Item 11 below for information with respect to our equity compensation plans.

 

Consolidated Statements of Operations Data							Three month transitional period ended
	Years ended March 31,						March 31,			Years ended December 31,
Revenues	$	38,356,676		$	13,144,037		$	35,245		$	-		$	-
Cost of revenue		22,975,385			8,404,507			134,622			-			-
Research and development		2,605,112			2,113,255			978,539			1,578,833			333,038
Sales and marketing		16,084,353			7,117,613			2,548,583			583,897			79,811
General and administrative		6,084,728			4,050,312			2,010,907			2,923,792			1,983,759
Total operating expenses		47,749,578			21,685,687			5,672,651			5,086,522			2,396,608
Loss from operations		(9,392,902	)		(8,541,650	)		(5,637,406	)		(5,086,522	)		(2,396,608	)
Other (income) expense		443,019			1,844,801			1,905,937			2,631,055			(7,564	)
Net loss	$	(9,835,921	)	$	(10,386,451	)	$	(7,543,343	)	$	(7,717,577	)	$	(2,389,044	)
Net loss per share, basic and diluted	$	(0.84	)	$	(1.09	)	$	(0.84	)	$	(1.55	)	$	(0.56	)
Weighted average number of common
shares outstanding, basic and diluted		11,662,891			9,505,926			8,956,353			4,971,857			4,252,626
Consolidated Balance Sheet Data	March 31,									December 31,
Cash and cash equivalents	$	1,559,792		$	5,495,501		$	8,852,548		$	949,126		$	1,916,842
Total assets		11,919,629			13,041,806			9,841,009			2,543,598			1,998,470
Total liabilities		7,511,079			5,057,901			1,924,537			2,659,000			86,547
Total stockholder's equity		4,408,551			7,983,905			7,916,472			2,543,598			1,998,470

 

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS

 

The following discussion and analysis provides information which our management believes is relevant to an assessment and understanding of our business, operations, and financial condition. This discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. In addition to historical information, this Annual Report contains “forward-looking” statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including statements that include the words “may,” “will,” “believes,” “expects,” “anticipates,” or similar expressions. These forward-looking statements may include, among others, statements concerning our expectations regarding our business, growth prospects, revenue trends, operating costs, working capital requirements, competition, results of operations and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The forward-looking statements in this Annual Report involve known and unknown risks, uncertainties and other factors that could cause our actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements contained herein.

Each forward-looking statement should be read in context with, and with an understanding of, the various disclosures concerning our business made elsewhere in this Annual Report, inclusive of the section entitled Risk Factors, as well as other public reports filed by us with the SEC. Investors should not place undue reliance on any forward-looking statement as a prediction of actual results of developments. Except as required by applicable law or regulation, we undertake no obligation to update or revise any forward-looking statement contained in this Annual Report. 

Overview

 

We are in the business of developing, marketing, and distributing advanced indoor aeroponic garden systems. After more than three years of initial research and product development, we began sales activities in March 2006. Since that time we have significantly expanded all aspects of our operations in order to take advantage of what we believe to be an attractive market opportunity.  We have substantially increased the depth and breadth of distribution and as of March 31, 2008 sell products in over 5,100 domestic retail storefronts and more than a dozen countries internationally.  We have also developed direct sales channels including web sales, direct television sales, including infomercials and 60 and 120 second television commercials, and a direct mail catalogue business with more than 2 million catalogues mailed as of March 31, 2008.  In the past two years we have significantly expanded our product lines, and now offer 11 different indoor garden models, more than 50 seed kits, and various gardening and kitchen accessories.

Our Critical Accounting Policies

Inventory

 

Inventories are valued at the lower of cost, determined by the first-in, first-out method, or market. When we are the manufacturer, we include in inventory costs raw materials, labor and manufacturing overhead. We record the raw materials at delivered cost. Standard labor and manufacturing overhead costs are applied to the finished goods based on normal production capacity as prescribed under ARB No. 43, Chapter 4, “Inventory Pricing.” A majority of our products are manufactured overseas and are recorded at cost.

We determine an inventory obsolescence reserve based on historical experience and establish reserves against inventory according to the age of the product. As of March 31, 2008 and March 31, 2007 we determined that no inventory obsolescence reserve was required.

Revenue Recognition

 

We recognize revenue from product sales, net of estimated returns, when persuasive evidence of a sale exists: that is, a product is shipped under an agreement with a customer; risk of loss and title has passed to the customer; the fees are fixed or determinable; and collection of the resulting receivable is reasonably assured. Accordingly, we did not record $577,838 and $451,898 of revenue as of March 31, 2008 and March 31, 2007, respectively, related to the unpaid balance due for orders shipped in conjunction with our direct sales to consumers because the consumer had 36 days to evaluate the product, and is required to pay only the shipping and handling costs for such products before making the required installment payments after the expiration of the 36-day trial period. We also, as of March 31, 2008 and March 31, 2007, did not record $175,781 and $135,459, respectively, of product costs associated with the foregoing revenue because the customers would have been required to return the product in order to cancel further billing, and therefore we would have been able to recover these costs through resale of the goods. The liability for sales returns are estimated based upon historical experience of return levels.

Additionally, the Company did not record $69,339 of revenue as of March 31, 2008 related to the wholesale sales value of inventory held by its television shopping channel customers as these sales are contingent upon the shopping channel selling the goods. Deferred payments for these goods are charged to Customer Deposits. The Company has also deferred, as of March 31, 2008, recognition of $33,937 of product and freight costs associated with these sales, which have been included in inventory.

We record estimated reductions to revenue for customer and distributor programs and incentive offerings, including promotions and other volume-based incentives. Future market conditions and product transitions may require us to take actions to increase customer incentive offerings, possibly resulting in an incremental reduction of revenue at the time the incentives are offered. Additionally, certain incentive programs require us to estimate based on industry experience the number of customers who will actually redeem the incentive. At March 31, 2008 and March 31, 2007, we had accrued $226,729 and $65,385, respectively, as our estimate for the foregoing deductions and allowances.

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Warranty and Return Reserves

 

We record warranty liabilities at the time of sale for the estimated costs that may be incurred under our basic warranty program. The specific warranty terms and conditions vary depending upon the product sold but generally include technical support, repair parts and labor for periods up to one year. Factors that affect the Company’s warranty liability include the number of installed units currently under warranty, historical and anticipated rates of warranty claims on those units, and cost per claim to satisfy the Company’s warranty obligation.   The manufacturers of the Company’s products provide replacement parts for any defective components free of charge up to 2% of the total units purchased.  Based upon the foregoing, the Company has recorded as of March 31, 2008 and March 31, 2007 a provision for potential future warranty costs of $72,200 and $15,393, respectively.

The Company reserves for known and potential returns from customers and associated refunds or credits related to such returns based upon historical experience. In certain cases, customers are provided a fixed allowance, usually in the 1% to 2% range, to cover returned goods which allowance is deducted from payments from such customers. As of March 31, 2008 and March 31, 2007, the Company has recorded a reserve for customer returns of $674,120 and $238,569, respectively.

Shipping and Handling Costs

 

Shipping and handling costs associated with inbound freight are recorded in cost of revenue. Shipping and handling costs associated with freight out to customers are also included in cost of revenue. Shipping and handling charges to customers are included in sales.

Stock Based Compensation

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment.” Subsequently, the SEC provided for a phase-in implementation process for SFAS No. 123R, which required adoption of the new accounting standard no later than January 1, 2006. SFAS No. 123R requires accounting for stock options using a fair-value-based method as described in such statement and recognize the resulting compensation expense in the Company’s financial statements. Prior to January 1, 2006, the Company accounted for employee stock options using the intrinsic value method under Accounting Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees” and related interpretations, which generally results in no employee stock option expense. We adopted SFAS No. 123R on January 1, 2006 and do not plan to restate financial statements for prior periods. We plan to continue to use the Black-Scholes option valuation model in estimating the fair value of the stock option awards issued under SFAS No. 123R.  As a result of recognizing compensation expense for stock options pursuant to the provisions of SFAS No. 123(R), the net loss for the year ended March 31, 2008, March 31, 2007 and the three month transition period ended March 31, 2006, was increased by $710,899, $560,859 and $3,315,840, respectively.

Advertising and Production Costs

 

We expense all production costs related to advertising as incurred. These costs include actual advertising such as print, television, and radio advertisements which are expensed when the advertisement has been broadcast or otherwise distributed.  We record media costs related to our direct-to-consumer advertisements, inclusive of postage and printing costs incurred in conjunction with mailings of direct response catalogues, and related direct response advertising costs, in accordance with the AICPA Statement of Position, SOP 93-7, “Reporting on Advertising Costs.” In accordance with SOP 93-7, advertising costs incurred should be reported as assets and should be amortized over the estimated period of the benefits, based on the proportion of current period revenue from the advertisement to probable future revenue. As of March 31, 2008 and March 31, 2007, we had deferred $503,825 and $493,086, respectively, related to such media costs. Advertising expenses for the years ended March 31, 2008 and March 31, 2007 and for the three months ended March 31, 2006 were $6,955,555, $2,125,112 and $30,000, respectively.

Research and Development

 

Research, development, and engineering costs are expensed as incurred, in accordance with SFAS No. 2, “Accounting for Research and Development Costs.”  Research, development, and engineering expenses primarily include payroll and headcount related costs, contractor fees, infrastructure costs, and administrative expenses directly related to research and development support.

Registration Rights Penalties

 

The holders of securities issued in our 2006 Offering and 2005 Offering (see Notes 2 and 3 to our Financial Statements) had registration rights for the common stock and for the common stock underlying the convertible debt and the warrants held by them. Liquidated damages for failure to register and maintain registration for such common stock were payable in shares of our common stock under certain circumstances and were equal to 1% of the amount of the outstanding convertible debt per 30-day period up to a maximum of 24% and 1% of the amount of the investment in the 2006 Offering up to a maximum of 18%. In each case, the amount was payable in shares of our common stock valued at a rate of $2.00 per share. We elected to recognize the impact of such registration rights penalties as incurred, which commenced after July 23, 2006. We completed the registration of the foregoing securities on December 22, 2006 and recognized five months of penalty, resulting in the recording of 332,876 shares of common stock to be issued at a value of $5.00 for a total of $1,664,380. On December 21, 2006, the FASB Financial Statement Publication (“FSP”) Emerging Issues Task Force 00-19-2 that addresses the accrual and accounting for registration rights penalties became effective immediately. This FSP addresses the proper accounting of similarly arranged registration rights agreements entered into after the effective date of December 21, 2006.

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New Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 162 “The Hierarchy of Generally Accepted Accounting Principles” SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. This statement shall be effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” We do not expect its adoption will have a material impact on our financial statements

In March 2008, the FASB issued SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities—An Amendment of FASB Statement No. 133.”  SFAS 161 establishes the disclosure requirements for derivative instruments and for hedging activities with the intent to provide financial statement users with an enhanced understanding of the entity’s use of derivative instruments, the accounting of derivative instruments and related hedged items under Statement 133 and its related interpretations, and the effects of these instruments on the entity’s financial position, financial performance, and cash flows. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. We do not expect its adoption will have a material impact on our financial statement disclosures.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which amends SFAS No. 141, and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any non-controlling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning on or after January 1, 2009 and is to be applied prospectively. We are currently evaluating the potential impact of adopting this statement on our financial position, results of operations and cash flows and do not expect that the adoption will have a material impact on our financial statements.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements – an amendment of ARB No. 51,” which establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest, and the valuation of any retained non-controlling equity investment when a subsidiary is deconsolidated. SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS No. 160 is effective for fiscal years beginning on or after January 1, 2009. The Company does not expect that the adoption will have a material impact on the Company's financial statements.

In February 2007, the FASB issued SFAS No. 159,” The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment of FASB Statement 157.” We will adopt SFAS No. 159 in the fiscal year beginning April 1, 2008. The adoption of this Statement is not expected to have a material effect on our financial statements.

 

Inflation and Seasonality

 

We do not expect inflation to have a significant effect on our operations in the foreseeable future. Because our indoor garden systems are designed for an indoor gardening experience, it is likely that we may experience slower sales in the United States during June through September when our consumers may tend to garden outdoors. In addition, we have experienced increased sales during the holiday season in the fourth calendar quarter. We have had only two full fiscal years of operations, but it does appear that we have some seasonality.  We intend to sell to our international distributors in US Dollars thereby minimizing effects from currency fluctuations. Our purchases from China may be affected by changes in valuation of the US Dollar as compared to the Chinese currency.

 

Results of Operations

For the fiscal year ended March 31, 2008, our net sales totaled $38,356,676, an increase of 191.8% from the fiscal year ended March 31, 2007.  The sales increase reflected a number of factors including an increase in our retail presence from 750 storefronts as of December 31, 2006 to over 5,100 storefronts as of March 31, 2008, the launch of a direct mail catalogue operation during the fiscal year, and a geographic expansion of our presence to seven countries outside the United States.

Our gross margins improved to 40.1% in the year ended March 31, 2008 from 36.1% in the year ended March 31, 2007 primarily as a result of improved distribution logistics, particularly a reduction in the use of air freight to ship product from China to the United States.

Sales and marketing costs totaled $16,084,353 for the year ended March 31, 2008, an increase of 126.0% from the prior fiscal year, reflecting generally higher levels of spending in all categories to support the growth in our business.  General and administrative costs also increased, by 50.2% to $6,084,728 for the year ended March 31, 2008.  This increase was caused by a number of factors, including an increase in the number of our employees, higher depreciation and other facility costs related to our expansion, corporate governance and listing costs, and bad debt expense principally related to a reserve established to cover our exposure to the Linens ‘n Things, Inc. bankruptcy filing.

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Our net loss totaled $9,835,921 for the fiscal year ended March 31, 2008 as compared to a net loss of $10,386,451 for the fiscal year ended March 31, 2007.

We launched the AeroGarden products in March 2006, therefore the year ended March 31, 2007 represented our first full year of revenue from operations.  The following table sets forth, as a percentage of sales, our financial results for these first two full years of operations:

		Years ended March 31,
Revenue
Product sales- retail			62.4	%			68.1	%
Product sales- direct-to-consumer			35.7	%			31.9	%
Product sales- international			1.9	%			0.0	%
Total sales			100.0	%			100.0	%
Operating expenses
Cost of revenue			59.9	%			63.9	%
Research and development			6.8	%			16.1	%
Sales and marketing			41.9	%			54.2	%
General and administrative			15.9	%			30.8	%
Total operating expenses			124.5	%			165.0	%
Total other (income) expense, net			1.1	%			14.0	%