AeroGrow International, Inc. F4Q08 (Qtr End 03/31/08) Earnings Call Transcript

AeroGrow International, Inc. (AERO)

F4Q08 Earnings Call

June 26, 2008 2:00 pm ET

Executives

Jervis Perkins, President and Chief Executive Officer

H. MacGregor Clarke, Chief Financial Officer

Michael Bissonnette, Founder and Chairman of the Board

Analysts

Scott Van Winkle – Canaccord Adams

Rexford Darko – Keating Investments

John Hickman – MDB Capital Group

Suzanne Price – Thinkpanmure

Eric Appell – Appell Capital Management

Robert Straus – Merriman Curhan Ford & Co.

David Bricks

Presentation

Operator

Good morning! My name is Allison, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the AeroGrow Fourth Quarter and Fiscal Year 2008 Earnings Report Conference Call. (Operator Instructions).

Except for historical information contained herein, statements made during the conference call are forward-looking statements. These forward-looking statements include expectations related to factors impacting anticipated revenue, gross margins, expenses, earnings, inventory, and new product expectations. Investors are cautioned that all forward-looking statements involve risks and uncertainties, and several factors could cause actual results to differ materially from those in forward-looking statements. A more complete listing of these risk factors can be found in the company’s most recent report on form 10-K. Thank you.

I will now turn the call over to Mr. Perkins, President and CEO.

Jervis Perkins

Good Morning, and welcome to AeroGrow’s earnings call for the quarter and fiscal year ended March 31, 2008. I am AeroGrow’s CEO, Jerry Perkins. Also on the call today are Greg Clarke, our new CEO, and Michael Bissonnette, the company’s Founder and Chairman of the Board. We have a lot to cover today, so I’ll launch right in.

Fiscal 2008 was an incredible year for us. We tripled in size from $13 million in revenue for our fiscal year ended March 2007 to $38 million for the fiscal year ended March 2008. This is a truly a hyper-growth company in every market and every channel in which we do business. Quarter to quarter, we grew 73% from $6.4 million for the quarter ended March 2007 to $11.2 million for the quarter ended March 2008.

At retail, we expanded almost 500%, from 750 store fronts in December 2006 to 4300 in December 2007 and we continue to grow hitting 5100 as of March 31, 2008. More important, we established ourselves as a hit product with broad distribution at retail and one where our retailers are committed to us on a year-around basis. At most of our retailers, we were one of the best-selling products in the store in the weeks up to the Christmas holiday, and in fact we were the top selling product in the store chain-wide at one large retailer for the two weeks before Christmas. That gave us incredible traction, and we’re well on pace for our goal of more than doubling our store fronts once again by December 2008.

Our direct business grew more than 3 times from $4.2 to $13.7 million annually. In the March quarter, direct also grew dramatically as a percentage of total sales from the 30-35% it had been running to 45% of total sales. This increase was due to the rapid expansion of our in-house direct mail catalog business which did not even exist a year ago.

Finally, in international, we’ve gained distribution in about a dozen countries to date and have now sold our first million dollars worth of products, and we expect solid growth in that area in the coming year. All in all, we were extremely pleased with our product sell-through and tremendous consumer interest. In addition to gaining traction through multiple channels, the AeroGarden developed a passionate, loyal substitutive customer base that has shown it wants to keep using our products and make them a part of their life.

Rapid growth, however, creates stresses and strains on many organizations of this size, and we were no exception. For us, that stress and strain was manifested in a loss for the March quarter of $3.8 million. That loss is about $2 million larger than we anticipated due to more than $1 million on one-time expenses and write-offs and an additional $1 million attributable to forecasting errors. Simply put, our financial systems capabilities have not kept pace with our extraordinary growth. Recently, we have implemented a true cost accounting system for each element of our business in place of the forecasting model previously used. We have just completed a thorough audit in conjunction with our year-end close, and as you are aware from our announcement three weeks ago, we have changed the leadership of the finance department. Together, I believe these actions should bring our financial systems up to par with our needs both at the present and moving into the future.

Our new CFO is Greg Clarke, who today gets the dubious honor of reporting on our housecleaning in the March quarter. Greg was an amazing find for us, the results of a dedicated and rigorous search, and he’s made an impact in just a few weeks. He’s been a CEO and CFO at a wide variety of consumer products companies and worked in both large companies and small, including Johns Manvile, The Coleman Company, PepsiCo, and most recently Ankmar Garage Stores. He brings a range of vision and experience to help us finish the cleanup and build something special here. Here’s Greg now to take you through our quarter and year-end results.

Greg Clarke

Thanks Jerry. Good Morning Everyone! For the quarter and year-ended March 31, 2008, the story is a consistent one. We easily beat our expectations on the top line but missed them on the bottom line. First let me walk you through some of the details on the top line.

Revenue for the quarter and for the fiscal year ended March 21, 2008, were $11.2 million and $38.4 million respectively, compared to revenues of $6.4 million and $13.1 million for the same periods a year earlier. This means we almost doubled sales year over year for the quarter and almost tripled them for the year. In addition to the reported revenue, we also deferred about $578,000 in sales related to products shipped under our 36-day free trial offer for which payment had not yet been received by the end of the quarter.

Retail sales for the 2008 fiscal year were $23.9 million, an increase of 167% from the $8.9 million we recorded the year before. The increase reflects our expanded penetration in the retail channel as we rolled out from a presence in less than 1000 stores on March 31, 2007, to more than 5000 stores by March 31, 2008.

Direct sales to consumers totaled $13.7 million for the year, more than three times the $4.2 million in fiscal 2007. Driving the increase was the performance of our newly launched catalog operations and increased spending on TV advertising which also helped support our retail business. Our catalog business sent out its first mailing in June 2007 and by the end of March 2008, we had mailed 2 million catalogs. We also launched our international business during the fiscal year and recorded sales of $741,000, up from no sales at all in fiscal 2007.

Breaking the business down by product, garden sales totaled $31.5 million for the year, up 174% from the $11.5 million we reported in the previous year and representing about 82% of our annual sales. Seed kits and accessory sales were $6.8 million for the year ended March 31, 2008, a 320% increase from $1.6 million in fiscal 2007. On a percentage basis, seed kits and accessory sales represented 18% of total sales for the year and about 20% of total sales for the fourth quarter. For both time periods, the percentage mix represented by seed kits and accessories was up close to 5 points as we saw the recurring revenue benefit kick in from the accessories and more than $1.3 million seed kits we sold to support the 444,000 gardens that have been purchased through March 31, 2008.

On the margins side, we can point to some signs of improvement. Our gross margin for the fiscal year ended March 31, 2008, was 40% of revenues, up from 36% in the year ended March 31, 2007, as we were more efficient in managing our supply chain and distribution operations. To drive the growth in our business and further solidify our market position, we continue to spend heavily on sales and marketing. For the year ended March 31, 2008, our total spending in these categories was just over $16 million or 42% of sales versus $7 million or 54% of sales in fiscal 2007.

General and administrative costs for the year were $6.1 million, up on an absolute dollar basis from $4.1 million in fiscal 2007, but down to 16% of revenues from 31% a year earlier. Our net loss for the year ended March 31, 2008, was $9.8 million or $0.84 per share, down from $10.4 million or $1.09 per share for the year ended March 31, 2007. For the fourth quarter, we had a net loss of $3.8 million or $0.32 share as compared to a $2 million loss a year earlier or $0.19 per share.

As Jerry mentioned earlier, the size of the loss in the fourth quarter was higher than we had expected. There are a few things we can point to in order to explain this. First, about $1.1 million of the net loss came from a series of unusual items. We had $400,000 in increased bad debt expense related specifically to the Linens n’ Things Chapter 11. Also, we discovered that we had incorrectly accounted for some media expenses in the second and third quarters and therefore recognized a net catchup expense of $342,000 in the fourth quarter. During the quarter, we also resolved a legal dispute with a former customer, and the legal and settlement cost generated about $195,000 in one-time expense. Finally, filling out our senior management team also had a cost during the quarter, and we recognized more than $200,000 in incremental non-cash compensation expense related to option grants.

Of the remaining $2.7 million net loss excluding those unusual items in the fourth quarter is easiest to understand this by a sequential comparison to the third quarter ending in December 2007. In that quarter, we lost $1.6 million on $14.6 million in sales. In Q4, sales were $3.5 million lower, and our loss before the unusual items was $1.1 million higher, or about a 30% flow-through on the decrease in sales. This actually compares pretty well against our average 40% contribution margin on sales. Obviously though, we are not happy with the actual performance, and as Jerry will discuss in a minute, we have taken a number of steps to improve our financial performance. Of these, however, only a 28% reduction in head count happened in time to have any real impact on the March quarter performance. Going forward, we expect to see incremental improvement coming from manufacturing cost efficiencies as well as actions we’ve taken to increase the efficiency of our logistics operation.

If the loss in the quarter was significantly higher than we expected last year, it is also due to poor forecasting and modeling. Our models were based on aggregates and averages that in a steady state business would have worked fine but in a hyper-growth multichannel company like ours weren’t able to adequately anticipate the impact that changes in customer, channel, and product mix can have on our business. As a result, assumptions regarding spending and resultant profit contribution were inaccurate, and major discrepancies were not identified on a timely basis. We didn’t see trends early enough and therefore based some of our spending decisions during the quarter on faulty assumptions. As a specific example with more realtime systems, we likely would have made the decision to end or reduce our TV media spend earlier in the quarter. We spent about $2.5 million in the quarter and saw very little impact from the second half of that spend, but we didn’t have appropriate visibility to influence it within the quarter. We have since then implemented improved realtime systems and monitoring across all our channels, giving us access to data in a timeframe that can influence results. We have since built and are implementing a more detailed forecasting model based on customer and product-specific information. We expect this will improve our ability to accurately forecast our business, and more importantly give us the data we need to appropriately balance our spending against our anticipated margin dollars.

Turning to the balance sheet, as of March 31, 2008, we had $1.6 million in cash, down from $3.7 million at December 31. The principal reason for the decline was funding the cash impact of our net loss since our working capital requirements decreased as we headed into the post holiday quarter.

Inventory at March 31, 2008, totaled just under $4.7 million, down 19% from December 31^st and up only 19% from March 31, 2007, despite our sales for the quarter going up 73%. There was a similar story on receivables, which were $2.4 million at the end of the quarter, down from $6.7 million at the end of December and up only 28% from a year earlier. As we look forward, thanks in large part to our new asset-based revolver, other loans, and support from our key vendors, we believe we have sufficient liquidity in place to fund our expansion into the fall quarter at which point we expect our cash flow from operations to improve as we move into the peak selling season.

That’s it for my section. As I settle in here at AeroGrow, I look forward to the chance to get to know all of you over the coming weeks and months, and now let me turn it back over to Jerry.

Jervis Perkins

Thanks Greg. On the third quarter conference call, I outline 4 initiatives to profitability, and I’d like to bring you up to date on each of them. The first step we took was the establishment of our P&L centers, with changes in accountability and expectations for the organization, including building the cost accounting systems I talked about earlier. In the five months since we made that change, we’ve seen major progress in our understanding of the business. Now we have to give our management the real time results from our upgraded financial systems so we can drive the business going forward.

Number two is our new distribution center, which open in July just in time to maximize the benefits of the greatly expanded retail load for August and September leading to our core sales season. We’ll open the center in Indianapolis and expect to save about $1 million in shipping costs and gain 1.5 points of gross margin this year as a result of this change.

Number three is that we’ve taken significant steps to right-size our organization. We cut our head count by 28% since the first of the year, and although we’ll increase our headcount as we head into our busiest season, it will be at a rate substantially less than our anticipated sales increase. The changes we’ve made will make us a far more efficient company off a far bigger base of sales and increased operational leverage.

And finally, our new product lines have been designed for manufacturing efficiency, and that combined with a formal cost-reduction effort across the company will outpace the pricing pressures from increases in Chinese labor, oil, and metals and lead to further margin enhancement. All of this lead to the annualized 3- to 4-point margin gain I spoke of last quarter that begins to kick in during the July to September quarter.

The financial milestone we spoke of on our third quarter conference call was to get our working capital in order to fund our rapid expansion. A few weeks ago, we wrote that we had secured a major capital infusion to fund our expansion. That deal has opened this week, and we did it without any dilution to shareholders, on favorable terms and with a lender that is excited to be growing with us, and now we are in a position to grow this company quickly and far more efficiently. We said before that we plan on doubling our retail store front this year and I believe we’ll do even better than that. We have the funding, the team, the systems, the products, and most importantly the customer base with incredible consumer interest and strong retail support. We are doing what we need to be doing to maximize this opportunity. We’ve created an entirely new product category, established it, and now we want to own it lock, stock, and barrel.

Our indoor gardens have already demonstrated broad consumer appeal among men and women, young and old, gardener and nongardeners, cooks and noncooks, and more. We’re on trend and on target everywhere. We’re green, we’re healthy, we save water, we save gas, we’re fresh, all natural, and as an article in the New York Post mentioned earlier this week, we even grow tomatoes that are salmonella-free. You name it; we’re there.

At retail, I’ve never seen a product gain broader, deeper acceptance in a relatively short time period over a wide variety of channels in my life, and I was in on the early days of Gatorade. We’ll go from under 1000 stores to almost 9000 stores in less than two years, from culinary to department, to housewares, to lawn and garden, to hardware, to specialty stores, to mass merchants, and most important, we haven’t gone anywhere yet where we haven’t met or beat the expectations of the retailers. At most of those stores, we were one of the, if not, the best-selling products in the store leading up to the holidays. It gives you a lot of traction at retail, and we’re using that traction to double store fronts again this year, and in many cases, when they pulled branded line, $99 and $149 gardens and accessories all featured at retail on the same shelf, and at least one national chain in two different departments in the same stores. We’re expanding distribution in lawn in garden and department and mass, all in brand name place that you’ll know and testing in channels like grocery, drug chains, and office supplies. When we’re done with that, we will still only be in a about a third of the stores we have targeted for distribution, just in the next few years.

Equally important is our consumer acceptance. We’ve always used the analogy of a razor blade business, but this opportunity goes way beyond that. A razor you buy because you have to. People are buying our gardens and seed kits because they love the product. In fact, they love it so much that many are buying second AeroGardens and then a third and a fourth and a seed kit and light bulbs and accessories for each garden. Over the numbers we can track, just off our own database alone, almost 30% of our customers have come back and ordered and the total of their repeat orders averages $155. They are buying seed kits, but they’re also buying gardens. The simple explanation is that our products work, they deliver what we promise, and people are adopting are adopting an entirely new pastime in their lives. We’re becoming lifestyle product that people value and want to use on an ongoing basis.

In fact, that’s a question I hear all the time. Are you guys a flash in the pan or something that people will want to use over and over again for years, and I had concerns myself when I came on board, but when you look at the number of our repeat customers, when you look at the blogs and the passion people have for the product, when you consider we’ve sold products to less than 1% of Americans and that we offer something green, fresh, living gardens that you can grow year around, when you see all the channels we can sell through to such a broach range of consumers and when you look inside our product development and the all the different ways we can shape and complement the product to appeal to those consumers, you start to wonder not is this a flash in the pan, but just how broad a lifestyle product this will be.

This year, we expand from the kitchen to the rest of the home and office with an added emphasis on flowers and compact units for portability and style. This is going to be an enduring category and a profitable business for many years to come.

Therefore, what should you expect for fiscal ’09? As I said in our third quarter conference call, the April to June quarter will be our toughest one this year from both the top line and bottom line perspective. I’ll start from the top line for two reasons. The first is that we learned last year there is some seasonality to our business. Our orders fall off through our direct channels, and while we’re established as a year-around item at retail with solid movement outside of our season, sell-through does drop off and we see diminished reorders during the summer season as a result.

For the future, we’re looking to expand our Seed Starter and Master Gardener lines and developing indoor/outdoor gardens as a concept to balance this, but we won’t see any impact there until next year. The second and predominant reason is that the June quarter is tough for us this year because we’re making a conscious transition to our new product lines at many of our largest retailers. That will make for a great September sales quarter, but in the June quarter, it means that we are not getting wholesale replenishment orders from our largest retailers as they sell through their 7-pod inventory, which does minimize our returns in anticipation of loading in all new inventory in the fall.

Currently through all channels, we sell our classic 7-pod garden system. Seven-pod will continue to be supported and manufactured for years to come. However, our new line featuring units from $99 to $229 performed even better for the consumer, 25% more growth, and is a more efficient, leaner manufacturing process. The short story is that we learned how to make it better, so it would produce more with less chance of defect and smaller, more attractive units across a platform that is truly built for the long run. That’s the right thing to do for the long term, but it will have an impact on the April to June quarter.

On the top line, our analysts, and we have four analysts that are tracking us which may or may not show up on the service you look at, our analysts have us at an average of $7.1 million in revenues for the quarter. They are close, but we are likely to come in lower than that for the quarter. As for income, the majority of our margin improvement programs will not have an impact yet. The new product line doesn’t ship until August. The new distribution center does not come on line until July 1st, and we won’t see real savings there until we start shipping heavily in August. For the April to June quarter, our average from the analysts on the bottom line is a loss of $1.6 million, and we’ll see a larger loss than that due to the lower revenues. The good news is that we are well capitalized to get through it and move on.

The April to June quarter is really a turning point for us. By the start of the September quarter, the cost saving initiatives will be in place and producing, the sales will increase dramatically as we sell into major retails. We’ll be on pace for doubling of our store fronts this year, rolling out in mass, clubs, department stores, lawn and garden, grocery, drug chains, office with products consumers want with a business model and overhead that makes sense for continuing to pursue the scope of this opportunity with a sales engine, our web and TV and catalog helping drive a recurring revenue component that is exceeding all of our expectations. All of that will translate to finishing the year with a fast growing and profitable business. We’re comfortable on the top line with the analysts’ average of around $60 million for the year. That will translate into a range on the bottom line between breakeven and $2 million of profit for the year. Making that transition to positive cash flow capable of sustained hyper-growth on our own is needless to say a key milestone for us, and I feel like it is finally ours to make happen, that we have a team to deliver it and take it beyond that, to continue our rapid growth and expansion with this new product category.

We have a sound business model, a differentiated concept, a loyal franchise, a proven product in the market place, and we’ve made the tough decisions necessary to move toward profitability. This is a vastly different organization, and I can tell you that it is an excited group around here. We believe in our potential and where we are going. To further substantiate that statement, you can note that much of the board and senior management team had been invested in the debt package just announced. Our objective it to continue to build and our own lifestyle category, and we know we can do it with our magic growing machines.

With that let me open the line for questions.

Question-and-Answer Session

Operator

(Instructions). Your first question is from the line of Scott Van Winkle of Canaccord Adams.

Scott Van Winkle – Canaccord Adams

Two questions. First on the financial side, you’ve got new leadership in finance. You’ve gone through and you’ve found some issues in the March quarter. I’m wondering how far along in reviewing all the past data are we at this point.

Jervis Perkins

I’d say we’re 99.9% through the past data, and the very thorough audit that was done obviously brought forward a couple of things from previous quarters that you heard about today. So we are comfortable with our historical financials.

Scott Van Winkle – Canaccord Adams

Great! There’s a $20 rebate that’s being offered by a couple of retails and online. Is that new, or is that focused on this tougher period of clearing out some inventory between now and June?

Jervis Perkins

Exactly the latter on that one, and what we obviously are doing is moving through, and it’s 4 of our 5 biggest retailers that you’ve probably seen it at, plus several others. The $20 rebate is to move it all out so that we’re doing less shipping back as we bring forward a whole new line, something that we would only do in a situation like this.

Scott Van Winkle – Canaccord Adams

We’re already in late June. Your confidence in the level of channel clearing before the new products hit, are you pretty much along where you want to be?

Jervis Perkins

Definitely the channel clearing actually goes into end of July/early August period, so that there’s a rapid transition as the new comes on to the shelf in the mid-August period, the first couple of weeks of August. So we are right in line with our expectations and comfortable. In fact, we are fractionally ahead of them in terms of the transition itself.

Scott Van Winkle – Canaccord Adams

And just keeping with being able to manage this transition in inventory, your levels of inventory of the new products, where do you stand on manufacturing those, and how do you tiptoe through the DC transition?

Jervis Perkins

The real total full-out manufacturing began about 3 weeks ago, and we will be running full out to meet our very strong orders and estimates from our broader retail base as we go. Having the capital in place and borrowing against that inventory is obviously an important part of our management going forward here, but we are full out, running exactly according to plan, and continuing to challenge that plan as estimates go up and up and up before August and September.

Scott Van Winkle – Canaccord Adams

Does it make it easier transitioning to a new distribution center given that you’ve got new inventory coming in?

Jervis Perkins

In a way. Obviously you can split it different ways, although it’s really going to split regionally because we’re going to keep the West Coast operation going for a time. The benefit is that we’re going to be taking back that inventory and then shipping to other places so that we can with some new warehouse space keep it isolated in terms of where it come from and where it’s going to.

Scott Van Winkle – Canaccord Adams

Just quickly on the $400,000 with Linens n’ Things, does that stick to your receivables?

Greg Clarke

That represented the bulk of our receivables from Linens n’ Things. Linens n’ Things Canada as you probably know did not file, so we had some outstanding receivables from them, and we reserve what I would think was a very conservative percentage of our total receivables from Linens n’ Things.

Scott Van Winkle – Canaccord Adams

Last question. So we should expect it’s going to be quiet on the marketing front at retail just for a couple of months and then we’ll see that pick up towards right at the end of summer. Is that’s fair?

Jervis Perkins

Yes. That’s fair. We will probably even be announcing as we go and major retail accounts as we open them up and broaden it, so we will be full of early news and driving your forecasting higher and higher.

Operator

Your next question is from the line of Rexford Darko.

Rexford Darko – Keating Investments

A quick question regarding marketing expense. In absolute dollar terms, do you expect for fiscal 2009 marketing expense to be higher than in 2008 or broadly in line with 2008?

Jervis Perkins

It’s will be higher, not nearly the doubling of expense that we had because as of this point we can run very sufficient advertising, and it’ll be up fractionally compared to previous increases.

Operator

Your next question is from the line of John Hickman.

John Hickman – MDB Capital Group

You were talking about your new system and the fact that you can feed real-time data to your managers. Can you elaborate on that? Are you talking about daily or weekly sell-through, that kind of thing?

Jervis Perkins

Yes. For us to impact it, it has to be within the week. In terms of things like our direct sales model, it is obviously basically a daily feed in terms of the response to the medial that we have out there, so some of it is daily, some of it is weekly, and now that I think, we have the forecasting much more accurate than what it was before. We’re leveraging that. As Greg brought out this as an example, we ran more advertising from an efficiency standpoint than we should have in that quarter, and the fact is that the read we had of revenue returns from that advertising was overstating the case, and now that that is straightened out, I think we’ll be able to manage and target it when we’re really going to get the impact. We could have taken those dollars as an example and fed Mother’s Day and Father’s Day which apparently we’re going to own as holidays going forward and have it up there even more. So it really gets down to how you manage a highly leveragable business in real time.

John Hickman – MDB Capital Group

I have a financial question now. What was the stock-based compensation for the quarter? You said it was $200,000 more than before because of management additions, but can you give us the total?

Greg Clarke

Yes. That was the total. It was just about $200,000 during the quarter.

John Hickman – MDB Capital Group

So that’s not that big of a change then?

Greg Clarke

Yes. It depends on which quarter you’re comparing to, but certainly we’ve had compensation expense in prior quarters. I look at it though as being slightly different from the operating side of the business and thought it was worth highlighting.

John Hickman – MDB Capital Group

The TV thing that you were talking about, like this quarter that ends in June that we’re almost finished with, because this is a seasonally slow period for you, we can assume that you didn’t $2.5 million in TV advertising this quarter?

Jervis Perkins

That’s correct.

Greg Clarke

That’s a fair assumption.

Operator

Your next question is from the line of Suzanne Price.

Suzanne Price – Thinkpanmure

Greg, you mentioned the 30% reorder rate, and I was wondering if you had done some numbers on how many seed kits a person typically has ordered once they’ve bought a garden, or maybe you can just tell us how many seed kits have been sold out there in the world and how many gardens have been sold and we can do the math ourselves.

Greg Clarke

The number of gardens is 444,000, now approaching half a million obviously real-time. The number of seed kits is 1.14 million through the end of that time period and obviously approaching something like 1.33 million going forward. The numbers that we have now, we know that 25% of our users now own a second or more units, and the number of seed kits per capita per consumer out there is usually fairly much in line if not a little higher than the number of units owned. I guess it would be more 2:1 to get a number there. We don’t have that one readily available.

Suzanne Price – Thinkpanmure

Does that include the one free seed kit that comes inside the unit?

Greg Clarke

No.

Suzanne Price – Thinkpanmure

Okay.

Greg Clarke

It’s actually a fairly startling number. We were startled on how high that is. We barely had been in existence long enough to have much of a recurring revenue, and in fact, our average purchase is $180 something, which the average purchase is one product, one garden with which you get seed kit and light bulbs, and then on average one more light bulb and one more seed kit, so in fact they have almost a year’s worth of pantry load in terms of the product itself. So it wouldn’t have honestly surprised us if we come back single digits or zero in terms of a return rate other than the fact that people are buying multiple gardens and coming back a whole lot faster than we thought they were going to, so it’s really a very big number on our database right now. We can see it going up in leaps and bounds. We are at about 150,000, and in terms of value that thing is extraordinary obviously as we go forward.

Suzanne Price – Thinkpanmure

Have you introduced any programs where you automatically offer people another seed kit when you know that it’s time they’re due for one?

Greg Clarke

Yes, we have, and don’t you get yours?

Suzanne Price – Thinkpanmure

No.

Greg Clarke

Okay, well, we’ll make sure. We have several different forms going out. There’s an actual email response where we’re now trying to target it by timing, and then at the very least, you should be getting several of our 8 million reminders known as our beautiful catalog that we will have out this fiscal year. So we will be in your mailbox regularly enough, and you’ll know when to repurchase.

Suzanne Price – Thinkpanmure

I do get that, but I do think it’ll be easier to just click on something saying, okay, send me another seed kit.

Greg Clarke

We’re ready for you. The email may be in your inbox by the time you get off this call.

Suzanne Price – Thinkpanmure

Okay. Another question. On gross margins, you’ve definitely done a good job of improving them. Is there still room there to get some more efficiency out of the chain, and you’ve also been increasing direct sales. Does that help your gross margin go up as well?

Greg Clarke

Yes and yes. The bigger number off that 40 base, we’re still holding to our 3 to 4-point margin increase for this year, and that includes double-digit cost increases on China labor, obviously gas, resins for plastics which are oil based, metals which actually are the highest of all of them, and the cost reduction and the now totally different manufacturing process not only makes up for those, but we’ll increase our margin, part of it in conjunction obviously with the new logistics center and the head count reduction. So, we’re targeting 3 to 4 points above that for the year. The other part of the question…

Suzanne Price – Thinkpanmure

The direct sales, should we expect that to continue to go up and, if so, how does that affect the margins?

Greg Clarke

Yes. Direct is higher as a one for one trade-off, and that would impact it too, but what you’re going to see after the slower retail period, which will be fairly obvious in the June-ending quarter, is that retail is going to go rocketing up, so it’s really safer to look at our margins on a annual basis and we’ll explain each quarter what’s driving what in terms of the mix, which is going to vary dramatically from a very low retail percentage this next quarter ending in June to a very high retail percentage for September to what maybe an ongoing rate and an enormous number in the Christmas season.

Suzanne Price – Thinkpanmure

Great! Quickly, could you also give us an update on international where you are in the different countries and how much growth we should see from there that hasn’t been in the numbers yet?

Greg Clarke

Since we’re at about a million bucks, we’ll see multiple times growth. We’re in in shipping in 12 countries right now, and quickly they are the UK, France, Germany, Spain, Holland, Italy, Portugal, Iceland, Japan, South Korea, Australia, and South Africa, and to give you a range and a little bit of feedback on all of this, we’re filling everything from very well in places like Australia to what I would describe as mediocre in Japan, just to pick two of the big ones, and the big difference is which we can see across this range, although it’s very early, is that in Japan, as example, we started out with a very pure direct response program. Without having the retail in place, without the catalog, without the customer support, without a lot of the elements that we have seen drive the business here and in a place like Australia, which is on a percentage out of the blocks basis just smoking the US in terms of a response there, but they went out with a multimedia including PR, which I should mention here too, and had the communication and a base of understanding out there. So what we’re learning as we go here is that we really have to have all of these elements working together consistent with how people shop in each country, so there is a range there. Most of it is very positive. Our magic growing machines sold very well as you might expect internationally as they do in the US. And I forgot to mention Mexico and Canada that we count in North America, so I guess it could be 14 depending on which way we’re going, but several of those are very recent.

Operator

Your next question is from the line of Eric Appell.

Eric Appell – Appell Capital Management

Since the IPO, I’d been begging management to raise more capital doing the stepping step process that they’ve done, so anyway, I’m glad to see some more disciplined management on board. My question is this: there’s a huge opportunity in front of you. It’s obvious. Would it not be better for the company potentially to see a larger company and sell out so that a more well-capitalized company could take advantage of this monster opportunity in front? What are your thoughts there?

Jervis Perkins

In terms of the shorter term stock price, of course. If somebody came in bidding $25 for us, that might turn some heads, but the fact is we are appropriately capitalized for our company to step forward in the two times and three times steps and bounds that we’ve got, and what we try to make sure with our $14.5 million in financing is that that is enough to meet our needs with a massive expansion and rollout going forward. The things that a company would only be add is a little equity, and we’re comfortable with where our equity is today and going forward to meet our needs through this season.

Eric Appell – Appell Capital Management

Okay, so let me tap your experience just a little bit more. Let’s say the country runs into maybe a little bit deeper recession than maybe you’ve contemplated it internally. Would that $14 million in financing get you through the covenants such that you might be in fear of breaching covenants and then the ultimate?

Jervis Perkins

You’ll notice that this is the probably the first company call that you had that hasn’t mentioned the economy as a major driver in whatever their results are. Now, yes, we believe that and difficult at retail is an impact on our numbers, but we are in such position and with little comparative from last year that separating that out is difficult to do. We don’t that that drives us over the edge in anyway and we with better systems and processes going forward need to manage what sort of impact that we’re having in the market place, in that we’re going to be far better at doing that going forward.

Eric Appell – Appell Capital Management

Okay, so you benefit from being a hyper-growth company with no penetration, so that’s the advantage you have no matter what kind of Christmas season we have.

Jervis Perkins

Yes. As we get these orders in and challenge our manufacturing to speed up their already speeded-up process, the orders are going up and up. If that’s their reaction to the economy, I’m glad that the economy is a little depressed, because a little more stretch, and we’re going to have to change a few dates to be able to ship things out. So, it’s amazing, and we put a factor in as we looked to August and September, but it’s not holding back the buying of our major offense.

Eric Appell – Appell Capital Management

Okay, so I’ll just be satisfied that we have a more mature management team in place and good product. I appreciate it, gentlemen. Thank you.

Operator

Your next question is from the line of Robert Straus.

Robert Straus – Merriman Curhan Ford & Co.

Just to review. Your first quarter forecasted comment for the EPS loss. Just rephrase that just to remind me what that detail was.

Jervis Perkins

Yes. I’ll even try the Jerry mathematics way here just for one other number that hasn’t even come up yet. If you took our breakeven point, Jerry’s number is $14 million with a little range to it. We were going to sell, rounding to millions, $7 million or a little less we believe that quarter, with a 40 margin that puts us in the high 2’s obviously in terms of a loss, and we think that’s the predominant number that we will see in the EPS without my calculator going at the moment, but divided by 12.5, obviously I don’t have mine with me, but I’ll let you do that much.

Robert Straus – Merriman Curhan Ford & Co.

Greg, the other number, you had about $1.1 million in one-time charges. Can you just discuss a little bit how that fits into the P&L by line?

Greg Clarke

Sure. The bad debt expense runs through G&A. The legal dispute actually kind of runs up and down the P&L. There are some product costs. There are some G&A costs. The medial expense where we had to recognize to catch from prior quarters, that obviously hits the sales and marketing line, and then the noncash compensation expense hits the G&A line.

Robert Straus – Merriman Curhan Ford & Co.

This $1.1 million it sounds like you feel is all in and we shouldn’t be expecting to have additional conversations with one-time charges at least as it relates to this type of stuff going forward?

Greg Clarke

I think that’s right. I’ve been on the ground for about a month now, and obviously spent the better part of that month working with our auditors on getting the year end closed on and also getting our 10-K finalized and out the door, and so I feel pretty comfortable that the numbers have been scrubbed to find things like the accounting for the media expenses that we really needed to recognize the catch-up expense in the fourth quarter. Certainly, going forward, we all know that things happen, and so there may or may not be unusual items going forward, but as far as I know to date, I have not seen anything that’s going to come forward to bite us that’s out there now.

Robert Straus – Merriman Curhan Ford & Co.

Sounds good. Jerry, are there any statements that you can make regarding quarter to date trends at this point? (Pause) Actually, we’re at June 26^th. Scrap that question. Next question is for the catalog plans, I think you had stated you shipped about 2 million from June ’07 through March ’08. Is that correct?

Jervis Perkins

Yes.

Robert Straus – Merriman Curhan Ford & Co.

How do you expect the number of mailings going forward to change or what kind of increase would you accept?

Jervis Perkins

We have 8 million catalogs in the plan, so 4 times, and what we’ve seen is just incredible, and so we’re every month and a half sending them out and seeing how high is up. To give you an idea on that, in terms of our returns to our customer base, we get 7 to 10:1 returns. For each variable dollar spent, $7 in return at the lowest against our customer base, and even against the prospecting that we do, we get payback instantaneously, and most companies would spend a whole lot of money to underwrite that to bring in a prospect and have them pay out over time, so we’re more than thrilled with the strength of this user base and the leverage that’s in that, much less the advertising leverage. We’re obviously not even counting the recurring revenue in retails and other channels. We can count it our web site which also looks very strong, so it is a wonderful asset both as a marketing vehicle and as a sales vehicle.

Robert Straus – Merriman Curhan Ford & Co.

What percent of your maketing budget is accounted for by the 8-million catalog plan?

Jervis Perkins

I’ll stab a little bit, and we’ll…I guess 20-25% something like that.

Robert Straus – Merriman Curhan Ford & Co.

You had mentioned that you think the gross profit margins will expand by 3 to 4 percentage points. Is that by the end of this calendar year, or are you thinking this fiscal year?

Jervis Perkins

Fiscal year, but you’re going to see at least on an apples to apples comparison, most of it kicking in the July-September quarter. To Suzanne’s comment earlier, we’ll be nixed back in terms of retail which is obviously our lower gross margin sale, so we’ll separate the factors as we go through, but we’re going to be running the new regime here come mid-August and obviously through the end of the year, so I’m speaking on a fiscal year basis. Given the size of our December order expectations, it probably doesn’t make a whole lot of difference in which one you choose.

Robert Straus – Merriman Curhan Ford & Co.

And I think as you just stated that does include the retail expansion that you have in your plans.

Jervis Perkins

Yes, it does.

Robert Straus – Merriman Curhan Ford & Co.

Okay, last question, regarding the credit facility or the secured commitment that you announced a few weeks back, how much of that money is available today?

Jervis Perkins

It changes so dramatically day by day. Since we borrow against inventory, we could run a tab, but do we have about $1 million in borrowing power as of today? That’s probably pretty close, and then as we ramp up through July and receivables start catching up a little with inventory, we’re going to use a great part of that full facility.

Operator

Your next question is from the line of David Bricks.

David Bricks – Unknown Firm

Hi, AeroGrow. We love your product. The summer months are when you use the AeroGarden to start head lettuce which you rotate then into the garden toward the end of the quarter.

Jervis Perkins

That’s perfect. That’s indoor-outdoor concept that we will be furthering as we go. All of our starter kits and otherwise, we ran them well out of stock here in terms of the ordering on things that we put out there to see what happens at which time of the season depending on what climate you’re in.

David Bricks – Unknown Firm

The blank pods are a great benefit because then we can just go get whatever we want for whatever the crop is. The AeroGarden device doesn’t really lend itself to the head lettuce because of the constraint on space, but wow, do those plants do great when you finally move them into the dirt!

Jervis Perkins

David, I assume that you own our average 3 or 4 per user now, right?

David Bricks

I haven’t gotten my second one yet, but it may be on misses’ Christmas list this year.

Jervis Perkins

There you go, so that’s a great way to grow more lettuce, and the other one that we’re seeing right out of the blocks is as we get the 3-pod $99 unit in there that the initial sales are a whole lot of them, as it goes to other places in the house with flowers and otherwise. They are incremental on top of our customer base that we already have and so all this variety of products going forward is meeting a whole lot of different needs that we can see.

David Bricks

Any place you can put a vase, you can put an AeroGarden. The other suggestion I had was if you’re having trouble in Japan, go with the viral marketing if there isn’t a users group forum that you can find and see what you can do to start with a Japanese-literate person. There’s a new web site in the UK that just started in the last month called aerogardeners, and if your marketing department is involved at all in the viral marketing… actually, I see a post by Ben from AeroGarden on someone’s personal web blog.

Jervis Perkins

We join the majority of these things. I didn’t honesty know that Ben who runs our web was in on that one and I don’t know how good his Japanese is to tell you the truth, but the grassroots part of this as we get into these countries we have to be there with that because that’s really the heart and soul behind this business.

David Bricks

Absolutely! Very cost effective too.

Jervis Perkins

Absolutely!

Operator

Your next question is from the line of Martha Richie.

Martha Richie

Hi there. I’m a great fan guys. You’re doing a wonderful job. My question has to do with the product line. When you speak about the new product line, you are talking about the 3-pod units and the Pro Series or do you have even other new products in the works and what’s the date for the strawberries?

Jervis Perkins

I’ll warm up to the strawberry question. We have 6 different price points including $99 through $299, and yes, the Pro Series hovers in the $199 and $229 models, and for all of those, that’s growing our full size vegetables with our extended arm and higher lights and otherwise which, by the way we had several catalogs to show you high as up on thing where it is, outsold our mainstream $149 unit which is just amazing as a price point, but all of those models are out there across the new line and in terms of the extended arms and otherwise across the old line, so we are meeting the broader needs of both franchises as we go forward. The strawberries, so you know, we’re within inches about 5 different times since I’ve been here, and we just are not going to introduce them until we are 100% comfortable that we’re going to be there in space, and what we’ve proven is that strawberries are one of the most difficult products to grow, but we have actually done live plants which I’m sure you’ve seen and the technology and capability is there, but I hope you see strawberries very soon.

Let me just even branch into that a little bit because it brings up an area that we’ve barely touched here, and that is some of the things coming forward, I mentioned expansion, flowers, other rooms, in the office, indoor/outdoor for full size vegetables and plants, there’s going to be a big handset onto the patio and other things coming soon. We have a kids’ line which we are going to get a giant kick out of. As I was designing the globe on the 3-pod this morning, we had a high-end expansion which we think, I’ll throw another gem in here, and that is that I’ve never seen a product so price insensitive as we go forward, high end, I don’t know what the $279 model is going to be, but coming soon to a store near you, we have a desk garden series. What we have is enormous breath to differentiate our products and meet different consumers and for that matter different kinds of retailers, which is obviously critical as we go through this mass expansion to make sure that stores that are across the street are meeting different needs, featuring it, and merchandizing it in different ways. So that’s a long-winded answer to about the only thing we don’t have, the strawberries yet, and we’ll call you as soon as we do.

Martha Richie

Okay, thanks so much. I look forward to them.

Jervis Perkins

Thank you. Okay. I think we’re going to wrap it up here. John and I will be on the lines to meet you here and anytime you want to call on us. We’re tremendously excited here. In fact, I’ll give you the last warning to close off for the day, and that is we come out of our blackout period on July 1^st. Just so you know, from July 1^st, you will be bidding against all of us internally for your stock at whatever price that it’s it, so that’s my fair warning which I’m not even sure I can say, but I just did, so we’re going with that. With that, thank you all very much and we’ll talk to you soon.

Operator

This concludes today’s conference call. You may now disconnect.

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