AEROGROW INTERNATIONAL, INC. The discussion contained herein is for the three and nine months endedDecember 31, 2019 andDecember 31, 2018 . The following discussion should be read in conjunction with the financial statements ofAeroGrow International, Inc. (the "Company," "we," "AeroGrow ," or "our") 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, 2019 (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 necessary 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, 2019 . 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 ten 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 . As discussed in Note 4 to the Company's Condensed Consolidated financial statements, inApril 2013 we entered into a 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 our 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$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. OnJune 20, 2019 , the Company entered into a Working Capital Term Loan Agreement in the principal amount of up to$10.0 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$10.0 million with a due date ofMarch 31, 2020 . The Term Loan Agreement is secured by a lien on the assets of the Company. Interest is charged at the stated rate of 10% per annum and is payable quarterly in arrears, at the end of each September, December and March. The funding provides 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. See Note 3 "Notes Payable, Long Term Debt and Current Portion - Long Term Debt" to our condensed financial statements. 19
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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 proceeds will be made available as needed in increments of$100,000 , and the Company may pay down and reborrow during the Term Loan, not to exceed$1.5 million with a due date ofMarch 31, 2022 . The Term Loan Agreement is secured by a lien on the assets of the Company. Interest is charged at the stated rate of 10% per annum and is payable quarterly in arrears on each ofApril 30 ,July 31 ,October 31 andJanuary 31 . See Note 3 "Notes Payable, Long Term Debt and Current Portion - Long Term Debt" to our condensed financial statements. Results of Operations
Three Months Ended
Summary Overview
For the three months endedDecember 31, 2019 , we generated$18.5 million of total net revenue, an increase of 43.2%, or$5.6 million , relative to the same period in the prior year. Retail sales increased 46.4% to$13.6 million , primarily due to timing of load-in sales to the brick-and-mortar customers which occurred in the prior year at the end of the quarter endedSeptember 30, 2018 , as well as new retail accounts and continued strong sales with our web/internet channels (Amazon.com, Bed, Bath & Beyond, Kohls.com,Walmart.com , etc.). In addition, we expect returns from brick and mortar retail customers to decrease as a result of improved advertising efforts, which generate better understanding of the product by end users. Sales in our direct-to-consumer channel increased 62.4%, to$4.7 million . This increase resulted primarily from our efficiency of our promotional campaigns, scheduled promotional calendar and redesigned and effective website. For the three months endedDecember 31, 2019 , total gross dollar sales of AeroGarden units increased by 35.3% from the prior year period. Seed pod kit and accessory sales increased by 28.8% over the prior year period. AeroGarden sales, net of allowances, represented 81.1% of total revenue, as compared to 79.0% in the prior year period. This percentage increase, on a product line basis, was attributable to the later 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. Seed pod kit and accessory sales decreased as a percent of the total to 18.9% from 21.0% due to the increase in the sales of AeroGardens. The decrease in sales of seed pod kits and accessories are typically dependent on prior purchases of gardens. As noted above, the increase in seed pod kit and accessories sales as a percentage of revenue represented a total dollar sales increase of$783,000 or 28.8%. 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, 2019 , we spent$2.7 million in advertising expenditures, an increase of$169,000 , or 6.6%, compared to the same period endedDecember 31, 2018 . This increase was primarily due to an increase in our retail marketing campaigns and change in the advertising program mix, from digital advertising to television-related advertising. The advertising expenditures were divided as follows:
? Retail-specific advertising decreased to
the three months ended
respectively, as the Company changed from platforms focused on our retail
outlets (e.g. website banner ads, email blasts, targeted search campaigns,
inclusion in retail catalogues, etc.) towards more general and broad
programs designed to generate product and brand awareness.
? The Company continues to drive category and brand awareness the quarter
ended
general TV, YouTube, Facebook and other media advertising. The Company
views this investment as a long term commitment to increasing awareness of
the AeroGarden brand.
? Finally, direct-to-consumer advertising increased to
for the three months ended December 31, 2019 and December 31, 2018 ,
respectively. This increase reflects 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 $13.79 for
the three months ended December 31, 2019 , a 19.3% decline from $17.09 for
the same period in Fiscal 2019, in part due to the spillover effect of
increased sales through retail outlets.
Gross profit for the three months ended December 31, 2019 was 35.2%, up from
31.0% in the prior year period. This increase was attributable to the following
factors: (1) the introduction of new products with higher margins; (2) better
pricing strategies in the direct-to-consumer channel as compared to the prior
year quarter; and (3) a shift to retailers with higher margins and the impact of
a lower return reserve. This increase was partially offset by increases in
shipping costs and warehousing costs, as we began using several different
warehouses that put us in a better position to fulfill orders as we grow.
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In aggregate, our total operating expenses increased 17.0%, or$772,000 , year-over-year, principally as we drive our business toward future growth. The increase in gross spending was attributable to a$644,000 increase in personnel expenses driven by the company-wide incentive program and a few increases in employee headcount,$310,000 increase in bad debt and depreciation expenses, and approximately$75,000 of various contracted services, including web services, brick-and-mortar product set up and legal fees. This increase was partially offset by approximately$252,000 of reduced media, advertising, marketing expenses, new product development costs and company-wide travel expenses. Our operating profit was$1.2 million for the three months endedDecember 31, 2019 , as compared to an operating loss of$535,000 in the prior year period, for the reasons disclosed above. Net other expense for the three months endedDecember 31, 2019 totaled$141,000 , as compared to net other expense of$172,000 in the prior year period. The decrease is primarily attributable to$20,000 of reduced interest expense on the current year Term Loan as the average outstanding balance decreased. Net income for the three months endedDecember 31, 2019 was$1.1 million , as compared to net loss of$707,000 in the prior year quarter. The increase in net income is primarily a result of the overall increase in net sales discussed above. The following table sets forth, as a percentage of sales, our financial results for the three months endedDecember 31, 2019 and the three months endedDecember 31, 2018 : Three Months Ended December 31, 2019 2018 Net revenue Direct-to-consumer 25.2 % 22.2 % Retail 73.3 % 71.7 % International 1.5 % 6.1 % Total net revenue 100.0 % 100.0 % Cost of revenue 64.8 % 69.0 % Gross profit 35.2 % 31.0 % Operating expenses Research and development 1.7 % 0.6 % Sales and marketing 20.4 % 30.1 % General and administrative 6.6 % 4.4 % Total operating expenses 28.7 % 35.1 % Income (loss) from operations 6.5 % (4.1 )% Revenue For the three months endedDecember 31, 2019 , revenue totaled$18.5 million , a year-over-year increase of 43.2% or$5.6 million , from the three months endedDecember 31, 2019 . Three Months Ended December 31, (in thousands) Net Revenue 2019 2018 Direct-to-consumer$ 4,665 $ 2,872 Retail 13,579 9,274 International 282 795 Total$ 18,526 $ 12,941 Direct-to-consumer sales for the three months endedDecember 31, 2019 totaled$4.7 million , up$1.8 million , or 62.4%, from the prior year period. The increase in sales through direct-to-consumer channels is due a change in our marketing campaign contractor, better promotional scheduling and better returns on the general advertising programs established in the prior year quarter. 21
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Sales to retailer customers for the three months endedDecember 31, 2019 totaled$13.6 million , up$4.3 million , or 46.4%, principally reflecting the delayed timing of our load-in of sales to our brick-and-mortar stores and the additional testing of several new retail accounts. International sales totaled$282,000 , as compared to$795,000 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.
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)
2019 2018
Product revenue
AeroGardens $ 18,845 $ 13,925
Seed pod kits and accessories 3,498 2,715
Discounts, allowances and other (3,817 ) (3,699 )
Total $ 18,526 $ 12,941
% of total revenue
AeroGardens 101.7 % 107.6 %
Seed pod kits and accessories 18.9 % 21.0 %
Discounts, allowances and other (20.6 )% (28.6 )%
Total 100.0 % 100.0 %
AeroGarden sales increased $4.9 million , or 35.3%, from the prior year period,
reflecting increased retail channel sales due to delayed timing of the load-in
into brick-and-mortar stores in the quarter. The increase in seed pod kit and
accessory sales of $783,000 , or 28.8%, principally reflects the increase in our
established base of AeroGardens. For the three months ended December 31, 2019 ,
sales of seed pod kits and accessories represented 18.9% of total revenue, as
compared to 21.0% 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 (20.6)% from (28.6)% 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, 2019 totaled $12.0
million , an increase of $3.1 million , or 34.4%, from the three months ended
December 31, 2018 . 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
64.8% of revenue, as compared to 69.0% for the quarter ended December 31,
2018 . The percentage decrease was primarily attributable to increased sales
during the current quarter for customers with a higher margin product mix,
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 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
for the quarter ended December 31, 2019 was 35.2%, as compared to 31.0% for the
quarter ended December 31, 2018 . The increase in our gross profit was primarily
due to the shift to retailers with higher margin products and the impact of a
lower return reserve, partially offset by one-time fees related to establishing
new retail customers and additional shipping costs.
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Table of Contents Research and Development Research and development costs for the quarter endedDecember 31, 2019 totaled$308,000 , an increase of$232,000 from the quarter endedDecember 31, 2018 . The increase principally reflected expense increases of$118,000 related to new product design, development and testing,$83,000 in personnel expenses for full time employees and the company-wide incentive program, and$40,000 due to the termination of a collaboration expense offset program withScotts Miracle-Gro . Sales and Marketing Sales and marketing costs for the three months endedDecember 31, 2019 totaled$3.8 million , as compared to$3.9 million for the three months endedDecember 31, 2018 , a decrease of 3.0%. Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and order processing for our products, and consisted of the following: Three Months Ended December 31, (in thousands) 2019 2018 Advertising$ 2,723 $ 2,554 Personnel 571 328 Sales commissions 44 47 Trade shows 7 - Market research 112 - Travel 43 59 Media production and promotional products 35 54 Quality control and processing fees 65 78 General brand marketing - 567 Other 180 211$ 3,780 $ 3,898 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, 2019 , we spent$2.7 million in advertising expenditures to support our retail and direct-to-consumer channels, a 6.6% year-over-year increase compared to the same period in Fiscal 2019. The increase resulted from retail-specific advertising, which increased to$2.7 million from$2.6 million , as the Company invested more in driving brand product awareness through platforms made available by our retail partners, including increased spending in (i) general TV, YouTube, Facebook and other general media advertising and (2) direct-to-consumer 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 three months endedDecember 31, 2019 , personnel costs for sales and marketing were$571,000 , up$243,000 or 74.2% from the three months endedDecember 31, 2018 . The increase reflected the estimated employee incentive program expenses. 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 changes in overall promotional programs including a decrease in social media, digital marketing, market research programs and retailer marketing programs.
General and Administrative
General and administrative costs for the three months ended
Operating Income and Loss
Our operating income for the three months endedDecember 31, 2019 was$1.2 million , an increase of$1.7 million from a$535,000 operating loss for the three months endedDecember 31, 2018 . The increase reflected increased sales in both our retail and direct-to-consumer channels, along with fewer revenue reductions for various returns and allowances, partially offset by increases in operating expenses, including overall general advertising, as discussed in greater detail above. 23
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Table of Contents Net Income and Loss For the three months endedDecember 31, 2019 , we recorded net income of$1.1 million , a$1.8 million increase over the$707,000 net loss for the three months endedDecember 31, 2018 . The increase in the net income is primarily a result of increased sales volume in the current year period, partially offset by the increase in operating expenses.
Nine Months Ended
Summary Overview
For the nine months endedDecember 31, 2019 , total revenue increased$2.2 million , or 8.6%, to$27.4 million relative to the same period in the prior year. Retail sales decreased$158,000 , or 0.8%, due to fewer gardens sold to retailers, as we adopted a marketing strategy designed to focus on retailers with the lowest product returns. Sales in our direct-to-consumer channel increased 49.6%, or$2.7 million , primarily due to visibility and continued momentum from our general advertising and marketing campaign, increased user base, and increased presence on Amazon accounts and other select online retail distribution channels. Sales to international distributors decreased$395,000 to$481,000 in the nine months endedDecember 31, 2019 , relative to the same period in the prior year, primarily due to reduced distribution in certain international markets such as Amazon.uk,France ,Germany ,Spain andItaly . For the nine months endedDecember 31, 2019 , total dollar sales of AeroGardens decreased by 3.6% and seed pod kit accessories increased by 28.1%, over the prior year period. AeroGarden sales, net of allowances, represented 75.1% of total revenue, as compared to 78.9% in the prior year period. This percentage decrease, on a product line basis, was attributable to the strategic approach to reduce possible returns in the current year. Seed pod kit and accessory gross sales increased as a percent of the total sales to 24.9% from 21.1% in the prior year period, with total dollar sales increasing by$1.5 million . During the nine months endedDecember 31, 2019 , we spent$3.7 million in advertising expenditures to support our direct-to-consumer and retail channels, a year-over-year increase of 8.1%, compared to the same period endedDecember 31, 2018 . These expenditures included the following:
? Retail-specific advertising decreased
million for the nine months ended
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 increased
the nine months ended December 31, 2019 , due to increased 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.
? Finally, direct-to-consumer advertising increased to
for the nine months ended
respectively. This increase reflects 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 $16.35 for the same period in Fiscal 2019.
Gross profit for the nine months ended December 31, 2019 was 34.4%, as compared
to 34.7% during the prior year period. This decrease was attributable changes in
customer and product mix, and several one-time fees related to set up of a new
warehouse to serve select customers.
In aggregate, our total operating expenses increased 11.6%, or $1.1 million ,
year-over-year, principally to support new product introductions, general office
category expenses and increases in third party hosting and security.. Gross
spending increased in the following areas:
? A $363,000 increase in general office categories such as depreciation, baddebt, insurance, repairs and maintenance, office supplies, and equipment;
? A
? A
website introduced in the prior year and new strategies in web promotions;
? A
to e-commerce security;
? A $26,000 increase in company-wide travel to manufacturers in China ,
warehouses and potential domestic and European customers.
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As a result of continued growth in the online and housewares channels and our efforts to provide general awareness of our product, our operating loss increased by$401,000 to$918,000 for the nine months endedDecember 31, 2019 , from$517,000 in the prior year period. Other expense for the nine months endedDecember 31, 2019 , totaled to net other expense of$200,000 , as compared to net other expense of$177,000 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, offset by other income from consulting related revenue, and foreign exchange gains.
The net loss for the nine months ended
The following table sets forth, as a percentage of sales, our financial results for the nine months endedDecember 31, 2019 and the nine months endedDecember 31, 2018 : Nine Months Ended December 31, 2019 2018 Net revenue Direct-to-consumer 29.9 % 21.7 % Retail 68.3 % 74.8 % International 1.8 % 3.5 % Total net revenue 100.0 % 100.0 % Cost of revenue 65.6 % 65.3 % Gross profit 34.4 % 34.7 % Operating expenses Research and development 2.9 % 1.4 % Sales and marketing 23.8 % 26.8 % General and administrative 11.0 % 8.5 % Total operating expenses 37.7 % 36.7 % (Loss) income from operations (3.3 )% (2.0 )% Revenue For the nine months endedDecember 31, 2019 , revenue totaled$27.4 million , a year-over-year increase of 8.6%, or$2.2 million , from the nine months endedDecember 31, 2018 . Nine Months Ended December 31, (in thousands) Net Revenue 2019 2018 Direct-to-consumer$ 8,196 $ 5,480 Retail 18,747 18,905 International 481 876 Total$ 27,424 $ 25,261 Direct-to-consumer sales for the nine months endedDecember 31, 2019 totaled$8.2 million , up$2.7 million , or 49.6%, from the prior year period. The increase in sales to direct-to-consumer channels is due to focused marketing, better promotional scheduling, follow-on direct sales to customers that have previously purchased AeroGardens, and better returns on existing general advertising programs. As in the prior year, our launch of a new website encountered some difficulty and online sales were driven mostly by pricing strategies. Sales to retailer customers for the nine months endedDecember 31, 2019 totaled$18.7 million , down$258,000 , or 1.4%, from the prior-year period, principally reflecting our marketing strategy of focusing on brick-and-mortar retailer programs that have generated lower product return rates. 25
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International sales for the nine months endedDecember 31, 2019 decreased$395,000 , primarily due to reduced sales testing inEurope and as we continue to expand our understanding of international market factors, distribution models and acceptance of our products. Our products consist of AeroGardens, seed pod kits and accessories. A summary of the sales of these product categories for the nine months endedDecember 31, 2019 andDecember 31, 2018 is as follows: Nine Months Ended December 31, 2019 2018 Product revenue (in thousands) (in thousands) AeroGardens$ 25,654 $ 26,615 Seed pod kits and accessories 6,823 5,327 Discounts, allowances and other (5,053 ) (6,682 ) Total$ 27,424 $ 25,260 % of total revenue AeroGardens 93.5 % 105.4 % Seed pod kits and accessories 24.9 % 21.1 % Discounts, allowances and other (18.4 )% (26.5 )% Total 100.0 % 100.0 % AeroGarden sales decreased$961,000 , or 3.6%, from the prior year period, reflecting decreased sales in the retail channel, partially offset by increased sales in direct-to-consumer channels. This percentage decrease was attributable to strategic sales to existing customers, in particular brick-and-mortar retailers from the prior year, partially offset by expansion and product introduction into new retail accounts and increased direct-to-consumer channels. Sales of seed pod kits and accessories increased$1.5 million , or 28.1%, reflecting a large increase in direct-to-consumer sales, partially offset by a decrease in retail sales. Our customers have historically purchased seed pod kits and accessories after purchasing and using AeroGardens. For the nine months endedDecember 31, 2019 , sales of seed pod kits and accessories represented 24.9% of total revenue, as compared to 21.1% 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 the total to (18.4)% from (26.5)% in the prior year period due to fewer deductions for returns and accruals for sales allowances and future discounts for new in-store retail accounts. Cost of Revenue Cost of revenue for the nine months endedDecember 31, 2019 totaled$18.0 million , an increase of$1.5 million , or 9.0%, from the nine months endedDecember 31, 2018 . 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, 2019 , represented 65.6% of revenue, as compared to 65.3% during the nine months endedDecember 31, 2018 . The increase in costs as a percent of revenue reflected additional costs related to the new warehouses established in prior periods.
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. We saw increases at our established accounts, including direct-to-consumer, which were offset by the lower margins at some new retail accounts. The gross profit for the nine months endedDecember 31, 2019 was 34.4% as compared to 34.7% for the nine months endedDecember 31, 2018 . Research and Development Research and development costs for the nine months endedDecember 31, 2019 totaled$794,000 , an increase of 117.2%, or$428,000 , from the nine months endedDecember 31, 2019 . The increase is related to increases in prototype development, which includes investments in product development that we anticipate hitting the market in the next fiscal year, increased employee headcount and incentive program expenses, and$85,000 due to the termination of a collaboration expense offset program withScotts Miracle-Gro . 26
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Table of Contents Sales and Marketing Sales and marketing costs for the nine months endedDecember 31, 2019 totaled$6.6 million , as compared to$6.8 million for the nine months endedDecember 31, 2018 , a decrease of 3.2%, or$217,000 . Sales and marketing costs include all costs associated with the marketing, sales, operations, customer support, and order processing for our products, and consisted of the following: Nine Months Ended December 31, (in thousands) 2019 2018 Advertising$ 3,667 $ 3,392 Personnel 1,556 1,591 Sales commissions 67 103 Trade shows 8 3 Market research 256 158 Travel 200 190 Media production and promotional products 64 66 Quality control and processing fees 148 198 General brand marketing - 614 Other 587 455$ 6,553 $ 6,770 Advertising expense totaled$3.7 million for the nine months endedDecember 31, 2019 , a year-over-year increase of 8.1%, or$275,000 . These increase in advertising expenditures was attributable to: (i) approximately$919,000 in general TV, YouTube, Facebook and other general media advertising; and (ii) direct-to-consumer advertising (which increased to$526,000 from$321,000 ). The increase was partially offset by a$205,000 decrease in retail-specific advertising, from$2.8 million to$2.2 million . 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, 2019 , personnel costs for sales and marketing were$1.6 million , for a 2.2% decrease from the nine months endedDecember 31, 2018 . The decrease reflected changes in the incentive program and 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 general brand marketing. In the prior year our advertising approach was highly focused on general branding and we did not utilize the same agency or campaign in the current year.
General and Administrative
General and administrative costs for the nine months endedDecember 31, 2019 totaled$3.0 million , as compared to$2.2 million for the nine months endedDecember 31, 2018 , an increase of 40.0%, or$862,000 . The increase is attributable to (i) payroll-related expenses, including incentive programs, salaries, bonuses and employee benefits; (ii) consulting and legal fees associated with a credit card breach, and web hosting, electronic data processing, and network consulting and software troubleshooting fees; (iii) office rent relating to new accounting guidance on leases and relocation of the corporate headquarters; and (iv) estimates for the allowance for bad debt and depreciation. Operating Loss Our operating loss for the nine months endedDecember 31, 2019 was$918,000 , a decline of$401,000 from the operating loss of$517,000 for the nine months endedDecember 31, 2018 . The increased operating loss was attributable to a decrease in the retail channel sales and increased general operating and media expenses designed to drive brand awareness (as discussed in greater detail above), partially offset by increased sales in the direct-to consumer channels. Net Loss
The net loss for the nine months ended
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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 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.
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.
Nine Months Ended December 31, 2018
(dollar amounts in thousands) Direct-to-consumer Retail Corporate/Other Consolidated
Net sales $ 5,480 $ 19,781 $ - $ 25,261
Cost of revenue 3,617 12,870 - 16,487
Gross profit 1,863 6,911 - 8,774
Gross profit percentage 34.0 % 34.9 % - 34.7 %
Sales and marketing (1) 655 2,954 1,080 4,689
Segment profit 1,208 3,957 (1,080 ) 4,085
Segment profit percentage 22.0 % 20.0 % - 16.2 %
(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 loss for non-cash items and changes in operating assets and liabilities, the net cash used by operating activities totaled$2.2 million for the nine months endedDecember 31, 2019 , as compared to cash used of$9.5 million in the prior year period. Non-cash items, comprising depreciation, amortization, bad debt (recoveries) allowances, and inventory allowance, totaled to a net gain of$782,000 for the nine months endedDecember 31, 2019 , as compared to a net gain of$364,000 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
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As ofDecember 31, 2019 , the total inventory balance was$7.3 million , representing approximately 111 days and 56 days of sales activity at the average daily rate of product cost expensed during the twelve months and three months endedDecember 31, 2019 , 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
Net investing activity used
Net financing activity provided net cash of
Cash As ofDecember 31, 2019 , we had a cash balance of$2.3 million , of which$15,000 was restricted as collateral for various corporate obligations. This compares to a cash balance of$1.8 million as ofMarch 31, 2019 , of which$15,000 was restricted. The increase in cash is primarily attributable to the purchase of inventory in the current quarter to meet anticipated peak season sales demand, particularly the load-in sales with brick-and-mortar retail customers.
Borrowing Agreements
As ofDecember 31, 2019 andMarch 31, 2019 , we have$3.4 million and zero of outstanding long-term debt, respectively. We have entered into a Working Capital Term Loan Agreement in the principal amount of up to$10.0 million and Real Estate Term Loan Agreement in the principal amount of up to$1.5 million withScotts Miracle-Gro . As ofDecember 31, 2019 andMarch 31, 2019 , the outstanding balance of our note payable and debt, including accrued interest, was as follows: December 31, March 31, 2019 2019 (in thousands) (in thousands) Notes payable-related party $ 3,415 $ - Total debt 3,415 - Less notes payable and current portion - long term debt 2,505 - Long term debt $ 910 $ - 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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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
for our various corporate obligations) as of December 31, 2019 ;
? our cash of $2.9 million , ($15,000 of which is restricted as
collateral for our various corporate obligations) as of February 7,
2020 ,
? 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 $10.0 million from Scotts Miracle-Gro and Real Estate Term
loan of up to $1.5 million , of which we had borrowed $3.4 million and
$900,000 of the combined $11.5 million in principal amount as of
December 31, 2019 and February 7, 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 June 20, 2019 , the Company entered into a Working Capital Term Loan Agreement
in the principal amount of up to $10.0 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 $10.0 million with
a due date of March 31, 2020 . 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 at the end of each September, December and
March. 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 repaid in
full, including interest, the remaining $2.5 million borrowed as of February 7,
2020 and can reborrow amounts repaid against the $10.0 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 is charged at the stated
rate of 10% and is payable quarterly in arrears on each of April 30 , July 31 ,
October 31 and January 31 . As of December 31, 2019 , 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 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;? 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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