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AeroGrow International, Inc. (collectively, the “Company,"” “AeroGrow,” “we,” “our” or “us”) was formed as aincorporated in the State of Nevada corporation inon March 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 manufactures, distributes and markets nineten 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 retail distribution via online retail outlets and brick(brick and mortar storefronts,and online), catalogue and direct-to-consumer sales primarily in the United States and Canada.

Basis of Presentation

The unaudited interim financial statements of the Company included herein have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting including the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. These condensed statements do not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for annual audited financial statements and should be read in conjunction with the Company’s audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2017,2018 (“Fiscal 2018”), as filed with the SEC on June 26, 2017.

In the opinion of management, the accompanying unaudited interim financial statements reflect all adjustments, including recurring adjustments, necessary to present fairly the financial position of the Company at June 30, 2017,2018, the results of operations for the three months ended June 30, 20172018 and 2016,2017, and the cash flows for the three months ended June 30, 20172018 and 2016.2017. The results of operations for the three months ended June 30, 20172018 are not necessarily indicative of the expected results of operations for the full year or any future period. In this regard, the Company’s business is highly seasonal, with approximately 65.7%60.1% of revenues in the fiscal year ended March 31, 2017 (“Fiscal 2017”)2018 occurring in the four consecutive calendar months from October through January.   Furthermore, duringDuring the three-month period ended June 30, 2017,2018, the Company has further expanded its distribution channels and invested in necessary overhead in anticipation of the Fiscal 2019 peak sales season.  The balance sheet as of March 31, 20172018 is derived from the Company’s audited financial statements.

Liquidity 

Sources of funding to meet prospective cash requirements during Fiscal 2019 include the Company’s existing cash balances, cash flow from operations, and borrowings under the Company’s debt arrangements.  We may need to seek additional debt or equity capital, however, to address the seasonal nature of our working capital needs, increase the scale of our business and provide a cash reserve against contingencies.  There can be no assurance we will be able to raise this additional capital.

Significant Accounting Policies

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  It is reasonably possible that a change in the Company’s estimates could occur in the near term as additional or new information becomes available.

The Company computes net income (loss) per share of common stock in accordance with Accounting Standards Codification (“ASC”) 260.  ASC 260 requires companies with complex capital structures to present basic and diluted earnings per share (“EPS”).  Basic EPS is measured as the income or loss available to common stockholders divided by the weighted average shares of common stock outstanding for the period. Diluted EPS is similar to basic EPS, but presents the dilutive effect on a per share basis of potential common stock equivalents (e.g., convertible securities, options, and warrants) as if such securities had been converted into common stock at the beginning of the periods presented. Potential shares of common stockSecurities that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.  Securities not included in the computation of diluted EPS because to do so would have been anti-dilutive wereinclude: (i) employee stock options to purchase 175,000125,000 shares and warrants to purchase 2,000 shares of common stock for the period ended June 30, 20172018; and (ii) employee stock options to purchase 656,000175,000 shares and warrants to purchase 3,093,0002,000 shares for the three months ended June 30, 2016.

ASC 825-10-50-20requires disclosure of significant concentrations of credit risk regardless of the degree of such risk.  

The Company maintains cash depository accounts with financial institutions.  The amount on deposit with several financial institutions exceeded the $250,000 federally insured limit as of June 30, 2017.2018.  The Company has not historically incurred any losses related to these deposits.  The financial institutions are highly rated, financially sound and the risk of loss is minimal.

For the three months ended June 30, 20172018 and 2016,2017, one customer, Amazon.com, represented 23.0%41.8% and 35.8%23%, respectively, of the Company’s net revenue.

As of June 30, 2017,2018, the Company had three customers, Amazon.com, Bed, Bath & Beyond and Amazon.ca,Kohl’s, that represented 26.5%26.1%, 16.3%18.5% and 15.8%11.6% of the Company’s outstanding accounts receivable, respectively.  As of March 31, 2017,2018, the Company had threetwo customers, Amazon.com, Amazon.ukCanadian Tire Corporation and Amazon.ca,Amazon.com, which represented 33.9%, 14.3%27.3% and 11.0%22.3%, respectively, of outstanding accounts receivable.  The Company believes that all receivables from these customers are collectible.

For the three months ended June 30, 2018, the Company purchased inventories and other inventory-related items from one supplier totaling $2.7 million. For the three months ended June 30, 2017, the Company purchased inventories and other inventory-related items from one supplier totaling $1.7 million.  For the three months ended June 30, 2016, the Company purchased inventories and other inventory-related items from one supplier totaling $300,000.  The purchase of inventories and other inventory-related items is dependent ontied to the anticipated timing and amount of purchasessales for our highly seasonal business and payment terms with our suppliers.

The Company’s primary contract manufacturers are located in China.  As a result, the Company may be subject to political, currency, regulatory, transportation/shipping and weather/natural disaster risks.  Although the Company believes alternate sources of manufacturing could be obtained, the riskthese risks and any potential loss of an interruption in product sourcingsupply could have an adverse impact on operations.

The Company follows the guidance in ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), as it relates to the fair value of its financial assets and liabilities. ASC 820 provides for a standard definition of fair value to be used in new and existing pronouncements. This guidance requires disclosure of fair value information about certain financial instruments (insurance contracts, real estate, goodwill and taxes are excluded) for which it is practicable to estimate such values, whether or not these instruments are included in the balance sheet at fair value. The fair values presented for certain financial instruments are estimates, which, in many cases, may differ significantly from the amounts that could be realized upon immediate liquidation.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants.  ASC 820 also provides a hierarchy for determining fair value, which emphasizes the use of observable market data whenever available. The three broad levels defined by the hierarchy are as follows, with the highest priority given to Level 1 as these are the most reliable, and the lowest priority given to Level 3.

Level 1 – Quoted prices in active markets for identical assets.

Level 2 – Quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, including model-derived valuations.

Level 3 – Unobservable inputs that are supported by little or no market activity.

The carrying value of financial instruments including cash, receivables and accounts payable and accrued expenses, approximates their fair value at June 30, 20172018 and March 31, 20172018 due to the relatively short-term nature of these instruments. 

The Company’s intellectual property liability carrying value was determined utilizing Level 3 inputs.  As discussed below in Notes 3 and 4, this liability was incurred in conjunction with the Company’s strategic alliance with Scotts Miracle-Gro.  As of June 30, 20172018 and March 31, 2017,2018, the fair value of the Company's sale of the intellectual property liability was estimated using the discounted cash flow method, which is based on expected future cash flows, discounted to present value using a discount rate of 15%.  As of June 30, 2017,2018, the Company did not have any financial assets or liabilities that were measured at fair value on a recurring basis, subsequent to initial recognition.   

The Company sells its products to retailers and directly to consumers. Retailer sales terms vary by customer, but generally range from net 30 days to net 60 days, while direct-to-consumer transactions are primarily paid by credit card.  Accounts receivable are reported at net realizable value and net of the allowance for doubtful accounts. The Company uses the allowance method to account for uncollectible accounts receivable. The Company's allowance estimate is based on a review of the current status of trade accounts receivable, which resulted in an allowance of $10,000$23,000 and $20,000$39,000 at June 30, 20172018 and March 31, 2017,2018, respectively.

In conjunction with the Company’s processing of credit card transactions for its direct-to-consumer sales activities and as security with respect to the Company’s performance for credit card refunds and charge backs, the Company is required to maintain a cash reserve with Litle and Company,Vantiv, the Company’s credit card processor. This reserve is equal to 5% of the credit card sales processed during the previous six months. As of June 30, 20172018 and March 31, 2017,2018, the balance in this reserve account was $176,000$195,000 and $258,000,$281,000, respectively.

The Company expenses all production costs related to advertising, including print, television, and radio advertisements when the advertisement has been broadcast or otherwise distributed.  In contrast, the Company records media and marketing costs related to its 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 ASC 340-20 Capitalized Advertising Costs.  As prescribed by ASC 340-20-25, direct-to-consumercosts. Direct-to-consumer advertising costs incurred are 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 the Company has continued to expand its retail distribution channel, the Company has expanded its advertising to include online gateway and portal advertising, as well as placement in third party catalogues.

Advertising expense for the three months ended June 30, 20172018 and June 30, 2016,2017, were as follows:

As of June 30, 20172018 and March 31, 2017,2018, the Company had deferred $4,000$3,000 and $24,000,$14,000, respectively, related to such media and advertising costs which include the catalogue costcosts described above.  The costs are included within the “prepaid expenses and other” line of the balance sheet.

Inventories are valued at the lower of cost, determined on the basis of standard costing, which approximates the first-in, first-out method, or net realizable value.  When the Company is the manufacturer, raw materials, labor and manufacturing overhead are included in inventory costs. The Company records the raw materials at delivered cost. Standard labor and manufacturing overhead costs are applied to the finished goods based on normal production capacity.  A majority of the Company’s products are manufactured overseas and are recorded at standard cost, which includes product costs for purchased and manufactured products, and freight and transportation costs for inbound freight from manufacturers. Inventory values at June 30, 20172018 and March 31, 20172018 were as follows:

The Company determines an inventory obsolescence reserve based on management’s historical experience and establishes reserves against inventory according to the age of the product. As of June 30, 20172018 and March 31, 2017,2018, the Company had reserved $346,000 and $362,000$66,000 for inventory obsolescence, respectively.obsolescence.  The inventory values are shown net of these reserves.

The Company recognizes revenueadopted ASU No. 2014-09, "Revenue from productContracts with Customers", and all the related amendments (collectively “ASC 606”) on April 1, 2018 using the modified retrospective method. The adoption did not have a material impact to the nature and timing of its revenues, results of operations, cash flows and statement of financial position. The comparative information has not been restated and continues to be reported under the accounting standards in effect in those periods.

The following table summarizes the impacts of adopting ASC 606 on the Company’s unaudited consolidated balance sheets as of June 30, 2018:

The Company currently has two operating and reportable segments, (i) the Direct to Consumer segment, which composed of sales netdirectly from our website, mail order or customer calls to our customer service department and (ii) the Retail segment, which is comprised of estimated returns, when persuasive evidenceall sales related to retailers, including where possession of a sale exists, including the following; (i) aour product is shipped under an agreement withtaken and sold by the retailer in store or online, and drop ship orders that process from the retailer and drop directly to our warehouse for us to ship on behalf of the retailer.

The majority of the Company’s revenue is recognized when it satisfies a customer; (ii)single performance obligation by transferring control of its products and the risk of loss to a customer. Control is generally transferred when the Company’s products are either shipped or delivered based on the terms contained within the underlying contracts or agreements.  The Company’s general payment terms are short-term in duration. The Company does not have significant financing components or payment terms. The Company did not have any material unsatisfied performance obligations as of June 30, 2018 or March 31, 2018.

The Company excludes from revenues all taxes assessed by a governmental authority that are imposed on the sale of its products and title has passedcollected from customers.

There were no changes to the customer; (iii)Company’s accounting for variable consideration under ASC 606. However, the fee is fixedclassification from a liability to a contra asset to show net realizable accounts receivable results in a change in presentation on the balance sheet. Promotional and other allowances (variable consideration) recorded as a reduction to net sales, primarily include consideration given to retail customers including, but not limited to the following:

The Company’s promotional allowance programs with its retailers are executed through separate agreements in the ordinary course of business. These agreements generally provide for one or determinable; and (iv) collectionmore of the resulting receivable is reasonably assured.arrangements described above and are of varying durations, ranging from one day to one year. The Company’s promotional and other allowances are calculated based on various programs with retail customers, and accruals are established during the year for its anticipated liabilities. These accruals are based on agreed upon terms, as well as the Company’s historical experience with similar programs, and require management’s judgment with respect to estimating consumer participation and retail customer performance levels. Differences between such estimated expense and actual expenses for promotional and other allowance costs have historically been insignificant and are recognized in earnings in the period such differences are determined.