AeroGrow: Product's Not the Problem

Fiscal year 2008 came to a close for AeroGrow on March 31, 2008. The conference call was held on June 26 (see call transcript) and I think it is a good time to provide an update.

Previously I had written about AeroGrow and pointed out good and bad points, but mostly good. With the stock price lower by approximately 35% from my time of purchase, in this post, I won’t gloss over the increase in revenue or store presence and other obvious matters. This post, I’ll be going over the problems.

Here are some recent points to consider.

Positive Points

• Revenue increased from $13 million to $38 million compared to prior fiscal year March 31 2007
• Expanded from a presence of 750 stores in December 2006 to 4300 in December 2007 and 5100 in March 31, 2008
• Direct business grew from $4.2 to $13.7 million (35.7% of revenue)
• Sold first million dollars of products Internationally (1.9% of revenue)
• Gross margins increased from 36% to 40% for the fiscal year.

Negative Points

• Bottom line isn't improving
• Management on financial handling
• Net loss of $3.8 million for the quarter as opposed to an expected loss of $1 million
• Net loss for the year was $9.8 million. Only slight improvement from $10.4 million the year ago
• Very small insider buying.

Viewing Perspective

The numbers look very impressive, and they are, but that depends on how you look at it.

In a 1km race, if a runner sprinted the first 800m only to realize that he didn’t have any energy left for the last 200m and barely finished, how would you rate that performance? I doubt people would pat the runner on the back for doing a great job.

AeroGrow does so well with income, only to disappoint at the finish line. This has become the performance and risk of AeroGrow. The problem lies in AeroGrow, not the AeroGarden.

Invert, Always Invert

I’ve been reminded the importance of bottom up thinking when researching companies. Unfortunately, a question that I did not ask myself and fully investigate was “what is wrong with the company?” or “why is it the way it is?”. Had I told myself that the answer was “I’m not sure”, it would be safe to say that I would have kept waiting and monitoring the company on the sideline.

So, what is wrong with the picture? Simply, I see it as the lack of discipline in capital expenditure and experience within the management team. This was the risk I outlined in my previous posts and one which played out.

“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.”

This above statement shows that management wasn’t expecting much from their bottom line to begin with. In fact, it doesn’t sound promising at all if management themselves call it a “consistent” story.

Future Steps to Improve The Business?

During the conference call, the CEO briefly went over 3 issues from the previous quarter conference call.

1. “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.”
2. “Number two is our new distribution center…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.”
3. “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…he changes we’ve made will make us a far more efficient company..”

Unfortunately, this wasn’t the information I was hoping for. There were no explanations, elaborations or deadlines on how the above was going to be achieved. I was a little surprised that deeper-probing questions weren’t raised during the Q&A section. I wanted to know things like how saving $1 million in shipping would prevent or benefit the company when they are still losing around $10 million, or as it is stated in the 2008 annual report in the risk section:

“As of March 31, 2008, our losses from operations have resulted in an accumulated deficit of $39,628,084. There is no assurance that we will ever attain profitability.”

Insider Buying

During the conference call, the CEO mentioned that insider buying would begin on July 2. Since then I’ve been monitoring every SEC filing (I have the RSS set up for AeroGrow). What I see isn’t a whole lot of insider buying. The max number of shares purchased is 5,000. I don’t know whether there is a rule or anything, but 5,000 shares at around $2 doesn’t show a whole lot of conviction in the company. Except for Walker Jack Jonas, who has purchased 20,000 shares during this time, even the CEO has only committed to 5,000 shares.

If a CEO of the company, whom I assume is getting paid in the six-figure range, commits around $10,000, that $10,000 corresponding to my standard would be equivalent to $1,000. i.e. a small portion of his portfolio.

Opinion

I could be coming across as stubborn, but considering it’s a small portion of my portfolio and I have been aware of the risk to some extent, I’ll be holding onto my shares.

I don’t agree with the “dump AeroGrow” call, but if the company does not break even or become profitable by 2009, I will definitely reconsider my position.

Disclosure: I am long AeroGrow.

Comments

[Jason T]

Good analysis. I had same situation with recent quarter from PRXI. PRXI however has recently got some shareholder activism going on. A strong shareholder in AERO could be good to help keep company from destroying potential future shareholder value. Good luck with this one.

[Aileen B]

Your analysis appears to be pretty spot-on. I'm monitoring, but haven't yet purchased any shares. I may buy shortly, but this is a company that should be closely monitored. They have a lock on this particular product category in the market, which is another of their strong points. Lastly, I appreciate that you own shares in this company, so you're writing about something you're familiar with from your own experience.