UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington, D.C.
20549







FORM
10-K





x
            
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the fiscal year ended March 31,
      2009oro
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




For
the transition period from  to




(Commission File
No.)  001-33531





AEROGROW
INTERNATIONAL, INC.


(Exact
name of registrant as specified in its charter)





Nevada
              
              46-0510685(State
      or other jurisdiction ofincorporation
      or organization)
              
              (I.R.S.
      EmployerIdentification
      No.)




6075
Longbow Drive, Suite 200


Boulder,
Colorado 80301




(303) 444-7755




(Address,
including zip code and telephone number, including area code, of registrant's of
principal executive office)




Securities
registered pursuant to Section 12(b) of the Act:





Title
      of each class:
              
              Name
      of each exchange on which registered:Common
      Stock, par value $0.001 per share
              
              OTC
      Bulletin Board




Securities
registered pursuant to Section 12(g) of the Act:




None




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o  No 
ý




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes  o No  ý




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes  ý No  o




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files). Yes o No o




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or
any amendment to the Form 10-K.  o .




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check
one):





Large
      accelerated filer  o
                
                Accelerated
      filer o
                
                Non-accelerated
      filer  o
                  (Do
      not check if a smaller reporting company)
                
                Smaller
      reporting company  ý




Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes o No ý




The
aggregate market value of the voting common stock held by non-affiliates of the
registrant as of September 30, 2008 was $25,811,157.  For the purpose
of the foregoing calculation only, all directors and executive officers of the
registrant and owners of more than 5% of the registrant's common stock are
assumed to be affiliates of the registrant. This determination of affiliate
status is not necessarily conclusive for any other purpose.




The
number of shares of the registrant's common stock outstanding as of June 30,
2009 is 12,425,249.




DOCUMENTS
INCORPORATED BY REFERENCE


None.




Table of Contents




AeroGrow International Inc.


Annual
Report on Form 10-K


Year
Ended March 31, 2009




PART I
                    PageItem 1.
                    Description ofBusiness
                    3Item 1A.
                    Risk
      Factors
                    12Item 1B.
                    Unresolved Staff
      Comments
                    17Item 2.
                    Description of
      Property
                    17Item 3.
                    Legal
      Proceedings
                    17Item 4.
                    Submission of
      Matters to a Vote of Security Holders
                    17PART IIItem 5.
                    Market for the
      Registrant's Common Equity and Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                    18Item 6.
                    Selected Financial
      Data
                    19Item 7.
                    Management's
      Discussion and Analysis or Plan of Operations
                    19Item 7A.
                    Quantitative and
      Qualitative Disclosures About Market Risk
                    33Item 8.
                    Financial
      Statements
                    34Item 9.
                    Changes in and
      Disagreements with Accountants on Accounting and Financial
      Disclosure
                    34Item 9A.
                    Controls and
      Procedures
                    34Item 9B.
                    Other
      Information
                    35PART IIIItem 10.
                    Directors,
      Executive Officers and Corporate Governance
                    37Item 11.
                    Executive
      Compensation
                    40Item 12.
                    Security Ownership
      of Certain Beneficial Owners and Management and Related Stockholder
      Matters
                    48Item 13.
                    Certain
      Relationships and Related Transactions, and Director
      Independence
                    52Item 14.
                    Principal
      Accounting Fees and Services
                    53PART IVItem 15.
                    Exhibits, Financial Statement
      SchedulesSignatures
                    55




In
addition to historical information, this Annual Report on Form 10-K (“Annual
Report”) for AeroGrow International, Inc. (“AeroGrow” the “Company,” “we,” “our”
or “us”) contains “forward-looking” statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended (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, as well as other public reports filed by us with the
United States Securities and Exchange Commission. 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.






Table of Contents




PART
I




ITEM
      1.
            DESCRIPTION
      OF BUSINESS





Our
Business





AeroGrow
is a developer, marketer, distributor, and seller of advanced indoor garden
systems, designed for consumer use and priced to appeal to the gardening,
cooking, small indoor appliance, healthy eating, and home and office décor
markets worldwide. To date, we have launched multiple lines of proprietary
indoor gardens, more than 50 corresponding proprietary seed kits, and various
cooking, gardening and décor accessories, both nationally and
internationally.




As of
March 31, 2009, we had manufactured and shipped over 795,000 AeroGarden® garden
units and 1,700,000 seed kits to consumer and retailers worldwide.  We
commenced initial marketing and distribution of our products in March 2006 and
have expanded these marketing efforts to encompass broad retail distribution,
home shopping networks, catalogue, international, and direct-to-consumer sales
channels which include direct television, Internet, and our own in-house direct
mail catalogue.




Our
principal products are indoor gardens and proprietary seed kits that allow
consumers, with or without gardening experience, the ability to grow vegetables
such as tomatoes, chili peppers and salad greens, fresh herbs including
cilantro, chives, basil, dill, oregano, and mint, and flowers such as
petunias,  snapdragons, pink geraniums and phlox. Consumers can also
plant and grow their own seeds using our proprietary “master gardener” kits, or
use their AeroGardens as seed starters for their outdoor gardens with our
“garden starter” trays.





Our
indoor gardens are designed to be simple, consistently successful, and
affordable. We believe that our focus on the design and features of our indoor
gardening products made them the first of their kind on the consumer
market.  This conclusion was reached on the basis of market research,
review of potentially competitive products offered at all ranges of
functionality and price, and testing of products that may be considered
competitive in function although not necessarily competitive in market
orientation.




We
believe that our products allow almost anyone, from consumers who have no
gardening experience to professional gardeners, to produce year-round harvests
of a variety of herbs, vegetables, and flowers, regardless of experience,
season, weather, or availability of natural light. We believe that our indoor
gardening products’ unique and attractive designs make them appropriate for use
in almost any location, including kitchens,  living areas, and
offices.




Our
indoor gardening units currently on the market retail from approximately $79 to
$229 depending on the features and components, including size, design elements,
light intensity and automated features, and are sold through different channels
matching customer needs and interests with the appropriate garden unit features
and benefits.




Corporate
History




AeroGrow
International, Inc. (“AeroGrow”) was formed as a Nevada corporation on March 25,
2002. AeroGrow merged with Wentworth I, Inc., a Delaware corporation on February
24, 2006, and AeroGrow was the surviving corporation.





After
more than three years of initial research and product development, we began
sales activities in March of 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 our distribution.  At the peak of
our 2008 holiday season, AeroGarden products were selling in an estimated 10,000
retail storefronts domestically 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 4.8 million catalogues mailed in fiscal 2009.  In the past
two years we have significantly expanded our product lines, now offering 11
different indoor garden models, more than 50 seed kits, and various gardening
and kitchen accessories.





Hydroponics Industry -
Background





Hydroponics
is the science of growing plants using nutrients suspended in water instead of
soil. Used commercially worldwide, hydroponics is considered an advanced and
often preferred crop production method. Hydroponics is typically used inside
greenhouses to give growers the ability to better regulate and control nutrient
delivery, light, air, water, humidity, pests, and temperature. Hydroponic
growers benefit by producing crops faster and enjoying higher crop yields per
acre than traditional soil-based growers.





Aeroponic
technology is derived from hydroponics and occurs when plant roots are suspended
in an air chamber and bathed with a nutrient solution. AeroGrow believes that
the aeroponic technology used in our indoor gardening products is a
technological advance over most hydroponic growing systems because plant roots
are partially suspended in air and allowed direct access to oxygen, while being
bathed in a highly-oxygenated, nutrient rich solution.  For these
reasons, we believe the use of a well designed and maintained aeroponic system
can yield increases in growth rate and plant survival when compared to most
hydroponic or dirt-based systems.




3
 Table of Contents




Until the
development of our indoor gardening products, significant barriers have
prevented hydroponic or aeroponic technology from being incorporated into
mainstream, mass-marketed consumer products, including:




·   Consumers
generally lack the specialized knowledge required to select, set up, operate,
and maintain the various components for a typical hydroponic or aeroponic
system, including growing trays, irrigation channels, growing media nutrient
reservoirs, and nutrient delivery systems consisting of electronic timers,
pumps, motors, tubing, and nozzles;




·   Consumers
generally do not possess the specialized knowledge required to select, set up,
operate, and maintain the varied indoor lighting systems that are necessary to
grow plants indoors in the absence of adequate natural light;




·   Consumers
are often unable to properly mix and measure complex hydroponic nutrient
formulas, which change depending on the plant variety and the stage of plant
growth. In addition, consumers are unable to deal with the problem of nutrient
spoilage; and




·  
Federally-mandated water quality reports show that the water in many large
cities is not suitable for hydroponic or aeroponic growing and requires
treatments in order to sustain growth.





Our
research has led us to believe that these complexities have been accepted in
existing hydroponic market channels because hydroponic manufacturers have
generally focused their product development and marketing efforts on satisfying
the needs of the commercial greenhouse and dedicated hobbyist markets. These
users are motivated to gain the specialized knowledge, equipment and experience
currently required to successfully grow plants with these
products.  Our research indicated that the hydroponic growing
equipment currently available in these markets is bulky, expensive and comprised
of many, often unintegrated, parts.




We
believe that the complexities of currently available commercial hydroponic
products fail to address the needs and wants of the mass consumer market,
leaving that market unserved. We further believe that our trade secrets,
patented and patent-pending inventions, and companion technologies have
simplified and improved hydroponic and aeroponic technologies and have enabled
us to create the first indoor aeroponic gardening system appropriate for the
mass consumer market.





Our
Proprietary Technology




We have
spent seven years innovating, simplifying, combining, and integrating numerous
proprietary technologies and inventions into a family of “plug and grow” indoor
gardening products and related seed kits specifically designed and priced for
the mass consumer market. We have used this technology platform to develop 11
different models of indoor gardens, each with different features and technology
groupings, priced from approximately $79 to $229.  We have filed 18
patent applications in the United States and internationally to protect our
inventions, and 4 patents have been issued (1 in the United States and 3
internationally).  Following is a description of our proprietary
technologies and inventions that are used in our indoor garden system and seed
kits.




Rainforest Nutrient Delivery
System. Our “rainforest” nutrient delivery system combines our
patent-pending technologies with features from several hydroponic or aeroponic
methodologies into a proprietary system that leaves plant roots suspended in an
air gap.  Plant roots take oxygen directly out of the air and, in
testing of aeroponic systems by multiple different sources, including NASA Small
Business Innovation Research lettuce studies, plants grow faster as a
result.




Advanced Growing System.Our Advanced Growing
System (AGS) is available on many of our newer indoor gardening products and
combines features from our rainforest delivery system with new technologies that
deliver increased nutrient oxygenation, faster, healthier root growth, decreased
needs for consumer maintenance, and increased product
reliability.  With AGS, plant roots are suspended in air in a 100%
humid aeroponic chamber and then grow into a continuously oxygenated nutrient
bath.




Pre-Seeded Bio-Grow Seed Pods.
Our proprietary bio-grow seed pods include pre-implanted, specially selected
seeds, a bio-sponge growing medium, removable bio-dome covers, and a grow basket
to assist with the proper distribution of moisture. In development, attention
was paid to delivering optimal amounts of nutrient, oxygen and moisture to seeds
to maximize germination and survival rates.





Microprocessor-Based Control Panel
and Nutrient Cycle Delivery System. Microprocessor-based control panels
can include automated grow lights to ensure that plants receive proper lighting
and nutrient and water reminder systems that alert consumers to add water and
nutrients when needed.  In addition, several systems allow consumers
to select from multiple plant types (for example, lettuce, herbs, tomatoes, or
flowers) and the system then automatically adjusts and optimizes the nutrient,
water and lighting cycles based on the plant variety selected.  In
addition, some systems take into account stage of growth of the specific plants
when optimizing these factors.




4
 Table of Contents




Custom Nutrient Tablets and Automatic
pH Adjustment. We have developed time-release nutrient tablets designed
specifically to deliver the proper nutrients to the plants, while offering
consumers a user-friendly nutrient system. Plant specific nutrients are included
with each seed kit, and consumers simply add them when instructed by the
microprocessor-based nutrient reminder. The nutrient tablets eliminate the need
for measuring and mixing multi-part nutrient formulas and storing various
nutrients in separate containers. Also formulated into the nutrient tablets is a
proprietary buffer that automatically adjusts tap water from around the country
to the right pH ranges for plant growth.  Without this adjustment, tap
water from many areas in the country will severely limit, or inhibit, plant
growth in most aeroponic and hydroponic systems.




Integrated and Automated Lighting
System. Hydroponic systems typically do not incorporate built-in lighting
systems. Our indoor gardening products include built-in adjustable grow lights
with ballast, reflector hood, grow bulbs and an electronic timer. Our integrated
lighting systems include high-output compact fluorescent light bulbs that
deliver a spectrum and intensity of light designed to help optimize plant growth
without natural light. In addition, our lighting system is fully automated and
controlled by our microprocessor-based control panel described above. Variations
in lighting are a differentiator in our product lines, and we have several
gardens on the market with “twice the light and twice the height” of our initial
gardens, allowing consumers to grow larger plants such as full-sized tomatoes in
our indoor gardens, and deliver higher yields.





New Technologies in
Development.  We are continually engaged in developing
incremental improvements in lights, nutrients, oxygenation, seed variety
selection, and style and design innovation that are introduced to products on an
ongoing basis.




Markets




Based on
our sales experience to date and our existing channels of distribution, and
supplemented by our own formal and informal market research consisting of
individual consumer interviews, focus groups, blog monitoring, customer
modeling, and Internet survey responses, we believe that our indoor gardening
products appeal to a broad spectrum of consumers across multiple areas of
interest.  For these and other reasons, our products have gained broad
distribution through retailers and other sales channels.  We believe
that our products appeal to at least four major market segments:





Gardener Market. The 2002
National Gardening Survey conducted by the National Gardening Association states
that gardening is America’s number one hobby with more than 70 million active
gardeners. Based upon this survey, there were estimated to be: 27 million
vegetable gardeners, with one out of every four households having a vegetable
garden; over 15 million fresh herb gardeners; and over 20 million flower
gardeners. We believe that our indoor gardening products and related products
offer both expert and novice gardeners several major benefits not readily
available through traditional gardening methods, including:




·
              the
      ability to grow fresh herbs, lettuces, vegetables, tomatoes, and flowers
      year-round, regardless of indoor light levels or seasonal weather
      conditions,
 ·
                the
      ability to easily start plants indoors during colder months and then
      transplant them outdoors at the onset of the outdoor growing
      season,
 ·
                  the
      ability to use stem cuttings to propagate multiple reproductions of the
      desired plants in our indoor gardening products,
  and
 ·
                    the
      ease of growing in our indoor gardens in contrast to the toil associated
      with traditional gardening, including preparing the soil, planting,
      thinning, weeding, watering, and removing
  pests.


“Want-to-be” Gardener Market.
We believe that many people have an interest in gardening but lack the
knowledge, confidence, available space, equipment, or time to garden. We have
observed the following barriers that often prevent people from
gardening:




·
            gardening
      requires an ongoing time
commitment,





·
            apartment,
      high-rise, and condominium dwellers often lack the land needed for a
      traditional garden,





·
            gardening
      requires physical work, which can be a significant barrier to people with
      limited mobility or health issues,





·
            buying
      the necessary equipment to garden can be expensive,
  and





·
            gardening
      requires knowledge and expertise.




We
believe that our indoor gardening products overcome many of these barriers and
provide a simple, convenient way for many current non-gardeners to begin to
garden.




5
 Table of Contents




Kitchen Products and Small Appliances
Market. Many Americans enjoy cooking as a hobby Consumers in this market
include:




·
            people
      interested in cooking who would appreciate the convenience and
      satisfaction of having a readily available supply of fresh-cut herbs to
      flavor soups, salads, and other
dishes,





·
            people
      who prefer the distinctive texture and taste of freshly picked,
      vine-ripened tomatoes, basil, lettuces, and other vegetables over days-old
      supermarket produce, and





·
            people
      interested in healthy, pesticide-free foods for themselves and their
      families, reflecting both the rapidly growing interest in naturally and
      organically grown foods and the increasing number of people who, for
      health or weight concerns, include salads and fresh vegetables as part of
      their families’ diets.




We
believe that our indoor gardening products are embraced in this market by people
who understand the value of having an ongoing supply of fresh herbs and fresh
produce throughout the year.




Office and Home Decor Market.
Flowers are frequently used to brighten homes and offices around the world. It
is difficult to readily grow flowers indoors due to a lack of sufficient light
and growing knowledge. As a result, people often use cut flowers, which are
expensive, short-lived, and require ongoing maintenance. Our indoor gardening
products enable colorful and fragrant flowers to be easily grown indoors
year-round. Flowers grown with our indoor gardening products will last for
months with minimal care and maintenance. Flowers can be grown in a wide variety
of indoor locations, including kitchen and bathroom countertops, living rooms,
bedrooms, family rooms, offices, work stations, waiting rooms, and
lobbies.





Products




AeroGarden Indoor
Gardens.  We currently offer 11 different indoor garden models
priced from approximately $79 to $229 and differentiated based on size, design,
light intensity, degree of automation, inclusion of Adaptive Growth Technology
or Advanced Growing Systems, height potential of light hoods, and inclusions of
plant support systems.





Currently,
our product lines are divided into four main categories:





1.
            AeroGarden Classic 7-Pod
      Series.  Our first products launched feature the
      rainforest nutrient delivery system and automated lights and reminder
      systems. Retail price $149.





2.
            AeroGarden Pro
      Series.  Seven pod garden configuration with degrees of
      upgraded, stainless steel trim, Adaptive Growth Software, more lumens of
      light output, and extended lamp arms for growing larger
      vegetables.  Retail price $169 to
  $229.





3.
            AeroGarden 6
      Series.  Features the Advanced Growing System, improved
      grow lights, and an innovative design that delivers increased outputs
      (relative to our classic 7-pod systems).  Some include a space
      saving configuration with a 30% smaller footprint to fit more easily on
      countertops and in corners for apartments, condos, and smaller kitchens.
      Other models include upgraded trim and extended growing arms and lumen
      output for growing larger plants.  Retail price $129 to
      $199.





4.
            AeroGarden3 Series – The
      AeroGarden3 series features the Advanced Growing System, improved grow
      lights, a smaller footprint, and an attractive, stylish design that makes
      it suitable for use as a decorative feature throughout the home or
      office.  AeroGarden 3’s fit easily on kitchen counters, night
      stands, and end tables. Some models include upgraded trim and new finish
      designs such as the “Ladybug” garden targeted at all-family
      usage.  Retail price $79 to
$109.




6
 Table of Contents




AeroGarden Seed
Kits.  We currently offer more than 50 seed kits for use in our
indoor gardening products. These seed kits include pre-seeded bio-grow seed pods
and a three-to-six-month supply of nutrients, including our proprietary formula
for adjusting water quality. Our seed kits retail at prices ranging from $14.99
to $24.99, and include kits like:




·   Vegetable
Gardens:  cherry tomato, chili pepper, green beans, salsa
garden.




·   Herb
Gardens: gourmet herbs, Italian herbs, pesto basil.




·   Flower
Gardens: cascading petunias,  English cottage, scented blooms,
mountain meadow.




·   Salad
Gardens: salad greens, romaine lettuce.





Our seed
kits are sold to consumers for use with our indoor gardening
products.  Individual seed kits are grown by consumers for three to
six months and then new seed kits may be purchased for replanting.





AeroGarden Seed-Starting
Kits.  Developed for more experienced gardeners, our line of
Seed Starting Trays and Master Gardner Kits are designed to allow consumers to
plant and grow their own seeds in the AeroGarden.  With our Seed
Starter Trays, consumers can start up to 70 seedlings in our indoor gardens for
transplant into their outdoor gardens when weather allows.  With the
Master Gardener Kit, consumers can grow their own seeds to maturity in the
AeroGarden, or transplant seeds outdoors when weather allows.





Other
Accessories.  To complement and expand the functionality of our
indoor gardening products, we have developed a variety of accessory products
including cookbooks and cooking accessories.  We also offer multiple
wall brackets and other shelving and support systems, which can hold multiple
indoor gardens at the same time. We also offer the Herb ‘n Serve, a
battery-operated herb blender and salad dressing maker, and the Herb ‘n Ice, an
easy-to-use fresh herb storage device.




Future
Products.  Our core technology platform can be leveraged by
bundling different components into new products with a wide variety of features
and price points that then can be sold through a variety of retail and direct
channels for use in different settings around the home or
office.   Examples include a desk garden series, a professional
system for larger plants and vegetables, patio and deck gardens, home décor and
air freshening gardens, and additional seed kits and accessories.





For the fiscal years ending March 31, 2009, 2008 and 2007, we invested
$2,146,493, 2,605,112 and $2,113,255, respectively, in research and development
activities.  As a result, we have a strong backlog of new product
innovations in the pipeline and are waiting for ideal timing for launch in terms
of market opportunity, marketing and capitalization.  In calendar
2009, we plan to introduce a six-pod configuration ”Veggie Pro” model, for
growing full-sized vegetables with our AGS technology, and a variety of new seed
kits and accessory items.





Integrated Marketing and Sales Channel
Strategy




We
consider our products to be an entirely new product category. A primary
objective since launch has been to maximize the exposure of the product and
educate consumers on the benefits of indoor gardening through an integrated
marketing and distribution strategy.  We launched with a nationwide
public relations campaign during the first quarter of 2006, and have since
received extensive media exposure, with multiple features on national talk shows
as well local television features, local and national print articles and blog
and Internet pieces.  We combined the public relations launch with a
retail and direct strategy focusing on high visibility partners and media,
including product sales through mass retail chains, national cataloguers, home
shopping channels, direct television commercials, our own in-house direct
response catalogue and inbound and outbound telemarketing.





Retail Sales. Initial
shipments to retail launch partners, including Sur La Table, Frontgate, and
others commenced in March 2006.  By December 2006, our products were
distributed through more than 750 retailers, including catalogers like Skymall,
Brookstone and Herrington, and web merchants like Amazon.com.  In 2007
we expanded into Linen’s n Things, Bed, Bath & Beyond, Sears, Macy’s and
JCPenney, and had successful tests at Target and other large
chains.  This grew our retail distribution to 4,300 retailers by
December 2007, and by March 31, 2008, we had expanded to 5,100. Continued
rollout into large retailers like Kmart, Costco, Sam’s, Target, and Kohls pushed
retail distribution to a high of more than 9,000 stores by the end of the 2008
holiday season, much of that on an “in and out” seasonal basis.  As of
March 31, 2009, our products were being sold in approximately 7,500 retail
storefronts.  We expect that the number of retailers carrying the
AeroGarden line will decrease somewhat during the 2009 holiday season relative
to the 2008 holiday season as some retailers rethink their strategies in the
face of the prolonged economic downturn and as we focus our attention and
resources to maximize sales through our primary retailers.  For the
fiscal year ended March 31, 2009, approximately 61% of our net sales were to
retailer customers and approximately 50% of our total sales to retailers
represented sales to five retailer customers.  One of our retailer
customers represented 10% of our total net sales for the fiscal year ended March
31, 2009.  Long-term, we believe that our indoor gardening products
present opportunities in up to 15 different retail channels, including culinary,
department stores, mass, clubs, specialty, home centers, lawn and garden,
hardware, office, drugstores, gift shops, grocery, toy, schools/education, and
hydroponic.




7
 Table of Contents





Direct Sales.In the fall of
2006 we launched an infomercial advertising campaign, which began with 30 minute
programming and has since been supplemented with 60-second and 120-second
television commercials. In 2008 we created new 60-second and 120-second
commercials highlighting our new products, and in 2009 we’re planning direct
response TV advertisements for our 3 pod and 6 pod lines.  Overall
spending on TV advertising has decreased as a percentage of the overall
marketing budget in the most recent year as we have focused on more profitable
and efficient media spending.





In June
of 2007 we produced and began mailing our own in-house, direct mail product
catalogue, which tested successfully with a mailing of approximately 60,000
catalogues.  In fiscal 2009 we mailed more than 4.8 million
catalogues.  With our catalogue sales we focus on remarketing to
current customers and also prospecting for new customer acquisition using
database marketing techniques.





We
established our first consumer product website in the fall of 2006 and in late
2007 supplemented this with search engine advertising, banner advertising, email
campaigns and web affiliate programs.  In the fall of 2008 we took on
in-house management of many of these programs from third-party providers and
have seen resulting increases in profitability and efficiency.  A key
focus of our web and catalogue marketing will continue to be repeat sales of our
seed kits, light bulbs and accessories to our existing customers, and focusing
on building and maximizing the lifetime value of our AeroGarden
customers.





International Sales.We began
testing international sales opportunities in the UK and Japan in late 2007, and
have since expanded internationally into Australia, South Korea, Mexico, France
and several other countries.  International expansion in 2009 will
likely focus on gaining broader distribution in existing markets, while
incrementally expanding into new areas as resources allow.





Competition




Aeroponic
and hydroponic technologies have historically been limited to ardent hobbyists
and commercial growing facilities.  We believe that we are the first
company to develop and offer a simple soil-less indoor growing system for the
mass consumer market.




Typical
hydroponic manufacturers offer a range of equipment and accessories through
distributors or small independent “hydro-shops” in a trade-oriented manner
similar to plumbing or electrical suppliers. Purchasers typically mix and match
equipment from various suppliers in an “a la carte” fashion to individually
customize a large system that they then assemble on their
premises.  We believe that these products are substantially more
expensive than our products.




We
believe that our simplified and complete indoor gardening products and current
and planned methods of distribution offer significant benefits from these
traditional hydroponic industry practices.  To date, we have
discovered a kitchen design firm that has tried to introduce an indoor growing
system into the market, to what appears to be very limited
success.  In our in-house laboratory tests, these systems have
performed at levels far below our own systems in terms of germination success,
longevity, speed-of-growth and overall yields.





However,
we recognize that a large market exists for products like ours and that there
are other companies that are better funded and have greater experience in
producing hydroponic products in commercial markets, or that are successful in
manufacturing or selling consumer product or soil-based gardening
products.





Manufacturing




We
manufacture our products using contract manufacturing sources, which are
supervised by our internal engineering and manufacturing teams. Our seed kits
are currently produced and assembled in our facilities in Indianapolis,
Indiana.




We
currently have primary main suppliers of our different indoor garden models in
China, and multiple, dual sourced manufacturers of our many component parts and
accessories.    Our first garden manufacturer was Mingkeda
Industries Co, Ltd. (“Mingkeda”) a Chinese company capable of producing 20,000
gardens per month.  Our second manufacturer was Main Power Electrical
Factory Ltd. (“Main Power”), which began shipping products during the first
calendar quarter of 2007.  Production capacity at Main Power is
estimated to be 100,000 units per month.  Our third manufacturer,
Kayue Electric Company Limited, started producing gardens in June 2007, and has
a production capacity of 20,000 units per month.  Capacity expansion
is available through all manufacturers in a reasonable period of time with a
nominal tooling investment.





In
July 2008 we opened a company-owned distribution center in Indianapolis,
Indiana.   We also produce and assemble our seed kits in this
facility. Indoor gardening products are shipped from China either to our primary
fulfillment center in Indianapolis, or to third-party fulfillment centers in
Chino, California and in countries outside the United States.





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Product
Returns and Warranties




To
date, product returns have been within our expectations for both retail and
direct-to-consumer sales.  At retail, we utilize a “Destroy in Field”
methodology for certain customers as the cost of shipping the return, if used,
does not justify the value of the recovered unit. 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.  To our knowledge, our retailers are satisfied with this
arrangement.    Our manufacturers will provide us with
replacement parts at no charge for products which are deemed defective due to
materials or manufacturing complications. 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 our 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 our warranty obligation.




Intellectual
Property





As of
March 31, 2009, we had filed 13 patent applications in the United States and 4
patent applications internationally to protect our inventions, and of these, 1
United States and 3 international patents had issued.  Subsequently we
filed 1 additional patent application in the United States, for a total of 14
patent applications covering our technologies in the United States. Following
are descriptions of our pending patent applications and issued patents related
to technologies that are used in our indoor garden systems and seed
kits:





United
States





●
            devices
      and methods for growing plants, RAIN (rain-aerated ionized nutrient)
      system technology, which hyper-oxygenates and ionizes plant roots in 7-pod
      garden systems, filed in March 2005, application serial number 10/528,110,
      and responded to examiner’s second action with allowable subject
      matter,





●
            methods
      for growing plants using seed germination pods, filed in April 2005,
      application serial number 11/112,269, and responded to examiner’s fifth
      action,





●
            indoor
      gardening appliance, filed in August 2005, application serial number
      29/235,880, design of AeroGarden 6 and 7-Pod gardens, and issued as design
      patent number D586,688 in February
2009,





●
            pH
      buffered plant nutrient compositions and methods for growing plants, filed
      in December 2005, application serial number 11/321,023, and responding to
      examiner’s first action,





●
            smart
      garden devices and methods for hydroponic gardens, filed in June 2006,
      application serial number 11/455,364, and responded to examiner’s first
      action,





●
            devices
      and methods for growing plants, filed in January 2007, application serial
      number 11/653,121, and responded to examiner’s first
    action,





●
            systems
      and methods for controlling liquid delivery and distribution to plants,
      filed January 2007, application serial number
  11/654,164,




●
            indoor gardening
      appliance, design of 3-pod gardens, filed in October 2007, application
      serial number
      29/292,564, and responding to first examiner’s action with allowable
      subject matter,




●
            indoor gardening
      appliance, design of 6-pod gardens, filed in November 2007, application
      serial number
      29/293,343, and responded to examiner’s first action with allowable
      subject matter,





●
            devices
      and methods for growing plants by measuring liquid or nutrient usage rate,
      the adaptive growth learning technologies, filed in December 2007,
      application serial number
12/002,543,





●
            devices
      and methods for growing plants, RAIN (rain-aerated ionized nutrient)
      system technology, which hyper-oxygenates and ionizes plant roots in 7-pod
      garden systems, filed in March 2008, application serial number
      12/073,984,





●
            methods
      for growing plants using seed germination pods, filed in March 2008,
      application serial number
12/073,985,




●
            devices and methods
      for growing plants, directed to liquid, oxygen, and light delivery systems
      in 3-Pod
      and 6-Pod garden systems, filed October 2008, application serial number
      12/261,821, and




●
            indoor
      gardening appliance and task light, design for a garden for a desk or side
      table, filed May 2009,
      application serial number not yet
  assigned.




9
 Table of Contents




I nternational




●
              indoor gardening appliance,
      design of 3-pod gardens, filed in April 2008, European Community covering
      35 countries, issued in September 2008, serial number
      000918842,
  ●
              indoor gardening appliance,
      design of 6-pod gardens, filed in May 2008, European Community covering
      35 countries, issued in December 2008, serial numbers 000935366-0001,
      -0002, -0003,-0004,
      -0005, and -0006,
  ●
              indoor gardening appliance,
      design of 6-pod gardens, filed in May 2008, Japan, issued in November
      2008, serial number 1345980,
and
  ●
              indoor gardening appliance,
      design of 6-pod gardens, filed in May 2008, Korea, serial number 30-20080020737,
      responding to examiner’s first
action.


We believe that the technology covered by these patent
applications does not infringe on issued patents owned by others. We believe
that if we fail to receive patents for any one of these patent applications, our
operations will not be materially, adversely affected. We believe that failure
to obtain patents, however, will make it easier for competitors to bring
competitive products to market. If such competitive products performed better
and/or were marketed by companies with greater financial and distribution
resources than us, such competitive products may adversely affect our
operations. In addition to the patents being sought, we maintain critical
information about our products as trade secrets. The inventions under the patent
applications have not been granted patents, and there can be no assurance that
patents will be granted.





We have
filed 39 trademark applications in the United States, 26 of which have
registered and 8 of which have been allowed; and 5 trademark applications
designating 33 countries, 27 of which have registered; which we intend to
prosecute to protect our products and brand equity. The applications are
for:





Registered





●
            AeroGarden,
      filed in 31 countries under the Madrid Protocol in June 2006, application
      serial number A0005030, and received a general statement of grant of
      protection; received notices that protected in 25 countries: European
      Community, Australia, Norway, Japan, and Korea; pending in 6
      countries,




●
              AeroGarden, registered in Mexico in March 2007,
      registration number 977468,


●
            AeroGarden,
      registered in Canada in August 2007, registration number
      TMA693,363,





●
            AeroGarden
      registered for 7-pod gardens in June 2007, registration number
      3,252,527,





●
            AeroGarden,
      registered for printed material in October 2007, registration number
      3,311,054,





●
            AeroGarden,
      registered for smart garden control panels and DVDs in October 2007,
      registration number 3,311,062,




●
            AeroGarden,
      registered in stylized form in October 2007, registration number
      3,322,684,





●
            AeroGarden,
      for toys, registered in January 2009, registration number
      3,568,085,





●
            Herb
      ‘n Serve, registered in January 2008, registration number
      3,376,411,





●
            Chef
      in a Box, registered in January 2008, registration number
      3,373,707,





●
            Sweet
      Rubies, registered in January 2008, registration number
      3,370,002,





●
            Wall
      Farm, registered in February 2008, registration number
      3,389,624,





●
            Wall
      Garden, registered in February 2008, registration number 3,389,625,
      and





10
 Table of Contents




●
            Ultimate
      Kitchen Gardener registered in March 2008, registration number
      3,392,651;





●
            AeroGrow,
      registered in April 2008, registration number
  3,412,797,





●
            Bio-Dome,
      registered in October 2008, registration number
  3,525,830,





●
            Farmer’s
      Market Fresh, registered in June 2008, registration number
      3,455,606,





●
            Herb
      Appeal, registered in October 2008, registration number
      3,524,683,





●
            Plug
      & Grow, registered in January 2009, registration number
      3,565,083,





●
            Veg-e-Garden,
      registered in April 2008, registration number
  3,413,666,





●
            Florist
      in a Box, registered in January 2009, registration number
      3,568,213,





●
            Herb
      It Up, registered in March 2009, registration number
    3,592,160





●
            Florist
      in a Box logo, registered in February 2009, registration number
      3,573,607,





●
            Chef
      in a Box logo, registered in February 2009, registration number
      3,573,608,





●
            English
      Cottage, registered in March 2009, registration number
      3,592,303,





●
            Splash
      of Color, registered in March 2009, registration number
      3,592,304,





●
            Mountain
      Meadow, registered in November 2008, registration number
      3,528,760,





●
            Advanced
      Growing System logo, registered in November 2008, registration number
      3,522,253, and





●
            Herb
      ‘n Ice, registered in February 2009, registration number
      3,570,754.




Pending





●
            AeroGarden,
      filed in July 2007, application serial number 77229682, and
      allowed,





●
            Plant
      Pillow, filed in April 2008, application serial number 77440754, and
      allowed,





●
            Patioponics,
      filed in May 2008, application serial number 77464412, and
      allowed,





●
            SleepGarden,
      filed in May 2008, application serial number 77478932, and
      allowed,





●
            Herb
      ‘n Save, filed in August 2008, application serial number 77550915, and
      allowed,





●
            FreshAir,
      filed in August 2008, application serial number
  77550941,





●
            Gift
      That Keeps On Growing, filed in August 2008, application serial number
      77550953, and allowed,





●
            365
      Sun/Snowflake Logo, filed in August 2008, application serial number, and
      allowed,





●
            AeroGarden
      Antics, filed in September 2008, application serial number
      77573358,





●
            Greenspace,
      filed in October 2008, application serial number 77584019, and
      allowed,





●
            VeggiePro,
      filed in January 2009, application serial number
  77651442,





●
            Grow
      Anything, Anytime, Anywhere, filed in January 2009, application serial
      number 77655735, and





●
            AeroFood,
      filed in April 2009, application serial number
  77720608.





11
 Table of Contents




Each of
our employees, independent contractors, interns, and consultants has executed
assignment of rights to intellectual property agreements and nondisclosure
agreements. The assignment of application rights to intellectual property
agreements grant us the right to own inventions and related patents which may be
granted in the United States and throughout the world. The nondisclosure
agreements generally provide that these people will not disclose our
confidential information to any other person without our prior written consent.
We have also obtained, both domestically and internationally, domain names for
AeroGrow.com, AeroGarden.com, AeroGarden.net, AeroGarden.tv, AeroGarden.biz, and
Getthegarden.com, among others.





Governmental
Regulation and Certification





We
believe that we are complying with United States regulations concerning the
shipping and labeling of seeds and nutrients. Currently, the components for the
indoor garden system are UL and/or ETL certified. These certifications confirm
that the products have been tested and conform to a recognized level of fire and
other safety standards for consumers. Such independent third party certification
is required for sales of products through many major retailers.





We believe that our costs of compliance with environmental laws will not be
material.





Personnel




As of
March 31, 2009, AeroGrow employed 66 employees with 65 full-time and 1
part-time.  Subsequent to March 31, 2009, we initiated further staff
reductions and, as of June 15, 2009, we employed 58 employees, with 53 full-time
and 5 part-time.  In addition, we contract the services of part-time and
project consultants on an “as needed” basis.  We believe that our employee
relations are good. Our outsourced business includes (but is not limited to)
manufacturing, some telemarketing, infomercial production, and some fulfillment
and shipping.  Additional employees and/or consultants will be hired in the
future as our operations grow.





ITEM
      1A.
            RISK
      FACTORS





Our
business, future performance and forward-looking statements are affected by
general industry and market conditions and growth rates, general U.S. and
non-U.S. economic and political conditions (including the global economy),
competition, interest rate and currency exchange rate fluctuations and other
events. The following items are representative of the risks, uncertainties and
other conditions that may impact our business, future performance and the
forward-looking statements that we make in this report or that we may make in
the future.





Risks
Related to our Business, Products and Markets





We
will likely need additional capital to fund our future operations and we may not
be able to obtain the amount of capital required, particularly when the credit
and capital markets are unstable.




On June
30, 2009, we issued $6,250,341in Series A Convertible Preferred stock to address
our immediate short-term liquidity needs, fund prior operating losses and
provide capital to support business operations.  In addition, during
June 2009 we converted certain accounts payable totaling approximately $1.4
million to long-term debt, amended our working capital financing agreement and
negotiated concessions with certain of our accounts payable creditors with
regard to payment timing and amounts due.   (See Item 9b. Other
Information, Liquidity and Capital Resources, and Note 11 – Subsequent Events in
the accompanying Financial Statements for additional details.)




We will
likely require additional capital to support our future growth and cover
operational expenses as we expand the scale of our operations.  It is
possible that none of our outstanding warrants and options will be exercised and
we will therefore not receive additional capital from these
sources.  We currently rely upon our senior secured revolving credit
facility to support our operations.  It is possible that our access to
funding from this facility could be curtailed.  We may need to issue
equity, debt, or securities convertible into equity, which could dilute the
current stock ownership in AeroGrow.  If we are unable to raise
additional capital, or cannot raise capital on acceptable terms, we may not have
sufficient capital to operate our business as planned and would have to modify
our business plan or curtail some or all of our operations.





Because
we have a limited operating history, we may not be able to successfully manage
our business or achieve profitability.




We have a
limited operating history upon which to base an evaluation of our prospects and
the potential value of our common stock.  Since commencing operations
in 2002, we have not achieved profitability in any of our fiscal year
periods.  We are confronted with the risks inherent in an early stage
company, including difficulties and delays in connection with the production and
sales of our indoor garden systems, reliance on a small number of products and
manufacturers, operational difficulties, and difficulty in estimating future
sales, production requirements and costs, and administrative
costs.  If we cannot successfully manage our business, we may not be
able to generate future profits and may not be able to support our
operations.  It is possible that we will incur additional expenses and
losses in the further implementation of our business plan.  We may not
be able to improve operations and therefore may not become
profitable.





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 Table of Contents




We
have incurred substantial losses since inception and may never achieve
profitability.




Since we
commenced operations in 2002, and through March 31, 2009, we incurred
substantial losses, including a net loss of $10,313,514 for the most recent
fiscal year ended March 31, 2009.  As of March 31, 2009, our losses
have resulted in an accumulated deficit of $49,941,597.  The future
success of our business will depend on our ability to profitably expand sales
and distribution of our AeroGarden indoor garden systems, seed kits and
accessory products to consumers, and develop new product extensions and
applications.




We are
subject to many of the risks common to developing enterprises, including
undercapitalization, cash shortages, limitations with respect to financial and
other resources, and insufficient revenue to be self-sustaining. There is no
assurance that we will ever attain profitability.





A
worsening of the United States economy could materially adversely affect our
business.





The
success of our business operations depends significantly on consumer confidence
and spending, which have deteriorated as a result of the worldwide economic
downturn.  This economic downturn and decrease in consumer spending
may adversely impact our revenue, ability to market our products, build customer
loyalty, or otherwise implement our business strategy.  If the current
economic situation persists, or deteriorates significantly, our business could
be negatively impacted.





Our
sales to retailer customers are highly concentrated in a small number of major
retail chains in the United States and Canada.  The loss of one or
more of these customers could have a material adverse impact on our
business.





In the fiscal year ended March 31,
2009, approximately 61% of our net sales were to retailer
customers.  Of these sales, 50% represented sales to the top five
retailer customers.  The loss of one or more of these customers, or a
significant decline in orders from one or more of these retailers could
materially affect our sales of indoor garden systems, seed kits and accessories,
and therefore have a material adverse impact on our business and our financial
results.





A
significant portion of our sales are to retailers, many of which have been
adversely impacted by the deterioration in economic conditions and the
consequent impact on consumer spending.





In the fiscal year ended March 31,
2009, approximately 61% of our net sales were to retailer
customers.  Our business plan anticipates continued sales through this
distribution channel.  Uncertainty about the current and future global
economic conditions may cause consumers and retailers to defer purchases or
cancel purchase orders for our products in response to tighter credit, decreased
cash availability and declining consumer confidence.  In the event
that certain retailers are adversely impacted by the current economic downturn,
re-structure their business operations to reduce costs and capital investment,
or choose to reduce the breadth of their product offering, our sales could be
adversely affected.





Our
future depends on the success of our indoor garden systems, seed kits and
accessory products. To date we have penetrated only a small portion of the
potential market for our products.  We therefore do not know if our
indoor garden systems, seed kits and accessory products will generate consumer
acceptance on a broader scale.




We have
introduced our indoor garden systems and seed kits as new products to consumer
markets unfamiliar with their use and benefits.  We cannot be certain
that our products will continue to generate and expand the consumer acceptance
we have observed to date. If consumers do not purchase our products in
sufficient numbers, we will not be profitable.





If
we are unable to recruit, train and retain key personnel necessary to operate
our business, our ability to successfully manage our business and develop and
market our products may be harmed.




To expand our business we will need to attract, retain, and motivate
highly skilled design, development, management, accounting, sales,
merchandising, marketing, and customer service personnel.  Competition
for many of these types of personnel can be intense, depending on general
economic conditions, alternative employment options, and job
location.  As a result, we may be unable to successfully attract or
retain qualified personnel. Additionally, any of our officers or employees can
terminate their employment with us at any time. The loss of any key employee, or
our inability to attract or retain other qualified employees, could harm our
business and results of operations.





As
a result of the economic downturn, decline in consumer spending and the
consequent impact on the sales of our products, we restructured our operations
and implemented a substantial workforce reduction.  These actions
could adversely impact the morale and performance of our remaining employees and
our ability to hire new personnel.





Our business was adversely impacted by
the deterioration in the global economy and the consequent impact on our various
channels of distribution.  We restructured our business operations in
order to re-size our overhead costs and streamline our distribution,
fulfillment, and manufacturing operations.  This resulted in a
substantial decrease in the number of our full-time employees.  These
restructuring actions and headcount reductions could have unintended impacts on
our remaining employees, could lead to a decline in employee morale, and could
lead to a loss of additional personnel over and above the level
desired  by the Company.  In the event of such employee
attrition, we may not be able to replace the lost personnel on a timely basis,
or with individuals having the same level of skills.  In either case,
our operations and our financial performance could be adversely
impacted.





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 Table of Contents




Our
marketing strategies may not be successful, which would adversely affect our
future revenue and profitability.




Our
future revenue and profitability depend on the successful marketing of our
indoor garden systems.  We cannot give assurance that consumers will
continue to be interested in purchasing our products.  We use direct
consumer marketing, including television commercials, infomercials, catalogue,
magazine and newspaper advertising, and the Internet. In addition, we
collaborate with our retailer customers to market our products to
consumers.  If our marketing strategies fail to attract customers, our
product sales will not produce future revenue sufficient to meet our operating
expenses or fund our future operations.





Our
current or future manufacturers could fail to fulfill our orders for indoor
garden systems, which would disrupt our business, increase our costs, and could
potentially cause us to lose our market.





We
currently depend on three contract manufacturers in China to produce our indoor
garden systems. These manufacturers could fail to produce the indoor garden
system to our specifications or in a workmanlike manner and may not deliver the
systems on a timely basis. Our manufacturers must also obtain inventories of the
necessary parts and tools for production. We own the tools and dies used by our
manufacturers. Our manufacturers operate in China and may be subject to business
risks that fall outside our control, including but not limited to, political,
currency, and regulatory risks, each of which may affect the manufacturer’s
ability to fulfill our orders for indoor garden systems. In addition, weather or
natural disasters in China could disrupt our supply of product.  Any
change in manufacturers could disrupt our ability to fulfill orders for indoor
garden systems. Any change in manufacturers could disrupt our business due to
delays in finding a new manufacturer, providing specifications, and testing
initial production.





Our
revenue and level of business activity are highly seasonal, requiring us to
staff our operations, incur overhead and marketing costs, purchase and
manufacture inventory, and incur other operating costs in advance of having firm
customer orders for our products.  A material variance in actual
orders relative to anticipated orders could have an adverse impact on our
business.





For the fiscal year ended March 31,
2009, approximately 55% of our total net sales occurred during the last four
calendar months.  We must estimate sales in advance of these peak
months and operate our business during the balance of the year in such a way as
to insure that we can meet the demand for our products during the peak
months.  This requires us to incur significant operating, marketing,
and overhead expenses, and to utilize cash and other capital resources to invest
in inventory in advance of having certainty as to the ultimate level of demand
for our product during the peak months.  Significant variations in
actual demand for our products during the peak months relative to our forecast
could result in our sales being limited by lack of product, our not achieving a
sufficient level of sales to cover expenses incurred throughout the balance of
the year, or in our having excess inventory to liquidate at potentially lower
margins.  In any of these cases, there could be a material adverse
impact on our financial performance.





We
are highly reliant upon a single company-operated distribution and manufacturing
facility.  Any material disruption to the operation of this facility
could adversely affect our business.





In July
2008 we opened a company-operated distribution and fulfillment center in
Indianapolis, Indiana to supplement our existing third-party logistics
providers.  Since then, our facility in Indianapolis has become our
primary distribution and fulfillment center for the United States and Canada,
with more than 75% of our shipment volume expected to be handled through this
facility in our fiscal year ending March 31, 2010.  In February 2009
we re-located our seed kit manufacturing operations to the facility in
Indianapolis from its previous location in Longmont, Colorado.  We now
manufacture all of our seed kits in the Indianapolis facility.  Any
material disruption to the operation of this facility, whether caused by
internal or external factors, could have a material adverse impact on our
business and financial performance.





We
rely on third party providers in our manufacturing, warehouse, distribution,
order processing, and fulfillment operations. If these parties are unwilling to
continue providing services to us, or are unable to adequately perform such
services for us on a cost effective basis, our business could be materially
harmed.




We engage
third parties to perform many critical functions supporting our business
operations.  Any disruption in our relationship with any of our
vendors could cause significant disruption to our business and we may not be
able to locate another party that can provide comparable services in a timely
manner or on acceptable commercial terms.  In addition, no assurance
can be made that these relationships will be adequate to support our business as
we follow our business plan.





Our
intellectual property and proprietary rights give us only limited protection,
and can be expensive to defend.





Our
ability to produce and sell indoor garden systems exclusively depends in part on
securing patent protection for the components of our systems, maintaining
various trademarks, and protecting our operational trade secrets. To protect our
proprietary technology, we rely on a combination of patents pending (and if
granted, patents), trade secrets, and non-disclosure agreements, each of which
affords only limited protection. We own the rights to 18 United States and
international patent applications. However, these patent applications may not
result in issued patents and even issued patents may be challenged. We are
selling our indoor garden systems prior to receiving issued patents relating to
our patent applications. All of our intellectual property rights may be
challenged, invalidated, or circumvented. Claims for infringement may be
asserted or prosecuted against us in the future and we may not be able to
protect our patents, if any are obtained, and intellectual property rights
against others. Our former employees or consultants may violate their
non-disclosure agreements, leading to a loss of proprietary intellectual
property. We could also incur substantial costs to assert our intellectual
property or proprietary rights against others.





14
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We
may face significant competition, and if we are unable to compete effectively,
our sales may be adversely affected.




We
believe that our complete indoor garden systems offer significant benefits over
traditional hydroponic industry products.  There are companies in a
variety of related markets including but not limited to, consumer electronics,
commercial hydroponics, gardening wholesale, and soil-based gardening that are
larger, better funded, have more recognizable brand names, and have experience
in our channels of distribution.  These companies could potentially
decide to develop products to compete with our products. These companies could
use hydroponic technologies, and could achieve better consumer
acceptance.  The success of any competing products may adversely
impact us.





Increases
in energy prices, resulting from general economic conditions, or other factors,
may raise our cost of goods sold and adversely affect our business, results of
operations and financial condition.




Energy
costs, especially gasoline and fuel costs, are significant expenses in the
delivery of our products. Increased costs resulting from general economic
conditions, acts of nature, or other factors, may result in declining margins
and operating results if market conditions prevent us from passing these
increased costs on to our customers through timely price increases on our
products.





Our
current or future manufacturers are located in China and therefore our product
costs may be subject to fluctuations in the value of the dollar against the
Chinese currency.





Although
we purchase our AeroGarden products in U.S. dollars, the prices charged by our
factories are predicated upon their cost for components, labor and overhead.
Therefore, changes in the valuation of the U.S. dollar in relation to the
Chinese currency may cause our manufacturers to raise prices of our products
which could reduce our profit margins.




If
our indoor garden systems fail to perform properly, our business could suffer
with increased costs and reduced income.




We have
sold over 795,000 AeroGardens since our inception and have provided a limited
warranty with each garden sold.  In addition, our indoor garden
systems are “guaranteed to grow.”  We therefore may be required to
replace or repair products or refund the purchase price to
consumers.  Failure of our products to meet expectations could damage
our reputation, decrease sales, increase costs related to returns and repairs,
delay market acceptance of our products, result in unpaid accounts receivable,
and divert our resources to remedy the malfunctions.  The occurrence
of any of these events would have an adverse impact on our results of
operations.





From
time to time, we may be subject to litigation that, if decided adversely to us,
could have a material adverse impact on our financial condition.




From time
to time, we are a party to various litigation matters, in most cases involving
ordinary and routine claims incidental to our business.  We cannot
estimate with certainty our ultimate legal and financial liability with respect
to any such pending litigation matters.  However, we believe, based on
our examination of such matters, that our ultimate liability, if any, will not
have a material adverse effect on our financial position, results of operations
or cash flows.




In
connection with the Linens ‘N Things (“LNT”) bankruptcy proceedings, a Complaint
to Avoid and Recover Preferential Transfers was filed by LNT in the United
States Bankruptcy Court for the District of Delaware on April 20, 2009 (the
“Complaint”).  The Complaint alleges that, pursuant to Sections 547
and 550 of the United States Bankruptcy Code, we are required to return to LNT
approximately $623,000 in “preferential” transfers allegedly made to AeroGrow
during the 90-day period preceding the filing of the LNT bankruptcy cases. The
Complaint also alleges that AeroGrow is required to pay to LNT approximately
$44,000 on account of credits allegedly earned but not redeemed by LNT prior to
the filing of the LNT bankruptcy cases.  We engaged outside counsel
and filed a response to the Complaint on May 8, 2009 disputing that we have any
obligation to either return the “preferential” transfers allegedly made, or to
pay the credits allegedly earned, to LNT.  As of March 31, 2009, an
estimate has been accrued in our balance sheet and consolidated statement of
operations in anticipation of the cost of defending, or settling, this
matter.  We believe we have a number of strong potential defenses to
all of the claims made in the Complaint and therefore do not expect that the
resolution of this matter will have a material adverse effect on
us.  However, we cannot at this time predict with certainty the
outcome of this matter.  If the Complaint were to be decided in a
manner adverse to us, which, if it were to occur, at a minimum is not expected
to occur during the fiscal year ended March 31, 2010, it could materially
adversely impact our results of operations for that period in which the
Complaint is finally decided.




Risks
Related to the Market for our Securities





The
market price of our shares may fluctuate greatly. Investors in AeroGrow bear the
risk that they will not recover their investment.




Effective
as of May 4, 2009 our common stock ceased to be listed on The Nasdaq Stock
Market and is now traded on the OTC Bulletin Board.  Currently,
trading in our common stock is limited, and the price per share is likely to be
influenced by the price at which and the amount of shares the selling security
holders are attempting to sell at any time.  This could have the
effect of limiting the trading price or lowering the market price to the selling
security holders’ offering prices. Shares such as ours are also subject to the
activities of persons engaged in short selling securities, which generally has
the effect of driving the price down. Also, the common stock of emerging growth
companies is typically subject to high price and volume volatility. Therefore,
the price of our common stock has fluctuated, and may continue to fluctuate,
widely. A full and stable trading market for our common stock may never develop
in which event holders of such shares may not be able to sell at the time they
elect, or at all.





15
 Table of Contents




There
may be substantial sales of our common stock by existing security holders which
could cause the price of our stock to fall.




Future
sales of substantial amounts of our common stock in the public market or the
perception that such sales might occur, could cause the market price of our
common stock to decline and could impair the value of an investment in our
common stock and our ability to raise equity capital in the
future.




Sales of
our common stock by security holders, or even the appearance that such holders
may make such sales, may limit the market for our common stock or depress any
trading market volume and price before other investors are able to sell the
common stock.  Moreover, a number of shareholders have held their
investment for a substantial period of time and may desire to sell their shares,
which could drive down the price of our common stock.





We can issue share of preferred stock
without stockholder approval, which could adversely affect the rights of common
shareholders.





Our Articles of Incorporation allow our
Board of Directors to approve the terms and conditions of preferred stock issued
by the Company, including but not limited to voting rights, conversion
privileges and liquidation preferences, without the approval of common
shareholders.  The rights of the holders of our common stock may be
adversely impacted as a result of the rights that could potentially be granted
to holders of preferred stock that we may issue in the future.  In
addition, there could be an impact on the price of our common shares because of
the potential impact on the rights of common shareholders resulting from future
issuances of preferred shares.





Our
outstanding warrants, options and additional future obligations to issue our
securities to various parties, may dilute the value of an investment in AeroGrow
and may adversely affect our ability to raise additional capital.





As of
March 31, 2009, we were committed to issue up to 8,434,815 additional shares of
common stock under the terms of outstanding warrants, options and other
arrangements as detailed in Item 6. Selected Financial Data, and Item 8.
Financial Statements.





In
addition, on June 30, 2009 we issued $6,250,341 in Series A Convertible
Preferred stock giving the holders the right to convert their preferred shares
into 34,180,000 common shares of AeroGrow.  The preferred shareholders
also received 3,414 warrants to purchase additional preferred shares that could
be converted into 17,070,000 shares of AeroGrow common stock. (see Liquidity and
Capital Resources and Note 11 – Subsequent Events in the accompanying Financial
Statements).





For the
length of time the warrants, options and preferred shares are outstanding, the
holders will have an opportunity to profit from a rise in the market price of
our common stock without assuming all the risks of common share ownership. This
may adversely affect the terms upon which we can obtain additional capital. The
holders of such derivative securities would likely exercise or convert them at a
time when we would be able to obtain equity capital on terms more favorable than
the exercise or conversion prices provided by the notes, warrants or
options.





Further,
future sales of substantial amounts of these shares, or the perception that such
sales might occur, could cause the market price of our common stock to decline
and could impair the value of an investment in our common stock and our ability
to raise equity capital in the future.





On
June 30, 2009, we issued $6,250,341 in Series A Convertible Preferred
securities.  The terms and conditions of these securities could
significantly impact the price of our common shares, and could adversely impact
our ability to raise additional equity capital.





The
holders of our Series A Convertible Preferred shares (the “Preferred
Shareholders”) have the right to convert their shares and warrants into
51,250,000 common shares of AeroGrow.  In addition, the Preferred
Shareholders have the right to vote their shares on an as-converted basis on all
matters voted on by common shareholders.  The Preferred Shareholders
also have the right to elect three Directors of AeroGrow, voting as a separate
class.  As a result of these rights, the Preferred Shareholders have
effective control over AeroGrow and its governance.  In addition, the
Preferred Shareholders possess certain rights that give them preferences
relative to common shareholders in the event of a sale or liquidation of the
Company.  It is possible that the Preferred Shareholders could take
actions that could adversely impact the value of investments in common shares of
the Company.  In addition, the control position of the Preferred
Shareholders, as well as other anti-dilution rights held by the Preferred
Shareholders, could adversely impact our ability to raise capital in the
future.  (For more detail on the Series A Convertible Preferred
securities, see Liquidity and Capital Resources and Note 11 – Subsequent Events
in the accompanying Financial Statements.)





If
an exemption from registration on which we have relied for any of our past
offerings of common stock or warrants are challenged legally, our principals may
have to spend time defending claims, and we would then risk paying expenses for
defense, rescission, and/or regulatory sanctions.




To raise
working capital, we offered common stock and warrants in private transactions
that we believed to be exempt from registration under the Securities Act and
state securities laws. In 2004 we conducted a state-registered offering in
Colorado of common stock and warrants, intended to be exempt from registration
under the Securities Act as an intrastate offering. However, because we are
incorporated in Nevada, the offering did not satisfy all of the requirements for
an intrastate offering. This could result in investors or regulators asserting
that the Colorado offering and/or private offerings subsequent to the Colorado
offering (if the private offerings were integrated with the Colorado offering)
violated the Securities Act. There can be no assurance that investors or
regulators will not be successful in asserting a claim that these transactions
should not be integrated. In the event that one or more investors seeks
rescission, with resulting return of investment funds and interest at a market
rate, or that state or federal regulators seeks sanctions against us or our
principals, we would spend time and financial resources to pay expenses for
defense, rescission awards, or regulatory sanctions. The use of funds would
reduce the capital available to operate our business. No assurance can be given
regarding the outcome of any such actions.





16
 Table of Contents




ITEM
      1B.
            UNRESOLVED
      STAFF COMMENTS




None.




ITEM
      2.
            DESCRIPTION OF
      PROPERTY





We lease
a 21,012 square foot office space in, Boulder, Colorado, with a current monthly
rent of $18,385. We also pay our proportionate share of building taxes,
insurance and operating expenses. The initial term continues until January 31,
2012, unless modified under specified circumstances. The agreement contains
other standard office lease provisions.





We
rent space in Longmont, Colorado, pursuant to a month-to-month rental
agreement.  The Longmont facility temporarily houses our nutrient
tablet manufacturing operation.  We currently lease approximately
2,400 square feet of space in the Longmont facility at a monthly rental rate of
$1,662 plus operating expenses.





We also
rent warehouse and manufacturing space in Indianapolis, Indiana.  The
Indianapolis facility houses our distribution and fulfillment operations and our
seed kit manufacturing operations.  We currently lease approximately 90,400
square feet of space in this facility at a monthly rental rate of $16,950 with
no additional operating expenses.  The initial term of the lease
expires on February 28, 2011.





While our
facilities appear adequate for the foreseeable future, we may add space to meet
future growth as needed. Upon expiration of our current leases, we believe that
we will be able to either renew our existing leases or arrange new leases in
nearby locations on acceptable terms. We believe that these properties are
adequately covered by insurance.





ITEM
      3.
            LEGAL
      PROCEEDINGS




In
connection with the Linens ‘N Things (“LNT”) bankruptcy proceedings, a Complaint
to Avoid and Recover Preferential Transfers was filed by LNT in the United
States Bankruptcy Court for the District of Delaware on April 20, 2009 (the
“Complaint”).  The Complaint alleges that, pursuant to Sections 547
and 550 of the United States Bankruptcy Code, we are required to return to LNT
approximately $623,000 in “preferential” transfers allegedly made to AeroGrow
during the 90-day period preceding the filing of the LNT bankruptcy cases. The
Complaint also alleges that AeroGrow is required to pay to LNT approximately
$44,000 on account of credits allegedly earned but not redeemed by LNT prior to
the filing of the LNT bankruptcy cases.  We engaged outside counsel
and filed a response to the Complaint on May 8, 2009 disputing that we have any
obligation to either return the “preferential” transfers allegedly made, or to
pay the credits allegedly earned, to LNT.  As of March 31, 2009, an
estimate has been accrued in our balance sheet and consolidated statement of
operations in anticipation of the cost of defending, or settling, this
matter.  We believe we have a number of strong potential defenses to
all of the claims made in the Complaint and therefore do not expect that the
resolution of this matter will have a material adverse effect on
us.  However, we cannot at this time predict with certainty the
outcome of this matter.  If the Complaint were to be decided in a
manner adverse to us, which, if it were to occur, at a minimum is not expected
to occur during the fiscal year ended March 31, 2010, it could materially
adversely impact our results of operations for that period in which the
Complaint is finally decided.




From time
to time, we are also a party to various other litigation matters, in most cases
involving ordinary and routine claims incidental to our business.  We
cannot estimate with certainty our ultimate legal and financial liability with
respect to any such pending litigation matters.  However, we believe,
based on our examination of such matters, that our ultimate liability, if any,
will not have a material adverse effect on our financial position, results of
operations or cash flows.





ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS





On
February 5, 2009, the Company held a Special Meeting of
Stockholders.  At the meeting, the stockholders present in person or
by proxy approved an amendment to our Articles of Incorporation giving our Board
of Directors the authority to designate the rights and preferences of AeroGrow’s
preferred stock.








Votes
      For
              Votes
      Against
              Votes
      Abstained6,449,229
              430,005
              70,689


17
 Table of Contents
  PART
II


ITEM
      5.
            MARKET
      FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES.




We
began trading on the OTC Bulletin Board (the “OTCBB”) on June 9, 2009, ticker
symbol AERO, and have also been trading on the Pink Sheets Electronic OTC Market
since May 4, 2009.  We traded on the NASDAQ Capital Market from June
13, 2007, to May 1, 2009, after trading on the OTCBB from January 8, 2007 to
June 12, 2007 under the ticker symbol AGWI.   The following table
sets forth, for the periods indicated, the high and low prices of our common
stock while trading on these markets.  As of June 22, 2009, we had
approximately 521 stockholders of record of our common stock. We have never
declared or paid any cash dividends on our capital stock. We currently expect to
retain future earnings, if any, to support operations and to finance the growth
and development of our business. We do not expect to pay cash dividends in the
foreseeable future.





Fiscal
      Year Ended 3/31/09
                
                
                Fiscal
      Year Ended 3/31/08
                
                
                Fiscal
      Year Ended 3/31/07High
                
                
                Low
                
                
                High
                
                
                Low
                
                
                High
                
                
                Low1st
      Quarter - Ended June 30
                
                $
                3.75
                
                
                $
                1.81
                
                
                $
                9.00
                
                
                $
                5.65
                
                
                
                N/A
                
                
                
                N/A2nd
      Quarter - Ended Sept 30
                
                $
                3.22
                
                
                $
                1.27
                
                
                $
                9.24
                
                
                $
                6.85
                
                
                
                N/A
                
                
                
                N/A3rd
      Quarter - Ended Dec 31
                
                $
                2.94
                
                
                $
                0.19
                
                
                $
                8.73
                
                
                $
                4.30
                
                
                
                N/A
                
                
                
                N/A4th
      Quarter - Ended Mar 31
                
                $
                0.40
                
                
                $
                0.08
                
                
                $
                6.75
                
                
                $
                2.60
                
                
                $
                10.00
                
                
                $
                5.52




COMPANY
STOCK PERFORMANCE


COMPARISON
OF CUMULATIVE TOTAL RETURN


Among
AeroGrow International, Inc., the Russell 2000 Index


and
the Russell Microcap Index





The
following graph compares the cumulative total stockholder return data for our
stock for the period beginning April 1, 2008 and ending on March 31, 2009 to the
cumulative return over such period of (i) The Russell 2000 Index (RUT) and (ii)
the Russell Microcap Index (IWC).  The graph assumes $100 was invested on
March 31, 2008 in our Common Stock and in each of the comparative indices. Note
that the historical stock price performance on the following graph is not
necessarily indicative of future stock price performance.





Holders
of Record





As of
June 22, 2009, we had approximately 521 holders of record of our common
stock.





Dividends




We have
never declared or paid cash dividends on our common stock. We currently intend
to retain all available funds and any future earnings for use in the operation
of our business and do not anticipate paying any cash dividends in the
foreseeable future. Any future determination to declare cash dividends will be
made at the discretion of our board of directors, subject to compliance with
covenants under any existing financing agreements, which may restrict or limit
our ability to declare or pay dividends, and will depend on our financial
condition, results of operations, capital requirements, general business
conditions, and other factors that our board of directors may deem
relevant.





Equity
Compensation Plan Information





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




18
 Table of Contents





ITEM
      6.
            SELECTED
      FINANCIAL DATA


Consolidated
Statements of Operations
Data


Years ended March 31,2009
                    
                    
                    2008
                    
                    
                    2007Revenues
                    
                    $
                    37,449,868
                    
                    
                    $
                    38,356,676
                    
                    
                    $
                    13,144,037Cost
      of revenue
                    
                    
                    23,710,787
                    
                    
                    
                    22,975,385
                    
                    
                    
                    8,404,507Research
      and development
                    
                    
                    2,146,493
                    
                    
                    
                    2,605,112
                    
                    
                    
                    2,113,255Sales
      and marketing
                    
                    
                    13,772,822
                    
                    
                    
                    16,084,353
                    
                    
                    
                    7,117,613General
      and administrative
                    
                    
                    7,043,391
                    
                    
                    
                    6,084,728
                    
                    
                    
                    4,050,312Total
      operating expenses
                    
                    
                    46,673,493
                    
                    
                    
                    47,749,578
                    
                    
                    
                    21,685,687Loss
      from operations
                    
                    
                    (9,223,625
                    )
                    
                    
                    (9,392,902
                    )
                    
                    
                    (8,541,650
                    )Other
      (income) expense
                    
                    
                    1,089,889
                    
                    
                    
                    443,019
                    
                    
                    
                    1,844,801Net
      loss
                    
                    $
                    (10,313,514
                    )
                    
                    $
                    (9,835,921
                    )
                    
                    $
                    (10,386,451
                    )Net
      loss per share, basic and diluted
                    
                    $
                    (0.82
                    )
                    
                    $
                    (0.84
                    )
                    
                    $
                    (1.09
                    )Weighted
      average number of commonshares
      outstanding, basic and diluted
                    
                    
                    12,519,999
                    
                    
                    
                    11,662,891
                    
                    
                    
                    9,505,926Consolidated
      Balance Sheet Data
                    
                    March
      31,2009
                    
                    
                    2008
                    
                    
                    2007Cash
      and cash equivalents
                    
                    $
                    332,698
                    
                    
                    $
                    1,559,792
                    
                    
                    $
                    5,495,501Total
      assets
                    
                    $
                    14,609,190
                    
                    
                    $
                    11,919,629
                    
                    
                    $
                    13,041,806Total
      liabilities
                    
                    $
                    18,840,815
                    
                    
                    $
                    7,511,078
                    
                    
                    $
                    5,057,901Total
      stockholders’ equity (deficit)
                    
                    $
                    (4,231,625
                    )
                    
                    $
                    4,408,551
                    
                    
                    $
                    7,983,905






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, 2009 sell products in over 7,500 domestic
retail storefronts and nine 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 4.8 million catalogues mailed in
the fiscal year ended March 31, 2009.  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.




19
 Table of Contents




Our
Critical Accounting Policies





Inventory


Inventories
are valued at the lower of cost, determined by the first-in, first-out method,
or market. Included in inventory costs where the Company is the manufacturer are
raw materials, labor and manufacturing overhead. 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 as prescribed
under Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, “Inventory
Pricing”.  A majority of the Company’s products are manufactured
overseas and are recorded at cost.





March 31, 2009
                    
                    
                    March 31, 2008Finished
      goods
                    
                    $
                    6,799,996
                    
                    
                    $
                    3,669,693Raw
      materials
                    
                    
                    1,550,139
                    
                    
                    
                    1,018,751$
                    8,350,135
                    
                    
                    $
                    4,688,444





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 March 31, 2009, the Company had
reserved $335,705 for inventory obsolescence and as of March 31, 2008 and March
31, 2007, the Company determined that no inventory obsolescence reserve was
required.





Revenue
Recognition


The
Company recognizes 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 fee is fixed or determinable; and collection of the resulting receivable is
reasonably assured. Accordingly, the Company did not record $0 and $577,838 of
revenue as of March 31, 2009 and March 31, 2008, respectively, related to the
unpaid balance due for orders shipped in conjunction with the Company’s direct
sales to consumers because the consumer has 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.  During the year ending March 31, 2009, the Company
discontinued offering the 36-day trail period.  The Company also, as
of March 31, 2009 and March 31, 2008, did not record $0 and $175,781,
respectively, of product costs associated with the foregoing revenue in as much
as the customer is required to return the product and the Company is therefore
able to recover these costs through resale of the goods. The liability for sales
returns is estimated based upon historical experience of return
levels.





Additionally,
the Company did not record $46,131 and $69,339 of revenue as of March 31, 2009
and March 31, 2008, respectively, related to the wholesale sales value of
inventory held by its retail shopping channel customers as these sales are
contingent upon the shopping channels selling the goods. Deferred payments for
these goods are charged to Customer Deposits. The Company has also deferred, as
of March 31, 2009 and March 31, 2008, recognition of $21,336, and $33,937 of
product and freight costs associated with these sales, which have been included
in inventory.





The
Company records estimated reductions to revenue for customer and distributor
programs and incentive offerings, including promotions and other volume-based
incentives. Certain incentive programs require the Company to estimate based on
industry experience the number of customers who will actually redeem the
incentive. At March 31, 2009 and March 31, 2008, the Company had accrued
$431,148 and $226,729 respectively, as its estimate for the foregoing deductions
and allowances.  In addition, for the fiscal year ended March 31,
2009, the Company had accrued $2,077,622 for possible returns or price markdowns
associated with several large retailer accounts.  These accruals were
recorded as a reduction of sales, and an increase in allowance for bad debt,
which reduced net trade receivables relating to retailers.





Warranty and Return
Reserves


The
Company records warranty liabilities at the time of sale for the estimated costs
that may be incurred under its 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, 2009 and March 31, 2008 a provision for potential
future warranty costs of $69,587 and $72,200, 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 from which this allowance is deducted from
payments from such customers. As of March 31, 2009 and March 31, 2008, the
Company has recorded a reserve for customer returns of $101,743 and $674,120,
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 product sales.





20
 Table of Contents




Stock Based
Compensation


In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, “Share-Based Payment.” Subsequently, the Securities and Exchange
Commission (“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 recognizing 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 APB No. 25, “Accounting for Stock Issued to
Employees” and related Interpretations, which generally results in no employee
stock option expense. The Company adopted SFAS No. 123R on January 1, 2006 and
does not plan to restate financial statements for prior periods. The Company
uses the Black-Scholes option valuation model to estimate the fair value of
stock option awards issued under SFAS No. 123R.  In addition, the
Company uses the “simplified” method for determining the expected term of its
“plain vanilla” stock options as permitted by Staff Accounting Bulletin No.
107.  For the years ended March 31, 2009, March 31, 2008, and March
31, 2007, equity compensation in the form of stock options and grants of
restricted stock totaled $723,406, $710,899, and $1,077,029, respectively, and
is included in the accompanying Statements of Operations in the following
categories:




Years
      endedMarch31,
      2009
                                    
                                    
                                    March 31, 2008
                                    
                                    
                                    March 31, 2007General
      and administrative
                                    
                                    $
                                    457,592
                                    
                                    
                                    $
                                    225,730
                                    
                                    
                                    $
                                    356,720Research
      and development
                                    
                                    
                                    121,952
                                    
                                    
                                    
                                    300,702
                                    
                                    
                                    
                                    336,482Sales
      and  marketing
                                    
                                    
                                    143,862
                                    
                                    
                                    
                                    184,467
                                    
                                    
                                    
                                    383,827$
                                    723,406
                                    
                                    
                                    $
                                    710,899
                                    
                                    
                                    $
                                    1,077,029
 Advertising and Production
Costs


The
Company expenses all production costs related to advertising, including, print,
television, and radio advertisements when the advertisement has been broadcast
or otherwise distributed.  The Company records media 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 the Statement of Position,
SOP 93-7, “Reporting on Advertising Costs.” In accordance with SOP 93-7, direct
response 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, 2009 and March 31, 2008, the Company had deferred $346,130 and
$503,825, respectively, related to such media costs. Advertising expenses for
the years ended March 31, 2009, March 31, 2008 and March 31, 2007 were
$5,101,910, $6,955,555 and $2,125,112, 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.





Deferred Debt Issuance
Costs


The Company capitalizes debt issuance
costs that are directly attributable to realizing the proceeds of the debt
issued and it is amortized over the contractual life of the debt.





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.





New
Accounting Pronouncements





In May
2009, the FASB issued Statement of SFAS No. 165, Subsequent Events. This
Statement establishes general standards of accounting for and disclosures of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued.  It requires the disclosure of
the date through which an entity has evaluated subsequent events and the basis
for that date. This Statement is effective for interim and annual periods ending
after June 15, 2009 and as such, we will adopt this standard in the first
quarter of fiscal year 2010. We are currently assessing the impact of the
adoption of SFAS 165, if any, on our financial position, results of operations
or cash flows.





21
 Table of Contents




In April
2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments.  This FSP amends FASB Statement No.
107 to require disclosures about fair values of financial instruments for
interim reporting periods as well as in annual financial
statements.  The FSP also amends APB Opinion No. 28 to require those
disclosures in summarized financial information at interim reporting
periods.  This FSP becomes effective for interim reporting periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009.  The adoption of this FSP is not expected to
have a material impact on our financial statements.





In
October 2008, the FASB issued FASB Staff Position No. FAS 157-3, Determining the Fair Value of a
Financial Asset in a Market That is Not Active (FSP 157-3), which
clarifies the application of SFAS 157 when the market for a financial asset
is inactive. Specifically, FSP 157-3 clarifies how (1) the internal
assumptions should be considered in measuring fair value when observable data
are not present, (2) observable market information from an inactive market
should be taken into account, and (3) the use of broker quotes or pricing
services should be considered in assessing the relevance of observable and
unobservable data to measure fair value. The guidance in FSP 157-3 was effective
immediately. The adoption of FSP 157-3 did not have a material effect on our
financial statements.





In May
2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee
Insurance Contracts-an interpretation of FASB Statement No.
60. Diversity exists in practice in accounting for financial guarantee
insurance contracts by insurance enterprises under FASB Statement No. 60, (Accounting and Reporting by
Insurance Enterprises). This results in inconsistencies in the
recognition and measurement of claim liabilities. This Statement requires that
an insurance enterprise recognize a claim liability prior to an event of default
(insured event) when there is evidence that credit deterioration has occurred in
an insured financial obligation. This Statement requires expanded disclosures
about financial guarantee insurance contracts. The accounting and disclosure
requirements of the Statement will improve the quality of information provided
to users of financial statements.  SFAS 163 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The adoption of FASB 163 is not
expected to have a material impact on the Company's financial
position.





In May
2008, the FASB issued SFAS No. 162 The Hierarchy of Generally Accepted
Accounting Principles (“SFAS 162”). SFAS 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 GAAP. This statement was effective 60 days
following the Securities Exchange and Commission’s September 16, 2008 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. The adoption did not have a material impact on our financial
statements




In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of
Intangible Assets. This FSP amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful life
of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible
Assets. This FSP is effective prospectively for fiscal years beginning
after December 15, 2008, which for the Company is April 1, 2009. The
Company is currently assessing the impact of this FSP.





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 adopted SFAS No. 159 in the fiscal
year beginning April 1, 2008. The adoption of this Statement did not have a
material effect on our financial statements.




22
 Table of Contents




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, we experience slower sales in the United States during the
late spring and summer months 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 sell to our
international distributors in US Dollars thereby minimizing effects from
currency fluctuations.  We purchase our gardens and other accessory
products from Chinese manufacturers, and these purchases are denominated in US
Dollars.  However, over time, the cost of the products we procure from
China may be affected by changes in the value of the US Dollar relative to the
Chinese currency.




Results
of Operations





The
following table sets forth, as a percentage of sales, our financial results for
the last three fiscal years:





Fiscal Years Ended March
31,2009
                    
                    
                    2008
                    
                    
                    2007RevenueProduct
      sales- retail
                    
                    
                    60.9
                    %
                    
                    
                    62.
      4
                    %
                    
                    
                    68.1
                    %Product
      sales- direct-to-consumer
                    
                    
                    32.9
                    %
                    
                    
                    35.7
                    %
                    
                    
                    31.9
                    %Product
      sales- international
                    
                    
                    6.2
                    %
                    
                    
                    1.9
                    %
                    
                    
                    -Total
      sales
                    
                    
                    100.00
                    %
                    
                    
                    100.00
                    %
                    
                    
                    100.00
                    %Operating
      expensesCost
      of revenue
                    
                    
                    63.3
                    %
                    
                    
                    59.9
                    %
                    
                    
                    63.9
                    %Research
      and development
                    
                    
                    5.7
                    %
                    
                    
                    6.8
                    %
                    
                    
                    16.1
                    %Sales
      and marketing
                    
                    
                    36.8
                    %
                    
                    
                    41.9
                    %
                    
                    
                    54.2
                    %General
      and administrative
                    
                    
                    18.8
                    %
                    
                    
                    15.9
                    %
                    
                    
                    30.8
                    %Total
      operating expenses
                    
                    
                    124.6
                    %
                    
                    
                    124.5
                    %
                    
                    
                    165.0
                    %Total
      other (income) expense, net
                    
                    
                    2.9
                    %
                    
                    
                    1.1
                    %
                    
                    
                    14.0
                    %Loss
      from operations
                    
                    
                    -27.5
                    %
                    
                    
                    -25.6
                    %
                    
                    
                    -79.0
                    %








Fiscal
Years Ended March 31, 2009 and March 31, 2008





Summary Overview:For the
fiscal year ended March 31, 2009, our net sales totaled $37,449,868, a decrease
of 2.4% from the fiscal year ended March 31, 2008.  The sales decrease
reflected the impact of the sudden disruptions in the global credit markets, the
decline in general economic activity, and the consequent decline in consumer
spending that occurred in the second half of our fiscal year.  In the
first half of the fiscal year (the six month period ended September 30, 2008),
our sales increased almost 63.8% reflecting our greatly expanded distribution
through our retailer customers; however, the sudden change in the economic
environment resulted in our sales declining 34.6% in the second half of the
fiscal year.  This impact of the economic downturn on sales was
experienced in both our sales to retailer customers and in our
direct-to-consumer business.  In our international business, sales
increased 213.7% year-over-year, principally reflecting the comparison to a
partial year of operations in the prior fiscal year.  Our sales to
retailers were also adversely impacted during the second half of the fiscal year
by an unusually high level of sales allowances, totaling $2,077,622, that we
recognized to reflect our cost of supporting discounting programs executed by
some of our largest retailer customers.  These discounting programs
were instituted during the 2008 holiday selling season by retailers in
recognition of the impact that the global credit crisis, stock market declines,
and sudden downturn in economic activity during the fourth calendar quarter of
2008 had on consumer confidence, and therefore on the level of consumer
spending.  Because of these factors, discounting and other price
actions were prevalent at most retailers and on many products during the 2008
holiday selling season in order to try to incent the consumer to purchase
products during what is traditionally the highest volume selling season for
retailers.  We do not expect that the confluence of a dramatic change
in consumer spending habits immediately in advance of the holiday selling season
and the impact of other economic factors will recur to the extent experienced
during the fiscal year ended March 31, 2009.  Therefore, we do not
believe that the unusually high level of sales allowances we experienced in the
fiscal year ended March 31, 2009 will be experienced in future fiscal
years.  Excluding the impact of these unusual sales allowances, our
adjusted sales for the fiscal year ended March 31, 2009 increased 3.1% relative
to the prior fiscal year.





23
 Table of Contents




Our gross
margin for the fiscal year ended March 31, 2009 was 36.7%, down from 40.1% in
the prior year.  The reduction in margin reflected a number of factors
including the $2,077,622 in unusual sales allowances (which reduced sales and
gross profit), inventory reserves we established during the year totaling
$391,490, and the increased percentage mix of our sales that came from our
lower-margin international operations.  Partially offsetting these
negative impacts were cost reductions we achieved in our manufacturing and
distribution operations, most notably resulting from the opening of a
company-operated distribution facility in Indianapolis, Indiana in July
2008.  Excluding the impact of the unusual sales allowances, the
adjusted gross margin was 40.0% in the fiscal year ended March 31,
2009.





Operating
expenses other than cost of revenue for the fiscal year ended March 31, 2009
decreased $1,811,487, or 7.3%, reflecting reduced spending in our sales and
marketing operations and in our research and development
operations.   In both cases, the declines reflected cost saving
actions, including headcount reductions, taken in the second half of the fiscal
year in response to the sudden decline in sales volume we
experienced.  Offsetting the decline in sales and marketing and
research and development expense was a year-over-year $958,663 increase in
general and administrative expense.  This increase principally
reflected severance expense of $362,271, amortization of debt issuance costs of
$243,937, and a $414,831 increase in depreciation and amortization, partially
offset by the net impact of cost reduction actions taken during the
year.





Other
expense for the fiscal year ended March 31, 2009, principally interest expense,
increased $646,870 to $1,089,889 from the prior fiscal year reflecting the
higher proportion of debt in our capital structure during the
year.  Our net loss totaled $10,313,514 for the fiscal year ended
March 31, 2009, $477,593 higher than the prior year as the increase in other
expense more than offset the decline in our loss from operations.





The table
set forth below shows quarterly revenues by sales channel for the fiscal years
ended March 31, 2009, and March 31, 2008:




Quarters
      ended
                                                  
                                                  
                                                  Year
      ended30-Jun-07
                                                  
                                                  
                                                  30-Sep-07
                                                  
                                                  
                                                  31-Dec-07
                                                  
                                                  
                                                  31-Mar-08
                                                  
                                                  
                                                  31-Mar-08Sales-
      Retail
                                                  
                                                  $
                                                  4,129,853
                                                  
                                                  
                                                  $
                                                  4,850,298
                                                  
                                                  
                                                  $
                                                  9,145,317
                                                  
                                                  
                                                  $
                                                  5,785,314
                                                  
                                                  
                                                  $
                                                  23,910,782Sales-
      Direct-to-Consumer
                                                  
                                                  
                                                  2,148,832
                                                  
                                                  
                                                  
                                                  1,433,347
                                                  
                                                  
                                                  
                                                  5,109,405
                                                  
                                                  
                                                  
                                                  5,013,133
                                                  
                                                  
                                                  
                                                  13,704,717Sales
      - International
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  383,020
                                                  
                                                  
                                                  
                                                  358,157
                                                  
                                                  
                                                  
                                                  741,177$
                                                  6,278,685
                                                  
                                                  
                                                  $
                                                  6,283,645
                                                  
                                                  
                                                  $
                                                  14,637,742
                                                  
                                                  
                                                  $
                                                  11,156,604
                                                  
                                                  
                                                  $
                                                  38,356,676Quarters
      ended
                                                  
                                                  
                                                  Year
      ended30-Jun-08
                                                  
                                                  
                                                  30-Sep-08
                                                  
                                                  
                                                  31-Dec-08
                                                  
                                                  
                                                  31-Mar-09
                                                  
                                                  
                                                  31-Mar-09Sales-
      Retail
                                                  
                                                  $
                                                  2,642,575
                                                  
                                                  
                                                  $
                                                  11,508,030
                                                  
                                                  
                                                  $
                                                  5,621,688
                                                  
                                                  
                                                  $
                                                  3,048,651
                                                  
                                                  
                                                  $
                                                  22,820,944Sales-
      Direct-to-Consumer
                                                  
                                                  
                                                  3,339,410
                                                  
                                                  
                                                  
                                                  1,365,438
                                                  
                                                  
                                                  
                                                  4,867,808
                                                  
                                                  
                                                  
                                                  2,731,362
                                                  
                                                  
                                                  
                                                  12,304,018Sales
      - International
                                                  
                                                  
                                                  738,096
                                                  
                                                  
                                                  
                                                  981,462
                                                  
                                                  
                                                  
                                                  521,389
                                                  
                                                  
                                                  
                                                  83,959
                                                  
                                                  
                                                  
                                                  2,324,906$
                                                  6,720,081
                                                  
                                                  
                                                  $
                                                  13,854,930
                                                  
                                                  
                                                  $
                                                  11,010,885
                                                  
                                                  
                                                  $
                                                  5,863,972
                                                  
                                                  
                                                  $
                                                  37,449,868




For the
fiscal year ended March 31, 2009, revenue totaled $37,449,868, a decrease of
2.4% from the fiscal year ended March 31, 2008.  Overall, the decline
reflected the impact of the dramatic slowdown in economic activity in the United
States that began in the calendar fourth quarter.  For the first half
of our fiscal year, net revenue increased 63.8%, principally because of the
impact of a substantial increase in the number of retail storefronts in the
United States and Canada carrying our AeroGardens, seed kits and accessory
items, which rose to over 9,000 stores by the December 2008 holiday shopping
season.





The
increase in retail storefronts carrying our products resulted in a large volume
of stocking shipments to new retailer customers during the six months ended
September 30, 2008, causing sales into the retail channel to increase by 57.6%
relative to the same time period in the prior year.  In the following
two quarters, however, our sales were constrained by the combined impact of two
factors: first, the economic downturn caused a reduction in the level of
consumer spending, and second, our retailer customers reduced the level of their
purchases of our products relative to the levels they had originally
projected.  The combination of these factors resulted in our sales
into the retail channel for the second half of the fiscal year to decline by
41.9% from the same period in the prior fiscal year.  For the full
fiscal year, our sales into the retail channel declined by 4.6%, to
$22,820,944.





As of
December 31, 2008, our products were being sold in over 9,000 traditional “brick
and mortar” storefronts, as compared to approximately 4,300 as of December 31,
2007.  As of March 31, 2009, AeroGrow products were being sold through
approximately 7,500 storefronts, as compared to approximately 5,100 storefronts
at March 31, 2008.  Because of the impact of the deteriorating economy
following the high load-in level of shipments to retailers in the three months
ended September 30, 2008, we did experience a decline in order rates from our
key customers during the six months ended March 31, 2009.  We expect
the number of stores carrying our products will vary during the fiscal year
ending March 31, 2010, and will likely decline due to our focus on servicing a
more limited number of key customers, and because certain retailers are expected
to reduce the breadth of products they carry as a result of their increased
focus on cash flow and inventory management practices.  In addition, a
number of our retailer customers purchase our products on a seasonal basis and
do not carry the products year-round in their stores.  As a result,
the number of storefronts offering our product can vary depending on the time of
year.  Because of the impact of this variability, and the impact of
web-based retailers, TV sales channels, and catalogue retailers, which do not
have storefronts, on our retail sales, we do not believe “sales per store” is a
meaningful metric for assessing our retail business.





24
 Table of Contents




Our net
revenue from sales into the retail channel was also adversely impacted by sales
allowances over and above those allowances we normally recognize to account for
the costs of our account relationships with larger retailers.  These
unusual allowances were taken to reflect the cost we incurred to support
discounting programs by our retailer customers during the 2008 holiday selling
season and in the first calendar quarter of 2009.  These discounting
programs were instituted during the 2008 holiday selling season by retailers in
recognition of the impact that the global credit crisis, stock market declines,
and sudden downturn in economic activity during the fourth calendar quarter of
2008 had on consumer confidence, and therefore on the level of consumer
spending.  Because of these factors, discounting and other price
actions were prevalent at most retailers and on many products during the 2008
holiday selling season in order to try to incent the consumer to purchase
products during what is traditionally the highest volume selling season for
retailers.  We do not expect that the confluence of a dramatic change
in consumer spending habits immediately in advance of the holiday selling season
and the impact of other economic factors will recur to the extent experienced
during the fiscal year ended March 31, 2009.  Therefore, we do not
believe that the unusually high level of sales allowances we experienced in the
fiscal year ended March 31, 2009 will be experienced in future fiscal
years.  We recognized $1,725,213 in unusual allowances in the three
months ended December 31, 2008 and $352,409 during the three months ended March
31, 2009.  In the prior fiscal year, we recognized no unusual
allowances.  Excluding the impact of unusual sales allowances in the
fiscal year ended March 31, 2009, our adjusted sales into the retail channels
increased 4.1% relative to the prior fiscal year.





Our
direct-to-consumer sales also declined during the fiscal year ended March 31,
2009, by 10.2% to $12,304,018 from the prior fiscal year.  The decline
reflected the offsetting impacts of an approximate 85.0% decline in sales
generated by television advertising and infomercials, and an approximate 20.0%
increase in sales generated from all other direct-to-consumer channels,
including an approximate 93.9% increase in sales generated by our catalogue
operations.  The decline in sales generated by television media was
caused by a shift in our media spending from long-form and short-form television
infomercials designed specifically to drive direct-to-consumer sales, to more
traditional television advertising designed to support the sales and marketing
efforts of our retailer customers, as well as support our direct-to-consumer
operations.  In addition, we reduced the level of our overall
television media spending relative to the prior fiscal year, as a result of our
constrained capital availability and because of analysis demonstrating that
television media purchased during the low seasonal period of our fiscal year
represented an inefficient use of our resources as it generated
direct-to-consumer sales that were less than the cost of media.  The
year-over-year increase in sales from all other direct-to-consumer channels
during the fiscal year ended March 31, 2009, principally reflected a 132.9%
increase in the number of catalogues we mailed to consumers, to more than 4.8
million catalogues.  The increase in catalogues mailed reflected our
strategy to increase marketing spending in this channel of our
direct-to-consumer business, as well as a comparison to operations for only part
of the prior fiscal year.





During
the fiscal year ended March 31, 2009, from time-to-time we offered our direct
customers 36 days to evaluate the product (“Trial Sales”), with the customer
paying only the shipping and handling costs for such products before making
required installment payments after the expiration of the 36-day trial period.
As of March 31, 2009, we had discontinued offering Trial
Sales.  During the prior fiscal year, we also offered Trial Sales, and
therefore did not record $577,838 of revenue as of March 31, 2008, related to
the unpaid balance due for orders shipped in conjunction with these Trial Sales.
Also, as of March 31, 2008, we did not record $175,781 of product costs
associated with the foregoing Trial Sales because in the event the customer
returned the product, we were able to recover these costs through resale of the
goods.





The
fiscal year ended March 31, 2009 was the first full fiscal year of revenue for
our international operations.  Total sales into markets outside the
United States and Canada increased to $2,324,906, or 213.7% higher than
international sales during the fiscal year ended March 31, 2008.  The
increase principally reflected an increase in our penetration of new markets
through local distributors, as well as the comparison to a partial fiscal year
of operations in the fiscal year ended March 31, 2008.  As of March
31, 2009, our products were being sold in nine countries outside the United
States and Canada, principally in Europe, Asia and in Australia.




The
following table presents our quarterly sales by product category, in US Dollars
and as a percent of total net revenue, for the fiscal years ending March 31,
2009 and March 31, 2008.




Quarters
      ended
                                        
                                        
                                        Year
      ended30-Jun-07
                                        
                                        
                                        30-Sep-07
                                        
                                        
                                        31-Dec-07
                                        
                                        
                                        31-Mar-08
                                        
                                        
                                        31-Mar-08Product
      RevenueAeroGardens
                                        
                                        $
                                        5,643,885
                                        
                                        
                                        $
                                        4,816,504
                                        
                                        
                                        $
                                        12,145,733
                                        
                                        
                                        $
                                        8,934,285
                                        
                                        
                                        $
                                        31,540,407Seed
      kits and accessories
                                        
                                        
                                        634,800
                                        
                                        
                                        
                                        1,467,141
                                        
                                        
                                        
                                        2,492,009
                                        
                                        
                                        
                                        2,222,319
                                        
                                        
                                        
                                        6,816,269Total
                                        
                                        $
                                        6,278,685
                                        
                                        
                                        $
                                        6,283,645
                                        
                                        
                                        $
                                        14,637,742
                                        
                                        
                                        $
                                        11,156,604
                                        
                                        
                                        $
                                        38,356,676%
      of RevenueAeroGardens
                                        
                                        
                                        89.9
                                        %
                                        
                                        
                                        76.7
                                        %
                                        
                                        
                                        83.0
                                        %
                                        
                                        
                                        80.1
                                        %
                                        
                                        
                                        82.2
                                        %Seed
      kits and accessories
                                        
                                        
                                        10.1
                                        %
                                        
                                        
                                        23.3
                                        %
                                        
                                        
                                        17.0
                                        %
                                        
                                        
                                        19.9
                                        %
                                        
                                        
                                        17.8
                                        %Total
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %Quarters
      ended
                                        
                                        
                                        Year
      ended30-Jun-08
                                        
                                        
                                        30-Sep-08
                                        
                                        
                                        31-Dec-08
                                        
                                        
                                        31-Mar-09
                                        
                                        
                                        31-Mar-09Product
      RevenueAeroGardens
                                        
                                        $
                                        4,983,416
                                        
                                        
                                        $
                                        11,278,260
                                        
                                        
                                        $
                                        8,683,670
                                        
                                        
                                        $
                                        4,189,614
                                        
                                        
                                        $
                                        29,134,960Seed
      kits and accessories
                                        
                                        
                                        1,736,665
                                        
                                        
                                        
                                        2,576,670
                                        
                                        
                                        
                                        2,327,215
                                        
                                        
                                        
                                        1,674,358
                                        
                                        
                                        
                                        8,314,908Total
                                        
                                        $
                                        6,720,081
                                        
                                        
                                        $
                                        13,854,930
                                        
                                        
                                        $
                                        11,010,885
                                        
                                        
                                        $
                                        5,863,972
                                        
                                        
                                        $
                                        37,449,868%
      of RevenueAeroGardens
                                        
                                        
                                        74.2
                                        %
                                        
                                        
                                        81.4
                                        %
                                        
                                        
                                        78.9
                                        %
                                        
                                        
                                        71.4
                                        %
                                        
                                        
                                        77.8
                                        %Seed
      kits and accessories
                                        
                                        
                                        25.8
                                        %
                                        
                                        
                                        18.6
                                        %
                                        
                                        
                                        21.1
                                        %
                                        
                                        
                                        28.6
                                        %
                                        
                                        
                                        22.2
                                        %Total
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        100.0
                                        %





25
 Table of Contents




Year-over-year,
sales of our AeroGardens decreased 7.6% during the fiscal year ended March 31,
2009, to $29,134,960, reflecting the decline in sales to retailer customers, and
in our direct-to-consumer business detailed above.  Year-over-year
seed kit and accessory sales increased, however, by 22.0%, to $8,314,908 during
the same time period.  The increase in seed kit and accessory sales
reflected the impact of our expanded base of cumulative gardens sold since
inception, to 795,708.  On a cumulative basis, we have sold over
1,722,000 seed kits to-date, and, in the fiscal year ended March 31, 2009, sales
of seed kits and accessories represented 22.2% of our total net revenue, up from
17.8% in the prior fiscal year.





Cost of
revenue for the year ended March 31, 2009 totaled $23,710,787, a 3.2% increase
from the prior fiscal year.  Cost of revenue includes product costs
for purchased and manufactured products, freight costs for inbound freight from
manufacturers and outbound freight to customers, costs related to warehousing
and the shipping of products to customers and duties and customs applicable to
products imported. The increase in cost of revenue principally reflected the
increase in adjusted net revenue (with the increase being calculated after
excluding the impact of $2,077,622 in unusual sales allowances), as well as
$391,490 in reserves established for inventory damage and
obsolescence.  As a percent of net revenue, cost of revenue increased
to 63.3% from 59.9% in the prior fiscal year.  This increase reflects
the impact of the unusual sales allowances that reduced net revenue in the
fiscal year ended March 31, 2009, a higher percentage of our revenue coming from
international sales, at a lower average margin, offset partially by the impact
of various cost savings initiatives executed in our manufacturing and
distribution operations.





Our gross
margin varies based upon the factors impacting net revenue and cost of revenue
as discussed above, as well as the mix of our revenue that comes from the
retail, direct-to-consumer, and international channels.  In a
direct-to-consumer sale, we recognize as revenue the full consumer purchase
price for the product as opposed to retail sales, where we recognize as revenue
the wholesale price for the product which we charge to the
retailer.  Media costs associated with direct sales are included in
sales and marketing costs.  For international sales, margins are
structured based on the distributor purchasing products by letter of credit or
cash in advance terms with the distributor bearing all of the marketing and
distribution costs within their territory, hence international margins are lower
than margins from domestic retail sales.





Gross
margin for the year ended March 31, 2009 was 36.7% of net revenue, as compared
to 40.1% in the prior fiscal year.  The decline in gross margin as a
percent of net revenue principally reflected the impacts of the unusual sales
allowances, the inventory reserves established during the fiscal year ended
March 31, 2009, and the higher mix of our sales coming from international
operations, offset by the cost reductions we were able to achieve in our
manufacturing and distribution operations.  Excluding the impacts of
the unusual sales allowances, the adjusted gross margin for the fiscal year
ended March 31, 2009 was 41.0%.





Sales and
marketing costs for the fiscal year ended March 31, 2009 totaled $13,772,822,a
reduction of $2,311,531, or 14.4%, from the prior fiscal year.  Sales
and marketing costs include all costs associated with the marketing, sales,
operations, customer support, and sales order processing for our
products.  The following table breaks down the components of our sales
and marketing costs for the fiscal years ended March 31, 2009 and March 31,
2008:








Fiscal Years Ended March
31,2009
                          
                          
                          2008Advertising
                          
                          $
                          5,101,910
                          
                          
                          $
                          8,291,987Salaries
      and related expenses
                          
                          
                          3,772,942
                          
                          
                          
                          3,541,337Sales
      commissions
                          
                          
                          1,145,141
                          
                          
                          
                          1,104,241Trade
      Shows
                          
                          
                          302,138
                          
                          
                          
                          398,337Other
                          
                          
                          3,450,691
                          
                          
                          
                          2,748,451$
                          13,772,822
                          
                          
                          $
                          16,084,353





Advertising
is principally made up of the costs of developing and airing our infomercials
and short-form television commercials, the costs of development, production,
printing, and postage for our catalogues, and mailing and web media costs for
search and affiliate web marketing programs.  Each of these are key
components of our integrated marketing strategy because they help build
awareness of, and consumer demand for, our products, for all our channels of
distribution, in addition to generating direct-to-consumer
sales.  Advertising expense totaled $5,101,910 for the fiscal year
ended March 31, 2009, a decrease of $3,190,077 from the prior fiscal year,
reflecting the offsetting impacts of a $3,647,172 reduction in television
advertising expense, and a $1,720,143 increase in the level of our catalogue and
web media spending.





Sales and
marketing personnel costs include salaries, payroll taxes, employee benefits and
other payroll costs for our sales, operations, customer service, graphics and
marketing departments.  For the fiscal year ended March 31, 2009,
these costs totaled $3,772,942, an increase of $231,605 from the prior fiscal
year.  The increase primarily reflects the impact of higher average
levels of staffing in our customer support and telesales operations early in the
fiscal year, severance expense totaling $101,788, reflecting the departure of
our Chief Marketing Officer, and new staffing for our Indianapolis, Indiana
distribution and manufacturing facility opened in July 2008, partially offset by
the impact of headcount reductions implemented in December 2008 and in the first
calendar quarter of 2009.





26
 Table of Contents




Sales
commissions, ranging from 2.5% to 7% of cash collections from our retailer
customers, are paid to third-party sales representative organizations that
assist us in developing and maintaining our relationships with
retailers.  For the fiscal year ended March 31, 2009, sales
commissions totaled $1,145,141, a 3.7% increase relative to the prior fiscal
year.  The increase principally reflects changes in the mix of our
collections from retailer customers and the differential commission rates
associated with each customer, partially offset by the impact of the overall
decline in sales to retailers during the fiscal year.





General
and administrative expense for the fiscal year ended March 31, 2009 totaled
$7,043,391, up $958,663, or 15.8% from the prior fiscal
year.  Contributing to the increase was severance expense of $362,271
relating to overall staff reductions, including the departure of our former
chief executive officer, chief financial officer, and vice president of human
resources, and $243,937 in amortization of debt issuance costs.  The
balance of the increase principally reflects increases in executive and
managerial headcount costs, facility costs, insurance costs, and outside legal
costs, in addition to a $414,831 increase in non-cash depreciation and
amortization charges, offset by a $312,512 reduction in bad debt expense
reflecting a comparison to the prior fiscal year that included a $400,000
reserve established as a result of receivables due from Linens ‘N Things, Inc.,
which filed for protection under Chapter 11 of the U.S. Bankruptcy code on May
2, 2008.





Research
and development costs totaled $2,146,493 for the fiscal year ended March 31,
2009, a $458,619 or 17.6% decline from the prior fiscal
year.  Research and development costs comprise the costs associated
with our engineering staff that develops new AeroGarden models and technologies,
and our plant laboratories that research new plant varieties that will grow well
in our AeroGarden products, as well as technologies such as improved lighting
and nutrient formulation and delivery to enhance the performance of our
products.  The decline in expense during the year ended March 31, 2009
principally reflected a comparison to the prior fiscal year that included a high
level of spending on product development, testing and certification for products
that were launched during the fiscal year ended March 31, 2009, or that will be
launched in future periods, as well as reductions in the staffing of the
research and development departments.





The loss
from operations totaled $9,223,625 for the fiscal year ended March 31, 2009,
$169,277 or 1.8% less than the prior year.  Total other expense was
$1,089,889 during the fiscal year ended March 31, 2009 as compared to $443,019
for the fiscal year ended March 31, 2008.  The $646,870 year-over-year
increase reflected a higher average level of interest-bearing debt and capital
leases outstanding, combined with a lower average level of interest-bearing cash
equivalents.  Our net loss was $10,313,514 for the fiscal year ended
March 31, 2009, a $477,593 increase from the previous year as the lower loss
from operations was more than offset by the increase in other
expense.





Fiscal
Years Ended March 31, 2008 and March 31, 2007





Summary Overview: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.




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.





The table
set forth below shows quarterly revenues by sales channel for the fiscal years
ending March 31, 2008 and March 31, 2007:





Quarters
      ended
                                      
                                      
                                      Year
      ended30-Jun-06
                                      
                                      
                                      30-Sep-06
                                      
                                      
                                      31-Dec-06
                                      
                                      
                                      31-Mar-07
                                      
                                      
                                      31-Mar-07Sales-
      Retail
                                      
                                      $
                                      693,610
                                      
                                      
                                      $
                                      799,335
                                      
                                      
                                      $
                                      3,266,226
                                      
                                      
                                      $
                                      4,189,871
                                      
                                      
                                      $
                                      8,949,042Sales-
      Direct-to-Consumer
                                      
                                      
                                      128,328
                                      
                                      
                                      
                                      230,981
                                      
                                      
                                      
                                      1,591,378
                                      
                                      
                                      
                                      2,244,308
                                      
                                      
                                      
                                      4,194,995Sales
      - International
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -$
                                      821,938
                                      
                                      
                                      $
                                      1,030,316
                                      
                                      
                                      $
                                      4,857,604
                                      
                                      
                                      $
                                      6,434,179
                                      
                                      
                                      $
                                      13,144,037Quarters
      ended
                                      
                                      
                                      Year
      ended30-Jun-07
                                      
                                      
                                      30-Sep-07
                                      
                                      
                                      31-Dec-07
                                      
                                      
                                      31-Mar-08
                                      
                                      
                                      31-Mar-08Sales-
      Retail
                                      
                                      $
                                      4,129,853
                                      
                                      
                                      $
                                      4,850,298
                                      
                                      
                                      $
                                      9,145,317
                                      
                                      
                                      $
                                      5,785,314
                                      
                                      
                                      $
                                      23,910,782Sales-
      Direct-to-Consumer
                                      
                                      
                                      2,148,832
                                      
                                      
                                      
                                      1,433,347
                                      
                                      
                                      
                                      5,109,405
                                      
                                      
                                      
                                      5,013,133
                                      
                                      
                                      
                                      13,704,717Sales
      - International
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      383,020
                                      
                                      
                                      
                                      358,157
                                      
                                      
                                      
                                      741,177$
                                      6,278,685
                                      
                                      
                                      $
                                      6,283,645
                                      
                                      
                                      $
                                      14,637,742
                                      
                                      
                                      $
                                      11,156,604
                                      
                                      
                                      $
                                      38,356,676




27
 Table of Contents




For the
year ended March 31, 2008, net sales totaled $38,356,676 as compared to
$13,144,037 for the year ended March 31, 2007, an increase of $25,212,639 or
191.8%.  In retail channels, the number of retail storefronts carrying
our products was 750 in December 2006, and increased to over 4,300 by December
2007. At March 31, 2008, our products were being sold in over 5,100 retail
storefronts.  In our direct-to-consumer channel, we expanded our sales
efforts to encompass multiple channels and formats.  For the year
ended March 31, 2007, direct-to-consumer sales represented primarily sales to
new customers and were generated primarily through our television advertisements
and our own websites.  During the year ended March 31, 2008, we
expanded our direct-to-consumer sales efforts to encompass web search engine and
affiliate marketing, in-house catalogue mailings to both our in house mailing
list and external prospect lists and to 60 second and 120 second television
commercials. We also saw a growing percentage of our direct-to-consumer business
result from our existing customer database representing repeat sales of
additional seed kits, accessories and additional AeroGarden units.





In regard
to our direct sales, we offered our direct customers 36 day Trial Sales to
evaluate the product, with the customer paying only the shipping and handling
costs for such products before making the required installment payments after
the expiration of the 36- day trial period. 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 these Trial Sales. Also, as of March 31, 2008 and March 31,
2007, we did not record $175,781 and $135,459, respectively, of product costs
associated with the foregoing Trial Sales because the customer is required to
return the product and we are therefore able to recover these costs through
resale of the goods.





During
the fiscal year ended March 31, 2008, we began to build our international
distributor network and entered into agreements and began shipments to
distributors in the United Kingdom, Germany, Korea, Australia, Japan, Mexico and
Canada.





The
following table presents our quarterly sales by product category, in US Dollars
and as a percent of total net revenue, for the fiscal years ending March 31,
2008 and March 31, 2007.





Quarters
      ended
                                  
                                  
                                  Year
      ended30-Jun-06
                                  
                                  
                                  30-Sep-06
                                  
                                  
                                  31-Dec-06
                                  
                                  
                                  31-Mar-07
                                  
                                  
                                  31-Mar-07Product
      RevenueAeroGardens
                                  
                                  $
                                  726,891
                                  
                                  
                                  $
                                  889,979
                                  
                                  
                                  $
                                  4,438,916
                                  
                                  
                                  $
                                  5,464,416
                                  
                                  
                                  $
                                  11,520,202Seed
      kits and accessories
                                  
                                  
                                  95,047
                                  
                                  
                                  
                                  140,337
                                  
                                  
                                  
                                  418,688
                                  
                                  
                                  
                                  969,763
                                  
                                  
                                  
                                  1,623,835Total
                                  
                                  $
                                  821,938
                                  
                                  
                                  $
                                  1,030,316
                                  
                                  
                                  $
                                  4,857,604
                                  
                                  
                                  $
                                  6,434,179
                                  
                                  
                                  $
                                  13,144,037%
      of RevenueAeroGardens
                                  
                                  
                                  88.4
                                  %
                                  
                                  
                                  86.4
                                  %
                                  
                                  
                                  91.4
                                  %
                                  
                                  
                                  84.9
                                  %
                                  
                                  
                                  87.6
                                  %Seed
      kits and accessories
                                  
                                  
                                  11.6
                                  %
                                  
                                  
                                  13.6
                                  %
                                  
                                  
                                  8.6
                                  %
                                  
                                  
                                  15.1
                                  %
                                  
                                  
                                  12.4
                                  %Total
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %Quarters
      ended
                                  
                                  
                                  Year
      ended30-Jun-07
                                  
                                  
                                  30-Sep-07
                                  
                                  
                                  31-Dec-07
                                  
                                  
                                  31-Mar-08
                                  
                                  
                                  31-Mar-08Product
      RevenueAeroGardens
                                  
                                  $
                                  5,643,885
                                  
                                  
                                  $
                                  4,816,504
                                  
                                  
                                  $
                                  12,145,733
                                  
                                  
                                  $
                                  8,934,285
                                  
                                  
                                  $
                                  31,540,407Seed
      kits and accessories
                                  
                                  
                                  634,800
                                  
                                  
                                  
                                  1,467,141
                                  
                                  
                                  
                                  2,492,009
                                  
                                  
                                  
                                  2,222,319
                                  
                                  
                                  
                                  6,816,269Total
                                  
                                  $
                                  6,278,685
                                  
                                  
                                  $
                                  6,283,645
                                  
                                  
                                  $
                                  14,637,742
                                  
                                  
                                  $
                                  11,156,604
                                  
                                  
                                  $
                                  38,356,676%
      of RevenueAeroGardens
                                  
                                  
                                  89.9
                                  %
                                  
                                  
                                  76.7
                                  %
                                  
                                  
                                  83.0
                                  %
                                  
                                  
                                  80.1
                                  %
                                  
                                  
                                  82.2
                                  %Seed
      kits and accessories
                                  
                                  
                                  10.1
                                  %
                                  
                                  
                                  23.3
                                  %
                                  
                                  
                                  17.0
                                  %
                                  
                                  
                                  19.9
                                  %
                                  
                                  
                                  17.8
                                  %Total
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  100.0
                                  %





For the
fiscal year ended March 31, 2008, sales of AeroGardens increased 173.8% to
$31,540,407, from the prior fiscal year, reflecting the overall increase in
sales in our retail and direct-to-consumer channels.  Seed kit and
accessory sales also increased, by 319.8%, reflecting the overall sales
increase, as well as the impact of recurring revenues generated by the
cumulative number of AeroGardens sold to-date.  The faster rate of
growth in seed kit and accessory sales was reflected in the increase in the
percent of total revenue represented by seed kit and accessory sales, to 17.8%
during the fiscal year ended March 31, 2008 from 12.4% in the prior fiscal
year.





Cost of
revenue for the year ended March 31, 2008 was $22,975,385 as compared to
$8,404,507 for the year ended March 31, 2007, an increase of $14,570,878, or
173.4%.  As a percentage of sales, cost of revenue decreased 4
percentage points from 63.9% to 59.9%.  Included in cost of revenue
for the year ended March 31, 2007 were costs associated with expedited shipping
of approximately 15,000 of our AeroGarden units from China by air rather than by
sea in order to expedite our initial deliveries in April 2006, and to satisfy
customer demands in the November/December 2006 holiday timeframe at an
incremental airfreight cost of $27 per unit, as well as airfreight costs
associated with expediting components parts for our seed kits in the January
2007 timeframe, for a total of additional freight cost of approximately
$490,000.





Gross
profit for the year ended March 31, 2008 totaled $15,381,291 or 40.1% of
revenues, as compared to $4,739,530 for the year ended March 31, 2007,
representing 36.1% of revenues. Affecting gross margins for the year ended March
31, 2007, as discussed above, were airfreight costs of $490,000, reducing gross
margins by 4%.





28
 Table of Contents




Sales and
marketing costs for the year ended March 31, 2008 totaled $16,084,353 as
compared to $7,117,613 for the year ended March 31, 2007, an increase
$8,966,740, or 126.0%.  The breakdown of sales and marketing costs for
these two fiscal years is presented in the table below:





Years ended March 31,2008
                        
                        
                        2007Advertising
                        
                        $
                        8,291,987
                        
                        
                        $
                        2,892,710Personnel
                        
                        
                        3,541,337
                        
                        
                        
                        2,036,104Sales
      commissions
                        
                        
                        1,104,241
                        
                        
                        
                        556,531Trade
      Shows
                        
                        
                        398,337
                        
                        
                        
                        156,320Other
                        
                        
                        2,748,451
                        
                        
                        
                        1,475,948$
                        16,084,353
                        
                        
                        $
                        7,117,613





Advertising
expense increased principally because of an increase in the amount of television
airtime purchased, a $568,832 increase in the costs of producing our
infomercials, and the costs of producing and mailing our direct-to-consumer
catalogues in the fiscal year ended March 31, 2008.  Personnel costs
increased because of a higher average level of headcount in our sales,
marketing, customer service, and operations departments.  Sales
commissions, ranging from 4% to 7% of cash collected from our retailer
customers, increased primarily because of the increase in our overall level of
sales to retailer customers.  Trade shows and other sales and
marketing expense increased principally because of the increased scale of our
operations.





General
and administrative costs for the year ended March 31, 2008 totaled $6,084,728 as
compared to $4,050,312 for the year ended March 31, 2007, an increase of
$2,034,416, or 50.2%. Contributing to the increase in general and administrative
costs was an increase of $480,000 in salary and wage related costs as we added
additional executive and managerial staff to manage our growth, $226,000 in
additional facility costs due to additional space requirements, $279,000 in
additional depreciation expense related to our expansion of our IT
infrastructure as well as tooling for new models of our AeroGardens, $185,000 in
increased corporate governance and investor relations costs due in part to our
listing on NASDAQ and $653,000 in additional bad debt expenses primarily as a
result of a reserve established against approximately $500,000 in outstanding
accounts receivable at March 31, 2008 from Linens ‘n Things, Inc., which filed
for protection under Chapter 11 of the U.S. Bankruptcy code on May 2,
2008.





During
the year ended March 31, 2008 we incurred $2,605,112 in research and development
costs as compared to $2,113,255 for the year ended March 31, 2007, an increase
of $491,887 or 23.3%. Research and development costs encompass the costs
associated with our engineering staff whose function is the development of new
AeroGarden models and technologies and our plant laboratories whose principal
function is the research of new plant varieties that will grow well in our
AeroGarden products as well as technologies such as improved lighting and
nutrient formulation and delivery to enhance our products performance. The
increase in research and development costs is primarily attributable to
increased staffing for our plant labs.





Other
expense totaled $443,019 for the fiscal year ended March 31, 2008, a decrease of
$1,401,782 from the total other expense of $1,844,801 for the prior fiscal year,
which included the impact of a $1,664,380 registration rights
penalty.





Our net
loss totaled $9,835,921 for the fiscal year ended March 31, 2008, $550,530 less
than in the prior fiscal year.





Liquidity
and Capital Resources





After
adjusting the net loss for non-cash items, including depreciation, amortization,
bad debt allowances and issuances of common stock and options, the net cash loss
for the fiscal year ended March 31, 2009 totaled $7,589,946 as compared to an
$8,096,771 net cash loss in the prior year.





Changes
in working capital accounts contributed cash of $635,873 during the twelve
months ended March 31, 2009, as increases in accounts payable and accrued
liabilities more than offset increases in inventory and accounts receivable
balances.  We source the majority of our inventory from Chinese
manufacturers and therefore face production and delivery lead times that average
60 to 90 days.  In order to be prepared to meet anticipated fall and
holiday demand for our products, we contracted to purchase inventory in the
quarter ended September 30, 2008.  As consumer demand declined in
response to the global credit crisis in October and November, we reduced our
orders for product from China to the extent possible, but because of the long
procurement lead times we face, were unable to effectively manage inventory
levels to the new lower demand expectations.  As a result, inventory
on hand as of March 31, 2009 totaled $8,350,135, representing approximately 155
days of sales activity, and 208 days of sales activity, at the average daily
rate of product cost expensed during the twelve months and three months ended
March 31, 2009, respectively.  Net accounts receivable totaled
$2,278,052 as of March 31, 2009, representing approximately 37 days of net
retail sales activity, and 67 days of net retail sales activity, at the average
daily rate of sales experienced during the twelve months and three months ended
March 31, 2009, respectively.  Accounts payable totaled $8,338,559 as
of March 31, 2009, representing approximately 65 days of daily expense activity,
and 83 days of daily expense activity, at the average daily rate of expenses
experienced during the twelve months and three months ended March 31, 2009,
respectively.  On June 30, 2009, approximately $1 million in accounts
payable were converted to Series A Convertible Preferred Stock, and
approximately $1.4 million in accounts payable were converted to a two-year,
interest-bearing note.  In addition, during June 2009, we reached
agreements with certain vendors to reduce the amounts payable to them by an
aggregate amount of approximately $1 million.  We also reached
agreements with certain vendors to defer payments due to later
dates.





29
 Table of Contents




Net cash
used by operating and investing activities totaled $8,263,205 for the twelve
months ended March 31, 2009 as compared to $10,175,596 in the year earlier
period.  The cash requirement for the fiscal year ended March 31, 2009
was funded by increases in net borrowings under our debt facilities and payments
on capital lease obligations totaling $7,566,329, a reduction in our
unrestricted cash balances of $1,227,094, and proceeds from the exercise of
warrants and options to purchase our common stock totaling
$949,932.  Included in the latter amount is $873,289 in proceeds from
warrants exercised in November 2008, when the Company reset the exercise price
on 1,189,979 warrants, in accordance with the terms and conditions of the
warrants, from a range of $5.00 – $8.25 per share to a range of $0.66 – $0.75
per share in return for an agreement by the warrant holders to exercise the
warrants immediately.  In addition, the warrant holders were issued an
aggregate of 594,990 new warrants with an exercise price of $2.00 per share,
representing one-half new warrant for every existing warrant exercised at the
reset exercise price.





As of
March 31, 2009, we had a cash balance of $771,029, including $438,331 in cash
that is restricted as collateral for letters of credit and other corporate
obligations.  This compares to $1,646,468 as of March 31, 2008, of
which $86,676 was restricted as to use.





During
the fiscal year ended March 31, 2009, we relied on a variety of external debt
funding sources to meet our liquidity requirements:





First
National Loan





On May
19, 2008, the Company and Jack J. Walker, one of the Company’s directors, acting
as co-borrowers, entered into a Business Loan Agreement with First National Bank
(the “Business Loan Agreement”) for a loan to the Company in the principal
amount of $1,000,000 (the “First National Loan”).  The Company has
agreed, among other things, that while the Business Loan Agreement is in effect,
the Company will not (without First National Bank's prior written consent): (i)
incur or assume indebtedness, except for trade debt in the ordinary course of
business, capital leases in an amount not to exceed $500,000, and capital
expenditures of not more than $500,000 during any fiscal year; (ii) sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or
encumber any of the Company’s assets (except as specifically allowed), or
(iii) sell with recourse any of the Company’s accounts, except to First
National Bank. In the event of a default under the First National Loan, at First
National Bank's option, all indebtedness owed under the First National Loan will
become immediately due and payable.





Pursuant
to the Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19,
2009.  The First National Note also provides for a minimum interest
charge of $250, but otherwise may be prepaid at any time without
penalty.  In the event of a default under the First National Note, the
interest rate will be increased by a margin of 4% over the current rate of
interest.  As of March 31, 2009, $1,001,146 was outstanding under the
First National Note, including accrued interest.





On May
19, 2009, the Company, Mr. Walker, and FNB entered into a Change in Terms
Agreement (the “Change in Terms Agreement”), extending the maturity of the First
National Loan until July 19, 2009, and increasing the interest rate from the
Wall Street Journal Prime Rate plus .50% floating to the Wall Street Journal
Primate Rate plus 2.0% floating, with a floor interest rate of
5.50%.





WLLC
Loan Agreement





On May
22, 2008, the Company entered into a Loan Agreement (the “WLLC Loan Agreement”)
and associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLLC Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the
Company.  As a condition of the WLLC Loan, the Company paid WLLC a
non-refundable commitment fee of $37,500. Further, in consideration of WLLC
holding available funds equal to the principal amount not yet disbursed, the
Company must pay a non-refundable fee of 1% of the retained funds as a holding
fee, payable quarterly.  If not paid sooner, the WLLC Loan, if drawn
upon, will be due and payable on April 1, 2009.  We granted WLLC a
security interest in all of the Company’s assets, subordinate to the security
interests in such assets granted to FCC and First National Bank (each as
described herein).  Further, in the event we receive any equity
financing, all obligations due under the WLLC Loan Agreement become immediately
due and payable.  In the event of any default under the WLLC Loan
Agreement, WLLC may, at its option, declare all amounts owed immediately due and
payable, foreclose on the security interest granted, and increase the annual
rate of interest to 18%.  As of March 31, 2009, loans totaling
$1,233,371 were outstanding under the WLLC Loan Agreement, including accrued
interest.





The WLLC
Loan Agreement also set forth the terms and conditions under which Mr. Walker
agreed to act as co-borrower on the First National Loan. In consideration for
Mr. Walker's agreement to act as co-borrower, the Company agreed to: (i) pay Mr.
Walker a service fee of $50,000; (ii) allow Mr. Walker to purchase the First
National Loan in the event of the Company’s default under the First National
Loan and to repay Mr. Walker any amounts expended by Mr. Walker on the First
National Loan, together with interest at an annual rate of 18%; and (iii)
terminate and release Mr. Walker from any obligation under the First National
Loan on the one-year anniversary of the execution date of the First National
Loan Agreement.





On May
19, 2009, Mr. Walker, WLLC, and the Company entered into a Loan Extension
Agreement (the “Loan Extension Agreement”) effective April 1, 2009, extending
the maturity date of the WLLC Loan until June 30, 2009.  The Company
paid WLLC $5,000 in consideration for the loan extension.  The balance
of principal due on the WLLC Loan as of May 19, 2009 was
$1,200,000.  The parties agreed that the Company is not entitled to
any further disbursements under the WLLC Loan.  In the event the
Company receives any equity financing, all obligations due under the WLLC Loan
become immediately due and payable.





On June
30, 2009, principal totaling $1,200,000 outstanding under the WLLC Loan
Agreement was converted to 1,200 shares of Series A Convertible Preferred Stock,
and the WLLC Loan Agreement was terminated.





30
 Table of Contents




Revolving
Credit Facility





On June
23, 2008, the Company entered into a Loan and Security Agreement with FCC, LLC,
d/b/a First Capital (“FCC”) (the “FCC Loan Agreement”) for a revolving credit
facility up to a maximum amount of $12,000,000 (the “Revolving Credit
Facility”).  The actual amount available for borrowing under the
Revolving Credit Facility is limited at any given time to the sum of a
percentage of eligible inventory and a percentage of eligible accounts
receivable, each as defined in the FCC Loan Agreement.  Mr. Walker
provided a guarantee against certain contingent liabilities related to the FCC
Loan Agreement.  In return for this guarantee, the Company paid Mr.
Walker a fee of $7,500.





The
Revolving Credit Facility has an initial two-year term, with one-year renewals
thereafter.  Continued availability of the Revolving Credit Facility
is subject to the Company’s compliance with customary financial and reporting
covenants.  The purpose of the Revolving Credit Facility is to provide
additional working capital.  As collateral for the Revolving Credit
Facility, the Company granted to FCC a first priority security interest over all
of the Company’s assets, including, but not limited to, accounts receivable,
inventory, and equipment.  As of March 31, 2009, loans totaling
$5,515,685 were outstanding under the Revolving Credit Facility, including
accrued interest, and there was an estimated remaining availability of
approximately $120,000.  The amount available under the Revolving
Credit Facility varies from day-to-day, depending on the level of sales,
accounts receivable collections, and inventory on-hand levels.





As of
June 30, 2008, the Company was not in compliance with two covenants under the
FCC Loan Agreement.  As of July 31, 2008, FCC and AeroGrow executed an
amendment to the FCC Loan Agreement (the “First FCC Amendment”).  The
First FCC Amendment re-set the covenant levels for June 30, 2008 and future
periods, thus waving the non-compliance as of June 30, 2008, under the old
covenants, temporarily reduced certain restrictions on the Company’s ability to
borrow against inventory, and increased the interest rate from Base Rate plus 2%
to the current rate of Base Rate plus 3.5%.  After the First FCC
Amendment, the Company was in compliance with the revised covenants as of June
30, 2008.





As of
September 30, 2008, the Company was not in compliance with two covenants under
the revised FCC Loan Agreement.  On October 24, 2008, FCC and the
Company executed a second amendment to the FCC Loan Agreement (the “Second FCC
Amendment”).  The Second FCC Amendment waived the covenant violations
as of September 30, 2008.  In addition, the Second FCC Amendment
changed the definition of Base Rate to be the higher of the prime rate or
one-month LIBOR + 2.75%, and adjusted the interest calculation under the FCC
Loan Agreement such that the interest rate resets monthly, rather than
daily.





As of
October 27, 2008, FCC and the Company executed a temporary amendment to the FCC
Loan Agreement that temporarily reduced certain restrictions on the Company’s
ability to borrow against inventory, and increased the advance rate against
inventory.





On
January 16, 2009, the Company and FCC executed a temporary amendment to the FCC
Loan Agreement that temporarily reduced certain restrictions on the Company’s
ability to borrow against inventory, and increased the advance rate against
inventory as of January 1, 2009.





As of
December 31, 2008, the Company was not in compliance with three covenants under
the revised FCC Loan Agreement.  Effective as of January 31, 2009, FCC
and the Company executed a forbearance agreement related to the FCC Loan
Agreement (the “Forbearance Agreement”).  Pursuant to the terms of the
Forbearance Agreement, FCC agreed to forbear its rights and remedies under the
FCC Loan Agreement and related documents with respect to any existing defaults
under the FCC Loan Agreement (the “Existing Defaults”) until the earlier of June
30, 2009, or the date of occurrence of a default other than the Existing
Defaults.  The Forbearance Agreement also increases the Company’s
ability to borrow against inventory and accounts receivable during the term of
the Forbearance Agreement (the “Additional Borrowing Capacity”).  In
return for FCC providing the forbearance period and the Additional Borrowing
Capacity, the Company agreed to pay FCC a $25,000 forbearance fee (in five
monthly installments), an amendment fee equal to 1.5% per month on the average
utilization of the Additional Borrowing Capacity, and issue to FCC a minimum of
250,000 warrants to purchase common stock of the Company at a purchase price of
$1.00 per share.  Simultaneously with the execution of the Forbearance
Agreement, Mr. Walker provided a $1 million guarantee against certain
liabilities under the FCC Loan Agreement.  As compensation for
providing the guarantee, the Company issued to Mr. Walker 50,000 warrants to
purchase common stock of the Company at a purchase price of $1.00 per
share.





On June
1, 2009, the Company, FCC, and Jack J. Walker, as guarantor, executed a Second
Forbearance Agreement, effective as of April 29, 2009 (the “Second Forbearance
Agreement”), in which FCC agreed to forbear from exercising its rights and
remedies under the Loan Agreement until June 30, 2009, if no further defaults
occur.  The Second Forbearance Agreement also increased the advance
rate against inventory until July 1, 2009, and eliminated the Company’s
obligation to pay the monthly forbearance and amendment fees and to provide cash
flow projections.  In return, AeroGrow agreed to pay FCC a fee of
$60,000 no later than June 30, 2009.





In
connection with the Second Forbearance Agreement, FCC is permitting AeroGrow to
borrow up to $800,000 more than would otherwise be permitted by the applicable
borrowing base calculation under the Loan Agreement.  Such additional
borrowing must be repaid by June 30, 2009.  FCC is not charging
AeroGrow a fee for this additional borrowing capacity.





As of
July 1, 2009, FCC, AeroGrow, and Jack J. Walker, as guarantor, executed an
amendment to the FCC Loan Agreement (the “Third FCC Amendment”).  The
Third FCC Amendment reduced the maximum amount of the Revolving Credit Facility
to $8 million, re-set the covenant levels beginning July 1, 2009, and waived
existing defaults.  In addition, the Third FCC Amendment re-set the
formulas for determining the borrowing base against which the Company can
borrow.  The Third FCC Amendment also changed the definition of Base
Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%, and
increased the interest rate to Base Rate plus 4.0%.  The Third FCC
Amendment provides for a $30,000 success fee to be paid by the Company to FCC on
April 30, 2010.  In addition, the Third FCC Amendment replaces a
minimum borrowing fee with a fee calculated as 0.50% per annum of the daily
average unused portion of the Revolving Credit Facility, payable monthly in
arrears.  Finally, the Third FCC Amendment increased the annual
facility fee to 1.0% of the maximum amount of the Revolving Credit Facility,
from 0.75%.





31
 Table of Contents




Cash
Requirements





Over
the course of the fiscal year ending March 31, 2010, we will require cash
to:





·
            Fund
      our operations and working capital
requirements,


·
            Develop
      and execute our product development and market introduction
      plans,


·
            Execute
      our sales and marketing plans,


·
            Fund
      research and development efforts,
and


·
            Expand
      our international presence, particularly in Europe and
    Asia.





We expect
to fund these, and any other cash requirements, with cash provided by
operations, our Revolving Credit Facility, and other debt facilities, as well as
with existing cash.  We will also utilize funding provided by the
issuance of $6.25 million in Series A Convertible Preferred
Stock.  Our cash requirements for the fiscal year ending March 31,
2010 have been reduced by the conversion of certain accounts payable totaling $1
million into the Series A Convertible Preferred Stock, the conversion of $1.4
million of accounts payable to long-term debt, and concessions we have agreed
with certain unsecured creditors to reduce the balances owed and/or defer the
timing of required payments.  Based on a variety of assumptions
including, but not limited to, the level of customer and consumer demand, the
impact of cost reduction programs, and the state of the general economic
environment in which we operate, our business plan for the fiscal year ending
March 31, 2010 projects that these internal and external sources of funding will
be sufficient to meet our cash requirements for the next twelve
months.





We cannot
predict with certainty the cash and other ongoing operational requirements for
our proposed plans as market conditions, competitive pressures, regulatory
requirements, and customer requirements can change rapidly.  If we are
unable to generate cash from operations at currently estimated levels, or if our
access to new borrowings under our debt agreements is constrained, or if we
cannot raise additional capital if we deem it to be necessary, our ability to
execute our operational plans could be adversely impacted.  In
addition, given the high degree of uncertainty regarding the general
macroeconomic environment in which we operate and the timing of an economic
recovery, if any, it is possible that we may find it necessary to, or choose to,
raise additional funding to support our business over the next twelve
months.





At this
time, we do not expect to enter into additional capital leases to finance major
purchases.  At present, we have no binding commitments with any third
parties to obtain any material amount of equity or debt financing other than the
financing arrangements described in this report.  However, given our
operating history, and our expectation of future growth, we will continue to
monitor the global capital markets and may choose to raise additional capital if
market conditions prove to be favorable.  The terms, conditions, and
timing of any future transactions have not been conclusively
determined.





Assessment
of Future Liquidity and Results of Operations





Liquidity.  To assess
our ability to fund ongoing operating requirements over the next twelve months,
we developed assumptions regarding our business plan, projected operating cash
flow, anticipated capital expenditures, and availability under our various
existing credit facilities.  Critical sources of funding, and key
assumptions include:





·
            Our
      cash of $771,029 (including restricted cash) as of March 31,
      2009,


·
            $3.8
      million of cash raised by issuing Series A Convertible Preferred Stock,
      and $1 million of existing obligations of the Company that were converted
      to Series A Convertible Preferred Stock, both on June 30,
    2009


·
            $1.4
      million of existing obligations of the Company that were converted to a
      two-year, interest-bearing note.


·
            $1
      million in concessions we negotiated with certain of our unsecured
      creditors, as well as deferred payment schedules we agreed with a number
      of these, and other, unsecured
creditors.


·
            The
      continued availability of funding from the Revolving Credit Facility and
      our other existing credit facilities.  As of March 31, 2009,
      there was approximately $120,000 in remaining availability under the
      Revolving Credit Facility.  The amount available under the
      Revolving Credit Facility varies from day-to-day, depending on the level
      of sales, accounts receivable collections, and inventory on-hand
      levels,


·
            The
      continued support of our suppliers,


·
            Our
      anticipated sales to retail customers, international distributors, and
      consumers,


·
            The
      anticipated level of spending to support our planned initiatives,
      and


·
            Our
      expectations regarding cash flow from
  operations.





The
availability of borrowings under the Revolving Credit Facility is subject to
covenants and limitations that require us to maintain compliance with specified
operating and financial covenants.  Although our lender agreed to
forbear its rights and remedies with respect to our non-compliance with these
covenants at March 31, 2009, there can be no assurance that we will regain
compliance with these covenants over time, as and if amended, or that our lender
will waive or forbear its rights and remedies with respect to any future
violations, especially if our borrowings increase or our operating results are
not sufficient to cover our fixed financing payments.





As of
July 1, 2009, we executed an amendment to the Revolving Credit Facility that
reduced the maximum amount of the Revolving Credit Facility to $8 million,
re-set the covenant levels beginning July 1, 2009, and waived existing
defaults.  In addition, the amendment to the Revolving Credit Facility
re-set the formulas for determining the borrowing base against which the Company
can borrow (see Item 9b. Other Information and Note 11 – Subsequent Events in
the accompanying Financial Statements).





32
 Table of Contents




Results of Operations. 
There are several factors that could affect our future results of
operations.  These factors include, but are not limited to, the
following:





·
            Sell-through
      of our products by our retailer customers to consumers, and the consequent
      impact on expected re-orders from our retailer
  customers,


·
            Uncertainty
      regarding the impact of macroeconomic conditions on the retail market and
      on consumer spending,


·
            Uncertainty
      regarding the impact of macroeconomic conditions, particularly with regard
      to the capital markets, on our access to sufficient capital to support our
      current and projected scale of
operations,


·
            The
      effectiveness of our consumer-focused marketing efforts in generating both
      direct-to-consumer sales, and sales to consumers by our retailer
      customers, and


·
            Sufficient
      capacity to meet demand and a continued, uninterrupted supply of product
      from our third-party manufacturing suppliers in
  China.





Based on
the qualifications and contingencies presented above regarding liquidity, we
believe we can execute our operating plans.  However, the factors
noted above regarding results of operations could impact our expected financial
results, either positively or negatively.  As a result, we cannot be
certain that third-party financial forecasts will prove to be
accurate.




Off-Balance
Sheet Arrangements





We
have certain current commitments under capital leases and have not entered into
any contacts for financial derivative such as futures, swaps and options. We do
not believe that these arrangements are material to our current or future
financial condition, results of operations, liquidity, capital resources or
capital expenditures.





Obligations and
Commitments





As part
of our ongoing operations, we enter into arrangements that obligate us to make
future payments under contracts, such as leases and the timing and effect that
such commitments are expected to have on our liquidity and cash flow in future
periods.  The following is a summary of these obligations as of March
31, 2009.





Less
      than 1 year
                        
                        
                        1
      -3 years
                        
                        
                        More
      than 3 years
                        
                        
                        TotalCapital
      Lease Obligations
                        
                        $
                        107,239
                        
                        
                        $
                        32,803
                        
                        
                        $
                        -
                        
                        
                        $
                        140,042Operating
      Leases
                        
                        
                        613,839
                        
                        
                        
                        909,425
                        
                        
                        
                        -
                        
                        
                        
                        1,523,264Long
      term debt
                        
                        
                        1,001,146
                        
                        
                        
                        6,739,056
                        
                        
                        
                        -
                        
                        
                        
                        7,740,202Totals:
                        
                        $
                        1,722,224
                        
                        
                        $
                        7,681,284
                        
                        
                        $
                        -
                        
                        
                        $
                        9,403,508




\


See Notes
5 and 9 to our consolidated financial statements for additional information
related to our capital and operating leases.




ITEM
      7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




Interest
Rate Risk




Our
interest income is most sensitive to fluctuations in the general level of U.S.
interest rates. As such, changes in U.S. interest rates affect the interest
earned on our cash, cash equivalents, and short-term investments, the value of
those investments. Due to the short-term nature of our cash equivalents and
investments, we have concluded that a change in interest rates does not pose a
material market risk to us with respect to our interest income. The interest
payable to our lenders is determined in part based on variable interest rates
and, therefore, is affected by changes in market interest rates. Interest rates
on our capital leases are dependent on interest rates in effect at the time the
lease is drawn upon. Total liabilities outstanding at March 31, 2009 under our
credit facilities and capital leases were approximately $7.9 million. Based
on amounts borrowed as of March 31, 2009, we would have a resulting decline in
future annual earnings and cash flows of approximately $79,000 for every one
percentage point increase in our lending rates.





33
 Table of Contents




Foreign
Currency Exchange Risk





We
transact business in primarily in U.S. currency.  Although we purchase
our products in U.S. dollars, the prices charged by our China factories are
predicated upon their cost for components, labor and overhead. Therefore,
changes in the valuation of the U.S. dollar in relation to the Chinese currency
may cause our manufacturers to raise prices of our products which could reduce
our profit margins.





In future
periods over the long term, we anticipate we will be exposed to fluctuations in
foreign currency exchange rates on accounts receivable from sales in these
foreign currencies and the net monetary assets and liabilities of the related
foreign subsidiary.  To date, however, virtually all of our
transactions have been denominated in US Dollars.




ITEM
      8.
            FINANCIAL
      STATEMENTS




Our
financial statements appear in a separate section at the end of this Annual
Report. Such information is incorporated herein by reference.





ITEM
      9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





Gordon,
Hughes & Banks, LLP (“GHB”) has audited our financial statements annually
since inception through March 31, 2008.  On November 1, 2008, GHB
resigned as our independent registered public accounting firm because it had
entered into an agreement with Eide Bailly LLP (“Eide Bailly”), pursuant to
which Eide Bailly acquired the operations of GHB.  Certain of the
professional staff and shareholders of GHB joined Eide Bailly either as
employees or partners of Eide Bailly and continued to practice as members of
Eide Bailly.  Concurrent with the resignation of GHB, we engaged Eide
Bailly as our independent registered public accounting firm as of November 1,
2008, through and with the approval of our Audit Committee.





The
report of GHB on our financial statements for the fiscal years ended March 31,
2008 and 2007 did not contain an adverse opinion or a disclaimer of opinion, and
was not qualified or modified as to uncertainty, audit scope, or accounting
principles.





In
connection with the audit for the past two fiscal years and through November 1,
2008, there were no disagreements with GHB on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of GHB,
would have caused GHB to make reference to the subject matter of the
disagreements in connection with its audit reports on the Company’s financial
statements.







ITEM 9A.
            CONTROLS
      AND PROCEDURES




Disclosure
Controls and Procedures





The
Company’s management assessed the effectiveness of the Company’s internal
control over financial reporting as of March 31, 2009.  In making this
assessment, the Company’s management used the criteria set forth by the
Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission’s
Internal Control-Integrated Framework.





Based on
our assessment, management has concluded that, as of March 31, 2009, the
Company’s internal control over financial reporting was effective based on those
criteria.





Management’s
Annual Report on Internal Control Over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal controls over
financial reporting for the Company.  Internal control over financial
reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the
Securities Exchange Act of 1934 as a process designed by, or under the
supervision of, the company’s principal executive and principal financial
officers and effected by the company’s board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:




·  Pertain
to the maintenance of records that in reasonable detail accurately and fairly
reflect


the
transactions and dispositions of the assets of the company;




·  Provide
reasonable assurance that transactions are recorded as necessary to permit
preparation


of
financial statements in accordance with generally accepted accounting
principles, and that


receipts and expenditures of the company are being made only in accordance
with authorizations


of
management and directors of the company; and




·  Provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition,


use or disposition of the company’s assets that could have a material effect on
the financial statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent
limitations.  Internal control over financial reporting is a process
that involves human diligence and compliance and is subject to lapses in
judgment and breakdowns resulting from human failure.  Internal
control over financial reporting can also be circumvented by collusion or
improper management override.  Because of such limitations, there is a
risk that material misstatements may not be prevented or detected on a timely
basis by internal control over financial reporting.  However, these
inherent limitations are known features of the financial reporting
process.  Therefore, it is possible to design into the process
safeguards to reduce, though not eliminate, this risk.





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Attestation Report of the Independent
Registered Public Accounting Firm





This
Annual Report does not include an attestation report of the Company’s
independent registered public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
SEC that permit the Company to provide only management’s report in this Annual
Report.




Changes in Internal Control Over
Financial Reporting




There
have been no changes in our internal control over financial reporting during the
fourth quarter of fiscal year ended March 31, 2009 that have or are
reasonably likely to materially affect our internal control over financial
reporting identified in connection with the previously mentioned
evaluation.




ITEM 9B.
            OTHER
      INFORMATION





On April
16, 2009, the Company was notified by The Nasdaq Stock Market (“Nasdaq”) that
the Company had not paid certain fees required by Listing Rule
5210(d).  On April 30, 2009, Nasdaq notified the Company that the
Nasdaq Hearing Panel had determined to delist the
Company.  Accordingly, Nasdaq suspended trading in the Company’s
shares at the open of business on Monday, May 4, 2009.  On May 4,
2009, the Company’s shares began trading on the Pink Sheets OTC
Market.  On June 8, 2009, the Company’s shares began trading on the
OTC Bulletin Board.





On April
16, 2009, the Company was notified by The Nasdaq Stock Market (“Nasdaq”) that
the Company had not paid certain fees required by Listing Rule
5210(d).  On April 30, 2009, Nasdaq notified the Company that the
Nasdaq Hearing Panel had determined to delist the
Company.  Accordingly, Nasdaq suspended trading in the Company’s
shares at the open of business on Monday, May 4, 2009.  On May 4,
2009, the Company’s shares began trading on the Pink Sheets OTC
Market.  On June 8, 2009, the Company’s shares began trading on the
OTC Bulletin Board.





During
June 2009, the Company entered into a series of transactions to raise new
capital and to enhance liquidity.





·
            Issuance of Series A
      Convertible Preferred Stock – On June 30, 2009, the Company issued
      6,836 shares of Series A Convertible Preferred Stock (the “Series A
      Shares”) for aggregate consideration totaling $6,250,341.  2,690
      Series A Shares were issued in exchange for cash invested into the Company
      totaling $2,690,000.  2,332 Series A Shares were issued in
      exchange for the release of existing obligations of the Company totaling
      $2,332,000.  1,642 Series A Shares were issued in exchange for a
      combination of $950,000 in cash, 924,703 shares of the Company’s common
      stock, and 462,352 warrants to purchase shares of the Company’s common
      stock.  172 Series A Shares were issued in exchange for $172,000
      in short term notes receivable having maturities of 90 days or
      less.





The
Series A Shares carry certain rights, preferences and designations, including
the right to convert each Series A Share into 5,000 shares of the Company’s
common stock.  Each Series A Share has an original issue price of
$1,000.  In addition, the Series A Shares were issued with a total of
3,414 warrants (the “Warrants”) to purchase additional Series A Shares at an
exercise price of $1,250 per Series A Share.  The exercise period for
the Warrants expires five years from the date of issuance.  The
holders of the Series A Shares are entitled to receive cumulative dividends in
preference to any dividend on the Company’s common stock at the rate of 8% of
the original issue price per annum, and are entitled to participate pro rata in
any dividends paid on the Company’s common stock on as as-if-converted
basis.  In the event of a sale, liquidation, or other winding up of
the Company, the holders of the Series A Shares are entitled to receive in
preference to the holders of the Company’s common stock a per share amount equal
to the greater of (i) 1.5 times the original issue price, plus any accrued but
unpaid dividends or (ii) the amount that the holder of a Series A Share would
otherwise receive in such event on an as-converted to common stock
basis.  The holders of the Series A Shares will vote along with
holders of the Company’s common stock on an as-if-converted
basis.  Each Series A Share shall have a number of votes equal to the
number of shares of the Company’s common stock then issuable upon conversion of
such Series A Share.  In addition, the holders of the Series A Shares
are entitled to elect three members of the Company’s Board of Directors by an
affirmative vote or consent of the holders of at least a majority of the
outstanding Series A Shares, voting together as a single class.  The
Series A shares also carry certain other rights, including the right to block
certain actions of the Company unless such actions are approved by a vote of the
holders of the Series A Shares voting together as a single class, anti-dilution
provisions, and other rights and preferences commonly associated with preferred
shares.





As a
result of the issuance of the Series A Shares, holders of the Series A shares
acting individually together will have the power to direct the affairs of
AeroGrow and elect all of AeroGrow’s directors.  See “Item
12.  Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.”





The
issuance of the Series A Shares was conducted in reliance upon exemptions from
registration under the Securities Act of 1933, as amended (the “Securities
Act”), including, without limitation, those under Regulation D promulgated under
the Securities Act.  The Series A Shares were offered and sold only to
investors who are “accredited investors,” as defined in Rule 501 under the
Securities Act.





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·
            Amendment to Revolving
      Credit Facility – Effective as of July 1, 2009, FCC, AeroGrow, and
      Jack J. Walker, as guarantor, executed an amendment to the FCC Loan
      Agreement (the “Third FCC Amendment”).  The Third FCC Amendment
      reduced the maximum amount of the Revolving Credit Facility to $8 million,
      re-set the covenant levels beginning July 1, 2009, and waived existing
      defaults.  In addition, the Third FCC Amendment re-set the
      formulas for determining the borrowing base against which the Company can
      borrow.  The Third FCC Amendment also changed the definition of
      Base Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%,
      and increased the interest rate to Base Rate plus 4.0%.  The
      Third FCC Amendment provides for a $30,000 success fee to be paid by the
      Company to FCC on April 30, 2010.  In addition, the Third FCC
      Amendment replaces a minimum borrowing fee with a fee calculated as 0.50%
      per annum of the daily average unused portion of the Revolving Credit
      Facility, payable monthly in arrears.  Finally, the Third FCC
      Amendment increased the annual facility fee to 1.0% of the maximum amount
      of the Revolving Credit Facility, from
0.75%.





·
            Accounts Payable
      Conversion to Long-term Debt – On June 30, 2009, the Company
      executed a Promissory Note (the “Promissory Note”) and, along with
      MainPower Electrical Factory, Ltd. (“MainPower), executed a Letter
      Agreement (the “Letter Agreement”).  Pursuant to the terms of
      the Letter Agreement, MainPower agreed to release the Company from
      $1,388,190.79 of existing accounts payable obligations owed by the Company
      to MainPower in return for the Company executing the Promissory Note for
      the same amount.  In addition, the Letter Agreement included
      other provisions relating to the terms and conditions under which AeroGrow
      will purchase AeroGarden products from MainPower.  The
      Promissory Note has a final maturity of June 30, 2011 and carries an
      interest rate of 8% per annum, with interest accrued and added to the
      principal amount of the Promissory Note for the first
      year.  During the second year of the Promissory Note, interest
      is due and payable quarterly.    Principal payments of
      $150,000 are due and payable monthly beginning January 31, 2011, with a
      final payment of all principal and accrued but unpaid interest due on June
      30, 2011.







·
            Adjustments to the
      Amounts and Timing of Payment Against Accounts Payable Balances Due
      – During June 2009, the Company reached agreement with certain suppliers
      of goods and services (the “Suppliers”) to reduce the amounts of existing
      accounts payable obligations owed by the Company to the
      Suppliers.  In aggregate, the accounts payable obligations were
      reduced by approximately $1 million.  The impact of the
      reduction in accounts payable obligations will be reflected in the
      Company’s financial statements for the three months ended June 30,
      2009.  In addition, deferred payment schedules were agreed with
      certain of the Suppliers.





On
June 29, 2009, the Board of Directors of the Company approved an amendment
to the Company’s Bylaws to opt out of the control shares provisions of the
Nevada Revised Statutes.





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PART
III





ITEM
      10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE




Directors and
Officers




The following table shows the names and
ages of our directors and executive officers and the positions they hold with
us.  Our bylaws provide that directors are generally elected at our
annual shareholders meeting and hold office until the next annual shareholders
meeting and until their successors are elected and qualified.  Our
bylaws provide that our board of directors (the “Board”) shall consist of such
number of members as the Board may determine from time to time, but not less
than one and not more than 15.  In addition, pursuant to the bylaws,
the Board may add members as needed.  The Board currently consists of
six individuals.  Executive officers are selected by the Board and
serve until their termination or the appointment of a successor.




Name
              Age
              Position
      with AeroGrow
              Served
      as a Director SinceJack
      J.  Walker
              74
              Chairman,
      Board of Directors
              2006Linda
      Graebner
              59
              Director
              2008Peter
      A.  Michel
              66
              Director
              2008Suresh
      Kumar
              54
              Director
              2008Michael
      D.  Dingman, Jr.
              55
              Director
              2008Jervis
      B.  Perkins
              54
              Chief
      Executive Officer, President, and Director
              2008H.  MacGregor
      Clarke
              48
              Chief
      Financial Officer
              n/aJeffrey
      M. Brainard
              55
              Vice
      President, Sales
              n/a




Jack J. Walker has
been a director since the February 23, 2006 annual meeting of shareholders, and
became Chairman as of July 23, 2008.  He is the Managing Member of
Walker Enterprises LLLP, a real estate investment and development company, since
2000.  He is on the Board of Pathogen Systems, Inc and Modern Hotels
Limited.  He is an English Solicitor and began his career in 1956 in
London, England.  In 1968 he founded English & Continental
Property Company, and served as Joint Managing Director of this commercial
property development company, which operated in Europe with over 200 staff,
until its sale to the Post Office Pension Fund in 1973.  From 1973 he
controlled several English listed companies, including Charles Spreckly
Industries, Town & Commercial Properties and Associated Development
Holdings, with worldwide interests and over 3,500 employees.  Mr.
Walker served as a director of supermarket group Megafoods Stores, Inc from 1987
to 1993, and was CFO for part of that time.  Mr. Walker created the
Walker Foundation for Charitable Activities in England, and serves as a director
of various civic and charitable organizations.




Linda Graebner has been a
director since July 2, 2008. From June 1993 to January 2007, Ms. Graebner served
as President and CEO of Tilia Inc., a leading manufacturer of premier lines of
small electric kitchen appliances (FoodSaver® and
VillaWare® brands)
with annual revenues in excess of $200 million. She managed the sale of this
privately held company to Jarden Corporation in 2002. Ms. Graebner has served on
multiple boards, including Bradshaw International Inc., Wine.com, Inc., the
Association of Corporate Growth, and Pacific Community Ventures, and as Chairman
of the International Housewares Association.




Peter A. Michel has been a
director since July 2, 2008.  Since 2006, Mr. Michel has been employed
as President and CEO of iSECUREtrac Corporation, a leading provider of
electronic monitoring systems.  From 2005 to 2006, he was an operations
team member of Cerberus Capital Management, L.P., where he provided operations
turnaround/enhancement advice and services and served as fulltime interim CEO
when required for portfolio companies of this private investment
firm.  Mr. Michel was previously President and CEO of General Fiber
Communications, Inc. on an interim basis from May 23, 2005 to July 8,
2005.  The Company filed for Chapter 7 Bankruptcy on July 8,
2005. From 2003 to 2004 he served as President and CEO of NEP Broadcasting,
L.L.C. where he led the sale of the business to private equity
investors.  He has led four companies as CEO, including Brink's Home
Security, a $258 million leader in high-tech home protection services supporting
over 700,000 households in more than 100 markets and 42 states.  Mr.
Michel is currently on the board of iSECUREtrac Corporation,
ISEC.OB.




Suresh Kumar
has been a director since July 2, 2008.  Mr. Kumar has been the
President and Managing Partner of KaiZen Innovation, LLC, a management advisory
firm that specializes in installing global marketing processes and programs,
since January of 2004.  From 2006 to 2007, he was special advisor to
the Clinton Foundation working closely with the principals and
governments to establish private-public partnerships that stimulate
international economic development.  From 1999 to 2003, Mr. Kumar
served as head of Worldwide Consumer Pharmaceuticals for Johnson & Johnson,
where he was responsible for all aspects of a $580 million (revenue) consumer
medicines business in Asia, Latin America, and Europe.  From 1993 to
1999, Mr. Kumar served as the Marketing Director, Consumer Healthcare, then Vice
President, Consumer Products, Latin America & Asia, for Warner Lambert,
USA.




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Michael
D.  Dingman, Jr. has been a director since July 2,
2008.  Mr. Dingman served as Chief Investment Administration Officer
for Spencer Trask & Co, a venture capital firm based in New York City, from
April 2008 through March 2009, where he was responsible for restructurings,
recapitalizations, and the development and implementation of strategies to
enhance the value and liquidity of individual portfolio
companies.  From June 2006 to July 2007, Mr. Dingman was chief
financial officer of Local Matters, Inc., a pre-IPO software and media services
company supporting yellow pages and delivery assistance providers, where he was
responsible for the financial and capital markets strategies, budgeting, and
forecasting.  From September 2000 until April 2006, Mr. Dingman served
as the chief financial officer of Intrado Inc., a provider of 911 information
services and systems to telecommunications companies, where he was responsible
for budgeting, forecasting, investor relations, capital market and financial
strategy development and all aspects of the accounting/financial reporting
functions.  Prior to joining Intrado, from March 1999 to August 2000,
Mr. Dingman was the chief financial officer and treasurer of Internet Commerce
and Communication (formerly RMI NET, Inc.).  Mr. Dingman's prior work
experience includes five years of banking in merger and acquisitions with Lazard
Freres in New York during the late 1980s, three years as an independent
consultant specializing in debt restructuring and workouts during the early
1990s, and five years as an investment advisor specializing in corporate
retirement plans and high-net-worth accounts.




Jervis B. Perkins has
been Chief Executive Officer and a director of AeroGrow since March 2008, and
President and Chief Operating Officer since November 2007.  From
January 2003 to May 2006, Mr. Perkins served as President and Chief Operating
Officer of Johnson Outdoors, Inc., a publicly-traded global manufacturer of
outdoor recreation products with revenue of approximately $400 million per
year.  At Johnson Outdoors, Mr. Perkins was directly responsible for
all aspects of sales, marketing, product development, manufacturing, and
distribution.  From 1995 to 2003, Mr. Perkins served as Executive Vice
President and General Manager at Brunswick Corporation, a leading consumer
brands company.  Prior to Brunswick, Mr. Perkins worked at Quaker Oats
for 17 years, serving in a variety of general management and senior marketing
roles.




H. MacGregor Clarkebecame Chief Financial Officer on May 23, 2008.  From 2007 to
2008, Mr. Clarke was president and chief executive officer, and from 2006 to
2007, chief financial officer, of Ankmar, LLC, a garage door manufacturer,
distributor and installer.  From 2003 to 2006, Mr. Clarke was a senior
investment banker with FMI Corporation, a management consulting and investment
banking firm serving the building and construction industry.  At FMI
Corporation, Mr. Clarke was responsible for delivering consulting and investment
banking services to clients, and for marketing to prospective clients in the
financial services industry.  From 1997 to 2002, Mr. Clarke served as
an operating group chief financial officer, then vice president and general
manager for Johns Manville Corporation, a subsidiary of Berkshire Hathaway
Inc.  Mr. Clarke also served as vice president, corporate treasurer,
and international division chief financial officer for The Coleman Company,
Inc.  Prior to Coleman, Mr. Clarke was with PepsiCo, Inc. for over
nine years and served in a range of financial roles, including director of
corporate strategic planning, where he led strategy and planning related to the
worldwide beverage sector.




Jeffrey M. Brainardhas been Vice President,
Sales at AeroGrow since joining the company in March 2006.  From 2003
to 2006, Mr. Brainard was vice president of sales and marketing for Tensor
Lighting, a manufacturer and marketer of task and functional
lighting.  From 2000 to 2002 he was senior vice president of sales for
The Holmes Group, a manufacturer and marketer of kitchen appliances and seasonal
appliances, including products under the brand names Holmes, Pollenex, Bionaire,
Rival, and Family Care.  Previously, Mr. Brainard held various
positions in sales and marketing with Brita Water Filters, a division of the
Clorox Company, over an 11 year period.




Board
Committees and Meetings




We
have established three standing committees so that certain matters can be
addressed in more depth than may be possible in a full Board meeting: an Audit
Committee, a Governance, Compensation and Nominating Committee, and a Special
Committee.  These first two committees each operate under a written
charter.  The Special Committee is governed by a set of Board
resolutions.




Audit
Committee.  The current members of our Audit Committee are Mr.
Dingman (chairman), Mr. Kumar, and Mr. Michel.  The members were
elected to the committee, and the chairman was appointed, by the
Board.  Mr. Dingman is considered a financial expert and Messrs Kumar
and Michel are considered financially literate under the rules of the SEC for
audit committee members.  The Board has affirmatively determined that each
of these persons is an independent director as defined by applicable securities
law and NASDAQ corporate governance guidelines.  The Audit Committee’s
charter provides that the committee shall:




·
            oversee
      the accounting and financial reporting processes and audits of the
      financial statements;




·
            assist
      the Board with oversight of the integrity of our financial statements, the
      Company’s compliance with legal and regulatory requirements, its
      independent auditors’ qualifications, and independence and the performance
      of the independent auditors; and




·
            provide
      the Board with the results of its
monitoring.




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Governance, Compensation
and Nominating Committee.  The current members of the
Governance, Compensation and Nominating Committee are Mr. Michel
(chairman), Mr. Kumar, and Ms. Graebner.  The Board has affirmatively
determined that each of these persons is an independent director as defined by
applicable securities law and NASDAQ corporate governance guidelines. The
members were elected to the committee, and the chairman was appointed, by the
Board.  The Governance, Compensation and Nominating Committee’s
charter provides that the committee shall:




·
            recommend
      to the Board the corporate governance guidelines to be
      followed;




·
            review
      and recommend the nomination of  Board
  members;




·
            set
      the compensation for the chief executive officer and other officers;
      and




·
              administer
      the equity-based performance compensation plans of
    AeroGrow.




Special
Committee. The current members of the Special Committee are Mr.
Dingman (chairman), Ms. Graebner, Mr. Kumar, and Mr. Michel.  The
Board has affirmatively determined that each of these persons is an independent
director as defined by applicable securities law and NASDAQ corporate governance
guidelines.  The resolutions forming the Special Committee provide
that the committee shall:




·
            consider
      all possible strategic alternatives for the Company which may be available
      from time to time;




·
            negotiate
      the terms and conditions of any such alternatives to the best interests of
      the Company and its shareholders;
and




·
            make
      recommendations to the Board and shareholders regarding any such
      alternatives.




Meetings.  During
the fiscal year ended March 31, 2009 the Board met four times and held twelve
conference calls.  Each director attended all of the meetings held by
the Board during the period that he or she served as a director of
AeroGrow.  Ms. Graebner missed two of the conference calls while
traveling.  Also during the fiscal year ended March 31, 2009, the
Audit Committee met three times and held three conference calls; the Governance,
Compensation and Nominating Committee met three times and held four conference
calls.  There were no member absences from any of the committee
meetings or conference calls, except for one Governance, Compensation and
Nominating Committee conference call, in which Ms. Graebner was unable to
participate.




Code of
Ethics




We have
adopted a Code of Ethics that applies to each of our employees, executive
officers, and directors.  A copy is available free of charge in the
“Investor” section of our website at www.aerogrow.com.  Any
amendment to or waiver of the Code of Ethics will be disclosed promptly
following the date of such amendment or waiver in a Current Report on Form
8-K.


Section 16(a) Beneficial
Ownership Reporting Compliance




Section 16(a)
of the Exchange Act requires our executive officers and directors, and persons
who own more than 10% of our common stock (herein collectively, our
“Section 16 insiders”) to file certain forms reporting their ownership and
changes in ownership of our stock with the SEC, and to furnish us with copies of
these filings.




Based
solely on our review of the copies of such forms that we received and written
representations from our Section 16 insiders, we believe that all of our
Section 16 insiders complied with their Section 16(a) reporting obligations
for Fiscal 2009 with one exception.  Dennis A. Channer, a former
director who resigned from the Board of Directors effective July 2, 2008, sold
AeroGrow common stock on December 31, 2008 and his Form 4 was filed late on
January 6, 2009.





39
 Table of Contents




ITEM 11.
            EXECUTIVE
      COMPENSATION




COMPENSATION
DISCUSSION AND ANALYSIS




Compensation
Philosophy




The Governance,
Compensation and Nominating Committee of our Board is responsible for guiding
and overseeing the formulation and application of the compensation and benefit
programs for our executive officers.  The Committee acts pursuant to a
charter that has been approved by our Board.  None of our executive
officers are members of the Governance, Compensation and Nominating
Committee.




The
Governance, Compensation and Nominating Committee believes that the most
effective compensation program is one that is designed to reward the achievement
of specific annual, long-term, and strategic goals by AeroGrow, and which aligns
executives’ interests with those of the stockholders by rewarding performance
above established goals, with the ultimate objective of increasing stockholder
value.  The Governance, Compensation and Nominating Committee
evaluates both performance and compensation to ensure that AeroGrow
maintains its ability to attract and retain superior employees in key positions
and that compensation provided to key employees remains competitive relative to
the compensation paid to similarly situated executives of our peer
companies.  Accordingly, the Governance, Compensation and Nominating
Committee believes executive compensation packages provided by AeroGrow to its
executives, including the executive officers, should include salary
compensation, annual cash incentives based on fundamental measures of financial
performance, and longer-term stock-based compensation.




Compensation
Objectives




The
Governance, Compensation and Nominating Committee has worked with AeroGrow’s
management to design compensation programs that encourage high performance,
promote accountability and assure that employee interests are aligned with the
interests of AeroGrow’s stockholders.  The primary objectives of our
executive compensation policies are to:




·
            attract,
      retain, and motivate highly qualified executives utilizing a mix of
      compensation opportunities that include fixed short-term as well as
      performance-related medium and long-term incentives tied to measurable
      results;


·
            reward
      executives based upon our financial performance at levels competitive with
      peer companies;


·
            ensure
      that the compensation amounts do not exceed what the company can
      reasonably afford by regularly measuring total compensation for all
      employees against a variety of financial metrics, including net income;
      and


·
            align
      a significant portion of the executives’ compensation with AeroGrow’s
      performance and stockholder value, by using performance-based executive
      bonuses and long-term equity
incentives.




We
compensate our executives through a mix of base salary, bonus, and equity
compensation designed to be competitive with comparable employers and to align
management’s incentives with the long-term interests of our
stockholders.




Competitive
Benchmarking




In making
compensation decisions, the Governance, Compensation and Nominating Committee,
may compare certain elements of total compensation against other comparable
publicly-traded and privately-held companies that compete in our markets
(“Compensation Peers”).  The Compensation Peers consist of companies
which the Governance, Compensation and Nominating Committee believes to be
comparable in terms of size and market composition (primarily in AeroGrow’s
market area), and in certain instances, which compete for talent and for
stockholder investment.  The Compensation Peers are not utilized by
the Governance, Compensation and Nominating Committee strictly as a formal peer
group, but are instead used as a reference source, from time to time, as to
certain specific compensation issues, such as the extent of usage of stock
options as a compensation component.




A
significant percentage of total compensation is allocated to incentive
compensation as a result of the philosophy mentioned above.  There is
no pre-established policy or target for the allocation between either cash and
non-cash or short-term and long-term incentive compensation.  Rather,
the Governance, Compensation and Nominating Committee reviews information such
as that referenced above with respect to the Compensation Peers to determine the
appropriate level and mix of incentive compensation.  Income from such
incentive compensation is realized as a result of the performance of AeroGrow or
the individual, depending on the type of award.




Compensation
Process




The
Governance, Compensation and Nominating Committee reviews the benchmarking and
performance results presented by management in determining the appropriate
aggregate and individual compensation levels for the performance
year.  In conducting its review, the Governance, Compensation and
Nominating Committee considers quantitative performance results, the overall
need of the organization to attract, retain and motivate the executive team, and
the total cost of compensation programs.




Generally,
base salaries and annual incentive awards will be reviewed at the end of each
fiscal year with changes made to the base salaries effective April 1 of the
following fiscal year. Whether an individual’s salaries and incentive awards are
increased or decreased depends on the individual’s performance as well as that
of the Company.




Stock
options and other stock grants are reviewed and approved at meetings of the
Governance, Compensation and Nominating Committee and the full
Board.  By establishing the meeting schedule and agenda for these
grants in advance, AeroGrow diminishes any opportunity for manipulation of
exercise prices on option grants to the extent any recipients are in possession
of non-public information at the time of the meetings.  Approval of
grants for any newly-hired or promoted executives during the course of the year
generally occurs at the Governance, Compensation and Nominating Committee’s
meeting immediately following the hiring or promotion.




40
 Table of Contents




Role
of Executive Officers in Compensation Decisions




The
Governance, Compensation and Nominating Committee makes all compensation
decisions for the executive officers and approves recommendations regarding
equity awards to all elected officers of AeroGrow.  The Chief
Executive Officer annually reviews the performance of each Named Executive
Officer (other than the Chief Executive Officer, whose performance is reviewed
by the Governance, Compensation and Nominating Committee).  “Named
Executive Officers” are the Company’s (i) Chief Executive Officer and (ii) other
two most highly compensated executive officers based on SEC regulations. The
conclusions reached and recommendations based on these reviews, including with
respect to salary adjustments and annual award amounts, are presented to the
Governance, Compensation and Nominating Committee.  The Governance,
Compensation and Nominating Committee can exercise its discretion in modifying
any recommended adjustments or awards to executives.




Components
of Total Compensation




For
Fiscal 2009, the principal components of compensation for executive officers
were:




·
            base
      salary;


·
            annual
      incentive compensation;


·
            stock
      options; and


·
            benefits
      and other perquisites.




Each
component is designed to achieve a specific purpose and to contribute to a total
package that is competitive, appropriately performance-based, and valued by
AeroGrow’s executives.




Base
Salaries




AeroGrow
provides executive officers and other employees with base salary to compensate
them for services rendered during the fiscal year.  Base salary ranges
for executive officers are determined for each executive based on his or her
position and responsibility.  During its review of base salaries for
executives, the Governance, Compensation and Nominating Committee primarily
considers:




·
            individual
      scope of responsibility;


·
            years
      of experience;


·
            market
      data, such as that obtained from a review of our Compensation
      Peers;


·
            internal
      review of the executive’s compensation, both individually and relative to
      other officers; and


·
            individual
      performance of the executive.




Salary
levels are typically considered annually as part of AeroGrow’s performance
review process as well as upon a promotion or other change in job
responsibility.




Performance-Based
Annual Incentive Compensation




Though markets dictate that base
salaries must be competitive, AeroGrow is moving towards basing a greater
proportion of its executive compensation on the achievement of
measurable individual and company results through the award of annual incentive
bonuses.  These bonusesareoftentied toa percentage of theCompany’s EBITDAas well as to other financial goals
and metrics.By
increasing variable pay as a percentage of total compensation, AeroGrow can
better align executive compensation with value delivered to its
shareholders.  This limits fixed costs and also results in higher pay
occurring only in years when merited by high performance.




Long
Term Stock-based Compensation





This category of awards covers options
granted to executives out of the Company’s 2005 Equity Compensation Program, and
that vest over time, at different rates for different
executives.  Because these awards vest over time and become more
valuable to the recipient only as AeroGrow’s stock price increases, the
Governance, Compensation and Nominating Committee believes these are a useful
form of long-term incentive compensation, with the potential to directly align
the interests of shareholders and management.





41
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Liquidity
Performance Award Plan





On March
23, 2009, the Board, upon recommendation by the Governance, Compensation and
Nominating Committee, adopted a Liquidity Performance Award Plan, which provides
compensation to certain executives in the event of a Company Sale if certain
conditions are met.  The covered executives qualify for a payment
under the Liquidity Performance Award Plan if (a) the value of all cash,
securities, and other consideration actually received by the holders of the
Company’s outstanding capital stock in connection with the Company Sale is
$2,000,000 or more, and (b) the covered executive is employed by the
Company at the time of the Company Sale.    All awards will
be reduced by any proceeds received by a covered executive in respect of Company
stock options held by such covered executive.  The aggregate maximum
amount payable to all participants under this plan is $500,000.  Under
the Liquidity Performance Award Plan’s formula, the following executives are
eligible for the listed awards:





Jervis
      B. Perkins
              President
      and Chief Executive Officer
              $150,000H.
      MacGregor Clarke
              Chief
      Financial Officer and Treasurer
              $100,000Jeffrey
      M. Brainard
              Vice
      President of Sales
              $ 
      50,000All
      other participants (in aggregate)
              
              $200,000




COMPENSATION OF DIRECTORS AND
EXECUTIVE OFFICERS




Executive
Compensation




Executives and Employment
Arrangements




The
following discussion and table relate to compensation arrangements on behalf of,
and compensation paid by us to our Named Executive Officers who were employed by
the Company as of March 31, 2009, for Fiscal 2009.




Employment
Contracts




We have
entered into employment agreements with Jervis B. Perkins, H. MacGregor Clarke,
and Jeffrey M. Brainard.




Jervis
B. Perkins




The
employment agreement for Mr. Perkins, dated as of March 1, 2008 (the “Perkins
Agreement”), provides that he will be employed as the Chief Executive Officer of
the Company.  He must devote his entire business
time to the affairs of the Company.  The initial term is one year and
renewable for successive one year terms. Mr. Perkinsis entitled
toreceive
base compensation of $300,000 per year, and an annualbonus of not less than
2.0% of EBITDA.  As of
December 8, 2008,Mr. Perkins agreed to temporarily defer 20% of his
salary.  Mr. Perkins may be eligible to receive an additional annual
cash bonus based upon an increase in the stock price of the Company over the
previous year (as calculated under the Agreement).  Under this
provision, an increase of less than 33% will yield no bonus, an increase of 33%
to 49% will yield a bonus of $50,000, an increase of 50% to 99% will yield a
bonus of $100,000, and an increase of 100% or greater will yield a bonus of
$200,000.   Mr. Perkins is entitled to reimbursement for car
expenses at the rate of $1,000 per month.  The agreement also provides
for medical, vacation and other benefits commensurate with the policies and
programs adopted by us for our senior executives.  If the Company
terminates the employment of Mr. Perkins without cause (as determined under the
Perkins Agreement), then Mr. Perkins will be entitled to receive his base salary
for 12 months following the date of termination, and a pro-rated portion of his
annual cash bonus.  During the first three months of the Perkins
Agreement, the Company paid Mr. Perkins’s reasonably incurred commuting expenses
from Chicago, Illinois to Boulder, Colorado, including airline travel, rental
housing or hotel charges, and rental cars or car service.  Mr. Perkins
was granted five-year options, subject to shareholder approval at the next
annual meeting, to purchase 216,666 shares of the Company’s common stock on
March 1, 2008, under the Company’s 2005 Equity Compensation Plan.  The
exercise price is $4.74, the price of the Company’s common stock at market close
on the day of the grant.  On March 1, 2008, 43,334 of the options
vested.  One quarter of the remaining options will vest every six
months thereafter, starting on September 1, 2008, and ending on March 1,
2010.  Under his previous employment agreement, dated November 12,
2007, Mr. Perkins was granted five-year options to purchase 33,334 shares of the
Company’s common stock on February 1, 2008, under the Company’s 2005 Equity
Compensation Plan.  The options have a $5.85 exercise price, which was
the price of the Company’s common stock at market close on the day of grant, and
were fully vested on the day of grant.  On March 4, 2009, Mr. Perkins
was granted five-year options to purchase 300,000 shares of AeroGrow’s common
stock under the Company’s 2005 Equity Compensation Plan.  The options
have an exercise price of $0.18 per share which was the price at market close on
the date of grant.  The options vest quarterly over a two-year
period.  For Fiscal 2009, the Company paid Mr. Perkins $294,692 in
cash compensation and expensed $112,798 in equity compensation.




42
 Table of Contents




H.
MacGregor Clarke




The
employment agreement for Mr. Clarke, dated as of May 23, 2008 (the “Clarke
Agreement”), provides that he will be employed as the Chief Financial Officer of
the Company.  He must devote all of his business time to the affairs
of the Company.  The initial term is one year ending May 23, 2009, and
renewable for successive one year terms.  Mr. Clarke is entitled to
receive base compensation of $200,000 per year and an annual bonus of not less
than 1.5% EBITDA of the Company, as determined by our annual financial
statements and prorated for any portion of such annual period covered under the
Clarke Agreement.  As of December 8, 2008,
Mr. Clarke agreed to temporarily defer 20% of
his salary.Mr. Clarke is entitled to reimbursement for car
expenses at the rate of $750 per month.  The Clarke Agreement also
provides for medical, vacation, and other benefits commensurate with the
policies and programs as adopted by us for our senior executives.  If
the Company terminates the employment of Mr. Clarke without cause (as determined
under the Clarke Agreement), then Mr. Clarke will be entitled to receive his
base salary for 12 months following the date of termination, and a prorated
portion of his annual cash bonus.  Further, pursuant to the Clarke
Agreement, Mr. Clarke was granted five year options to purchase our common stock
under the 2005 Equity Compensation Plan on three different dates.  The
first grant was for 30,000 fully vested options to purchase the common stock of
the Company on June 1, 2008 at an exercise price of $2.60 per
share.  On July 1, 2008, Mr. Clarke was granted 60,000 options to
purchase our common stock at an exercise price of $2.07 per
share.  The vesting schedule for these options is 50% as of December
1, 2008 and 50% as of June 1, 2009.  The final grant of options per
the Clarke Agreement was on October 1, 2008.  The grant was for 60,000
options to purchase common stock of the Company at an exercise price of $2.86
per share with a vesting schedule of 50% on December 1, 2009 and 50% on June 1,
2010.  The exercise prices of these options are equal to the price of
the Company’s common stock at market close on the dates of grant.  On
March 4, 2009, Mr. Clarke was granted five-year options to purchase 200,000
shares of AeroGrow’s common stock under the Company’s 2005 Equity Compensation
Plan.  The options have an exercise price of $0.18 per share which was
the price at market close on the date of grant.  The options vest
quarterly over a two-year period. For Fiscal 2009, the Company paid Mr. Clarke
$162,490 in cash compensation and expensed $134,257 in equity
compensation.




JeffreyM.Brainard




The
employment agreement for Mr. Brainard, dated as of March 31, 2006 (the
“Brainard Agreement”), provides that he will be employed as the Vice President,
Sales of the Company. He must devote his entire business time to the affairs of
the Company, working from his home office in Lexington, Massachusetts. The
initial term was two years and renewable for successive one year terms. Mr.
Brainard is entitled to receive base compensation of $150,000 per year and an
annual bonus in an amount not less than the greater of: (i) $50,000;
(ii) 0.5 per cent of retail net sales, net of all customer deductions
including but not limited to returns, allowances, bad debts and other
deductions; or (iii) 1.5% of the EBITDA of the Company as determined by our
annual financial statements and pro-rated for any portion of such annual period
covered under this agreement.  The
bonus amount due for Fiscal 2007 was paid in installments in accordance with the
terms of the Brainard Agreement.  The Brainard Agreement also provides
for medical, vacation, and other benefits commensurate with the policies and
programs adopted by us for our senior executives. Further, pursuant to the
Brainard Agreement, Mr. Brainard was granted 125,000 options to purchase
our common stock under our 2005 Plan at an exercise price of $5.00. The options
will: (i) vest pursuant to a schedule that provides for vesting of at least
of 33% of the amount of the grant at the date granted and 33% per each 12-month
period from the date of grant; (ii) not expire in less than five years from
the date of grant; and (iii) be subject to other standard terms and
conditions under the 2005 Plan. Under the Brainard Agreement, Mr. Brainard was
also entitled to grants of shares of our common stock equal in value to $25,000
semi-annually until such time as his salary reached a rate of $200,000 annually.
The first 5,000 shares (valued at a price of $5.00 per share) were granted
immediately upon Mr. Brainard’s joining AeroGrow, and 5,000 additional shares
were granted six months thereafter. Effective March 31, 2007, Mr. Brainard’s
salary was increased to $200,000 annually. Effective April 1, 2008, Mr.
Brainard’s salary was increased to $206,000 annually.  However, as of
December 8, 2008, Mr. Brainard agreed to temporarily defer 20% of his
salary.  Mr. Brainard has agreed to regular confidentiality and
inventions assignment provisions and agreed not to compete with AeroGrow for a
period equal to the term employed after the termination of employment. If
Mr. Brainard is terminated without cause by us or Mr. Brainard
terminates under certain circumstances constituting a breach of the agreement by
us, Mr. Brainard shall be entitled to receive severance compensation
equivalent to six months base salary and a pro rata bonus. In addition, if Mr.
Brainard is terminated in the event of a change in control of AeroGrow,
including a change in chief executive officer, Mr. Brainard shall be
entitled to receive severance equal to his base salary for one year. On
March 4, 2009, Mr. Brainard was granted five-year options to purchase 100,000
shares of AeroGrow’s common stock under the Company’s 2005 Equity Compensation
Plan.  The options have an exercise price of $0.18 per share which was
the price at market close on the date of grant.  The options vest
quarterly over a two-year period.  Mr. Brainard received $321,977 in
cash compensation and expensed $333 in equity compensation from the Company
during Fiscal 2009.




Other
Company officers who do not qualify as Named Executive Officers are employed on
an “at will” basis subject to varying lengths of employment agreements and
severance agreements.




43
 Table of Contents




Summary
Compensation Table




The
following table sets forth information regarding all forms of compensation
received by the Named Executive Officers during Fiscal 2009. Fiscal 2008 and the
fiscal year ended March 31, 2007 (“Fiscal 2007”):




Name
      and Principal Position
                                    
                                    Fiscal
                                      Year
                                    
                                    Salary
      Paid
                                    
                                    Bonus
                                    
                                    
                                    Stock
      Awards
                                    
                                    Option
      Awards
                                    (1 )
                                    
                                    All
      Other Compensation
                                    
                                    
                                    TotalJervis
      B. Perkins, CEO,
                                      President
      and Director (2)
                                    
                                    2009
                                    
                                    $
                                    282,692
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    75,531
                                    (3)
                                    
                                    $
                                    12,000
                                    (4)
                                    
                                    
                                    $
                                    370,2232008
                                    
                                    $
                                    94,447
                                    
                                    $
                                    217
                                    (5)
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    87,002
                                    (6)
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    181,6662007
                                    
                                    $
                                    --
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --H.
      MacGregor Clarke, CFO
                                    
                                    2009
                                    
                                    $
                                    154,615
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    134,257
                                    (7)
                                    
                                    $
                                    7,875
                                    (8)
                                    
                                    
                                    $
                                    296,7472008
                                    
                                    $
                                    --
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --2007
                                    
                                    $
                                    --
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    --Jeffrey
      M.  Brainard,
                                      Vice
      President of Sales
                                    
                                    2009
                                    
                                    $
                                    193,977
                                    
                                    $
                                    128,000
                                    (9)
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    333
                                    (10)
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    322,3102008
                                    
                                    $
                                    200,000
                                    
                                    $
                                    27,189
                                    (11)
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    227,1892007
                                    
                                    $
                                    150,000
                                    
                                    $
                                    63,462
                                    
                                    
                                    
                                    $
                                    25,000
                                    (11)
                                    
                                    $
                                    9,604
                                    (12)
                                    
                                    $
                                    --
                                    
                                    
                                    
                                    $
                                    248,066


(1)
            The
      compensation value of the stock option awards is determined by the vesting
      schedule of the options.  The Option Awards reflect the
      compensation value of the options that have vested as of March 31,
      2009.  The compensation value for options that vest after this
      date will be recognized in future
periods.





(2)
            Mr.
      Perkins did not receive compensation for his service on the Board of
      Directors.





(3)
            On
      March 4, 2009, Mr. Perkins was granted 300,000 five year options to
      purchase our common stock at an exercise price of $0.18 per share, which
      vest quarterly over a 2 year
period.




(4)
            Per
      the Perkins Agreement, Mr. Perkins received $1,000 per month for car
      expenses.(5)
            All
      employees were given a holiday bonus on 12/21/07 of $200, net of
      taxes.




(6)
            Pursuant
      to Mr.  Perkins’ employment agreement dated November 12, 2007,
      he was granted 33,334 five year options to purchase our common stock at an
      exercise price of $5.85 per share, which vested upon date of
      grant.  In accordance with Mr.  Perkins’ employment
      agreement entered into as of March 1, 2008, the company granted him
      216,666 five year options to purchase our common stock at an exercise
      price of $4.74 per share.  43,334 of these options vested on the
      grant date and the rest will vest at a rate of 25% per six months over a
      two year period.  The 216,666 options were issued subject to
      shareholder approval at the company’s next annual meeting, with their
      compensation value to be determined at the time of their approval by our
      shareholders, in accordance with Financial Accounting Standards Board
      Statement No. 123 (revised 2004), Share-Based
      Payment.  The options were approved at the October 1,
      2008 Annual Meeting of
Shareholders.




(7)
            On
      March 4, 2009, Mr. Clarke was granted 200,000 five year options to
      purchase our common stock at an exercise price of $0.18 per share, which
      vest quarterly over a 2 year period.  Per the Clarke Agreement,
      Mr. Clarke was granted 30,000 fully vested options to purchase the common
      stock of the Company on June 1, 2008 at an exercise price of $2.60 per
      share.  On July 1, 2008, Mr. Clarke was granted 60,000 options
      to purchase our common stock at an exercise price of $2.07 per
      share.  The vesting schedule for these options is 50% as of
      December 1, 2008 and 50% as of June 1, 2009.  The final grant of
      options per the Clarke Agreement was on October 1, 2008.  The
      grant was for 60,000 options to purchase common stock of the Company at an
      exercise price of $2.86 per share with a vesting schedule of 50% on
      December 1, 2009 and 50% on June 1,
2010.





(8)
            In
      accordance with Mr. Clarke’s employment agreement, he was paid $750 per
      month for auto expenses.(9)
            Mr.
      Brainard was paid the balance of the sales incentive bonus earned in
      Fiscal 2008.(10)
            On
      March 4, 2009, Mr. Brainard was granted 100,000 five year options to
      purchase our common stock at an exercise price of $0.18 per share, which
      vest quarterly over a 2 year period.(11)
            Mr.  Brainard
      was paid a $1,986 bonus and a bonus installment payment of $25,000, in
      addition to the holiday bonus awarded to all
  employees.





(12)
            In
      accordance with Mr. Brainard’s employment agreement, we issued 5,000
      shares of our common stock on January 3, 2007 valued by us at $5.00 per
      share. In addition, in December 2006, Mr. Brainard was granted five year
      options to purchase our common stock at an exercise price of $5.00 per
      share, which will vest monthly pro-rata over a two year
      period.





44
 Table of Contents




The
following table provides information with respect to the Named Executive
Officers concerning unexercised stock options held by them at May 31,
2009.  All options granted to date to the Named Executive Officers are
unexercised.


Outstanding Equity Awards at Fiscal
Year End




Name
                                                      Number
      of Securities Underlying
                                                        Unexercised
      Options
                                                        (Exercisable)
                                                      
                                                      Number
      of Securities Underlying
                                                        Unexercised
      Options
                                                        (Unexercisable)
                                                      
                                                      Exercise
                                                        Price
      per Share
                                                      
                                                      Expiration
      DateJervis
      B. Perkins
                                                      
                                                      33,334
                                                      
                                                      --
                                                      
                                                      $
                                                      5.85
                                                      
                                                      28-Feb-2013Jervis
      B. Perkins
                                                      
                                                      130,000
                                                      
                                                      86,666
                                                      (1)
                                                      $
                                                      4.74
                                                      
                                                      1-Mar-2013Jervis
      B. Perkins
                                                      
                                                      --
                                                      
                                                      300,000
                                                      (2)
                                                      $
                                                      0.18
                                                      
                                                      4-Mar-2014H.
      MacGregor Clarke
                                                      
                                                      30,000
                                                      
                                                      --
                                                      
                                                      $
                                                      2.60
                                                      
                                                      1-Jun-2013H.
      MacGregor Clarke
                                                      
                                                      30,000
                                                      
                                                      30,000
                                                      (3)
                                                      $
                                                      2.07
                                                      
                                                      1-Jul-2013H.
      MacGregor Clarke
                                                      
                                                      --
                                                      
                                                      60,000
                                                      (4)
                                                      $
                                                      2.86
                                                      
                                                      1-Oct-2013H.
      MacGregor Clarke
                                                      
                                                      --
                                                      
                                                      200,000
                                                      (2)
                                                      $
                                                      0.18
                                                      
                                                      4-Mar-2014Jeffrey
      M. Brainard
                                                      
                                                      125,000
                                                      
                                                      --
                                                      
                                                      $
                                                      5.00
                                                      
                                                      27-Mar-2011Jeffrey
      M. Brainard
                                                      
                                                      2,331
                                                      
                                                      --
                                                      
                                                      $
                                                      5.00
                                                      
                                                      14-Dec-2011Jeffrey
      M. Brainard
                                                      
                                                      --
                                                      
                                                      100,000
                                                      (2)
                                                      $
                                                      0.18
                                                      
                                                      4-Mar-2014






45
 Table of Contents




(1)
            Mr.
      Perkin’s unexercisable options will vest as follows:  43,333
      options will vest on September 1, 2009 and 43,333 options will vest on
      March 1, 2010.




(2)
            The
      options granted on March 4, 2009 at an exercise price of $0.18 per share
      will vest quarterly over a 2 year period.(3)
            Mr.
      Clarke’s unexercisable options will vest as follows:  30,000
      will vest on June 1, 2009.(4)
            Mr.
      Clarke’s unexercisable options will vest as follows:  30,000
      will vest on December 1, 2009, and 30,000 will vest on June 1,
      2010.




Director
Compensation




Current and Historical Compensation
Program




Commencing
March 2009, non-employee director compensation is $5,000 per year for general
service, plus $1,000 for each Board meeting attended in person and $500 per
telephonic meeting of the Board (or any Board committee of which such
non-employee director is a member); provided, that the aggregate of such per
meeting fees will be capped at $2,000 per calendar week (Sunday to
Saturday).  In addition, directors receive reimbursement of travel
expenses and an annual grant of 18,000 options to purchase our common stock,
exercisable in whole or in part within five years from the date of grant at an
exercise price equal to the market closing price on the day of
grant.  The compensation for the Chairman is $10,000 per year for
general service, plus $2,000 for each Board meeting attended; reimbursement of
travel expenses and an annual grant of 36,000 options to purchase our common
stock exercisable in whole or in part within five years from the date of grant
at an exercise price equal to the market closing price on the date of
grant.  Each member of the Audit Committee receives an option to
purchase 3,000 shares of common stock for membership on the committee and each
member of the Governance, Compensation and Nominating Committee receives an
option to purchase 2,000 shares of common stock for membership on that
committee.  The committee chairmen receive additional
compensation.  The Chairman of the Audit Committee receives an
additional $5,000 per year and the Chairman of the Governance, Compensation, and
Nominating Committee receives an additional 4,000 options to purchase common
stock per year.  Director options vest pro-rata monthly (one-twelfth
per month) on the last day of each month throughout the term of
service.  If a director is unable to finish his or her term of service
by reason of death or disability, the director options vest
immediately.  The Company maintains $10 million of director and
officer insurance, and has entered into an agreement indemnifying each director
against liabilities under certain circumstances.




In 2004 and
2005 each non-employee director received 2,000 shares of common stock for his
service as director. Outside directors were compensated $500 for attending
meetings and reimbursed for out-of-pocket expenses for attending meetings. On
March 28, 2006, we granted to each of our four outside directors 2,500
shares of our common stock at a value of $5.00 per share for a total of $12,500
for each director, or an aggregate total of $50,000, and 10,000 fully-vested
five-year options to purchase our common stock at an exercise price of $5.00 per
share for services for Fiscal 2007. In addition, Mr. Walker, and former
directors Wayne Harding and Kenneth C. Leung received grants of 1,250
shares for service on the Audit Committee and 750 shares for service on the
Governance, Compensation and Nominating Committee. On March 22, 2007, we
granted to three of our four outside directors, Messrs. Leung, Walker and former
director Richard Kranitz, 2,500 shares of our common stock at a market value of
$5.90 per share for a total of $14,750 for each director, or an aggregate total
of $59,000, and 10,000 fully vested five-year options to purchase our common
stock at an exercise price of $5.90 per share, the price per share equal to the
fair market value of the common stock on the date of the option grant, for
services on the Board for the calendar year ending December 31, 2007. In
addition, on March 22, 2007, Messrs. Walker and Leung received grants of 1,250
shares for service on the Audit Committee and 750 shares for service on the
Governance, Compensation and Nominating Committee. Also, Mr. Harding, the
previous Chairman of the Audit and Governance Committees, received a grant on
March 22, 2007 for services rendered of 3,500 shares of our common stock at a
market value of $5.90 per share for a total of $20,650 and 5,000 fully vested
five-year options to purchase our common stock at an exercise price of $5.90 per
share, the price per share equal to the fair market value of the common stock on
the date of the option grant.  During Fiscal 2008, Messrs Channer,
Kranitz, and Walker were paid $1,500 for meeting attendance.  Mr.
Leung was absent from one meeting and therefore was paid $1,000 during the
fiscal year for meeting attendance.  There was no equity compensation
granted to the directors during Fiscal 2008.




46
 Table of Contents




Director
Compensation Table




The
following table sets forth information regarding all forms of compensation
received by directors of the Company during Fiscal 2009:





Director
                
                Director
      Fees Earned or Paid in Cash
                
                
                Stock
      Awards
                
                
                Option
      Awards (1)
                
                
                Warrant
      Awards
                
                
                All
      Other Compensation
                
                
                TotalW.
      Michael Bissonnette, Former Chairman and Director (2)
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Jervis
      B. Perkins, Director (2)
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -Dennis
      A. Channer, Former Director
                
                $
                500
                
                
                $
                11,257
                (3)
                
                $
                -
                
                
                $
                -
                (3)
                
                $
                -
                
                
                $
                11,757Kenneth
      C. Leung, Former Director
                
                $
                500
                
                
                $
                4,658
                (4)
                
                $
                -
                
                
                $
                -
                (4)
                
                $
                -
                
                
                $
                5,158Jack
      J. Walker, Chairman and Director
                
                $
                22,500
                
                
                $
                9,315
                (5)
                
                $
                43,364
                (6)
                
                $
                -
                (7)
                
                $
                7,500
                (7)
                
                $
                82,679Michael
      D. Dingman Jr., Director
                
                $
                20,000
                
                
                $
                -
                
                
                $
                24,728
                (8)
                
                $
                -
                
                
                $
                -
                
                
                $
                44,728Linda
      Graebner, Director
                
                $
                15,000
                
                
                $
                -
                
                
                $
                23,555
                (9)
                
                $
                -
                
                
                $
                5,000
                (10)
                
                $
                43,555Suresh
      Kumar, Director
                
                $
                15,000
                
                
                $
                -
                
                
                $
                27,238
                (11)
                
                $
                -
                
                
                $
                -
                
                
                $
                42,238Peter
      A. Michel, Director
                
                $
                15,000
                
                
                $
                -
                
                
                $
                29,396
                (12)
                
                $
                -
                
                
                $
                -
                
                
                $
                44,396




(1)
            The
      compensation value of the stock option awards is determined by the vesting
      schedule of the options.  The Option Awards reflect the
      compensation value of the options that have vested as of March 31,
      2009.  The compensation value for options that vest after this
      date will be recognized in future
periods.





(2)
            Mr.
      Bissonnette and Mr. Perkins did not receive compensation for their service
      on the Board of Directors.




(3)
            On
      July 1, 2008, Mr. Channer was granted 5,438 shares of our common stock for
      his service on the Board for the previous year.  He was also
      granted five year warrants to purchase 8,000 shares of common stock at an
      exercise price of $2.07 per share.  The warrants do not have a
      compensation value because they were priced at market value and did not
      create an expense for the Company.  During his tenure as a
      Director, Mr. Channer did not receive awards other than those described
      above.





(4)
            On
      July 1, 2008, Mr. Leung was granted 2,250 shares of our common stock for
      his service on the Board for the previous year.  He was also
      granted five year warrants to purchase 4,000 shares of common stock at an
      exercise price of $2.07 per share.  The warrants do not have a
      compensation value because they were priced at market value and did not
      create an expense for the Company.  For service on the Board
      since 2006, Mr. Leung was granted the following awards in
      aggregate:  11,250 shares of common stock with a compensation
      value of $53,708, 20,000 options to purchase common stock with a
      compensation value of $64,000, and 4,000 warrants to purchase common stock
      with no compensation value.  These awards remain outstanding as
      of March 31, 2009.





(5)
            On
      July 1, 2008, Mr. Walker was granted 4,500 shares of our common stock for
      his service on the Board for the previous
year.





(6)
            On
      July 2, 2008, Mr. Walker was granted 23,000 options of our common stock at
      an exercise price of $2.03 per share.  When he assumed
      Chairmanship of the Board on July 23, 2008, Mr. Walker was granted an
      additional 13,000 options to purchase our common stock at an exercise
      price of $1.80 per share.  All options vest monthly over a 12
      month period.  For service on the Board since 2006, Mr. Walker
      was granted the following awards in aggregate:  13,500 shares of
      common stock with a compensation value of $58,365 and 56,000 options to
      purchase common stock with a compensation value of
      $107,364.  These awards remain outstanding as of March 31,
      2009.





(7)
            Mr.
      Walker’s warrant awards resulted from his guarantee of loan made to
      AeroGrow and were not compensation for service on the Board of
      Directors.  The 50,000 warrants do not have a compensation value
      because they were priced at market value and did not create an expense for
      the Company.  All Other Compensation includes $7,500 paid to Mr.
      Walker relating to his loan to the
Company.





(8)
            On
      July 2, 2008, Mr. Dingman was granted 21,000 options to purchase our
      common stock at an exercise price of $2.03 per share.  The
      options vest monthly over a 12 month period and remain outstanding as of
      March 31, 2009.





(9)
            On
      July 2, 2008, Ms. Graebner was granted 20,000 options to purchase our
      common stock at an exercise price of $2.03 per share.  The
      options vest monthly over a 12 month period and remain outstanding as of
      March 31, 2009.





(10)
            Ms.
      Graebner was paid $5,000 in consulting fees prior to becoming a
      director.





(11)
            On
      July 2, 2008, Mr. Kumar was granted 21,000 options to purchase our common
      stock at an exercise price of $2.03 per share.  Upon joining the
      Governance, Compensation and Nominating Committee on July 23, 2008, Mr.
      Kumar was granted 2,000 options to purchase our common stock at an
      exercise price of $1.80 per share.  All of the options vest
      monthly over a 12 month period and remain outstanding as of March 31,
      2009.





(12)
            On
      July 2, 2008, Mr. Michel was granted 20,000 options to purchase our common
      stock at an exercise price of $2.03 per share.  Upon joining the
      Audit Committee on July 23, 2008, Mr. Michel was granted 3,000 options to
      purchase our common stock at an exercise price of $1.80 per
      share.  The options vest monthly over a 12 month
      period.  On October 1, 2008, for service as Chairman of the
      Governance, Compensation and Nominating Committee, Mr. Michel was granted
      4,000 options to purchase our common stock at an exercise price of $1.75
      per share.  These options vest monthly over a 9 month
      period.  All of Mr. Michel’s options remain outstanding as of
      March 31, 2009.





47
 Table of Contents





ITEM
      12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





The
following table sets forth certain information as of June 30, 2009 regarding our
common stock owned of record or known by the Company to be owned beneficially by
(i) each director, (ii) each executive officer named in the Summary
Compensation Table (the “Named Executive
Officers”), (iii) all those known by the Company to beneficially own
more than 5% of the Company’s common stock, and (iv) all directors and
Named Executive Officers as a group.





In general, a person is deemed to be a
“beneficial owner” of a security if that person has or shares the power to vote
or direct the voting of such security, or the power to dispose or to direct the
disposition of such security.  A person is also deemed to be a
beneficial owner of any securities of which the person has the right to acquire
beneficial ownership within 60 days.  To the best of our knowledge,
subject to community and marital property laws, all persons named have sole
voting and investment power with respect to such shares except as otherwise
noted.  The table assumes a total of 12,425,249 shares of common stock
outstanding and 6,836 shares of Series A preferred stock
outstanding.  Unless otherwise indicated the address of each
beneficial owner shown is c/o AeroGrow International, Inc., 6075 Longbow Drive,
Suite 200, Boulder, Colorado 80301.





Name
      of Beneficial Owner
                                      
                                      Number
      of Common Shares Beneficially Owned (1)
                                      
                                      
                                      Number
      of Common Shares Acquirable Within 60 Days (2)
                                      
                                      
                                      Percent
      of Class
                                      
                                      
                                      Number
      of Series A Preferred Shares Beneficially Owned (1)
                                      
                                      
                                      Number
      of Series A Preferred Shares Acquirable Within 60 Days (2)
                                      
                                      
                                      Percent
      of Class
                                      
                                      
                                      Percent
      Total Voting Power (3)5%
      Beneficial OwnersJack
      J. Walker (4)
                                      
                                      
                                      27,731,408
                                      
                                      
                                      
                                      27,536,000
                                      
                                      
                                      
                                      69.40
                                      %
                                      
                                      
                                      5,474
                                      
                                      
                                      
                                      1,824
                                      
                                      
                                      
                                      63.21
                                      %
                                      
                                      
                                      39.58
                                      %Lazarus
      Investment Partners LLLP (5)
                                      
                                      
                                      9,199,673
                                      
                                      
                                      
                                      8,600,000
                                      
                                      
                                      
                                      43.76
                                      %
                                      
                                      
                                      1,720
                                      
                                      
                                      
                                      573
                                      
                                      
                                      
                                      23.22
                                      %
                                      
                                      
                                      13.59
                                      %Mingkeda
      Industries Co., Ltd. (6) (7)
                                      
                                      
                                      4,135,000
                                      
                                      
                                      
                                      4,125,000
                                      
                                      
                                      
                                      24.98
                                      %
                                      
                                      
                                      825
                                      
                                      
                                      
                                      275
                                      
                                      
                                      
                                      11.60
                                      %
                                      
                                      
                                      5.92
                                      %Kayue
      Electric Company Ltd. (6) (8)
                                      
                                      
                                      2,825,000
                                      
                                      
                                      
                                      2,825,000
                                      
                                      
                                      
                                      18.52
                                      %
                                      
                                      
                                      217
                                      
                                      
                                      
                                      188
                                      
                                      
                                      
                                      3.09
                                      %
                                      
                                      
                                      4.04
                                      %H.
      Leigh Severance (6) (9)
                                      
                                      
                                      1,744,378
                                      
                                      
                                      
                                      1,628,335
                                      
                                      
                                      
                                      12.41
                                      %
                                      
                                      
                                      325
                                      
                                      
                                      
                                      108
                                      
                                      
                                      
                                      4.68
                                      %
                                      
                                      
                                      2.58
                                      %Jervis
      B. Perkins
                                      
                                      
                                      1,721,334
                                      
                                      
                                      
                                      1,715,834
                                      
                                      
                                      
                                      12.17
                                      %
                                      
                                      
                                      303
                                      
                                      
                                      
                                      101
                                      
                                      
                                      
                                      4.37
                                      %
                                      
                                      
                                      2.18
                                      %J.
      Michael Wolfe
                                      
                                      
                                      1,496,875
                                      
                                      
                                      
                                      1,496,875
                                      
                                      
                                      
                                      10.75
                                      %
                                      
                                      
                                      270
                                      
                                      
                                      
                                      90
                                      
                                      
                                      
                                      3.90
                                      %
                                      
                                      
                                      1.93
                                      %Jerome
      P. Lauffenburger (6) (10)
                                      
                                      
                                      1,161,334
                                      
                                      
                                      
                                      1,021,000
                                      
                                      
                                      
                                      8.64
                                      %
                                      
                                      
                                      133
                                      
                                      
                                      
                                      66
                                      
                                      
                                      
                                      1.93
                                      %
                                      
                                      
                                      1.73
                                      %Michael
      F. Barish (6) (11)
                                      
                                      
                                      1,138,750
                                      
                                      
                                      
                                      1,085,000
                                      
                                      
                                      
                                      8.43
                                      %
                                      
                                      
                                      145
                                      
                                      
                                      
                                      72
                                      
                                      
                                      
                                      2.10
                                      %
                                      
                                      
                                      1.67
                                      %Wildernest
      Logistics Solutions Inc. (6) (12)
                                      
                                      
                                      870,000
                                      
                                      
                                      
                                      870,000
                                      
                                      
                                      
                                      6.54
                                      %
                                      
                                      
                                      174
                                      
                                      
                                      
                                      58
                                      
                                      
                                      
                                      2.52
                                      %
                                      
                                      
                                      1.24
                                      %Enable
      Capital Management LLC and affiliated holders (13)
                                      
                                      
                                      840,000
                                      
                                      
                                      
                                      840,000
                                      
                                      
                                      
                                      6.33
                                      %
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      *H.
      MacGregor Clarke
                                      
                                      
                                      680,000
                                      
                                      
                                      
                                      675,000
                                      
                                      
                                      
                                      5.19
                                      %
                                      
                                      
                                      112
                                      
                                      
                                      
                                      37
                                      
                                      
                                      
                                      1.63
                                      %
                                      
                                      
                                      *DirectorsJack
      J. Walker (4)
                                      
                                      
                                      27,731,408
                                      
                                      
                                      
                                      27,536,000
                                      
                                      
                                      
                                      69.40
                                      %
                                      
                                      
                                      5,474
                                      
                                      
                                      
                                      1,824
                                      
                                      
                                      
                                      63.21
                                      %
                                      
                                      
                                      39.58
                                      %Jervis
      B. Perkins
                                      
                                      
                                      1,721,334
                                      
                                      
                                      
                                      1,715,834
                                      
                                      
                                      
                                      12.17
                                      %
                                      
                                      
                                      303
                                      
                                      
                                      
                                      101
                                      
                                      
                                      
                                      4.37
                                      %
                                      
                                      
                                      2.18
                                      %Peter
      A  Michel
                                      
                                      
                                      27,000
                                      
                                      
                                      
                                      27,000
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      *Suresh
      Kumar
                                      
                                      
                                      23,000
                                      
                                      
                                      
                                      23,000
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      *Michael
      D. Dingman, Jr.
                                      
                                      
                                      21,000
                                      
                                      
                                      
                                      21,000
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      *Linda
      Graebner
                                      
                                      
                                      20,000
                                      
                                      
                                      
                                      20,000
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      *Named
      Executive OfficersH.
      MacGregor Clarke
                                      
                                      
                                      680,000
                                      
                                      
                                      
                                      675,000
                                      
                                      
                                      
                                      5.19
                                      %
                                      
                                      
                                      112
                                      
                                      
                                      
                                      37
                                      
                                      
                                      
                                      1.63
                                      %
                                      
                                      
                                      *Jeffrey
      M. Brainard
                                      
                                      
                                      185,831
                                      
                                      
                                      
                                      169,831
                                      
                                      
                                      
                                      1.48
                                      %
                                      
                                      
                                      6
                                      
                                      
                                      
                                      2
                                      
                                      
                                      
                                      *
                                      
                                      
                                      
                                      *All
      AeroGrow Named Executive Officers and Directors as a Group (8
      Persons)
                                      
                                      
                                      30,409,573
                                      
                                      
                                      
                                      30,187,665
                                      
                                      
                                      
                                      71.36
                                      %
                                      
                                      
                                      5,895
                                      
                                      
                                      
                                      1,964
                                      
                                      
                                      
                                      66.99
                                      %
                                      
                                      
                                      42.65
                                      %





* Less
than 1 percent.




48
 Table of Contents




(1) Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission, which include holding voting and investment power with
respect to the securities.  Shares of common stock subject to
preferred stock, options or warrants currently exercisable, or exercisable
within 60 days, are deemed outstanding for computing the percentage of the total
number of shares beneficially owned by the designated person, but are not deemed
outstanding for computing the percentage for any other person.


(2) The
number of shares acquirable within 60 days includes any preferred stock, options
or warrants currently exercisable or exercisable within the next 60
days.  This number is included in the number of shares beneficially
owned.




(3) The
percent total voting power is based on the number of preferred shares and common
shares presently held that could be voted.  It does not include any
exercisable options or warrants.


(4) Mr.
Walker’s beneficial ownership includes 325 shares of preferred stock and
warrants to purchase 162 shares of preferred stock that are held of record by
M&J Walker Charitable Remainder Trust, of which Mr. Walker is a controlling
person.   Mr. Walker’s beneficial ownership also includes 100
shares of preferred stock, warrants to purchase 50 shares of preferred stock,
and 76,122 shares of common stock held of record by March Trade & Finance,
Inc. of which Mr. Walker is a controlling person.




(5) Based on
information provided in Schedule 13G as filed January 12, 2009, and holdings
known to the Company through Lazarus Investment Partners LLLP’s participation in
the Series A Preferred Stock issue that closed on June 30,
2009.  Lazarus Investment Partners LLLP holds 599,673 shares of
common stock, 1,147 shares of Series A Preferred Stock, and 573 warrants to
purchase shares of Series A Preferred Stock.  Lazarus Investment
Partners LLLP’s address is 2401 East 2nd Avenue, #600, Denver, CO
80206.




(6) Beneficial
ownership is based on holdings known to the Company and may not include all
shares of common stock beneficially owned but held in street
name.


(7) Mingkeda
Industries Co. Ltd.’s address is 1825 Renmin E Road, Heshan City, Guangdong
Province, China.


(8) Kayue
Electric Company Ltd.’s address is Unit C, 19/F, Dragon Centre, 79 Wing Hong
Street, Cheung Sha Wan, Kowloon, Hong Kong.


(9) Mr.
Severance’s beneficial ownership includes 106 shares of preferred stock,
warrants to purchase an additional 53 shares of preferred stock, and 57,709
shares of common stock held of record by H. Leigh Severance, Inc. Profit Sharing
Plan and Trust, of which Mr. Severance is a controlling person. Mr. Severance’s
beneficial ownership also includes 5 shares of preferred stock, warrants to
purchase an additional 2 shares of preferred stock, and 3,335 shares of
common stock held of record by H. Leigh Severance, Inc. Pension Plan and
Trust, of which Mr. Severance is a controlling person.  Mr.
Severance’s address is 14282 E. Caley Ave., Aurora, CO 80016.


(10) Mr.
Lauffenburger’s address is 2095 Heritage Place, Erie, CO
80516.


(11) Mr.
Barish’s address is c/o Lazarus Investment Partners LLLP, 2401 East 2nd Avenue,
#600, Denver, CO 80206.


(12) Wildernest
Logistics Solutions, Inc.’s address is 3500 N Windsor Dr., Suite 400, Aurora, CO
80011.




(13) As of
December 31, 2008, based on information provided in Schedule 13G as filed
February 11, 2009.  According to these filings, Enable Capital
Management, LLC (“ECM”) is the beneficial owner of warrants to purchase up to
840,000 shares of our common stock.  ECM is located at One Ferry
Building, Suite 255, San Francisco, CA 94111.  Mr. Mitchell S. Levine
is the managing member and majority owner of ECM.  Mr. Levine’s
address is One Ferry Building, Suite 255, San Francisco, CA
94111.  ECM acts as the general partner and/or investment manager of
Enable Growth Partners, L.P.  Enable Growth Partners L.P. is located
at One Ferry Building, Suite 255, San Francisco, CA 94111.




49
 Table of Contents


Securities
Authorized for Issuance Under Equity Compensation Plans




2003 Stock Option
Plan.On January 3, 2003, our Board adopted a stock
option plan (the “2003 Plan”) for key employees (including key employees who are
directors), non-employee directors, consultants, and investors.  An
aggregate of 400,000 shares of our common stock were available for grants under
the 2003 Plan.  Upon shareholder approval on February 23, 2006, the
2003 Plan was merged into the 2005 Equity Compensation Plan (as defined below)
and ceased to exist separately.  The 195,131 options still available
for grants under the 2003 Plan as of that date were contributed to the 2005
Equity Compensation Plan  The options for the 204,869 shares
originally issued under the 2003 Plan continue to be governed by their grant
agreements but are administered under the 2005 Equity Compensation
Plan.  All grants under the 2003 Plan were fully vested as of December
2005.




Administration.  The
2003 Plan was administered by our Governance, Compensation and Nominating
Committee, and in the past was administered by the Board.  The plan
provided that it could be administered by either the committee or Board, and in
its administration it could:




·
            select
      participants,




·
            determine
      the date of grant, exercise price and other terms of
    options,




·
            establish
      rules and regulations to administer the
  plan,




·
            amend,
      suspend, or discontinue the plan subject to applicable shareholder
      approval,




·
            interpret
      the rules relating to the plan, and




·
            otherwise
      administer the plan.




2005 Equity Compensation
Plan.  In August 2005 we adopted the 2005 Equity Compensation
Plan (the “2005 Plan”) to promote our interests and the interests of our
shareholders by attracting, retaining, and motivating our key officers,
employees, directors, and consultants.  The 2005 Plan was approved by
our stockholders at the annual meeting of stockholders held on February 23,
2006.  A total of 1,505,000 shares of our common stock were originally
available for grant under the 2005 Plan in the form of stock options or awards
of shares of restricted stock, in addition to the available options remaining to
be granted under the 2003 Plan.  In November 2007, our Board approved
a resolution authorizing an additional 1 million shares for issuance under the
2005 Plan, subject to shareholder approval.  In July 2008, our Board
revised this resolution to authorize a total of 2 million additional shares for
issuance under the 2005 Plan, subject to shareholder approval.  On
October 1, 2008, upon recommendation by the Board, the shareholders approved an
amendment to the 2005 Equity Compensation Plan to authorize an additional
2,000,000 shares for issuance under the 2005 Plan.




Shares Available for
Awards.  Shares subject to an award that is cancelled, expired,
unexercised, forfeited, settled in cash, or otherwise terminated remain
available for awards under the 2005 Plan.  Shares issued under the
2005 Plan may be either newly issued shares or shares which we have
reacquired.  The 2005 Plan imposes individual limitations on the
amount of certain awards in order to comply with Section 162(m) of the
Internal Revenue Code of 1986.  Under these limitations, no single
participant may generally receive awards in any calendar year that represent
more than $1 million.  The Governance, Compensation and Nominating
Committee may adjust awards to prevent dilution or enlargement of benefits when
certain events occur such as a stock dividend, reorganization, recapitalization,
stock split, combination, merger, or consolidation.




Eligibility.  Our
employees, directors, and consultants may be granted awards under the
plan.  As of March 31, 2009, approximately 70 individuals were
eligible to participate.




50
 Table of Contents




Administration.  The
plan is administered by the Governance, Compensation and Nominating
Committee.  Awards to directors serving on the Governance,
Compensation and Nominating Committee are determined and administered by the
full Board.  The Governance, Compensation and Nominating Committee
may:




·
            select
      participants;




·
            determine
      the type and number of awards to be
granted;




·
            determine
      the exercise or purchase price, vesting periods and any performance
      goals;




·
            determine
      and later amend the terms and conditions of any
  award;




·
            interpret
      the rules relating to the plan; and




·
            otherwise
      administer the plan.




Stock Options.  The
Governance, Compensation and Nominating Committee may grant both incentive stock
options, which can result in potentially favorable tax treatment to the
participant, and non-qualified stock options.  The Governance,
Compensation and Nominating Committee determines the terms and individual
vesting schedules for each grant including the exercise price, which may not be
less than the fair market value of a share of common stock on the date of the
grant.




Restricted
Shares.  The Governance, Compensation and Nominating Committee
may grant restricted shares of common stock.  Restricted shares are
shares of common stock with transfer restrictions.  These restrictions
lapse on the basis of performance and/or continued employment as determined in
advance by the committee.  They may be forfeited by participants as
specified by the committee in the award agreement.  A participant who
has received a grant of restricted shares will be eligible to receive dividends
and have the right to vote those shares.  Restricted shares may not be
transferred, encumbered or disposed of during the restricted period or until
after the restrictive conditions are met.




Other Terms.All
outstanding awards vest, become exercisable or payable, and have all
restrictions lifted upon a change in control of the Company.  The
Board may amend or terminate the plan subject to applicable stockholder
approval.  The Governance, Compensation and Nominating Committee may
not amend the terms of previously granted options to reduce the exercise price
or cancel options and grant substitute options with a lower exercise price than
the cancelled options.  The Governance, Compensation and Nominating
Committee also may not adversely affect the rights of any award holder without
the award holder’s consent.




During Fiscal 2009, we
granted 1,781,701 options with exercise prices from $0.18 to $2.96 per share and
were issued 22,605 shares of common stock at a value of $2.07 per share under
the 2005 Plan.  Of the common stock grants, 10,000 shares were issued
to a consultant and the remaining 12,605 shares were issued to directors for
service on the Board of Directors during the previous year.  During
Fiscal 2008 we issued 272,911 options under the plan, 234,577 of which are
subject to shareholder approval.  In addition to a total of 222,131
options granted during Fiscal 2007, we granted under the 2005 Plan a total of
98,194 shares of common stock at a value of $5.00 to $5.90 per share consisting
of 5,000 shares issued to our former Chief Financial Officer, 5,000 shares
issued to our Vice President of Engineering and Manufacturing, 18,044 shares
issued to other employees, 49,150 shares granted to consultants for services,
and 21,000 shares granted to directors for service on the  Audit
Committee and on the Governance, Compensation and Nominating
Committee.




Equity
Compensation Plan Information


As
of March 31, 2009




Plan
      category
                                Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
                                
                                Weighted
      average exercise price of outstanding options, warrants and
      rights
                                
                                Number
      of securities remaining
                                  available
      for future issuanceEquity
      compensation plans
                                8,431,601
                                
                                $
                                4.69
                                
                                551,746




At March
31, 2009, we had granted options for 1,325,076 shares of our common stock that
are unvested that will result in $460,093 of compensation expense in future
periods if fully vested.





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ITEM
      13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE




The
following transactions were entered into with our executive officers, directors
and 5% or greater shareholders.




In April
2008, the Company paid Linda Graebner $5,000 in consulting fees prior to her
joining the Board of Directors in July.




On May
19, 2008, the Company and Jack J. Walker, one of the Company’s directors, acting
as co-borrowers, entered into a Business Loan Agreement with First National Bank
(the “Business Loan Agreement”) for a loan to the Company in the principal
amount of $1,000,000 (the “First National Loan”).  The Company has
agreed, among other things, that while the Business Loan Agreement is in effect,
the Company will not (without First National Bank's prior written consent): (i)
incur or assume indebtedness, except for trade debt in the ordinary course of
business, capital leases in an amount not to exceed $500,000, and capital
expenditures of not more than $500,000 during any fiscal year; (ii) sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or
encumber any of the Company’s assets (except as specifically allowed), or
(iii) sell with recourse any of the Company’s accounts, except to First
National Bank. In the event of a default under the First National Loan, at First
National Bank's option, all indebtedness owed under the First National Loan will
become immediately due and payable.





Pursuant
to the Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19,
2009.  The First National Note also provides for a minimum interest
charge of $250, but otherwise may be prepaid at any time without
penalty.  In the event of a default under the First National Note, the
interest rate will be increased by a margin of 4% over the current rate of
interest.  As of March 31, 2009, $1,001,146 was outstanding under the
First National Note, including accrued interest.





On May
19, 2009, the Company, Mr. Walker, and FNB entered into a Change in Terms
Agreement (the “Change in Terms Agreement”), extending the maturity of the First
National Loan until July 19, 2009, and increasing the interest rate from the
Wall Street Journal Prime Rate plus .50% floating to the Wall Street Journal
Primate Rate plus 2.0% floating, with a floor interest rate of
5.50%.





On May
22, 2008, the Company entered into a Loan Agreement (the “WLLC Loan Agreement”)
and associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLLC Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the
Company.  As a condition of the WLLC Loan, the Company paid WLLC a
non-refundable commitment fee of $37,500. Further, in consideration of WLLC
holding available funds equal to the principal amount not yet disbursed, the
Company must pay a non-refundable fee of 1% of the retained funds as a holding
fee, payable quarterly.  If not paid sooner, the WLLC Loan, if drawn
upon, will be due and payable on April 1, 2009.  We granted WLLC a
security interest in all of the Company’s assets, subordinate to the security
interests in such assets granted to FCC and First National Bank (each as
described herein).  Further, in the event we receive any equity
financing, all obligations due under the WLLC Loan Agreement become immediately
due and payable.  In the event of any default under the WLLC Loan
Agreement, WLLC may, at its option, declare all amounts owed immediately due and
payable, foreclose on the security interest granted, and increase the annual
rate of interest to 18%.  As of March 31, 2009, loans totaling
$1,233,371were outstanding under the WLLC Loan Agreement, including accrued
interest.





The WLLC
Loan Agreement also set forth the terms and conditions under which Mr. Walker
agreed to act as co-borrower on the First National Loan. In consideration for
Mr. Walker's agreement to act as co-borrower, the Company agreed to: (i) pay Mr.
Walker a service fee of $50,000; (ii) allow Mr. Walker to purchase the First
National Loan in the event of the Company’s default under the First National
Loan and to repay Mr. Walker any amounts expended by Mr. Walker on the First
National Loan, together with interest at an annual rate of 18%; and (iii)
terminate and release Mr. Walker from any obligation under the First National
Loan on the one-year anniversary of the execution date of the First National
Loan Agreement.





On May
19, 2009, Mr. Walker, WLLC, and the Company entered into a Loan Extension
Agreement (the “Loan Extension Agreement”) effective April 1, 2009, extending
the maturity date of the WLLC Loan until June 30, 2009.  The Company
paid WLLC $5,000 in consideration for the loan extension.  The current
balance of principal due on the WLLC Loan is $1,200,000.  The parties
agreed that the Company is not entitled to any further disbursements under the
WLLC Loan.  In the event the Company receives any equity financing,
all obligations due under the WLLC Loan become immediately due and
payable.





On June
30, 2009, principal totaling $1,200,000 outstanding under the WLLC Loan
Agreement was converted to 1,200 shares of Series A Convertible Preferred Stock,
and the WLLC Loan Agreement was terminated.





On June
23, 2008, the Company entered into a Loan and Security Agreement with FCC, LLC,
d/b/a First Capital (“FCC”) (the “FCC Loan Agreement”) for a revolving credit
facility in the amount of $12,000,000 (the “Revolving Credit
Facility”).  The actual amount available for borrowing under the
Revolving Credit Facility is limited at any given time to the sum of a
percentage of eligible inventory and a percentage of eligible accounts
receivable, each as defined in the FCC Loan Agreement.  Mr. Walker
provided a guarantee against certain contingent liabilities related to the FCC
Loan Agreement.  In return for this guarantee, the Company paid Mr.
Walker a fee of $7,500.





52
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As of
December 31, 2008, the Company was not in compliance with three covenants under
the revised FCC Loan Agreement.  Effective as of January 31, 2009, FCC
and the Company executed a forbearance agreement related to the FCC Loan
Agreement (the “Forbearance Agreement”).  Pursuant to the terms of the
Forbearance Agreement, FCC agreed to forbear its rights and remedies under the
FCC Loan Agreement and related documents with respect to any existing defaults
under the FCC Loan Agreement (the “Existing Defaults”) until the earlier of June
30, 2009, or the date of occurrence of a default other than the Existing
Defaults.  The Forbearance Agreement also increases the Company’s
ability to borrow against inventory and accounts receivable during the term of
the Forbearance Agreement (the “Additional Borrowing Capacity”).  In
return for FCC providing the forbearance period and the Additional Borrowing
Capacity, the Company agreed to pay FCC a $25,000 forbearance fee (in five
monthly installments), an amendment fee equal to 1.5% per month on the average
utilization of the Additional Borrowing Capacity, and issue to FCC a minimum of
250,000 warrants to purchase common stock of the Company at a purchase price of
$1.00 per share.  Simultaneously with the execution of the Forbearance
Agreement, Mr. Walker provided a $1 million guarantee against certain
liabilities under the FCC Loan Agreement.  As compensation for
providing the guarantee, the Company has agreed to issue Mr. Walker 50,000
warrants to purchase common stock of the Company at a purchase price of $1.00
per share.





On June
1, 2009, the Company, FCC, and Jack J. Walker, as guarantor, executed a Second
Forbearance Agreement, effective as of April 29, 2009 (the “Second Forbearance
Agreement”), in which FCC agreed to forbear from exercising its rights and
remedies under the Loan Agreement until June 30, 2009, if no further defaults
occur.  The Second Forbearance Agreement also increased the advance
rate against inventory until July 1, 2009, and eliminated the Company’s
obligation to pay the monthly forbearance and amendment fees and to provide cash
flow projections.  In return, AeroGrow agreed to pay FCC a fee of
$60,000 no later than June 30, 2009.





As of
July 1, 2009, FCC, AeroGrow, and Jack J. Walker, as guarantor, executed an
amendment to the FCC Loan Agreement (the “Third FCC Amendment”).  The
Third FCC Amendment reduced the maximum amount of the Revolving Credit Facility
to $8 million, re-set the covenant levels beginning July 1, 2009, and waived
existing defaults.  In addition, the Third FCC Amendment re-set the
formulas for determining the borrowing base against which the Company can
borrow.  The Third FCC Amendment also changed the definition of Base
Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%, and
increased the interest rate to Base Rate plus 4.0%.  The Third FCC
Amendment provides for a $30,000 success fee to be paid by the Company to FCC on
April 30, 2010.  In addition, the Third FCC Amendment replaces a
minimum borrowing fee with a fee calculated as 0.50% per annum of the daily
average unused portion of the Revolving Credit Facility, payable monthly in
arrears.  Finally, the Third FCC Amendment increased the annual
facility fee to 1.0% of the maximum amount of the Revolving Credit Facility,
from 0.75%.




Also see
Item 7.  Management’s Discussion And Analysis Of Operations -
Liquidity and Capital Resources, and Note 11 – Subsequent Events to our
financial statements, for additional information.




Director
Independence




Our Board of Directors comprises Jack
J. Walker, Linda Graebner, Peter Michel, Suresh Kumar, Michael D. Dingman, Jr.,
and Jervis B. Perkins.  Our Board of Directors has determined that Mr.
Dingman, Ms. Graebner, Mr. Michel and Mr. Kumar are “independent” as that term
is defined by NASDAQ.  Under the NASDAQ definition, an independent
director is a person who is not an executive officer or employee of the Company
and who does not have a relationship with the Company that, in the opinion of
our Board of Directors, would interfere with the exercise of independent
judgment in carrying out the responsibilities of a director.  All
Audit Committee Governance, Compensation and Nominating Committee, and Special
Committee members are independent directors as that term is defined by
NASDAQ.




During
Fiscal 2009, a number of individuals served as directors of
AeroGrow.  Jack J. Walker and Jervis B. Perkins were on the Board
throughout Fiscal 2009.  W. Michael Bissonnette, Dennis E. Channer,
and Kenneth C. Leung. resigned from the Board in July 2008.  At that
time, Michael D. Dingman, Jr., Linda Graebner, Suresh Kumar, and
Peter  Michel joined the Board.  Messrs. Channer, Leung,
Dingman, Kumar and Michel, as well as Ms. Graebner, were independent as defined
by NASDAQ.    All Audit Committee and Governance,
Compensation and Nominating Committee, and Special Committee  members
during Fiscal Year 2009 were independent directors.




ITEM
      14.
            PRINCIPAL ACCOUNTANT FEES AND
      SERVICES




Aggregate
fees billed by Eide Bailly, our current independent registered public accounting
firm, and by Gordon, Hughes & Banks, LLP (“GHB”), its predecessor, for the
fiscal years ended March 31, 2009, 2008 and 2007 are as follows:




Fiscal
                            2009
                          
                          Fiscal
      2008
                          
                          
                          Fiscal
                            2007Eide
      Bailly Audit Fees
                          
                          $
                          8,315
                          
                          
                          $
                          --
                          
                          
                          $
                          --All
      Other Eide Bailly Fees
                          
                          
                          --
                          
                          
                          
                          --
                          
                          
                          
                          --GHB
      Audit Fees
                          
                          
                          50,000
                          
                          
                          
                          35,728
                          
                          
                          
                          26,000All
      Other GHB Fees
                          
                          
                          10,814
                          
                          
                          
                          24,387
                          
                          
                          
                          15,564Tax
      Fees
                          
                          
                          --
                          
                          
                          
                          3,448
                          
                          
                          
                          3,375Totals
                          
                          $
                          69,129
                          
                          
                          $
                          63,563
                          
                          
                          $
                          44,939





Other
fees paid to Eide Bailly and GHB were for review of SEC filings during these
periods.  Eide Bailly acquired GHB as of November 1,
2008.




53
 Table of Contents




Tax
Fees




Tax fees
consist of fees for tax compliance, including the preparation of tax returns,
tax advice, and tax planning services.  Tax advice and tax planning
services relate to advice regarding mergers and acquisitions and assistance with
tax audits and appeals.  We use a firm other than Eide Bailly for
these services.




Policy
on Accounting Matters; Pre-Approval of Audit and Non-Audit Services of
Independent Registered Public Accounting Firm




The
primary purpose of the Audit Committee is to assist the Board in monitoring (i)
the integrity of our financial statements and disclosures, including oversight
of the accounting and financial reporting processes and the audits of our
financial statements, (ii) compliance with our legal, ethical, and regulatory
requirements, and (iii) the independence and performance of our independent
registered public accounting firm.




The Audit
Committee’s policy is to pre-approve all audit and non-audit services, other
than de minimis non-audit services, provided by the independent registered
public accounting firm.  These services may include, among others,
audit services, audit-related services, tax services, and other
services.  Pre-approval is generally provided for up to one year and
any pre-approval is detailed as to particular services or categories of services
and is generally subject to a specific budget.  The independent
registered public accounting firm and management are required to periodically
report to the full Board regarding the extent of services provided by the
independent registered public accounting firm in accordance with this
pre-approval, and the fees for the services performed to date.




The Audit
Committee considers the provision of non-audit services by our independent
registered public accounting firm compatible with its
independence.  The Audit Committee will continue to approve all audit
and permissible non-audit services provided by our independent registered public
accounting firm.





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SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.







AEROGROW
      INTERNATIONAL, INC.,
                A
      NEVADA CORPORATIONDate
      July 2, 2009
              By:
              /s/ JERVIS B.
      PERKINSJervis
      B. PerkinsPresident and Chief Executive
      Officer







55
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POWER OF
ATTORNEY





KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below does
hereby constitute and appoint Jervis B. Perkins with full power of substitution
and full power to act as his or her true and lawful attorney-in-fact and agent
with full power and authority to do and perform all and every act and thing
whatsoever requisite and necessary to be done in and about the premises as
fully, to all intents and purposes, as he or she might or could do if personally
present at the doing thereof, hereby ratifying and confirming all that said
attorney-in-fact and agent may or shall lawfully do, or cause to be done, in
connection with the proposed filing by AeroGrow International, Inc. with the
Securities and Exchange Commission, under the provisions of the Securities
Exchange Act of 1934, as amended, of an Annual Report on Form 10-K for the
fiscal year ended March 31, 2008 (the “Annual Report”), including but not
limited to, such full power and authority to do the following: (i) execute and
file such Annual Report; (ii) execute and file any amendment or amendments
thereto; (iii) receive and respond to comments from the Securities and Exchange
Commission related in any way to such Annual Report or any amendment or
amendments thereto; and (iv) execute and deliver any and all certificates,
instruments or other documents related to the matters enumerated above, as the
attorney-in-fact in her sole discretion deems appropriate.





Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
the 2nd day of July 2009.






Signature
                          
                          Title
                          
                          Date/s/
      JACK J.
      WALKER
                          
                          Chairman
      of the Board
                          
                          July
      2, 2009Jack
      J. Walker/s/
      H. MACGREGOR
      CLARKE
                          
                          Chief
      Financial Officer and Treasurer
                          
                          July
      2, 2009H.
      MacGregor
      Clarke/s/
      GREY H.
      GIBBS
                          
                          Controller
      and Chief Accounting
      Officer
                          
                          July
      2, 2009Grey
      H. Gibbs
  /s/
      LINDA
      GRAEBNER
                                
                                Director
                                
                                July
      2, 2009Linda
      Graebner/s/
      PETER A.
      MICHEL
                                
                                Director
                                
                                July
      2, 2009Peter
      A. Michel/s/
      SURESH
      KUMAR
                                
                                Director
                                
                                July
      2, 2009Suresh
      Kumar/s/ MICHAEL D. DINGMAN,
      JR.
                                
                                Director
                                
                                July
      2, 2009Michael
      D. Dingman, Jr.
  56
 Table of Contents
  REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the
Board of Directors of


AeroGrow
International, Inc.


Boulder,
Colorado








We have
audited the accompanying balance sheet of AeroGrow International, Inc. (the
“Company”) as of March 31, 2009 and the related statements of operations,
changes in shareholders’ equity (deficit) and cash flows for the year then
ended.  These financial statements are the responsibility of the
Company’s management.  Our responsibility is to express an opinion on
these financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company has
determined that it is not required to have, nor were we engaged to perform, an
audit of its internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation.  We
believe that our audit provides a reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of AeroGrow International, Inc. as of
March 31, 2009, and the results of its operations and its cash flows for the
year then ended, in conformity with accounting principles generally accepted in
the United States of America.




Eide
Bailly LLP




Greenwood
Village, Colorado


July 1,
2009




57
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REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors


AeroGrow
International, Inc.


Boulder,
Colorado





We have
audited the accompanying balance sheet of AeroGrow International, Inc. as of
March 31, 2008 and the related statements of operations, shareholders’ equity
and cash flows for each of the years ended March 31, 2008 and
2007.  These financial statements are the responsibility of the
Company’s management.  Our responsibility is to express an opinion on
these financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of AeroGrow International, Inc. as of
March 31, 2008, and the results of its operations and its cash flows for each of
the one year periods ended March 31, 2008 and 2007, in conformity with
accounting principles generally accepted in the United States of
America.








/s/ Gordon, Hughes & Banks,  LLP




Greenwood
Village, Colorado


June 10,
2008




58
 Table of Contents




AEROGROW INTERNATIONAL, INC.


BALANCE
SHEETS




March
      31,
                  
                  
                  March
      31,2009
                  
                  
                  2008ASSETSCurrent
      assetsCash
      and cash equivalents
                  
                  $
                  332,698
                  
                  
                  $
                  1,559,792Restricted
      cash
                  
                  
                  438,331
                  
                  
                  
                  86,676Accounts
      receivable, net of allowance for doubtful accounts of$1,423,508
      and $511,710
                    at
      March 31, 2009 and March 31, 2008,respectively
                  
                  
                  2,278,052
                  
                  
                  
                  2,412,101Other
      receivables
                  
                  
                  332,059
                  
                  
                  
                  422,530Inventory,
      net
                  
                  
                  8,350,135
                  
                  
                  
                  4,688,444Prepaid
      expenses and other
                  
                  
                  565,454
                  
                  
                  
                  762,013Total
      current assets
                  
                  
                  12,296,729
                  
                  
                  
                  9,931,556Property
      and equipment, net of accumulated depreciation of $1,675,148 and $816,804
                    at
      March 31, 2009 and March 31, 2008, respectively
                  
                  
                  1,768,369
                  
                  
                  
                  1,830,646Other
      assetsIntangible
      assets, net of $3,515 and $17,432 of accumulated
                    amortization
      at March 31, 2009 and March 31, 2008, respectively
                  
                  
                  231,590
                  
                  
                  
                  56,263Deposits
                  
                  
                  110,776
                  
                  
                  
                  101,164Deferred debt issuance costs, net of accumulated amortization
      of
                    $243,937
      and $0 at March 31, 2009 and March 31, 2008,respectively
                  
                  
                  201,726
                  
                  
                  
                  -Total
      other Assets
                  
                  
                  554,092
                  
                  
                  
                  157,427Total
      Assets
                  
                  $
                  14,609,190
                  
                  
                  $
                  11,919,629LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      liabilitiesAccounts
      payable
                  
                  $
                  8,338,559
                  
                  
                  $
                  3,023,366Current
      portion  - long term debt
                  
                  
                  1,099,060
                  
                  
                  
                  128,927Current
      portion
                  
                  
                  -
                  
                  
                  
                  -Accrued
      expenses
                  
                  
                  2,318,670
                  
                  
                  
                  2,452,025Due
      to factor
                  
                  
                  -
                  
                  
                  
                  1,480,150Customer
      deposits
                  
                  
                  246,728
                  
                  
                  
                  232,200Deferred
      rent
                  
                  
                  57,283
                  
                  
                  
                  65,037Total
      current liabilities
                  
                  
                  12,060,030
                  
                  
                  
                  7,381,705Long-term
      debt
                  
                  
                  5,547,144
                  
                  
                  
                  129,373Long-term
      debt-related party
                  
                  
                  1,233,371
                  
                  
                  
                  -Stockholders'
      equity (deficit)Preferred
      stock, $.001 par value, 20,000,000 shares authorized,
                    none
      issued or outstanding
                  
                  
                  -
                  
                  
                  
                  -Common
      stock, $.001 par value, 75,000,000 shares authorized,13,342,877
      and 12,076,717
                    shares
      issued and outstanding atMarch
      31, 2009 and March 31, 2008, respectively
                  
                  
                  13,343
                  
                  
                  
                  12,076Additional
      paid-in capital
                  
                  
                  45,696,630
                  
                  
                  
                  44,024,559Accumulated
      (deficit)
                  
                  
                  (49,941,598
                  )
                  
                  
                  (39,628,084
                  )Total
      Stockholders' Equity (Deficit)
                  
                  
                  (4,231,625
                  )
                  
                  
                  4,408,551Total
      Liabilities and Stockholders' Equity (Deficit)
                  
                  $
                  14,609,190
                  
                  
                  $
                  11,919,629




See
accompanying notes to the financial statements




59
 Table of Contents




AEROGROW
INTERNATIONAL, INC.


STATEMENTS
OF OPERATIONS





Years ended March 31,2009
              
              
              2008
              
              
              2007RevenueProduct
      sales, net
              
              $
              37,449,868
              
              
              $
              38,356,676
              
              
              $
              13,144,037Operating
      expensesCost
      of revenue
              
              
              23,710,787
              
              
              
              22,975,385
              
              
              
              8,404,507Research
      and development
              
              
              2,146,493
              
              
              
              2,605,112
              
              
              
              2,113,255Sales
      and marketing
              
              
              13,772,822
              
              
              
              16,084,353
              
              
              
              7,117,613General
      and administrative
              
              
              7,043,391
              
              
              
              6,084,728
              
              
              
              4,050,312Total
      operating expenses
              
              
              46,673,493
              
              
              
              47,749,578
              
              
              
              21,685,687(Loss)
      from operations
              
              
              (9,223,625
              )
              
              
              (9,392,902
              )
              
              
              (8,541,650
              )Other
      (income) expense, netInterest
      (income)
              
              
              (6,285
              )
              
              
              (115,070
              )
              
              
              (176,173
              )Interest
      expense
              
              
              900,213
              
              
              
              558,089
              
              
              
              356,594Interest
      expense – related party
              
              
              195,961
              
              
              
              -
              
              
              
              -Registration
      rights penalty
              
              
              -
              
              
              
              -
              
              
              
              1,664,380Total
      other (income) expense, net
              
              
              1,089,889
              
              
              
              443,019
              
              
              
              1,844,801Net
      (loss)
              
              $
              (10,313,514
              )
              
              $
              (9,835,921
              )
              
              $
              (10,386,451
              )Net
      (loss) per share, basic and diluted
              
              $
              (0.82
              )
              
              $
              (0.84
              )
              
              $
              (1.09
              )Weighted
      average number of commonshares
      outstanding, basic and diluted
              
              
              12,519,999
              
              
              
              11,662,891
              
              
              
              9,505,926




See
accompanying notes to the financial statements




60
 Table of Contents




AEROGROW
INTERNATIONAL, INC.


STATEMENT
OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)




Common
                            
                            
                            
                            
                            
                            AdditionalStock
                            
                            
                            
                            
                            
                            Paid-in
                            
                            
                            AccumulatedShares
                            
                            
                            Amount
                            
                            
                            Capital
                            
                            
                            (Deficit)
                            
                            
                            TotalBalances,
      April 1, 2006
                            
                            
                            9,102,622
                            
                            
                            $
                            9,103
                            
                            
                            $
                            27,313,081
                            
                            
                            $
                            (19,405,712
                            )
                            
                            $
                            7,916,472Common
      stock issued in private placements
                            
                            
                            1,166,760
                            
                            
                            
                            1,167
                            
                            
                            
                            6,199,147
                            
                            
                            
                            -
                            
                            
                            
                            6,200,314Exercise
      of common stock warrants at $2.50
                            
                            
                            34,000
                            
                            
                            
                            34
                            
                            
                            
                            84,966
                            
                            
                            
                            -
                            
                            
                            
                            85,000Exercise
      of common stock warrants at $6.25
                            
                            
                            5,000
                            
                            
                            
                            5
                            
                            
                            
                            31,245
                            
                            
                            
                            -
                            
                            
                            
                            31,250Common
      stock issued upon conversion of convertible debt
                            
                            
                            240,006
                            
                            
                            
                            240
                            
                            
                            
                            839,760
                            
                            
                            
                            -
                            
                            
                            
                            840,000Common
      stock issued under equity compensation plans
                            
                            
                            98,194
                            
                            
                            
                            98
                            
                            
                            
                            516,072
                            
                            
                            
                            -
                            
                            
                            
                            516,170Common
      stock issued to landlord as rent
                            
                            
                            8,872
                            
                            
                            
                            9
                            
                            
                            
                            44,351
                            
                            
                            
                            -
                            
                            
                            
                            44,360Common
      stock issued to public relations firm for services
                            
                            
                            11,354
                            
                            
                            
                            11
                            
                            
                            
                            56,759
                            
                            
                            
                            -
                            
                            
                            
                            56,770Common
      stock issued in settlement of claim
                            
                            
                            6,858
                            
                            
                            
                            7
                            
                            
                            
                            40,455
                            
                            
                            
                            -
                            
                            
                            
                            40,462Repurchase
      of common stock
                            
                            
                            (3,000
                            )
                            
                            
                            (3
                            )
                            
                            
                            (14,997
                            )
                            
                            
                            -
                            
                            
                            
                            (15,000
                            )Adjustment
      for error in warrant exercise
                            
                            
                            67
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Stock
      options issued under equity compensation plans
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            560,859
                            
                            
                            
                            -
                            
                            
                            
                            560,859Accretion
      of loss on modification of debt
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            119,319
                            
                            
                            
                            -
                            
                            
                            
                            119,319Common
      stock issued for registration rights penalty
                            
                            
                            332,876
                            
                            
                            
                            332
                            
                            
                            
                            1,664,048
                            
                            
                            
                            -
                            
                            
                            
                            1,664,380Mandatory
      redeemable common stock converted
                            
                            
                            62,000
                            
                            
                            
                            62
                            
                            
                            
                            309,938
                            
                            
                            
                            -
                            
                            
                            
                            310,000Net
      (loss)
                            
                            -
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (10,386,451
                            )
                            
                            
                            (10,386,451
                            )Balances,
      March 31, 2007
                            
                            
                            11,065,609
                            
                            
                            
                            11,065
                            
                            
                            
                            37,765,003
                            
                            
                            
                            (29,792,163
                            )
                            
                            
                            7,983,905Common
      stock issued in private placements
                            
                            
                            800,000
                            
                            
                            
                            800
                            
                            
                            
                            4,432,572
                            
                            
                            
                            -
                            
                            
                            
                            4,433,372Exercise
      of common stock warrants at $2.50
                            
                            
                            19,250
                            
                            
                            
                            19
                            
                            
                            
                            48,106
                            
                            
                            
                            -
                            
                            
                            
                            48,125Exercise
      of common stock warrants at $5.00
                            
                            
                            20,000
                            
                            
                            
                            20
                            
                            
                            
                            99,980
                            
                            
                            
                            -
                            
                            
                            
                            100,000Exercise
      of common stock warrants at $6.00
                            
                            
                            10,000
                            
                            
                            
                            10
                            
                            
                            
                            59,990
                            
                            
                            
                            -
                            
                            
                            
                            60,000Exercise
      of common stock warrants at $6.25
                            
                            
                            125,500
                            
                            
                            
                            126
                            
                            
                            
                            779,249
                            
                            
                            
                            -
                            
                            
                            
                            779,375Exercise
      of stock options
                            
                            
                            36,358
                            
                            
                            
                            36
                            
                            
                            
                            36,695
                            
                            
                            
                            -
                            
                            
                            
                            36,731Warrants
      issued to consultants
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            92,065
                            
                            
                            
                            -
                            
                            
                            
                            92,065Stock
      options issued under equity compensation plans
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            710,899
                            
                            
                            
                            -
                            
                            
                            
                            710,899Net
      (loss)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (9,835,921
                            )
                            
                            
                            (9,835,921
                            )Balances,
      March 31, 2008
                            
                            
                            12,076,717
                            
                            
                            
                            12,076
                            
                            
                            
                            44,024,559
                            
                            
                            
                            (39,628,084
                            )
                            
                            
                            4,408,551Common
      stock issued in private placements
                            
                            
                            22,605
                            
                            
                            
                            23
                            
                            
                            
                            46,769
                            
                            
                            
                            -
                            
                            
                            
                            46,792Exercise
      of common stock warrants at $.66
                            
                            
                            213,276
                            
                            
                            
                            213
                            
                            
                            
                            140,549
                            
                            
                            
                            -
                            
                            
                            
                            140,762Exercise
      of common stock warrants at $.75
                            
                            
                            976,703
                            
                            
                            
                            977
                            
                            
                            
                            731,550
                            
                            
                            
                            -
                            
                            
                            
                            732,527Exercise
      of common stock warrants at $2.50
                            
                            
                            10,000
                            
                            
                            
                            10
                            
                            
                            
                            24,990
                            
                            
                            
                            -
                            
                            
                            
                            25,000Exercise
      of stock options
                            
                            
                            43,576
                            
                            
                            
                            44
                            
                            
                            
                            51,599
                            
                            
                            
                            -
                            
                            
                            
                            51,643Stock
      options issued under equity compensation plans
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            676,614
                            
                            
                            
                            -
                            
                            
                            
                            676,614Net
      (loss)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (10,313,514
                            )
                            
                            
                            (10,313,514
                            )Balances,
      March 31, 2009
                            
                            
                            13,342,877
                            
                            
                            $
                            13,343
                            
                            
                            $
                            45,696,630
                            
                            
                            $
                            (49,941,598
                            )
                            
                            $
                            (4,231,625
                            )




See
accompanying notes to the financial statements








61
 Table of Contents


AEROGROW
INTERNATIONAL, INC.


STATEMENTS
OF CASH FLOWS




Years Ended March 31,2009
                        
                        
                        2008
                        
                        
                        2007Cash
      flows from operating activities:Net
      (loss)
                        
                        $
                        (10,313,514
                        )
                        
                        $
                        (9,835,921
                        )
                        
                        $
                        (10,386,451
                        )Adjustments
      to reconcile net (loss) to cash provided(used)
      by operations:Common
      stock issued for registration rights penalty
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,664,380Issuance
      of common stock and options under equity compensation plans
                          plans
                        
                        
                        723,406
                        
                        
                        
                        710,899
                        
                        
                        
                        1,077,029Issuance
      of common stock not under equity compensation plans
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        141,592Issuance
      of warrants for services
                        
                        
                        -
                        
                        
                        
                        92,065
                        
                        
                        
                        -Depreciation
      and amortization expense
                        
                        
                        844,427
                        
                        
                        
                        505,171
                        
                        
                        
                        225,949Allowance
      for bad debt
                        
                        
                        911,798
                        
                        
                        
                        431,015
                        
                        
                        
                        80,695Amortization
      of debt issuance costs
                        
                        
                        191,437
                        
                        
                        
                        -
                        
                        
                        
                        242,399Amortization
      of debt issuance costs –related party
                        
                        
                        52,500
                        
                        
                        
                        -
                        
                        
                        
                        -Change
      in assets and liabilities:(Increase)
      in accounts receivable
                        
                        
                        (777,749
                        )
                        
                        
                        (958,373
                        )
                        
                        
                        (1,922,282
                        )(Increase)
      in other receivable
                        
                        
                        90,471
                        
                        
                        
                        (240,309
                        )
                        
                        
                        (182,221
                        )(Increase)
      in inventory
                        
                        
                        (3,661,691
                        )
                        
                        
                        (747,830
                        )
                        
                        
                        (3,747,668
                        )(Increase)
      decrease in debt issuance costs
                        
                        
                        (393,163
                        )
                        
                        
                        -
                        
                        
                        
                        -(Increase)
      in debt issuance costs-related party
                        
                        
                        (52,500
                        )
                        
                        
                        -
                        
                        
                        
                        -(Increase)
      in other current assets
                        
                        
                        196,559
                        
                        
                        
                        (281,023
                        )
                        
                        
                        (281,400
                        )(Increase)
      decrease  in deposits
                        
                        
                        (9,612
                        )
                        
                        
                        (66,009
                        )
                        
                        
                        -Increase
      (decrease) in accounts payable
                        
                        
                        5,315,193
                        
                        
                        
                        (169,368
                        )
                        
                        
                        2,705,260Increase
      (decrease) in accrued expenses
                        
                        
                        (133,355
                        )
                        
                        
                        1,285,541
                        
                        
                        
                        831,961Increase
      in accrued interest –related party
                        
                        
                        19,418
                        
                        
                        
                        -
                        
                        
                        
                        -Increase
      in accrued interest
                        
                        
                        35,528
                        
                        
                        
                        -
                        
                        
                        
                        -Increase
      (decrease) in customer deposits
                        
                        
                        14,528
                        
                        
                        
                        232,200
                        
                        
                        
                        (30,471
                        )Increase
      in deferred rent
                        
                        
                        (7,754
                        )
                        
                        
                        11,506
                        
                        
                        
                        53,531Net
      cash (used) by operating activities
                        
                        
                        (6,954,073
                        )
                        
                        
                        (9,030,436
                        )
                        
                        
                        (9,527,697
                        )Cash
      flows from investing activities:Increase
      in restricted cash
                        
                        
                        (351,655
                        )
                        
                        
                        (2,313
                        )
                        
                        
                        (84,363
                        )Purchases
      of equipment
                        
                        
                        (796,067
                        )
                        
                        
                        (1,104,534
                        )
                        
                        
                        (649,087
                        )Patent
      expenses
                        
                        
                        (161,410
                        )
                        
                        
                        (38,313
                        )
                        
                        
                        (12,615
                        )Net
      cash (used) by investing activities
                        
                        
                        (1,309,132
                        )
                        
                        
                        (1,145,160
                        )
                        
                        
                        (746,065
                        )Cash
      flows from financing activities:(Decrease)
      in amount due to factor
                        
                        
                        (1,480,150
                        )
                        
                        
                        834,999
                        
                        
                        
                        645,151Proceeds
      from long term debt borrowings
                        
                        
                        27,034,153
                        
                        
                        
                        -
                        
                        
                        
                        -Stock
      repurchase
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (15,000
                        )Proceeds
      from long term debt borrowings–related
      party
                        
                        
                        1,213,953
                        
                        
                        
                        -
                        
                        
                        
                        -Proceeds
      from issuance of common stock, net
                        
                        
                        -
                        
                        
                        
                        4,433,372
                        
                        
                        
                        6,200,314Proceeds
      from exercise and issuance of warrants
                        
                        
                        898,289
                        
                        
                        
                        987,500
                        
                        
                        
                        116,250Proceeds
      from the exercise of stock options
                        
                        
                        51,643
                        
                        
                        
                        36,731
                        
                        
                        
                        -Principal
      payments on capital leases
                        
                        
                        (128,927
                        )
                        
                        
                        (52,715
                        )
                        
                        
                        -Repayment
      of long term borrowings
                        
                        
                        (20,552,850
                        )
                        
                        
                        -
                        
                        
                        
                        -Repayment
      of convertible debentures
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (30,000
                        )Net
      cash provided by financing activities
                        
                        
                        7,036,111
                        
                        
                        
                        6,239,887
                        
                        
                        
                        6,916,715Net
      increase (decrease) in cash
                        
                        
                        (1,227,094
                        )
                        
                        
                        (3,935,709
                        )
                        
                        
                        (3,357,047
                        )Cash,
      beginning of period
                        
                        
                        1,559,792
                        
                        
                        
                        5,495,501
                        
                        
                        
                        8,852,548Cash,
      end of period
                        
                        $
                        332,698
                        
                        
                        $
                        1,559,792
                        
                        
                        $
                        5,495,501




See
supplemental disclosures on the following page and the accompanying notes to the
financial statements




62
 Table of Contents


Years Ended March 31,2009
                
                
                2008
                
                
                2007Supplemental
      disclosure of non-cash investing and financing activities:Interest
      paid
                
                $
                1,041,228
                
                
                $
                560,731
                
                
                $
                83,158Income
      taxes paid
                
                $
                -
                
                
                $
                -
                
                
                $
                -Purchase
      of equipment through
                  assumption
      of capital lease obligations
                
                $
                -
                
                
                $
                311,015
                
                
                $
                -Accretion
      of debt modification
                
                $
                -
                
                
                $
                -
                
                
                $
                119,319Convertible
      debentures converted to common stock
                
                $
                -
                
                
                $
                -
                
                
                $
                840,000Conversion
      of mandatorily redeemable stock
                
                $
                -
                
                
                $
                -
                
                
                $
                310,000





See
accompanying notes to the financial statements




63
 Table of Contents




AEROGROW
INTERNATIONAL, INC.


NOTES
TO FINANCIAL STATEMENTS





Note
1 – Description of the Business and Summary of Significant Accounting
Policies




Organization
and Description of the Business





AeroGrow
International, Inc. ("the Company") was incorporated in the State of Nevada on
March 25, 2002.  On January 12, 2006, the Company and Wentworth I,
Inc., a Delaware corporation (“Wentworth”), entered into an Agreement and Plan
of Merger (the “Merger Agreement”) which was consummated on February 24,
2006.  Under the Merger Agreement, Wentworth merged with and into the
Company, and the Company was the surviving corporation (“Merger”). The Merger,
for accounting and financial reporting purposes, has been accounted for as an
acquisition of Wentworth by the Company.  As such, the Company was the
accounting acquirer in the Merger, and the historical financial statements of
the Company will be the financial statements for the Company following the
Merger.





The
Company’s principal business is developing, marketing, and distributing advanced
indoor aeroponic garden systems designed and priced to appeal to the consumer
gardening, cooking and small indoor appliance markets worldwide.  The
Company’s principal activities from its formation through March 2006, consisted
of product research and development, market research, business planning, and
raising the capital necessary to fund these activities. In December 2005, the
Company commenced pilot production of its AeroGarden system and, in March 2006,
began shipping these systems to retail and catalogue customers. The Company
manufactures, distributes and markets over eleven different models of its
AeroGarden systems in multiple colors, as well as over 50 varieties of seed kits
and a full line of accessory products through multiple channels including
retail, catalogue and direct-to-consumer sales in the United States as well as
selected countries in Europe, Asia and Australia.





Liquidity
and Basis of Presentation





The
Company has incurred net losses since its inception, including a net loss for
the fiscal year ended March 31, 2009 of $10,313,514.  As more fully
discussed in the Liquidity and Capital Resources section of Item 7. Management’s
Discussion and Analysis of Operations, the Company has developed sources of
funding that management believes are sufficient to support the Company’s
operating plan for the fiscal year ending March 31, 2010.  These
sources of funding include cash flow from operations, $3.8 million in cash
proceeds from the issuance of Series A Convertible Preferred shares on June 30,
2009, the conversion of $2.3 million of unsecured obligations into Series A
Convertible Preferred shares, borrowings under the Company’s revolving credit
facility and other debt arrangements, as well as agreements reached with certain
unsecured creditors of the Company to defer payments of amounts owed, and, in
some cases, to reduce the amounts owed by the Company.  The Company’s
operating plan is predicated on a variety of assumptions including, but not
limited to, the level of customer and consumer demand, the impact of cost
reduction programs, and the state of the general economic environment in which
the Company operates.  There can be no assurances that these
assumptions will prove to be accurate in all material respects, or that the
Company will be able to successfully execute its operating plan.  In
such cases, there can also be no assurances that the Company’s existing funding
sources will prove to be sufficient to support the Company’s
operations.





Significant
Accounting Policies





Use of
estimates


The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 with regards to return reserves, inventory obsolescence and the
allowance for bad debts will occur in the near term.





Net Income (Loss) per Share
of Common Stock


The
Company computes net income (loss) per share of common stock in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 128, “Earnings per
Share,” and Securities and Exchange Commission Staff Accounting Bulletin No. 98
(“SAB 98”).  SFAS No. 128 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 stock shareholders 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 (e.g.,
convertible securities, options and warrants) as if they had been converted at
the beginning of the periods presented. Potential shares of common stock 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.  For the years ended March 31, 2009, March 31, 2008 and March 31,
2007, the Company had 8,434,815, 6,248,687 and 7,061,454, respectively,
securities that could potentially dilute basic EPS in the future that were not
included in the computation of diluted EPS because to do so would have been
antidilutive for the periods presented.





Reclassifications


Certain
prior year amounts have been reclassified to conform to current year
presentation.





Cash and Cash
Equivalents


The
Company considers all highly liquid investments with an original maturity of
three months or less when purchased to be cash equivalents.  There
were no cash equivalents at March 31, 2009 and March 31, 2008.





64
 Table of Contents




Restricted
Cash


The Company has secured activity
related to its corporate credit card purchase account with a restricted money
market account as well as a money set aside for potential bankruptcies as
required as part of termination with our factoring relationship. The balances in
this account as of March 31, 2009 and March 31, 2008 were $438,331 and $86,676,
respectively.





Concentrations of
Risk


Statement
of Financial Accounting Standards ("SFAS") No. 105, "Disclosure of Information
About Financial Instruments with Off-Balance Sheet Risk and Financial
Instruments with Concentrations of Credit Risk," requires disclosure of
significant concentrations of credit risk regardless of the degree of such
risk.  Financial instruments with significant credit risk include
cash.  The amount on deposit with a financial institution exceeded the
$250,000 federally insured limit as of March 31, 2009.  However,
management believes that the financial institution is financially sound and the
risk of loss is minimal.





Customers:


The
Company maintains a credit insurance policy on many of its trade accounts
receivables. For the year ended March 31, 2009, the Company had one customer who
represented 10% of the Company’s net product sales.





For the
year ended March 31, 2008, the Company had one customer who represented 15% of
the net product sales.





For the
year ended March 31, 2007, the Company had two customers who represented 15% and
10% of net sales, respectively.





Suppliers:


For the
year ended March 31, 2009, the Company purchased inventories and other inventory
related items from three suppliers totaling $8,862,484, 3,857,284 and
$3,345,734, representing 37%, 16% and 14% of cost of sales,
respectively.  For the year ended March 31, 2008, the Company
purchased inventories and other inventory-related items from two suppliers
totaling $7,931,115 and $4,779,949, representing 35% and 21% of cost of sales,
respectively.  For the year ended March 31, 2007, the Company
purchased inventory and other inventory related items from two suppliers
totaling $2,307,826 and 4,686,403, representing 27% and 56% of cost of sales,
respectively. Although the Company believes alternate sources of manufacturing
could be obtained, loss of any of these three suppliers could have an adverse
impact on operations.





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





Account
Receivables


For
the year ended March 31, 2009, the Company had five customers who represented
12.6%, 14.7%, 14.8%, 16.7% and 18.0% of outstanding accounts
receivables.





For
the year ended March 31, 2008, the Company had one customer who represented
14.0% of outstanding accounts receivables.





Fair Value of Financial
Instruments


The
carrying value of financial instruments including cash, receivables, accounts
payable, accrued expenses and debt,
approximates their fair value at March 31, 2009 and 2008 due to the
relatively short-term nature of these instruments.




On April
1, 2008, the Company adopted the portion of SFAS No. 157, Fair Value
Measurements (“SFAS 157”) that was not delayed by FASB Staff Position FAS 157-2
(“FSP FAS 157-2”). FSP FAS 157-2 delays theeffective date of SFAS 157 as it
applies to non-financial assets and liabilities that are not required to be
measured at fair value on a recurring (at least annual) basis. As a result of
the delay, SFAS 157 will be applied to the Company’s non-financial assets and
liabilities effective on April 1, 2009. SFAS 157 defines fair value as the price
that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date (also
referred to as an exit price). SFAS 157 also establishes a three-level fair
value hierarchy for classifying financial instruments that is based on whether
the inputs to the valuation techniques used to measure fair value are observable
or unobservable. The three levels of the SFAS 157 fair value hierarchy are
described below:





Level
      1:
            Quoted
      prices (unadjusted) in active markets for identical assets or
      liabilities.




Level
      2:
            Observable
      market-based inputs, other than quoted prices in active markets for
      identical assetsor liabilities.





Level
      3:
            Unobservable
      inputs.





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As of
March 31, 2009, the Company did not have any financial assets or liabilities
that were measured at fair value on a recurring basis subsequent to initial
recognition.





Property and
Equipment


Property
and equipment are stated at cost.  Depreciation for financial
accounting purposes is computed using the straight-line method over the
estimated lives of the respective assets.  Office equipment and
computer hardware are depreciated over five years.  Tooling is
depreciated over three years. Leasehold improvements are being amortized over
the life of the lease which is five years.





Property
and equipment consist of the following as of:


March 31
                        
                        
                        March 312009
                        
                        
                        2008Manufacturing
      equipment and tooling
                        
                        $
                        2,124,385
                        
                        
                        $
                        1,616,946Computer
      equipment and software
                        
                        
                        724,088
                        
                        
                        
                        476,576Leasehold
      improvements
                        
                        
                        129,118
                        
                        
                        
                        111,759Other
      equipment
                        
                        
                        465,926
                        
                        
                        
                        442,1693,443,517
                        
                        
                        
                        2,647,450Less:  accumulated
      depreciation
                        
                        
                        (1,675,148
                        )
                        
                        
                        (816,804
                        )Property
      and equipment, net
                        
                        $
                        1,768,369
                        
                        
                        $
                        1,830,646





Depreciation
expense for the years ended March 31, 2009, March 31, 2008, and March 31, 2007
was $858,145, $494,399 and $220,362, respectively.





Intangible
Assets


Intangible
assets, to date, have consisted of the direct costs incurred for application
fees and legal expenses associated with patents and trademarks on the Company's
products.  The Company periodically reviews the recoverability from future
operations using undiscounted cash flows.  To the extent carrying values
exceed fair values, an impairment loss will be evaluated for possible
recording.  The Company amortizes its patent and trademark costs on a
straight line basis over their estimated useful life of 5 years.





Intangible
assets consist of the following:





March 31,
                      
                      
                      March 31,2009
                      
                      
                      2008Patents
                      
                      $
                      190,100
                      
                      
                      $
                      36,257Trademarks
                      
                      
                      45,005
                      
                      
                      
                      37,438235,105
                      
                      
                      
                      73,695Less:  accumulated
      amortization
                      
                      
                      (3,515
                      )
                      
                      
                      (17,432
                      )Intangible
      assets, net
                      
                      $
                      231,590
                      
                      
                      $
                      56,263





Amortization
expense for the years ended March 31, 2009, March 31, 2008 and March 31, 2007,
was $61,656, $10,772 and $5,588, respectively.





Inventory


Inventories
are valued at the lower of cost, determined by the first-in, first-out method,
or market. Included in inventory costs where the Company is the manufacturer are
raw materials, labor and manufacturing overhead. 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 as prescribed
under Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, “Inventory
Pricing”.  A majority of the Company’s products are manufactured
overseas and are recorded at cost.





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March 31,
                      
                      
                      March 31,2009
                      
                      
                      2008Finished
      goods
                      
                      $
                      6,799,996
                      
                      
                      $
                      3,669,693Raw
      materials
                      
                      
                      1,550,139
                      
                      
                      
                      1,018,751$
                      8,350,135
                      
                      
                      $
                      4,688,444





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 March 31, 2009, the Company had
reserved $335,705 for inventory obsolescence and as of March 31, 2008, the
Company determined that no inventory obsolescence reserve was
required.





Accounts Receivable and
Allowance for Doubtful Accounts


The
Company sells its products to retailers and consumers. Consumer transactions are
paid primarily by credit card. Retailer sales terms vary by customer, but are
generally net 30 days. 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 also
maintains a credit insurance policy which insures against losses from most
retailer accounts. The Company's allowance estimate is based on a review of the
current status of trade accounts receivable which resulted in an allowance of
$1,423,508 and $511,710 at March 31, 2009  and March 31, 2008,
respectively.





Other
Receivables


In
conjunction with the Company’s processing of credit card transactions and for
its direct-to-consumer sales activities and as security with respect to the
Company’s performance for required credit card refunds and chargebacks, the
Company is required to maintain a cash reserve with Litle and Company, 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 March 31, 2009
and March 31, 2008, the balance in this reserve account was $332,059 and
$422,530, respectively.





Advertising and Production
Costs


The
Company expenses all production costs related to advertising, including, print,
television, and radio advertisements when the advertisement has been broadcast
or otherwise distributed.  The Company records media 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 the Statement of Position,
“No. SOP 93-7” “Reporting on Advertising Costs”. In accordance with SOP 93-7,
direct response 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, 2009 and March 31, 2008, the Company had deferred
$346,130 and $503,825, respectively, related to such media costs. Advertising
expenses for the years ended March 31, 2009, March 31, 2008 and March 31, 2007
were $5,101,910, $6,955,555 and $2,125,112, 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.





Stock Based
Compensation


In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, “Share-Based Payment” (“SFAS No. 123R”).Subsequently, the Securities and
Exchange Commission (“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 recognizing 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 APB No. 25, “Accounting for Stock Issued to
Employees” and related Interpretations, which generally results in no employee
stock option expense. The Company adopted SFAS No. 123R on January 1, 2006. The
Company uses the Black-Scholes option valuation model to estimate the fair value
of stock option awards issued under SFAS No. 123R. For the years ended March 31,
2009, March 31, 2008 and March 31, 2007, equity compensation in the form of
stock options and grants of restricted stock totaled $723,406, $710,899, and
$1,077,029, respectively, and is included in the accompanying Statements of
Operations in the following categories:




Years
      ended March 31,2009
                          
                          
                          2008
                          
                          
                          2007General
      and administrative
                          
                          $
                          457,592
                          
                          
                          $
                          225,730
                          
                          
                          $
                          356,720Research
      and development
                          
                          
                          121,952
                          
                          
                          
                          300,702
                          
                          
                          
                          336,482Sales
      and  marketing
                          
                          
                          143,862
                          
                          
                          
                          184,467
                          
                          
                          
                          383,827$
                          723,406
                          
                          
                          $
                          710,899
                          
                          
                          $
                          1,077,029





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Income
Taxes


In
September 2006, the issued FASB Interpretation No. (“FIN”) 48, “Accounting for
Uncertainty in Income Taxes.” FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements in accordance
with SFAS No. 109, Accounting for Income Taxes. This Interpretation defines the
minimum recognition threshold a tax position is required to meet before being
recognized in the financial statements. The Company adopted FIN 48 on April 1,
2007. As a result of the implementation, the Company recognized no material
adjustment in the liability of unrecognized income tax benefits. At the adoption
date of April 1, 2007, the Company had no unrecognized tax benefits, all of
which would affect the Company’s effective tax rate if recognized. It is
reasonably possible that the Company’s unrecognized tax benefit could change;
however, the Company does not expect any such change to be
material.





Deferred
income taxes are recognized for the tax consequences in future years of
differences between the tax basis of assets and liabilities and their financial
reporting amounts at the end of each period, based on enacted laws and statutory
rates applicable to the periods in which the differences are expected to affect
taxable income.  Any liability for actual taxes to taxing authorities
is recorded as income tax liability.The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is established
against such assets where management is unable to conclude more likely than not
that such asset will be realized. For the years ended March 31, 2009 and March
31, 2008, the Company recognized a valuation allowance equal to 100% of the net
deferred tax asset balance.





Revenue
Recognition


The
Company recognizes 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 fee is fixed or determinable; and collection of the resulting receivable is
reasonably assured. Accordingly, the Company did not record $0 and $577,838 of
revenue as of March 31, 2009 and March 31, 2008, respectively, related to the
unpaid balance due for orders shipped in conjunction with the Company’s direct
sales to consumers because the consumer has 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. During the year ending March 31, 2009, the Company discontinued
offering the 36-day trial period.  The Company also, as of March 31,
2009 and March 31, 2008, did not record $0 and $175,781, respectively, of
product costs associated with the foregoing revenue in as much as the customer
is required to return the product and the Company is therefore able to recover
these costs through resale of the goods. The liability for sales returns is
estimated based upon historical experience of return levels.





Additionally,
the Company did not record $46,131 and $69,339 of revenue as of March 31, 2009
and March 31, 2008, respectively, related to the wholesale sales value of
inventory held by its retail shopping channel customers as these sales are
contingent upon the shopping channels selling the goods. Deferred payments for
these goods are charged to Customer Deposits. The Company has also deferred, as
of March 31, 2009 and March 31, 2008, recognition of $21,336, and $33,937 of
product and freight costs associated with these sales, which have been included
in inventory.





The
Company records estimated reductions to revenue for customer and distributor
programs and incentive offerings, including promotions and other volume-based
incentives. Certain incentive programs require the Company to estimate based on
industry experience the number of customers who will actually redeem the
incentive. At March 31, 2009 and March 31, 2008, the Company had accrued
$431,148 and $226,729 respectively, as its estimate for the foregoing deductions
and allowances.  In addition, for the fiscal year ended March 31,
2009, the Company had accrued $2,077,622 for possible returns or price markdowns
associated with several large retailer accounts.  These accruals were
recorded as a reduction of sales, and an increase in allowance for bad debt,
which reduced net trade receivables relating to retailers.




Warranty and Return
Reserves


The
Company records warranty liabilities at the time of sale for the estimated costs
that may be incurred under its 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, 2009 and March 31, 2008 a provision for potential
future warranty costs of $69,587 and $72,200, 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 from which this allowance is deducted from
payments from such customers. As of March 31, 2009 and March 31, 2008, the
Company has recorded a reserve for customer returns of $101,743 and $674,120,
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 product sales.





Deferred
Rent


In July
2006, the Company entered into a facility lease with a term through January
2012, for its corporate offices in Boulder, Colorado.  At March 31,
2009 and March 31, 2008, the Company had recorded deferred rent related to this
agreement in the amount of $57,283 and $65,037, respectively, based on the
difference between rent expense recorded and the rent payment
obligation.





Deferred Debt Issuance
Costs


The Company capitalizes debt issuance
costs that are directly attributable to realizing the proceeds of the debt
issued and it is amortized over the contractual life of the debt.





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Registration Rights
Penalties


The
holders of securities issued in prior Company stock offerings and 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
common stock of the Company under certain circumstances and were limited 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 the
Company’s common stock valued at a rate of $2.00 per share.  The
Company elected to recognize the impact of such registration rights penalties as
incurred, which commenced after July 23, 2006. The Company 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 (“EITF”) 00-19-2 that addresses the accrual and accounting for
registration rights penalties became effective for all fiscal years beginning
after December 15, 2006 and immediately for all new arrangements entered into
after this date.  The Company adopted this FSP immediately for the
year ended March 31, 2007.





Segments of an Enterprise
and Related Information


SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131") replaces the industry segment approach under previously issued
pronouncements with the management approach.  The management approach
designates the internal organization that is used by management for allocating
resources and assessing performance as the source of the Company's reportable
segments.  SFAS 131 also requires disclosures about products and
services, geographic areas and major customers.  At present, the
Company only operates in one segment.





New Accounting
Pronouncements


In May
2009, the FASB issued Statement of SFAS No. 165, Subsequent Events. This
Statement establishes general standards of accounting for and disclosures of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued.  It requires the disclosure of
the date through which an entity has evaluated subsequent events and the basis
for that date. This Statement is effective for interim and annual periods ending
after June 15, 2009 and as such, we will adopt this standard in the first
quarter of fiscal year 2010. We are currently assessing the impact of the
adoption of SFAS 165, if any, on our financial position, results of operations
or cash flows.





In April
2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments.  This FSP amends FASB Statement No.
107 to require disclosures about fair values of financial instruments for
interim reporting periods as well as in annual financial
statements.  The FSP also amends APB Opinion No. 28 to require those
disclosures in summarized financial information at interim reporting
periods.  This FSP becomes effective for interim reporting periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009.  The adoption of this FSP is not expected to
have a material impact on our financial statements.





In
October 2008, the FASB issued FASB Staff Position No. FAS 157-3, Determining the Fair Value of a
Financial Asset in a Market That is Not Active (FSP 157-3), which
clarifies the application of SFAS 157 when the market for a financial asset
is inactive. Specifically, FSP 157-3 clarifies how (1) the internal
assumptions should be considered in measuring fair value when observable data
are not present, (2) observable market information from an inactive market
should be taken into account, and (3) the use of broker quotes or pricing
services should be considered in assessing the relevance of observable and
unobservable data to measure fair value. The guidance in FSP 157-3 was effective
immediately. The adoption of FSP 157-3 did not have a material effect on our
financial statements.





In May
2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee Insurance
Contracts-an interpretation of FASB Statement No. 60. Diversity exists in
practice in accounting for financial guarantee insurance contracts by insurance
enterprises under FASB Statement No. 60, Accounting and Reporting by Insurance
Enterprises. This results in inconsistencies in the recognition and measurement
of claim liabilities. This Statement requires that an insurance enterprise
recognize a claim liability prior to an event of default (insured event) when
there is evidence that credit deterioration has occurred in an insured financial
obligation. This Statement requires expanded disclosures about financial
guarantee insurance contracts. The accounting and disclosure requirements of the
Statement will improve the quality of information provided to users of financial
statements.  SFAS 163 is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those
fiscal years. The adoption of FASB 163 is not expected to have a material impact
on the Company's financial position.





In May
2008, the FASB issued SFAS No. 162 “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”). SFAS 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 GAAP. This statement was effective 60 days
following the Securities Exchange and Commission’s September 16, 2008 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.” The adoption of FAS 162 did not have a
material impact on our financial statements.




In April
2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of
Intangible Assets. This FSP amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful life
of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible
Assets. This FSP is effective prospectively for fiscal years beginning
after December 15, 2008, which for the Company is April 1, 2009. The
adoption of FAS 142-3 is not expected to have a material impact on the Company’s
financial position.





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”). 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.





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In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”
("SFAS 141(R)"), 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 141(R) is effective for fiscal years beginning on or
after January 1, 2009 and is to be applied prospectively. The Company does
not expect that the adoption will have a material impact on the Company's
financial statements.





In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements- an amendment of ARB No. 51”
("SFAS 160") 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 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 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 adopted SFAS 159 in the fiscal year beginning April 1, 2008. The adoption of
this Statement did not have a material effect on our consolidated financial
statements.





Note
2 – Merger and 2006 Private Placement




The
Company entered into a Merger Agreement on January 12, 2006, with Wentworth I,
Inc., a Delaware corporation. Wentworth was a non-operating entity without
significant assets. Under the Merger Agreement, Wentworth merged with and into
the Company, and the Company was the surviving corporation (“Merger”). The
Merger, for accounting and financial reporting purposes, has been accounted as
an acquisition of Wentworth by the Company.





As a
condition of the closing of the Merger Agreement, the Company was required to
complete a private placement offering of its common stock shares and common
stock warrants with gross proceeds of not less than $5 million (the “2006
Offering”). Under the terms of the Merger Agreement, the Company paid a
financial advisory fee of $350,000 to Keating Securities, Wentworth’s financial
advisor in the transaction.





The
closing of the Merger Agreement occurred on February 24, 2006 and closings of
the 2006 Offering occurred on February 24, 2006 and March 1, 2006. The Company
received gross proceeds of $10,740,000 in the 2006 Offering from the sale of
2,148,000 units (“Unit(s)”); each Unit consisted of one share of common stock
and a five-year warrant to purchase one share of common stock at an exercise
price of $6.25 per share. The price per Unit in the 2006 Offering was $5.00.
After commissions, expenses and the reverse merger fee payable to Keating
Securities, the Company received net proceeds of $8,964,952 in the 2006
Offering. This offering required registration of the common stock issued and the
shares of common stock underlying the warrants. Liquidated damages were payable
to investors under the following circumstances: (a) if a registration statement
was not filed by the Company on or prior to 45 days after the closing date (such
an event, a “Filing Default”); (b) if the registration statement was not
declared effective by the SEC on or prior to the 150th day after the Closing
Date (such an event, an “Effectiveness Default”); and/or (c) if the Registration
Statement (after its effectiveness date) ceases to be effective and available to
investors for any continuous period that exceeds 30 days or for one or more
periods that exceeds in the aggregate 60 days in any 12-month period (such an
event, a “Suspension Default” and together with a Filing Default and an
Effectiveness Default, a “Registration Default”). In the event of a Registration
Default, the Company was to pay as Liquidated Damages, for each 30-day period of
a Registration Default, an amount equal to 1% of the aggregate purchase price
paid by the investors  up to a maximum of 18% of the aggregate
purchase price paid, provided that liquidation damages in respect of a
Suspension Default were not payable in relation to any securities not owned by
the investors at the time of the Suspension Default and, provided further, that
no liquidated damages were due in respect of the warrants. In the event of a
Filing Default or an Effectiveness Default, the Liquidated Damages were to be
paid by the issuance of additional common stock at the rate of the amount of the
liquidated damages due divided by $2.00. In the event of a Suspension Default,
the liquidated damages were to be paid in cash. The Company filed the required
Registration Statement within the 45 days pursuant to (a) above and completed
the registration of the foregoing securities on December 22, 2006. Accordingly,
for the year ended March 31, 2007, the Company 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, inclusive of 74,250
penalty shares issued to investors in the Company’s 2005 Offering (See Note
3).





Note
3 – Current and Long-term portion – Long-term debt





During
the fiscal year ended March 31, 2009, we relied on a variety of external debt
funding sources to meet our liquidity requirements:





First
National Loan





On May
19, 2008, the Company and Jack J. Walker, one of the Company’s directors, acting
as co-borrowers, entered into a Business Loan Agreement with First National Bank
(the “Business Loan Agreement”) for a loan to the Company in the principal
amount of $1,000,000 (the “First National Loan”).  The Company has
agreed, among other things, that while the Business Loan Agreement is in effect,
the Company will not (without First National Bank's prior written consent): (i)
incur or assume indebtedness, except for trade debt in the ordinary course of
business, capital leases in an amount not to exceed $500,000, and capital
expenditures of not more than $500,000 during any fiscal year; (ii) sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or
encumber any of the Company’s assets (except as specifically allowed), or
(iii) sell with recourse any of the Company’s accounts, except to First
National Bank. In the event of a default under the First National Loan, at First
National Bank's option, all indebtedness owed under the First National Loan will
become immediately due and payable.





Pursuant
to the Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19,
2009.  The First National Note also provides for a minimum interest
charge of $250, but otherwise may be prepaid at any time without
penalty.  In the event of a default under the First National Note, the
interest rate will be increased by a margin of 4% over the current rate of
interest.  As of March 31, 2009, $1,001,146 was outstanding under the
First National Note, including accrued interest.





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On May
19, 2009, the Company, Mr. Walker, and FNB entered into a Change in Terms
Agreement (the “Change in Terms Agreement”), extending the maturity of the First
National Loan until July 19, 2009, and increasing the interest rate from the
Wall Street Journal Prime Rate plus .50% floating to the Wall Street Journal
Primate Rate plus 2.0% floating, with a floor interest rate of
5.50%.





WLLC
Loan Agreement





On May
22, 2008, the Company entered into a Loan Agreement (the “WLLC Loan Agreement”)
and associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLLC Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the
Company.  As a condition of the WLLC Loan, the Company paid WLLC a
non-refundable commitment fee of $37,500. Further, in consideration of WLLC
holding available funds equal to the principal amount not yet disbursed, the
Company must pay a non-refundable fee of 1% of the retained funds as a holding
fee, payable quarterly.  If not paid sooner, the WLLC Loan, if drawn
upon, will be due and payable on April 1, 2009.  We granted WLLC a
security interest in all of the Company’s assets, subordinate to the security
interests in such assets granted to FCC and First National Bank (each as
described herein).  Further, in the event we receive any equity
financing, all obligations due under the WLLC Loan Agreement become immediately
due and payable.  In the event of any default under the WLLC Loan
Agreement, WLLC may, at its option, declare all amounts owed immediately due and
payable, foreclose on the security interest granted, and increase the annual
rate of interest to 18%.  As of March 31, 2009, loans totaling
$1,233,371 were outstanding under the WLLC Loan Agreement, including accrued
interest.





The WLLC
Loan Agreement also set forth the terms and conditions under which Mr. Walker
agreed to act as co-borrower on the First National Loan. In consideration for
Mr. Walker's agreement to act as co-borrower, the Company agreed to: (i) pay Mr.
Walker a service fee of $50,000; (ii) allow Mr. Walker to purchase the First
National Loan in the event of the Company’s default under the First National
Loan and to repay Mr. Walker any amounts expended by Mr. Walker on the First
National Loan, together with interest at an annual rate of 18%; and (iii)
terminate and release Mr. Walker from any obligation under the First National
Loan on the one-year anniversary of the execution date of the First National
Loan Agreement.





On May
19, 2009, Mr. Walker, WLLC, and the Company entered into a Loan Extension
Agreement (the “Loan Extension Agreement”) effective April 1, 2009, extending
the maturity date of the WLLC Loan until June 30, 2009.  The Company
paid WLLC $5,000 in consideration for the loan extension.  The current
balance of principal due on the WLLC Loan is $1,200,000.  The parties
agreed that the Company is not entitled to any further disbursements under the
WLLC Loan.  In the event the Company receives any equity financing,
all obligations due under the WLLC Loan become immediately due and
payable.





On June
30, 2009, principal totaling $1,200,000 outstanding under the WLLC Loan
Agreement was converted to 1,200 shares of Series A Convertible Preferred Stock,
and the WLLC Loan Agreement was terminated.





Revolving
Credit Facility





On June
23, 2008, the Company entered into a Loan and Security Agreement with FCC, LLC,
d/b/a First Capital (“FCC”) (the “FCC Loan Agreement”) for a revolving credit
facility in the amount of $12,000,000 (the “Revolving Credit Facility”), with an
initial termination date of June 23, 2010, subject to automatic one-year
renewals in the event advance written notice of non-renewal is not provided by
either party.  The actual amount available for borrowing under the
Revolving Credit Facility is limited at any given time to the sum of a
percentage of eligible inventory and a percentage of eligible accounts
receivable, each as defined in the FCC Loan Agreement.  Mr. Walker
provided a guarantee against certain contingent liabilities related to the FCC
Loan Agreement.  In return for this guarantee, the Company paid Mr.
Walker a fee of $7,500.





The
Revolving Credit Facility has an initial two-year term, with one-year renewals
thereafter.  Continued availability of the Revolving Credit Facility
is subject to the Company’s compliance with customary financial and reporting
covenants.  The purpose of the Revolving Credit Facility is to provide
additional working capital.  As collateral for the Revolving Credit
Facility, the Company granted to FCC a first priority security interest over all
of the Company’s assets, including, but not limited to, accounts receivable,
inventory, and equipment.  As of March 31, 2009, loans totaling
$5,515,685 were outstanding under the Revolving Credit Facility, including
accrued interest, and there was an estimated remaining availability of
approximately $120,000.  The amount available under the Revolving
Credit Facility varies from day-to-day, depending on the level of sales,
accounts receivable collections, and inventory on-hand levels.





As of
June 30, 2008, the Company was not in compliance with two covenants under the
FCC Loan Agreement.  As of July 31, 2008, FCC and AeroGrow executed an
amendment to the FCC Loan Agreement (the “First FCC Amendment”).  The
First FCC Amendment re-set the covenant levels for June 30, 2008 and future
periods, thus waving the non-compliance as of June 30, 2008, under the old
covenants, temporarily reduced certain restrictions on the Company’s ability to
borrow against inventory, and increased the interest rate from Base Rate plus 2%
to the current rate of Base Rate plus 3.5%.  After the First FCC
Amendment, the Company was in compliance with the revised covenants as of June
30, 2008.





As of
September 30, 2008, the Company was not in compliance with two covenants under
the revised FCC Loan Agreement.  On October 24, 2008, FCC and the
Company executed a second amendment to the FCC Loan Agreement (the “Second FCC
Amendment”).  The Second FCC Amendment waived the covenant violations
as of September 30, 2008.  In addition, the Second FCC Amendment
changed the definition of Base Rate to be the higher of the prime rate or
one-month LIBOR + 2.75%, and adjusted the interest calculation under the FCC
Loan Agreement such that the interest rate resets monthly, rather than
daily.





As of
October 27, 2008, FCC and the Company executed a temporary amendment to the FCC
Loan Agreement that temporarily reduced certain restrictions on the Company’s
ability to borrow against inventory, and increased the advance rate against
inventory.





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On
January 16, 2009, the Company and FCC executed a temporary amendment to the FCC
Loan Agreement that temporarily reduced certain restrictions on the Company’s
ability to borrow against inventory, and increased the advance rate against
inventory as of January 1, 2009.





As of
December 31, 2008, the Company was not in compliance with three covenants under
the revised FCC Loan Agreement.  Effective as of January 31, 2009, FCC
and the Company executed a forbearance agreement related to the FCC Loan
Agreement (the “Forbearance Agreement”).  Pursuant to the terms of the
Forbearance Agreement, FCC agreed to forbear its rights and remedies under the
FCC Loan Agreement and related documents with respect to any existing defaults
under the FCC Loan Agreement (the “Existing Defaults”) until the earlier of June
30, 2009, or the date of occurrence of a default other than the Existing
Defaults.  The Forbearance Agreement also increases the Company’s
ability to borrow against inventory and accounts receivable during the term of
the Forbearance Agreement (the “Additional Borrowing Capacity”).  In
return for FCC providing the forbearance period and the Additional Borrowing
Capacity, the Company agreed to pay FCC a $25,000 forbearance fee (in five
monthly installments), an amendment fee equal to 1.5% per month on the average
utilization of the Additional Borrowing Capacity, and issue to FCC a minimum of
250,000 warrants to purchase common stock of the Company at a purchase price of
$1.00 per share.  Simultaneously with the execution of the Forbearance
Agreement, Mr. Walker provided a $1 million guarantee against certain
liabilities under the FCC Loan Agreement.  As compensation for
providing the guarantee, the Company issued to Mr. Walker 50,000 warrants to
purchase common stock of the Company at a purchase price of $1.00 per
share.





On June
1, 2009, the Company, FCC, and Jack J. Walker, as guarantor, executed a Second
Forbearance Agreement, effective as of April 29, 2009 (the “Second Forbearance
Agreement”), in which FCC agreed to forbear from exercising its rights and
remedies under the Loan Agreement until June 30, 2009, if no further defaults
occur.  The Second Forbearance Agreement also increased the advance
rate against inventory until July 1, 2009, and eliminated the Company’s
obligation to pay the monthly forbearance and amendment fees and to provide cash
flow projections.  In return, AeroGrow agreed to pay FCC a fee of
$60,000 no later than June 30, 2009.





In
connection with the Second Forbearance Agreement, FCC is permitting AeroGrow to
borrow up to $800,000 more than would otherwise be permitted by the applicable
borrowing base calculation under the Loan Agreement.  Such additional
borrowing must be repaid by June 30, 2009.  FCC is not charging
AeroGrow a fee for this additional borrowing capacity.





As of
July 1, 2009, FCC, AeroGrow, and Jack J. Walker, as guarantor, executed an
amendment to the FCC Loan Agreement (the “Third FCC Amendment”).  The
Third FCC Amendment reduced the maximum amount of the Revolving Credit Facility
to $8 million, re-set the covenant levels beginning July 1, 2009, and waived
existing defaults.  In addition, the Third FCC Amendment re-set the
formulas for determining the borrowing base against which the Company can
borrow.  The Third FCC Amendment also changed the definition of Base
Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%, and
increased the interest rate to Base Rate plus 4.0%.  The Third FCC
Amendment provides for a $30,000 success fee to be paid by the Company to FCC on
April 30, 2010.  In addition, the Third FCC Amendment replaces a
minimum borrowing fee with a fee calculated as 0.50% per annum of the daily
average unused portion of the Revolving Credit Facility, payable monthly in
arrears.  Finally, the Third FCC Amendment increased the annual
facility fee to 1.0% of the maximum amount of the Revolving Credit Facility,
from 0.75%.




Note
4 – Due to Factor





On
February 9, 2007, the Company entered into an agreement with Benefactor Funding
Corp. (“Benefactor”) whereby Benefactor agreed to factor the company’s retail
accounts receivable invoices.  On April 16, 2008, the Company gave
notice to Benefactor of its intent to terminate the facility.  The
facility was terminated on June 24, 2008.  As of March 31, 2008,
Benefactor had advanced the Company $1,480,150 against invoices totaling
$1,915,815.  Fees paid to Benefactor for interest, discounts, and
other services for the year end March 31, 2009, March 31, 2008, and March 31,
2007 totaled $0, $503,164 and $39,556, respectively.  The receivables
are considered recourse and are presented at gross value in the accompanying
balance sheets.





Note
5 - Capital Lease Obligations





The
Company has capitalized lease obligations for computer equipment, licensed
software, and factory equipment due on various dates through November 2010 of
$140,042 as of March 31, 2009. The interest rates range from 12% to 15% per
annum. These lease obligations are collateralized by the related assets with a
net book value of $179,540 as of March 31, 2009. In addition, recorded in
deposits, is a security deposit of $48,180 which will be released upon the
Company achieving certain financial requirements. The leases also required
$21,465 in prepaid rents.





Maturities
of capital lease obligations as of March 31, 2009, are as follows:





Year
      ended March 31, 2010
                    
                    $
                    107,239Year
      ended March 31, 2011
                    
                    
                    32,803Total
      minimum lease payments
                    
                    
                    140,042Less
      - amount related to interest
                    
                    
                    (10,669
                    )Principal
      portion of future obligations
                    
                    
                    129,373Less
      - current portion
                    
                    
                    (97,914
                    )$
                    31,459





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The
following table summarizes the assets recorded in property and equipment that
were acquired under the capital leases as of March 31, 2009:





Class
      of propertyComputer
      equipment
                      
                      $
                      58,618Factory
      equipment
                      
                      
                      101,985Software
                      
                      
                      150,412311,015Accumulated
      depreciation
                      
                      
                      (131,475
                      )Net
      book value
                      
                      $
                      179,540





Note
6 – Equity Compensation Plans




In 2003,
the Company's Board of Directors approved a Stock Option Plan (the “2003 Plan”)
pursuant to which nonqualified stock options are reserved for issuance to
eligible employees, consultants and directors of the Company.  The
2003 Plan was administered by the Board of Directors, which had the authority to
select the individuals to whom awards were to be granted, the number of shares
of common stock to be covered by each award, the vesting schedule of stock
options, and all other terms and conditions of each award.  The
Company has granted nonqualified stock options to purchase shares of common
stock to certain employees at exercise prices ranging from $0.01 to $5.00 per
share.  In August 2005, the 2003 Plan was merged into the 2005 Equity
Compensation Plan and it no longer separately exists. However, options issued
and outstanding under the 2003 Plan continue to be governed by the original
grant agreements but are administered under the 2005 Equity Compensation
Plan.





In August
2005, the Company’s Board of Directors approved the 2005 Equity Compensation
Plan (the 2005 Plan) pursuant to which both qualified and nonqualified stock
options as well as restricted shares of common stock are reserved for issuance
to eligible employees, consultants and directors of the Company.  A
total of 3,505,000 shares of our common stock may be granted under the 2005 Plan
as the original 1,505,000 was increased by 2,000,000 shares at the October 1,
2008 shareholders meeting.





The 2005
Plan is administered by the Company’s compensation committee which has the
authority to select the individuals to whom awards are to be granted, the number
of shares of common stock to be covered by each award, the vesting schedule of
stock options, and all other terms and conditions of each award.  The
Company has granted qualified stock options to purchase shares of common stock
to certain employees at exercise prices ranging from $0.01 to $6.00 per
share.





Effective
January 1, 2006, the Company adopted the fair value recognition provisions of
SFAS No. 123(R), “Share-Based Payment.”  In addition to recognizing
compensation expense related to restricted stock and performance units, SFAS No.
123(R) also requires recognition of compensation expense related to the
estimated fair value of stock options. The Company adopted SFAS No. 123(R) using
the modified-prospective-transition method. Under that transition method,
compensation expense recognized subsequent to adoption includes: (a)
compensation cost for all share-based payments granted prior to, but not yet
vested as of January 1, 2006, based on the values estimated in accordance with
the original provisions of SFAS No. 123, and (b) compensation cost for all
share-based payments granted subsequent to January 1, 2006, based on the
grant-date fair values estimated in accordance with the provisions of SFAS No.
123(R). Consistent with the modified-prospective-transition method, the
Company’s results of operations for prior periods have not been adjusted to
reflect the adoption of FAS 123(R).





For the
years ended March 31, 2009, March 31, 2008 and March 31, 2007, respectively, the
Company granted 1,781,701, 272,911 and 222,131 options to purchase the Company’s
common stock at exercise prices ranging from $0.18 to $5.90 per share under the
2005 Plan as follows:




Years
      ended March 31,2009
                        
                        
                        2008
                        
                        
                        2007Employees
                        
                        
                        1,641,591
                        
                        
                        
                        272,911
                        
                        
                        
                        170,131Consultants
                        
                        
                        13,110
                        
                        
                        
                        -
                        
                        
                        
                        17,000Directors
                        
                        
                        127,000
                        
                        
                        
                        -
                        
                        
                        
                        35,0001,781,701
                        
                        
                        
                        272,911
                        
                        
                        
                        222,131





In
November 2007, the Board of Directors of the Company approved a resolution
authorizing that an increase of 1.0 million shares in the 2005 Plan be submitted
as a matter to be voted on by the shareholders of the Company at the next annual
shareholders meeting and that all grants of options in excess of the 1,505,000
shares allowable pursuant to the current 2005 Plan be issued subject to such
shareholder approval. On July 23, 2008, the Board of Directors approved a
revised resolution that increased the number of shares to be added to the 2005
Plan to 2,000,000.  Included in the options granted for the year ended
March 31, 2008 were 221,063 options which exceeded the 1,505,000 shares eligible
to be issued under the 2005 Plan.  On October 1, 2008, the
shareholders of the Company approved the increase of 2,000,000 shares for the
2005 Plan.





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In March
2007, in as much as the Company’s stock had begun trading in the public market
but trading history was limited, the Company reviewed the assumptions utilized
for the volatility rate, researching companies within the consumer products
category with comparable market capitalizations, comparable per share prices and
with a minimum of five years of trading history, the length of time the options
are exercisable. Accordingly, for the options granted for the period January 1,
2007 through December 31, 2007, the Company used the following weighted average
assumptions: no dividend yield; expected volatility rate of 50.3%; risk free
interest rate of 5%; and average lives of 3 years resulting in a value of $2.28
per option granted based upon a market value of $5.90 per share on the date of
grant. The foregoing assumptions were re-evaluated in March 2008 using the same
comparison companies and researching additional companies with similar
characteristics. Accordingly, for the options granted for the period
January 1, 2008 through March 31, 2009, the Company used the following weighted
average assumptions: no dividend yield; expected volatility rate of 61.0%; risk
free interest rate of 5%; and average lives of 3 years resulting in values of
$.18 to $2.61 per option granted based upon market values on the date of
grant.  As a result of recognizing compensation expense for stock
options pursuant to the provisions of SFAS No. 123(R), the net loss for the
years ended March 31, 2009, March 31, 2008 and the March 31, 2007, was increased
by $676,614, $710,899 and $560,859, respectively.





A summary
of option activity in the 2005 Plan is as follows:





Exercise priceWeighted-Options
                          
                          
                          Low
                          
                          
                          High
                          
                          
                          AverageBalances
      at April 1, 2006
                          
                          
                          1,117,269
                          
                          
                          $
                          0.01
                          
                          
                          $
                          5.00
                          
                          
                          $
                          4.44Granted
                          
                          
                          222,131
                          
                          
                          $
                          5.00
                          
                          
                          $
                          5.90
                          
                          
                          $
                          5.24Exercised
                          
                          
                          -
                          
                          
                          $
                          0.00
                          
                          
                          $
                          0.00
                          
                          
                          $
                          0.00Forfeited
                          
                          
                          (2,040
                          )
                          
                          $
                          0.00
                          
                          
                          $
                          0.00
                          
                          
                          $
                          5.00Balances
      at March 31, 2007
                          
                          
                          1,337,360
                          
                          
                          $
                          0.01
                          
                          
                          $
                          5.00
                          
                          
                          $
                          4.58Granted
                          
                          
                          272,911
                          
                          
                          $
                          4.74
                          
                          
                          $
                          5.85
                          
                          
                          $
                          5.15Exercised
                          
                          
                          (36,358
                          )
                          
                          $
                          0.00
                          
                          
                          $
                          5.00
                          
                          
                          $
                          1.66Forfeited
                          
                          
                          (19,962
                          )
                          
                          $
                          2.50
                          
                          
                          $
                          5.00
                          
                          
                          $
                          3.63Balances
      at March 31,2008
                          
                          
                          1,553,951
                          
                          
                          $
                          0.01
                          
                          
                          $
                          5.90
                          
                          
                          $
                          4.46Granted
                          
                          
                          1,781,701
                          
                          
                          $
                          0.18
                          
                          
                          $
                          2.96
                          
                          
                          $
                          1.07Exercised
                          
                          
                          (43,576
                          )
                          
                          $
                          0.50
                          
                          
                          $
                          2.95
                          
                          
                          $
                          0.60Forfeited
                          
                          
                          (273,003
                          )
                          
                          $
                          0.01
                          
                          
                          $
                          5.90
                          
                          
                          $
                          2.52Balances
      at March 31,2009
                          
                          
                          3,019,073
                          
                          
                          $
                          0.01
                          
                          
                          $
                          5.90
                          
                          
                          $
                          2.77




Information
regarding all stock options outstanding under the 2005 Plan as of March 31, 2009
is as follows:




OPTIONS
      OUTSTANDING
                    
                    OPTIONS
      EXERCISABLEWeighted-
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    Weighted-average
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    
                    average
                    
                    
                    WeightedRemaining
                    
                    
                    average
                    
                    Aggregate
                    
                    
                    
                    
                    Remaining
                    
                    
                    average
                    
                    AggregateExercise
                    
                    
                    
                    
                    Contractual
                    
                    
                    Exercise
                    
                    Intrinsic
                    
                    
                    
                    
                    Contractual
                    
                    
                    Exercise
                    
                    Intrinsicprice range
                    
                    Options
                    
                    
                    Life (years)
                    
                    
                    Price
                    
                    Value
                    
                    Options
                    
                    
                    Life (years)
                    
                    
                    Price
                    
                    ValueOver
      $0.00 to $0.50
                    
                    
                    1,082,965
                    
                    
                    
                    4.90
                    
                    
                    $
                    0.18
                    
                    
                    
                    
                    60,297
                    
                    
                    
                    4.68
                    
                    
                    $
                    0.17Over
      $0.50 to $2.50
                    
                    
                    319,677
                    
                    
                    
                    3.93
                    
                    
                    $
                    2.00
                    
                    
                    
                    
                    226,492
                    
                    
                    
                    3.80
                    
                    
                    $
                    1.98Over
      $2.50 to $5.00
                    
                    
                    503,287
                    
                    
                    
                    4.05
                    
                    
                    $
                    3.75
                    
                    
                    
                    
                    297,678
                    
                    
                    
                    4.02
                    
                    
                    $
                    5.00Over
      $5.00 to $5.50
                    
                    
                    1,021,810
                    
                    
                    
                    1.99
                    
                    
                    $
                    5.00
                    
                    
                    
                    
                    1,020,472
                    
                    
                    
                    1.98
                    
                    
                    $
                    5.00Over
      $5.50
                    
                    
                    91,334
                    
                    
                    
                    3.33
                    
                    
                    $
                    5.89
                    
                    
                    
                    
                    89,058
                    
                    
                    
                    3.32
                    
                    
                    $
                    5.883,019,073
                    
                    
                    
                    3.62
                    
                    
                    $
                    2.77
                    
                    $ 20,834
                    
                    
                    1,693,997
                    
                    
                    
                    2.75
                    
                    
                    $
                    4.26
                    
                    $
1,667





The
aggregate intrinsic value in the preceding table represents the difference
between the Company’s closing stock price and the exercise price of each
in-the-money option on the last trading day of the period presented. For the
year ended March 31, 2009, 43,576 options to purchase the Company’s common stock
were exercised under the plan resulting in $51,643 in proceeds to the
Company.





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At March
31, 2009 the Company has granted options for 1,325,076 shares of the Company’s
common stock that are unvested that will result in $460,093 of compensation
expense over the weighted-average period of  20.3 months.


In
addition to option grants, during the years ended March 31, 2009 and March 31,
2008 and March 31, 2007, the Company granted and issued under the 2005 Equity
Compensation Plan a total of $0, $0 and $98,194 and $0 shares, respectively, of
common stock at $5.00 to $5.90 per share to employees, consultants and directors
for services provided.





Year
      ended
                      March 31, 2009
                    
                    
                    Year
      ended
                      March 31, 2008
                    
                    
                    Year
      ended
                      March 31, 2007Shares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    AmountEmployees
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    
                    28,044
                    
                    
                    $
                    140,220Consultants
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    49,150
                    
                    
                    
                    257,450Directors
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21,000
                    
                    
                    
                    118,500-
                    
                    
                    $
                    -
                    
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    
                    98,194
                    
                    
                    $
                    516,170





Note
7 – Income Taxes





The
Company accounts for income taxes in accordance with Statement of Financial
Accounting Standard No. 109, Accounting for Income Taxes (SFAS
109).  Under the provisions of SFAS 109, a deferred tax liability or
asset (net of a valuation allowance) is provided in the financial statements by
applying the provisions of applicable laws to measure the deferred tax
consequences of temporary differences that will result in net taxable or
deductible amounts in future years as a result of events recognized in the
financial statements in the current or proceeding years.





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Income
tax provision consisted of the following:




Income
      tax provision consisted of the following:2009
                      
                      
                      2008Current:Federal
                      
                      $
                      -
                      
                      
                      $
                      -ForeignState
                      
                      
                      3,238
                      
                      
                      
                      -3,238
                      
                      
                      
                      -Deferred:Federal
                      
                      
                      -
                      
                      
                      
                      -Foreign
                      
                      
                      -
                      
                      
                      
                      -State
                      
                      
                      -
                      
                      
                      
                      --
                      
                      
                      
                      -Income
      Tax Provision
                      
                      $
                      3,238
                      
                      
                      $
                      -Reconciliation
      of effective tax rate:2009
                      
                      
                      2008Federal
      taxes at statutory rate
                      
                      
                      34.00
                      %
                      
                      
                      34.00
                      %State
      taxes, net of federal benefit
                      
                      
                      3.01
                      %
                      
                      
                      0.00
                      %Permanent
      items
                      
                      
                      -2.51
                      %
                      
                      
                      0.00
                      %Change
      in Effective Tax Rate
                      
                      
                      -4.62
                      %
                      
                      
                      0.00
                      %Other
      Adjustments
                      
                      
                      1.96
                      %
                      
                      
                      0.00
                      %Valuation
      Allowance
                      
                      
                      -31.88
                      %
                      
                      
                      -34.00
                      %Effective
      income tax rate
                      
                      
                      -0.03
                      %
                      
                      
                      0.00
                      %2009
                      
                      
                      2008Deferred
      tax assets:Net
      Operating Loss
                      
                      $
                      14,037,255
                      
                      
                      $
                      10,470,067R
      & D Credit carryforwards
                      
                      
                      622,739
                      
                      
                      
                      448,892Intangibles
      and Fixed Assets
                      
                      
                      32,486
                      
                      
                      
                      66,332Accrued
      Compensation
                      
                      
                      256,172
                      
                      
                      
                      33,589Allowance
      for Bad Debt
                      
                      
                      24,056
                      
                      
                      
                      197,674Reserve
      for Customer Returns
                      
                      
                      37,835
                      
                      
                      
                      260,413Warranty
      Reserve
                      
                      
                      25,877
                      
                      
                      
                      27,891Other
      Accrued Liabilities
                      
                      
                      -
                      
                      
                      
                      -Prepaid
      Expenses
                      
                      
                      (45,654
                      )
                      
                      
                      -SFAS
      123R
                      
                      
                      1,483,389
                      
                      
                      
                      1,684,483Charitable
      Contributions
                      
                      
                      4,760
                      
                      
                      
                      1,989Other
                      
                      
                      -Gross
      deferred tax assets
                      
                      $
                      16,478,915
                      
                      
                      $
                      13,191,330Deferred
      tax liabilities:Intangibles
      and fixed assets
                      
                      $
                      -
                      
                      
                      $
                      -Other
                      
                      
                      -Gross
      deferred tax liabilities
                      
                      
                      -
                      
                      
                      
                      -Net
      deferred tax assets before valuation allowance
                      
                      
                      16,478,915
                      
                      
                      
                      13,191,330Valuation
      Allowance
                      
                      
                      (16,478,915
                      )
                      
                      
                      (13,191,330
                      )Deferred
      Tax Assets (Liabilities), Net
                      
                      $
                      -
                      
                      
                      $
                      -




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The Tax
Reform Act of 1986 contains provisions that limit the utilization of net
operating loss and tax credit carry-forwards if there has been a change of
ownership as described in Section 382 of the Internal Revenue
Code.  The Company has not prepared an analysis to determine if a
change of ownership has occurred.  Such a change of ownership may
limit the Company’s utilization of its net operating losses.





At March
31, 2009 and March 31, 2008, respectively, approximately $38.3 million of net
operating loss carry-forwards for federal income tax purposes were available to
offset future taxable income through the year 2029.  As of March 31,
2009 approximately $546 thousand of the net operating loss carry-forwards are
attributable to stock options, the benefit of which will be credited to
additional paid-in capital if realized.  The ultimate realization of
these assets is dependent upon the generation of future taxable income
sufficient to offset the related deductions and loss carry-forwards within the
applicable carry-forward period.  Accordingly, a valuation allowance
has been established against all deferred tax assets including the net operating
loss carry-forwards.





The Tax
Reform Act of 1986 contains provisions that limit the utilization of net
operating loss and tax credit carry-forwards if there has been a change of
ownership as described in Section 382 of the Internal Revenue
Code.  The Company has not prepared an analysis to determine if a
change of ownership has occurred.  Such a change of ownership may
limit the Company's utilization of its net operating losses.





At March
31, 2009 and March 31, 2008, respectively, approximately $38.3 million and $28.5
million of net operating loss carry-forwards for federal income tax purposes
were available to offset future taxable income through the year
2029.  As of March 31, 2009 approximately $546 thousand of the net
operating loss carry-forwards are attributable to stock options, the benefit of
which will be credited to additional paid-in capital if realized. The ultimate
realization of these assets is dependent upon the generation of future taxable
income sufficient to offset the related deductions and loss carry-forwards
within the applicable carry-forward period.  Accordingly, a valuation
allowance has been established against all deferred tax assets including the net
operating loss carry-forwards.





In
June 2006, the Financial Accounting Standards Board (“FASB”) issued
Interpretation No. 48, “Accounting for Uncertainties in
Income Taxes, an interpretation of SFAS No. 109, Accounting for Income
Taxes” (“FIN 48”). FIN 48 prescribes a recognition threshold and
measurement attribute for the recognition and measurement of tax positions taken
or expected to be taken on income tax returns.  FIN 48 also provides
guidance on de-recognition of income tax assets and liabilities, classification
of current and deferred income tax assets and liabilities, and accounting for
interest and penalties associated with tax positions.





Based on
management’s assessment of FIN 48, it was concluded that the adoption of FIN 48,
as of April 1, 2007, had no significant impact on the Company’s results of
operations or financial position, and required no adjustments to the opening
balance sheet accounts.  The year-end analysis supports the same
conclusion, and the Company does not have an accrual for uncertain tax positions
as of March 31, 2009.  Included in net deferred tax assets is $622k of
research credits.  While the company believes that the credit
calculations are correct, it is possible that upon an examination by taxing
authorities, the research credits available to offset future taxable income may
be reduced in whole or in part.  However, as the company is not
currently recognizing a benefit for the research credits, there is no impact to
the financial statements pursuant to FIN 48.  There have been no
income tax related interest or penalties assessed or recorded and if interest
and penalties were to be assessed, the Company would charge interest and
penalties to income tax expense.  It is not anticipated that unrecognized
tax benefits would significantly increase or decrease within 12 months of the
reporting date.  The Company files income tax returns in the U.S. and
various state jurisdictions and there are open statutes of limitations for
taxing authorities to audit the Company’s tax returns from year ended December
31, 2005 through the current period.




Note
8 – Related Party Transactions




The
following transactions were entered into with our executive officers, directors
and 5% or greater shareholders.




In April
2008, the Company paid Linda Graebner $5,000 in consulting fees prior to her
joining the Board of Directors in July.





On May
19, 2008, the Company and Jack J. Walker, one of the Company’s directors, acting
as co-borrowers, entered into a Business Loan Agreement with First National Bank
(the “Business Loan Agreement”) for a loan to the Company in the principal
amount of $1,000,000 (the “First National Loan”).  The Company has
agreed, among other things, that while the Business Loan Agreement is in effect,
the Company will not (without First National Bank's prior written consent): (i)
incur or assume indebtedness, except for trade debt in the ordinary course of
business, capital leases in an amount not to exceed $500,000, and capital
expenditures of not more than $500,000 during any fiscal year; (ii) sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or
encumber any of the Company’s assets (except as specifically allowed), or
(iii) sell with recourse any of the Company’s accounts, except to First
National Bank. In the event of a default under the First National Loan, at First
National Bank's option, all indebtedness owed under the First National Loan will
become immediately due and payable.





Pursuant
to the Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19,
2009.  The First National Note also provides for a minimum interest
charge of $250, but otherwise may be prepaid at any time without
penalty.  In the event of a default under the First National Note, the
interest rate will be increased by a margin of 4% over the current rate of
interest.  As of March 31, 2009, $1,001,146 was outstanding under the
First National Note, including accrued interest.





On May
19, 2009, the Company, Mr. Walker, and FNB entered into a Change in Terms
Agreement (the “Change in Terms Agreement”), extending the maturity of the First
National Loan until July 19, 2009, and increasing the interest rate from the
Wall Street Journal Prime Rate plus .50% floating to the Wall Street Journal
Primate Rate plus 2.0% floating, with a floor interest rate of
5.50%.





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On May
22, 2008, the Company entered into a Loan Agreement (the “WLLC Loan Agreement”)
and associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLLC Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the
Company.  As a condition of the WLLC Loan, the Company paid WLLC a
non-refundable commitment fee of $37,500. Further, in consideration of WLLC
holding available funds equal to the principal amount not yet disbursed, the
Company must pay a non-refundable fee of 1% of the retained funds as a holding
fee, payable quarterly.  If not paid sooner, the WLLC Loan, if drawn
upon, will be due and payable on April 1, 2009.  We granted WLLC a
security interest in all of the Company’s assets, subordinate to the security
interests in such assets granted to FCC and First National Bank (each as
described herein).  Further, in the event we receive any equity
financing, all obligations due under the WLLC Loan Agreement become immediately
due and payable.  In the event of any default under the WLLC Loan
Agreement, WLLC may, at its option, declare all amounts owed immediately due and
payable, foreclose on the security interest granted, and increase the annual
rate of interest to 18%.  As of March 31, 2009, loans totaling
$1,233,371 were outstanding under the WLLC Loan Agreement, including accrued
interest.





The WLLC
Loan Agreement also set forth the terms and conditions under which Mr. Walker
agreed to act as co-borrower on the First National Loan. In consideration for
Mr. Walker's agreement to act as co-borrower, the Company agreed to: (i) pay Mr.
Walker a service fee of $50,000; (ii) allow Mr. Walker to purchase the First
National Loan in the event of the Company’s default under the First National
Loan and to repay Mr. Walker any amounts expended by Mr. Walker on the First
National Loan, together with interest at an annual rate of 18%; and (iii)
terminate and release Mr. Walker from any obligation under the First National
Loan on the one-year anniversary of the execution date of the First National
Loan Agreement.





On May
19, 2009, Mr. Walker, WLLC, and the Company entered into a Loan Extension
Agreement (the “Loan Extension Agreement”) effective April 1, 2009, extending
the maturity date of the WLLC Loan until June 30, 2009.  The Company
paid WLLC $5,000 in consideration for the loan extension.  The current
balance of principal due on the WLLC Loan is $1,200,000.  The parties
agreed that the Company is not entitled to any further disbursements under the
WLLC Loan.  In the event the Company receives any equity financing,
all obligations due under the WLLC Loan become immediately due and
payable.





On June
30, 2009, principal totaling $1,200,000 outstanding under the WLLC Loan
Agreement was converted to 1,200 shares of Series A Convertible Preferred Stock,
and the WLLC Loan Agreement was terminated.




As
further discussed in Note 3, on June 23, 2008, the Company entered into a Loan
and Security Agreement with FCC, LLC, d/b/a First Capital (“FCC”) (the “FCC Loan
Agreement”) for a revolving credit facility in the amount of $12,000,000 (the
“Revolving Credit Facility”).  The actual amount available for
borrowing under the Revolving Credit Facility is limited at any given time to
the sum of a percentage of eligible inventory and a percentage of eligible
accounts receivable, each as defined in the FCC Loan Agreement.  Mr.
Walker provided a guarantee against certain contingent liabilities related to
the FCC Loan Agreement.  In return for this guarantee, the Company
paid Mr. Walker a fee of $7,500.





As of
December 31, 2008, the Company was not in compliance with three covenants under
the revised FCC Loan Agreement.  Effective as of January 31, 2009, FCC
and the Company executed a forbearance agreement related to the FCC Loan
Agreement (the “Forbearance Agreement”).  Pursuant to the terms of the
Forbearance Agreement, FCC agreed to forbear its rights and remedies under the
FCC Loan Agreement and related documents with respect to any existing defaults
under the FCC Loan Agreement (the “Existing Defaults”) until the earlier of June
30, 2009, or the date of occurrence of a default other than the Existing
Defaults.  The Forbearance Agreement also increases the Company’s
ability to borrow against inventory and accounts receivable during the term of
the Forbearance Agreement (the “Additional Borrowing Capacity”).  In
return for FCC providing the forbearance period and the Additional Borrowing
Capacity, the Company agreed to pay FCC a $25,000 forbearance fee (in five
monthly installments), an amendment fee equal to 1.5% per month on the average
utilization of the Additional Borrowing Capacity, and issue to FCC a minimum of
250,000 warrants to purchase common stock of the Company at a purchase price of
$1.00 per share.  Simultaneously with the execution of the Forbearance
Agreement, Mr. Walker provided a $1 million guarantee against certain
liabilities under the FCC Loan Agreement.  As compensation for
providing the guarantee, the Company issued to Mr. Walker 50,000 warrants to
purchase common stock of the Company at a purchase price of $1.00 per
share.





On June
1, 2009, the Company, FCC, and Jack J. Walker, as guarantor, executed a Second
Forbearance Agreement, effective as of April 29, 2009 (the “Second Forbearance
Agreement”), in which FCC agreed to forbear from exercising its rights and
remedies under the Loan Agreement until June 30, 2009, if no further defaults
occur.  The Second Forbearance Agreement also increased the advance
rate against inventory until July 1, 2009, and eliminated the Company’s
obligation to pay the monthly forbearance and amendment fees and to provide cash
flow projections.  In return, AeroGrow agreed to pay FCC a fee of
$60,000 no later than June 30, 2009.





As of
July 1, 2009, FCC, AeroGrow, and Jack J. Walker, as guarantor, executed an
amendment to the FCC Loan Agreement (the “Third FCC Amendment”).  The
Third FCC Amendment reduced the maximum amount of the Revolving Credit Facility
to $8 million, re-set the covenant levels beginning July 1, 2009, and waived
existing defaults.  In addition, the Third FCC Amendment re-set the
formulas for determining the borrowing base against which the Company can
borrow.  The Third FCC Amendment also changed the definition of Base
Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%, and
increased the interest rate to Base Rate plus 4.0%.  The Third FCC
Amendment provides for a $30,000 success fee to be paid by the Company to FCC on
April 30, 2010.  In addition, the Third FCC Amendment replaces a
minimum borrowing fee with a fee calculated as 0.50% per annum of the daily
average unused portion of the Revolving Credit Facility, payable monthly in
arrears.  Finally, the Third FCC Amendment increased the annual
facility fee to 1.0% of the maximum amount of the Revolving Credit Facility,
from 0.75%.





During
the years ended March 31, 2009, March 31, 2008 and March 31, 2007, the Company
paid $0, $24,000 and $44,472, respectively, to a director for legal
services.





During
the years ended March 31, 2009, March 31, 2008 and March 31, 2007, the Company
paid consulting fees totaling $0, $0 and $81,238, respectively, to one of its
directors who resigned on April 16, 2007, for services related to the
development of an international channel of distribution for the Company’s
products and other consulting services.





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Also,
during the years ended March 31, 2009, March 31, 2008 and March 31, 2007, the
Company incurred fees totaling $0, $771,102 and $640,186, respectively, for
various video and web projects, including production of the Company’s
infomercial to promote its products, to MedEd Architects LLC a video production
company owned 33% by the Company’s former Chief Marketing Officer.





During
the years ended March 31, 2009, March 31, 2008 and March 31, 2007, the Company
paid fees totaling $0, $20,000 and $0, respectively, to one of its directors for
services provided to the Board of Directors in connection with the hiring and
company integration of a new chief executive officer.





Note
9 – Commitments and Contingencies





We lease
a 21,012 square foot office space in, Boulder, Colorado, with a current monthly
rent of $18,385. We also pay our proportionate share of building taxes,
insurance and operating expenses. The initial term continues until January 31,
2012, unless modified under specified circumstances. The agreement contains
other standard office lease provisions.





We
rent space in Longmont, Colorado, pursuant to a month-to-month rental
agreement.  The Longmont facility temporarily houses our nutrient
tablet manufacturing operation.  We currently lease approximately
2,400 square feet of space in the Longmont facility at a monthly rental rate of
$1,662 plus operating expenses.





We also
rent warehouse and manufacturing space in Indianapolis, Indiana.  The
Indianapolis facility houses our distribution and fulfillment operations and our
seed kit manufacturing operations.  We currently lease approximately 90,400
square feet of space in this facility at a monthly rental rate of $16,950 with
no additional operating expenses.  The initial term of the lease
expires on February 28, 2011.





Future
cash payments under such operating lease for the remaining years of the leases
are as follows:




Year
      Ended
                                  
                                  RentMarch
      31, 2010
                                  
                                  $
                                  613,839March
      31, 2011
                                  
                                  
                                  576,818March
      31, 2012
                                  
                                  
                                  332,607$
                                  1,523,264


Rent
expense for the years ended March 31, 2009, March 31, 2008 and March 31, 2007,
was $807,702, $432,338 and $348,454, respectively.




In
connection with the Linens ‘N Things (“LNT”) bankruptcy proceedings, a Complaint
to Avoid and Recover Preferential Transfers was filed by LNT in the United
States Bankruptcy Court for the District of Delaware on April 20, 2009 (the
“Complaint”).  The Complaint alleges that, pursuant to Sections 547
and 550 of the United States Bankruptcy Code, we are required to return to LNT
approximately $623,000 in “preferential” transfers allegedly made to AeroGrow
during the 90-day period preceding the filing of the LNT bankruptcy cases. The
Complaint also alleges that AeroGrow is required to pay to LNT approximately
$44,000 on account of credits allegedly earned but not redeemed by LNT prior to
the filing of the LNT bankruptcy cases.  We engaged outside counsel
and filed a response to the Complaint on May 8, 2009 disputing that we have any
obligation to either return the “preferential” transfers allegedly made, or to
pay the credits allegedly earned, to LNT.  As of March 31, 2009, an
estimate has been accrued in our balance sheet and consolidated statement of
operations in anticipation of the cost of defending, or settling, this
matter.  It is reasonably possible that a change in such estimate will
occur in the near term.





Note
10 – Stockholders’ Equity





During
the year ended March 31, 2007, the Company issued 98,194 shares of common stock
under its 2005 Plan including 5,000 shares to the Company’s Chief Financial
Officer as additional compensation, 21,000 shares to its directors, 23,044
shares to other employees, and 49,150 shares to consultants.




During
the year ended March 31, 2007, the Company issued 8,872 shares of stock to a
landlord and recorded $44,360 as additional rent expense.




During
the year ended March 31, 2007, the Company issued 11,354 shares of stock to its
public relations firm and recorded $56,770 as additional marketing
expense.




During
the year ended March 31, 2007, the Company issued 6,858 shares of stock to an
unrelated third-party in settlement of a claim from its previous parent company
and recorded $40,462 as additional general and administrative
expense.




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On March
16, 2007, the Company completed a private offering in which the Company sold an
aggregate of 833,400 shares of common stock and warrants to purchase 833,400
shares of common stock (the "2007 Investor Warrants") in the form of units
consisting of one share of common stock and one warrant per unit (the "2007
Offering"). The units were sold at a price of $6.00 per unit. In addition,
warrants to purchase 83,340 shares of common stock were issued to the placement
agent of the 2007 Offering (the "2007 Agent Warrants," and together with the
2007 Investor Warrants, the "2007 Warrants").




Each 2007
Investor Warrant is exercisable for one share of common stock at an exercise
price of $7.50 per share, and each 2007 Agent Warrant is exercisable for one
share of common stock at an exercise price of $8.25 per share. Each 2007 Warrant
will be exercisable for five years from the closing of the 2007 Offering. The
exercise price and number of shares of common stock underlying the 2007 Warrants
is subject to adjustment on certain events, including reverse stock splits,
stock dividends and recapitalizations, combinations, and mergers where the
Company is not the surviving company. The Company will at all times reserve and
keep available, solely for issuance and delivery upon the exercise of the 2007
Warrants, such shares of common stock underlying the 2007 Warrants, as from time
to time shall be issuable upon the exercise of the 2007 Warrants.




The
Company has the right to require the holders of 2007 Investor Warrants to
exercise the 2007 Investor Warrant if our common stock is quoted on the NASDAQ
Capital Market and, for a period of 20 consecutive trading days, the closing bid
price of the common stock has been above $10.00 per share and the daily trading
volume has been at least 50,000 shares, in each case on each of the 20
consecutive trading days.




On March
28, 2007, the Company completed an additional private offering in which the
Company sold an aggregate of 333,360 shares of common stock and warrants to
purchase 333,360 shares of common stock in the form of units consisting of one
share of common stock and one warrant per unit. The units were sold at a price
of $6.00 per unit. In addition, warrants to purchase 33,336 shares of common
stock were issued to the placement agent of this private offering. The warrants
issued to the investors and the placement agent has the same terms as the 2007
Investor Warrants and the 2007 Agent Warrants, respectively.




In
September 2007, the Company completed a private offering in which it sold an
aggregate of 800,000 shares of common stock and warrants to purchase 800,000
shares of common stock at an exercise price of $8.00 per share in the form of
units consisting of one share of common stock and one warrant per unit, (the
“September 2007 Offering”). The units were sold at a per unit price of $6.25.
Upon closing of offering, the Company received gross proceeds of $5,000,000,
less a placement agent fee in the amount of $400,000 and approximately $170,000
in other expenses related to the offering. In addition, the Company issued
warrants to purchase 80,000 shares of common stock at an exercise price of $8.25
per share to the placement agent of this offering.




During
the year ended March 31, 2008, the Company received proceeds, net of $5,000 in
expenses, of $987,500 from the exercise of warrants to purchase 174,750 shares
of the Company’s common stock at prices ranging from $2.50 to $6.25 per
share.




On August
1, 2007, the Company entered into an agreement with an investor relations firm
that included a grant of a five year warrant to purchase 50,000 shares of the
Company’s common stock at an exercise price of $6.96, the closing market price
as of the date of the agreement. The warrants will vest monthly over a one year
period unless the agreement is terminated. The Company used the following
weighted average assumptions for valuation of the warrants issued: no dividend
yield; expected volatility rate of 50.3%; risk free interest rate of 6%; and
average lives of three years, resulting in a total value of $138,023 to be
recognized monthly over the twelve month period. As of March 31, 2008, the
Company had recognized $92,065 of this expense.




Between
November 17, 2008 and November 21, 2008, the Company agreed to reduce the per
share exercise prices of certain of its outstanding warrants to purchase shares
of its common stock from original exercise prices ranging from $5.00 to $8.25 to
reduced exercise prices ranging from $0.66 to $0.75 in connection with an
agreement by the holders of such warrants to immediately exercise such
warrants.  In connection with such warrant exercises, the Company
received $873,289 in cash proceeds and issued 1,189,979 shares of its common
stock.





In
connection with the warrant repricing and exercise of such warrants, the Company
issued replacement warrants to such warrant holders (the “Replacement
Warrants”), permitting the holder to purchase one share of the Company’s common
stock for every two shares that were purchased pursuant to the exercise of such
repriced warrants at an exercise price of $2.00 per share.  In total,
Replacement Warrants representing the right to purchase 594,990 shares of
Company’s common stock were issued, and the Replacement Warrants have
termination dates ranging from September 13, 2010 to September 4,
2014.





The
shares of common stock issued upon exercise of the repriced warrants and the
issuance of the Replacement Warrants were done in reliance on Section 4(2) of
the Securities Act of 1933, as amended, and Rule 506 promulgated
thereunder.





The
Company's Articles of Incorporation authorize the issuance of 20,000,000 shares
of preferred stock with $.001 par value.    As of March 31,
2009, no shares of preferred stock have been issued.




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A summary
of the Company’s warrant activity for the period from April 1, 2006 through
March 31, 2009 is presented below:




WeightedWarrants
                                                
                                                
                                                Average
                                                
                                                AggregateOutstanding
                                                
                                                
                                                Exercise Price
                                                
                                                Intrinsic ValueOutstanding,
      April 1, 2006
                                                
                                                
                                                4,515,658
                                                
                                                
                                                $
                                                7.04Granted
                                                
                                                
                                                1,283,436
                                                
                                                
                                                
                                                7.57Exercised
                                                
                                                
                                                (39,000
                                                )
                                                
                                                
                                                2.98Expired
                                                
                                                
                                                (36,000
                                                )
                                                
                                                
                                                3.08Outstanding,
      March 31, 2007
                                                
                                                
                                                5,724,094
                                                
                                                
                                                
                                                7.21Granted
                                                
                                                
                                                930,000
                                                
                                                
                                                
                                                7.97Exercised
                                                
                                                
                                                (174,750
                                                )
                                                
                                                
                                                5.68Expired
                                                
                                                
                                                (784,608
                                                )
                                                
                                                
                                                12.46Outstanding,
      March 31, 2008
                                                
                                                
                                                5,694,736
                                                
                                                
                                                
                                                6.66Granted
                                                
                                                
                                                935,991
                                                
                                                
                                                
                                                1.65Exercised
                                                
                                                
                                                (1,199,979
                                                )
                                                
                                                
                                                .75Expired
                                                
                                                
                                                (15,006
                                                )
                                                
                                                
                                                2.50Outstanding,
      March 31, 2009
                                                
                                                
                                                5,415,742
                                                
                                                
                                                $
                                                5.76
                                                
                                                $                                                         -






As of
March 31, 2009, the Company had the following outstanding warrants to purchase
its common stock


:




Weighted
                        
                        
                        WeightedWarrants
                        
                        
                        Average
                        
                        
                        AverageOutstanding
                        
                        
                        Exercise Price
                        
                        
                        Remaining Life (Yrs)3,200
                        
                        
                        $
                        0.66
                        
                        
                        
                        1.45325,000
                        
                        
                        $
                        1.00
                        
                        
                        
                        4.88594,991
                        
                        
                        $
                        2.00
                        
                        
                        
                        2.5916,000
                        
                        
                        $
                        2.07
                        
                        
                        
                        4.25450,000
                        
                        
                        $
                        5.00
                        
                        
                        
                        1.45505,796
                        
                        
                        $
                        6.00
                        
                        
                        
                        1.941,937,299
                        
                        
                        $
                        6.25
                        
                        
                        
                        1.9150,000
                        
                        
                        $
                        6.96
                        
                        
                        
                        3.34746,956
                        
                        
                        $
                        7.50
                        
                        
                        
                        2.95720,000
                        
                        
                        $
                        8.00
                        
                        
                        
                        5.4366,500
                        
                        
                        $
                        8.25
                        
                        
                        
                        5.435,415,742
                        
                        
                        $
                        5.76
                        
                        
                        
                        2.80








81
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Note
11 – Subsequent Events





On April
16, 2009, the Company was notified by The Nasdaq Stock Market (“Nasdaq”) that
the Company had not paid certain fees required by Listing Rule
5210(d).  On April 30, 2009, Nasdaq notified the Company that the
Nasdaq Hearing Panel had determined to delist the
Company.  Accordingly, Nasdaq suspended trading in the Company’s
shares at the open of business on Monday, May 4, 2009.  On May 4,
2009, the Company’s shares began trading on the Pink Sheets OTC
Market.  On June 8, 2009, the Company’s shares began trading on the
OTC Bulletin Board.





On May
19, 2008, the Company and Jack J. Walker, one of the Company’s directors, acting
as co-borrowers, entered into a Business Loan Agreement with First National Bank
for a loan to the Company in the principal amount of $1,000,000 (the “First
National Loan”).  On May 19, 2009, the Company, Mr. Walker, and First
National Bank entered into a Change in Terms Agreement, extending the maturity
of the First National Loan until July 19, 2009, and increasing the interest rate
from the Wall Street Journal Prime Rate plus .50% floating to the Wall Street
Journal Primate Rate plus 2.0% floating, with a floor interest rate of
5.50%.





On May
22, 2008, the Company entered into a Loan Agreement and associated Promissory
Note with WLoans, LLC, a Colorado limited liability company, as lender, and Jack
J. Walker.  The WLLC Loan Agreement provides for a loan up to a
maximum of $1,500,000 for business purposes, at an annual interest rate of
12%.  On May 19, 2009, Mr. Walker, WLoans, LLC, and the Company
entered into a Loan Extension Agreement effective April 1, 2009, extending the
maturity date of the WLLC Loan until June 30, 2009.  The Company paid
WLLC $5,000 in consideration for the loan extension.  The parties
agreed also that the Company is not entitled to any further disbursements under
the WLLC Loan.  In the event the Company receives any equity
financing, all obligations due under the WLLC Loan become immediately due and
payable.  On June 30, 2009, principal totaling $1,200,000 outstanding
under the WLLC Loan Agreement was converted to 1,200 shares of Series A
Convertible Preferred Stock, and the WLLC Loan Agreement was
terminated.





On June
23, 2008, the Company entered into a Loan and Security Agreement with FCC, LLC,
d/b/a First Capital for a revolving credit facility in the amount of
$12,000,000.  On June 1, 2009, the Company, FCC, and Jack J. Walker,
as guarantor, executed a Second Forbearance Agreement, effective as of April 29,
2009, in which FCC agreed to forbear from exercising its rights and remedies
under the FCC Loan Agreement until June 30, 2009, if no further defaults
occur.  The Second Forbearance Agreement also increased the advance
rate against inventory until July 1, 2009, and eliminated the Company’s
obligation to pay the monthly forbearance and amendment fees and to provide cash
flow projections.  In return, AeroGrow agreed to pay FCC a fee of
$60,000 no later than June 30, 2009.  In connection with the Second
Forbearance Agreement, FCC is permitting AeroGrow to borrow up to $800,000 more
than would otherwise be permitted by the applicable borrowing base calculation
under the Loan Agreement.  Such additional borrowing must be repaid by
June 30, 2009.  FCC is not charging AeroGrow a fee for this additional
borrowing capacity.





During
June 2009, the Company entered into a series of transactions to raise new
capital and to enhance liquidity.





·
            Issuance of Series A
      Convertible Preferred Stock – On June 30, 2009, the Company issued
      6,836 shares of Series A Convertible Preferred Stock (the “Series A
      Shares”) for aggregate consideration totaling $6,250,341.  2,690
      Series A Shares were issued in exchange for cash invested into the Company
      totaling $2,690,000.  2,332 Series A Shares were issued in
      exchange for the release of existing obligations of the Company totaling
      $2,332,000.  1,642 Series A Shares were issued in exchange for a
      combination of $950,000 in cash, 924,703 shares of the Company’s common
      stock, and 462,352 warrants to purchase shares of the Company’s common
      stock.  172 Series A Shares were issued in exchange for $172,000
      in short term notes receivable having maturities of 90 days or
      less.





The
Series A Shares carry certain rights, preferences and designations, including
the right to convert each Series A Share into 5,000 shares of the Company’s
common stock.  Each Series A Share has an original issue price of
$1,000.  In addition, the Series A Shares were issued with a total of
3,414 warrants (the “Warrants”) to purchase additional Series A Shares at an
exercise price of $1,250 per Series A Share.  The exercise period for
the Warrants expires five years from the date of issuance.  The
holders of the Series A Shares are entitled to receive cumulative dividends in
preference to any dividend on the Company’s common stock at the rate of 8% of
the original issue price per annum, and are entitled to participate pro rata in
any dividends paid on the Company’s common stock on as as-if-converted
basis.  In the event of a sale, liquidation, or other winding up of
the Company, the holders of the Series A Shares are entitled to receive in
preference to the holders of the Company’s common stock a per share amount equal
to the greater of (i) 1.5 times the original issue price, plus any accrued but
unpaid dividends or (ii) the amount that the holder of a Series A Share would
otherwise receive in such event on an as-converted to common stock
basis.  The holders of the Series A Shares will vote along with
holders of the Company’s common stock on an as-if-converted
basis.  Each Series A Share shall have a number of votes equal to the
number of shares of the Company’s common stock then issuable upon conversion of
such Series A Share.  In addition, the holders of the Series A Shares
are entitled to elect three members of the Company’s Board of Directors by an
affirmative vote or consent of the holders of at least a majority of the
outstanding Series A Shares, voting together as a single class.  The
Series A shares also carry certain other rights, including the right to block
certain actions of the Company unless such actions are approved by a vote of the
holders of the Series A Shares voting together as a single class, anti-dilution
provisions, and other rights and preferences commonly associated with preferred
shares.





The
issuance of the Series A Shares was conducted in reliance upon exemptions from
registration under the Securities Act of 1933, as amended (the “Securities
Act”), including, without limitation, those under Regulation D promulgated under
the Securities Act.  The Series A Shares were offered and sold only to
investors who are “accredited investors,” as defined in Rule 501 under the
Securities Act.





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·
            Amendment to Revolving
      Credit Facility – Effective as of July 1, 2009, FCC, AeroGrow, and
      Jack J. Walker, as guarantor, executed an amendment to the FCC Loan
      Agreement (the “Third FCC Amendment”).  The Third FCC Amendment
      reduced the maximum amount of the Revolving Credit Facility to $8 million,
      re-set the covenant levels beginning July 1, 2009, and waived existing
      defaults.  In addition, the Third FCC Amendment re-set the
      formulas for determining the borrowing base against which the Company can
      borrow.  The Third FCC Amendment also changed the definition of
      Base Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%,
      and increased the interest rate to Base Rate plus 4.0%.  The
      Third FCC Amendment provides for a $30,000 success fee to be paid by the
      Company to FCC on April 30, 2010.  In addition, the Third FCC
      Amendment replaces a minimum borrowing fee with a fee calculated as 0.50%
      per annum of the daily average unused portion of the Revolving Credit
      Facility, payable monthly in arrears.  Finally, the Third FCC
      Amendment increased the annual facility fee to 1.0% of the maximum amount
      of the Revolving Credit Facility, from
0.75%.





·
            Accounts Payable
      Conversion to Long-term Debt – On June 30, 2009, the Company
      executed a Promissory Note (the “Promissory Note”) and, along with
      MainPower Electrical Factory, Ltd. (“MainPower), executed a Letter
      Agreement (the “Letter Agreement”).  Pursuant to the terms of
      the Letter Agreement, MainPower agreed to release the Company from
      $1,388,190.79 of existing accounts payable obligations owed by the Company
      to MainPower in return for the Company executing the Promissory Note for
      the same amount.  In addition, the Letter Agreement included
      other provisions relating to the terms and conditions under which AeroGrow
      will purchase AeroGarden products from MainPower.  The
      Promissory Note has a final maturity of June 30, 2011 and carries an
      interest rate of 8% per annum, with interest accrued and added to the
      principal amount of the Promissory Note for the first
      year.  During the second year of the Promissory Note, interest
      is due and payable quarterly.    Principal payments of
      $150,000 are due and payable monthly beginning January 31, 2011, with a
      final payment of all principal and accrued but unpaid interest due on June
      30, 2011.







·
            Adjustments to the
      Amounts and Timing of Payment Against Accounts Payable Balances Due
      – During June 2009, the Company reached agreement with certain suppliers
      of goods and services (the “Suppliers”) to reduce the amounts of existing
      accounts payable obligations owed by the Company to the
      Suppliers.  In aggregate, the accounts payable obligations were
      reduced by approximately $1 million.  The impact of the
      reduction in accounts payable obligations will be reflected in the
      Company’s financial statements for the three months ended June 30,
      2009.  In addition, deferred payment schedules were agreed with
      certain of the Suppliers.





On
June 29, 2009, the Board of Directors of the Company approved an amendment
to the Company’s Bylaws to opt out of the control shares provisions of the
Nevada Revised Statutes.





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 Table of Contents




INDEX
TO EXHIBITS




3.1
            Articles
      of Incorporation of the Company (incorporated by reference to Exhibit 3.1
      of our Current Report on Form 8-K/A-2, filed November 16,
      2006)






3.2
            Certificate
      of Amendment to Articles of Incorporation, dated November 3, 2002
      (incorporated by reference to Exhibit 3.2 of our Current Report on Form
      8-K/A-2, filed November 16, 2006)






3.3
            Certificate
      of Amendment to Articles of Incorporation, dated January 31, 2005
      (incorporated by reference to Exhibit 3.3 of our Current Report on Form
      8-K/A-2, filed November 16, 2006)






3.4
            Certificate
      of Change to Articles of Incorporation, dated July 27, 2005 (incorporated
      by reference to Exhibit 3.4 of our Current Report on Form 8-K/A-2, filed
      November 16, 2006)






3.5
            Certificate
      of Amendment to Articles of Incorporation, dated February 24, 2006
      (incorporated by reference to Exhibit 3.5 of our Current Report on Form
      8-K/A-2, filed November 16, 2006)




3.6
            Certificate
      of Amendment to Articles of Incorporation, dated March 2, 2009
      (incorporated by reference to Exhibit A to our definitive proxy statement
      filed January 2, 2009)


3.7*
              Certificate of Designations of Series
      A Convertible Preferred Stock


3.8
            Amended
      and Restated Bylaws of the Registrant (incorporated by reference to
      Exhibit 3.1 of our Current Report on Form 8-K, filed September 26,
      2008)


3.9*
                Amendment to Bylaws of the
      Registrant




4.1
            Form
      of Certificate of Common Stock of Registrant (incorporated by reference to
      Exhibit 4.1 of our Current Report on Form 8-K, filed March 7,
      2006)




4.2
            Form
      of 2005 Warrant (incorporated by reference to Exhibit 4.2 of our Current
      Report on Form 8-K, filed March 7,
2006)




4.3
            Form
      of 2006 Warrant (incorporated by reference to Exhibit 4.3 of our Current
      Report on Form 8-K, filed March 7,
2006)




4.4
            Form
      of 10% Convertible Note (incorporated by reference to Exhibit 4.4 of our
      Current Report on Form 8-K, filed March 7,
2006)




4.5
            Form
      of $10.00 Redeemable Warrant (incorporated by reference to Exhibit 4.5 of
      our Current Report on Form 8-K, filed March 7,
  2006)




4.6
            Form
      of $15.00 Redeemable Warrant (incorporated by reference to Exhibit 4.6 of
      our Current Report on Form 8-K, filed March 7,
  2006)






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4.7
            Form
      of Conversion Warrant (incorporated by reference to Exhibit 4.7 of our
      Current Report on Form 8-K, filed March 7,
2006)




4.8
            Form
      of 2005 Placement Agent Warrant (incorporated by reference to Exhibit 4.8
      of our Current Report on Form 8-K, filed March 7,
  2006)




4.9
            Form
      of 2006 Placement Agent Warrant (incorporated by reference to Exhibit 4.9
      of our Current Report on Form 8-K, filed March 7,
  2006)




4.10
            Form
      of $2.50 Warrant (incorporated by reference to Exhibit 4.10 of our Current
      Report on Form 8-K, filed March 7,
2006)




4.11
            Form
      of $5.00 Warrant (incorporated by reference to Exhibit 4.11 of our Current
      Report on Form 8-K, filed March 7,
2006)




4.12
            Form
      of Convertible Note Modification Agreement (incorporated by reference to
      Exhibit 10.27 of our Current Report on Form 8-K/A-2, filed November 16,
      2006)




4.13
            Form
      of 2007 March Offering Investor Warrant (incorporated by reference to
      Exhibit 4.1 of our Current Report on Form 8-K, filed March 16,
      2007)




4.14
            Form
      of 2007 March Offering Agent Warrant (incorporated by reference to Exhibit
      4.2 of our Current Report on Form 8-K, filed March 16,
    2007)




4.15
            Form
      of 2007 March Offering Second Tranche Investor Warrant (incorporated by
      reference to Exhibit 4.15 of our Annual Report on Form 10-KSB, filed June
      29, 2007)




4.16
            Form
      of 2007 March Offering Second Tranche Agent Warrant (incorporated by
      reference to Exhibit 4.16 of our Annual Report on Form 10-KSB, filed June
      29, 2007)




4.17
            Form
      of 2007 September Offering Investor Warrant (incorporated by reference to
      Exhibit 4.1 of our Current Report on Form 8-K, filed September 5,
      2007)




4.18
            Form
      of 2007 September Offering Agent Warrant (incorporated by reference to
      Exhibit 4.2 of our Current Report on Form 8-K, filed September 5,
      2007)




4.19*
            Form of Series A Preferred Stock
    Warrant




4.20*
            Investor Rights
Agreement




10.1
            Lease
      Agreement between the Company and United Professional Management, Inc.
      dated October 1, 2003, as amended by a Lease Amendment dated October 7,
      2003, and a Lease Amendment dated April 71 2005 (incorporated by reference
      to Exhibit 10.1 of our Current Report on Form 8-K, filed March 7,
      2006)




10.2
            Amended
      2003 Stock Option Plan (incorporated by reference to Exhibit 10.2 of our
      Current Report on Form 8-K, filed March 7,
2006)




85
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10.3
            Form
      of Stock Option Agreement relating to the 2003 Stock Option Plan
      (incorporated by reference to Exhibit 10.3 of our Current Report on Form
      8-K, filed March 7, 2006)




10.4
            2005
      Equity Compensation Plan (incorporated by reference to Exhibit 10.4 of our
      Current Report on Form 8-K, filed March 7,
2006)




10.5
            Form
      of Stock Option Agreement relating to the 2005 Equity Compensation Plan
      (incorporated by reference to Exhibit 10.5 of our Current Report on Form
      8-K, filed March 7, 2006)




10.6
            Form
      of Restricted Stock Grant Agreement relating to the 2005 Equity
      Compensation Plan (incorporated by reference to Exhibit 10.6 of our
      Current Report on Form 8-K, filed March 7,
2006)




10.7
            Form
      of Lock-up Agreement for certain investors (incorporated by reference to
      Exhibit 10.7 of our Current Report on Form 8-K, filed March 7,
      2006)




10.8
            Placement
      Agent Agreement between Keating Securities, LLC and the Company dated May
      27, 2005 with respect to the Convertible Note offering (incorporated by
      reference to Exhibit 10.8 of our Current Report on Form 8-K, filed March
      7, 2006)




10.9
            Placement
      Agent Agreement between Keating Securities, LLC and the Company dated
      February 6, 2006 with respect to the 2006 Offering (incorporated by
      reference to Exhibit 10.9 of our Current Report on Form 8-K, filed March
      7, 2006)




10.10
            Business
      Lease dated December 8, 2004, between the Company and Investors
      Independent Trust Company (incorporated by reference to Exhibit 10.10 of
      our Current Report on Form 8-K, filed March 7,
  2006)




10.11
            Consulting
      Arrangement between Randy Seffren and the Company dated October 13, 2004
      (incorporated by reference to Exhibit 10.11 of our Current Report on Form
      8-K, filed March 7, 2006)




10.12
            Contract
      between the Company and Innotrac Corporation dated October 7, 2005
      (incorporated by reference to Exhibit 10.12 of our Current Report on Form
      8-K, filed March 7, 2006)




10.13
            Letter
      of Agreement dated September 30, 2005, between the Company and Kenneth
      Dubach (incorporated by reference to Exhibit 10.13 of our Current Report
      on Form 8-K, filed March 7, 2006)




10.14
            Consulting
      Agreement between the Company and Jerry Gutterman dated May 16, 2005
      (incorporated by reference to Exhibit 10.14 of our Current Report on Form
      8-K, filed March 7, 2006)




10.15
            Manufacturing
      Agreement among Mingkeda Industries Co., LTD., Source Plus, Inc. and the
      Company dated September 30, 2005 (incorporated by reference to Exhibit
      10.15 of our Current Report on Form 8-K, filed March 7,
    2006)




10.16
            Form
      of Subscription Agreement relating to the issuance of our convertible
      notes and redeemable 2005 warrants (incorporated by reference to Exhibit
      10.16 of our Current Report on Form 8-K, filed March 7,
    2006)






86
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10.17
            Form
      of Assignment of Application Agreement between the Company and our
      executives, employees and consultants (incorporated by reference to
      Exhibit 10.17 of our Current Report on Form 8-K, filed March 7,
      2006)




10.18
            Form
      of Non-disclosure Agreement between the Company and our executives,
      employees and consultants (incorporated by reference to Exhibit 10.18 of
      our Current Report on Form 8-K, filed March 7,
  2006)




10.19
            Form
      of Statement of Confidentiality, Non-Disclosure and Non-Compete Agreement
      between AeroGrow and our employees, consultants and other third-party
      contractors (incorporated by reference to Exhibit 10.19 of our Current
      Report on Form 8-K, filed March 7,
2006)




10.20
            Letter
      agreement dated July 15, 2005 between the Company and Patrice Tanaka &
      Company (incorporated by reference to Exhibit 10.20 of our Current Report
      on Form 8-K, filed March 7, 2006)




10.21
            Production
      Agreement dated October 3, 2005, between AeroGrow and Respond2, Inc.
      (incorporated by reference to Exhibit 10.21 of our Current Report on Form
      8-K, filed March 7, 2006)




10.22
            Form
      of Subscription Agreement relating to offering consummated February 24,
      2006 for the sale of common stock and warrants* (incorporated by reference
      to Exhibit 10.22 of our Current Report on Form 8-K, filed March 7,
      2006)




10.23
            Employment
      Agreement between the Company and W. Michael Bissonnette (incorporated by
      reference to Exhibit 10.23 of our Current Report on Form 8-K, filed March
      7, 2006)




10.24
            Employment
      Agreement between the Company and Mitchell Rubin (incorporated by
      reference to Exhibit 10.24 of our Current Report on Form 8-K, filed March
      7, 2006)




10.25
            Employment
      Agreement between the Company and Jeff Brainard (incorporated by reference
      to Exhibit 10.25 of our Current Report on Form 8-K/A, filed May 16,
      2006)




10.26
            Employment
      Agreement between the Company and Randal Seffren, dated July 24, 2006
      (incorporated by reference to Exhibit 10.26 of our Current Report on Form
      8-K, filed July 27, 2006)




10.27
            Waiver
      and Amendment No. 1 to Agreement and Plan of Merger (incorporated by
      reference to Exhibit 10.26 our Current Report on Form 8-K/A-2, filed
      November 16, 2006)




10.28
            Lease
      Agreement with Pawnee Properties, LLC (incorporated by reference to
      Exhibit 10.27 of our Current Report on Form 8-K, filed August 2,
      2006)




10.29
            Registration
      Rights Agreement dated as of March 12, 2007, by and between the Company
      International, Inc. and the other parties thereto (incorporated by
      reference to Exhibit 10.1 of our Current Report on Form 8-K, filed March
      16, 2007)




10.30
            Product
      Supply Agreement between the Company and Global Infomercial Services,
      Inc., dated May 30, 2007 (incorporated by reference to Exhibit 10.1 of our
      Current Report on Form 8-K, filed June 4,
2007)




10.31
            Registration
      Rights Agreement dated as of March 30, 2007, by and betweenthe
      Company and the other parties thereto.
      (incorporated by reference to Exhibit 10.31 of our Annual Report on Form
      10-KSB for the year ended March 31,
2007)




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 Table of Contents




10.32
            Registration
      Rights Agreement, dated as of September 4, 2007, by and between the
      Company and the other parties thereto (incorporated by reference to
      Exhibit 10.1 of our Current Report on Form 8-K, filed September 5,
      2007)




10.33
            Letter
      Agreement between the Company and Jervis B. Perkins dated
      November 12, 2007 (incorporated by reference to Exhibit 10.1 of our
      Current Report on Form 8-K, filed November 11,
  2007)




10.34
            Employment
      Agreement between the Company and Jervis B. Perkins, effective March 1,
      2008 (incorporated by reference to Exhibit 10.34 of our Annual Report on
      Form 10-K  for the year ended March 31,
  2008)




10.35
            Commitment
      for Credit Facility by and between the Company and FCC, LLC, d/b/a First
      Capital, dated May 20, 2008 (incorporated by reference to Exhibit 10.1 of
      our Current Report on Form 8-K, filed May 23,
  2008)




10.36
            Business
      Loan Agreement by and between the Company, Jack J. Walker and First
      National Bank, dated May 16, 2008 (incorporated by reference to Exhibit
      10.2 of our Current Report on Form 8-K, filed May 23,
  2008)




10.37
            Promissory
      Note made by the Company and Jack J. Walker, dated May 16, 2008
      (incorporated by reference to Exhibit 10.3 of our Current Report on Form
      8-K, filed May 23, 2008)




10.38
            Commercial
      Pledge Agreement by and between the Company, Jack J. Walker and First
      National Bank, dated May 16, 2008 (incorporated by reference to Exhibit
      10.4 of our Current Report on Form 8-K, filed May 23,
  2008)




10.39
            Loan
      Agreement by and between the Company, Jack J. Walker, and WLoans, LLC,
      dated May 19, 2008 (incorporated by reference to Exhibit 10.5 of our
      Current Report on Form 8-K, filed May 23,
2008)




10.40
            Promissory
      Note made by the Company, dated May 19, 2008 (incorporated by reference to
      Exhibit 10.6 of our Current Report on Form 8-K, filed May 23,
      2008)




10.41
            Letter
      Agreement between the Company and H. MacGregor (Greg) Clarke, dated May
      21, 2008 (incorporated by reference to Exhibit 10.1 of our Current Report
      on Form 8-K, filed May 28, 2008)




10.42
            Loan
      and Security Agreement by and between FCC, LLC, d/b/a First Capital and
      the Company, dated June 24, 2008 (incorporated by reference to Exhibit
      10.1 of our Current Report on Form 8-K, filed June 30,
    2008)




10.43
            Validity
      Agreement by and between Jervis B. Perkins, the Company and First Capital,
      dated June 24, 2008 (incorporated by reference to Exhibit 10.2 of our
      Current Report on Form 8-K, filed June 30,
2008)




10.44
            Validity
      Agreement, by and between H. MacGregor Clarke, the Company and First
      Capital, dated June 24, 2008 (incorporated by reference to Exhibit 10.3 of
      our Current Report on Form 8-K, filed June 30,
  2008)




10.45
            Agreement
      between Benefactor Funding Corp, the Company and FCC, LLC, d/b/a First
      Capital, dated June 24, 2008 (incorporated by reference to Exhibit 10.4 of
      our Current Report on Form 8-K, filed June 30,
  2008)






88
 Table of Contents




10.46
            Irrevocable
      Standby Letter of Credit in favor of Benefactor Funding Corp. in the
      amount of $343,092.34, dated June 25, 2008 (incorporated by reference to
      Exhibit 10.5 of our Current Report on Form 8-K, filed June 30,
      2008)




10.47
            Irrevocable
      Standby Letter of Credit in favor of Benefactor Funding Corp. in the
      amount of $38,193.66, dated June 25, 2008 (incorporated by reference to
      Exhibit 10.6 of our Current Report on Form 8-K, filed June 30,
      2008)




10.48
            First
      Amendment to Loan and Security Agreement between the Company and FCC, LLC
      d/b/a/ First Capital, dated July 31, 2008 (incorporated by reference to
      Exhibit 10.1 of our Current Report on Form 8-K, filed August 6,
      2008)




10.49
            Employment
      Agreement between the Company and H. MacGregor Clarke, dated as of May 23,
      2008 (incorporated by reference to Exhibit 10.2 of our Quarterly Report on
      Form 10-Q, for the period ended September 30,
  2008)




10.50
            Second
      Amendment to Loan and Security Agreement between the Company and FCC, LLC
      d/b/a/ First Capital, dated October 24, 2008 (incorporated by referenced
      to Exhibit 10.1 of our Current Report on Form 8-K, filed October 30,
      2008)




10.51
            Temporary
      Amendment to Loan and Security Agreement between the Company and FCC, LLC
      d/b/a/ First Capital, dated October 27, 2008 (incorporated by referenced
      to Exhibit 10.2 of our Current Report on Form 8-K, filed October 30,
      2008)




10.52
            Forbearance
      Agreement among the Company, FCC, LLC d/b/a/ First Capital, and Jack J.
      Walker, effective January 31, 2009 (incorporated by reference to Exhibit
      10.3 of our Quarterly Report on Form 10-Q, for the period ended December
      31, 2008)




10.53
            Temporary
      Amendment to Loan and Security Agreement between the Company and FCC, LLC
      d/b/a/ First Capital, effective as of January 1, 2009 (incorporated by
      referenced to Exhibit 10.1 of our Current Report on Form 8-K, filed
      January 21, 2009)




10.54*
            Liquidity
      Performance Award Plan




10.55*
            Change in Terms Agreement among the Company, First
      National Bank, and Jack J. Walker, dated May 19,
  2009




10.56*
            Loan Extension Agreement among the Company, WLoans,
      LLC, and Jack J. Walker, effective June 30,
  2009




10.57*
            Second Forbearance Agreement among the Company, FCC,
      LLC d/b/a First Capital, and Jack J. Walker, effective as of April 29,
      2009




10.58*
            Waiver and Third Amendment to Loan and Security
      Agreement among the Company, FCC, LLC d/b/a First Capital, and Jack J.
      Walker, effective as of July 1,
2009




89
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23.1*
            Consent of Independent Registered Public Accounting Firm
      to incorporate its report dated June 29, 2009, with respect to the balance
      sheet of AeroGrow International Inc. as of March 31, 2009, and the related
      statements of operations, shareholders’ equity (deficit) and cash flows
      for the year ended March 31,
2009.




23.2*
            Consent of Independent Registered Public Accounting Firm
      to incorporate its report dated June 10, 2008, with respect to the balance
      sheet of AeroGrow International Inc. as of March 31, 2008, and the related
      statements of operations, shareholders’ equity and cash flows for each of
      the years ended March 31, 2008 and
2007.




24.1*
            Power
      of Attorney (included on the signature page to this Annual Report on Form
      10-K)




31.1*
            Chief Executive Officer Certification pursuant to
      Section 302 of the Sarbanes-Oxley Act of
  2002




31.2*
            Chief Financial Officer Certification pursuant to
      Section 302 of the Sarbanes-Oxley Act of
  2002




32.1*
            Chief Executive Officer Certification pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002




32.2*
            Chief Financial Officer Certification pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002






*
      Filed herewith







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