UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington, D.C.
20549
 
 FORM
10-K
 
 ý ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934


For
the fiscal year ended March 31,
2008
  or
  o
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.)  000-50888
 
 AEROGROW
INTERNATIONAL, INC.
 (Exact
name of registrant as specified in its charter)
 
 Nevada
              
              46-0510685(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (I.R.S.
      Employer
                Identification
      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
              
              The
      NASDAQ Capital Market
  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 x
  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 x
  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  x 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 x
  Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes o No x
  The
aggregate market value of the voting common stock held by non-affiliates of the
registrant as of September 28, 2007 was $68,771,665. 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 16,
2008 is 12,100,387    .
 Table of Contents
  DOCUMENTSINCORPORATED BY REFERENCE
  Part III
incorporates certain information by reference from the registrant's proxy
statement for the 2008 annual meeting of stockholders to be filed no later than
July 29, 2008.
  AeroGrow International
Inc.
 Annual Report on
Form 10-K
 Year Ended March 31,
2008
  PART I
              PageItem 1.
              Description ofBusiness
              3Item 1A.
              Risk
    Factors
              12Item 1B.
              Unresolved Staff
      Comments
              16Item 2.
              Description of
      Property
              16Item 3.
              Legal
      Proceedings
              16Item 4.
              Submission of Matters to a Vote of
      Security Holders
              16PART IIItem 5.
              Market for the Registrant's Common
      Equity and Related Stockholder Matters and Issuer Purchases of Equity
      Securities
              17Item 6.
              Selected Financial
      Data
              18Item 7.
              Management's Discussion and Analysis
      or Plan of Operations
              19Item 7A.
              Quantitative and Qualitative
      Disclosures About Market Risk
              27Item 8.
              Financial
      Statements
              27Item 9.
              Changes in and Disagreements with
      Accountants on Accounting and Financial
    Disclosure
              27Item 9A.
              Controls and
      Procedures
              27Item 9B.
              Other
      Information
              28PART IIIItem 10.
              Directors, Executive Officers and
      Corporate Governance
              29Item 11.
              Executive
      Compensation
              29Item 12.
              Security Ownership of Certain
      Beneficial Owners and Management and Related Stockholder
      Matters
              29Item 13.
              Certain Relationships and Related
      Transactions, and Director Independence
              29Item 14.
              Principal Accounting Fees and
      Services
              29PART IVItem 15.
              Exhibits, Financial Statement
      SchedulesSignatures
              30
 
 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
  ITEM1.  DESCRIPTION OF BUSINESS
  
 Our
Business
 
 We are a
developer, marketer, distributor, and seller of advanced indoor garden systems,
designed for consumer use and priced to appeal to the gardening, cooking and
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, 2008, we had manufactured and shipped over 440,000 AeroGarden® garden
units and 1,137,000 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 including 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 cherry tomatoes, chili peppers and salad greens, a variety of fresh
herbs including cilantro, chives, basil, dill, oregano, and mint, as well as
flowers such as petunias, roses, snapdragons, pink geraniums, and phlox.
Consumers can also plant and grow their own seeds using our proprietary “master
gardener” kits.
 
 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 lack 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, bathrooms, living areas, and
offices.
  Our
indoor gardening units currently on the market retail from approximately $99 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. Wentworth I, Inc., a Delaware corporation (“Wentworth”), organized
under the laws of the State of Delaware on March 6, 2001, entered into an
Agreement and Plan of Merger with us (the “Merger Agreement”) on January 12,
2006, which was consummated on February 24, 2006.  Under the Merger
Agreement, Wentworth merged with and into AeroGrow, and AeroGrow was the
surviving corporation (“Merger”).  Our certificate of incorporation
and by-laws prior to the Merger are now those of the surviving company, and the
surviving company is governed by the corporate law of the State of
Nevada.
 
 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 distribution and as of March 31, 2008, sell
products nationally and internationally in over 5,100 domestic retail
storefronts and more than a dozen countries.  We have also developed
direct sales channels including web sales, direct television sales including
infomercials and 60 and 120 second television commercials, and a direct mail
catalogue business with more than 2 million catalogues mailed as of March 31,
2008.  In the past two years we have significantly expanded our
product lines, now offering 11 different indoor garden models, more than 50 seed
kits, and various gardening and kitchen accessories.
 
 Hydroponics
Industry - Background and Opportunity
  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 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 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,
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 almost six 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 $99 to $229.  We have
filed 18 patent applications in the United States to protect our
inventions.  Following is a description of our proprietary
technologies and inventions that are used in our indoor garden system and seed
kits. The inventions under the patent applications have not been granted
patents, and there can be no assurance that patents will be
granted.
  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, 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 pass 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
are included on our current indoor gardening products. This control panel can
include microprocessor-controlled lights and nutrient and water reminder systems
that alert consumers to add water and nutrients when needed and help ensure that
plants are properly fed and receive the proper lighting. 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.
  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 included in the nutrient tablets is a
proprietary formula 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.
  4
 Table of Contents
  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 standard 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 and these people
repeatedly purchase new kitchen appliances and will be motivated to purchase our
indoor gardening products and related seed kits. Consumers in this potential
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, basils, 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 $99 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 SpaceSaver 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 with a 30% smaller
      footprint.  Fits easily on countertops and in corners for
      apartments, condos, and smaller kitchens. Retail price $149 to
      $169.
 
 4.
              AeroGarden3 Series – The
      AeroGarden3 series features the Advanced Growing System, improved grow
      lights, and an attractive, stylish design that makes it suitable for use
      as a decorative feature throughout the home or office.  Our
      smallest gardens fit easily on kitchen counters, night stands, and end
      tables. Retail price $99 to $109.
  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 $29.99, and include kits like:
  ●
                Vegetable Gardens: cherry tomato, chili pepper, green beans,
      salsa garden.
  ●
                Herb Gardens: gourmet herbs, Italian herbs, herbs for poultry,
      herbs for seafood, French herbs.
  ●
                Flower Gardens: petunias, baby roses, spring bouquet, English
      garden, splash of color.●
                Salad Gardens: salad greens, romaine lettuce, baby greens, mesclun
      mix.
 6
 Table of Contents
  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 our own design of a
battery-operated herb blender and salad dressing maker called the Herb ‘n
Serve.
  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 channels for
use in a variety of different settings around the home or
office.   Examples include a children’s garden series, 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, 2008 and 2007, we invested $2,605,112 and
$2,113,255 in research and development activities.  As a result, we
have a strong backlog of new product innovations in the pipeline.  In
calendar 2008, we are introducing additions to our product line-up, including a
six-pod configuration in both a traditional footprint and a space-saver design,
launching a three-pod model at retail, 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. In 2008 we plan
additional retail distribution into existing channels like lawn and garden, mass
and department stores, and new retail distribution with tests or rollouts into
grocery, office and drug store chains.  Further, based on the breadth
of concept application and the range of interest of many consumer segments, 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.
 
 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 are planning the creation of new 60-second
and 120-second commercials focused on highlighting our new
products.
 
 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 50,000
catalogues.  We mail up to 750,000 catalogues every 45 to 60
days.  With our catalogue sales we focus on remarketing to current
customers and also prospect 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, some of which are managed by third-party
providers. A key focus of our web and catalogue marketing will continue to be
sales of our repeat purchase seed kits, light bulbs, and accessories to our
existing customers, and focusing on building and maximizing the lifetime value
of our AeroGarden customers.
 
 In the
fall of 2007 we successfully tested our own in-house telemarketing center to
handle inbound and outbound orders for our various direct sales
channels.  This call center supplements our outsourced call center
which handles the bulk of our infomercial calls.
 
 7
 Table of Contents
  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,
Germany, and several other European countries.  International
expansion in 2008 will likely focus primarily on gaining broader distribution in
existing countries in Europe and the Pacific Rim, 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.  However, we recognize that
there are companies that are better funded and have greater experience in
producing hydroponic products in commercial markets, including, but not limited
to, companies such as General Hydroponics and American Hydroponics. These
companies could potentially decide to focus on the consumer market with
competing products. We could also potentially face competition from gardening
wholesalers and large and profitable soil-based gardening companies, including,
but not limited to, the Burpee Seed Company and Gardener’s Supply Company,
should they decide to produce a competitive product. These companies may have
better consumer acceptance and may be better funded than us.
 
 Manufacturing
  We
manufacture our products using contract manufacturing sources, which are
supervised by our internal engineering and manufacturing teams. Our bio-grow
seed pods are currently produced and assembled in our laboratory facilities in
Longmont, Colorado.
  We
currently have three 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, Ltc. (“Mingkeda”) a Chinese company capable of producing 40,000
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 180,000 units per month, with more capacity available with the
addition of multiple sets of tools in a short time period.  Our third
manufacturer, Kayue Electric Company Limited, started producing gardens in June
2007, and has a production capacity of 50,000 units per
month.  Capacity expansion up to 100,000 per month can be achieved
over a short period of time with a nominal tooling investment.
 
 We
produce and assemble our seed kits in our manufacturing facilities in Longmont,
Colorado. The seed kits and indoor gardening products are shipped to a
fulfillment center in Chino, California. A third-party logistics firm provides
warehousing, order fulfillment, and shipping for our products.  Our
2008 plans call for the opening of an additional, company-owned distribution
center in Indianapolis, Indiana.  Some seed kit manufacturing may be
completed there as well.
  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.
  8
 Table of Contents
  Intellectual
Property
 
 We have
filed 18 patent applications in the United States to protect our technologies
and products. These applications are for:
  ●
              seed
      germination pods that transport, support and germinate seedlings in
      aeroponic or hydroponic devices and support the growth of the plant to
      maturity, filed in November 2003, application serial number 10/714,786,
      and have responded to examiner’s fourth
action,
 
 ●
              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 responding to examiner’s first
action,
 
 ●
              methods
      for growing plants using seed germination pods, filed in April 2005,
      application serial number 11/112,269, and responding to examiner’s fourth
      action,
 
 ●
              indoor
      gardening appliance, filed in August 2005, application serial number
      29/235,880, design of 7-pod gardens, and responded to an office
      communication,
 
 ●
              devices
      and methods for growing plants by measuring liquid or nutrient usage rate,
      the adaptive growth learning technologies, filed in December 2005,
      application serial number 11/321,368, and have responded to examiner’s
      first action,
 
 ●
              pH
      buffered plant nutrient compositions and methods for growing plants, filed
      in December 2005, application serial number
  11/321,023,
 
 ●
              smart
      garden devices and methods for hydroponic gardens, filed in June 2006,
      application serial number 11/455,364, and have responded to an office
      communication,
 
 ●
              devices
      and methods for growing plants, filed in January 2007, application serial
      number 11/653,121,
 
 ●
              indoor
      gardening appliance, design of 7-pod gardens, filed in January 2007,
      application serial number
29/271,209
 
 ●
              indoor
      gardening appliance, design of 7-pod gardens, filed in January 2007,
      application serial number
29/271,259,
 
 ●
              systems
      and methods for controlling liquid delivery and distribution to plants,
      filed in 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,
 
 ●
              indoor
      gardening appliance, design of 6-pod gardens, filed in November 2007,
      application serial number
29/293,343,
 
 ●
              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,
and
 
 ●
              soil-less
      seed support medium and method for germinating a seed, seed germination
      pods that transport, support and germinate seedlings in aeroponic or
      hydroponic devices and support the growth of the plant to maturity, filed
      in March 2008, application serial number
  12/073,987,
 
 ●
              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,
 
 ●
              hydroponic
      gardening apparatus, design of modular gardens, filed in March 2008,
      application serial number
29/300,326.
 
 9
 Table of Contents
  We
believe that the technology covered by our patent applications does not infringe
on issued patents owned by others. We believe that if we fail to receive patents
for any one of our 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 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 some crucial 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 36 trademark applications
in the United States (ten of which have registered; 13 of which have been
allowed) and three trademark applications designating 33 countries (29 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 24 countries: European
      Community, Australia, Norway, and Korea; pending in seven countries,
      responded to an office action in
Japan,
 
 ●
              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,
 
 ●
              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
 
 ●
              Ultimate
      Kitchen Gardener registered in March 2008, registration number
      3,392,651;
   10
 Table of Contents
  Pending
  ●
              AeroGrow,
      filed in April 2005, application serial number 78614573, and
      allowed,
 
 ●
              Farmers
      Market Fresh, filed in July 2005 for gardens, application serial number
      78671280, and allowed,
 
 ●
              Bio-Dome,
      filed in March 2006, application serial number 78836718, and
      allowed,
 
 ●
              Farmer’s
      Market Fresh, filed in May 2006 for seed kits, application serial number
      78882877, and allowed,
 
 ●
              GrowNow,
      filed in August 2006, application serial number 78955692, and
      allowed,
 
 ●
              Herb
      Appeal, filed November 2006, application serial number 77045636, and
      allowed,
 
 ●
              Plug
      & Grow, filed December 2006, application serial number 77058534, and
      responding to examiner’s second
action,
 
 ●
              AeroGarden,
      filed December 2006 for toys, application serial number 77073345, and
      allowed,
 
 ●
              Get
      The Garden, filed in April 2007, application serial number 77154135, and
      allowed,
 
 ●
              Veg-e-Garden,
      filed in May 2007, application serial number 77170403, and
      allowed,
 
 ●
              Florist
      in a Box, filed in May 2007, application serial number 77185032, and
      allowed,
 
 ●
              AeroFlower,
      filed in June 2007, application serial number 77202957, and
      allowed,
 
 ●
              AeroGarden,
      filed in July 2007, application serial number 77229682, and
      allowed,
 
 ●
              Herb
      It Up, filed in July 2007, application serial number 77238309, and
      allowed,
 
 ●
              AeroGarden
      Mini logo, filed in October 2007, application serial number 77304395, and
      responded to examiner’s amendment,
 
 ●
              Florist
      in a Box logo, filed in October 2007, application serial number 77304513,
      and responded to examiner’s
amendment,
 
 ●
              Chef
      in a Box logo, filed in October 2007, application serial number 77304572,
      and responded to examiner’s
amendment,
 
 ●
              Snip
      It Chop It Herb It Up logo, filed in October 2007, application serial
      number 77304131,
 
 ●
              Leaves
      logo, filed in October 2007, application serial number
      77304079,
 
 ●
              Corner
      Market, filed in October 2007, application serial number
      77301478,
 
 ●
              English
      Cottage, filed in October 2007, application serial number 77303340, and
      responding to office action,
 
 ●
              Splash
      of Color, filed in October 2007, application serial number
      77303344,
 
 ●
              Mountain
      Meadow, filed in October 2007, application serial number
      77304010,
 
 ●
              Aero-Fresh,
      filed in October 2007, application serial number
  77304030,
 
 ●
              Advanced
      Growing System logo, filed in December 2007, application serial number
      77347195, and
 
 ●
              Master
      Chef in a Box, filed in December 2007, application serial number
      77347256.
 
 11
 Table of Contents
  Each of
our employees, independent contractors 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, the 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
AeroGarden Classic 7-Pod series, AeroGarden Pro series, AeroGarden SpaceSaver 6
series, and AeroGarden 3 servies are certified by Underwriters Laboratories,
Inc.  Our Classic 7-Pod series and AeroGarden3 series have also
received approval from Electronic Testing Laboratories.  The Classic
7-Pod series hs been approved by the British Electronic Approvals Board and has
been CE marked for European sales.  The Classic 7-Pod series is also
certified for Australian and South Korean sales.  We expect that
additional product lines will gain certification as we work to introduce the
lines internationally. 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 and effects of compliance with environmental laws will
not be material.
  Personnel
  As of
March 31, 2008, AeroGrow employed 114 employees with 7 part-time and 107
full-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, telemarketing, public relations, infomercial production,
fulfillment and shipping.  Additional employees and/or consultants will be
hired in the future as our operations grow.
 ITEM1A.  RISK FACTORS
  
 RISKS
RELATED TO 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. In 2006, we began to produce our garden
systems and seed kits and we are still in the process of ramping up our
production and sales, with multiple new models commencing initial production in
the next six months. 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 production
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. We expect to incur substantial 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.  Because
we are in the early stages of implementing our business plan, we cannot predict
now if we will ever be profitable.
  We
have incurred substantial losses since inception and may never achieve
profitability.
  Since we
commenced operations in 2002, through March 31, 2008, we have incurred
substantial operating losses. For the years ended March 31, 2008 and March
31, 2007, we had net losses of $9,835,921 and $10,386,451, respectively, and for
the transition period of the three months ended March 31, 2006, we had a net
loss of $7,543,343. As of March 31, 2008, our losses from operations have
resulted in an accumulated deficit of $39,628,084. The success of our business
will depend on our ability to profitably expand sales and distribution of our
AeroGarden indoor garden systems 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 lack of revenues to be self-sustaining. There is no
assurance that we will ever attain profitability.
    12
 Table of Contents
  If
our indoor garden systems fail to perform properly, our business could suffer
with increased costs and reduced income.
  We have
limited experience with returns and warranty claims for certain of our products,
particularly new models that will be introduced later this calendar year. We 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.
  We
will likely need additional capital to fund our growth.
  We will
likely require additional capital to support our growth and cover operational
expenses as we expand our marketing and product development. It is possible that
none of our remaining outstanding warrants will be exercised and we will
therefore not receive any proceeds therefrom. We may need to issue equity, debt,
or securities convertible into equity, which could dilute the current stock
ownership in AeroGrow. If we cannot obtain additional financing 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.
  To
address our short-term liquidity needs and the working capital increases
necessary to support our anticipated growth, we have put in place a new
financing agreement with FCC, LLC d/b/a First Capital that provides us with
additional borrowing capacity relative to our prior financing arrangement with
Benefactor Funding Corp. (see Liquidity and Capital Resources and Note 12
– Subsequent Events in the accompanying Financial
Statements).
 Our
intellectual property and proprietary rights are only filed in the United
States, 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 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.
  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.
 
 13
 Table of Contents
  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.
 
 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.
 
 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. We plan to hire additional personnel in all
areas of our business. Competition for many of these types of personnel is
intense. 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.
  We
rely on third parties for a significant portion of 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. For example, we have
outsourced our manufacturing, warehouse, distribution, order processing, and
fulfillment operations. Any disruption in our relationship with any of our
vendors could cause significant disruption in 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.
 
 RISKS
RELATED TO THE RELEVANT MARKET FOR OUR PRODUCT
  Our
future depends on the financial success of our indoor garden systems. Since we
have introduced entirely new products without comparable sales history, we do
not know if our indoor garden systems and seed kits will generate continued wide
acceptance by consumers.
  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.
  Our
marketing strategies may not be successful, which would adversely affect our
future revenue and profitability.
  Our
revenue and future 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.
  We
may face significant competition, and if we are unable to compete effectively,
our sales may be adversely affected.
  We
believe that our simplified and complete indoor garden systems offer significant
benefits over traditional hydroponic industry products. We recognize, however,
that there are companies that are better funded and that have greater experience
in producing hydroponic products in commercial markets, including, but not
limited to, companies such as General Hydroponics and American
Hydroponics.  These companies could potentially decide to focus on the
consumer market with competing products. We could also face competition from
gardening wholesalers and large and profitable soil-based gardening companies,
including, but not limited to, the Burpee Seed Company and Gardener’s Supply
Company, should they decide to produce a competitive product. In addition, other
consumer products companies could develop products to compete with our products.
These companies may use hydroponic technologies, and may have better consumer
acceptance.  The success of any competing products may adversely
impact us.
  14
 Table of Contents
  RISKS
RELATED TO OUR CAPITALIZATION
  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 following 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.
 
 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.  As of March 31, 2008, we had 12,076,717 shares of common
stock outstanding, of which 10,060,514 shares may be sold without
restriction.  (See the following risk factor for discussion of
7,248,687 additional shares that are subject to issuance pursuant to outstanding
warrants and options.)  The remaining 2,016,203 became tradable,
subject to securities laws, on June 22, 2008, in each case when lockup
restrictions covering the shares expired.
  The 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.
  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, 2008, we were committed to issue up to 7,248,687 additional shares of
common stock under the terms of outstanding warrants, options and other
arrangements:
 
 ●
              1,553,591
      shares issuable under our 2005 Equity Compensation
  Plan
  ●
              5,694,736
      shares issuable under warrants to purchase our common stock as
      follows:
 
 Weighted
              
              
              WeightedWarrants
              
              
              Average
              
              
              AverageOutstanding
              
              
              Exercise Price
              
              
              Remaining Life10,000
              
              
              $
              2.50
              
              
              
              0.0715,000
              
              
              $
              5.00
              
              
              
              0.10580,000
              
              
              $
              5.01
              
              
              
              2.45644,000
              
              
              $
              6.00
              
              
              
              3.622,232,300
              
              
              $
              6.25
              
              
              
              2.9050,000
              
              
              $
              6.96
              
              
              
              4.331,283,436
              
              
              $
              7.57
              
              
              
              3.99800,000
              
              
              $
              8.00
              
              
              
              6.4280,000
              
              
              $
              8.25
              
              
              
              6.425,694,736
              
              
              $
              6.66
              
              
              
              2.53
  For the
length of time these warrants, and options are outstanding, the holders will
have an opportunity to profit from a rise in the market price of our common
stock without assuming the risks of 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.
 
 15
 Table of Contents
  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.
  The
market price of the shares may fluctuate greatly. Investors in AeroGrow bear the
risk that they will not recover their investment.
  We
started trading on the NASDAQ Capital Market under the ticker symbol AERO, on
June 13, 2007, after trading on the OTCBB from January 8, 2007 to June 12, 2007
under the ticker symbol AGWI.   No assurance can be made that an
active market will develop on the NASDAQ.  Currently, trading in our
common stock on NASDAQ is limited, and the per share price 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 any holder of such shares may not be able to sell at the time he
elects, or at all.
 ITEM1B.  UNRESOLVED STAFF COMMENTS
  None.
  ITEM2.  DESCRIPTION OF PROPERTY
  On July
27, 2006, we entered into a lease with Pawnee Properties, LLC to consolidate our
operations, other than our seed kit manufacturing operations, into a 21,012
square foot office space at 6075 Longbow Drive, Boulder, Colorado 80301. The
initial rent of $15,759 per month increased to $17,510 per month as of February
1, 2008.  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 also
rent storage and manufacturing space in Longmont, Colorado, pursuant to
short-term rental agreements.  The Longmont facility houses our seed kit
manufacturing operations.  The short-term rental agreements are designed to
accommodate the variability in our space requirements.  We currently lease
approximately 36,100 square feet of space in this facility at a monthly rental
rate of $24,965 plus operating expenses.
 
 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.
 ITEM3.  LEGAL PROCEEDINGS
  To the
best of our knowledge, there are no legal proceedings pending or threatened
against us.
 ITEM4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
  None.
  16
 Table of Contents
 PART
II
 ITEM5.    MARKET FOR REGISTRANT’S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
  We
started trading on the NASDAQ Capital Market under the ticker symbol AERO, on
June 13, 2007, 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 16, 2008, we had approximately
671 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 3/31/08
              
              
              Fiscal
      Year Ended 3/31/07High
              
              
              Low
              
              
              High
              
              
              Low1st
      Quarter - Ended June 30
              
              $
              9.00
              
              
              $
              5.65
              
              
              
              N/A
              
              
              
              N/A2nd
      Quarter - Ended Sept 30
              
              $
              9.24
              
              
              $
              6.85
              
              
              
              N/A
              
              
              
              N/A3rd
      Quarter - Ended Dec 31
              
              $
              8.73
              
              
              $
              4.30
              
              
              
              N/A
              
              
              
              N/A4th
      Quarter - Ended Mar 31
              
              $
              6.75
              
              
              $
              2.60
              
              
              $
              10.00
              
              
              $
              5.52
  COMPANY
STOCK PERFORMANCE
 COMPARISON
OF CUMULATIVE TOTAL RETURN
 Among
AeroGrow International, Inc., The NASDAQ Composite Index
 and
The Consumer Discretionary Index Fund
 
 The
following graph compares the cumulative total stockholder return data for our
stock for the period beginning March 31, 2007 and ending on March 31, 2008 to
the cumulative return over such period of (i) The NASDAQ Composite Index (^IXIC)
and (ii) the Consumer Discretionary Index Fund (RXI).  The graph
assumes $100 was invested on March 31, 2007 in our Common Stock and in each of
the comparative indices. Note that the historic stock price performance on the
following graph is not necessarily indicative of future stock price
performance.
 
 
 
 17
 Table of Contents
 
 Holders
of Record
 
 As of
June 16, 2008, we had approximately 671 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.
  Lock
Up Restrictions
 
 In
conjunction with the closing of the Merger with Wentworth in February 2006, the
former stockholders of Wentworth holding an aggregate of 396,813 shares of
common stock, AeroGrow stockholders (including all shares of AeroGrow held by
our current officers and directors) holding an aggregate of 4.8 million shares
of our common stock, and 1.8 million shares of common stock underlying our
warrants and options had entered into lock up agreements under which they were
prohibited from selling or otherwise transferring: (i) any of their shares of
common stock for a period of 12 months following the effective date of the
registration statement (“Initial Lock Up Period”) that registers their shares
for resale, and (ii) 50% of their shares of common stock after the expiration of
Initial Lock Up Period until the date which is 18 months after the effective
date of the registration statement filed by us.  The registration statement
went effective on December 22, 2006.  As of March 31, 2008, approximately
2.0 million outstanding shares of common stock remain subject to a lock up,
which later expired on June 22, 2008.
 ITEM6. SELECTED FINANCIAL DATA
 Consolidated
      Statements ofOperations
      Data
              
              
              
              
              Three
      month transitional period endedYears ended March 31,
              
              March 31,
              
              Years ended December 31,2008
              
              2007
              
              2006
              
              2005
              
              2004Revenues
              $
              38,356,676
              
              $
              13,144,037
              
              $
              35,245
              
              $
              -
              
              $
              -Cost
      of revenue
              
              22,975,385
              
              
              8,404,507
              
              
              134,622
              
              
              -
              
              
              -Research
      and development
              
              2,605,112
              
              
              2,113,255
              
              
              978,539
              
              
              1,578,833
              
              
              333,038Sales
      and marketing
              
              16,084,353
              
              
              7,117,613
              
              
              2,548,583
              
              
              583,897
              
              
              79,811General
      and administrative
              
              6,084,728
              
              
              4,050,312
              
              
              2,010,907
              
              
              2,923,792
              
              
              1,983,759Total
      operating expenses
              
              47,749,578
              
              
              21,685,687
              
              
              5,672,651
              
              
              5,086,522
              
              
              2,396,608Loss
      from operations
              
              (9,392,902
              )
              
              (8,541,650
              )
              
              (5,637,406
              )
              
              (5,086,522
              )
              
              (2,396,608
              )Other
      (income) expense
              
              443,019
              
              
              1,844,801
              
              
              1,905,937
              
              
              2,631,055
              
              
              (7,564
              )Net
      loss
              $
              (9,835,921
              )
              $
              (10,386,451
              )
              $
              (7,543,343
              )
              $
              (7,717,577
              )
              $
              (2,389,044
              )Net
      loss per share, basic and diluted
              $
              (0.84
              )
              $
              (1.09
              )
              $
              (0.84
              )
              $
              (1.55
              )
              $
              (0.56
              )Weighted
      average number of commonshares
      outstanding, basic and diluted
              
              11,662,891
              
              
              9,505,926
              
              
              8,956,353
              
              
              4,971,857
              
              
              4,252,626Consolidated
      Balance Sheet Data
              March
      31,
              
              December
      31,2008
              
              2007
              
              2006
              
              2005
              
              2004Cash
      and cash equivalents
              $
              1,559,792
              
              $
              5,495,501
              
              $
              8,852,548
              
              $
              949,126
              
              $
              1,916,842Total
      assets
              
              11,919,629
              
              
              13,041,806
              
              
              9,841,009
              
              
              2,543,598
              
              
              1,998,470Total
      liabilities
              
              7,511,079
              
              
              5,057,901
              
              
              1,924,537
              
              
              2,659,000
              
              
              86,547Total
      stockholder's equity
              
              4,408,551
              
              
              7,983,905
              
              
              7,916,472
              
              
              2,543,598
              
              
              1,998,470
 18
 Table of Contents
 ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF
OPERATIONS
 
 The
following discussion and analysis provides information which our management
believes is relevant to an assessment and understanding of our business,
operations, and financial condition. This discussion and analysis contains
forward-looking statements that involve risks, uncertainties, and assumptions.
In addition to historical information, this Annual Report contains
“forward-looking” statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act, including statements that include the
words “may,” “will,” “believes,” “expects,” “anticipates,” or similar
expressions. These forward-looking statements may include, among others,
statements concerning our expectations regarding our business, growth prospects,
revenue trends, operating costs, working capital requirements, competition,
results of operations and other statements of expectations, beliefs, future
plans and strategies, anticipated events or trends, and similar expressions
concerning matters that are not historical facts. The forward-looking statements
in this Annual Report involve known and unknown risks, uncertainties and other
factors that could cause our actual results, performance or achievements to
differ materially from those expressed or implied by the forward-looking
statements contained herein.
 Each
forward-looking statement should be read in context with, and with an
understanding of, the various disclosures concerning our business made elsewhere
in this Annual Report, inclusive of the section entitled Risk Factors, as well
as other public reports filed by us with the SEC. Investors should not place
undue reliance on any forward-looking statement as a prediction of actual
results of developments. Except as required by applicable law or regulation, we
undertake no obligation to update or revise any forward-looking statement
contained in this Annual Report.
 
 Overview
  We are in
the business of developing, marketing, and distributing advanced indoor
aeroponic garden systems. After more than three years of initial research and
product development, we began sales activities in March 2006. Since that time we
have significantly expanded all aspects of our operations in order to take
advantage of what we believe to be an attractive market
opportunity.  We have substantially increased the depth and breadth of
distribution and as of March 31, 2008 sell products in over 5,100 domestic
retail storefronts and more than a dozen countries
internationally.  We have also developed direct sales channels
including web sales, direct television sales, including infomercials and 60 and
120 second television commercials, and a direct mail catalogue business with
more than 2 million catalogues mailed as of March 31, 2008.  In the
past two years we have significantly expanded our product lines, and now offer
11 different indoor garden models, more than 50 seed kits, and various gardening
and kitchen accessories.
 
 Our
Critical Accounting Policies
 
 Inventory
  Inventories
are valued at the lower of cost, determined by the first-in, first-out method,
or market. When we are the manufacturer, we include in inventory costs raw
materials, labor and manufacturing overhead. We record the raw materials at
delivered cost. Standard labor and manufacturing overhead costs are applied to
the finished goods based on normal production capacity as prescribed under ARB
No. 43, Chapter 4, “Inventory Pricing.” A majority of our products are
manufactured overseas and are recorded at cost.
 
 We
determine an inventory obsolescence reserve based on historical experience and
establish reserves against inventory according to the age of the product. As of
March 31, 2008 and March 31, 2007 we determined that no inventory obsolescence
reserve was required.
 Revenue
Recognition
  We
recognize revenue from product sales, net of estimated returns, when persuasive
evidence of a sale exists: that is, a product is shipped under an agreement with
a customer; risk of loss and title has passed to the customer; the fees are
fixed or determinable; and collection of the resulting receivable is reasonably
assured. Accordingly, we did not record $577,838 and $451,898 of revenue as of
March 31, 2008 and March 31, 2007, respectively, related to the unpaid balance
due for orders shipped in conjunction with our direct sales to consumers because
the consumer had 36 days to evaluate the product, and is required to pay only
the shipping and handling costs for such products before making the required
installment payments after the expiration of the 36-day trial period. We also,
as of March 31, 2008 and March 31, 2007, did not record $175,781 and $135,459,
respectively, of product costs associated with the foregoing revenue because the
customers would have been required to return the product in order to cancel
further billing, and therefore we would have been able to recover these costs
through resale of the goods. The liability for sales returns are estimated based
upon historical experience of return levels.
 
 Additionally,
the Company did not record $69,339 of revenue as of March 31, 2008 related to
the wholesale sales value of inventory held by its television shopping channel
customers as these sales are contingent upon the shopping channel selling the
goods. Deferred payments for these goods are charged to Customer Deposits. The
Company has also deferred, as of March 31, 2008, recognition of $33,937 of
product and freight costs associated with these sales, which have been included
in inventory.
 
 We record
estimated reductions to revenue for customer and distributor programs and
incentive offerings, including promotions and other volume-based incentives.
Future market conditions and product transitions may require us to take actions
to increase customer incentive offerings, possibly resulting in an incremental
reduction of revenue at the time the incentives are offered. Additionally,
certain incentive programs require us to estimate based on industry experience
the number of customers who will actually redeem the incentive. At March 31,
2008 and March 31, 2007, we had accrued $226,729 and $65,385, respectively, as
our estimate for the foregoing deductions and allowances.
 
 19
 Table of Contents
  Warranty
and Return Reserves
  We record
warranty liabilities at the time of sale for the estimated costs that may be
incurred under our basic warranty program. The specific warranty terms and
conditions vary depending upon the product sold but generally include technical
support, repair parts and labor for periods up to one year. Factors that affect
the Company’s warranty liability include the number of installed units currently
under warranty, historical and anticipated rates of warranty claims on those
units, and cost per claim to satisfy the Company’s warranty
obligation.   The manufacturers of the Company’s products provide
replacement parts for any defective components free of charge up to 2% of the
total units purchased.  Based upon the foregoing, the Company has
recorded as of March 31, 2008 and March 31, 2007 a provision for potential
future warranty costs of $72,200 and $15,393, respectively.
 
 The
Company reserves for known and potential returns from customers and associated
refunds or credits related to such returns based upon historical experience. In
certain cases, customers are provided a fixed allowance, usually in the 1% to 2%
range, to cover returned goods which allowance is deducted from payments from
such customers. As of March 31, 2008 and March 31, 2007, the Company has
recorded a reserve for customer returns of $674,120 and $238,569,
respectively.
 
 Shipping
and Handling Costs
  Shipping
and handling costs associated with inbound freight are recorded in cost of
revenue. Shipping and handling costs associated with freight out to customers
are also included in cost of revenue. Shipping and handling charges to customers
are included in sales.
 
 Stock
Based Compensation
  In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based
Payment.” Subsequently, the SEC provided for a phase-in implementation process
for SFAS No. 123R, which required adoption of the new accounting standard no
later than January 1, 2006. SFAS No. 123R requires accounting for stock
options using a fair-value-based method as described in such statement and
recognize the resulting compensation expense in the Company’s financial
statements. Prior to January 1, 2006, the Company accounted for employee
stock options using the intrinsic value method under Accounting Principles Board
(“APB”) No. 25, “Accounting for Stock Issued to Employees” and related
interpretations, which generally results in no employee stock option expense. We
adopted SFAS No. 123R on January 1, 2006 and do not plan to restate financial
statements for prior periods. We plan to continue to use the Black-Scholes
option valuation model in estimating the fair value of the stock option awards
issued under SFAS No. 123R.  As a result of recognizing compensation
expense for stock options pursuant to the provisions of SFAS No. 123(R), the net
loss for the year ended March 31, 2008, March 31, 2007 and the three month
transition period ended March 31, 2006, was increased by $710,899, $560,859 and
$3,315,840, respectively.
 
 Advertising
and Production Costs
  We
expense all production costs related to advertising as incurred. These costs
include actual advertising such as print, television, and radio advertisements
which are expensed when the advertisement has been broadcast or otherwise
distributed.  We record media costs related to our direct-to-consumer
advertisements, inclusive of postage and printing costs incurred in conjunction
with mailings of direct response catalogues, and related direct response
advertising costs, in accordance with the AICPA Statement of Position, SOP 93-7,
“Reporting on Advertising Costs.” In accordance with SOP 93-7, advertising costs
incurred should be reported as assets and should be amortized over the estimated
period of the benefits, based on the proportion of current period revenue from
the advertisement to probable future revenue. As of March 31, 2008 and March 31,
2007, we had deferred $503,825 and $493,086, respectively, related to such media
costs. Advertising expenses for the years ended March 31, 2008 and March 31,
2007 and for the three months ended March 31, 2006 were $6,955,555, $2,125,112
and $30,000, respectively.
 
 Research
and Development
  Research,
development, and engineering costs are expensed as incurred, in accordance with
SFAS No. 2, “Accounting for Research and Development
Costs.”  Research, development, and engineering expenses primarily
include payroll and headcount related costs, contractor fees, infrastructure
costs, and administrative expenses directly related to research and development
support.
 
 Registration
Rights Penalties
  The
holders of securities issued in our 2006 Offering and 2005 Offering (see Notes 2
and 3 to our Financial Statements) had registration rights for the common stock
and for the common stock underlying the convertible debt and the warrants held
by them. Liquidated damages for failure to register and maintain registration
for such common stock were payable in shares of our common stock under certain
circumstances and were equal to 1% of the amount of the outstanding convertible
debt per 30-day period up to a maximum of 24% and 1% of the amount of the
investment in the 2006 Offering up to a maximum of 18%. In each case, the amount
was payable in shares of our common stock valued at a rate of $2.00 per share.
We elected to recognize the impact of such registration rights penalties as
incurred, which commenced after July 23, 2006. We completed the registration of
the foregoing securities on December 22, 2006 and recognized five months of
penalty, resulting in the recording of 332,876 shares of common stock to be
issued at a value of $5.00 for a total of $1,664,380. On December 21, 2006, the
FASB Financial Statement Publication (“FSP”) Emerging Issues Task Force 00-19-2
that addresses the accrual and accounting for registration rights penalties
became effective immediately. This FSP addresses the proper accounting of
similarly arranged registration rights agreements entered into after the
effective date of December 21, 2006.
 
 20
 Table of Contents
  New
Accounting Pronouncements
 
 In May
2008, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 162 “The Hierarchy of Generally
Accepted Accounting Principles” SFAS No. 162 identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles. This
statement shall be effective 60 days following the SEC’s approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, “The
Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles.” We do not expect its adoption will have a material impact on our
financial statements
 
 In March
2008, the FASB issued SFAS No. 161 “Disclosures about Derivative
Instruments and Hedging Activities—An Amendment of FASB Statement
No. 133.”  SFAS 161 establishes the disclosure requirements for
derivative instruments and for hedging activities with the intent to provide
financial statement users with an enhanced understanding of the entity’s use of
derivative instruments, the accounting of derivative instruments and related
hedged items under Statement 133 and its related interpretations, and the
effects of these instruments on the entity’s financial position, financial
performance, and cash flows. This statement is effective for financial
statements issued for fiscal years beginning after November 15, 2008. We do
not expect its adoption will have a material impact on our financial statement
disclosures.
 
 In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which
amends SFAS No. 141, and provides revised guidance for recognizing and measuring
identifiable assets and goodwill acquired, liabilities assumed, and any
non-controlling interest in the acquiree. It also provides disclosure
requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination. SFAS No. 141(R) is effective
for fiscal years beginning on or after January 1, 2009 and is to be applied
prospectively. We are currently evaluating the potential impact of adopting this
statement on our financial position, results of operations and cash flows and do
not expect that the adoption will have a material impact on our financial
statements.
 
 In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51,” which
establishes accounting and reporting standards pertaining to ownership interests
in subsidiaries held by parties other than the parent, the amount of net income
attributable to the parent and to the non-controlling interest, changes in a
parent's ownership interest, and the valuation of any retained non-controlling
equity investment when a subsidiary is deconsolidated. SFAS No. 160 also
establishes disclosure requirements that clearly identify and distinguish
between the interests of the parent and the interests of the non-controlling
owners. SFAS No. 160 is effective for fiscal years beginning on or after January
1, 2009. The Company does not expect that the adoption will have a material
impact on the Company's financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159,” The Fair Value Option for
Financial Assets and Financial Liabilities—including an amendment of FASB
Statement 157.” We will adopt SFAS No. 159 in the fiscal year beginning April 1,
2008. The adoption of this Statement is not expected to have a material effect
on our financial statements.
  Inflation
and Seasonality
  We do not
expect inflation to have a significant effect on our operations in the
foreseeable future. Because our indoor garden systems are designed for an indoor
gardening experience, it is likely that we may experience slower sales in the
United States during June through September when our consumers may tend to
garden outdoors. In addition, we have experienced increased sales during the
holiday season in the fourth calendar quarter. We have had only two full fiscal
years of operations, but it does appear that we have some
seasonality.  We intend to sell to our international distributors in
US Dollars thereby minimizing effects from currency fluctuations. Our purchases
from China may be affected by changes in valuation of the US Dollar as compared
to the Chinese currency.
  Results
of Operations
 
 For the
fiscal year ended March 31, 2008, our net sales totaled $38,356,676, an increase
of 191.8% from the fiscal year ended March 31, 2007.  The sales
increase reflected a number of factors including an increase in our retail
presence from 750 storefronts as of December 31, 2006 to over 5,100 storefronts
as of March 31, 2008, the launch of a direct mail catalogue operation during the
fiscal year, and a geographic expansion of our presence to seven countries
outside the United States.
 
 Our gross
margins improved to 40.1% in the year ended March 31, 2008 from 36.1% in the
year ended March 31, 2007 primarily as a result of improved distribution
logistics, particularly a reduction in the use of air freight to ship product
from China to the United States.
 
 Sales and
marketing costs totaled $16,084,353 for the year ended March 31, 2008, an
increase of 126.0% from the prior fiscal year, reflecting generally higher
levels of spending in all categories to support the growth in our
business.  General and administrative costs also increased, by 50.2%
to $6,084,728 for the year ended March 31, 2008.  This increase was
caused by a number of factors, including an increase in the number of our
employees, higher depreciation and other facility costs related to our
expansion, corporate governance and listing costs, and bad debt expense
principally related to a reserve established to cover our exposure to the Linens
‘n Things, Inc. bankruptcy filing.
 
 21
 Table of Contents
  Our net
loss totaled $9,835,921 for the fiscal year ended March 31, 2008 as compared to
a net loss of $10,386,451 for the fiscal year ended March 31, 2007.
 
 We
launched the AeroGardenproducts
in March 2006, therefore the year ended March 31, 2007 represented our first
full year of revenue from operations.  The following table sets forth,
as a percentage of sales, our financial results for these first two full years
of operations:
 
 Years ended March 31,2008
              
              
              2007RevenueProduct
      sales- retail
              
              
              62.4
              %
              
              
              68.1
              %Product
      sales- direct-to-consumer
              
              
              35.7
              %
              
              
              31.9
              %Product
      sales- international
              
              
              1.9
              %
              
              
              0.0
              %Total
      sales
              
              
              100.0
              %
              
              
              100.0
              %Operating
      expensesCost
      of revenue
              
              
              59.9
              %
              
              
              63.9
              %Research
      and development
              
              
              6.8
              %
              
              
              16.1
              %Sales
      and marketing
              
              
              41.9
              %
              
              
              54.2
              %General
      and administrative
              
              
              15.9
              %
              
              
              30.8
              %Total
      operating expenses
              
              
              124.5
              %
              
              
              165.0
              %Total
      other (income) expense, net
              
              
              1.1
              %
              
              
              14.0
              %Loss
      from operations
              
              
              -25.6
              %
              
              
              -79.0
              %
 
 Since
inception, we have experienced significant revenue growth as a result of sales
of our AeroGarden products. The table set forth below shows quarterly revenues
by sales channel for our initial two years of operations.
 
 Quarter
      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
              
              
              $
              13,144,037Quarter
      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
  22
 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%.  Direct sales are generated as a result of airings of our
infomercial, our websites, our own in house catalogue mailings and other
direct-to-consumer advertisements. Retail sales are generated through sales to
“brick and mortar” retailers, catalogues and home shopping companies who in turn
sell to consumers. International sales, which began in the quarter ended October
2007, are made to distributors in each specific country. We have seen growth in
all channels as consumer awareness and acceptance has grown for our products. In
retail channels, we have grown the number of retail storefronts from 30 in March
2006, to 750 in December 2006 to over 4,300 in December 2007. At March 31, 2008,
our products were being sold in over 5,100 retail storefronts.  In our
direct-to-consumer channel, we have 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 have also seen 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. The tables below show the quarterly data for
our first two years of operations with regard to our sales of garden products
versus sales of seed kit and accessory products.
 
 Quarter
      ended
              
              
              Year
      ended30-Jun-06
              
              
              30-Sep-06
              
              
              31-Dec-06
              
              
              31-Mar-07
              
              
              31-Mar-07Product
      RevenuesAeroGardens
              
              $
              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 RevenuesAeroGardens
              
              
              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
              %Quarter
      ended
              
              
              Year
      ended30-Jun-07
              
              
              30-Sep-07
              
              
              31-Dec-07
              
              
              31-Mar-08
              
              
              31-Mar-08Product
      RevenuesAeroGardens
              
              $
              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 RevenuesAeroGardens
              
              
              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
              %
  In regard
to our direct sales, we offer 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 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.
 
 For the
year ended March 31, 2008, we had one customer who represented 15% ($5,915,458)
of our net product sales. During the year ended March 31, 2007, we had two
retail customers who accounted for 15% ($1,962,968) and 10% ($1,303,899),
respectively, of our net sales.
 
 23
 Table of Contents
  During
the fiscal year ended March 31, 2008, we began to build our international
distributor network and had entered into agreements and have begun shipments
with distributors in the United Kingdom, Germany, Korea, Australia, Japan,
Mexico and Canada. On September 1, 2006, we retained the services of a
consultant in London to assist in developing our international distributor
network in Europe and Asia. The terms of our international agreements generally
provide for a test period commencing from the first shipment of product, usually
around 90 to 120 days, during which the distributor will air an infomercial and
otherwise evaluate the product potential in its market. Thereafter, if electing
to go forward, the distributor will be subject to minimum purchase requirements
on a quarterly or semi-annual basis based upon the size of the market and the
distribution channels granted the distributor in the market. To date, our
agreements are either still in the test period or have remained in force
subsequent to the test period with the exception of Japan, where the
distribution agreement was cancelled due to insufficient response to the
infomercial in that market.
 
 Cost of
revenues for the year ended March 31, 2008 were $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%.  Cost of revenues include 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. As
a percentage of sales, cost of revenues decreased 4.0% from 63.9% to 59.9%.
Included in cost of revenue for the year ended March 31, 2007 are costs
associated with expedited shipping of approximately 15,000 of our AeroGarden
units from our factory in 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
margins vary based upon the factors impacting cost of revenue discussed above as
well as the ratio of direct sales versus retail sales. In a direct-to-consumer
sale, we recognize as revenue the full purchase price for the product as opposed
to retail sales, where we recognize as revenue the wholesale price for the
product charged to the retailer. Media costs associated with direct sales are
included in sales and marketing costs. On 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 they are lower than margins
from domestic retail sales. Gross margins for the year ended March 31, 2008 were
$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%.  In the next twelve months, we
anticipate establishing an additional distribution center in Indianapolis,
Indiana which will enable savings in outbound freight costs. We also plan the
introduction of several new models of AeroGardens which are expected to yield
higher margins than the current models. The foregoing are anticipated to result
in improved gross margins.
 
 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%. Sales and marketing costs for the year ended March 31,
2008 and 2007 include all costs associated with the marketing, sales and
distribution of our products and consist of the following:
 
 Year ended March 31,2008
              
              2007Advertising
              
              $
              6,955,556
              
              $
              2,125,111Salaries
      and related expenses
              
              
              3,541,337
              
              
              2,036,104Infomercial
      production costs
              
              
              1,336,431
              
              
              767,599Sales
      commissions
              
              
              1,104,241
              
              
              556,531Trade
      Shows
              
              
              398,337
              
              
              156,320Telemarketing
              
              
              538,875
              
              
              168,572Other
              
              
              2,209,576
              
              
              1,307,376$
              16,084,353
              
              $
              7,117,613
 
 Advertising
is comprised of media costs for airing our infomercials and short form
television commercials, printing and postage costs related to our internal
catalogue production, and mailing and web media expenses for search and
affiliate web marketing programs. We consider all of this direct-to-consumer
media a key component of our marketing strategy in that it helps build awareness
and therefore consumer demand for all channels of distribution, as well as
generating revenues from direct-to-consumer sales and enhancing our user
database for future sales opportunities. Salaries and related costs consist of
salaries, payroll taxes, employee benefits and other payroll costs for our
sales, customer service operations, graphics, and marketing departments.
Infomercial production costs represent costs related to the development,
production, editing and revision of our thirty-minute infomercial and short
form, 0:60 and 1:20 second, television commercials. Sales commissions represent
commissions paid to our sales representatives which range from 4% to 7% of
collections from net sales.
 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.
 24
 Table of Contents
  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.
 
 Liquidity
and Capital Resources
  Since
inception, we have financed our operations primarily through the sale of equity
securities. As of March 31, 2008, we had a cash balance of $1,559,792 as
compared to a cash balance of $5,495,501 as of March 31, 2007.
 
 On May
20, 2008, we entered into a Commitment for Credit Facility with FCC, LLC, d/b/a
First Capital ("FCC") (the "FCC Commitment"), for a revolving credit facility in
the amount of $12,000,000 (the "Revolving Credit Facility"). In consideration of
FCC issuing the FCC Commitment, we paid FCC a commitment fee of $10,000. The
Revolving Credit Facility will have a maturity date of two years, with one-year
renewals thereafter. The Revolving Credit Facility will bear interest at a rate
of prime plus 2%, with the interest rate adjusting to prime plus 1.5% as of
January 1, 2009, and we are obligated to pay a minimum monthly interest that
would have been earned on an outstanding principal amount of $3,000,000.
Continued availability of the Revolving Credit Facility will also be subject to
our compliance with customary financial and reporting covenants. The purpose of
the Revolving Credit Facility is to pay off our current accounts receivable
factoring facility and to provide additional working capital. As collateral for
the Revolving Credit Facility, we will grant FCC a first priority security
interest over all of our assets, including, but not limited to, accounts
receivable, inventory, and equipment. On
June __, 2008, the RevolvingCredit
Facility was finalized and became effective.
 
 On May
19, 2008, AeroGrow and Jack J. Walker, one of our directors, acting as
co-borrowers, entered into a Business Loan Agreement with First National Bank
(the "Business Loan Agreement") dated May 16, 2008, for a loan in the principal
amount of $1,000,000 (the "First National Loan”). We have agreed, among other
things, that while the Business Loan Agreement is in effect, we 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 our assets
(except as specifically allowed), or (iii) sell with recourse any of our
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 terms of the First National Loan, we and Mr. Walker simultaneously
entered into a promissory note (the "First National Note") in the principal
amount of $1,000,000, at an initial interest rate of 5.5% with a maturity date
of May 16, 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 16, 2009. The First National Note also provides for a
minimum interest charge of $250.00, 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.
 
 On May
19, 2008, we also entered into a Loan Agreement and associated Promissory Note
with WLoans, LLC, a Colorado limited liability company, ("WLLC") as lender, and
Jack J. Walker, as co-borrower under the First National Loan (the "WLLC Loan
Agreement"), providing 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 AeroGrow officers and directors. As a
condition of the WLLC Loan, we must pay the 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, we 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. Under
the terms of the WLLC Loan Agreement, we will grant WLLC a security interest in
all of our assets, subordinate to the security interests in such assets to be
granted to FCC and First National Bank (each as described above). 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%.
 
 The WLLC
Loan Agreement also sets forth the terms and conditions under which Mr. Walker
agrees to act as Co-Borrower on the First National Loan (described above). In
consideration for Mr. Walker's agreement to act as co-borrower, we agreed to:
(i) pay to Mr. Walker a service fee of $50,000; (ii) allow Mr. Walker to
purchase the First National Loan in the event of our 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.
 
 We
anticipate our principal sources of liquidity during the next fiscal year ending
March 31, 2009 will be proceeds from sales of our products and the debt
facilities described above. We intend to use our working capital principally to
purchase inventory, fund media advertising, fund product promotion, and trade
show costs as well as support ongoing product development, overheads and
operational costs. In the event retail and/or direct response sales accelerate
more rapidly than currently anticipated, we would need to support this growth
through additional asset-based or other debt financing or the raising of
additional equity.
 25
 Table of Contents
  The
following table presents selected financial information for each of the last two
fiscal years and for the three month transitional period ended March 31,
2006:
 
 Three month transitional period
      endedYear Ended March 31,
              
              
              March 31,2008
              
              
              2007
              
              
              2006Cash
      and cash equivalents
              
              $
              1,559,792
              
              
              $
              5,495,501
              
              
              $
              8,852,548Cash
      provided by (used in) operating activities
              
              
              (9,030,436
              )
              
              
              (9,527,697
              )
              
              
              (803,382
              )Cash
      provided by (used in) investing activities
              
              
              (1,145,160
              )
              
              
              (746,065
              )
              
              
              (103,131
              )Cash
      provided by financing activities
              
              
              6,239,887
              
              
              
              6,916,715
              
              
              
              8,809,935Net
      increase (decrease) in cash and cash equivalents
              
              $
              (3,935,709
              )
              
              $
              (3,357,048
              )
              
              $
              7,903,422
  For the
year ended March 31, 2008, cash used in operations was $9,030,436 as compared to
cash used in operations for the year ended March 31, 2007 of $9,527,697. The
principal use of cash in operations was the net loss.  Increases in
all current assets exceeded offsetting increases in current liabilities by
$933,665.
 
 Cash used
by investing activities totaled $1,145,160 for the year ended March 31, 2008, as
compared to $746,065 used in investing activities for the year ended March 31,
2007. The principal use of cash in investing activities was the addition of
$612,985 in tooling for our new products and $406,482 in new computers and
office equipment. In addition, we purchased $105,000 in manufacturing and
$206,000 in computer equipment and software related to the installation of a new
computer network and an ERP accounting and purchasing system through a
capitalized lease program that did not require the outlay of cash.
 
 Cash
provided by financing activities was $6,239,887 for the year ended March 31,
2008, as compared to cash provided by financing activities of $6,916,715 for the
year ended March 31, 2007. Cash provided by financing activities included
$4,433,272 from the issuance of common stock in a September 2007 offering,
$987,500 of proceeds from exercise of warrants, and $835,000 from our accounts
receivable factoring facility.
 
 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,
2008.
 
 Less
      than 1 year
              
              
              1
      -3 years
              
              
              More
      than 3 years
              
              
              TotalCapital
      Lease Obligations
              
              $
              155,964
              
              
              $
              140,042
              
              
              $
              -
              
              
              $
              296,006Operating
      Leases
              
              
              328,400
              
              
              
              686,654
              
              
              
              268,691
              
              
              
              1,283,745Totals:
              
              $
              484,364
              
              
              $
              826,696
              
              
              $
              268,691
              
              
              $
              1,579,751
  See Notes
5 and 9 to our consolidated financial statements for additional information
related to our capital and operating leases.
  26
 Table of Contents
  ITEM7A.  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 accounts receivable factor is determined in part based on a
variable interest rate of the prime rate 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, 2008 under the line of credit and capital leases were
approximately $1.7 million. Based on amounts borrowed as of March 31, 2008,
we would have a resulting decline in future annual earnings and cash flows of
approximately $17,000 for every 1% increase in prime lending rates.
 
 Foreign
Currency Exchange Risk
 
 We
transact business 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.
  ITEM8.  FINANCIAL STATEMENTS
   Our
financial statements appear in a separate section at the end of this Annual
Report. Such information is incorporated herein by reference.
 ITEM9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
  On
February 24, 2006, we dismissed Hein & Associates LLP (“Hein”), the former
accountants for Wentworth, the company which merged with and into AeroGrow, as
our independent certified public accountants. The decision was approved by our
Board of Directors. We are the “successor issuer” to Wentworth I, Inc. within
the meaning of Rule 12(g)-3 under the Exchange Act and became a Section 12(g)
reporting company under the Exchange Act.
 
 The
reports of Hein on Wentworth’s financial statements for the fiscal years ended
December 31, 2005 did not contain an adverse opinion or disclaimer of opinion
and were not modified as to uncertainty, audit scope, or accounting principles,
except the report did contain an explanatory paragraph related to Wentworth’s
ability to continue as a going concern.  During Wentworth’s fiscal
year ended December 31, 2005, there were no disagreements with Hein 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 Hein would have caused Hein to make reference to the subject
matter of the disagreements in connection with its report on the financial
statements for such years. Wentworth requested that Hein furnish it with a
letter addressed to the SEC stating whether or not it agrees with Wentworth’s
statements in this Item 4.01(a). A copy of the letter furnished by Hein in
response to that request, dated February 27, 2006 which was filed as Exhibit
16.1 to the Form 8-K reporting the change.
 
 Gordon,
Hughes & Banks, LLP (“GHB”) has audited our financial statements annually
since inception through March 31, 2008. At a shareholder’s meeting held on
February 21, 2006, our shareholder’s ratified the appointment of GHB as auditors
for fiscal year ending March 31, 2007. At a meeting held on November 16, 2007,
the audit committee decided to engage GHB as the Company’s auditors for the year
ended March 31, 2008. During the years ended December 31, 2005 and 2004, and the
period from January 1, 2006 through March 31, 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 reports on the
our financial statements. In addition, none of the events described in Item
304(a)(1)(iv) of Regulation S-K occurred during such periods.
 ITEM9A. 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, 2008.  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, 2008, the
Company’s internal control over financial reporting was effective based on those
criteria.
 27
 Table of Contents
  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.
 
 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, 2008 that have or are
reasonably likely to materially affect our internal control over financial
reporting identified in connection with the previously mentioned
evaluation.
  
 ITEM9B. OTHER
INFORMATION
 
 Not
applicable.
   28
 Table of Contents
  PART
III
  ITEM10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
  The
information required by this item is incorporated by reference to our definitive
proxy statement for the 2008 Annual Meeting of Shareholders to be filed with the
SEC within 120 days after the end of the fiscal year ended March 31,
2008.
 
 Code
of Ethics
  We have a
written code of ethics in place that applies to all our employees, including our
principal executive officer, principal financial officer, and controller. A copy
of our business code of conduct and ethics is available on our website:
www.aerogrow.com. We are required to disclose any change to, or waiver from, our
business code of conduct and ethics for our senior financial officers. We intend
to use our website as a method of disseminating any change to, or waiver from,
our business code of conduct and ethics as permitted by applicable SEC
rules.
 ITEM11. EXECUTIVE COMPENSATION
  The
information required by this item is incorporated by reference to our definitive
proxy statement for the 2008 Annual Meeting of Shareholders to be filed with the
SEC within 120 days after the end of the fiscal year ended March 31,
2008.
 ITEM12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
  The
information required by this item is incorporated by reference to our definitive
proxy statement for the 2008 Annual Meeting of Shareholders to be filed with the
SEC within 120 days after the end of the fiscal year ended March 31,
2008.
 
 ITEM13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE
  The
information required by this item is incorporated herein by reference to our
definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year ended
March 31, 2008.
  ITEM14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
 The
information required by this item is incorporated herein by reference to our
definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed with the SEC within 120 days after the end of the fiscal year ended
March 31, 2008.
    29
 Table of Contents
 
 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
      CORPORATIONBy:
              /s/
      JERVIS B.
      PERKINSJervis B.
      PerkinsPresident and Chief Executive
      Officer
  30
 Table of Contents
  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 26th day of June 2008.
 
  Signature
              Title
              Date/s/
      W. MICHAEL BISSONNETTE
              Chairman of the
      Board
              June 26,
    2008W. Michael
      Bissonnette/s/
      H. MACGREGOR CLARKE
              Chief Financial
      Officer and Treasurer
              June 26,
    2008H. MacGregor
      Clarke/s/
      GREY H. GIBBS
              Controller and Chief
      Accounting Officer
              June 26,
    2008Grey H.
    Gibbs/s/
      DENNIS CHANNER
              Director
              June 26,
    2008Dennis
    Channer/s/
      JACK J. WALKER
              Director
              June 26,
    2008Jack J.
    Walker/s/
      KENNETH LEUNG
              Director
              June 26,
    2008Kenneth
    Leung
          31
 Table of Contents
  REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
   The Board
of Directors
 AeroGrow
International, Inc.
 Boulder,
CO
  We have
audited the accompanying balance sheets ofAeroGrow
International, Inc.(the
“Company”) as ofMarch 31,
2008and
2007, and the related statements of operations, changes in
stockholders’equity
(deficit) and cash flows for the years endedMarch 31,
2008and
March 31, 2007, and the three month transitional period ended March 31,
2006.  AeroGrow International, Inc.’s
management is responsible for these financial statements.  Our
responsibility is to express an opinion on these financial statements based
onour
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
expressno
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 evaluatingthe
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 ofAeroGrow
International, Inc.as
ofMarch 31,
2008and
2007, and the results of its operations and its cash flows for the years endedMarch 31,
2008and
March 31, 2007, and the three month transitional period ended March 31, 2006, in
conformity with accounting principles generally accepted in the United States of
America.
    Gordon,
Hughes & Banks, LLP
  Greenwood
Village, Colorado
 June 10,
2008
 
 
  
 
 32
 Table of Contents
  AEROGROW
INTERNATIONAL, INC.
 BALANCE
SHEETS
 
 March
      31,
              
              
              March
      31,2008
              
              
              2007ASSETSCurrent
      assetsCash
      and cash equivalents
              
              $
              1,559,792
              
              
              $
              5,495,501Restricted
      cash
              
              
              86,676
              
              
              
              84,363Accounts
      receivable, net of allowance for doubtful accounts of
                $511,710
      and $80,695 at March 31, 2008 and March 31, 2007,
                respectively
              
              
              2,412,101
              
              
              
              1,884,743Other
      receivables
              
              
              422,530
              
              
              
              182,221Inventory
              
              
              4,688,444
              
              
              
              3,940,614Prepaid
      expenses and other
              
              
              762,013
              
              
              
              480,990Total
      current assets
              
              
              9,931,556
              
              
              
              12,068,432Property
      and equipment, net of accumulated depreciation of $816,804 and $322,405 at
      March 31, 2008 and March 31, 2007, respectively
              
              
              1,830,646
              
              
              
              909,496Other
      assetsIntangible
      assets, net of $17,432 and $6,659 of accumulatedamortization
      at March 31, 2008 and March 31, 2007, respectively
              
              
              56,263
              
              
              
              28,723Deposits
              
              
              101,164
              
              
              
              35,155157,427
              
              
              
              63,878Total
      Assets
              
              $
              11,919,629
              
              
              $
              13,041,806LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilitiesCurrent
      portion  - capital lease obligations
              
              $
              128,927
              
              
              $
              -Due
      to factor
              
              
              1,480,150
              
              
              
              645,151Accounts
      payable
              
              
              3,023,366
              
              
              
              3,192,734Accrued
      expenses
              
              
              2,452,025
              
              
              
              1,166,485Customer
      deposits
              
              
              232,200
              
              
              
              -Deferred
      rent
              
              
              65,037
              
              
              
              53,531Total
      current liabilities
              
              
              7,381,705
              
              
              
              5,057,901Capital
      lease obligations, less current portion
              
              
              129,373
              
              
              
              -Stockholders'
      equityPreferred
      stock, $.001 par value, 20,000,000 shares authorized, noneissued
      or outstanding
              
              
              -
              
              
              
              -Common
      stock, $.001 par value, 75,000,000 shares authorized,12,076,717
      and 11,065,609 shares issued and outstanding at March31,
      2008 and March 31, 2007, respectively
              
              
              12,076
              
              
              
              11,065Additional
      paid-in capital
              
              
              44,024,559
              
              
              
              37,765,003Accumulated
      (deficit)
              
              
              (39,628,084
              )
              
              
              (29,792,163
              )Total
      Stockholders' Equity
              
              
              4,408,551
              
              
              
              7,983,905Total
      Liabilities and Stockholders' Equity
              
              $
              11,919,629
              
              
              $
              13,041,806
 
 See
accompanying notes to the financial statements
  33
 Table of Contents
  AEROGROW
INTERNATIONAL, INC.
 STATEMENTS
OF OPERATIONS
 
 Three
      month transitional period endedYears ended March 31,
              
              
              March 31,2008
              
              
              2007
              
              
              2006RevenueProduct
      sales, net
              
              $
              38,356,676
              
              
              $
              13,144,037
              
              
              $
              35,245Operating
      expensesCost
      of revenue
              
              
              22,975,385
              
              
              
              8,404,507
              
              
              
              134,622Research
      and development
              
              
              2,605,112
              
              
              
              2,113,255
              
              
              
              978,539Sales
      and marketing
              
              
              16,084,353
              
              
              
              7,117,613
              
              
              
              2,548,583General
      and administrative
              
              
              6,084,728
              
              
              
              4,050,312
              
              
              
              2,010,907Total
      operating expenses
              
              
              47,749,578
              
              
              
              21,685,687
              
              
              
              5,672,651Loss
      from operations
              
              
              (9,392,902
              )
              
              
              (8,541,650
              )
              
              
              (5,637,406
              )Other
      (income) expense, netInterest
      (income)
              
              
              (115,070
              )
              
              
              (176,173
              )
              
              
              (39,919
              )Interest
      expense
              
              
              558,089
              
              
              
              356,594
              
              
              
              1,813,278Loss
      on modification of debt
              
              
              -
              
              
              
              -
              
              
              
              132,578Registration
      rights penalty
              
              
              -
              
              
              
              1,664,380
              
              
              
              -Total
      other (income) expense, net
              
              
              443,019
              
              
              
              1,844,801
              
              
              
              1,905,937Net
      loss
              
              $
              (9,835,921
              )
              
              $
              (10,386,451
              )
              
              $
              (7,543,343
              )Net
      loss per share, basic and diluted
              
              $
              (0.84
              )
              
              $
              (1.09
              )
              
              $
              (0.84
              )Weighted
      average number of common shares outstanding, basic and
    diluted
              
              
              11,662,891
              
              
              
              9,505,926
              
              
              
              8,956,353
  See
accompanying notes to the financial statements
 
 34
 Table of Contents
  AEROGROW
INTERNATIONAL, INC.
 STATEMENT
OF CHANGES IN STOCKHOLDERS' EQUITY
  Common
              
              
              
              
              
              AdditionalStock
              
              
              
              
              
              Paid-in
              
              
              AccumulatedShares
              
              
              Amount
              
              
              Capital
              
              
              (Deficit)
              
              
              TotalBalances,
      January 1, 2006
              
              
              5,578,740
              
              
              $
              5,579
              
              
              $
              11,741,388
              
              
              $
              (11,862,369
              )
              
              $
              (115,402
              )Adjustment
      for error in prior year warrant exercise
              
              
              2,000
              
              
              
              2
              
              
              
              (2
              )
              
              
              -
              
              
              
              -Common
      stock issued in private placement
              
              
              2,148,000
              
              
              
              2,148
              
              
              
              8,807,787
              
              
              
              -
              
              
              
              8,809,935Common
      stock issued for conversion of convertible debentures
              
              
              710,009
              
              
              
              710
              
              
              
              2,129,290
              
              
              
              -
              
              
              
              2,130,000Common
      stock issued in exchange for stock of Wentorth I
              
              
              580,136
              
              
              
              580
              
              
              
              (580
              )
              
              
              -
              
              
              
              -Common
      stock issued under equity compensation plans
              
              
              83,737
              
              
              
              84
              
              
              
              418,600
              
              
              
              -
              
              
              
              418,684Stock
      options issued under equity compensation plans
              
              
              -
              
              
              
              -
              
              
              
              3,315,840
              
              
              
              -
              
              
              
              3,315,840Beneficial
      conversion value due to modification of the convertible
      debentures
              
              
              -
              
              
              
              -
              
              
              
              900,758
              
              
              
              -
              
              
              
              900,758Net
      (loss)
              
              
              
              
              
              
              
              
              -
              
              
              
              (7,543,343
              )
              
              
              (7,543,343
              )Balances,
      March 31, 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
              )
              
              $
              4,408,551
 
 See
accompanying notes to the financial statements
  35
 Table of Contents
  AEROGROW
INTERNATIONAL, INC.
 STATEMENTS
OF CASH FLOWS
  Three
      month transitional period endedYears
      Ended March 31,
                
                
                March
      31,2008
                
                
                2007
                
                
                2006Cash
      flows from operating activities:Net
      (loss)
                
                $
                (9,835,921
                )
                
                $
                (10,386,451
                )
                
                $
                (7,543,343
                )Adjustments
      to reconcile net (loss) to cash provided (used) by
    operations:Common
      stock issued for registration rights penalty
                
                
                -
                
                
                
                1,664,380
                
                
                
                -Issuance
      of common stock and options under equity compensation
plans
                
                
                710,899
                
                
                
                1,077,029
                
                
                
                3,734,525Issuance
      of common stock not under equity compensation plan
                
                
                -
                
                
                
                141,592
                
                
                
                -Issuance
      of warrants for services
                
                
                92,065
                
                
                
                -
                
                
                
                -Depreciation
      and amortization expense
                
                
                505,171
                
                
                
                225,949
                
                
                
                41,514Allowance
      for bad debt
                
                
                431,015
                
                
                
                80,695Amortization
      of debt issuance costs
                
                
                -
                
                
                
                242,399
                
                
                
                164,119Amortization
      of convertible debentures, beneficial conversion feature
                
                
                -
                
                
                
                -
                
                
                
                1,180,937Interest
      expense from warrants issued with convertible debentures
                
                
                -
                
                
                
                -
                
                
                
                414,522Effects
      of variable accounting for modification of warrant terms
                
                
                -
                
                
                
                -
                
                
                
                132,578Change
      in assets and liabilities:Decrease
      in subscriptions receivable
                
                
                -
                
                
                
                -
                
                
                
                840,000(Increase)
      in accounts receivable
                
                
                (958,373
                )
                
                
                (1,922,282
                )
                
                
                (43,156
                )(Increase)
      in other receivable
                
                
                (240,309
                )
                
                
                (182,221
                )
                
                
                -(Increase)
      in inventory
                
                
                (747,830
                )
                
                
                (3,747,668
                )
                
                
                (173,466
                )(Increase)
      in other current assets
                
                
                (281,023
                )
                
                
                (281,400
                )
                
                
                (119,870
                )(Increase)
      decrease  in deposits
                
                
                (66,009
                )
                
                
                -
                
                
                
                -Increase
      (decrease) in accounts payable
                
                
                (169,368
                )
                
                
                2,705,260
                
                
                
                290,634Increase
      in accrued expenses
                
                
                1,285,541
                
                
                
                831,961
                
                
                
                277,624Increase
      (decrease) in customer deposits
                
                
                232,200
                
                
                
                (30,471
                )
                
                
                -Increase
      in deferred rent
                
                
                11,506
                
                
                
                53,531
                
                
                
                - -Net
      cash (used) by operating activities
                
                
                (9,030,436
                )
                
                
                (9,527,697
                )
                
                
                (803,382
                )Cash
      flows from investing activities:Increase
      in restricted cash
                
                
                (2,313
                )
                
                
                (84,363
                )
                
                
                -Purchases
      of equipment
                
                
                (1,104,534
                )
                
                
                (649,087
                )
                
                
                (100,771
                )Patent
      expenses
                
                
                (38,313
                )
                
                
                (12,615
                )
                
                
                (2,360
                )Net
      cash (used) by investing activities
                
                
                (1,145,160
                )
                
                
                (746,065
                )
                
                
                (103,131
                )Cash
      flows from financing activities:Increase
      in amount due to factor
                
                
                834,999
                
                
                
                645,151
                
                
                
                -Stock
      repurchase
                
                
                -
                
                
                
                (15,000
                )
                
                
                -Proceeds
      from issuance of common stock, net
                
                
                4,433,372
                
                
                
                6,200,314
                
                
                
                8,809,935Proceeds
      from exercise and issuance of warrants
                
                
                987,500
                
                
                
                116,250
                
                
                
                -Proceeds
      from the exercise of stock options
                
                
                36,731
                
                
                
                -
                
                
                
                -Principal
      payments on capital leases
                
                
                (52,715
                )
                
                
                -
                
                
                
                -Repayment
      of convertible debentures
                
                
                -
                
                
                
                (30,000
                )
                
                
                -Net
      cash provided by financing activities
                
                
                6,239,887
                
                
                
                6,916,715
                
                
                
                8,809,935Net
      increase (decrease) in cash
                
                
                (3,935,709
                )
                
                
                (3,357,047
                )
                
                
                7,903,422Cash,
      beginning of period
                
                
                5,495,501
                
                
                
                8,852,548
                
                
                
                949,126Cash,
      end of period
                
                $
                1,559,792
                
                
                $
                5,495,501
                
                
                $
                8,852,548
 
 See
supplemental disclosures on the following page and the accompanying notes to the
financial statements
 36
 Table of Contents
   Year Ended
              
              
              Three
      month transitionalperiod
      endedMarch 31,
              
              
              March 31,
              
              
              March 31,2008
              
              
              2007
              
              
              2006Supplemental
      disclosure of non-cash investing and financing activities:Interest
      paid
              
              $
              560,731
              
              
              $
              83,158
              
              
              $
              32,700Income
      taxes paid
              
              $
              -
              
              
              $
              -
              
              
              $
              -Purchase
      of equipment throughassumption
      of capital lease obligations
              
              $
              311,015
              
              
              $
              -
              
              
              $
              -Accretion
      of debt modification
              
              $
              -
              
              
              $
              119,319
              
              
              $
              13,249Convertible
      debentures converted to common stock
              
              $
              -
              
              
              $
              840,000
              
              
              $
              2,130,000Conversion
      of mandatorily redeemable stock
              
              
              
              
              
              $
              310,000
 
 See
accompanying notes to the financial statements
    37
 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. Prior to March
2006 when the Company commenced sales of its aeroponic garden systems, the
Company was considered a Development Stage Enterprise in accordance with FAS No.
7, “Accounting and Reporting by Development Stage Enterprises.” Today 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.
 
 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.
 
 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.
 
 38
 Table of Contents
  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, 2008 and March 31, 2007.
 
 Restricted
Cash
  The Company has secured activity
related to its corporate credit card purchase account with a restricted money
market account. The balances in this account as of March 31, 2008 and March 31,
2007 were $86,676 and $84,363, respectively.
 
 Concentrations of
Risk
  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 $100,000 federally insured limit as of March 31, 2008
and March 31, 2007.  However, management believes that the financial
institution is financially sound and the risk of loss is
minimal.
 Financial
instruments consist of cash and cash equivalents, accounts receivable and
accounts payable. The carrying values of all financial instruments approximate
their fair value.
 
 Customers:
  The
Company maintains a credit insurance policy on many of its trade accounts
receivables. For the year ended March 31, 2008, the Company had one customer who
represented 15% of the Company’s net product sales.  At March 31,
2008, the foregoing customer accounted for 12% of the total outstanding accounts
receivable. In addition, at March 31, 2008, the Company had accounts receivable
from one customer, Linens ‘n Things, Inc., totaling $502,088, representing 17.2%
of the outstanding accounts receivables at March 31, 2008 before allowance for
bad debts, and which amount was outstanding on May 2, 2008, when Linens ‘n
Things, Inc. filed for protection under Chapter 11 of the U.S. Bankruptcy Code.
In as much as this balance had been excluded from coverage under the Company’s
credit insurance policy and supplemental credit coverage obtained by the Company
had expired April 15, 2008, the Company has, as of March 31, 2008, reserved for
and expensed $400,000 (80%) of the outstanding balance due from Linens ‘n
Things, Inc. in determining its Allowance for Doubtful Accounts.
 
 For the
year ended March 31, 2007, the Company had two customers who represented 15% and
10% of the Company’s net product sales, respectively.  At March 31,
2007, the foregoing customers accounted for 13% and 2% of the total outstanding
accounts receivable, respectively.  In addition, at March 31, 2007,
the Company had three additional customers accounting for 15%, 11% and 11%,
respectively, of total accounts receivable outstanding.
 
 For the
three months ended March 31, 2006, one customer represented 93% of the Company’s
net product sales.
 
 Suppliers:
  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 inventories and other
inventory-related items from these two suppliers totaling $2,307,826 and
$4,686,403, representing 27% and 56% of cost of sales,
respectively.  During the three months ended March 31, 2006, the
Company purchased inventory and other inventory related items from one supplier
totaling $160,523. 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 could
have an adverse impact on operations.
 
 
 39
 Table of Contents
  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 31,2008
              
              
              2007Manufacturing
      equipment and tooling
              
              $
              1,616,946
              
              
              $
              823,675Computer
      equipment and software
              
              
              476,576
              
              
              
              131,625Leasehold
      improvements
              
              
              111,759
              
              
              
              104,994Other
      equipment
              
              
              442,169
              
              
              
              171,6072,647,450
              
              
              
              1,231,901Less:  accumulated
      depreciation
              
              
              (816,804
              )
              
              
              (322,405
              )Property
      and equipment, net
              
              $
              1,830,646
              
              
              $
              909,496
 
 Depreciation
expense for the year ended March 31, 2008, for the year ended March 31, 2007,
and for the three months ended March 31, 2006 was $494,399, $220,362 and $40,
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 31,2008
              
              
              2007Patents
              
              $
              36,257
              
              
              $
              22,858Trademarks
              
              
              37,438
              
              
              
              12,52473,695
              
              
              
              35,382Less:  accumulated
      amortization
              
              
              (17,432
              )
              
              
              (6,659
              )Intangible
      assets, net
              
              $
              56,263
              
              
              $
              28,723
 
 Amortization
expense for the year ended March 31, 2008, the year ended March 31, 2007 and for
the three months ended March 31, 2006, was $10,772, $5,588 and $1,071,
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.
 
 40
 Table of Contents
  March 31,
              
              
              March 31,2008
              
              
              2007Finished
      goods
              
              $
              3,669,693
              
              
              $
              3,626,671Raw
      materials
              
              
              1,018,751
              
              
              
              313,943$
              4,688,444
              
              
              $
              3,940,614
 
 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, 2008 and March 31, 2007, 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
$511,710 and $80,695 at March 31, 2008  and March 31, 2007,
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, 2008
and March 31, 2007, the balance in this reserve account was $422,530 and
$182,221, respectively.
 
 Advertising and Production
Costs
  The
Company expenses all production costs related to advertising as incurred. These
costs include actual advertising such as print, television, and radio
advertisements which are expensed when the advertisement has been broadcast or
otherwise distributed.  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, 2008 and March 31, 2007, the Company had deferred $503,825 and
$493,086, respectively, related to such media costs. Advertising expenses for
the years ended March 31, 2008, March 31, 2007 and for the three months ended
March 31, 2006 were $6,955,555, $2,125,112 and $30,000,
respectively.
 
 Research and
Development
  Research,
development, and engineering costs are expensed as incurred, in accordance with
SFAS No. 2, “Accounting for Research and Development
Costs.”  Research, development, and engineering expenses primarily
include payroll and headcount related costs, contractor fees, infrastructure
costs, and administrative expenses directly related to research and development
support.
 
 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. For the years ended March 31,
2008 , March 31, 2007 and the three month transition period ended March 31,
2006, equity compensation in the form of stock options and grants of restricted
stock totaled $710,899, $1,077,029 and $3,734,525, respectively, and is included
in the accompanying Statements of Operations in the following
categories:
 
 41
 Table of Contents
  Year
      ended
                March 31, 2008
              
              
              Year
      ended
                March 31, 2007
              
              
              Three
      month transition period ended March 31,
      2006General
      and administrative
              
              $
              225,730
              
              
              $
              356,720
              
              
              $
              1,332,540Research
      and development
              
              
              300,702
              
              
              
              336,482
              
              
              
              651,417Sales
      and  marketing
              
              
              184,467
              
              
              
              383,827
              
              
              
              1,724,940Cost
      of revenue
              
              
              -
              
              
              
              -
              
              
              
              25,628$
              710,899
              
              
              $
              1,077,029
              
              
              $
              3,734,525
 
 Income
Taxes
  In
September 2006, the FASB 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, 2008 and March 31, 2007,
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 $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 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. The Company also, as of March 31, 2008
and March 31, 2007, did not record $175,781 and $135,459, respectively, of
product costs associated with the foregoing revenue 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 $69,339 of revenue as of March 31, 2008 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, 2008, recognition of $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, 2008 and March 31, 2007, the Company had accrued
$226,729 and $65,385 respectively, as its estimate for the foregoing deductions
and allowances.
 
 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, 2008 and March 31, 2007 a provision for potential
future warranty costs of $72,200 and $15,393, respectively.
 
 The
Company reserves for known and potential returns from customers and associated
refunds or credits related to such returns based upon historical experience. In
certain cases, customers are provided a fixed allowance, usually in the 1% to 2%
range, to cover returned goods from which this allowance is deducted from
payments from such customers. As of March 31, 2008 and March 31, 2007, the
Company has recorded a reserve for customer returns of $674,120  and
$238,569, respectively.
 
 42
 Table of Contents
  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,
2008 and March 31, 2007, the Company had recorded deferred rent related to this
agreement in the amount of $65,037 and $53,531, respectively, based on the
difference between rent expense recorded and the rent payment
obligation.
 
 Registration Rights
Penalties
  The
holders of securities issued in the Company’s 2006 Offering and 2005 Offering
(see Note 3) 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.
 
 Debt Issuance
Costs
  Debt
issuance costs consist of consideration paid to third parties with respect to a
$3.0 million debt financing in July 2005, including cash payments for legal fees
and placement agent fees. Such costs are being deferred and were to be amortized
over the term of the related debt, which was one year.  On February
24, 2006, $2,130,000 of the debt associated with these costs converted to
710,009 shares of common stock (See Note 3, Convertible
Debentures).  The pro rata costs associated with the $2,130,000 which
converted to common stock was expensed as interest as of the date converted. The
amortization of the remaining debt issuance costs will be amortized over the
remaining life of the debt.
 
 Beneficial Conversion
Feature of Debentures
  In
accordance with Emerging Issues Task Force No. 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios,” and Emerging Issues Task Force No. 00-27, “Application of
Issue No. 98-5 to Certain Convertible Instruments,” the Company recognized the
advantageous value of conversion rights attached to convertible debt. Such
rights give the debt holder the ability to convert debt into shares of common
stock at a price per share that is less than the fair market value of the common
stock on the day the loan is made to the Company. The beneficial value was
calculated as the intrinsic value (the fair market value of the stock at the
commitment date in excess of the conversion rate) of the beneficial conversion
feature of the debentures and the related accrued interest and was recorded as a
discount to the related debt and an addition to additional paid in capital. The
discount was subsequently amortized to interest expense over the remaining
outstanding period of the related debt using the interest method.
 
 New Accounting
Pronouncements
  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 shall be effective 60 days
following the Securities Exchange and Commission’s approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, “The
Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles.” We do not expect its adoption will have a material impact on our
financial statements
 
 43
 Table of Contents
  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.
 
 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 is
currently evaluating the potential impact of adopting this statement on its
financial position, results of operations and cash flows and 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 will adopt SFAS 159 in the fiscal year beginning April 1, 2008. The adoption
of this Statement is not expected to 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 – Convertible Debentures
  On May
27, 2005, the Company issued $3,000,000 of convertible debentures, through a
private placement offering consisting of up to 300 units at an offering price of
$10,000 per unit (the “2005 Offering”). Each unit was comprised of a convertible
debenture evidenced by a 10% unsecured convertible promissory note in the
principal amount of $10,000 (a total of $3,000,000), and 2,000 five-year
warrants (a total of 600,000 warrants), each warrant providing for the purchase
of one share of the Company's common stock at the exercise price of $5.01 per
share. The Company received proceeds of $3,000,000 from this private placement
less $419,471 in directly incurred debt issuance costs. In addition to the
foregoing, for each share of common stock issuable upon conversion, each note
holder received an additional five year warrant to purchase one share of common
stock at an exercise price of $6.00 per share. The Company had agreed to
registration rights related to both the shares underlying the convertible debt
and the related warrants.  In the event the Company failed to fulfill
its registration obligations the Company agreed to pay liquidated damages. For
the year ended March 31, 2007, the Company recorded penalties for failing to
meet the registration requirements with regard to the 2005 Offering through
December 22, 2006, the effective date of the registration of the underlying
shares, of 74,250 shares of common stock valued at $371,250.
  44
 Table of Contents
  In
conjunction with the 2005 Offering, the Company recognized at the time of
issuance $750,000 of beneficial conversion costs, representing the value of the
beneficial conversion rights of the convertible debentures, determined by
calculating the difference of the fair market value of the stock at the
commitment date, or $5.00 per share, less the conversion exercise price of $4.00
times the number of shares to be issued upon conversion or 750,000 shares. This
value was recorded as a discount to the convertible debentures and an addition
to additional paid-in capital. This discount was completely amortized as
interest expense over the term of the convertible debentures which were
originally due, if not converted, by June 30, 2006.
  Also in
conjunction with the 2005 Offering, the Company recognized at the time of
issuance $1,059,480 representing the fair value of the five year warrants issued
with the convertible debentures. The value of these warrants was determined in
accordance with the Black-Scholes pricing model utilizing a historic volatility
factor of 129.67%, a risk free interest rate of 5.0% and an expected life for
the warrants of five years, resulting in a value of $2.73 per warrant. This
value was recorded as an additional discount to the convertible debentures and
an addition to additional paid-in capital. This discount was completely
amortized to interest expense over the term of the convertible debentures which
were originally due if not converted by June 30, 2006.
  Prior to
the closings of the Merger and the 2006 Offering but contingent upon their
successful completion, in February 2006, the Company entered into agreements
with the convertible debt holders of the 2005 Offering whereby certain debt
holders converted $2,130,000 of their outstanding debt obligations into common
stock of the Company at a conversion price of $3.00 per share and certain other
debt holders agreed to extend the maturity dates of $840,000 of debt obligations
from June 30, 2006 to December 31, 2006. The $2,130,000 of debt that converted
immediately resulted in additional beneficial conversion expense of $887,500 to
account for the additional fair value attributed to the additional shares of
common stock that were issued as a result of the change in the conversion price
to $3 per share from the original conversion price of $4 per share. The fair
value of the foregoing additional shares was based upon a price of $5.00 per
share. The converting note holders also were issued, pursuant to the terms of
the original note offering, five-year warrants to purchase 426,000 shares of the
Company’s common stock at an exercise price of $6.00 per share. With respect to
the $840,000 of convertible debentures that were modified by extension of the
due date from June 30, 2006 to December 31, 2006 and modification of the
embedded conversion feature from a conversion price of $4.00 per share to a
conversion price of $3.50 per share, based on the significant change in the
terms of these $840,000 in debentures, the original debt was deemed extinguished
and a debt extinguishment loss was recognized. This loss was based on the fair
value of the new debt instrument in accordance with EITF 96-19, “Debtor’s
Accounting for a Modification or Exchange of Debt Instruments and EITF 05-07,
Accounting for Modifications to Conversion Options Embedded in Debt Instruments
and Related Issues.”  The Company recognized a loss on extinguishment
of debt of $132,578. This loss was determined by calculating the change in net
present value of the cash flows from the convertible debt, inclusive of the
change in the embedded conversion feature determined by comparing the fair value
of the conversion option immediately following such modification with its fair
value immediately prior to the modification. This loss was recorded as of
February 2006 with a corresponding increase in fair value of the modified
convertible debenture balance and is being amortized over the remaining term of
these debentures to additional paid in capital. As of December 31, 2006, the
Company has accreted $132,578 of the recognized loss on extinguishment of debt
to additional paid in capital.  Of the original amount of $3,000,000
in convertible debentures disclosed as outstanding as of December 31, 2005,
$2,130,000 converted to common stock in February 2006, $30,000 was repaid in
June 2006 and $840,000 converted to common stock in March 2007.
 
 The
holders of securities issued in the private placement offering and the
convertible debt offering had registration rights under the common stock and for
the common stock underlying the warrants held by them. Liquidated damages for
failure to register and maintain registration for the common stock and for the
common stock underlying the warrants held by investors were
payable  under certain circumstances The Company completed the
registration on December 22, 2006 which was five months beyond the required
registration requirement. Accordingly, the Company recognized five months of
penalty and issued 74,250 penalty shares of common stock in January 2007 to
investors in the Company’s 2005 Offering aggregating a total charge to expense
of $371,250.
 
 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. The term of the agreement is for one year but can
be terminated by the Company with 60 days written notice. In accordance with the
terms of the agreement, Benefactor will purchase the invoices that it approves
for an initial payment of 85% of the amount of the invoice with the remaining
15% paid upon collection less any deductions from the customer. Benefactor
charges a commission of 1 1⁄4% of the gross amount of the invoice and a
maintenance fee equal to an annual rate of prime plus 3%, prime being determined
by Benefactor based upon either the prime rate published by Benefactor Funding
Corp.’s bank or the Wall Street Journal, (8.25% at March 31, 2008) charged on a
daily basis for the unpaid invoice amounts outstanding. The Company has agreed,
beginning May 2007, to factor with Benefactor a minimum of $800,000 of invoices
monthly. The Company is responsible for any invoices which are unpaid after 91
days or are subject to other defaults by the customer and this obligation is
secured by the Company with a security interest granted to Benefactor on all
assets. As of March 31, 2008, Benefactor had advanced the Company $1,480,150
against invoices totaling $1,915,815. As of March 31, 2007, Benefactor had
advanced the Company $645,151 against invoices totaling $764,338. Fees paid to
Benefactor for interest, discounts and other services for the year ended March
31, 2008 and March 31, 2007 totaled $503,164 and $39,556,
respectively.  The receivables are considered recourse and are
presented at gross value in the accompanying balance sheets.
 
 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.
 
 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
$296,006 as of March 31, 2008. 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 $269,614 as of March 31, 2008. 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.
 
 45
 Table of Contents
  Maturities
of capital lease obligations as of March 31, 2008, are as follows:
 
 Year
      ended March 31, 2009
              
              $
              155,964Year
      ended March 31, 2010
              
              
              107,239Year
      ended March 31, 2011
              
              
              32,803Total
      minimum lease payments
              
              
              296,006Less
      - amount related to interest
              
              
              (37,706
              )Principal
      portion of future obligations
              
              
              258,300Less
      - current portion
              
              
              (128,927
              )$
              129,373
 
 The
following table summarizes the assets recorded in property and equipment that
were acquired under the capital leases as of March 31, 2008:
 
 Class
      of propertyComputer
      equipment
              
              $
              58,618Factory
      equipment
              
              
              101,985Software
              
              
              150,412311,015Accumulated
      depreciation
              
              
              (41,401
              )Net
      book value
              
              $
              269,614
 
 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 $5.90 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 1,505,000 shares of our common stock may be granted under the 2005
Plan.
 
 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 $5.90 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).
 
 46
 Table of Contents
  For the
years ended March 31, 2008 and March 31, 2007 and three months March 31, 2006,
respectively, the Company granted 272,911, 222,131 and 888,153 options to
purchase the Company’s common stock at exercise prices ranging from $4.74 to
$5.90 per share under the 2005 Plan as follows:
 
 Yearended
      March 31, 2008
              
              
              YearendedMarch
      31, 2007
              
              
              Three
      month transition period ended March 31, 2006Employees
              
              
              272,911
              
              
              
              170,131
              
              
              
              810,700Consultants
              
              
              -
              
              
              
              17,000
              
              
              
              40,000Directors
              
              
              -
              
              
              
              35,000
              
              
              
              37,453272,911
              
              
              
              222,131
              
              
              
              888,153
 
 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. Included in the options granted for the year ended March
31, 2008 are 221,063 options which exceed the current 1,505,000 shares eligible
to be issued under the 2005 Plan.
 
 For the
option grants issued during the three month transition period ended March 31,
2006 and through December 31, 2006, the Company used the following weighted
average assumptions: no dividend yield; expected volatility rate of 129.67%;
risk free interest rate of 5%; and average lives of 4 years resulting in a value
of $4.12 per option granted. 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, 2008,
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 $2.12 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 year ended March 31, 2008, March 31, 2007
and the three month transition period ended March 31, 2006, was increased by
$710,899, $560,859 and $3,315,840, respectively.
 
 A summary
of option activity in the 2005 Plan is as follows:
 
 Exercise priceWeighted-Options
              
              
              Low
              
              
              High
              
              
              AverageBalance
      outstanding at January 1, 2006
              
              
              233,270
              
              
              $
              0.01
              
              
              $
              5.00
              
              
              $
              2.34Granted
              
              
              888,153
              
              
              $
              5.00
              
              
              $
              5.00
              
              
              $
              5.00Exercised
              
              
              -
              
              
              $
              0.00
              
              
              $
              0.00
              
              
              $
              0.00Forfeited
              
              
              (4,154
              )
              
              $
              5.00
              
              
              $
              5.00
              
              
              $
              5.00Balance
      at March 31, 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
              
              
              $
              5.00Balance
      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
              
              
              $
              3.63Balance
      at March 31,2008
              
              
              1,553,951
              
              
              $
              0.01
              
              
              $
              5.90
              
              
              $
              4.46
 
 47
 Table of Contents
  Information
regarding all stock options outstanding under the 2005 Plan as of March 31, 2008
is as follows:
 
 OPTIONS
      OUTSTANDING
              
              OPTIONS
      EXERCISABLEWeighted-
              
              
              
              
              
              
              
              
              
              Weighted-average
              
              
              Weighted-
              
              
              
              
              
              
              average
              
              
              Weighted-Remaining
              
              
              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
              
              
              8,295
              
              
              
              1.16
              
              
              $
              0.12
              
              
              
              
              8,295
              
              
              
              2.57
              
              
              $
              0.12Over
      $0.50 to $2.50
              
              
              110,618
              
              
              
              0.84
              
              
              $
              1.63
              
              
              
              
              110,618
              
              
              
              2.58
              
              
              $
              1.63Over
      $5.00 to $5.50
              
              
              1,341,404
              
              
              
              3.33
              
              
              $
              5.00
              
              
              
              
              1,179,939
              
              
              
              3.22
              
              
              $
              5.00Over
      $5.50
              
              
              93,634
              
              
              
              4.28
              
              
              $
              5.90
              
              
              
              
              53,670
              
              
              
              5.00
              
              
              $
              5.901,553,951
              
              
              
              3.20
              
              
              $
              4.46
              
              $ 417,437
              
              
              1,352,523
              
              
              
              3.05
              
              
              $
              4.46
              
              $
417,437
 
 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 (March 30, 2008) of the period
presented. For the year ended March 31, 2008, 36,358 options to purchase the
Company’s common stock were exercised under the plan resulting in $36,731 in
proceeds to the Company.
 
 At March
31, 2008 the Company has granted options for 201,428 shares of the Company’s
common stock that are unvested that will result in $463,903 of compensation
expense in future periods if fully vested.
 
 In
addition to option grants, during the years ended March 31, 2008 and March 31,
2007 and the three month transition period ended March 31, 2006, the Company
granted and issued under the 2005 Equity Compensation Plan a total of 98,194,
83,737 and 157,192 shares, respectively, of common stock at $5.00 to $5.90 per
share to employees, consultants and directors for services
provided.  Other than grants in March 2007, which were valued at
market on the date of grant, the fair value of these shares was determined based
upon sales of common stock in private transactions prior to the services being
provided as follows:
 
 Year
      ended
                March 31, 2008
              
              
              Year
      ended
                March 31, 2007
              
              
              Three
      Months ended
                March 31, 2006Shares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Shares
              
              
              AmountEmployees
              
              
              -
              
              
              $
              -
              
              
              
              28,044
              
              
              $
              140,220
              
              
              
              34,000
              
              
              $
              170,000Consultants
              
              
              -
              
              
              
              -
              
              
              
              49,150
              
              
              
              257,450
              
              
              
              39,737
              
              
              
              198,685Directors
              
              
              -
              
              
              
              -
              
              
              
              21,000
              
              
              
              118,500
              
              
              
              10,000
              
              
              
              50,000-
              
              
              $
              -
              
              
              
              98,194
              
              
              $
              516,170
              
              
              
              83,737
              
              
              $
              418,685
 
 Note
7 – Income Taxes
 
 In
September 2006, the FASB 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.
 
 The
Company is subject to U.S. federal income tax as well as income tax of several
state jurisdictions including primarily Colorado and California. With few
exceptions, the Company is no longer subject to U. S. federal, state, and local
income tax examinations by tax authorities for the years before 2004 for federal
and 2003 for state returns.    Some federal and state income
tax returns for 2003 through 2007 were or will be filed on a delinquent basis to
the applicable jurisdictions.
 
 48
 Table of Contents
  The
Company did not record any provision for federal and state income taxes for the
year ended March 31, 2008, March 31, 2007 and the three months ended March 31,
2006.  Variations from the federal statutory rate are as
follows:
 
 Year
                ended
                March
      31, 2008
              
              
              Year
                ended
                March
      31, 2007
              
              
              Three
      month transition period ended March 31,
                2006Expected
      income tax benefit atthe
      statutory rate of 34%
              
              $
              3,667,285
              
              
              $
              4,083,171
              
              
              $
              2,179,733Net
      operating (loss) carryforward
              
              
              (3,667,285
              )
              
              
              (4,083,171
              )
              
              
              (2,179,733
              )Net
      tax expense
              
              $
              -
              
              
              $
              -
              
              
              $
              -
 
  Deferred
income tax assets result from federal and state operating loss carryforwards in
the amounts of $10,402,418 as of March 31, 2006, $8,895,243 for the year ended
March 31, 2007 and $7,805,801 for the year ended March 31, 2008. The loss carry
forwards will begin to expire in 2021.  At March 31, 2008, March 31,
2007 and March 31, 2006, the Company had research and development tax credit
carryforwards of $448,892, $362,672 and $118,285, respectively, which will begin
to expire in 2021.
  Net
deferred tax assets consist of the following as of:
 
 Year
                ended
                March
      31, 2008
              
              
              Year
                ended
                March
      31, 2007
              
              
              Three
      month transition period ended March 31,
                2006Tax
      effect of net operating loss carryforwards
              
              $
              10,470,067
              
              
              $
              7,454,687
              
              
              $
              4,021,104Tax
      effect of employee equity compensation
              
              
              1,684,483
              
              
              
              1,374,298
              
              
              
              1,157,638Tax
      effect of other temporary differences
              
              
              421,693
              
              
              
              166,194
              
              
              
              (22,348
              )Research
      and development tax credit
              
              
              448,892
              
              
              
              362,672
              
              
              
              118,285Less
      valuation allowance
              
              
              (13,025,136
              )
              
              
              (9,357,850
              )
              
              
              (5,274,679
              )Net
      deferred tax assets
              
              $
              -
              
              
              $
              -
              
              
              $
              -
 
  In
assessing the realizability of deferred tax assets, the Company considers
whether it is more likely than not that some or the entire deferred tax asset
will not be realized.  The Company believes that sufficient
uncertainty exists regarding the realizability of the deferred tax assets such
that valuation allowances equal to the entire balance of the deferred tax assets
are necessary.  In accordance with Sections 382 and 383 of the
Internal Revenue Code, a change in ownership of greater than 50% of a
corporation within a three-year period will place an annual limitation on our
ability to utilize our existing tax loss and tax credit carry
forwards.  The Company did incur such a change in ownership effective
in the fourth quarter of 2004.  The result of the section 382
limitation was that the NOL carryover from 2004 and previous years was limited
to $1,042,501.  At this time the Company does not anticipate a Section
383 limitation as a result of this ownership change.
  Note
8 – Related Party Transactions
 
 During
the years ended March 31, 2008, March 31, 2007 and the three month transition
period ended March 31, 2006, the Company paid $24,000, $44,472 and $24,000,
respectively, to a director for legal services.
 
 During
the three-month transition period ended March 31, 2006, the Company paid $12,500
to a director for consulting fees in connection with a corporate presentation
given in conjunction with its private placement in February 2006.
 
 During
the year ended March 31, 2007, the Company paid consulting fees totaling $81,238
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.
 
 49
 Table of Contents
  Also,
during the years ended March 31, 2008 and March 31, 2007, the Company incurred
fees totaling $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 Chief Marketing Officer. During the three month transition period
ended March 31, 2006, the Company incurred $131,894 in expenses to MedEd
Architects, LLC for video production, printing, duplication, and web
design.
 
 During
the year ended March 31, 2008, the Company paid fees totaling $20,000 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
 
 On July
27, 2006 the Company entered into a lease with Pawnee Properties, LLC to
consolidate its operations, other than its seed kit manufacturing operations,
into a 21,012 square foot office space at 6075 Longbow Drive, Boulder, Colorado
80301, commencing December 1, 2006.  The initial rent of $15,759 per
month increased to $17,510 per month as of February 1, 2008, plus the Company’s
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.
 
 Future
cash payments under such operating lease for the upcoming five years are as
follows:
  Year
      Ended
              
              RentMarch 31,
    2009
              
              
              328,400March 31,
    2010
              
              
              341,970March 31,
    2011
              
              
              344,684March 31,
    2012
              
              
              268,691$
              1,283,745
  Rent
expense for the years ended March 31, 2008, March 31, 2007 and for the three
months ended March 31, 2006, was $432,338, $348,454 and $33,458,
respectively.
 
 Note
10 – Stockholders’ Equity
 
 During
the three-month transition period ended March 31, 2006, the Company issued
2,148,000 shares of common stock valued at $5.00 per unit (each unit included
one share and one warrant to purchase a share of common stock at an exercise
price of $7.50 per share ) in a private placement (Note 2 – Merger and 2006
Private Placement).
  During
the three month transition period ended March 31, 2006, the Company issued
710,009 shares of common stock valued at $5.00 per share and five year warrants
issuable upon conversion with an exercise price of $6.00 per share in exchange
for conversion of convertible debentures (Note 3 – Convertible
Debentures).
  During
the three month transition period ended March 31, 2006, the Company issued
580,136 shares of common stock in conjunction with a merger with Wentworth I
(Note 2 – Merger and 2006 Private Placement).
  In June
2006, a warrant holder with warrants expiring June 30, 2006 exercised warrants
to purchase 10,000 shares of the Company’s common stock at $2.50 per
share.
  In July
2006, a warrant holder with warrants from the Company’s 2006 Offering exercised
warrants to purchase 5,000 shares of the Company’s common stock at $6.25 per
share.
  The
Company purchased 3,000 shares of its own common stock at a price of $5.00 per
share in July 2006 that had been previously issued as compensation to a
consultant based upon an agreement to allow such consultant to convert such
stock to cash if the consultant so elected prior to June 30, 2006.
  In
December 2006 a warrant holder with warrants expiring December 31, 2006
exercised warrants to purchase 24,000 shares of the company’s common stock at
$2.50 per share.
  50
 Table of Contents
  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.
  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.
  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,
2008,  no shares of preferred stock have been issued.
   51
 Table of Contents
  A summary
of the Company’s warrant activity for the period from December 31, 2006 through
March 31, 2008 is presented below:
  WeightedWarrants
              
              
              Average
              
              AggregateOutstanding
              
              
              Exercise Price
              
              Intrinsic ValueOutstanding,
      January 1, 2006
              
              
              1,552,858
              
              
              $
              8.64Granted
              
              
              2,962,800
              
              
              
              6.20Exercised
              
              
              -
              
              
              
              -Expired
              
              
              -
              
              
              
              -Outstanding,
      March 31, 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
              
              
              $
              6.66
              
              $      4,900
 
 As of
March 31, 2008, the Company had the following outstanding warrants to purchase
its common stock:
  Weighted
              
              WeightedWarrants
              
              Average
              
              AverageOutstanding
              
              Exercise Price
              
              Remaining Life (Yrs)10,000
              
              $
              2.50
              
              
              0.0715,000
              
              $
              5.00
              
              
              0.10580,000
              
              $
              5.01
              
              
              2.45644,000
              
              $
              6.00
              
              
              3.622,232,300
              
              $
              6.25
              
              
              2.9050,000
              
              $
              6.96
              
              
              4.331,283,436
              
              $
              7.57
              
              
              3.99800,000
              
              $
              8.00
              
              
              6.4280,000
              
              $
              8.25
              
              
              6.425,694,736
              
              $
              6.66
              
              
              2.53
  
 52
 Table of Contents
  Note
11 – Unaudited Quarterly Condensed Financial Information
   FISCAL
      YEAR ENDED MARCH 31, 2008Quarter
      Ended30-Jun-07
              
              
              30-Sep-07
              
              
              31-Dec-07
              
              
              31-Mar-08
              
              
              Fiscal YearTotal
      Revenue
              
              $
              6,278,685
              
              
              $
              6,283,645
              
              
              $
              14,637,742
              
              
              $
              11,156,604
              
              
              $
              38,356,676Operating
      expensesCost
      of revenue
              
              
              3,575,276
              
              
              
              3,765,376
              
              
              
              8,938,857
              
              
              
              6,695,876
              
              
              
              22,975,385Research
      and development
              
              
              521,819
              
              
              
              628,542
              
              
              
              682,453
              
              
              
              772,298
              
              
              
              2,605,112Sales
      and marketing
              
              
              2,920,987
              
              
              
              3,156,414
              
              
              
              4,997,801
              
              
              
              5,009,151
              
              
              
              16,084,353General
      and administrative
              
              
              1,255,008
              
              
              
              982,181
              
              
              
              1,471,364
              
              
              
              2,376,175
              
              
              
              6,084,728Total
      operating expenses
              
              
              8,273,090
              
              
              
              8,532,513
              
              
              
              16,090,475
              
              
              
              14,853,500
              
              
              
              47,749,578Other
      (income) expense, net
              
              
              28,325
              
              
              
              90,394
              
              
              
              203,154
              
              
              
              121,146
              
              
              
              443,019Net
      Loss
              
              $
              (2,022,730
              )
              
              $
              (2,339,262
              )
              
              $
              (1,655,887
              )
              
              $
              (3,818,042
              )
              
              $
              (9,835,921
              )Net
      loss per share, basic and diluted
              
              $
              (0.18
              )
              
              $
              (0.20
              )
              
              $
              (0.13
              )
              
              $
              (0.32
              )
              
              $
              (0.84
              )
  FISCAL
      YEAR ENDED MARCH 31, 2007Quarter
      Ended30-Jun-06
                
                
                30-Sep-06
                
                
                31-Dec-06
                
                
                31-Mar-07
                
                
                Fiscal YearTotal
      Revenue
                
                $
                821,938
                
                
                $
                1,030,316
                
                
                $
                4,857,604
                
                
                $
                6,434,179
                
                
                $
                13,144,037Operating
      expensesCost
      of revenue
                
                
                675,695
                
                
                
                827,165
                
                
                
                3,282,291
                
                
                
                3,619,356
                
                
                
                8,404,507Research
      and development
                
                
                434,931
                
                
                
                409,453
                
                
                
                700,111
                
                
                
                568,760
                
                
                
                2,113,255Sales
      and marketing
                
                
                960,474
                
                
                
                1,359,797
                
                
                
                1,965,578
                
                
                
                2,831,764
                
                
                
                7,117,613General
      and administrative
                
                
                856,040
                
                
                
                773,362
                
                
                
                1,042,537
                
                
                
                1,378,373
                
                
                
                4,050,312Total
      operating expenses
                
                
                2,927,140
                
                
                
                3,369,777
                
                
                
                6,990,517
                
                
                
                8,398,253
                
                
                
                21,685,686Other
      (income) expense, net
                
                
                17,687
                
                
                
                1,069,305
                
                
                
                725,325
                
                
                
                32,484
                
                
                
                1,844,801Net
      Loss
                
                $
                (2,122,889
                )
                
                $
                (3,408,766
                )
                
                $
                (2,858,238
                )
                
                $
                (1,996,558
                )
                
                $
                (10,386,451
                )Net
      loss per share, basic and diluted
                
                $
                (0.23
                )
                
                $
                (0.37
                )
                
                $
                (0.30
                )
                
                $
                (0.19
                )
                
                $
                (1.09
                )
  53
 Table of Contents
  Note
12 – Subsequent Events (Unaudited)
 
 On May
20, 2008, the Company entered into a Commitment for Credit Facility with FCC,
LLC, d/b/a First Capital ("FCC") (the "FCC Commitment"), for a revolving credit
facility in the amount of $12,000,000 (the "Revolving Credit Facility"). In
consideration of FCC issuing the FCC Commitment, the Company paid FCC a
commitment fee of $10,000. The Revolving Credit Facility will have a maturity
date of two years, with one-year renewals thereafter. The Revolving Credit
Facility will bear interest at a rate of prime plus 2%, with the interest rate
adjusting to prime plus 1.5% as of January 1, 2009, and the Company is obligated
to pay a minimum monthly interest that would have been earned on an outstanding
principal amount of $3,000,000. Continued availability of the Revolving Credit
Facility will also be subject to the Company’s compliance with customary
financial covenants relating to minimum tangible net worth, debt to tangible net
worth ratios and minimum earnings to debt service ratios. The purpose of the
Revolving Credit Facility is to pay off the Company's current accounts
receivable factoring facility with Benefactor and to provide additional working
capital. As collateral for the Revolving Credit Facility, the Company will grant
FCC a first priority security interest in all of its assets, including, but not
limited to, accounts receivable, inventory, and equipment.On June 24, 2008, the
Revolving Credit Facility was finalized and became
effective.
 
 On May
19, 2008, the Company, together with Jack J. Walker, a director of the Company,
entered into a Business Loan Agreement with First National Bank (the "Business
Loan Agreement") dated May 16, 2008, for a loan in the principal amount of
$1,000,000 (the "First National Loan") with the Company and Mr. Walker as
co-borrowers. The Company has further agreed, among other things, that while the
Business Loan Agreement is in effect, it 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 Borrower's assets (except as specifically
allowed), or (iii) sell with recourse any of Borrower'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 terms of the First National Loan, the Company and Mr. Walker
simultaneously entered into a promissory note (the "First National Note"),
wherein they jointly and severally promise to pay to First National Bank the
principal amount of $1,000,000, at an initial interest rate of 5.5% with a
maturity date of May 16, 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 16, 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.
 
 In
connection with the First National Loan, Mr. Walker as pledgor and the Company
as co-borrower entered into a Commercial Pledge Agreement, wherein Mr. Walker
granted First National Bank a security interest in a certain investment account
in his name, as collateral for the First National Loan. Upon execution of
definitive agreements for the Revolving Credit Facility with FCC, it is
anticipated that the Company will enter into a new security agreement with First
National Bank, subordinate to FCC's security interest, substituting collateral
of the Company for the collateral of Jack J. Walker covered by the Commercial
Pledge Agreement.
 
 On May
19, 2008, the Company entered into a Loan Agreement and associated Promissory
Note with WLoans, LLC, a Colorado limited liability company ("WLLC") as lender,
and Jack J. Walker as co-borrower, under the First National Loan, (the "WLLC
Loan Agreement") providing for a loan up to a maximum of One Million Five
Hundred Thousand Dollars ($1,500,000), for business purposes, at an annual
interest rate of 12% (the "WLLC Loan"). Jack J. Walker, a director of the
Company, 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 must pay the 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. Under the terms of the WLLC Loan Agreement,
the Company will grant WLLC a security interest in all of its assets,
subordinate to the security interest in such assets to be granted to FCC and
First National Bank (each as described above). Further, in the event the Company
receives 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, the 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%.
 
 The WLLC
Loan Agreement also sets forth the terms and conditions under which Jack J.
Walker agrees to act as Co-Borrower on the First National Loan (described
above). In consideration for Mr. Walker's agreement to act as co-borrower, the
Company agreed to: (i) pay to 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
29, 2008, the Company entered into a sub-lease with Coleman Cable, Inc. to
secure approximately 90,000 square feet of warehouse and distribution space in
Indianapolis, IN.   The space will be occupied in July 2008 and will
be utilized to handle fulfillment and shipping operations in support of
distribution to the Company’s eastern and mid-western customers, which represent
approximately 70% of the total customer base. The rent during the term of
the sub-lease is $15,895 per month on a gross basis.   The term of the
sub-lease continues until February 11, 2011, unless modified under specified
circumstances. The agreement contains other standard office lease
provisions.
  
 54
 Table of Contents
  INDEX
TO EXHIBITS
 
 3.1
              Articles
      of Incorporation of the Registrant (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
              Amended
      Bylaws of the Registrant (incorporated by reference to Exhibit 3.6 of our
      Current Report on Form 8-K/A-2, filed November 16,
  2006)
  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)
  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)
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  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)
  10.1
              Lease
      Agreement between AeroGrow 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)
  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 AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow 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
      AeroGrow 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)
  10.17
              Form
      of Assignment of Application Agreement between AeroGrow 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 AeroGrow 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)
   56
 Table of Contents
   10.20
              Letter
      agreement dated July 15, 2005 between AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow 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 AeroGrow
      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 AeroGrow 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 between AeroGrow
      International, Inc. and the other parties
  thereto.
  10.32
              Registration
      Rights Agreement, dated as of September 4, 2007, by and between AeroGrow
      International, Inc. 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 AeroGrow International, Inc. 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*
  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)
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 Table of Contents
   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)
  23.1
              Consent of Independent Registered Public Accounting
      Firm*
  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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