Review, Approval or Ratification of Transactions with Related Parties

Since April 1, 2009, our Board of Directors reviewed and did not object to any of the related party transactions reported in this proxy statement. Our Board recognizes that related party transactions present a heightened risk of conflicts of interest and/or improper valuation (or the perception thereof) and therefore follows the procedures as described below to address such risks.

 

Our Board of Directors is required to review all related party transactions. AeroGrow is prohibited from entering or continuing a material related party transaction that has not been reviewed and approved or ratified by the Board. Additionally, in transactions where an executive officer is related to any of our goods or services provider, the board of directors must approve the transaction. In reviewing a related party transaction the board of directors considers all of the relevant factors surrounding the transaction including:

1.	whether there is a valid business reason for us to enter into the related party transaction consistent with the best interests of AeroGrow and our stockholders;

2.	whether the transaction is negotiated on an arm’s length basis on terms comparable to those provided to unrelated third parties or on terms comparable to those provided to employees generally;

3.

whether the board of directors determines that it has been duly apprised of all significant conflicts that may exist or may otherwise arise on account of the transaction, and it believes, nonetheless, that we are warranted in entering into the related party transaction and have developed an appropriate plan to manage the potential conflicts of interest;

4.	whether the rates or charges involved in the transaction are determined by competitive bids, or the transaction involves rates or charges fixed in conformity with law or governmental authority; and/or

5.	whether the interest of the related party or that of a member of the immediate family of the related party arises solely from the ownership of our class of equity securities and all holders of our equity securities received the same benefit on a pro-rata basis.

During the fiscal year ended March 31, 2010 and in prior years, we relied upon a variety of debt funding sources to meet our liquidity requirements, including the following transactions: (i) which involved members of our Board, management team and certain stockholders that beneficially own more than five percent of our outstanding voting securities and (ii) which are required to be disclosed pursuant to Item 404 of Regulation S-K.

First National Loan

On May 19, 2008, the Company and Jack J. Walker, then one of the Company’s directors and now the Company’s Chairman, President and CEO, acting as co-borrowers, entered into a Business Loan Agreement with First National Bank (the “FNB Loan Agreement”) for a loan to the Company in a principal amount of up to $1,000,000 (the “FNB Loan”).  The Company agreed, among other things, that while the FNB Loan Agreement is in effect, the Company will not (without FNB's prior written consent): (i) incur or assume indebtedness, except for trade debt in the ordinary course of business, capital leases in an amount not to exceed $500,000, and capital expenditures of not more than $500,000 during any fiscal year; (ii) sell, transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber any of the Company’s assets (except as specifically allowed); or (iii) sell with recourse any of the Company’s accounts, except to FNB. In the event of a default under the FNB Loan, at FNB's option, all indebtedness owed under the FNB Loan will become immediately due and payable.  The FNB Loan had an initial maturity date of May 19, 2009.

On May 19, 2009, the Company, Mr. Walker, and FNB entered into a Change in Terms Agreement (the “First Change in Terms Agreement”), extending the maturity of the FNB Loan until July 19, 2009, and increasing the interest rate from the Wall Street Journal Prime Rate plus 0.50% floating to the Wall Street Journal Prime Rate plus 2.0% floating, with a floor interest rate of 5.50%.

On August 28, 2009, the Company, Mr. Walker, and FNB entered into a second Change in Terms Agreement (the “Second Change in Terms Agreement”) extending the maturity of the FNB Loan to November 30, 2009.  The Second Change in Terms Agreement increased the interest rate to a fixed rate effective July 19, 2009, of 7% per annum, and provided for principal payments of $100,000 and a loan origination payment of $2,500 at closing of the Second Change in Terms Agreement and then principal payments of $50,000, $50,000, and $100,000 on August 31, 2009, September 30, 2009, and October 31, 2009, respectively.  The terms and conditions of the Second Change in Terms Agreement were consented to by FCC, LLC d/b/a First Capital (“FCC”), the Company’s senior lender, in accordance with the Subordination and Intercreditor Agreement by and among FNB, FCC, and the Company (the “Subordination Agreement”).  The Company is prohibited from making principal payments against the FNB Loan, including scheduled principal payments, unless and until such time as FCC provides its consent or such time as the Company’s liquidity position exceeds certain thresholds defined in the Subordination Agreement.

 

At closing of the Second Change in Terms Agreement on August 31, 2009, the Company made the scheduled $100,000 principal payment with the consent of FCC.  Principal payments totaling $200,000 that were due during the term of the Second Change in Terms Agreement were made by Mr. Walker to FNB because FCC did not consent to the Company making such payments.  The first $150,000 of payments made by Mr. Walker was recorded by the Company as an offset to a $150,000 receivable due from Mr. Walker.  Effective as of November 20, 2009, the Company executed a promissory note in favor of Mr. Walker for the remaining $50,000.  The promissory note matured on February 1, 2010 and carries an interest rate of 20% per annum.  As of February 1, 2010, Mr. Walker agreed to extend the maturity date of this promissory note to April 30, 2010.  As of March 31, 2010, $53,589 was outstanding under the promissory note, including accrued interest.  On May 7, 2010, the Company repaid this promissory note in full.

As of February 16, 2010, Mr. Walker made an additional $200,000 payment to FNB, reducing the outstanding principal balance on the FNB Loan to $500,000.  Effective as of the same date, the Company executed a promissory note for $200,000 in favor of Mr. Walker having a maturity date of April 30, 2010 and carrying an interest rate of 20% per annum.  As of March 31, 2010, $213,350 was outstanding under the promissory note, including accrued interest.  On June 24, 2010, Mr. Walker converted $206,406 of the principal and accrued interest on this promissory note into three year convertible promissory notes (the “Subordinated Secured Convertible Notes”) issued by the Company, as further described below.

As of March 31, 2010, $506,397 in loans were outstanding under the FNB Loan, including accrued interest.  On May 24, 2010, the Company paid $511,647 to repay, in full, the FNB Loan and all accrued interest.

WLLC Loan Agreement

On May 22, 2008, the Company entered into a Loan Agreement (the “WLLC Loan Agreement”) and associated Promissory Note with WLoans, LLC, a Colorado limited liability company (“WLLC”), as lender, and Jack J. Walker.  The WLLC Loan Agreement provided for a loan up to a maximum of $1,500,000 for business purposes, at an annual interest rate of 12% (the “WLLC Loan”). The Company granted WLLC a security interest in all of the Company’s assets, subordinate to the security interests in such assets granted to FCC and FNB.  The WLLC Loan had an initial maturity date of April 1, 2009.  Mr. Walker is the manager of WLLC and owns a 73.3% membership interest in WLLC, with the remaining membership interest owned by former officers and former directors of the Company.

On May 19, 2009, Mr. Walker, WLLC, and the Company entered into a Loan Extension Agreement (the “Loan Extension Agreement”) effective April 1, 2009, extending the maturity date of the WLLC Loan until June 30, 2009.  The Company paid WLLC $5,000 in consideration for the loan extension.  The balance of principal due on the WLLC Loan as of May 19, 2009, was $1,200,000.

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

Revolving Credit Facility

On June 23, 2008, the Company entered into a Loan and Security Agreement with FCC (the “FCC Loan Agreement”) for a revolving credit facility up to a maximum amount of $12,000,000 (the “Revolving Credit Facility”) to fund working capital requirements.  The actual amount available for borrowing under the Revolving Credit Facility is limited at any given time to the sum of a percentage of eligible inventory and a percentage of eligible accounts receivable, each as defined in the FCC Loan Agreement.

The Revolving Credit Facility has an initial termination date of June 23, 2010, with one-year renewals thereafter, unless prior written notice is provided by either party.  Continued availability of the Revolving Credit Facility is subject to the Company’s compliance with customary financial and reporting covenants.  As collateral for the Revolving Credit Facility, the Company granted 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 December 31, 2008, the Company was not in compliance with three covenants under the FCC Loan Agreement.  Effective as of January 31, 2009, FCC and the Company executed a forbearance agreement related to the FCC Loan Agreement (the “Forbearance Agreement”).  Pursuant to the terms of the Forbearance Agreement, FCC agreed to forbear its rights and remedies under the FCC Loan Agreement and related documents with respect to any existing defaults under the FCC Loan Agreement (the “Existing Defaults”) until the earlier of June 30, 2009, or the date of occurrence of a default other than the Existing Defaults.  The Forbearance Agreement also increased the Company’s ability to borrow against inventory and accounts receivable during the term of the Forbearance Agreement (the “Additional Borrowing Capacity”).  In return for FCC providing the forbearance period and the Additional Borrowing Capacity, the Company agreed to pay FCC a $25,000 forbearance fee (in five monthly installments), an amendment fee equal to 1.5% per month on the average utilization of the Additional Borrowing Capacity, and issue to FCC a minimum of 250,000 warrants to purchase common stock of the Company at a purchase price of $1.00 per share.  Simultaneously with the execution of the Forbearance Agreement, Mr. Walker provided a $1 million guarantee against certain liabilities under the FCC Loan Agreement.  As compensation for providing the guarantee, the Company issued to Mr. Walker 50,000 warrants to purchase common stock of the Company at a purchase price of $1.00 per share.

On June 1, 2009, the Company, FCC, and Jack J. Walker, as guarantor, executed a Second Forbearance Agreement, effective as of April 29, 2009 (the “Second Forbearance Agreement”), in which FCC agreed to forbear from exercising its rights and remedies under the Loan Agreement until June 30, 2009, if no further defaults occurred.  The Second Forbearance Agreement also increased the advance rate against inventory until July 1, 2009, and eliminated the Company’s obligation to pay the monthly forbearance and amendment fees and to provide cash flow projections.  In return, AeroGrow agreed to pay FCC a fee of $60,000.  In connection with the Second Forbearance Agreement, FCC permitted AeroGrow to borrow up to $800,000 more than would otherwise be permitted by the applicable borrowing base calculation under the Loan Agreement, with such additional borrowing to be repaid by June 30, 2009.  FCC did not charge AeroGrow a fee for the additional borrowing capacity.

As of July 1, 2009, FCC, AeroGrow, and Jack J. Walker, as guarantor, executed an amendment to the FCC Loan Agreement (the “Third FCC Amendment”).  The Third FCC Amendment reduced the maximum amount of the Revolving Credit Facility to $8 million, re-set the covenant levels beginning July 1, 2009, and waived existing defaults.  In addition, the Third FCC Amendment re-set the formulas for determining the borrowing base against which the Company can borrow.  The Third FCC Amendment also changed the definition of Base Rate to the greater of (a) the Prime Rate, or (b) LIBOR plus 3.25%, and increased the interest rate to Base Rate plus 4.0%.  The Third FCC Amendment provides for a $30,000 success fee to be paid by the Company to FCC on April 30, 2010.  In addition, the Third FCC Amendment replaces a minimum borrowing fee with a fee calculated as 0.50% per annum of the daily average unused portion of the Revolving Credit Facility, payable monthly in arrears.  Finally, the Third FCC Amendment increased the annual facility fee to 1.0% of the maximum amount of the Revolving Credit Facility, from 0.75%.  The Company paid Mr. Walker a $25,000 fee as compensation for providing the guarantee associated with the Third FCC Amendment.  The Third FCC Amendment did not change the original due date of June 23, 2010, with one year renewals, thereafter, unless prior written notice is provided by either party.

On October 8, 2009, the Company and FCC executed a temporary amendment to the FCC Loan Agreement, effective as of September 30, 2009, that delayed a reduction in the advance rate against inventory from 80% to 70%, originally scheduled to take effect on October 1, 2009, until November 15, 2009.

As of September 30, 2009, the Company was not in compliance with the minimum fixed charge coverage covenant under the revised FCC Loan Agreement.  On November 19, 2009, FCC and the Company executed a Waiver Agreement to the FCC Loan Agreement (the “Waiver Agreement”).  The Waiver Agreement waived the covenant violations as of September 30, 2009.  FCC charged the Company a $10,000 waiver fee.

As of December 31, 2009, the Company was not in compliance with the minimum fixed charge coverage and minimum tangible net worth covenants under the revised FCC Loan Agreement.  As of February 15, 2010, the Company, FCC, and Jack J. Walker, as guarantor, executed a Forbearance Agreement and Fourth Amendment, (the “Fourth Amendment”), in which FCC agreed to forbear from exercising its rights and remedies with regard to the Company’s non-compliance with financial covenants until April 30, 2010, if no other defaults occurred.  The Fourth Amendment increased the advance rate against eligible inventory from 50% to 60% until April 30, 2010, and reduced the maximum amount of the Revolving Credit Facility to $2.25 million until March 19, 2010, and then to $2.0 million thereafter.  In connection with the Fourth Amendment, FCC permitted AeroGrow to borrow up to $600,000 more than would otherwise be permitted by the applicable borrowing base calculation under the Loan Agreement, with such additional borrowing to be repaid by April 30, 2010.  The Fourth Amendment provided for a $500 per day forbearance fee, with such fee to be payable on the earlier of April 30, 2010 or the date on which loans under the Revolving Credit Facility are repaid in full.  Simultaneous with the execution of the Fourth Amendment, Mr. Walker provided a $1.5 million guarantee against certain liabilities under the FCC Loan Agreement.

 

As of March 31, 2010, loans totaling $1,565,395 were outstanding, including accrued interest, under the Revolving Credit Facility.  Also as of March 31, 2010, there was approximately $290,000 in additional borrowing capacity available under the Revolving Credit Facility.

On May 3, 2010, the Company, FCC, and Jack J. Walker, as guarantor, executed a Forbearance Agreement and Fifth Amendment (the “Fifth Amendment”) effective as of April 30, 2010.  Under the Fifth Amendment FCC agreed to forbear from exercising its rights and remedies with regard to the Company’s non-compliance with financial covenants until May 21, 2010, if no other defaults occur.  The Fifth Amendment enabled the Company to borrow up to $600,000 more than would otherwise be permitted by the applicable borrowing base calculation under the Revolving Credit Facility until the earlier of (i) the Company closing on a sale of subordinated secured convertible promissory notes, or (ii) the termination date of the forbearance period.  In addition, the Fifth Amendment set the maximum borrowing under the Revolving Credit Facility at $2,000,000 until such time as the Company closed on a sale of subordinated secured convertible promissory notes, at which time the maximum borrowing amount was required to be reduced to $1,000,000.  The Fifth Amendment provided for a continuation of the $500 per day forbearance fee set forth in the Fourth Amendment, with such fees related to both the Fourth Amendment and Fifth Amendment to be payable on the earlier of (i) May 21, 2010 or (ii) the date on which loans under the Revolving Credit Facility were repaid in full.

On May 24, 2010, the Company paid $673,600 to FCC to repay, in full, amounts due under the Revolving Credit Facility, and the Revolving Credit Facility was terminated.

Bridge Financing

Bridge Loans .  On August 28 through September 1, 2009, the Company entered into bridge financing arrangements totaling $500,000 (the “Bridge Loans”) with six lenders (the “Lenders”) as detailed in the table below.  The Bridge Loans are unsecured, subordinated to loans made to the Company by FCC, and bear interest at 15% per annum.  The Company issued 500,000 warrants to purchase common shares of the Company to the Lenders.  Each of the warrants has a five-year term and an exercise price of $0.25 per common share.

The Bridge Loans were originally scheduled to mature on November 16, 2009; however, no cash principal payments were made by the Company at maturity because FCC had not provided the consent required under the terms of the intercreditor subordination agreements executed by the Company, the Lenders, and FCC.  Interest totaling $25,069 was paid to the Lenders during the fiscal year ended March 31, 2010.  No payments of principal were made to the Lenders during the fiscal year ended March 31, 2010.  As of March 31, 2010, $518,493 was outstanding under the Bridge Loans, including accrued interest.

 

 

 

On May 6, 2010, Bridge Loans with an initial principal balance of $412,342 (and accrued interest of $18,124) were converted into Subordinated Secured Convertible Notes issued by the Company in a secondary offering, as further described below under the caption “Subordinated Secured Convertible Notes.”  In addition, on May 6, 2010, Bridge Loans with an initial principal balance of $25,000 held by Mr. Perkins were extended to a new maturity date of February 1, 2011.  On June 24, 2010, Bridge Loans with an initial principal balance of $37,657 (plus additional accrued interest of $5,936) were converted into Subordinated Secured Convertible Notes issued by the Company, as described below.  As a result, as of June 30, 2010, all of the Bridge Loans have either been liquidated or converted into Subordinated Secured Convertible Notes, except for the Bridge Loans held by Messrs. Perkins and Wolfe, and the interest owed on these two loans.

 

Additional Bridge Loans .  Between October 30 and November 9, 2009, the Company entered into additional bridge financing arrangements totaling $580,000 (the “Additional Bridge Loans”) with five lenders (the “Additional Lenders”) as detailed in the table below.  The Additional Bridge Loans are unsecured, subordinated to loans made to the Company by FCC, and bear interest at 20% per annum.  The Company issued 580,000 warrants to purchase common shares of the Company to the Additional Lenders.  Each of the warrants has a five-year term and an exercise price of $0.25 per common share.  One of the Additional Bridge Loans in the principal amount of $180,000 is guaranteed by Jack J. Walker, the Company’s Chairman, President and CEO.

The Additional Bridge Loans were originally scheduled to mature on February 1, 2010; however, no cash payments were made by the Company at maturity because FCC had not provided the consent required under the terms of the intercreditor subordination agreements executed by the Company, the Lenders, and FCC.  No interest or principal had been paid to the Lenders as of March 31, 2010.  As of March 31, 2010, $626,575 was outstanding under the Bridge Loans, including accrued interest.

 

On May 6, 2010, Additional Bridge Loans with an initial principal balance of $475,000 (plus additional accrued interest of $29,534) were converted into Subordinated Secured Convertible Notes issued by the Company in a secondary offering, as described below under the caption “Subordinated Secured Convertible Notes.”   In addition, on May 6, 2010, Additional Bridge Loans with an initial principal balance of $50,000 held by Mr. Perkins were extended to a new maturity date of February 1, 2011.  Finally, on June 1, 2010, a payment totaling $74,390 ($55,000 in principal and $19,390 in interest) was made against the Additional Bridge Loans.  As a result, as of June 30, 2010, all of the Additional Bridge Loans have either been liquidated or converted into Subordinated Secured Convertible Notes except for the Additional Bridge Loan held by Mr. Perkins and the interest owed on the Additional Bridge Loans held by Messrs. Perkins and Wolfe.

Subordinated Secured Convertible Notes

Beginning in March 2010, the Company began a private offering of units comprising an aggregate of up to $8.4 million of 8% Senior Secured Convertible Notes (“Subordinated Secured Convertible Notes”) and warrants to purchase 84,000,000 shares of the Company’s common stock (the “Warrants”).   On May 6, 2010, the Company closed on the private sale of units (the “Units”) comprising an aggregate of $4,200,000 in Subordinated Secured Convertible Notes and an aggregate of 42,000,000 Warrants.  The Units were sold at a price equal to the face value of the Subordinated Secured Convertible Notes.  Consideration for the Units sold comprised $3,265,000 in cash and $935,000 from the conversion of existing obligations of the Company into the Subordinated Secured Convertible Notes.

 

On June 24, 2010, the Company closed on the private sale of additional units (the “Additional Units”) comprising an aggregate of $2,600,000 in 8% Subordinated Secured Convertible Notes and an aggregate of 26,000,000 Warrants.  The Additional Units were sold at a price equal to the face value of the Subordinated Secured Convertible Notes.  The Company also received a commitment to purchase an additional $200,000 face value of Subordinated Secured Convertible Notes under the same terms and conditions as the Additional Units.  Consideration for the Additional Units sold comprised $2,300,000 in cash and $300,000 from the conversion of existing obligations of the Company into the Subordinated Secured Convertible Notes.

As stated above under the caption “Bridge Financing,” some of the Units and Additional Units were issued to officers, directors and major stockholders of the Company (collectively, “Related Parties”) in exchange for their Bridge Loans and Additional Bridge Loans.  Furthermore, some Related Parties purchased Units and Additional Units for cash.  The following table summarizes issuance of Units and Additional Units to Related Parties:

 
 

 

(1)  Includes accrued interest on Bridge Loan and/or Additional Bridge Loan.

(2)  Includes $20,000 investment on behalf of Mr. Severance and his spouse, as well $50,000 invested on behalf of H. Leigh Severance, Inc. Profit Sharing Plan and Trust.

 

The Subordinated Secured Convertible Notes bear interest at 8% per year, payable quarterly in cash, additional Subordinated Secured Convertible Notes, or in registered common stock of the Company, at the option of the Company, and mature on May 6, 2013.  The Subordinated Secured Convertible Notes can be converted into shares of the Company's common stock at any time, initially at a conversion price of $0.10 per share. The Subordinated Secured Convertible Notes will automatically convert into shares of the Company’s common stock in the event (i) there is an effective registration statement registering the resale under the Securities Act of 1933 (“Securities Act”) of the underlying stock (“Conversion Shares”) or the Conversion Shares are eligible to be resold without restriction or limitation under Rule 144 under the Securities Act, and (ii)  the closing bid price of the Company’s common stock as quoted on the OTC Bulletin Board or other principal trading market is at least $0.25 per share for 20 out of 30 consecutive trading days with an average daily trading volume of at least one million shares.  The Subordinated Secured Convertible Notes are secured by a subordinated lien on all assets of the Company.

Each Warrant entitles the holder to purchase one share of the Company's common stock at a price of $0.20 per share, and contains customary anti-dilution rights (for stock splits, stock dividends and sales of substantially all the Company’s assets) and piggyback registration rights.  The Warrants expire May 6, 2015.  For additional details regarding the Subordinated Secured Convertible Notes and the Warrants, please refer to the disclosure under the caption “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources” in our Annual Report on Form 10-K for the year ended March 31, 2010.

First Western Trust Credit Facilities

On May 21, 2010, the Company, FWTB and Jack J. Walker, the Company’s Chairman and CEO, as guarantor, executed a business loan agreement and related promissory note (the “FWTB Term Loan”) for a four-year loan in an initial principal amount of $1 million.  The FWTB Term Loan is secured by a lien on the Company’s assets.  In addition, Mr. Walker provided a guaranty of all Company obligations relating to the FWTB Term Loan.  The Company paid Mr. Walker $50,000 as compensation for guaranteeing the FWTB Term Loan.  The FWTB Term Loan bears interest at a fixed rate of 7.25% per annum and the Company paid a $12,500 origination fee to FWTB.  The Company will make equal monthly payments of principal/interest over the four-year term of the FWTB Term Loan, which has a final maturity date of May 21, 2014.  The terms and conditions of the FWTB Term Loan include limitations on the Company incurring additional debt and paying dividends on the Company’s stock without the consent of FWTB.  In the event of a default under the FWTB Term Loan, FWTB has the option to declare the loan immediately due and payable.

Jack J. Walker , see “Action 1 — Election of Directors,” above.

H. MacGregor Clarke , see “Action 1 — Election of Directors,” above.

 

John K. Thompson became Senior Vice President of Sales and Marketing on January 14, 2010.  Mr. Thompson joined AeroGrow in 2002 and has served in a variety of senior management positions at the Company, including his most recent position as Vice President of Marketing, which he assumed in October 2009.  Mr. Thompson also served as the Company’s International Division General Manager and Vice President of Investor Relations, and was instrumental in the research activities leading up to the development and launch of the Company’s AeroGarden product line.  Prior to joining AeroGrow, Mr. Thompson was Director of Marketing for Productivity Point International, a direct marketing and direct sales company, and Sales and Marketing Manager for CareerTrack, a direct marketing company that sold personal and professional growth products to the consumer and commercial markets.

J. Michael Wolfe became the Chief Operating Officer on January 14, 2010.  He previously served as Vice President of Operations since April 1, 2006.  Prior to joining AeroGrow, Mr. Wolfe was an independent consultant.  From 1992 to 2002, he was President and COO of Concepts Direct and was its CEO from 2000 to 2001.  At Concepts Direct, Mr. Wolfe oversaw the development, launch and operations of seven independent catalogs.  From 1987 to 1992, Mr. Wolfe served as Vice President of database management company Wiland Services, Inc, where he oversaw the redesign of the company’s product line, its sales and investor relations.

 

 

EXECUTIVE COMPENSATION

Compensation Philosophy

The Governance, Compensation and Nominating Committee of our Board is responsible for guiding and overseeing the formulation and application of the compensation and benefit programs for our executive officers and our directors.  A description of compensation for our non-employee directors is included above under the caption “Corporate Governance and Board Matters -- Director Compensation.”  The Committee acts pursuant to a charter that has been approved by our Board.

 

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

We compensate our executives through a mix of base salary, bonus, and equity compensation designed to be competitive with comparable employers and to align management’s incentives with the long-term interests of our stockholders.  In making compensation decisions, the Governance, Compensation and Nominating Committee, may compare certain elements of total compensation against other comparable publicly traded and privately held companies that compete in our markets.  However, the Committee did not use any peer group or benchmarking data in determining executive compensation during Fiscal 2010.  Rather, the Committee’s primary focus was on liquidity issues facing the Company and the compensation amounts that the Company could reasonably afford to pay.  A significant percentage of total compensation is allocated to incentive compensation as a result of the philosophy mentioned above.  There is no pre-established policy or target for the allocation between either cash and non-cash or short-term and long-term incentive compensation.  Rather, the Governance, Compensation and Nominating Committee reviews information such as that referenced above with respect to the Compensation Peers to determine the appropriate level and mix of incentive compensation.  Income from such incentive compensation is realized as a result of the performance of AeroGrow or the individual, depending on the type of award.

Compensation Process

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

 

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

Role of Executive Officers in Compensation Decisions

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

Components of Total Compensation

For the year ended March 31, 2010 (“Fiscal 2010”), the principal components of compensation for executive officers were:

·	base salary;

·	annual incentive compensation;

·	stock options; and

·	benefits and other perquisites.

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

Base Salaries

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

·	individual scope of responsibility;

 

·	years of experience;

·	market data, such as that obtained from a review of other similarly situated companies;

 

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

 

·	individual performance of the executive.

 

Salary levels are typically considered annually as part of AeroGrow’s performance review process as well as upon a promotion or other change in job responsibility.  Mr. Walker, our current Chief Executive Officer, has refused to accept any salary or bonus compensation since his appointment on January 15, 2010, in part due to the Company’s recent liquidity issues.

 

Performance-Based Annual Incentive Compensation

Though markets dictate that base salaries must be competitive, AeroGrow is moving towards basing a greater proportion of its executive compensation on the achievement of measurable individual and company results through the award of annual incentive bonuses.  These bonuses are often tied to performance against the Company’s EBITDA objectives.   By increasing variable pay as a percentage of total compensation, the Governance, Compensation and Nominating Committee believes that executive compensation will be more aligned with value delivered to its stockholders.  This limits fixed costs and also results in higher pay occurring only in years when merited by high performance.   In July 2009, the Company paid an aggregate of $95,000 in cash bonuses to its Named Executive Officers that were attributable to performance during Fiscal 2009.  The Company has not paid any cash bonuses that are attributable to performance in Fiscal 2010.

Long Term Stock-based Compensation

This category of awards covers options granted to executives out of the Company’s 2005 Equity Compensation Program, and that vest over time, at different rates for different executives.  Because these awards vest over time and become more valuable to the recipient only as AeroGrow’s stock price increases, the Governance, Compensation and Nominating Committee believes these are a useful form of long-term incentive compensation, with the potential to directly align the interests of shareholders and management.  During Fiscal 2010, we issued options to purchase 481,000 shares of common stock with exercise prices ranging from $0.07 to $0.20 per share under the 2005 Plan.  We did not issue any shares of common stock.  For more details about outstanding stock options held by our Named Executive Officers, please refer to the table below entitled “Outstanding Equity Awards at Fiscal Year End.”

Liquidity Performance Award Plan

On July 8, 2009, in light of the recently completed recapitalization, the Board decided to request the consent of the Covered Executives to terminate the Liquidity Performance Award Plan, which provided compensation to certain executives in the event of a Company Sale if specific conditions were met.  The Covered Executives provided such consent on July 13, 2009.

Equity Compensation Plan Information

2003 Stock Option Plan

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

 

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

·

select participants,

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

·	establish rules and regulations to administer the plan,

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

·	interpret the rules relating to the plan, and

·	otherwise administer the plan.

2005 Equity Compensation Plan

In August 2005 we adopted the 2005 Equity Compensation Plan (the “2005 Plan”) to promote our interests and the interests of our shareholders by attracting, retaining, and motivating our key officers, employees, directors, and consultants.  For more detailed information regarding the 2005 Plan, see “Action 2 – Approval of an Amendment to the 2005 Equity Compensation Plan to Authorize an Additional 10,000,000 Shares for Issuance under the Plan” above.

The following table provides information about common stock that may be issued under our prior and existing equity compensation plans (the 2003 Plan and the 2005 Plan) pursuant to all outstanding awards as of March 31, 2010.

 

Equity Compensation Plan Information

At March 31, 2010, we had granted options for 440,284 shares of our common stock that are unvested and that will result in $49,852 of compensation expense in future periods, if fully vested.

Executives and Employment Arrangements 

The following discussion and table relate to compensation arrangements on behalf of, and compensation paid by us during Fiscal 2010, to our Named Executive Officers who were employed by the Company as of March 31, 2010.

 

Employment Contracts

We have entered into employment agreements with H. MacGregor Clarke and J. Michael Wolfe, but Jack J. Walker’s employment is not governed by a contract.

Jack J. Walker

Mr. Walker was employed as the President and Chief Executive Officer of the Company as of January 15, 2010.  He has served as on the Board of Directors since February 2006 and as Chairman of the Board since July 2008.  Mr. Walker is not receiving cash compensation nor does he have an annual incentive bonus.  Instead, Mr. Walker was granted options to purchase 100,000 shares of the Company’s common stock on January 14, 2010.  The options were fully vested upon the date of grant and have an exercise price of $0.20 per share.   Mr. Walker receives medical benefits commensurate with the policies and programs adopted by us for our senior executives.  The options granted for his service as Chief Executive Officer created an expense of $11,000 in equity compensation for the Company during Fiscal 2010.

H. MacGregor Clarke

The employment agreement for Mr. Clarke, dated as of May 23, 2008 (the “Clarke Agreement”), provides that he will be employed as the Chief Financial Officer of the Company.  He must devote all of his business time to the affairs of the Company.  The initial term is one year ending May 23, 2009, and renewable for successive one year terms.  Mr. Clarke is entitled to receive base compensation of $200,000 per year and an annual bonus of not less than 1.5% EBITDA of the Company, as determined by our annual financial statements and prorated for any portion of such annual period covered under the Clarke Agreement.  Mr. Clarke is entitled to reimbursement for car expenses at the rate of $750 per month.  The Clarke Agreement also provides for medical, vacation, and other benefits commensurate with the policies and programs as adopted by us for our senior executives.  If the Company terminates the employment of Mr. Clarke without cause (as determined under the Clarke Agreement), then Mr. Clarke will be entitled to receive his base salary for 12 months following the date of termination, and a prorated portion of his annual cash bonus.  Further, pursuant to the Clarke Agreement, Mr. Clarke was granted five year options to purchase our common stock under the 2005 Equity Compensation Plan on three different dates.  The first grant was for 30,000 fully vested options to purchase the common stock of the Company on June 1, 2008 at an exercise price of $2.60 per share.  On July 1, 2008, Mr. Clarke was granted 60,000 options to purchase our common stock at an exercise price of $2.07 per share.  The vesting schedule for these options is 50% as of December 1, 2008 and 50% as of June 1, 2009.  The final grant of options per the Clarke Agreement was on October 1, 2008.  The grant was for 60,000 options to purchase common stock of the Company at an exercise price of $2.86 per share with a vesting schedule of 50% on December 1, 2009 and 50% on June 1, 2010.  The exercise prices of these options are equal to the price of the Company’s common stock at market close on the dates of grant.  On March 4, 2009, Mr. Clarke was granted five-year options to purchase 200,000 shares of AeroGrow’s common stock under the Company’s 2005 Equity Compensation Plan.  The options have an exercise price of $0.18 per share, which was the price at market close on the date of grant.  The options vest quarterly over a two-year period. On September 10, 2009, Mr. Clarke was granted five-year options to purchase 50,000 shares of AeroGrow’s common stock under the 2005 Equity Compensation Plan.  The options have an exercise price of $0.12 per share, which was the price at market close on the date of grant, and vest quarterly over a two-year period.  Also on September 10, 2009, the exercise prices of 150,000 options, previously granted to Mr. Clarke and exclusive of the March 4, 2009 grant, were adjusted to $0.12 per share, but all vesting schedules were unchanged. For Fiscal 2010, the Company paid Mr. Clarke $235,308 in cash compensation and expensed $10,000 in equity compensation.

 

J. Michael Wolfe

  The employment agreement for Mr. Wolfe, dated as of February 9, 2009 (the “Wolfe Agreement”), provides that he will be employed as the Vice President of Operations of the Company.  He must devote his entire business time to the affairs of the Company.  The initial term was until April 1, 2010 and renewable for successive one year terms.  Mr. Wolfe is entitled to receive base compensation of $175,000 per year and an annual bonus of 1.5% of the EBITDA of the Company as determined by our annual financial statements and pro-rated for any portion of such annual period covered under the Wolfe Agreement.  Mr. Wolfe is eligible to receive grants under the 2005 Equity Compensation Plan and such options will: (i) vest pursuant to a schedule that provides for vesting of at least of 50% of the amount of the grant per each 12-month period from the date of grant; (ii) not expire in less than five years from the date of grant; (iii) be subject to other standard terms and conditions under the 2005 Equity Compensation Plan; and (iv) shall have other terms and conditions no less favorable than that granted to other senior executives of the Company. The Wolfe Agreement also provides for medical, vacation, and other benefits commensurate with the policies and programs adopted by us for our senior executives.  If Mr. Wolfe is terminated without cause by us or Mr. Wolfe terminates under certain circumstances constituting a breach of the agreement by us, Mr. Wolfe shall be entitled to receive severance compensation equivalent to six months base salary and a pro rata bonus. In addition, if Mr. Wolfe is terminated in the event of a change in control of AeroGrow, including a change in chief executive officer, Mr. Wolfe shall be entitled to receive severance equal to his base salary for one year.  At the time of his hire, on March 28, 2006, Mr. Wolfe was granted 125,000 fully vested five-year options to purchase AeroGrow common stock under our 2005 Equity Compensation Plan at an exercise price of $5.00.  On March 4, 2009, Mr. Wolfe was granted five-year options to purchase 175,000 shares of AeroGrow’s common stock under the Company’s 2005 Equity Compensation Plan.  The options have an exercise price of $0.18 per share which was the price at market close on the date of grant.  The options vest quarterly over a two-year period.  On September 10, 2009, Mr. Wolfe was granted five-year options to purchase 50,000 shares of AeroGrow’s common stock under the 2005 Equity Compensation Plan.  The options have an exercise price of $0.12 per share, which was the price at market close on the date of grant, and vest quarterly over a two-year period.  Also on September 10, 2009, the exercise prices of 125,000 options, previously granted to Mr. Wolfe on March 28, 2006, were adjusted to $0.12 per share. Mr. Wolfe received $244,988 in cash compensation and expensed $8,750 in equity compensation from the Company during Fiscal 2010.

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

 

 

(1)	Represents the aggregate grant date fair value of stock option awards, as computed in accordance with FASB ASC Topic 718.

(2)	Mr. Walker's compensation for service as a non-employee director from April 1, 2009 through January 14, 2010 is included in the Director Compensation Table.

(3)	Mr. Walker did not receive cash compensation for his service as Chief Executive Officer.  On January 14, 2010, he was granted 100,000 fully vested five year options to purchase shares of our common stock at an exercise price of $0.20 per share.

 

(4)	Mr. Perkins' compensation for his service as a non-employee director from January 15, 2010 through March 31, 2010 is included in the Director Compensation Table.
(5)	On July 8, 2009, Mr. Perkins was awarded a $36,000 bonus by the Board of Directors.

 

(6)

On September 10, 2009, Mr. Perkins was granted 50,000 options to purchase our common stock at an exercise price of $0.12 per share, which vest quarterly over a 2 year period.   On September 10, 2009, the exercise prices of 250,000 options, previously granted to Mr. Perkins and exclusive of the March 4, 2009 grant, were adjusted to $0.12 per share.  All of Mr. Perkins' options expire on February 1, 2015.

 

(7)	Pursuant to Mr. Perkins’ employment agreement, he received $1,000 per month for car expenses.

(8)	Pursuant to Mr. Perkins’ Separation Agreement, he received $58,192 in severance pay and the Company paid $2,395 for his insurance through COBRA.
(9)	On March 4, 2009, Mr. Perkins was granted 300,000 five year options to purchase our common stock at an exercise price of $0.18 per share, which vest quarterly over a 2 year period.

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

(11)	On July 8, 2009, Mr. Clarke was awarded a $23,000 bonus by the Board of Directors.

(12)

On September 10, 2009, Mr. Clarke was granted 50,000 five year options to purchase our common stock at an exercise price of $0.12 per share, which vest quarterly over a 2 year period.   On September 10, 2009, the exercise prices of 150,000 options, previously granted to Mr. Clarke and exclusive of the March 4, 2009 grant, were adjusted to $0.12 per share and the vesting schedules were unchanged.

(13)	In accordance with Mr. Clarke’s employment agreement, he was paid $750 per month for auto expenses.

(14)

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

 

(15)	On July 8, 2009, Mr. Wolfe was awarded a $36,000 bonus by the Board of Directors.

(16)

On September 10, 2009, Mr. Wolfe was granted 50,000 five year options to purchase our common stock at an exercise price of $0.12 per share, which vest quarterly over a 2 year period.   On September 10, 2009, the exercise prices of 125,000 options, previously granted to Mr. Wolfe on March 28, 2006, were adjusted to $0.12 per share.

(17)	On March 4, 2009, Mr. Wolfe was granted 175,000 five year options to purchase our common stock at an exercise price of $0.18 per share, which vest quarterly over a 2 year period.

 

 

The following table provides information with respect to the Named Executive Officers concerning unexercised stock options held by them at March 31, 2010.  All options granted to date to the Named Executive Officers are unexercised.

 

(1)	Mr. Walker's unexercisable options vested after the March 31, 2010 fiscal year end as follows:  3,417 vested on April 31, 2010, 3,417 vested on May 31, 2010, and 3,146 vested on June 30, 2010.

 

(2)	The options granted on September 10, 2009 at an exercise price of $0.12 per share will vest quarterly over a 2 year period.
(3)	The options granted on March 4, 2009 at an exercise price of $0.18 per share will vest quarterly over a 2 year period.
(4)	Mr. Clarke's unexercisable options vested after the end of the fiscal year end on June 1, 2010.