UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC 20549











FORM
10-Q







(MARK
      ONE)x
            QUARTERLY REPORT UNDER
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
  1934For
      the quarterly period ended June 30, 2008ORo
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACTFor
      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 jurisdictionof
      incorporation or organization)
            (IRS
      EmployerIdentification
      Number)




6075 Longbow Drive,
      Suite 200, Boulder, Colorado
            80301(Address
      of principal executive offices)
            (Zip
      Code)




(303)
444-7755


(Registrant's
telephone number, including area code)






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
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 whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.





Large
      accelerated filer   o
            Accelerated
      filer   oNon-accelerated
      filer     o(Do not check if
      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




Number
of shares of issuer's common stock outstanding as of July 31,
2008:  12,115,992







Table of Contents




AeroGrowInternational, Inc.


TABLE
OF CONTENTS


FORM
10-Q REPORT


June
30, 2008




PART
      I   Financial InformationItem
      1.
            Condensed Financial
      Statements
            3Condensed Balance
      Sheets as of June 30, 2008 (Unaudited) and March 31,
      2008
            3Condensed
      Statements of Operations for the Three Months Ended June 30, 2008 and June
      30, 2007 (Unaudited)
            4Condensed
      Statements of Cash Flows for the Three Months Ended June 30, 2008 and June
      30, 2007 (Unaudited)
            5Notes to
      the Condensed Financial Statements
    (Unaudited)
            6Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
            12Item
      3.
            Quantitative and
      Qualitative Disclosures About Market Risk
            19Item
      4T.
            Controls and
      Procedures
            20PART
      II  Other InformationItem
      1.
            Legal
      Proceedings
            20Item
      1A.
            Risk
      Factors
            20Item
      2.
            Unregistered Sales
      of Equity Securities and Use of Proceeds
            20Item
      3.
            Defaults Upon
      Senior Securities
            20Item
      4.
            Submission of
      Matters to Vote of Security Holders
            20Item
      5.
            Other
      Information
            20Item
      6.
            Exhibits
            21Signatures
            22




NOTE
CONCERNING FORWARD-LOOKING INFORMATION
  In
addition to historical information, certain matters contained in this report
contain "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, 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 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.
 
 Because
forward-looking statements involve risks and uncertainties, we caution that
there are important factors that may cause actual results to differ materially
from those contained in the forward-looking statements. For a detailed
discussion of those factors, see Part I, Item 1A. Risk Factors in our Annual
Report on Form 10-K for the year ended March 31, 2008.


Table of Contents




Item 1.Condensed Financial Statements




AEROGROW
INTERNATIONAL, INC.


CONDENSED
BALANCE SHEETS


(Unaudited)




June
      30,
              
              
              March
      31,2008
              
              
              2008ASSETSCurrent
      assetsCash
              
              $
              344,981
              
              
              $
              1,559,792Restricted
      cash
              
              
              473,275
              
              
              
              86,676Accounts
      receivable, net of allowance for doubtful accounts of $507,999 and
      $511,710 at
                June
      30, 2008 and March 31, 2008, respectively
              
              
              2,419,351
              
              
              
              2,412,101Other
      receivable
              
              
              323,451
              
              
              
              422,530Inventory
              
              
              4,951,647
              
              
              
              4,688,444Prepaid
      expenses and other
              
              
              730,137
              
              
              
              762,013Total
      current assets
              
              
              9,242,842
              
              
              
              9,931,556Property
      and equipment, net of accumulated depreciation of $1,002,849 and $816,804
      at June 30, 2008 and March 31, 2008, respectively
              
              
              1,820,669
              
              
              
              1,830,646Other
      assetsIntangible
      assets, net of $22,962 and $17,432 of accumulated amortization at June 30,
      2008 and March 31, 2008, respectively
              
              
              132,910
              
              
              
              56,263Deposits
              
              
              101,164
              
              
              
              101,164234,074
              
              
              
              157,427Total
      Assets
              
              $
              11,297,585
              
              
              $
              11,919,629LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilitiesCurrent
      portion  - long term debt
              
              $
              1,733,502
              
              
              $
              128,927Due
      to factor
              
              
              -
              
              
              
              1,480,150Accounts
      payable
              
              
              4,275,844
              
              
              
              3,023,366Accrued
      expenses
              
              
              2,145,248
              
              
              
              2,452,025Customer
      Deposits
              
              
              244,857
              
              
              
              232,200Deferred
      rent
              
              
              35,327
              
              
              
              65,037Total
      current liabilities
              
              
              8,434,778
              
              
              
              7,381,705Long
      term debt
              
              
              1,214,507
              
              
              
              129,373Stockholders'
      equityPreferred
      stock, $.001 par value, 20,000,000 shares authorized, none issued or
      outstanding
              
              
              --
              
              
              
              --Common
      stock, $.001 par value, 75,000,000 shares authorized, 12,100,387 and
      12,076,717 shares issued and outstanding at
                June
      30, 2008 and March 31, 2008, respectively
              
              
              12,100
              
              
              
              12,076Additional
      paid-in capital
              
              
              44,081,632
              
              
              
              44,024,559Accumulated
      (deficit)
              
              
              (42,445,432
              )
              
              
              (39,628,084
              )Total
      Stockholders' Equity
              
              
              1,648,300
              
              
              
              4,408,551Total
      Liabilities and Stockholders' Equity
              
              $
              11,297,585
              
              
              $
              11,919,629












See
accompanying notes to the condensed financial statements.







3
 Table of Contents




AEROGROWINTERNATIONAL, INC.


CONDENSED
STATEMENTS OF OPERATIONS


(Unaudited)






Three
      months ended June 30,2008
              
              
              2007RevenueProduct
      sales
              
              $
              6,720,081
              
              
              $
              6,278,685Operating
      expensesCost
      of revenue
              
              
              3,686,823
              
              
              
              3,575,276Research
      and development
              
              
              725,415
              
              
              
              521,819Sales
      and marketing
              
              
              3,449,883
              
              
              
              2,920,987General
      and administrative
              
              
              1,518,712
              
              
              
              1,255,008Total
      operating expenses
              
              
              9,380,833
              
              
              
              8,273,090Loss
      from operations
              
              
              (2,660,752
              )
              
              
              (1,994,405
              )Other
      (income) expense, netInterest
      (income)
              
              
              (1,050
              )
              
              
              (37,859
              )Interest
      expense
              
              
              157,647
              
              
              
              66,184Loss
      on modification of debt
              
              
              --
              
              
              
              --Registration
      rights penalty
              
              
              --
              
              
              
              --Total
      other (income) expense, net
              
              
              156,597
              
              
              
              28,325Net
      loss
              
              $
              (2,817,349
              )
              
              $
              (2,022,730
              )Net
      loss per share, basic and diluted
              
              $
              (0.23
              )
              
              $
              (0.18
              )Weighted
      average number of common shares outstanding, basic and
    diluted
              
              
              12,100,387
              
              
              
              11,085,389Gross
      Margin
              
              $
              3,033,258
              
              
              $
              2,703,409












See
accompanying notes to the condensed financial statements.







4
 Table of Contents






AEROGROW INTERNATIONAL, INC.


CONDENSED
STATEMENTS OF CASH FLOWS


(Unaudited)





Three months ended June 30,2008
            
            
            2007Cash
      flows from operating activities:Net
      (loss)
            
            $
            (2,817,349
            )
            
            $
            (2,022,730
            )Adjustments
      to reconcile net (loss) to cash provided (used) by
    operations:Issuance
      of common stock and options under equity compensation
plans
            
            
            15,011
            
            
            
            123,202Depreciation
      and amortization expense
            
            
            191,573
            
            
            
            87,802Allowance
      for bad debt
            
            
            (3,711
            )
            
            
            (24,099
            )Amortization
      of debt issuance costs
            
            
            22,135
            
            
            
            --Change
      in assets and liabilities:(Increase)
      in accounts receivable
            
            
            (3,539
            )
            
            
            (288,767
            )(Increase)
      decrease in other receivable
            
            
            99,079
            
            
            
            (47,249
            )(Increase)
      decrease in inventory
            
            
            (263,203
            )
            
            
            32,390Decrease
      in other current assets
            
            
            9,741
            
            
            
            61,900(Increase)
      in deposits
            
            
            --
            
            
            
            (100,884
            )Increase
      (decrease) in accounts payable
            
            
            1,252,478
            
            
            
            (1,591,211
            )(Decrease)
      in accrued expenses
            
            
            (306,777
            )
            
            
            (84,419
            )Increase
      in customer deposits
            
            
            12,657
            
            
            
            910,847Increase
      (decrease) in deferred rent
            
            
            (29,710
            )
            
            
            3,752Net
      cash (used) by operating activities
            
            
            (1,821,615
            )
            
            
            (2,939,466
            )Cash
      flows from investing activities:Increase
      in restricted cash
            
            
            (386,599
            )
            
            
            (673
            )Purchases
      of equipment
            
            
            (176,068
            )
            
            
            (129,433
            )Patent
      expenses
            
            
            (82,177
            )
            
            
            (3,691
            )Net
      cash (used) by investing activities
            
            
            (644,844
            )
            
            
            (133,797
            )Cash
      flows from financing activities:Increase
      (decrease) in amount due to factor
            
            
            (1,480,150
            )
            
            
            620,989Stock
      repurchase
            
            
            --
            
            
            
            --Proceeds
      from long term debt
            
            
            2,720,279
            
            
            
            --Proceeds
      from issuance of common stock, net
            
            
            --
            
            
            
            --Proceeds
      from exercise and issuance of warrants
            
            
            25,000
            
            
            
            375,000Proceeds
      from the exercise of stock options
            
            
            17,086
            
            
            
            --Principal
      payments on capital leases
            
            
            (30,567
            )
            
            
            --Repayment
      of convertible debentures
            
            
            --
            
            
            
            --Net
      cash provided by financing activities
            
            
            1,251,648
            
            
            
            995,989Net
      (decrease) in cash
            
            
            (1,214,811
            )
            
            
            (2,077,274
            )Cash,
      beginning of period
            
            
            1,559,792
            
            
            
            5,495,501Cash,
      end of period
            
            $
            344,981
            
            
            $
            3,418,227








See
accompanying notes to the condensed financial statements.




5
 Table of Contents







AEROGROWINTERNATIONAL INC.


NOTES
TO THE CONDENSED FINANCIAL STATEMENTS


(Unaudited)







1.
            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 (the “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
Statement of Financial Accounting Standards (“SFAS”) No. 7, “Accounting and
Reporting by Development Stage Enterprises.” Today the Company manufactures,
distributes, and markets over 11 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.





2.
            Basis
      of Presentation





Interim Financial
Information




The
unaudited interim financial statements of the Company included herein have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission (“SEC”) for interim reporting including the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. These condensed statements
do not include all disclosures required by accounting principles generally
accepted in the United States of America (“U.S. GAAP”) for annual audited
financial statements and should be read in conjunction with the Company’s
audited consolidated financial statements and related notes included in the
Company’s Annual Report on Form 10-K for the year ended March 31, 2008, as filed
with the SEC.





In the
opinion of management, the accompanying unaudited interim financial statements
reflect all adjustments, including normal recurring accruals, necessary to
present fairly the financial position of the Company at June 30, 2008, the
results of operations for the three months ended June 30, 2008 and 2007, and the
cash flows for the three months ended June 30, 2008 and 2007. The results of
operations for the three months ended June 30, 2008, are not necessarily
indicative of the expected results of operations for the full year or any future
period. The balance sheet as of March 31, 2008, is derived from the Company’s
audited financial statements.





Use of
estimates




The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period.  Actual results could differ
from those estimates.





Net Income (Loss) per Share
of Common Stock




The
Company computes net income (loss) per share of common stock in accordance with
SFAS No. 128, “Earnings per Share,” and SEC Staff Accounting Bulletin No.
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.








6
 Table of Contents




Reclassifications




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




Segments of an Enterprise
and Related Information




SFAS No.
131, “Disclosures about Segments of an Enterprise and Related Information,”
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 No. 131 also requires disclosures about products
and services, geographic areas, and major customers.  At present, the
Company only operates in one segment.




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 June 30, 2008,
and June 30, 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 three months ended June 30, 2008, the Company had two
customers who represented 6.0% and 5.8% of the Company’s net product
sales.  These customers accounted for 10.7% and 9.4% of the total
outstanding accounts receivable at June 30, 2008. The Company had one customer,
Linens ‘n Things, Inc., that accounted for 17.1% of the total outstanding
accounts receivables at June 30, 2008 before allowance for bad
debts.  This amount (the “Linens ‘n Things Receivable”) was
outstanding on May 2, 2008, when Linens ‘n Things, Inc. filed for protection
under Chapter 11 of the U.S. Bankruptcy Code. The Linens ‘n Things Receivable
was excluded from coverage under the Company’s credit insurance policy, and the
Company’s supplemental credit coverage expired April 15, 2008.  The
Company therefore has, as of June 30, 2008, reserved for $400,000, or
approximately 80%, of the Linens ‘n Things Receivable, in determining its
Allowance for Doubtful Accounts.





For the
three months ended June 30, 2007, the Company had one customer who represented
17.7% of net product sales.  At June 30, 2007, this customer accounted
for less than 1% of the total outstanding accounts receivable.  In
addition, at June 30, 2007, the Company had two customers accounting for 26.3%
and 19.7%, respectively, of total accounts receivable outstanding.





Suppliers:




For the
three months ended June 30, 2008, the Company purchased inventories and other
inventory related items from three suppliers totaling $996,481, $686,428, and
$267,154, representing 27.0%, 18.6%, and 7.2% of cost of sales,
respectively.  For the three months ended June 30, 2007, the Company
purchased inventories and other inventory-related items from one supplier
totaling $680,050, representing 19.0% of cost of sales.   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.





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.




June
      30,
            
            
            March
      31,2008
            
            
            2008Finished
      goods
            
            $
            3,771,233
            
            
            $
            3,669,693Raw
      materials
            
            
            1,180,414
            
            
            
            1,018,751$
            4,951,647
            
            
            $
            4,688,444





The
Company determines an inventory obsolescence reserve based on management’s
historical experience and establishes reserves against inventory according to
the age of the product. As of June 30, 2008, and March 31, 2008, the Company
determined that no inventory obsolescence reserve was required.





7
 Table of Contents




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 $105,933 and
$294,715 of revenue as of June 30, 2008 and June 30, 2007, respectively, related
to the unpaid balance due for orders shipped in conjunction with the Company’s
direct-to-consumer sales 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 June 30, 2008 and June 30,
2007, did not record $32,556 and $89,828, respectively, of product costs
associated with the foregoing revenue because 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 $56,924 and $910,847 of revenue as of June 30, 2008
and June 30, 2007, respectively, related to the wholesale sales value of
inventory held by its retail shopping channel customers as these sales are
contingent upon the shopping channels selling the goods. Deferred payments for
these goods are charged to Customer Deposits. The Company also deferred, as of
June 30, 2008 and June 30, 2007, recognition of $24,491 and $457,597,
respectively, 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, rebates, 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 June 30, 2008 and June 30, 2007, the Company had
accrued $358,096 and $148,089 respectively, as its estimate for the foregoing
deductions and allowances.





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 is 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”) No. 93-7, “Reporting on Advertising Costs.” In accordance with SOP No.
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 June 30, 2008 and June 30, 2007, the Company had deferred $27,066
and $0, respectively, related to such media costs. Advertising expenses for the
three months ended June 30, 2008 and June 30, 2007 were $3,449,883 and
$2,920,987, respectively.





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.  Based upon the foregoing, the Company has recorded as of
June 30, 2008 and June 30, 2007 a provision for potential future warranty costs
of $65,969 and $47,633, 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 June 30, 2008 and June 30, 2007, the Company
has recorded a reserve for customer returns of $291,382 and $166,159,
respectively.




Fair
Value
  The
Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157,
“Fair Value Measurements” (“SFAS No. 157”) for financial assets and liabilities,
which provides a single definition of fair value, establishes a framework for
the measurement of fair value and expands disclosure about the use of fair value
to measure assets and liabilities. The adoption of SFAS No. 157 for financial
assets and liabilities did not have a material impact on the Company’s financial
statements as of June 30, 2008.


New Accounting
Pronouncements





In May
2008, the Financial Accounting Standards Board (“FASB”) issued 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.” The Company does not expect its
adoption will have a material impact on the Company’s 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 SFAS No. 133, “Accounting for Derivate Instruments and
Hedging Activities.” 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. The Company does not expect
its adoption will have a material impact on the Company’s financial statement
disclosures.





8
 Table of Contents




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. 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,” 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.” The Company adopted SFAS No. 159 beginning April 1, 2008. The
Company does not expect that the adoption will have a material effect on the
Company’s financial statements.




3.
            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
$257,015 as of June 30, 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 $247,095 as of June 30, 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.





4.
            Long
      Term Debt and Current Portion – Long Term
Debt





On May
19, 2008, the Company 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”) for a loan to the Company in the principal
amount of $1,000,000 (the ‘First National Loan”). The Company has agreed, among
other things, that while the Business Loan Agreement is in effect, the Company
will not (without First National Bank's prior written consent): (i) incur or
assume indebtedness, except for trade debt in the ordinary course of business,
capital leases in an amount not to exceed $500,000, and capital expenditures of
not more than $500,000 during any fiscal year; (ii) sell, transfer, mortgage,
assign, pledge, lease, grant a security interest in, or encumber any of 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 Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19, 2009. The First
National Note also provides for a minimum interest charge of $250, but otherwise
may be prepaid at any time without penalty. In the event of a default under the
First National Note, the interest rate will be increased by a margin of 4% over
the current rate of interest.  As of June 30, 2008, $1,000,000 was
outstanding under the First National Note.





On May
22, 2008, we also entered into a Loan Agreement (the “WLLC Loan Agreement”) and
associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLoans Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the Company. As a
condition of the WLLC Loan, the Company paid WLLC a non-refundable commitment
fee of $37,500. Further, in consideration of WLLC holding available funds equal
to the principal amount not yet disbursed, the Company must pay a non-refundable
fee of 1% of the retained funds as a holding fee, payable quarterly. If not paid
sooner, the WLLC Loan, if drawn upon, will be due and payable on April 1, 2009.
We granted WLLC a security interest in all of 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%.  As of June 30, 2008, loans totaling $600,000 were
outstanding under the WLLC Loan Agreement.





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





9
 Table of Contents




On June
23, 2008, the Company entered into a Loan and Security Agreement with FCC, LLC,
d/b/a First Capital (“FCC”) (the “FCC Loan Agreement”) for a revolving credit
facility in the amount of $12,000,000 (the “Revolving Credit
Facility”).  The Revolving Credit Facility has an initial two-year
term, with one-year renewals thereafter. Loans under the Revolving Credit
Facility bear interest at a rate of prime plus 2%, with the interest rate
adjusting to prime plus 1.5% as of January 1, 2009.  The Company must
pay a minimum monthly interest payment equal to the amount that would have been
owed on an outstanding principal amount of $3,000,000. Continued availability of
the Revolving Credit Facility is subject to our compliance with customary
financial and reporting covenants. The purpose of the Revolving Credit Facility
is to provide additional working capital. As collateral for the Revolving Credit
Facility, the Company granted to FCC a first priority security interest over all
of the Company’s assets, including, but not limited to, accounts receivable,
inventory, and equipment.  As of June 30, 2008, loans totaling
$1,120,276 were outstanding under the Revolving Credit Facility.





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





5.
            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.  As of March 31, 2008, Benefactor had
advanced the Company $1,480,150 against invoices totaling
$1,915,815.   The factored 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.




6.
            Equity
      Compensation Plans





For the
three months ended June 30, 2008, the Company granted 30,000 options to purchase
the Company’s common stock at an exercise price of $2.60 per share and 237,423
options to purchase the Company’s common stock at an exercise price of $2.96 per
share under the 2005 Equity Compensation Plan (“2005 Plan”).  Options
granted during the three months ended June 30, 2008, are subject to shareholder
approval at the Company’s next annual meeting.  The Company did not
grant any options during the three months ended June 30,
2007.


During
the three months ended June 30, 2008, there were 6,067 options to purchase
common stock forfeited and 13,670 shares issued upon exercise of outstanding
stock options under the Company’s equity compensation plans.  There
were no exercises or forfeitures of stock options under the Company’s equity
compensation plans for the three months ended June 30, 2007.  As of
June 30, 2008, the Company had granted options for 7,136 shares of the Company’s
common stock that are unvested that will result in $15,483 of compensation
expense in future periods if fully vested.  As of June 30, 2008, the
Company had also granted 502,000 options, subject to shareholder
approval.  In accordance with Statement of Financial Accounting
Standards (“SFAS”) 123R, compensation expense related to options granted subject
to shareholder approval is not determined until such time as the options receive
final approval.





Information
regarding all stock options outstanding under the 2005 Plan as of June 30, 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
            
            
            8,231
            
            
            
            1.13
            
            
            $
            0.12
            
            
            
            
            8,231
            
            
            
            1.13
            
            
            $
            0.12Over
      $0.50 to $3.00
            
            
            358,368
            
            
            
            3.84
            
            
            $
            2.47
            
            
            
            
            150,623
            
            
            
            2.60
            
            
            $
            2.13Over
      $5.00 to $5.50
            
            
            1,341,404
            
            
            
            3.06
            
            
            $
            5.00
            
            
            
            
            1,218,273
            
            
            
            2.90
            
            
            $
            5.00Over
      $5.50
            
            
            93,634
            
            
            
            4.03
            
            
            $
            5.90
            
            
            
            
            55,880
            
            
            
            3.72
            
            
            $
            5.901,801,637
            
            
            
            3.26
            
            
            $
            4.42
            
            $    84,390
            
            
            1,433,007
            
            
            
            3.26
            
            
            $
            4.62
            
            $   84,390





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 (June 30, 2008) of the period
presented. For the three months ended June 30, 2008, 13,670 options to purchase
the Company’s common stock were exercised under the plan resulting in $17,086 in
proceeds to the Company.





10
 Table of Contents





7.
            Income
      Taxes





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes.” FIN
No. 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 possible that the
Company’s unrecognized tax benefit may 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 in the applicable
jurisdictions.





8.
            Related
      Party Transactions





On May
19, 2008, the Company 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”) for a loan to the Company in the principal
amount of $1,000,000 (the ‘First National Loan”). The Company has agreed, among
other things, that while the Business Loan Agreement is in effect, the Company
will not (without First National Bank's prior written consent): (i) incur or
assume indebtedness, except for trade debt in the ordinary course of business,
capital leases in an amount not to exceed $500,000, and capital expenditures of
not more than $500,000 during any fiscal year; (ii) sell, transfer, mortgage,
assign, pledge, lease, grant a security interest in, or encumber any of 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 Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19, 2009. The First
National Note also provides for a minimum interest charge of $250, but otherwise
may be prepaid at any time without penalty. In the event of a default under the
First National Note, the interest rate will be increased by a margin of 4% over
the current rate of interest.  As of June 30, 2008, $1,000,000 was
outstanding under the First National Note.





On May
22, 2008, we also entered into a Loan Agreement (the “WLLC Loan Agreement”) and
associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLoans Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the Company. As a
condition of the WLLC Loan, the Company paid WLLC a non-refundable commitment
fee of $37,500. Further, in consideration of WLLC holding available funds equal
to the principal amount not yet disbursed, the Company must pay a non-refundable
fee of 1% of the retained funds as a holding fee, payable quarterly. If not paid
sooner, the WLLC Loan, if drawn upon, will be due and payable on April 1, 2009.
We granted WLLC a security interest in all of 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%.  As of June 30, 2008, loans totaling $600,000 were
outstanding under the WLLC Loan Agreement.





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





Mr.
Walker provided a guarantee against certain contingent liabilities related to
the FCC Loan Agreement (described in Note 4. Long Term Debt and Current Portion
– Long Term Debt, and below in Liquidity and Capital Resources).  In
return for this guarantee, the Company paid Mr. Walker a fee of
$7,500.




11
 Table of Contents





9.
            Stockholders’
      Equity





A summary
of the Company’s warrant activity for the period from April 1, 2008, through
June 30, 2008, is presented below:




WeightedWarrants
            
            
            AverageOutstanding
            
            
            Exercise
      PriceOutstanding,
      March 31, 2008
            
            
            5,694,736
            
            
            $
            6.66Granted
            
            
            --
            
            
            $
            --Exercised
            
            
            (10,000
            )
            
            $
            2.50Expired
            
            
            --
            
            
            $
            --Outstanding,
      June 30, 2008
            
            
            5,684,736
            
            
            $
            6.67





As
of June 30, 2008, the Company had the following outstanding warrants to purchase
its common stock:





Weighted
            
            
            WeightedWarrants
            
            
            Average
            
            
            AverageOutstanding
            
            
            Exercise Price
            
            
            Remaining Life15,000
            
            
            $
            5.00
            
            
            
            0.35580,000
            
            
            $
            5.01
            
            
            
            2.20644,000
            
            
            $
            6.00
            
            
            
            2.872,232,300
            
            
            $
            6.25
            
            
            
            2.6550,000
            
            
            $
            6.96
            
            
            
            4.081,283,436
            
            
            $
            7.57
            
            
            
            3.74800,000
            
            
            $
            8.00
            
            
            
            6.1780,000
            
            
            $
            8.25
            
            
            
            6.175,684,736
            
            
            $
            6.67
            
            
            
            3.43





Item
2.Management’sDiscussion and Analysis of Financial Condition and
Results of Operations





The
discussion contained herein is for the three months ended June 30, 2008 and June
30, 2007. The following discussion should be read in conjunction with the
financial statements of AeroGrow International, Inc. (the “Company,” ” “we,” or
“our”) and the notes to the financial statements included elsewhere in this
Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2008 (this
“Quarterly Report”). The following discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended (the “Securities Act”), and Section 21E of the Securities Exchange Act
of 1934, as amended (the “Exchange Act”), including statements that include
words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “may,”
“will,” or similar expressions that are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections,
or other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. Such statements include,
but are not limited to, statements regarding our intent, belief, or current
expectations regarding our strategies, plans, and objectives, our product
release schedules, our ability to design, develop, manufacture, and market
products, our intentions with respect to strategic acquisitions, the ability of
our products to achieve or maintain commercial acceptance, and our ability to
obtain financing for our obligations. Such statements are not guarantees of
future performance and are subject to risks, uncertainties, and assumptions that
are difficult to predict. Therefore, the Company’s actual results could differ
materially and adversely from those expressed in any forward-looking statements
as a result of various factors. Factors that could cause or contribute to the
differences are discussed in “Risk Factors” and elsewhere in the Company’s
annual report on Form 10-K for the period ended March 31, 2008, and filed on
June 26, 2008 with the Securities and Exchange Commission (the “SEC”) and the
Form S-3/A filed with the SEC September 28, 2007. Except as required by
applicable law or regulation, the Company undertakes no obligation to revise or
update any forward-looking statements contained in this Quarterly Report. The
information contained in this Quarterly Report is not a complete description of
the Company’s business or the risks associated with an investment in the
Company’s common stock. Each reader should carefully review and consider the
various disclosures made by the Company in this Quarterly Report and in the
Company’s other filings with the SEC.





Overview





AeroGrow
International, Inc. 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 (the “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.





12
 Table of Contents




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
Statement of Financial Accounting Standards (“SFAS”) No. 7, “Accounting and
Reporting by Development Stage Enterprises.” Today the Company manufactures,
distributes, and markets over 11 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 and Asia, and in Australia.





Our
Critical Accounting Policies





Inventory


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





The
Company determines an inventory obsolescence reserve based on management’s
historical experience and establishes reserves against inventory according to
the age of the product. As of June 30, 2008 and March 31, 2008, the Company
determined that no inventory obsolescence reserve was required.





Revenue
Recognition


The
Company recognizes revenue from product sales, net of estimated returns, when
persuasive evidence of a sale exists: that is, a product is shipped under an
agreement with a customer; risk of loss and title has passed to the customer;
the fee is fixed or determinable; and collection of the resulting receivable is
reasonably assured. Accordingly, the Company did not record $105,933 and
$294,715 of revenue as of June 30, 2008 and June 30, 2007, respectively, related
to the unpaid balance due for orders shipped in conjunction with the Company’s
direct-to-consumer sales 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 June 30, 2008 and June 30,
2007, did not record $32,556 and $89,828, respectively, of product costs
associated with the foregoing revenue because 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 $56,924 and $910,847 of revenue as of June 30, 2008
and June 30, 2007, respectively, related to the wholesale sales value of
inventory held by its retail shopping channel customers as these sales are
contingent upon the shopping channels selling the goods. Deferred payments for
these goods are charged to Customer Deposits. The Company also deferred, as of
June 30, 2008 and June 30, 2007, recognition of $24,491 and $457,597,
respectively, 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, rebates, 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 June 30, 2008 and June 30, 2007, the Company had
accrued $358,096 and $148,089 respectively, as its estimate for the foregoing
deductions and allowances.




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 is 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”) No. 93-7, “Reporting on Advertising Costs.” In accordance with SOP No.
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 June 30, 2008 and June 30, 2007, the Company had deferred $27,066
and $0, respectively, related to such media costs. Advertising expenses for the
three months ended June 30, 2008 and June 30, 2007 were $3,449,883 and
$2,920,987, respectively.





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.  Based upon the foregoing, the Company has recorded as of
June 30, 2008 and June 30, 2007 a provision for potential future warranty costs
of $65,969 and $47,633, 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 June 30, 2008 and June 30, 2007, the Company
has recorded a reserve for customer returns of $291,382 and $166,159,
respectively.





13
 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 sales.
  Equity
Compensation Plans
 In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, “Share-Based Payment.” Subsequently, the SEC provided for a phased-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 recognition of 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.
  Fair
Value
  The
Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157,
“Fair Value Measurements” (“SFAS No. 157”) for financial assets and liabilities,
which provides a single definition of fair value, establishes a framework for
the measurement of fair value and expands disclosure about the use of fair value
to measure assets and liabilities. The adoption of SFAS No. 157 for financial
assets and liabilities did not have a material impact on the Company’s financial
statements as of June 30, 2008.
  Results
of Operations
  For
the quarter ended June 30, 2008, our sales totaled $6,720,081, an increase of 7%
from the same period in 2007, reflecting an increase in our direct-to-consumer
and international sales, partially offset by a decline in our sales to retailer
customers.  The increase in direct-to-consumer sales resulted
primarily from our catalogue operations which was newly-launched in August 2007,
and which mailed over 1.4 million catalogues during the quarter ended June 30,
2008.  The year-over-year retail sales decline principally reflected a
plan we developed in conjunction with our retailer customer to minimize the
potential disruption from a transition to our new, expanded product line in late
summer 2008 (the “Transition Plan”).  The Transition Plan called for
retailers to delay ordering product from us, allowing the retailers to reduce
the amount of our products they had in inventory at the time of the switch to
the new products.  This had the effect of reducing our sales to
retailers during the quarter ended June 30, 2008, despite an increase in the
number of storefronts carrying our products to 5,150 at June 30, 2008 from 1,250
at June 30, 2007, a 312% increase.





Our gross
margin for the quarter ended June 30, 2008 was 45.1%, an increase of 2
percentage points from the same period in 2007.  The improvement in
gross margin resulted from a number of factors, including an increased mix of
higher-priced direct-to-consumer sales, favorable product mix, and purchasing,
distribution logistics, and manufacturing efficiencies.





Sales and
marketing costs totaled $3,449,883 for the quarter ended June 30, 2008, an
increase of 18.1% from the quarter ended June 30, 2007, reflecting an increase
in sales and marketing headcount, and personnel-related costs necessary to
support the increased annual scale of our business.





General
and administrative costs increased by $263,704, or 21.0%, to $1,518,712 for the
quarter ended June 30, 2008.  $200,000 of the increase related to
severance expense recognized during the quarter that related to the departure of
our former chief financial officer.





Our net
loss for the quarter ended June 30, 2008 totaled $2,817,349, as compared to a
net loss of $2,022,730 in the same period in 2007.





The
following table sets forth, as a percentage of sales, our financial results for
the three months ended June 30, 2008 and the three months ended June 30,
2007:





Three
      Months Ended June 30,2008
            
            
            2007RevenueProduct
      sales - retail, net
            
            
            39.3
            %
            
            
            65.8
            %Product
      sales - direct to consumer, net
            
            
            49.7
            %
            
            
            34.2
            %Product
      sales – international
            
            
            11.0
            %
            
            
            --
            %Total
      sales
            
            
            100.0
            %
            
            
            100.0
            %Operating
      expensesCost
      of revenue
            
            
            54.9
            %
            
            
            56.9
            %Research
      and development
            
            
            10.8
            %
            
            
            8.3
            %Sales
      and marketing
            
            
            51.3
            %
            
            
            46.5
            %General
      and administrative
            
            
            22.6
            %
            
            
            20.0
            %Total
      operating expenses
            
            
            139.6
            %
            
            
            131.7
            %Other
      (Income) Expense, Net
            
            
            2.3
            %
            
            
            0.5
            %Net
      Loss
            
            
            -41.9
            %
            
            
            -32.2
            %








14
 Table of Contents




For the
three months ended June 30, 2008 and June 30, 2007, revenue totaled $6,720,081
and $6,278,685 respectively, an increase year-over-year of 7.0% or
$441,396.





Three
      Months Ended June 30,Product Revenue
            
            2008
            
            
            2007Retail, net
            
            $
            2,642,575
            
            
            $
            4,129,853Direct to consumer,
      net
            
            
            3,339,410
            
            
            
            2,148,832International
            
            
            738,096
            
            
            
            --Total
            
            $
            6,720,081
            
            
            $
            6,278,685





The
increase in revenue primarily came from an increase in sales made directly to
consumers, which are generated through television infomercials, our own
catalogue mailings, or through our website.  These direct-to-consumer
sales increased 55.4%, or $1,190,578, principally because of sales generated by
our catalogue mailings.  For the three months ended June 30, 2008 we
mailed approximately 1,443,000 catalogues to consumers.  We did not
begin our own catalogue operations until August 2007, and, as a result, had no
revenue from this source in the quarter ended June 30, 2007.





We offer
our direct customers trial sales, requiring them 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 (such sales, “Trial
Sales”). We do not recognize the revenue from Trial Sales until the expiration
of the trial period. Accordingly, we did not record $105,933 and $294,715 of
revenue from these Trial Sales as of June 30, 2008 and June 30, 2007,
respectively. We also deferred, as of June 30, 2008 and June 30, 2007,
recognition of $32,556 and $89,828, respectively, of product costs associated
with these Trial Sales because the customers are required to return the product
at the end of the trial period if they choose not to purchase the product, and
we are therefore able to recover these costs through resale of the goods. All
costs associated with the acquisition of Trial Sales, including media,
telemarketing, order processing, fulfillment, and outbound freight were expensed
as incurred during the quarter.





Sales to
our retailer customers totaled $2,642,575 during the quarter ended June 30,
2008, a decrease of 36.0%, or $1,487,278.  This decline in revenue was
primarily caused by an anticipated slow-down in orders from our retailer
customers in advance of the launch of several new products.  We
developed a plan, in conjunction with our retailer customers, to manage the
transition of product into the retail selling channel.  This plan
involved the retailers delaying new orders for our products in order to allow
their existing inventories of our products to decline prior to bringing in the
new, expanded product line, beginning in the fall of 2008.  This
managed transition program therefore constrained our sales to retailers during
the quarter ended June 30, 2008 by an undetermined amount.





The
decline in our sales to retailers came despite an increase in the number of
retail locations offering our products.  At June 30, 2008, our
products were being sold through retail chains and other retailers totaling
5,150 storefronts, up 312% from the 1,250 storefronts offering our products at
June 30, 2007.





In
addition, we did not record $56,924 and $910,847 of revenue as of June 30, 2008
and June 30, 2007, respectively, related to the wholesale sales value of
inventory held by our retail shopping channel customers as these sales are
contingent upon the shopping channel selling the goods. Payments for the goods
deferred in the foregoing were charged to customer deposits. We have also
deferred, as of June 30, 2008 and June 30, 2007, recognition of $24,491 and
$457,597, respectively, of product and freight costs associated with this sale,
which have been included in inventory.





We began
selling our products into markets outside North America in September,
2007.  In the quarter ended June 30, 2008, sales in Australia and
countries in Europe and Asia totaled $738,096, as compared to no international
sales for the three months ended June 30, 2007.





15
 Table of Contents





Our
products consist of our AeroGardens as well as seed kits and accessories, which
represent recurring revenue opportunity for each AeroGarden sold.  A
summary of the sales of these two product categories for the three months ended
June 30, 2008 and June 30, 2007 is as follows:





Three
      Months Ended June 30,2008
            
            
            2007Product RevenueAeroGardens
            
            $
            4,983,416
            
            
            $
            5,643,885Seed
      kits and accessories
            
            
            1,736,665
            
            
            
            634,800Total
            
            $
            6,720,081
            
            
            $
            6,278,685% of Total RevenueAeroGardens
            
            
            74.2
            %
            
            
            89.9
            %Seed
      kits and accessories
            
            
            25.8
            %
            
            
            10.1
            %Total
            
            
            100.0
            %
            
            
            100.0
            %





Sales of
AeroGardens were adversely impacted by the retail channel product transition
plan (described above), offset by the positive impact of increased catalogue
sales direct to consumers during the quarter ended June 30,
2008.  Overall, AeroGarden sales declined 11.7% or $660,469 from the
quarter ended June 30, 2007.  Seed kit and accessory sales increased
by 173.6% or $1,101,865, a result of the increase in the cumulative number of
AeroGardens we have sold, to 496,089 as of June 30, 2008, from 178,839 a year
earlier.





Cost of
revenue for the three months ended June 30, 2008 and June 30, 2007 totaled
$3,686,823 and $3,575,276, an increase of 3.1% or $111,547.  As a
percent of total revenue, these costs declined two percentage points to 54.9%
for the quarter ended June 30, 2008 from 56.9% a year earlier.  Cost
of revenue 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, credit card processing fees for direct sales, and duties and customs
applicable to products imported. The dollar amount of cost of revenue increased
primarily as a result of the 7.0% increase in revenue discussed above, offset by
cost savings associated with improved purchasing, distribution logistics, and
manufacturing efficiencies. Cost of revenue improved as a percent of sales over
the prior period because of a number of factors, including the increased mix of
higher-priced direct-to-consumer sales, favorable product mix, as well as the
purchasing, distribution logistics, and manufacturing efficiencies mentioned
above.





The gross
margin for the quarter ended June 30, 2008 was 45.1%, up two percentage points
from 43.1% for the quarter ended June 30, 2007.  The increase reflects
the impacts discussed above concerning the change in cost of
revenue.




Sales and
marketing costs for the three months ended June 30, 2008 totaled $3,449,883, as
compared to $2,920,987 for the three months ended June 30, 2007, an increase of
18.1% or $528,896.  Sales and marketing costs include all costs
associated with the marketing, sales, customer support, and sales order
processing for our products and consist of the following:





Three
      Months Ended June 30,2008
            
            
            2007Advertising
            
            $
            1,485,884
            
            
            $
            1,366,790Personnel
            
            
            1,117,969
            
            
            
            666,118Sales
      commissions
            
            
            141,881
            
            
            
            236,693Trade
      Shows
            
            
            113,219
            
            
            
            110,501Other
            
            
            590,930
            
            
            
            540,885$
            3,449,883
            
            
            $
            2,920,987





Advertising
is principally comprised of the costs of development, production and airing of
our infomercials and short-form television commercials, the costs of
development, production, printing, and postage for our catalogues, and mailing
and web media costs for search and affiliate web marketing programs. Each of
these are key components of our integrated marketing strategy because they help
build awareness of, and consumer demand for, our products, for all our channels
of distribution, in addition to generating direct-to-consumer
sales.  Advertising expense totaled $1,485,884 for the quarter ended
June 30, 2008, an increase of 8.7%, or $119,094.  The increase was
caused by costs related to our catalogue operations, which had not yet begun in
the year earlier quarter, offset by a 59% reduction in the amount of television
media expense we incurred during the quarter ended June 30, 2008.





16
 Table of Contents




Sales and
marketing personnel costs shown above consist of salaries, payroll taxes,
employee benefits, and other payroll costs for our sales, customer service
operations, graphics, and marketing departments. For the three months ended June
30, 2008, personnel costs for sales and marketing were $1,117,969 as compared to
$666,118 for the three months ended June 30, 2007, an increase of 67.8%, or
$451,851.  The increase principally reflects a higher number of
employees in our telesales operations, in our customer service department to
support the increase in our established customer base, and in our outside sales
force to support our expanded retail business.





Sales
commissions, ranging from 4% to 7% of collections from our retailer customers,
are paid to sales representative organizations that assist us in developing and
maintaining our relationships with retailers.  The year-over-year
decline in sales commissions reflects the decline in sales to retailers during
the quarter ended June 30, 2008, as discussed above.





General
and administrative costs for the three months ended June 30, 2008 totaled
$1,518,712 as compared to $1,255,008 for the three months ended June 30, 2007,
an increase of 21.0%, or $263,704.  The increase principally reflects
a severance expense accrual of $200,000 recognized upon the departure of our
former Chief Financial Officer, legal fees related to financing transactions
completed during the quarter (described in Liquidity and Capital Resources,
below), personnel expense related to new executives, and incentive compensation
accruals, offset by cost reductions associated with headcount reductions taken
during the quarter.




Research
and development costs for the quarter ended June 30, 2008 totaled $725,415, an
increase of 39.0%, or $203,596, from the quarter ended June 30,
2007.  The higher cost reflects our increased new product development
activity in anticipation of new products to be launched over the balance of
calendar 2008, and into the future, and includes higher costs associated with
product design, prototyping, testing, and engineering products for
manufacturability.





Our loss
from operations for the three months ended June 30, 2008 was $2,660,752 as
compared to $1,994,405 for the three months ended June 30, 2007, an increased
loss of $666,347.





Other
income and expense for the quarter ended June 30, 2008 totaled to a net expense
of $156,597, up 452.9%, or $128,272 from the net expense of $28,325 recorded for
the quarter ended June 30, 2007.  The increase reflected a higher
average level of interest bearing debt outstanding, an accrual related to sales
taxes, and new capital leases entered into subsequent to June 30, 2007, combined
with a lower average level of interest-bearing cash equivalents during the
quarter.





Liquidity
and Capital Resources




For the
quarter ended June 30, 2008 and June 30, 2007, cash used in operations totaled
$1,821,615 and $2,939,466, respectively.  The principal use of cash in
operations during the quarter ended June 30, 2008 was the net loss, offset by a
decrease in working capital requirements.





On May
19, 2008, the Company 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”) for a loan to the Company in the principal
amount of $1,000,000 (the ‘First National Loan”). The Company has agreed, among
other things, that while the Business Loan Agreement is in effect, the Company
will not (without First National Bank's prior written consent): (i) incur or
assume indebtedness, except for trade debt in the ordinary course of business,
capital leases in an amount not to exceed $500,000, and capital expenditures of
not more than $500,000 during any fiscal year; (ii) sell, transfer, mortgage,
assign, pledge, lease, grant a security interest in, or encumber any of 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 Business Loan Agreement, the Company and Mr. Walker provided First
National Bank with a promissory note for a principal amount of up to $1,000,000
(the “First National Note”).  The First National Note has an initial
interest rate of 5.5% and matures on May 19, 2009. The First National Note
provides for monthly payments of interest only, with the balance of principal
and all accrued but unpaid interest due and payable on May 19, 2009. The First
National Note also provides for a minimum interest charge of $250, but otherwise
may be prepaid at any time without penalty. In the event of a default under the
First National Note, the interest rate will be increased by a margin of 4% over
the current rate of interest.  As of June 30, 2008, $1,000,000 was
outstanding under the First National Note.





On May
22, 2008, we also entered into a Loan Agreement (the “WLLC Loan Agreement”) and
associated Promissory Note with WLoans, LLC, a Colorado limited liability
company (“WLLC”), as lender, and Jack J. Walker.  The WLoans Loan
Agreement provides for a loan up to a maximum of $1,500,000 for business
purposes, at an annual interest rate of 12% (the “WLLC Loan”). Mr. Walker is the
manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining
membership interest owned by other officers and directors of the Company. As a
condition of the WLLC Loan, the Company paid WLLC a non-refundable commitment
fee of $37,500. Further, in consideration of WLLC holding available funds equal
to the principal amount not yet disbursed, the Company must pay a non-refundable
fee of 1% of the retained funds as a holding fee, payable quarterly. If not paid
sooner, the WLLC Loan, if drawn upon, will be due and payable on April 1, 2009.
We granted WLLC a security interest in all of 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%.  As of June 30, 2008, loans totaling $600,000 were
outstanding under the WLLC Loan Agreement.





17
 Table of Contents




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





On June
23, 2008, the Company entered into a Loan and Security Agreement with FCC, LLC,
d/b/a First Capital (“FCC”) (the “FCC Loan Agreement”) for a revolving credit
facility in the amount of $12,000,000 (the “Revolving Credit
Facility”).  The Revolving Credit Facility has an initial two-year
term, with one-year renewals thereafter. Loans under the Revolving Credit
Facility bear interest at a rate of prime plus 2%, with the interest rate
adjusting to prime plus 1.5% as of January 1, 2009.  The Company must
pay a minimum monthly interest payment equal to the amount that would have been
owed on an outstanding principal amount of $3,000,000. Continued availability of
the Revolving Credit Facility is subject to our compliance with customary
financial and reporting covenants. The purpose of the Revolving Credit Facility
is to provide additional working capital. As collateral for the Revolving Credit
Facility, the Company granted to FCC a first priority security interest over all
of the Company’s assets, including, but not limited to, accounts receivable,
inventory, and equipment.  As of June 30, 2008, loans totaling
$1,120,276 were outstanding under the Revolving Credit Facility.





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





Cash
Requirements





In
addition to our contractual obligations through the balance of the fiscal year
for $597,981 of operating lease payments, $116,973 of capital lease payments,
and required debt service payments under our debt agreements, we will require
cash to:





·
            Fund
      ongoing operations and working capital
  requirements,





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





·
            Execute
      our sales and marketing plans,





·
            Fund
      research and development efforts,
and





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








We expect
to fund these, and any other cash requirements, with cash provided by
operations, our $12 million Revolving Credit Facility and other debt facilities,
as well as with existing cash and cash equivalents at June 30, 2008 totaling
$818,256.





We cannot
predict with certainty the cash and other, ongoing operational requirements for
our proposed plans as market conditions, competitive pressures, regulatory
requirements and customer requirements can change rapidly.  If we are
unable to generate cash from operations at currently estimated levels, or if our
access to new borrowings under our debt agreements are constrained, our ability
to execute our operational plans could be adversely impacted.





We do not
expect to enter into additional capital leases to finance major purchases. At
present, we have no binding commitments with any third parties to obtain any
material amount of equity or debt financing other than the financing
arrangements described in this report. However, if business opportunities arise
in the future, we may enter into financing arrangements to satisfy actual or
anticipated capital needs.





As of
June 30, 2008, we had cash and restricted cash totaling $818,256 as compared to
$1,646,468 as of March 31, 2008.





18
 Table of Contents




Assessment
of Future Liquidity and Results of Operations





Liquidity.  Based on
available cash resources, anticipated capital expenditures and projected
operating cash flow, we believe we will be able to adequately fund our
operations through at least the next twelve months. In making this assessment,
we have considered:





•
            Our
      cash and cash equivalents of $818,256 as of June 30,
      2008,





•
            The
      availability of funding under the Revolving Credit
    Facility,





•
            The
      anticipated level of spending to support our planned initiatives over the
      remainder of 2008 and into 2009,
and





•
            Our
      expectations regarding cash flow from operations through our fiscal year
      ending March 31, 2009.





The
availability of borrowings under the Revolving Credit Facility is subject to
covenants and limitations that require us to maintain compliance with specified
operating and financial covenants. While we were in compliance with all
covenants, as amended, at June 30, 2008, there can be no assurance that we
will continue to be in compliance with these covenants over time, especially if
our debt borrowings increase or our operating results are not sufficient to
cover our fixed financing payments.





Results of Operations. 
There are several factors that could affect our results of operations over the
remainder of the fiscal year ending March 31, 2009.  These factors include,
but are not limited to, the following:





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





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





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





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





Therefore,
although we believe we are well-positioned to execute our plans for the fiscal
year ending March 31, 2009, the factors noted above could impact our expected
financial results, either positively or negatively.  As a result, we
cannot be certain that third-party financial forecasts will prove to be
accurate.





Off-Balance
Sheet Arrangements





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




Item 3.
Quantitativeand QualitativeDisclosures About Market Risk





Interest
Rate Risk




Our
interest income and expense 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 we pay on our debt, the interest we earn on our cash, cash equivalents,
and short-term investments, and 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 under our various debt
agreements is determined in part based on 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. Interest-bearing debt outstanding at June 30, 2008 and capital leases
totaled approximately $2.9 million. Based on this amount, we would have a
resulting decline in future annual earnings and cash flows of approximately
$29,000 for every 1% increase in borrowing rates.





19
 Table of Contents




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 Chinese 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.





Item 4T. Controlsand
Procedures





(a)
Evaluation of Disclosure Controls and Procedures





Disclosure
controls and procedures are designed to ensure that information required to be
disclosed in the reports filed or submitted by the Company under the Exchange
Act is recorded, processed, summarized, and reported, within the time periods
specified in the rules and forms of the SEC. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in the reports filed under the Exchange Act
is accumulated and communicated to the Company’s management, including its
principal executive and financial officer, as appropriate, to allow timely
decisions regarding required disclosure.





The
Company carried out an evaluation, under the supervision and with the
participation of its management, including its principal executive officer and
principal financial officer, of the effectiveness of the design and operation of
the Company’s disclosure controls and procedures as of the end of the period
covered by this report. Based upon and as of the date of that evaluation, the
Company’s principal executive officer and financial officer concluded that the
Company’s disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports the Company files and
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and forms.





(b)
Changes in Internal Controls




There
were no changes in the Company’s internal controls or in other factors that
could have significantly affected those controls during the three months ended
June 30, 2008.




PARTII - OTHER INFORMATION





Item
1. Legal Proceedings





None.





Item
1A. Risk Factors





During
the three months ended June 30, 2008, there has not been any material changes in
risk factors previously disclosed.





Item
2. Unregistered Sales of Equity Securities and Use of Proceeds





None.





Item
3. Defaults Upon Senior Securities





None.





Item
4. Submission of Matters to a Vote of Security Holders





During
the three months ended June 30, 2008, there were no matters brought to a vote of
the security holders.





Item
5. Other Information





None





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Item6. Exhibits




3.1
            Articles
      of Incorporation of the Company (incorporated by reference to Exhibit 3.1
      of our Current Report on Form 8-K/A-2, filed November 16,
      2006)3.2
            Certificate
      of Amendment to Articles of Incorporation, dated November 3, 2002
      (incorporated by reference to Exhibit 3.2 of our Current Report on Form
      8-K/A-2, filed November 16, 2006)3.3
            Certificate
      of Amendment to Articles of Incorporation, dated January 31, 2005
      (incorporated by reference to Exhibit 3.3 of our Current Report on Form
      8-K/A-2, filed November 16, 2006)3.4
            Certificate
      of Change to Articles of Incorporation, dated July 27, 2005 (incorporated
      by reference to Exhibit 3.4 of our Current Report on Form 8-K/A-2, filed
      November 16, 2006)3.5
            Certificate
      of Amendment to Articles of Incorporation, dated February 24, 2006
      (incorporated by reference to Exhibit 3.5 of our Current Report on Form
      8-K/A-2, filed November 16, 2006)3.6
            Amended
      Bylaws of the Company (incorporated by reference to Exhibit 3.6 of our
      Current Report on Form 8-K/A-2, filed November 16,
2006)10.1
            Commitment
      for Credit Facility by and between FCC, LLC, d/b/a First Capital and
      AeroGrow, dated May 20, 2008 (incorporated by reference to Exhibit 10.1 of
      our Current Report on Form 8-K, filed May 23, 2008).10.2
            Business
      Loan Agreement by and between AeroGrow, 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).10.3
            Promissory
      Note made by AeroGrow 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).10.4
            Commercial
      Pledge Agreement by and between AeroGrow, 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).10.5
            Loan
      Agreement by and between AeroGrow, 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).10.6
            Promissory
      Note made by AeroGrow, dated May 19, 2008 (incorporated by reference to
      Exhibit 10.6 of our Current Report on Form 8-K, filed May 23,
      2008).10.7
            Letter
      Agreement between AeroGrow International, Inc. and H. MacGregor (Greg)
      Clarke, dated May 21, 2008 (incorporated by reference to Exhibit 10.1 of
      our Current Report on Form 8-K, filed May 28, 2008).10.8
            Loan
      and Security Agreement by and between FCC, LLC, d/b/a First Capital and
      AeroGrow, dated June 24, 2008 (incorporated by reference to Exhibit 10.1
      of our Current Report on Form 8-K, filed June 30,
2008).10.9
            Validity
      Agreement by and between Jervis B. Perkins, AeroGrow and First Capital,
      dated June 24, 2008 (incorporated by reference to Exhibit 10.2 of our
      Current Report on Form 8-K, filed June 30, 2008).10.10
            Validity
      Agreement, by and between H. MacGregor Clarke, AeroGrow and First Capital,
      dated June 24, 2008 (incorporated by reference to Exhibit 10.3 of our
      Current Report on Form 8-K, filed June 30, 2008).10.11
            Agreement
      between Benefactor Funding Corp, AeroGrow and FCC, LLC, d/b/a First
      Capital, dated June 24, 2008 (incorporated by reference to Exhibit 10.4 of
      our Current Report on Form 8-K, filed June 30, 2008).10.12
            Irrevocable
      Standby Letter of Credit in favor of Benefactor Funding Corp. in the
      amount of $343,092.34, dated June 25, 2008 (incorporated by reference to
      Exhibit 10.5 of our Current Report on Form 8-K, filed June 30,
      2008).10.13
            Irrevocable
      Standby Letter of Credit in favor of Benefactor Funding Corp. in the
      amount of $38,193.66, dated June 25, 2008 (incorporated by reference to
      Exhibit 10.6 of our Current Report on Form 8-K, filed June 30,
      2008).31.1
            Certifications of the Chief Executive Officer Under
      Section 302 of the Sarbanes-Oxley Act*31.2
            Certifications of the Chief Financial Officer Under
      Section 302 of the Sarbanes-Oxley Act*32.1
            Certifications of the Chief Executive Officer Under
      Section 906 of the Sarbanes-Oxley Act*32.2
            Certifications of the Chief Financial Officer Under
      Section 906 of the Sarbanes-Oxley
Act*





*
            Filed
      Herewith






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SIGNATURES





In
accordance with the requirements 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.Date:  August
      7, 2008
            
            /s/
      Jervis B.
      PerkinsBy:
      Jervis B. PerkinsIts:
      Chief Executive Officer (Principal Executive Officer) and
      DirectorDate:  August
      7, 2008
            
            /s/
      H. MacGregor
      ClarkeBy:
      H. MacGregor ClarkeIts:
      Chief Financial Officer (Principal Financial Officer)Date: : August
      7, 2008
            
            /s
      /Grey H.
      GibbsBy:
      Grey H. GibbsIts:
      Controller (Principal Accounting
Officer)








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