufactured products, freight costs for inbound freight from manufacturers, costs related to warehousing and shipping 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 for the nine months endedDecember 31, 2020 , represented 58.0% of revenue, as compared to 65.6% during the nine months endedDecember 31, 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 addition, we incurred one-time fees in the prior year related to establishing a new warehouse location, and additional warehouse fees for product preparation. 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 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, when we sell to a distributor 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. We have begun international test sales through Amazon in various countries, so this margin model may change over time. The gross profit percentage for the nine months endedDecember 31, 2020 was 42.0% as compared to 34.4% for the nine months endedDecember 31, 2019 , primarily due to higher overall sales volume with our established retailer accounts and direct-to-consumer segment, and supply chain economies of scale.
Research and Development
Research and development costs for the nine months endedDecember 31, 2020 totaled$1.0 million , an increase of 32.1%, or$255,000 , from the nine months endedDecember 31, 2019 . The increase reflects increases in personnel expenses for new R&D employees and a related incentive compensation attributable to a company-wide program that scales with growth in sales, partially offset by decreases in travel, new product testing and certification expenses.
Sales and Marketing
Sales and marketing costs for the nine months endedDecember 31, 2020 totaled$13.6 million , as compared to$6.6 million for the nine months endedDecember 31, 2019 , an increase of 107.0%, or$7.0 million . Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and order processing for our products, and consisted of the following: Nine Months Ended December 31, (in thousands) 2020 2019 Advertising$ 8,551 $ 3,718 Personnel 3,750 1,556 Sales commissions 235 67 Trade shows - 8 Market research 122 205 Travel 11 200
Media production and promotional products 109 141 Quality control and processing fees
241 148
Other 544 510
$ 13,563 $ 6,553
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Advertising expense totaled$8.6 million for the nine months endedDecember 31, 2020 , a year-over-year increase of 130.0%, or$4.8 million . These increase in advertising expenditures was attributable to: (i) direct-to-consumer advertising (which increased to$3.0 million from$526,000 ); (ii)$1.3 million in retail-specific advertising, from$2.2 million to$3.5 million and (iii)approximately$1.0 million in general TV, YouTube, Facebook and other general media 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 nine months endedDecember 31, 2020 , personnel costs for sales and marketing were$3.7 million , for a 141.0% increase from the nine months endedDecember 31, 2019 . The increase reflected the company-wide incentive program that scales with growth in sales and increases in employees. Personnel expenses include all related payroll expenses, including incentive programs, bonuses and employee benefits.
Other marketing expenses decreased year-over-year because of decreases in a variety of spending categories, primarily related to market research and travel.
General and Administrative General and administrative costs for the nine months endedDecember 31, 2020 totaled$5.7 million , as compared to$3.0 million for the nine months endedDecember 31, 2019 , an increase of 89.9%, or$2.7 million . The increase is attributable to (i) payroll-related expenses, including the company-wide incentive program that scales with sales growth, salaries, and employee benefits; (ii) consulting and legal fees associated with consideration and analysis of the proposed ScottsMiracle-Gro Merger discussed above; (iii) IT services as we expand our web based experience; and (iv) bad debt and depreciation expense. Operating Income and Loss Our operating income for the nine months endedDecember 31, 2020 was$8.7 million , an increase of$9.6 million from the operating loss of$918,000 for the nine months endedDecember 31, 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 also resulted in a reduction in operating expenses as a percentage of revenue.
Net Income and loss
The net income for the nine months ended
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 regularly receives discrete financial information about each reportable segment. The CODM uses all such information for performance assessment and resource allocation decisions. The CODM 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.
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Nine Months Ended December 31, 2020
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 28,095 $ 40,993 $ - $ 69,088
Cost of revenue 15,921 24,130 - 40,051
Gross profit 12,174 16,863 - 29,037
Gross profit percentage 43.3 % 41.1 % - 42.0 %
Sales and marketing (1) 3,848 3,662 1,816 9,326
Segment profit 8,326 13,201 (1,816 ) 19,711
Segment profit percentage 29.6 % 32.2 % - 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.
Nine Months Ended December 31, 2019
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 8,196 $ 19,228 $ - $ 27,424
Cost of revenue 5,312 12,666 - 17,978
Gross profit 2,884 6,562 - 9,446
Gross profit percentage 35.2 % 34.1 % - 34.4 %
Sales and marketing (1) 790 2,510 1,282 4,582
Segment profit 2,094 4,052 (1,282 ) 4,864
Segment profit percentage 25.5 % 21.1 % - 17.7 %
(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, the net cash used by operating activities totaled
Non-cash items, comprising depreciation, amortization, bad debt allowances, and inventory allowance, totaled to a net gain of$1.2 million for the nine months endedDecember 31, 2020 , as compared to a net gain of$781,000 in the prior year period. The increase principally reflected non-cash expenses, including charges arising from bad debt expense, depreciation and changes in the inventory allowance. Changes in current assets used net cash of$20.9 million during the nine months endedDecember 31, 2020 , principally from increases in accounts receivable balances and inventory as a result of our retail channel sales during the peak holiday season. As ofDecember 31, 2020 , the total inventory balance was$11.6 million , representing approximately 90 days and 47 days of sales activity at the average daily rate of product cost expensed during the twelve months and three months endedDecember 31, 2020 , respectively. The days in inventory calculation is based on three months of sales activity and is greatly affected by the seasonality of our sales, which are at their highest level during our quarter endingDecember 31 . Current operating liabilities increased$10.8 million during the nine months endedDecember 31, 2020 , reflecting seasonal increases in all operating liability accounts. Accounts payable as ofDecember 31, 2020 totaled$10.3 million , representing approximately 53 days and 28 days of daily expense activity at the average daily rate of expenses incurred during the twelve months and three months endedDecember 31, 2020 , respectively.
Net investing activity used
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Net financing activity provided net cash of
Cash As ofDecember 31, 2020 , we had a cash balance of$13.7 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 increase in cash is primarily attributable to the sales in the current quarter and the increased in cash collections particularly related to the direct-to-consumer customers.
Borrowing Agreements
As ofDecember 31, 2020 andMarch 31, 2020 , we have$7.4 million and$900,000 of outstanding long-term debt, respectively. 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 ofDecember 31, 2020 andMarch 31, 2020 , the outstanding balance of our note payable and debt, including accrued interest, was as follows: December 31, March 31, 2020 2020 (in thousands) (in thousands) Notes payable-related party $ 7,415 $ 915 Total debt 7,415 915 Less notes payable and current portion - long term debt 6,515 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 $13.7 million ($15,000 of which is restricted as
collateral for our various corporate obligations) as of December 31,
2020 ;
? our cash of $15.4 million , ($15,000 of which is restricted as
collateral for our various corporate obligations) as of February 8,
2021 ,
? 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 $7.5 million from Scotts Miracle-Gro and Real Estate Term
loan of up to $1.5 million , of which we had borrowed $6.5 million and
$900,000 of the combined $9.0 million in principal amount as of
December 31, 2020 and February 8, 2021 , 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.
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OnAugust 3, 2020 , the Company renewed 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 , 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 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$6.5 million as ofFebruary 8, 2021 and can reborrow amounts repaid against the$7.5 million loan in order to purchase additional inventory. See Note 3 "Notes Payable, Long Term Debt and Current Portion - Long Term Debt" to our condensed financial statements. OnJune 20, 2019 , the Company entered into a Real Estate Term Loan Agreement in the principal amount of up to$1.5 million withScotts 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 ofMarch 31, 2022 . Interest is charged at the stated rate of 10% and is payable quarterly in arrears on each ofApril 30 ,July 31 ,October 31 andJanuary 31 . As ofDecember 31, 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. However, we may need to seek additional capital to provide a cash reserve against contingencies, address the seasonal nature of our working capital needs, and to enable us to invest further in trying to increase the scale of our business. There can be no assurance we will be able to raise this additional capital.
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, including the COVID-19 pandemic, 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 (September through March);
? a continued, uninterrupted supply of product from our third-party
manufacturing suppliers in China ; and
? the success of our Scotts Miracle-Gro relationship.
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