** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**FORM 10-K**

** **

**(MarkOne)**

 
| **x** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|-------------------------------------------------------------------------------------------------------|

 

** **

**For thefiscal year ended December 31, 2006**

 

**or**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------------------|

 

** **

**For thetransition period from                  to                  .**

 

**Commission File Number 0-27517**

 

**GAIAM, INC.**(Exact name of registrant as specified in its charter)

 
| **COLORADO**                                                         | ** ** | **84-1113527**                              |
|----------------------------------------------------------------------|------------|---------------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer   Identification No.) |

 

** **

**360 INTERLOCKEN BOULEVARDBROOMFIELD, CO 80021**(Address of principal executive offices)

 

**(303) 222-3600**(Registrant’s telephone number, including area code)

 

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

 
| **Title of Each Class**                    | ** ** | **Name of  Each Exchange on Which Registered** |
|--------------------------------------------|------------|------------------------------------------------|
| ** **                                 | ** ** | ** **                                     |
| **Class A Common Stock, $.0001 par value** | ** ** | **NASDAQ  Stock Market LLC**                   |

 

Securities registered pursuant to section 12(g) of the Act:**None**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act.  YES **o**  NO **x**

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act.   YES **o**  NO **x**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  YES **x**  NO **o**

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§229.405 of this chapter) is not contained herein, and will notbe contained, to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K.  **x**

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

 
| Large accelerated filer **o** | Accelerated filer  **x** | Non-accelerated  filer **o** |
|-------------------------------|--------------------------|------------------------------|

 

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Act.)  YES **o**  NO **x**

Theaggregate market value of the voting common equity held by non-affiliates ofthe registrant was approximately $234,986,879 as of June 30, 2006, basedupon the closing price on the NASDAQ Global Market on that date.  The registrant does not have non-votingcommon equity.

 

As ofMarch 12, 2007, 19,250,276 shares of the registrant’s Class A commonstock and 5,400,000 shares of the registrant’s Class B common stock wereoutstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Thefollowing documents (or portions thereof) are incorporated by reference intothe Parts of this Form 10-K noted:

 

Part IIIincorporates by reference from the definitive proxy statement for theregistrant’s 2007 Annual Meeting of Shareholders to be filed with theCommission pursuant to Regulation 14A not later than 120 days after the end ofthe fiscal year covered by this Form.

 

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**GAIAM, INC.**

Annual Report onForm 10-K for the Fiscal Year Ended December 31, 2006
|               |                                                                                                                | **Page** |
|---------------|---------------------------------------------------------------------------------------------------------------------|----------|
| PART I   |                                                                                                                | 3        |
|          |                                                                                                                |     |
| Item  1.      | Business                                                                                                            | 3        |
| Item  1A.     | Risk  Factors                                                                                                       | 10       |
| Item 1B.      | Unresolved Staff  Comments                                                                                          | 14       |
| Item  2.      | Properties                                                                                                          | 14       |
| Item  3.      | Legal  Proceedings                                                                                                  | 14       |
| Item 4.       | Submission of  Matters to a Vote of Security Holders                                                                | 14       |
|          |                                                                                                                |     |
| PART II  |                                                                                                                | 15       |
| Item 5.       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 15       |
| Item 6.       | Selected Financial  Data                                                                                            | 16       |
| Item 7.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 17       |
| Item 7A.      | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 25       |
| Item 8.       | Financial  Statements and Supplementary Data                                                                        | 25       |
| Item 9.       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               | 48       |
| Item 9A.      | Controls and  Procedures                                                                                            | 48       |
| Item 9B.      | Other Information.                                                                                                  | 49       |
|          |                                                                                                                |     |
| PART III |                                                                                                                | 49       |
| Item 10.      | Directors and  Executive Officers of the Registrant                                                                 | 49       |
| Item 11.      | Executive  Compensation                                                                                             | 49       |
| Item 12.      | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 49       |
| Item 13.      | Certain  Relationships and Related Transactions, and Director Independence                                          | 50       |
| Item 14.      | Principal  Accountant Fees and Services                                                                             | 50       |
|          |                                                                                                                |     |
| PART IV  |                                                                                                                | 51       |
| Item 15.      | Exhibits and  Financial Statement Schedules                                                                         | 51       |
|          |                                                                                                                |     |
| SIGNATURES    | 54                                                                                                                  |

 

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**PART I**

**Item 1.  Business**

## **OURBUSINESS**

Gaiamis a lifestyle media company providing a broad selection of information, media,products and services to customers who value personal development, wellness,ecological lifestyles, responsible media and conscious community. We offer ourcustomers the ability to make purchasing decisions and find responsible contentbased on these values while providing quality offerings at a price comparableto mainstream alternatives. We market our media and products through a multi-channelapproach including traditional media channels, direct to consumers viacatalogs, the Internet, direct response television, and broadband andsubscription clubs and communities. At the end of 2006, Gaiam’s home media wascarried by more than 68,000 retail stores in the United States alone, and Gaiamhad approximately 7.5 million direct customers.

Gaiamhas established itself as a lifestyle media brand, content producer andlicensor, information resource and authority in the Lifestyles of Health andSustainability (“LOHAS”) market including the emerging “Media that Matters” (“MTM”)market. Gaiam seeks to become a unifying symbol of these emerging media andlifestyle genres. Our lifestyle brand is built around our ability to developand offer media content, products, lifestyle solutions and community toconsumers in the LOHAS and MTM markets. Our content forms the basis of ourproprietary offerings, on which we realize our highest margins, which thendrive demand for parallel product and service offerings. Gaiam’s operations arevertically integrated from content creation, through product development andsourcing, to customer service and distribution. We market our products andservices across two segments, business and direct-to-consumer. We distributeour products in each of these sales segments from a single fulfillment center.

**The LOHAS Market**

The LOHAS market, whichrepresented $227 billion in sales according to the 2000 Natural BusinessCommunication study, consists of five main sectors:

·                  ***Sustainable Economy*.** Renewableenergy, energy conservation, recycled goods, environmental management services,sustainable manufacturing processes and related information and services.

·                  ***Healthy Living*.** Natural and organicfoods, dietary supplements, personal care products and related information andservices.

·                  ***Alternative Healthcare*.** Health andwellness solutions and alternative health practices.

·                  ***Personal Development*.** Solutions,information, products and experiences relating to mind, body and spiritualdevelopment.

·                  ***Ecological Lifestyles*.**Environmentally friendly cleaning and household products, organic cottonclothing and bedding, and eco-tourism.

Gaiam participates in all five sectors of the LOHASmarket with an emphasis on Personal Development, Ecological Lifestyles andAlternative Healthcare.

**The MTMMarket**

Gaiam considersthe MTM market to consist of four distinct sectors:

·                  ***Childrens.***Children’s entertainmentand edutainment with a positive message.

·                  ***Family Entertainment.***Entertainmentthat can be enjoyed by the entire family, containing no violence or profanity.

·                  ***Documentaries.***Educational andinformational programming (edutainment).

·                  ***Inspirational Entertainment.***Entertainmentthat inspires people to expand their awareness and pursue positive changes intheir lives.

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**Our Content**

Gaiam’s business modelrevolves around content creation, which forms the basis for our proprietaryproducts. We have an “in house” production team that produces programming,which has won 65 Telly awards and several medals at the International New YorkFilm Festival. We are fully high definition and 5.1 surround sound capable anddo the majority of our authoring and editing at our Colorado facility ensuringthe quality standards that drives our awards. We also develop children’sprogramming, which have been the recipient of several Parent’s Choice and KidsFirst Awards recognizing new products that help children grow imaginatively,physically, and mentally. During 2006, we produced 45 new titles and added 150titles to our DVD library through acquisitions and remakes of some of theassets of GoodTimes Entertainment (“GoodTimes”). Gaiam also develops andmarkets music and audio CDs and publishes printed content.

**Our Products**

Our visual media programsrepresent an integral part of our proprietary product offering. We currentlystock approximately 10,000 stock keeping units (“SKUs”), of which approximately7,000 are branded proprietary offerings, including media, accessories and softgoods. In 2006, our proprietary products constituted over 70% of our productsales.

**Our Sales Channels**

We conduct our businessacross two segments. Our business segment customers are primarily nationalretailers, corporate accounts and the media. We conduct our direct-to-consumerbusiness through our catalogs, the Internet, direct response television andbroadband and subscription clubs and communities.

·                  *Media*

Gaiam develops, producesand licenses information and programming targeted to consumers who valuepersonal development, wellness, spirituality, inspirational entertainment and asense of community. Gaiam has an award-winning library of titles that it sellsto retailers, licenses to selected distributors operating outside of the UnitedStates, and licenses or sublicenses for broadcast and download. Some of ourmedia partners include Google, Comcast, LodgeNet, Blackberry and EntertainmentOne. All of our licensing arrangements require Gaiam branding to be prominenton the programming and are subject to our royalty agreements with ourperforming artists. While our licensing of the rights to manufacture anddistribute certain of our media lowers recognized revenue, contribution marginsand branding are improved.

·                  *DRTV*

Gaiam uses directresponse television (“DRTV”) marketing to promote LOHAS products and services,particularly those aimed at the fitness/wellness market. DRTV marketing is ahighly-scalable distribution channel for segments of our LOHAS product suite,and also provides broad marketing support for our retail partners, as well ascreates new direct customers to which we cross-market a wide range of LOHASproducts and services via our catalog, Internet, and subscription segments. Wecapitalize on both long-form DRTV shows as well as leading home shoppingchannels such as QVC. In 2006, we used the DRTV channel to launch our massmarket brand “The Firm”.

·                  *Retailers*

Since the inception ofour retailer channel in 1998, we have increased its breadth and diversity. Asof the end of 2006, Gaiam media titles may be found in over 68,000 stores inthe United States from 55,000 at the end of 2005. Gaiam media and otherproducts are currently sold across a variety of leading retailers, includingbookstores such as Barnes & Noble and Borders; media stores such asBest Buy and Blockbuster; lifestyle stores such as Discovery Channel Stores andEQ Life; beauty stores such as Ulta; home furnishing stores such as Bed, Bathand Beyond and ABC Carpet and Home; natural food stores such as Whole FoodsMarket and Wild Oats; sporting goods stores such as Dick’s and REI; massmerchants such as WalMart and Target, our largest customer, e-tailers such asAmazon.com and Drugstore.com; and wholesale clubs such as Costco and Sam’sClub. Many of these retailers display our products in brandedstore-within-store lifestyle presentations that may include custom fixturesdesigned and produced by Gaiam. We implemented our first store-within-storeconcept late in 2000 and the concept has grown to over 6,000 stores by the endof 2006, up from 4,500 stores at the end of 2005.

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Through distributorarrangements and acquisitions, Gaiam branded products may now be found inCanada, Japan, Korea, the United Kingdom and Australia. Our media products aresold to international accounts primarily under licensing agreements and theremaining products are sold through distributor relationships. During 2004,Gaiam entered into a joint venture in Australia to bring Gaiam products toconsumers through catalogs, internet and Australian retailers commencing in2005. Our majority owned UK subsidiary changed its name to Gaiam effectiveMarch 1, 2005.

·                  *Services*

Gaiam,through its Design and Consulting division and eco-travel company, NaturalHabitat, provides products and services to businesses, corporate accounts, andschools. Clients of our lifestyle services included The White House, NASA,Fetzer Winery, the U.S. Department of Energy, the Government of Brazil, theSmithsonian Institution, and the World Wildlife Fund.

·                  *Catalogs*

Gaiam offers a variety ofLOHAS products directly to the consumer through our catalogs and through someconsumer lifestyle publications. We mailed approximately 20 million catalogs in2006. Our customer demographics are highly regarded with an average income over$75,000 and over 70% college educated.

·                  *Internet*

We use the Internet to sellour products and to provide information on the LOHAS lifestyle.  We currently offer approximately 7,000 SKUson our website, www.gaiam.com.  Wepromote our website through our visual media, catalogs, print publications,product packaging and Internet Links. A key component of our Internet approachis to provide customer support for Internet sales from our in-house callcenter.

·                  *Subscription Services*

Gaiam offers a variety ofsubscription paid services.  Theseservices include online communities under various brands and subscriptionclubs.  During 2006, we acquiredSpiritual Cinema Circle and grew our membership to over 100,000 members.  In the fourth quarter of 2006, we also testeda beta site for Gaiam community development.

**Our Operations**

·                  *Product Development and Sourcing*

Gaiam branded productsare sold across our sales channels. Non-proprietary products are only availablethrough our catalogs and over the Internet. We use our catalog and Internetchannels to test products before we develop products under the Gaiam brand anddistribute them through our other sales channels. Our products are designed tosupply information, enhance customers’ lifestyles and experiences and providehealthy, natural solutions while being eco-friendly and promoting a sustainableeconomy. Because we use a multi-channel approach to our business we are able toleverage our product development costs across all channels of our business.

Our proprietary productsare designed by our product development team, sourced both domestically andinternationally by our merchandisers and produced by third party suppliers toour specifications. We also screen the environmental and social responsibilityof our suppliers. In order to minimize risk we often identify an alternatesupplier for our products in a separate location.

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·                  *Customer Service*

Gaiam focuses on buildingand maintaining customer relationships that thrive on loyalty and trust. Wemaintain a “no-risk guarantee” policy, whereby a customer is provided a fullrefund for Gaiam products that are returned at any time, for any reason. Wehave established a most valued customer program, which extends added benefitsto our most loyal catalog and Internet customers. Our in-house customer servicedepartment includes product specialists who have specific product knowledge andassist customers in selecting products and solutions that meet their needs. Weemploy telephone routing software that directs each call to the appropriaterepresentative. Our policy is to ship orders no later than the next businessday, which we accomplish by stocking inventory that supports over 92% of ourorders. We believe that by offering exceptional customer service we encouragerepeat purchases by our customers, enhance our brand identity and reputation andbuild stronger relationships with our customers.

·                  *Established Infrastructure*

We operate a 350,000square foot distribution center near Cincinnati, Ohio, which providesfulfillment for most of our current domestic business needs and has thecapacity to support the growth of our business. This central U.S. locationallows us to achieve shipping cost efficiencies to most locations. The centeris also located within 30 minutes of several major shipping company hubs. Weuse a supply chain management system that supports our entire operation,including fulfillment, inventory management, and customer service. Ourfulfillment center is connected to our other facilities by a state-of-the artvoice-over-Internet telecom network that allows us to maintain a high degree ofconnectivity within our organization.

**OurGrowth Strategies**

·                  *Expand our Media Offering*

Proprietary and authenticcontent lies at the core of our business model. Our media offerings introducecustomers to Gaiam and help establish Gaiam as an authority in the LOHASmarket. Gaiam’s primary focus is on leveraging our content with brandedlifestyle product offerings through various media, catalogs, the Internet, andnational retailers. We believe that the content-centric strategy is acompetitive advantage and the multi-channel approach allows us the broadestpossible consumer reach. It also provides the optimal “context” for us tomarket lifestyle products that are appropriate companions to the media.

We will continue todevelop authentic content that caters to the LOHAS lifestyle in DVD, book andaudio formats and also accelerate our efforts in the broadcast and onlinecategories. We intend to expand our brand to MTM, which incorporates children’s,family, inspirational and edutainment media. We believe we can establish theGaiam brand as a leading brand in these new media categories.

We have expanded ourvisual media offerings internationally and plan to continue to expand thisopportunity. We also intend to broaden the variety of formats we offer, from ourtraditional “physical media” (DVD, CD, etc), to making our content availableonline to our consumers in both one-shot “purchase” format and paidmonthly/annual subscription services.

·                  *Capitalize on our market share positioning*

Wecontinue to grow our media market share. Based on Nielsen’s Videoscan, Gaiamgrew its U.S. DVD market share from 15% in 2004 to 26% in 2005 (pro forma withGoodTimes of over 40%) to 45% in 2006 in the fitness/wellness category. Basedon the same Nielsen scanning, Gaiam ended sixth in the non-theatrical U.S. DVDcategory with 6% market share. We intend to continue to grow our market sharein the non-theatrical category through the production and acquisition of titlesin the MTM category, focusing on children’s and family entertainment.  We also plan to line extend into wellnesswith solution based programming and media based kits building store withinstore on wellness and continuing to grow our retail presence.

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·                  *Improve our Profit Margins*

Webelieve we can improve our profit margins with several distinct strategies. Wewill continue to focus our sales strategy on media that carries over 70% grossmargins. Gaiam is establishing itself as a brand in MTM and wellness/fitnessmedia as well as in a genre we call edutainment. By continuing to grow ourmarket share in media, we believe we can attract more media producers to workwith the Gaiam brand instead of the traditional studio or distributor model.

Wecontinue to improve margins as we are able to serve the large retailersdirectly instead of going through third party distributors allowed by theGoodTimes asset acquisition and the increased sales volume of Gaiam media.Since the GoodTimes transaction, we have been able to go directly to retailerslike Wal-Mart and Kmart that were serviced by third party distributors prior tothe acquisition.  During 2006 weimplemented a new Vendor Manager Inventory System allowing us to improve storeturns and reduce markdowns.

Welaunched a continuity and subscription club business in second quarter of 2005which was augmented with certain acquired assets of GoodTimes Entertainment andthe acquisition of a majority of Spiritual Cinema in 2006. These businessescarry over 85% gross margins and connect our media content directly to theconsumer. We ended 2006 with over 100,000 paying members. We expect to investin this channel of business. We believe that with the increase in broadbandacceptance in the consumer marketplace coupled with our specialized medialibrary and loyal direct customer base, we have an opportunity for stronggrowth at high margins.

Weexpect to grow our international business through licensing arrangements thatcarry low cost of goods. We have a valuable library of branded products that isnot being currently monetized with the exception of the UK and Australia. In2006, we hired personnel familiar with international licensing who will leadthis initiative.

·                  *Strengthen our Lifestyle Brand*

Our goal is to maintainthe Gaiam brand as an authority in the LOHAS market (including MTM) and toestablish Gaiam as a unifying symbol of the emerging LOHAS lifestyle. We planto strengthen the Gaiam brand by growing our media, making the Gaiam brand moreprominent across our catalog efforts, focusing on category managementinitiatives, increasing our store-within-store presence across nationalretailers, increasing our marketing and PR efforts, and aggressively developingand marketing proprietary products while maintaining our high level of customerservice. We initiated a branding study in late 2006 that will drive thisinitiative in 2007.

·                  *Launch a Mass Market Brand in Fitness*

Welaunched mass market media and products in fitness under “The Firm” brand inlate 2006. We believe that the aging baby boomers at all income levels will belooking for fitness/wellness products. We do not market the Gaiam brand exceptin media in certain mass market channels and believe there is growthopportunity for us in those channels under a different brand with the sameattention to quality that we have at Gaiam. We supported The Firm brand throughDRTV dollars during 2006 and ended the year with over 1,000 doors carrying TheFirm brand mainly through a SWIS display.

·                  *Expand our Proprietary Products*

Our proprietary products,which we introduced in 1997, represented over 70% of our revenues in fiscalyear 2006. These products carry a higher margin, provide for brandingopportunity and distinguish us from our competitors. We currently offerproprietary products that range from media products to sleep, stress relief,yoga and Pilates accessories to organic cotton bedding and bath products. Wehave also expanded our exclusive media library to over 2000 titles through ouracquisition of the assets of GoodTimes Entertainment. We continue to developand market proprietary products across the LOHAS sectors. We will continue tolook for additional library acquisitions as we expand our content across theMTM market. We are strengthening our supply chain globally by sourcing agreater number of products offshore and leveraging our expanding media sales toacquire lower costs from our replicators. We leverage our product developmentcosts over all sales channels.

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·                  *Capitalize on ourMulti-channel Approach*

Our multi-channelstrategy affords us the broadest possible customer reach, as well as theability to allow our customers to buy from us “what they want, when they want,where they want to.” This approach makes purchasing our lifestyle productsconvenient regardless of the channel that a customer prefers. It also allows usto migrate segments of our customer base across channels to develop deeper,longer-lasting relationships with them, and to convert them from purchasers ofindividual media products into subscribers to our “continuity programs,”whether those are DVD-based, or online access to communities and content on acontinuity basis. Additionally, this diversified, strategic approach shouldprovide for continued operating and business stability as we have the abilityto cross-market lifestyle products and services regardless of the customerlocation or the channel to which we are marketing.

In our direct-to-consumerbusiness we are open 24 hours a day, offering over 7,000 products on ourInternet site. As we increase the depth of media and community functionalityavailable to our consumers, our Internet presence will transform from beingmerely a place to “order” product to a place to “consume” it, in real-time.

In our business segment,we continue to expand our presence in national retailers and currently haveplacements in approximately 68,000 retail points in the United States up from50,000 at the end of 2005 and 25,000 at the end of 2004. We also continue toexpand our store-within-store concept in a variety of stores, including WholeFoods Market, Barnes & Noble Bookstores, Borders, Target, Ulta, Dick’sSporting Goods, REI, ABC Carpet and Home and other national retailers. Wecurrently have over 6,000 store within store concepts under the Gaiam and TheFirm brands.

·                  *Complement our Existing Business with Selective Strategic Acquisitions*

Our growth strategy isnot dependent on acquisitions. However, we will consider those strategicacquisitions in the LOHAS market that complement our existing business,increase our media and related product offerings, expand our geographicalreach, extend our channel distribution, and add to our direct customer base. Weespecially focus on companies with media content, a strong brand identity andcustomer and product information databases that augment our existing databases.Gaiam often allows some of the acquired company’s management team to retainresponsibility for front-end business functions such as creative presentationand marketing, while consolidating operational functions under Gaiam’s existinginfrastructure when economies of scale can be realized.

·                  *Establish a lifestyle community*

In2007, Gaiam plans to expand its community efforts, with specific focus onsustainability, personal development, healthy living, spirituality, alternativehealthcare, and responsible media. Gaiam already works with the leading expertsin these fields to produce our current suite of media offerings. In 2007, wewill launch the online “space” for our customers to come together with eachother and with Gaiam’s cadre of experts in these core LOHAS areas, to shareideas, discuss new trends and solutions, and allow our customers have access toworld-class resources to deepen their understanding of issues that are centralto how they choose to live their lives.

**OurBusiness Segments**

We separate our businessinto two business segments: the business segment which includes sales tobusinesses, retailers, corporate accounts and media outlets; and thedirect-to-consumer segment, which includes DRTV, catalogs, E-commerce,and subscription community services.

The business segmentrepresented 43% of 2006 revenues, while the direct to consumer segmentrepresented 57% of revenues. See Note 11 to our consolidated financialstatements for further information on our segments.

**Our Intellectual Property**

Our tradename Gaiam andvarious product and Internet domain names are subject to trademark or pendingtrademark applications of Gaiam or a Gaiam company. We believe these trademarksare significant assets to our business.

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**Our Competitive Position**

We believe that fragmented supplier and distributionnetworks characterize the LOHAS market, and we are not aware of a dominantleader. Gaiam’s goal is to establish itself as the market leader.

Our business is evolvingand competitive. Larger and better-established entities may acquire, invest inor form joint ventures with our competitors. Many of these entities have longeroperating histories and have greater financial and marketing resources than wehave. Increased competition from these or other competitors could reduce ourrevenue and profits. In addition, the smaller businesses we compete against maybe able to more effectively personalize their relationships with customers.

Because Gaiam usesmulti-channel distribution for our products, we compete with various producersof similar products and services. Our competitors include Warner Bros., Disney,Paramount, Fox, Anchor Bay, Inspired Entertainment, Goldhill Media, Nike,Reebok, thousands of small, local and regional businesses, and product lines oritems offered by large retailers, manufacturers, publishers and mediaproducers.

We believe the principalcompetitive factors in the LOHAS market are authenticity of information, uniquecontent and distinctiveness of products and services, quality of product, brandrecognition and price, and distribution capabilities. We believe we competefavorably on all these relevant factors.

We expect industryconsolidation to increase competition. As our competitors grow, they may adoptaggressive pricing or inventory policies, which could result in reducedoperating margins and loss of market share.

Our success also dependsupon the willingness of consumers to purchase media, goods and services thatpromote the values we espouse. While we believe our business plan andassumptions are reasonable, the demographic trends on which they are based maychange and the current consumption levels may not be sustained. The decrease ofconsumer interest in purchasing goods and services that promote the values weespouse would materially and adversely affect our customer base and revenuesand, accordingly, our financial prospects.

**Our Employees**

As of March 1, 2007,Gaiam and the Gaiam companies employed approximately 363 individuals. None ofour employees are covered by a collective bargaining agreement.

**Regulatory Matters**

A number of existing andproposed laws restrict disclosure of consumers’ personal information, which maymake it more difficult for Gaiam to generate additional names for its directmarketing, and restrict our ability to send unsolicited electronic mail orprinted materials. Although Gaiam believes it is generally in compliance withcurrent laws and regulations and that these laws and regulations have not had asignificant impact on our business to date, it is possible that existing orfuture regulatory requirements will impose a significant burden on us.

The Gaiam companiesgenerally collect sales taxes only on sales to residents of states in whichGaiam has locations.  Currently, Gaiamcollects sales taxes on sales to residents of California, Colorado, New Yorkand Ohio. A number of legislative proposals have been made at the federal,state and local level, and by foreign governments, that would impose additionaltaxes on the sale of goods and services over the Internet and certain stateshave taken measures to tax Internet-related activities. If legislation isenacted that requires Gaiam to collect sales taxes on sales to residents ofother states or jurisdictions, sales in our direct-to-consumer businesses maybe adversely affected.

Our business is alsosubject to a number of other governmental regulations, including the Mail orTelephone Order Merchandise Rule and related regulations of the FederalTrade Commission. These regulations prohibit unfair methods of competition andunfair or deceptive acts or practices in connection with mail and telephoneorder sales and require sellers of mail and telephone order merchandise toconform to certain rules of conduct with respect to shipping dates andshipping delays. We are also subject to regulations of the U.S. Postal Serviceand various state and local consumer protection agencies relating to matterssuch as advertising, order solicitation, shipment deadlines and customerrefunds and returns. In addition, merchandise imported by Gaiam is subject toimport and customs duties and, in some cases, import quotas.

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**Seasonality**

See the “Quarterly andSeasonal Fluctuations” section of Item 7, Management’s Discussion andAnalysis of Financial Condition and Results of Operations, for informationpertaining to the seasonal aspects of our business.

**Available Information**

Our corporate website atwww.gaiam.com/corporate provides information about Gaiam, its history, goalsand philosophy, as well as certain financial reports and corporate pressreleases. Our www.gaiam.com website features a library of information andarticles on personal development, healthy lifestyles and environmental issues,along with an extensive offering of media, products and services. We believeour website provides us with an opportunity to deepen our relationships withour customers and investors, educate them on a variety of issues, and improveour service. As part of this commitment, we have added a link on our corporatewebsite to our Securities and Exchange Commission filings, including our reportson Form 10-K, 10-Q and 8-K and all amendments to such reports. Thosereports are available through our website, free of charge, as soon asreasonably practicable after these reports are filed with the Securities andExchange Commission.

We have included ourwebsite addresses only as inactive textual reference, and the informationcontained on our website is not incorporated by reference into theForm 10-K.

**Item 1A.          RiskFactors**

We wish to caution youthat there are risks and uncertainties that could cause our actual results tobe materially different from those indicated by forward looking statements thatwe make from time to time in filings with the Securities and ExchangeCommission, news releases, reports, proxy statements, registration statementsand other written communications as well as oral forward looking statementsmade from time to time by our representatives. These risks and uncertaintiesinclude, but are not limited to, those risks described below. Additional risksand uncertainties not presently known to us or those we currently deemimmaterial also may impair our business operations, and historical results arenot necessarily an indication of the future results. The cautionary statementsbelow discuss important factors that could cause our business, financialcondition, operating results and cash flows to be materially adverselyaffected.

*Changes in general economic conditions could have a material impact onour business*

Our results of operationscould be impacted by changes in overall economic conditions that impactconsumer spending. Future economic conditions affecting disposable income suchas employment levels, consumer confidence, business conditions, stock marketvolatility, weather conditions, acts of terrorism, threats of war, and interestand tax rates could reduce consumer spending or cause consumers to shift theirspending away from our products. If the economic conditions and performance ofthe retail and media environment worsen, we may experience material adverseimpacts on our business, operating results and financial condition.

*Increasedcompetition could impact our financial results*

We believe that the LOHASmarket has thousands of small, local and regional businesses. Some smallerbusinesses may be able to more effectively personalize their relationships withcustomers, thereby gaining a competitive advantage. Although we believe that wedo not compete directly with any single company that offers our entire range ofmerchandise, within each merchandise category we have competitors and we mayface competition from new entrants. Some of our competitors or our potentialcompetitors may have greater financial and marketing resources and greaterbrand recognition. In addition, larger, well-established and well-financedentities may acquire, invest in or form joint ventures with our competitors.Increased competition from these or other competitors could negatively impactour business.

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*Changingconsumer preferences may have an adverse effect on our business*

Our business is targetedat consumers who assign high value to personal development, healthy lifestyles,responsible media, renewable energy and the environment. A decrease of consumerinterest in purchasing goods and services that promote the values we espousewould materially and adversely affect our customer base and sales revenues and,accordingly, our financial prospects. Further, consumer preferences and producttrends are difficult to predict. Our future success depends in part on ourability to anticipate and respond to changes in consumer preferences and we maynot respond in a timely or commercially appropriate manner to such changes.Failure to anticipate and respond to changing consumer preferences and producttrends could lead to, among other things, lower sales of our products,increased merchandise returns and lower margins, which would have a materialadverse effect on our business.

*Ourstrategy of offering branded products could lead to inventory risk and highercosts*

An important part of ourstrategy is to feature branded products. These products are sold under ourbrand names and are manufactured to our specifications. We expect our relianceon branded merchandise to increase. The use of branded merchandise requires usto incur costs and risks relating to the design and purchase of products,including submitting orders earlier and making longer initial purchasecommitments.

In addition, the use ofbranded merchandise limits our ability to return unsold products to vendors,which can result in higher markdowns in order to sell excess inventory. Ourcommitment to customer service typically results in us keeping a high level ofmerchandise in stock so we can fill orders quickly. Consequently, we run therisk of having excess inventory, which may also contribute to higher markdowns.Our failure to successfully execute a branded merchandise strategy or toachieve anticipated profit margins on these goods, or a higher than anticipatedlevel of overstocks, may materially adversely affect our revenues.

We offer our customersliberal merchandise return policies. Our consolidated financial statementsinclude a reserve for anticipated merchandise returns, which is based onhistorical return rates. It is possible that actual returns may increase as aresult of factors such as the introduction of new merchandise, changes inmerchandise mix or other factors. Any increase in our merchandise returns willcorrespondingly reduce our revenues.

*Acquisitions may harm our financial results*

Acquisitions have beenpart of our growth and may continue to be part of our growth in the future. Ouracquisitions may be of entire companies, certain assets of companies,controlling interests in companies or of minority interests in companies wherewe intend to invest as part of a strategic alliance. If we are not successfulin integrating companies that we acquire or are not able to generate adequatesales from the acquired entities, our business could be materially andadversely affected.

*The loss of the services of our key personnel coulddisrupt our business*

We depend on thecontinued services and performance of our senior management and other keypersonnel, particularly Jirka Rysavy and Lynn Powers. Our strategy of allowingthe management teams of some acquired companies to continue to exercisesignificant management responsibility for those companies makes it importantthat we retain key employees, particularly the sales and creative teams, of thecompanies we might acquire.

*Our founder and chief executive officer JirkaRysavy controls Gaiam*

Mr. Rysavy holds100% of Gaiam’s 5,400,000 outstanding shares of class B common stock and alsoowns 1,118,682 shares of class A common stock. The shares of class B commonstock are convertible into shares of class A common stock at any time. Eachshare of class B common stock has ten votes per share, and each share of classA common stock has one vote per share. Consequently, Mr. Rysavy is able tovote a majority of our stock, and will be able to exert substantial influenceover Gaiam and to control matters requiring approval by the shareholders ofGaiam, including the election of directors, increasing our authorized capitalstock, or a merger or sale of our assets. As a result of Mr. Rysavy’scontrol, no change of control of Gaiam can occur without Mr. Rysavy’sconsent.

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*Our success depends on the value of the Gaiam brand*

Because of our relianceon sales of proprietary products, our success depends on the Gaiam brand. Buildingand maintaining recognition of the Gaiam brand are important to attracting andexpanding our customer base. If the value of the Gaiam brand were adverselyaffected, we cannot be certain that we will be able to attract new customers,retain existing customers or encourage repeat purchases, and if the value ofour brand were to diminish, our revenues, results of operations and prospectswould be adversely affected.

*Disputesconcerning media content and intellectual property may adversely affect us*

Most of our media contentis subject to arrangements with third parties pursuant to which we havelicensed certain rights to use and distribute media content owned by thirdparties or have licensed to third parties certain rights to use and distributemedia content that we own. In addition, we have a number of agreements withthird parties concerning the use of our media content and intellectualproperty, including agreements regarding royalties, distribution, duplication,etc. Allegations that we do not have rights to use media content and otherdisputes arising from such arrangements can be costly and may have a materialadverse impact on our results.

*We aredependent on third party suppliers for the success of our proprietary products*

We are dependent on the successof our proprietary products, and we rely on a select group of manufacturers toprovide us with sufficient quantities to meet our customers’ demands in atimely manner, produce these products in a humane and safe environment for boththeir workers and the planet, maintain quality standards consistent with theGaiam brand, and meet certain pricing guarantees. Our sourcing of theseproducts overseas continues to increase, and these arrangements carry risksassociated with relying on products manufactured outside of the U.S., includingpolitical unrest and trade restrictions, currency fluctuations, transportationdifficulties, work stoppages, and other uncertainties. In addition, a number ofour suppliers are small companies, and some of these vendors may not havesufficient capital, resources or personnel to increase their sales to us or tomeet our needs for increased commitments from them. The failure of oursuppliers to provide sufficient quantities of our proprietary products coulddecrease our revenues, increase our costs, and damage our customer servicereputation.

*We rely on communications and shipping networks todeliver our products*

Given our emphasis oncustomer service, the efficient and uninterrupted operation of order-processingand fulfillment functions is critical to our business. To maintain a high levelof customer service, we rely heavily on a number of different outside serviceproviders, such as printers, telecommunications companies and deliverycompanies. Any interruption in services from our principal outside serviceproviders, including delays or disruptions resulting from labor disputes, poweroutages, human error, adverse weather conditions or natural disasters, couldmaterially adversely affect our business. In addition, products that we sourceoverseas must be shipped to our distribution center by freight carriers, and awork stoppage or political unrest could adversely affect our ability tofulfill our customer orders.

*Information systems upgrades or integrations maydisrupt our operations or financial reporting*

We continually evaluateand upgrade our management information systems, which are critical to ourbusiness. These systems assist in processing orders, managing inventory,purchasing and shipping merchandise on a timely basis, responding to customerservice inquiries, and gathering and analyzing operating data by businesssegment, customer, and SKU (a specific identifier for each different product).We are required to continually update these systems. Furthermore, if we acquireother companies, we will need to integrate the acquired companies’ systems withours, a process that could be time-consuming and costly. If our systems cannotaccommodate our growth or if they fail, we could incur substantial expenses.

Additionally, our successin E-commerce will depend upon our ability to provide a compelling andsatisfying shopping experience. To remain competitive, we must continue toenhance and improve the responsiveness, functionality and features of ouronline technology.

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*A material security breach could cause us to losesales, damage our reputation or result in liability to us*

Our computer servers maybe vulnerable to computer viruses, physical or electronic break-ins and similardisruptions. We may need to expend significant additional capital and otherresources to protect against a security breach or to alleviate problems causedby any breaches. Our relationships with our customers may be adversely affectedif the security measures that we use to protect personal information such ascredit card numbers are ineffective. We currently rely on security andauthentication technology that we license from third parties. We may notprevent all security breaches.

*Our systems may fail or limit user traffic, whichwould cause us to lose sales*

We support most of ourbusiness through our call center in Broomfield, Colorado. Even though we haveback up arrangements, we are dependent on our ability to maintain our computerand telecommunications equipment in this center in effective working order andto protect against damage from fire, natural disaster, power loss,telecommunications failure or similar events. In addition, growth of ourcustomer base may strain or exceed the capacity of our computer andtelecommunications systems and lead to degradations in performance or systemsfailure. We have experienced capacity constraints and failure of informationsystems in the past that have resulted in decreased levels of service deliveryor interruptions in service to customers for limited periods of time. Althoughwe continually review and consider upgrades to our technical infrastructure andprovide for system redundancies and backup power to limit the likelihood ofsystems overload or failure, substantial damage to our systems or a systemsfailure that causes interruptions for a number of days could adversely affectour business. Additionally, if we are unsuccessful in updating and expandingour infrastructure, including our call center, our ability to grow may beconstrained.

*Government regulation of the Internet andE-commerce is evolving and unfavorable changes could harm our business*

We are subject to generalbusiness regulations and laws, as well as regulations and laws specificallygoverning the Internet and E-commerce. Such existing and future laws andregulations may impede the growth of the Internet or other onlineservices.  These regulations and laws maycover taxation, user privacy, pricing, content, copyrights, distribution,consumer protection, the provision of online payment services and quality ofproducts and services.  There is lack ofclarity on how existing laws governing issues such as property ownership, salesand other taxes and personal privacy apply to the Internet and E-commerce.  Unfavorable resolution of these issues may harmour business.

*We may face legal liability for the contentcontained on our website*

We could face legalliability for defamation, negligence, copyright, patent or trademarkinfringement, personal injury or other claims based on the nature and contentof materials that we publish or distribute on our website. If we are heldliable for damages for the content on our website, our business may suffer.Further, one of our goals is for www.gaiam.com to be a trustworthy anddependable provider of information and services. Allegations of impropriety,even if unfounded, could therefore have a material adverse effect on ourreputation and our business.

*Relying on our centralized fulfillment center couldexpose us to losing revenue*

Prompt and efficientfulfillment of our customers’ orders is critical to our business. Our facilityin Cincinnati, Ohio handles our fulfillment functions and some customer-servicerelated operations, such as returns processing. A majority of our orders arefilled and shipped from the Cincinnati facility. The balance is shippeddirectly from suppliers. Because we rely on a centralized fulfillment center,our fulfillment functions could be severely impaired in the event of fire,extended adverse weather conditions, transportation difficulties or naturaldisasters. Because we recognize revenue only when we ship orders, interruptionof our shipping would diminish our revenues.

*We may face quarterly and seasonal fluctuationsthat could harm our business*

Our revenue and resultsof operations have fluctuated and will continue to fluctuate on a quarterlybasis as a result of a number of factors, including the timing of catalogofferings, timing of orders from retailers, recognition of costs or net salescontributed by new merchandise, fluctuations in response rates, fluctuations inpaper, production and postage costs and expenses, merchandise returns, adverseweather conditions that affect distribution or shipping, shifts in the timingof holidays and changes in our merchandise mix. In particular, our net salesand profits have historically been higher during the fourth quarter holidayseason. We believe that this seasonality will continue in the future.

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*Postage and shipping costs may increase andtherefore increase our expenses*

We ship our products, catalogs,and lifestyle publications to consumers and the cost of shipping is a materialexpenditure. Postage and shipping prices increase periodically and can beexpected to increase in the future. Any inability to secure suitable orcommercially favorable prices or other terms for the delivery of ourmerchandise and catalogs could have a material adverse effect on our financialcondition and results of operations.

*Our business is subject to reporting requirementsthat continue to evolve and change, which could continue to require significantcompliance effort and resources.*

Because our common stockis publicly traded, we are subject to certain rules and regulations offederal, state and financial market exchange entities charged with theprotection of investors and the oversight of companies whose securities arepublicly traded. These entities, including the Public Company AccountingOversight Board, the SEC and the NASDAQ, periodically issue new requirementsand regulations and legislative bodies also review and revise applicable lawssuch as the Sarbanes-Oxley Act of 2002. As interpretation and implementation ofthese laws and rules and promulgation of new regulations continues, wewill continue to be required to commit significant financial and managerial resourcesand incur additional expenses.

**Item 1B.          UnresolvedStaff Comments**

Not Applicable.

### **Item 2.             Properties**

Our principal executiveoffices are located in Broomfield, Colorado. Our fulfillment center is locatedin the Cincinnati, Ohio area. This facility houses most of our fulfillmentfunctions. We selected the Cincinnati site after considering the availabilityand cost of facilities and labor, proximity to major highways, air deliveryhubs and support of local government of new businesses. We also believe thatCincinnati is ideal for providing the low cost shipping available from a singlecentral point to a customer base that conforms to the overall U.S. population.

The following table setsforth certain information relating to our primary facilities:

 

| Primary  Locations | ** ** | **Size**        | ** ** | **Use**                            | ** ** | **Lease  Expiration** | ** ** |
|--------------------|------------|-----------------|------------|------------------------------------|------------|-----------------------|------------|
| ** **         | ** ** | ** **      | ** ** | ** **                         | ** ** | ** **            | ** ** |   |
| Broomfield,  CO    |       | 36,000 sq. ft.  |       | Headquarters and  customer service |       | May 2008         |       |   |
|               |       |            |       |                               |       |                  |       |   |
| Cincinnati,  OH    |       | 355,000 sq. ft. |       | Fulfillment  center                |       | September 2007   |       |   |
|               |       |            |       |                               |       |                  |       |   |
| New  York, NY      |       | 18,400 sq. ft.  |       | Media office                       |       | April  2008           |       |   |
|               |       |            |       |                               |       |                  |       |   |
| Hopland, CA        |       | 12 acres        |       | Renewable energy demo  site        |       | Owned                 |       |   |
|                    |            |                 |            |                                    |            |                       |            |  |  |

 

We have options to renewthe leases for our headquarters and our fulfillment center. We believe ourfacilities are adequate to meet our current needs and that suitable additionalfacilities will be available for lease or purchase when, and as, we need them.

### **Item 3.             Legal Proceedings**

From time to time, Gaiamis involved in legal proceedings that we consider to be in the normal course ofbusiness. We do not believe that any of these proceedings will have a materialadverse effect on our business.

##### **Item 4.             Submission of Matters to a Vote ofSecurity Holders**

No matters were broughtto a vote of our shareholders in the fourth quarter of the fiscal year endedDecember 31, 2006.

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###### **Part II**

##### **Item5.  Market for Registrant’s Common Equity, Related StockholderMatters and Issuer Purchases of Equity Securities**

Stock Price History

Gaiam’s Class Acommon stock has been quoted on the NASDAQ Global Market under the symbol “GAIA”since our initial public offering on October 29, 1999. On March 12,2007, we had 7,991 shareholders of record and 19,250,276 shares of $.0001 parvalue Class A common stock outstanding. We have 5,400,000 shares of $.0001par value Class B common stock outstanding, held by one shareholder.

The following table sets forth certain sales price andtrading volume data for Gaiam’s Class A common stock for the periodindicated: 

|                | ** ** | **High Bid** | ** ** | **Low Bid** | ** ** | **Close** | ** ** | **Average  Daily  Volume** | ** ** |
|----------------|------------|-------------------|------------|------------------|------------|-----------|------------|----------------------------|------------|
| Fiscal 2006:   |       |              |       |             |       |      |       |                       |       |
| Fourth Quarter |       | $                 | 15.20      |             | $          | 11.98     |       | $                          | 13.68      |   | 144,163 |   |
| Third Quarter  |       | $                 | 14.50      |             | $          | 9.80      |       | $                          | 12.91      |   | 168,695 |   |
| Second Quarter |       | $                 | 19.98      |             | $          | 13.88     |       | $                          | 14.02      |   | 140,701 |   |
| First Quarter  |       | $                 | 16.49      |             | $          | 12.18     |       | $                          | 16.11      |   | 59,677 |   |
|           |       |              |       |             |       |      |       |                       |       |
| Fiscal 2005:   |       |              |       |             |       |      |       |                       |       |
| Fourth Quarter |       | $                 | 14.90      |             | $          | 9.12      |       | $                          | 13.51      |   | 62,735 |   |
| Third Quarter  |       | $                 | 11.05      |             | $          | 6.90      |       | $                          | 10.32      |   | 33,038 |   |
| Second Quarter |       | $                 | 7.19       |             | $          | 5.35      |       | $                          | 6.96       |   | 4,270 |   |
| First Quarter  |       | $                 | 6.25       |             | $          | 5.17      |       | $                          | 5.54       |   | 9,587 |   |

 

DividendPolicy

Gaiam has never declaredor paid any cash dividends on its capital stock. In addition, our bank line ofcredit agreement prohibits payment of any dividends to our shareholders. As ofDecember 31, 2006, Gaiam had no outstanding advances under the line ofcredit agreement.

Salesof Unregistered Securities

During 2006, Gaiam issued369,724 shares of Class A common stock to Conscious Media, Inc. (“CMI”)shareholders to purchase shares of CMI. These shares were issued pursuant to anexemption from registration under Section 4(2) of the Securities Actof 1933.

IssuerPurchases of Equity Securities

We did not purchase anyof our equity securities during the fiscal year ended December 31, 2006.On February 6, 2007, Gaiam repurchased 2.5 million shares of its Class A commonstock from Revolution Living LLC. See Note 13 — Subsequent Events.

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Equity Compensation PlanInformation

 

| Plan Category                                           | ** ** | **Number of securities  to be issued upon  exercise of outstanding  options, warrants and  rights** | ** ** | **Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                         |       |                                                                                                                                             |       |                                                                                                             |       |                                                                                                                                    |       |
| Equity  compensation  plans approved by  security holders    |       | 1,027,740                                                                                                                                        |       | $                                                                                                                | 10.59      |                                                                                                                                    | 1,050,971  |   |
| Equity compensation  plans not approved by  security holders |       | —                                                                                                                                           |       | —                                                                                                           |       | —                                                                                                                                  |       |
| Total                                                        |       | 1,027,740                                                                                                                                        |       | $                                                                                                                | 10.59      |                                                                                                                                    | 1,050,971  |   |

 

**Item 6.****    Selected Financial Data**

The selected statement ofoperations for the years ended December 31, 2006, 2005 and 2004 andbalance sheet data as of December 31, 2006 and 2005 set forth below arederived from Gaiam’s audited consolidated financial statements which areincluded elsewhere in this Form 10-K. The selected statement of operationsfor the years ended December 31, 2003 and 2002 and balance sheet data asof December 31, 2004, 2003 and 2002 set forth below are derived from Gaiam’saudited consolidated financial statements which are not included in thisForm 10-K. The historical operating results are not necessarily indicativeof the results to be expected for any other period. The data set forth belowshould be read in conjunction with “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and Gaiam’s consolidatedfinancial statements and related notes, included elsewhere in thisForm 10-K.

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**GAIAM,INC.SELECTED FINANCIAL DATA**(Amounts in thousands, except per share data)
| ** **                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Statement of Operations Data**                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Net revenues                                                            |       | $                                          | 219,480    |   | $ | 142,492 |   | $ | 96,657 |   | $ | 102,000 |   | $ | 111,406 |   |
| Cost of goods sold                                                      |       | 79,150                                     |       | 61,977 |   | 48,646 |   | 48,927 |   | 45,475 |   |
| Gross profit                                                            |       | 140,330                                    |       | 80,515 |   | 48,011 |   | 53,073 |   | 65,931 |   |
| Selling, operating,  general and administrative expenses                |       | 134,689                                    |       | 77,429 |   | 54,301 |   | 54,355 |   | 57,180 |   |
| Operating income (loss)                                                 |       | 5,641                                      |       | 3,086 |   | (6,290 | ) | (1,282 | ) | 8,751 |   |
| Other income (loss)                                                     |       | 3,905                                      |       | (175 | ) | 109 |   | 546 |   | (261 | ) |
| Income (loss) before  income taxes and minority interest                |       | 9,546                                      |       | 2,911 |   | (6,181 | ) | (736 | ) | 8,490 |   |
| Income tax expense  (benefit)                                           |       | 3,774                                      |       | 974 |   | (2,440 | ) | (461 | ) | 3,002 |   |
| Minority interest in  net income of consolidated subsidiary, net of tax |       | (128                                       | )          | (601 | ) | (897 | ) | (697 | ) | (40 | ) |
| Net income (loss)                                                       |       | $                                          | 5,644      |   | $ | 1,336 |   | $ | (4,638 | ) | $ | (972 | ) | $ | 5,448 |   |
| Net income (loss) per  share:                                           |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                                   |       | $                                          | 0.23       |   | $ | 0.08 |   | $ | (0.32 | ) | $ | (0.07 | ) | $ | 0.39 |   |
| Diluted                                                                 |       | $                                          | 0.23       |   | $ | 0.08 |   | $ | (0.32 | ) | $ | (0.07 | ) | $ | 0.38 |   |
| Shares outstanding:                                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Basic                                                                   |       | 24,349                                     |       | 17,140 |   | 14,684 |   | 14,594 |   | 14,107 |   |
| Diluted                                                                 |       | 24,617                                     |       | 17,354 |   | 14,684 |   | 14,594 |   | 14,489 |   |

 
| ** **                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Balance Sheet Data**                      |       |                  |       |   |   |   |   |   |   |   |   |
| Cash                                        |       | $                     | 104,876    |   | $ | 15,028 |   | $ | 10,439 |   | $ | 8,384 |   | $ | 11,422 |   |
| Working capital                             |       | 140,147               |       | 37,216 |   | 31,488 |   | 29,531 |   | 33,944 |   |
| Total assets                                |       | 250,968               |       | 156,101 |   | 88,287 |   | 91,860 |   | 91,167 |   |
| Long-term debt (net of  current maturities) |       | —                |       | — |   | — |   | — |   | 55 |   |
| Stockholders’ equity                   |       | 218,606               |       | 107,286 |   | 66,346 |   | 69,485 |   | 69,371 |   |
|                                             |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 7.****          Management’s Discussionand Analysis of Financial Condition and Results of Operations**

**Forward-Looking Statements**

This report containsforward-looking statements that involve risks and uncertainties. When used inthis discussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,”“strive,” “future,” “intend” and similar expressions as they relate to Gaiam orits management are intended to identify such forward-looking statements. Gaiam’sactual results could differ materially from the results anticipated in theseforward-looking statements as a result of certain factors set forth under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” “MarketRisk” and elsewhere in this report. Risks and uncertainties that could causeactual results to differ include, without limitation, general economicconditions, competition, loss of key personnel, pricing, brand reputation,acquisitions, new initiatives undertaken by Gaiam, security and informationsystems, legal liability for website content, merchandise supply problems,failure of third parties to provide adequate service, reliance on centralizedcustomer service, overstocks and merchandise returns, our reliance on a centralizedfulfillment center, increases in postage and shipping costs, E-commercetrends, future Internet related taxes, control of Gaiam by its founder,fluctuations in quarterly operating results, consumer trends, customer interestin our products, the effect of government regulation and other risks anduncertainties included in Gaiam’s filings with the Securities and ExchangeCommission. We caution you that no forward-looking statement is a guarantee offuture performance, and you should not place undue reliance on theseforward-looking statements which reflect our management’s view only as of thedate of this report. We undertake no obligation to update any forward-lookinginformation.

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The following discussionand analysis of Gaiam’s financial condition and results of operations should beread in conjunction with the consolidated financial statements and relatednotes included elsewhere in this document.**Thissection is designed to provide information that will assist readers inunderstanding Gaiam’s consolidated financial statements, changes in certainitems in those statements from year to year, the primary factors that causedthose changes and how certain accounting principles, policies and estimatesaffect the consolidated financial statements.

Overview and Outlook

# Gaiam is alifestyle media company providing a broad selection of information, media,products and services to customers who value personal development, wellness,ecological lifestyles, responsible media and conscious community. Gaiam’s media brand is built around itsability to develop and offer media content, products, lifestyle solutions andcommunity to consumers in the LOHAS and the emerging MTM markets.

# Gaiam offers its customers the ability to make purchasing decisions andfind responsible content based on these values while providing qualityofferings at a price comparable to mainstream alternatives. Gaiam markets itsmedia and products through a multi-channel approach including traditional mediachannels, direct to consumers via the Internet, DRTV, subscription clubs,catalog, and through national retailers and corporate accounts.

# Gaiam’s content forms the basis of its proprietary offerings, which thendrive demand for parallel product and service offerings. Gaiam’s operations arevertically integrated from content creations, through product development andsourcing, to customer service and distribution. Gaiam markets its products andservices across two segments, business and direct-to-consumer. Products aredistributed in each of these sales segments from a single fulfillment center.

Gaiam’s business segmentsells directly to retailers, both domestically and abroad with Gaiam’s productsnow available in over 68,000 retail doors in the United States. In 2005,revenue in this segment was $70.2 million and grew to $93.8 million in 2006reflecting a 33.7% increase. This increase reflects the sales of media titlesacquired through acquisitions and asset purchases combined with internalgrowth.  During the year Gaiam expandedits store-within-store (“SWIS”) presence to over 6,000 lifestyle presentations,which are custom fixtures designed and produced by Gaiam.

Through its diverse mediareach, the direct to consumer segment provides an opportunity to launch andsupport new media releases, a sounding board for new product testing,promotional opportunities, a growing loyal community, and customer feedback onGaiam’s and the LOHAS industry’s focus and future. During 2006, this segmentgenerated revenues of $125.7 million, up from $72.3 million in 2005. Thisincrease reflects growth of 73.8% with the continued investment into brandedDRTV, clubs and membership programs.

During 2006, Gaiam completed several acquisitions targetedtowards expanding and enhancing its media content and reach. These acquisitionsincluded acquiring the remaining minority interests in CMI, a multimediacompany, and Newmark Media, Ltd., a retail distributor in the natural groceryand drug channel. Gaiam also acquired an 85% interest in a DVD subscriptionclub that provides inspirational and spiritual family films.

Webelieve our growth will be driven by information, media content, products, andcommunity delivered to the consumer via broadcast, catalog, Internet,retailers, international licensing and electronic downloads and subscriptionsystems. Gaiam has increased its focus on its media content creation anddistribution, which strategically provides increased branding opportunities,significantly higher operating contribution and greater mainstream penetration.Gaiam plans to invest in its community and membership businesses over the nexttwo years to better capitalize on strong relationships with its loyal consumeraudience and growing broadband subscription trends. This will allow Gaiam tofocus on better leveraging its content through subscription clubs andcommunity.

Factorsthat Gaiam believes are important to its long-term success include building itsbrands, increasing international growth by expanding into new markets primarilythrough license arrangements, extending its product lines into wellness andchildren’s programs, and enhancing its multimedia platform community throughnew media opportunities, new club and membership programs, initiatives andacquisitions.

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Critical Accounting Policies

Gaiam’s consolidated financial statements are preparedin conformity with accounting principles generally accepted in the UnitedStates, which require management to make judgments, estimates and assumptionsthat affect the amounts reported in the consolidated financial statements andaccompanying notes. Note 1 to the consolidated financial statements in Item 8of this Form 10-K summarizes the significant accounting policies andmethods used in the preparation of Gaiam’s consolidated financial statements.

Management believes the following to be criticalaccounting policies whose application has a material impact on Gaiam’sfinancial presentation, and involve a higher degree of complexity, as theyrequire management to make judgments and estimates about matters that areinherently uncertain.

*Provisions for Doubtful Accounts and Returns*

Gaiam records a provisionfor doubtful accounts for all receivables not expected to be collected. Gaiamgenerally does not require collateral. Gaiam evaluates the collectibility ofaccounts receivable based on a combination of factors. In circumstances inwhich Gaiam is aware of a specific customer’s inability to meet its financialobligations (e.g. bankruptcy filings), Gaiam records a specific reserve for baddebts against amounts due. For all other instances, Gaiam recognizes reservesbased on historical experience and review of individual accounts outstanding.

Gaiam records a provisionfor product returns to be received in future periods at the time the originalsale is recognized. The amount of the returns provision is based uponhistorical experience and future expectations.

*Inventory*

Inventory consistsprimarily of finished goods held for sale and is stated at the lower of cost(first-in, first-out method) or market. Gaiam identifies the inventory items tobe written down for obsolescence based on the item’s current sales status andcondition. If the item is discontinued or slow moving, it is written down basedon an estimate of the markdown to retail price needed to sell through itscurrent stock level of the item.

*Goodwill*

Goodwill represents theexcess of the purchase consideration over the fair value of assets acquiredless liabilities assumed in a business acquisition. In accordance with SFASNo. 142, “Goodwill and Other Intangible Assets,” goodwill is no longeramortized but is reviewed for impairment annually or more frequently ifimpairment indicators arise, on a reporting unit level.  The fair value of a reporting unit iscompared with its carrying amount, including goodwill. If the fair value of areporting unit exceeds its carrying amount, goodwill of the reporting unit isconsidered not impaired.

If the carrying amount ofa reporting unit exceeds its fair value, the goodwill impairment test isperformed to measure the amount of impairment loss. Gaiam has allocatedgoodwill to two reporting units, and uses a market value method for thepurposes of testing for potential impairment. The annual review requiresextensive use of financial judgment and estimates. Application of alternativeassumptions and definitions, such as a change in the composition of a reportingunit, could yield significantly different results.

*Investments*

Investments in limitedliability companies in which Gaiam does have the ability to exercisesignificant influence or control, or in which it holds a five percent or moremembership interest, are accounted for under the equity method. Investments incorporations in which Gaiam does have the ability to exercise significantinfluence or control, or in which it holds a twenty percent or more ownership,are also accounted for under the equity method. Under the equity method, Gaiamrecords its share of the income or losses of the investment by increasing ordecreasing the carrying value of its investment and recording the income orexpense through the consolidated statement of operations. Under the cost methodof accounting, investments in private companies are carried at cost and areadjusted only for other-than-temporary declines in fair value.

19

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*PurchaseAccounting*

Gaiam accounts for the acquisition of a controllinginterest in a company using the purchase method prescribed by FASB StatementNo. 141, *Business Combinations*(“SFAS 141”).  In determining the estimated fair value ofcertain acquired assets and liabilities, management makes assumptions basedupon historical and other relevant information and, in some cases, independentexpert appraisers.  Assumptions may beincomplete, and unanticipated events and circumstances may occur that couldaffect the validity of such assumptions, estimates, or actual results.  The estimated fair value of assets andliabilities acquired in accordance with SFAS 141 during 2006 are preliminary asof December 31, 2006.  We expect toobtain information necessary to finalize the estimated values during 2007.

*Media Library*

Themedia library asset represents the fair value of the library of produced videosacquired through business combinations, the purchase price of media rights toboth video and audio titles, and the capitalized cost to produce media productsmarketed by Gaiam to retailers and direct-mail and online customers. The fairvalue of acquired or purchased media titles and content is amortized on astraight-line basis over succeeding periods on the basis of its estimateduseful life. Capitalized production costs are deferred for financial reportingpurposes until the media is released and, then, amortized over succeedingperiods on the basis of estimated sales. Historical sales statistics are theprincipal factor used in estimating the amortization rate.

*Stock-Based Compensation*

EffectiveJanuary 1, 2006, Gaiam adopted the provisions of Statement of FinancialAccounting Standards No. 123 (revised 2004), *Share-BasedPayment* (“SFAS 123R”), a revision to the previously issued guidanceon accounting for stock options and other forms of equity-based compensationissued to employees and others over the their requisite service period(generally the vesting period).  The fairvalue of each grant is estimated as of the grant date using the Black-Scholesoption-pricing model.  This involvesassumptions calculated using management’s best estimates at the time of thegrant, which impacts the fair value of the option calculated under theBlack-Scholes methodology and, ultimately, the expense that will be recognizedover the life of the option.  Additionalinformation is included in Note 1 of the *Notes to ConsolidatedFinancial Statements*.

Results ofOperations

The following table sets forth certain financial dataas a percentage of revenues for the periods indicated:
| ** **                                                              | ** ** | **For the Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Net  revenue**                                                        |       | 100.0                                                        | %          | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                                     |       | 36.1                                                         | %          | 43.5 | % | 50.3 | % |
| **Gross  profit**                                                       |       | 63.9                                                         | %          | 56.5 | % | 49.7 | % |
| Expenses:                                                               |       |                                                         |       |   |   |   |   |
| Selling and operating                                                   |       | 54.6                                                         | %          | 47.5 | % | 47.7 | % |
| Corporate, general and administrative                                   |       | 6.8                                                          | %          | 6.9 | % | 8.5 | % |
| Total expenses                                                          |       | 61.4                                                         | %          | 54.3 | % | 56.2 | % |
| Income (loss)  from operations                                          |       | 2.5                                                          | %          | 2.2 | % | -6.5 | % |
| Other income  (expense), net                                            |       | 1.8                                                          | %          | -0.1 | % | 0.1 | % |
| Income (loss)  before income taxes and minority interest                |       | 4.3                                                          | %          | 2.0 | % | -6.4 | % |
| Income tax  (benefit) expense                                           |       | 1.7                                                          | %          | 0.7 | % | -2.5 | % |
| Minority  interest in net income of consolidated subsidiary, net of tax |       | —                                                       | %          | -0.4 | % | -0.9 | % |
| **Net income (loss)**                                                   |       | 2.6                                                          | %          | 0.9 | % | -4.8 | % |

 

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Year EndedDecember 31, 2006 Compared to Year Ended December 31, 2005

Revenue of $219.5 million during 2006 was 54.0% higher thanthe $142.5 million in revenue generated in 2005. Gaiam’s increase in revenuereflects the sales of media titles acquired from GoodTimes Entertainment,coupled with strong performance in our direct marketing programs, continuedpenetration into existing retail stores, and the addition of new retaildistribution outlets. During the year, Gaiam added distribution to over 18,000new retail doors, bringing the total number of doors in the United States to68,000. Revenue in Gaiam’s direct to consumer segment was $125.7 million in2006, an increase of $53.4 million or 73.8% over 2005 revenue of $72.3 million,primarily reflecting strong performance in our direct marketing programs andrevenue from the SCI acquisition in August 2006. DRTV continues to be a strongrevenue source for this segment while providing a test marketing platform fornew brands and products. Total revenue generated by Gaiam’s business segment,including revenue generated by acquisitions, increased by 33.7% to $93.8million in 2006 from $70.2 million in 2005.

Gross profit, which consists of revenue less cost of sales(primarily merchandise cost plus inbound freight and duties), increased to$140.3 million for 2006 from $80.5 million during 2005. As a percentage ofrevenue, gross profit increased 740 basis points to 63.9% in 2006 from 56.5% in2005. The increase was primarily due to strong sales of media and directmarketing products which carry higher margins, but also carry higher sellingand operating expenses. The increased media sales have allowed Gaiam toleverage its purchasing volume to receive improved buying discounts. Gaiam alsocontinued to benefit from the elimination of fees previously paid for thirdparty distribution following the GoodTimes transaction. Additionally, Gaiam’sstrong cash position allowed the Company to take advantage of prompt pay vendordiscounts.  The business segment’s grossprofit increased to 62.5% in 2006 from 57.3% in 2005. The direct to consumersegment’s gross profit increased to 65.0% in 2006, up from 55.7% in 2005.

Selling and operating expenses increased to $119.7 millionfor 2006 compared to $67.6 million in the same period of 2005, primarilyresulting from increased sales and operating expenses to support the revenueincreases described above and the additional amortization expense associatedwith GoodTimes’ media library. As a percentage of revenue, selling andoperating expenses increased to 54.6% in 2006 from 47.5% in 2005 reflecting achange in revenue mix toward increased media and direct marketing productswhich carry higher selling and operating expenses, such as merchandising feesand advertising costs, along with higher gross margins.

Corporate, general andadministration expenses increased to $15.0 million in 2006 from $9.8 million in2005 primarily due to Gaiam’s planned investments in its business to supportthe increased revenue base. As a percent of revenue, corporate general andadministration expenses decreased slightly to 6.8% of revenue in 2006 comparedto 6.9% of revenue in 2005.

Income from operations was $5.6 million in 2006, up from $3.1million in 2005, primarily reflecting higher sales and improved gross profitmargins, partially offset by higher selling and operating expenses associatedwith media and direct marketing products, as well as redundant system andoperating costs as a result of the GoodTimes acquisition.  As a percent of revenue, income fromoperations improved to 2.5% of revenue during 2006, as compared to 2.2% ofrevenue in 2005.

Gaiam recorded other income of $3.9 million in 2006 comparedto other expense of $0.2 million in 2005. The increase in 2006 other incomeprimarily consisted of interest on cash investments and a gain of $0.5 millionon the sale of 19,968 Series A Preferred Units of Life Balance Media HoldingsLLC (“LIME”). This investment was acquired in August 2005 and represented a19.9% interest in LIME. In 2005, Gaiam recorded a $646 thousand loss on thisinvestment for the period from August 22, 2005 through December 31,2005, which was partially offset by interest income of $0.4 million. The shareof net income associated with minority interest in consolidated subsidiarieswas $0.1 million in 2006, compared to the share of net income of $0.6 millionfor the comparable 2005 period.

Gaiam recorded an incometax expense of $3.8 million in 2006 compared to an income tax expense of $1.0million in 2005. Gaiam’s consolidated effective tax rate fluctuates based uponthe distribution of earnings/losses between its domestic and foreignoperations.

As a result of thefactors described above, Gaiam improved its financial performance over 2005. In2006, Gaiam produced net income of $5.6 million, or $0.23 per share, ascompared to a net income in 2005 of $1.3 million or $0.08 per share.

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Year EndedDecember 31, 2005 Compared to Year Ended December 31, 2004

Revenue of $142.5 millionduring 2005 was 47% higher than the $96.7 million in revenue generated in 2004.Gaiam’s increase in revenue primarily resulted from increased sales volume fromcontent acquired in the GoodTimes asset acquisition, which was coupled with a19% internal growth rate. Revenue in Gaiam’s direct to consumer segment was$72.3 million in 2005, an increase of $19.9 million or 38% over 2004 revenue of$52.4 million, primarily resulting from the advent of club, membership and DRTVrevenue, in addition to a 17% internal growth rate in the core components.Gaiam’s business segment generated positive internal growth of 21% for theyear, and, including revenue generated by acquisitions, increased the totalrevenue generated by this segment by 58.6% to $70.2 million in 2005 from $44.2million in 2004.

Gross profit, whichconsists of revenue less cost of sales (primarily merchandise cost plus inboundfreight and duties), increased to $80.5 million for 2005 from $48 millionduring 2004. As a percentage of revenue, gross profit increased 680 basispoints to 56.5% in 2005 from 49.7% in 2004. This was primarily attributable toa sales mix change favoring media, on which Gaiam generates significantlyhigher gross margins, and the cessation of markdowns and other costs associatedwith the format change from VHS to DVD which adversely affected 2004 results.Gross profit was also favorably impacted by improved pricing on DVDs associatedwith the higher volume, and new direct to retailer access, rather than the useof third party distributors, on several new key accounts. These improvementshad the greatest impact on the business segment, as gross profit for this segmentimproved to 57.3% in 2005 from 45.6% in 2004. The direct to consumer segmentalso improved, as the gross profit in this segment increased to 55.7% in 2005,up from 53.1% in 2004.

Selling and operatingexpenses increased to $67.6 million for 2005 compared to $46.1 million in thesame period of 2004, primarily resulting from increased sales and operatingexpenses to support the revenue increases described above, and transitionexpenses associated with the GoodTimes asset acquisition. As a percentage of revenue,selling and operating expenses decreased to 47.5% in 2005 from 47.7% in 2004due to higher revenue base.

Corporate, general andadministration expenses increased to $9.8 million in 2005 from $8.2 million in2004, but decreased significantly to 6.9% of revenue in 2005 from 8.5% ofrevenue in 2004. This expense increase primarily resulted from increasedfacilities, systems and other infrastructure costs associated with the acquiredassets and increased business volume.

As a result of the abovefactors, Gaiam generated $3.1 in income from operations, or 2.2% of revenue,during 2005, as compared to a $6.3 million operating loss in 2004, which was6.5% of revenue.

Gaiam recorded $175thousand in other expense during 2005 and $109 thousand in other income during2004. In August 2005, Gaiam acquired a 19.9% interest in LIME, andrecorded a one-time $646 thousand loss on this investment for the period fromAugust 22, 2005 through December 31, 2005. This loss was partiallyoffset by interest income of $358 thousand for 2005. During 2004, Gaiamgenerated $160 thousand in interest income. The share of net income associatedwith minority interest in consolidated subsidiaries was $601 thousand in 2005,compared to the share of net income of $897 thousand for the comparable 2004period.

Gaiam recorded an incometax expense of $974 thousand for 2005 compared to an income tax benefit of $2.4million in 2004. Gaiam’s consolidated effective tax rate fluctuates based uponthe distribution of earnings/losses between its domestic and foreignoperations.

As a result of thefactors described above, Gaiam improved its financial performance over 2004. In2005, Gaiam produced net income of $1.3 million, or $0.08 per share, ascompared to a net loss in 2004 of $4.6 million or $0.32 per share.

Quarterly and Seasonal Fluctuations

The following table setsforth our unaudited quarterly results of operations for each of the quarters in2006 and 2005. In management’s opinion, this unaudited financial informationincludes all adjustments, consisting solely of normal recurring accruals andadjustments, necessary for a fair presentation of the results of operations forthe quarters presented. This financial information should be read inconjunction with our consolidated financial statements and related notesincluded elsewhere in this Form 10-K. The results of operations for anyquarter are not necessarily indicative of future results of operations. Amountsare in thousands, except per share data.

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| ** **                                   | ** ** | **Fiscal 2006**   | ** ** |
|----------------------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|                                         |       |                   |       |   |   |   |   |   |   |
| Net revenue                                  |       | $                      | 51,752     |   | $ | 43,161 |   | $ | 51,786 |   | $ | 72,781 |   |
| Gross profit                                 |       | 33,162                 |       | 26,891 |   | 32,629 |   | 47,648 |   |
| Operating income  (loss)                     |       | 1,010                  |       | (2,676 | ) | 1,010 |   | 6,297 |   |
| Net income  (loss)                           |       | 890                    |       | (1,166 | ) | 1,653 |   | 4,267 |   |
| Diluted net  income (loss) per share         |       | $                      | 0.04       |   | $ | (0.05 | ) | $ | 0.06 |   | $ | 0.16 |   |
| Weighted average shares  outstanding-diluted |       | 20,795                 |       | 23,140 |   | 26,864 |   | 27,211 |   |

 
| ** **                                   | ** ** | **Fiscal 2005**   | ** ** |
|----------------------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|                                         |       |                   |       |   |   |   |   |   |   |
| Net revenue                                  |       | $                      | 26,324     |   | $ | 21,706 |   | $ | 30,139 |   | $ | 64,322 |   |
| Gross profit                                 |       | 13,749                 |       | 10,557 |   | 16,713 |   | 39,496 |   |
| Operating income  (loss)                     |       | 287                    |       | (1,271 | ) | 878 |   | 3,193 |   |
| Net income  (loss)                           |       | 116                    |       | (766 | ) | 505 |   | 1,481 |   |
| Diluted net  income (loss) per share         |       | $                      | 0.01       |   | $ | (0.05 | ) | $ | 0.03 |   | $ | 0.07 |   |
| Weighted average shares  outstanding-diluted |       | 14,914                 |       | 14,820 |   | 18,892 |   | 20,595 |   |

 

Note:  The aggregate of certain of the above amountsdiffers from that reported for the full fiscal year due to the effects ofrounding.

Quarterly fluctuations inGaiam’s revenues and operating results are due to a number of factors,including the timing of new product introductions and mailings to customers,advertising, acquisitions (including costs of acquisitions and expenses relatedto integration of acquisitions), competition, pricing of products by vendorsand expenditures on our systems and infrastructure. The impact on revenue andoperating results due to the timing and extent of these factors can besignificant. Our sales are also affected by seasonal influences. On an aggregatebasis, Gaiam generates its strongest revenues and net income in the fourthquarter due to increased holiday spending and retailer fitness purchases.

Liquidity and Capital Resources

 Gaiam’s capital needs arise from workingcapital required to fund our operations, capital expenditures related toacquisition and development of media content, development of our Internet andcommunity platforms and new products, acquisitions of new businesses,replacements, expansions and improvements to Gaiam’s infrastructure, and futuregrowth. These capital requirements depend on numerous factors, including therate of market acceptance of Gaiam’s product offerings, the ability to expandGaiam’s customer base, the cost of ongoing upgrades to Gaiam’s productofferings, the level of expenditures for sales and marketing, the level ofinvestment in distribution systems and facilities and other factors. The timingand amount of these capital requirements are variable and cannot accurately bepredicted. Additionally, Gaiam will continue to pursue opportunities to expandits media libraries, evaluate possible investments in businesses, products andtechnologies, and increase its sales and marketing programs and brandpromotions as needed.

Gaiam has a creditagreement with Wells Fargo that permits borrowings of up to $15 million basedupon the collateral value of Gaiam’s accounts receivable and inventory. AtDecember 31, 2006, Gaiam had no borrowings outstanding under thisagreement; however, $3.0 million was reserved for outstanding letters ofcredit. Gaiam has complied with all of the financial covenants. This creditagreement expires on July 31, 2007. Should Gaiam choose to borrow underthe credit agreement, outstanding advances would bear interest at the lower ofprime rate less 50 basis points or LIBO plus 275 basis points. Borrowings aresecured by a pledge of Gaiam’s assets, and the agreement contains variousfinancial covenants, including covenants prohibiting the payment of cashdividends to Gaiam shareholders and requiring compliance with certain financialratios.

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Gaiam’s operatingactivities provided net cash of $1.7 million and $6.7 million in 2006 and 2005,respectively. Gaiam’s net cash generated from operating activities in 2006 wasprimarily attributable to net income of $5.6 million, net non-cash expenses of$11.0 million and decreases to accounts receivable of $3.3 million, partiallyoffset by an increase in inventory of $5.4 million, reduced payables and otherliabilities of $11.0 million, and net other uses of $1.8 million.  The reduction in accounts payable of $6.9million reflects the Company’s decision to buy direct from overseas factorieswhich require payment upon shipment versus going through distributors withpayment terms.  This change in buyingstrategy, coupled with other cost saving initiatives, increased Gaiam’s grossprofit margin to 63.9% in 2006 from 56.5% in 2005.  The increase in inventory reflects theadditional products necessary to support the increased sales growth. Gaiam’snet cash generated from operating activities in 2005 was primarily attributableto net income of $1.3 million and noncash expenses of $6.4 million. The use ofcash to fund the growth in accounts receivable resulting from increased salesvolume was offset by the growth in accounts payable.

Gaiam’s investing andacquisition activities used net cash of $9.7 million and $40.4 million for 2006and 2005, respectively. In 2006, Gaiam increased its ownership interest in CMIand Newmark Media, Ltd. (“Newmark”) and acquired an 85% ownership interest inSpiritual Cinema, Inc. (“SCI”), resulting in net cash outlay of $7.0 million.Additionally, Gaiam acquired or produced additional media content and rights aswell as sold other property and equipment for a net cash outlay of $2.7million. During 2005, Gaiam used cash to acquire assets from GoodTimes and tofund Gaiam’s investment in LIME. In 2005 Gaiam used $1.6 million for thepurchase of property, equipment and media rights.

Gaiam’s financingactivities generated net cash of $97.0 million and $38.7 million for 2006 and2005, respectively. On May 24, 2006, Gaiam sold 5,000,000 shares of Class Acommon stock and on June 13, 2006 sold 690,000 shares of Class A common stock.The combined sale generated net proceeds of $93.0 million. On July 7,2005, Gaiam issued and sold 2,821,317 shares of unregistered Class Acommon stock for an aggregate purchase price of approximately $18.7 million tocertain funds advised by Prentice Capital Management, LP. On August 22,2005, Gaiam issued and sold 2,500,000 shares of unregistered Class Acommon stock for an aggregate purchase price of $20 million to RevolutionLiving, LLC. The remaining 2006 and 2005 cash generated by financing activitiesresulted primarily from the exercise of stock options under Gaiam’s 1999 LongTerm Incentive Program.

Gaiambelieves its available cash, cash expected to be generated from operations,cash generated by the sale of Class A common stock, and borrowing capabilitiesshould be sufficient to fund its operations on both a short-term and long-termbasis. However, Gaiam’s projected cash needs may change as a result ofacquisitions, product development, unforeseen operational difficulties or otherfactors.

Inthe normal course of our business, Gaiam investigates, evaluates and discussesacquisition, joint venture, minority investment, strategic relationship andother business combination opportunities in the LOHAS and MTM markets. For anyfuture investment, acquisition or joint venture opportunities, Gaiam mayconsider using then-available liquidity, issuing equity securities or incurringadditional indebtedness.

*ContractualObligations*

Gaiam has commitmentspursuant to lease and debt agreements, but does not have any outstandingcommitments pursuant to long-term debt obligations or purchase obligations. Thefollowing table shows our commitments to make future payments under operating leases(in thousands):
| ** **                   | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 yrs** | ** ** |
|------------------------------|------------|-----------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|--------------------------|------------|
|                         |       |      |       |                      |       |               |       |               |       |                     |       |
| Operating lease  obligations |       | $         | 6,153      |                      | $          | 4,597              |       | $                  | 1,008      |                     | $          | 304 |   | $ | 244 |   |
|                              |            |           |            |                           |            |                    |            |                    |            |                          |            |  |  |  |  |  |

 

*Off-BalanceSheet Arrangements*

Gaiamdoes not participate in transactions that generate relationships withunconsolidated entities or financial partnerships, such as special purposeentities (“SPEs”) or variable interest entities (“VIEs”), which have beenestablished for the purpose of facilitating off-balance sheet arrangements orother limited purposes. As of December 31, 2006, Gaiam is not involved inany unconsolidated SPEs or VIEs.

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##### **Item 7A.          Quantitative and QualitativeDisclosures About Market Risk**

We are exposed to marketrisks, which include changes in U.S. interest rates and foreign exchange rates.We do not engage in financial transactions for trading or speculative purposes.

Any borrowings we mightmake under our bank credit facility would bear interest at the lower of primerate less 50 basis points or LIBOR plus 275 basis points. Gaiam does not haveany amounts outstanding under its credit line, so any unfavorable change ininterest rates would not have a material impact on Gaiam’s results fromoperations or cash flows unless Gaiam makes borrowings in the future.

Gaiam purchases asignificant amount of inventory from vendors outside of the U.S. intransactions that are primarily U.S. dollar denominated transactions. Becausethe percentage of our international purchases denominated in currencies otherthan the U.S. dollar is small, any currency risks related to these transactionsare immaterial to Gaiam. A decline in the relative value of the U.S. dollar toother foreign currencies could, however, lead to increased purchasingcosts.  In order to mitigate thisexposure, Gaiam makes virtually all of its purchase commitments in U.S.dollars.

In 2003, Gaiam purchaseda 50.1% interest in Gaiam Limited, formerly known as Leisure Systems InternationalLimited, a U.K. based distributor. Because Gaiam Limited’s revenues areprimarily denominated in foreign currencies, this investment exposes Gaiam toaccounting risk associated with foreign currency exchange rate fluctuations.However, we have determined that there was no material market risk exposure toour consolidated financial position, results of operations or cash flows as ofDecember 31, 2006.

##### **Item 8.             Financial Statements andSupplementary Data**

**Index to FinancialStatements**

Report of Independent Registered Public Accounting Firm

 Consolidated Financial Statements:

ConsolidatedBalance Sheets

ConsolidatedStatements of Operations

ConsolidatedStatements of Stockholders’ Equity

Consolidated Statements of Cash Flows

Notes to ConsolidatedFinancial Statements

**Financial Statement Schedule:**

Schedule II — ConsolidatedValuation and Qualifying Accounts

 

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**Report of IndependentRegistered Public Accounting Firm**

To the Board of Directors and Stockholders of

Gaiam, Inc.

Broomfield, Colorado

We haveaudited the accompanying consolidated balance sheets of Gaiam, Inc. andsubsidiaries as of December 31, 2006 and 2005, and the related consolidatedstatements of operations, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2006.  Our audits alsoincluded the financial statement schedule II for the years endedDecember 31, 2006, 2005 and 2004.  We also have audited management’sassessment, included in the accompanying Managements’ Report on InternalControl over Financial Reporting included in Item 9A, that Gaiam, Inc. andsubsidiaries maintained effective internal control over financial reporting asof December 31, 2006 based on criteria established in*Internal Control-Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(the “COSO Criteria”).  The Company’s management is responsible for thesefinancial statements, for maintaining effective internal control over financialreporting, and for its assessment of the effectiveness of internal control overfinancial reporting.  Our responsibility is to express an opinion on thesefinancial statements, an opinion on management’s assessment, and an opinion onthe effectiveness of the Company’s internal control over financial reportingbased on our audits.

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).  Those standards require thatwe plan and perform the audits to obtain reasonable assurance about whether thefinancial statements are free of material misstatement and whether effectiveinternal control over financial reporting was maintained in all materialrespects.  Our audit of the financial statements included examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation.  Our audit of internal control over financial reportingincluded obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we considered necessary in the circumstances.  Webelieve that our audits provide a reasonable basis for our opinions.

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith accounting principles generally accepted in the United States.  Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Asdiscussed in Note 1 to the financial statements, in 2006 the Companyadopted Statement of Financial Accounting Standard No. 123 (revised 2004),*Share-Based Payment*, effectiveJanuary 1, 2006.

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In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofGaiam, Inc. and subsidiaries as of December 31, 2006 and 2005, andthe results of their operations and their cash flows for each of the threeyears in the period ended December 31, 2006 in conformity with accountingprinciples generally accepted in the United States of America.  Also, inour opinion, the related financial statement schedule II for the yearsended December 31, 2006, 2005 and 2004, when considered in relation to thebasic financial statements taken as a whole, presents fairly in all materialrespects the information set forth therein.  Also in our opinion,management’s assessment that Gaiam, Inc. and subsidiaries maintainedeffective internal control over financial reporting as of December 31,2006 is fairly stated, in all material respects, based on the COSOCriteria.  Furthermore, in our opinion, Gaiam, Inc. and subsidiariesmaintained, in all material respects, effective internal control over financialreporting as of December 31, 2006 based on the COSO Criteria.

Ehrhardt Keefe Steiner & Hottman PC

March 14, 2007Denver,Colorado

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**GAIAM, INC.CONSOLIDATED BALANCE SHEETS**(In thousands, except share data)
| ** **                                                                                                                                                                    | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                                                                    |       |                  |       |   |   |
| Current assets:                                                                                                                                                               |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                    |       | $                     | 104,876    |   | $ | 15,028 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $1,180 in 2006 and $761  in 2005                                                                              |       | 25,324                |       | 28,067 |   |
| Inventory, less  allowances                                                                                                                                                   |       | 24,313                |       | 20,792 |   |
| Deferred  advertising costs                                                                                                                                                   |       | 3,965                 |       | 3,917 |   |
| Deferred tax  assets                                                                                                                                                          |       | 3,404                 |       | 3,627 |   |
| Other current  assets                                                                                                                                                         |       | 4,965                 |       | 4,838 |   |
| Total current  assets                                                                                                                                                         |       | 166,847               |       | 76,269 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Property and equipment,  net                                                                                                                                                  |       | 7,784                 |       | 9,428 |   |
| Media library, net                                                                                                                                                            |       | 37,201                |       | 38,339 |   |
| Non-current deferred  tax assets                                                                                                                                              |       | 5,958                 |       | 7,282 |   |
| Goodwill and other  intangibles                                                                                                                                               |       | 28,879                |       | 17,541 |   |
| Notes receivable and  other assets                                                                                                                                            |       | 4,299                 |       | 7,242 |   |
| Total assets                                                                                                                                                                  |       | $                     | 250,968    |   | $ | 156,101 |   |
| ** **                                                                                                                                                                    | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Liabilities and Stockholders’  Equity**                                                                                                                                |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                          |       |                  |       |   |   |
| Accounts payable                                                                                                                                                              |       | $                     | 18,848     |   | $ | 25,843 |   |
| Accrued  liabilities                                                                                                                                                          |       | 7,437                 |       | 13,045 |   |
| Income taxes  payable                                                                                                                                                         |       | 415                   |       | 165 |   |
| Total current  liabilities                                                                                                                                                    |       | 26,700                |       | 39,053 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Long-term liabilities                                                                                                                                                         |       | —                |       | 1,663 |   |
| Total  liabilities                                                                                                                                                            |       | 26,700                |       | 40,716 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Minority interest                                                                                                                                                             |       | 5,662                 |       | 8,099 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Commitments and  contingencies                                                                                                                                                |       |                  |       |   |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                    |       |                  |       |   |   |
| Class A common  stock, $.0001 par value, 150,000,000 shares authorized, 21,749,936 and  15,010,736 shares issued and outstanding at December 31, 2006 and 2005,  respectively |       | 2                     |       | 1 |   |
| Class B common  stock, $.0001 par value, 50,000,000 shares authorized, 5,400,000 shares  issued and outstanding at December 31, 2006 and 2005                                 |       | 1                     |       | 1 |   |
| Additional  paid-in capital                                                                                                                                                   |       | 200,906               |       | 95,840 |   |
| Accumulated  other comprehensive income                                                                                                                                       |       | 873                   |       | 264 |   |
| Retained  earnings                                                                                                                                                            |       | 16,824                |       | 11,180 |   |
| Total  stockholders’ equity                                                                                                                                              |       | 218,606               |       | 107,286 |   |
| Total liabilities and  stockholders’ equity                                                                                                                              |       | $                     | 250,968    |   | $ | 156,101 |   |

 

See accompanying notes to the consolidated financialstatements.

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**GAIAM, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**(In thousands, except per share amounts)
| ** **                                                                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                                        |       | $                                           | 219,480    |   | $ | 142,492 |   | $ | 96,657 |   |
| Cost of goods  sold                                                                |       | 79,150                                      |       | 61,977 |   | 48,646 |   |
| Gross profit                                                                       |       | 140,330                                     |       | 80,515 |   | 48,011 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Expenses:                                                                          |       |                                        |       |   |   |   |   |
| Selling and operating                                                              |       | 119,700                                     |       | 67,639 |   | 46,060 |   |
| Corporate, general and administration                                              |       | 14,989                                      |       | 9,790 |   | 8,241 |   |
| Total expenses                                                                     |       | 134,689                                     |       | 77,429 |   | 54,301 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Income (loss)  from operations                                                     |       | 5,641                                       |       | 3,086 |   | (6,290 | ) |
|                                                                               |       |                                        |       |   |   |   |   |
| Other income (expense)                                                             |       | 645                                         |       | (533 | ) | (51 | ) |
| Interest income                                                                    |       | 3,260                                       |       | 358 |   | 160 |   |
| Other income  (expense)                                                            |       | 3,905                                       |       | (175 | ) | 109 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Income (loss)  before income taxes and minority interest                           |       | 9,546                                       |       | 2,911 |   | (6,181 | ) |
|                                                                               |       |                                        |       |   |   |   |   |
| Income tax  expense (benefit)                                                      |       | 3,774                                       |       | 974 |   | (2,440 | ) |
| Minority  interest in net income of consolidated subsidiaries, net of income taxes |       | (128                                        | )          | (601 | ) | (897 | ) |
| Net income  (loss)                                                                 |       | $                                           | 5,644      |   | $ | 1,336 |   | $ | (4,638 | ) |
|                                                                               |       |                                        |       |   |   |   |   |
| Net income  (loss) per share:                                                      |       |                                        |       |   |   |   |   |
| Basic                                                                              |       | $                                           | 0.23       |   | $ | 0.08 |   | $ | (0.32 | ) |
| Diluted                                                                            |       | $                                           | 0.23       |   | $ | 0.08 |   | $ | (0.32 | ) |
| Shares used in  computing net income (loss) per share:                             |       |                                        |       |   |   |   |   |
| Basic                                                                              |       | 24,349                                      |       | 17,140 |   | 14,684 |   |
| Diluted                                                                            |       | 24,617                                      |       | 17,354 |   | 14,684 |   |

 

See accompanying notes to the consolidated financialstatements.

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**GAIAM, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**(In thousands, except share data)
| ** **                                                                                                                                                       | ** ** | **Class A  Common  Stock** | ** ** | **Class B  Common  Stock** | ** ** | **Additional  Paid-In** | ** ** | **Deferred** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained**     | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|-------------------------|------------|--------------|------------|---------------------------------------|------------|------------------|------------|------------|------------|
| ** **                                                                                                                                                       | ** ** | **Shares**                      | ** ** | **Amount**                      | ** ** | **Shares**              | ** ** | **Amount**   | ** ** | **Capital**                           | ** ** | **Compensation** | ** ** | **Income** | ** ** | **Earnings** | ** ** | **Total** | ** ** |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Balance at  December 31, 2003                                                                                                                                    |       | 9,203,056                       |       | $                               | 1          |                    | 5,400,000  |         | $          | 1                                     |       | $                | 53,831     |       | $          | (72 | ) | $ | 525 |   | $ | 15,199 |   | $ | 69,485 |   |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Issuance of  common stock in conjunction with acquisitions and compensation                                                                                      |       | 208,841                         |       |                            |       |                    |       |         |       | 1,102                                 |       | 72               |       | —     |       | — |   | 1,174 |   |
| Comprehensive  loss:                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Net loss                                                                                                                                                         |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | (4,638 | ) | (4,638 | ) |
| Foreign currency translation adjustment, net of  income taxes of $75                                                                                             |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | 325        |       | — |   | 325 |   |
| Comprehensive  loss                                                                                                                                              |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | — |   | (4,313 | ) |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Balance at  December 31, 2004                                                                                                                                    |       | 9,411,897                       |       | 1                               |       | 5,400,000               |       | 1            |       | 54,933                                |       | —           |       | 850        |       | 10,561 |   | 66,346 |   |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Issuance of  common stock in conjunction with acquisitions and compensation                                                                                      |       | 5,598,839                       |       | —                          |       | —                  |       | —       |       | 40,907                                |       | —           |       | —     |       | — |   | 40,907 |   |
| Retained earnings  adjustment to reflect Conscious Media as an equity investment from the date  of initial investment through acquisition of a majority interest |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | (717 | ) | (717 | ) |
| Comprehensive  income:                                                                                                                                           |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Net income                                                                                                                                                       |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | 1,336 |   | 1,336 |   |
| Foreign currency translation adjustment, net of  income taxes of $(155)                                                                                          |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | (586       | )          | — |   | (586 | ) |
| Comprehensive  income                                                                                                                                            |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | — |   | 750 |   |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Balance at  December 31, 2005                                                                                                                                    |       | 15,010,736                      |       | 1                               |       | 5,400,000               |       | 1            |       | 95,840                                |       | —           |       | 264        |       | 11,180 |   | 107,286 |   |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Sale of common  stock in underwritten offerings                                                                                                                  |       | 5,690,000                       |       | 1                               |       | —                  |       | —       |       | 93,601                                |       | —           |       | —     |       | — |   | 93,602 |   |
| Issuance of  common stock in conjunction with acquisitions and compensation                                                                                      |       | 1,049,200                       |       | —                          |       | —                  |       | —       |       | 11,465                                |       | —           |       | —     |       | — |   | 11,465 |   |
| Comprehensive  income:                                                                                                                                           |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Net income                                                                                                                                                       |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | 5,644 |   | 5,644 |   |
| Foreign currency translation adjustment, net of income  taxes of $393                                                                                            |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | 609        |       | — |   | 609 |   |
| Comprehensive  income                                                                                                                                            |       | —                          |       | —                          |       | —                  |       | —       |       | —                                |       | —           |       | —     |       | — |   | 6,253 |   |
|                                                                                                                                                             |       |                            |       |                            |       |                    |       |         |       |                                  |       |             |       |       |       |   |   |   |   |
| Balance at December 31,  2006                                                                                                                                    |       | 21,749,936                      |       | $                               | 2          |                    | 5,400,000  |         | $          | 1                                     |       | $                | 200,906    |       | $          | — |   | $ | 873 |   | $ | 16,824 |   | $ | 218,606 |   |

 

See accompanying notes to the consolidated financialstatements.

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**GAIAM, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**(In Thousands)
| ** **                                                                                | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating  activities**                                                                 |       |                                        |       |   |   |   |   |
| Net income  (loss)                                                                        |       | $                                           | 5,644      |   | $ | 1,336 |   | $ | (4,638 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation                                                                              |       | 1,926                                       |       | 2,146 |   | 2,822 |   |
| Amortization                                                                              |       | 5,883                                       |       | 2,555 |   | 2,077 |   |
| Noncash stock-based compensation                                                          |       | 623                                         |       | — |   | 72 |   |
| Minority interest in consolidated subsidiaries                                            |       | 128                                         |       | 601 |   | 897 |   |
| Noncash loss on disposal of property and equipment                                        |       | —                                      |       | — |   | 259 |   |
| Noncash (gain) loss from equity method investment                                         |       | (680                                        | )          | 646 |   | — |   |
| Noncash gain on Gaiam.com stock redemption                                                |       | —                                      |       | — |   | (442 | ) |
| Deferred income tax expense (benefit)                                                     |       | 3,210                                       |       | 472 |   | (564 | ) |
| Changes in operating assets and liabilities, net of  effects from acquisitions:           |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                       |       | 3,319                                       |       | (11,066 | ) | 2,622 |   |
| Inventory                                                                                 |       | (5,373                                      | )          | 3,143 |   | 304 |   |
| Deferred advertising costs                                                                |       | (531                                        | )          | (1,281 | ) | (986 | ) |
| Other current assets                                                                      |       | (1,175                                      | )          | (1,674 | ) | (30 | ) |
| Notes receivable and other assets                                                         |       | (238                                        | )          | (139 | ) | 330 |   |
| Accounts payable                                                                          |       | (6,859                                      | )          | 11,399 |   | 192 |   |
| Accrued liabilities and income taxes payable                                              |       | (4,133                                      | )          | (1,404 | ) | 210 |   |
| Net cash  provided by operating activities                                                |       | 1,744                                       |       | 6,734 |   | 3,125 |   |
|                                                                                      |       |                                        |       |   |   |   |   |
| **Investing  activities**                                                                 |       |                                        |       |   |   |   |   |
| Purchase of  property, equipment, and media rights                                        |       | (3,412                                      | )          | (1,589 | ) | (1,649 | ) |
| Proceeds from  sale of property and equipment                                             |       | 668                                         |       | — |   | — |   |
| Purchase of  acquisitions, investments, and stock rights                                  |       | (6,998                                      | )          | (38,804 | ) | 26 |   |
| Net cash used in  investing activities                                                    |       | (9,742                                      | )          | (40,393 | ) | (1,623 | ) |
|                                                                                      |       |                                        |       |   |   |   |   |
| **Financing  activities**                                                                 |       |                                        |       |   |   |   |   |
| Principal  payments on capital leases                                                     |       | —                                      |       | — |   | (55 | ) |
| Proceeds from  issuance of common stock, net                                              |       | 97,022                                      |       | 38,708 |   | 427 |   |
| Net cash  provided by financing activities                                                |       | 97,022                                      |       | 38,708 |   | 372 |   |
|                                                                                      |       |                                        |       |   |   |   |   |
| Effects of  exchange rates on cash and cash equivalents                                   |       | 824                                         |       | (460 | ) | 181 |   |
|                                                                                      |       |                                        |       |   |   |   |   |
| Net increase in  cash and cash equivalents                                                |       | 89,848                                      |       | 4,589 |   | 2,055 |   |
| Cash and cash  equivalents at beginning of year                                           |       | 15,028                                      |       | 10,439 |   | 8,384 |   |
| Cash and cash  equivalents at end of year                                                 |       | $                                           | 104,876    |   | $ | 15,028 |   | $ | 10,439 |   |
|                                                                                      |       |                                        |       |   |   |   |   |
| **Supplemental  cash flow information**                                                   |       |                                        |       |   |   |   |   |
| Interest paid                                                                             |       | $                                           | 23         |   | $ | — |   | $ | 1 |   |
| Income taxes  paid                                                                        |       | 949                                         |       | 1,196 |   | 679 |   |
| Common stock issued for  acquisitions                                                     |       | 4,943                                       |       | 2,150 |   | 539 |   |

 

See accompanying notes to the consolidated financialstatements.

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**GAIAM, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.Summary of Significant Accounting Policies**

*Organizationand Nature of Operations*

Gaiam, Inc. (“Gaiam”) is a lifestyle media companyproviding a broad selection of information, media, products and services tocustomers who value personal development, wellness, ecological lifestyles,responsible media and conscious community. Gaiam was incorporated under thelaws of the State of Colorado on July 7, 1988.

*Principle of Consolidation and Basis of Presentation*

The accompanying consolidated financial statementsinclude the accounts of Gaiam and its subsidiaries in which Gaiam’s ownershipis greater than 50% and the subsidiary is considered to be under Gaiam’scontrol. All material intercompany accounts and transaction balances have beeneliminated in consolidation.

*Cash and Cash Equivalents*

Cash and cash equivalents include demand depositaccounts with financial institutions and highly liquid investments, whichmature within three months of date of purchase. The fair value of the cash andcash equivalents approximates their carrying value due to their shortmaturities.

*Provision for Doubtful Accounts and Returns*

Gaiam records a provision for doubtful accounts forall receivables not expected to be collected. Gaiam generally does not requirecollateral. Gaiam evaluates the collectibility of the accounts receivable basedon a combination of factors. In circumstances in which Gaiam is aware of aspecific customer’s inability to meet its financial obligations (e.g.bankruptcy filings), Gaiam records a specific reserve for bad debts againstamounts due. For all other instances, Gaiam recognizes reserves based onhistorical experience and review of individual accounts outstanding.

Gaiam records a provision for product returns to bereceived in future periods at the time the original sale is recognized. Theamount of the returns provision is based upon historical experience and futureexpectations.

*Inventory*

Inventory consists primarily of finished goods heldfor sale and is stated at the lower of cost (first-in, first-out method) ormarket. Gaiam identifies its inventory items to write down for obsolescencebased on the item’s current sales status and condition. If the item isdiscontinued or slow moving, it is written down based on an estimate of themarkdown to retail price needed to sell through its current stock level of theitem. The reserve for obsolescence was $3.6 million in 2006 and $1.9 million in2005.

*AdvertisingCosts*

Deferred advertising costs relate to the preparation,printing, advertising and distribution of infomercials and catalogs. Such costsare deferred for financial reporting purposes until the catalogs andinfomercials are distributed and advertised, then amortized over succeedingperiods on the basis of estimated sales. Seasonal catalogs are amortized withinseven months, while the amortization period for annual catalogs does not exceedone year. Historical sales statistics are the principal factor used inestimating the amortization rate. Other advertising and promotional costs areexpensed as incurred.

In accordance with Emerging Issues Task Force (“EITF”)Issue No. 01-9, *Accounting for ConsiderationGiven by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)*,Gaiam records sales discounts or other sales incentives as a reduction torevenues. Gaiam identifies and records as expense those cooperative advertisingexpenses paid by Gaiam, which are for advertisements meeting the separablebenefit and fair value tests, as part of selling and operating expense.

32

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Amounts recorded as advertising expense, includingthose related to Gaiam’s catalogs and infomercials were $35.5 million, $17.6million and $11.6 million for the years ended December 31, 2006, 2005 and 2004,respectively, and are included in selling and operating expense in theconsolidated statement of operations.

*Propertyand Equipment*

Property and equipment are stated at cost lessaccumulated depreciation and amortization, which includes the amortization ofassets recorded under capital leases. Included in property and equipment is thecost of internal-use software, including software used in connection with Gaiam’swebsites. Gaiam expenses all costs related to the development of internal-usesoftware other than those incurred during the application development stage inaccordance with AICPA Statement of Position No. (“SOP”) 98-1, *Accounting for Costs of Computer Software Developedor Obtained for Internal Use*. Costs incurred during the applicationdevelopment stage are capitalized and amortized over the estimated useful lifeof the software, which is typically three years. Depreciation of property andequipment is computed on the straight-line method over estimated useful lives(generally three to ten years). Property and equipment purchased under capitalleases are amortized on a straight-line basis over the lesser of the estimateduseful life of the asset or the lease term.

*Investments*

Investments in limited liability companies in whichGaiam does have the ability to exercise significant influence or control, or inwhich it holds a five percent or more membership interest, are accounted forunder the equity method. Investments in corporations in which Gaiam does havethe ability to exercise significant influence or control, or in which it holdsa twenty percent or more ownership, are also accounted for under the equitymethod. Under the equity method, Gaiam records its share of the income orlosses of the investment by increasing or decreasing the carrying value of itsinvestment and recording the income or expense through the consolidatedstatement of operations. Under the cost method of accounting, investments inprivate companies are carried at cost and are adjusted only forother-than-temporary declines in fair value. Investments under the cost andequity methods are included on the accompanying consolidated balance sheet in “Notesreceivable and other assets”.

Gaiam evaluates its long-lived assets, includinginvestments, on at least an annual basis to test for impairment or valuationissues, and concluded that, as of December 31, 2006 and 2005, no indicators ofimpairment were present.

*PurchaseAccounting*

Gaiam accounts for the acquisition of a controllinginterest in a company using the purchase method prescribed by FASB StatementNo. 141, *Business Combinations*(“SFAS 141”).  In determining the estimated fair value ofcertain acquired assets and liabilities, management makes assumptions basedupon historical and other relevant information and, in some cases, independentexpert appraisers.  Assumptions may beincomplete, and unanticipated events and circumstances may occur that couldaffect the validity of such assumptions, estimates, or actual results.  The estimated fair value of assets andliabilities acquired in accordance with SFAS 141 during 2006 are preliminary asof December 31, 2006.  We expect toobtain information necessary to finalize the estimated values during 2007.

*MediaLibrary*

The media library asset represents the fair value ofGaiam’s library of produced videos acquired through business combinations, thepurchase price of media rights to both video and audio titles, and thecapitalized cost to produce media products marketed by Gaiam to retailers anddirect-mail and online customers. The media library is presented net ofaccumulated amortization of approximately $16.2 million and $10.9 million atDecember 31, 2006 and 2005, respectively, and it is being amortized over theestimated useful life of the titles, which range from five to fifteen years.Additionally, Gaiam estimates approximately $9.6 million in participationexpenses, primarily royalties, on acquired and produced media content during2007.

33

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Inaccordance with SOP No. 00-2, *Accounting byProducers or Distributors of Films*, media library costs to producemedia content consists of costs incurred to produce the media content, net ofaccumulated amortization. These costs, as well as participation costs, arerecognized as operating expenses on an individual film basis in the ratio thatthe current year’s gross revenues bear to management’s estimate of totalultimate gross revenues from all sources to be earned over a seven year period.Capitalized production costs are stated at the lower of unamortized cost orestimated fair value on an individual film basis. Revenue forecasts, basedprimarily on historical sales statistics, are continually reviewed bymanagement and revised when warranted by changing conditions. When estimates oftotal revenues and other events or changes in circumstances indicate that a filmhas a fair value that is less than its unamortized cost, an impairment loss isrecognized in the current period for the amount by which the unamortized costexceeds the film’s fair value.

During 2006, capitalized production costs for releasedfilms were approximately $248 thousand, and for those films not yet releasedwas approximately $1.1 million. Additionally, as of December 31, 2006, Gaiamestimates that approximately $1.1 million or 21% of the unamortized costs forreleased films will be amortized during 2007, and approximately 81% of theunamortized costs for released films will be amortized within the next threeyears. Accumulated amortization for produced media content at December 31,2006 and 2005 was approximately $8.1 million and $6.8 million, respectively.Amortization expense for produced media content for the years ended December31, 2006, 2005 and 2004 was $1.4 million, $1.0 million, and $1.4 million,respectively.

The acquired and purchased media rights have $32.2million of remaining unamortized costs as of December 31, 2006 that will beamortized on a straight-line basis over 7 to 132 months. Amortization expensefor acquired and purchased media rights for the years ended December 31, 2006,2005 and 2004 was $4.1 million, $1.5 million, and $687 thousand, respectively.Based upon the acquired and purchased media and audio titles and rights atDecember 31, 2006, the annual amortization expense for the next five years isexpected to approximate $3.9 million per annum. In 2005, Gaiam added $32.3million in media assets from its acquisition of content and programming fromGoodTimes Entertainment.

Based on total media library costs at December 31,2006 and assuming no subsequent impairment of the underlying assets or amaterial increase in the video productions or media acquired, the amortizationexpense for the next five years is expected to continue to be approximately $5million or less per annum.

*Goodwill and OtherIntangibles*

Goodwill represents the excess of the purchaseconsideration over the estimated fair value of assets acquired less liabilitiesassumed in a business acquisition. Gaiam’s other intangibles mainly consist ofcustomer lists. In accordance with SFAS No. 142, *Goodwill and Other Intangible Assets*, goodwill is no longeramortized but is reviewed for impairment annually or more frequently ifimpairment indicators arise, on a reporting unit level. The estimated fairvalue of a reporting unit is compared with its carrying amount, includinggoodwill. If the estimated fair value of a reporting unit exceeds its carryingamount, goodwill of the reporting unit is considered not impaired.

If the carrying amount of a reporting unit exceeds itsestimated fair value, the goodwill impairment test is performed to measure theamount of impairment loss. Gaiam has allocated goodwill to two reporting units,and uses a market value method for the purposes of testing for potentialimpairment. The annual review requires extensive use of financial judgment andestimates. Application of alternative assumptions and definitions, such as achange in the composition of a reporting unit, could yield significantlydifferent results.

Gaiam completed its annual goodwill tests, usingcomparable company market multiples to establish the estimated fair value ofthe reporting units, and found no goodwill impairment in either of itsreporting units for 2006 and 2005. Gaiam has allocated all of its goodwillbalance of $28.3 million at December 31, 2006 to its two reporting units,business and direct to consumer, in the amounts of $17.0 million and $11.3million, respectively. At December 31, 2005, Gaiam allocated goodwill in theamounts of $11.7 million and $5.7 million, respectively, to its business anddirect to consumer reporting units. Goodwill is allocated to reporting units atthe time of acquisition. The following table sets forth the changes in goodwillfor the period December 31, 2004 through December 31, 2006 by business segment.

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| ** **                    | ** ** | **Direct to   Consumer   Segment** | ** ** | **Business   Segment** | ** ** | **Total** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|-----------------------------|------------|-----------|------------|
| ** **                    | ** ** | **(in thousands)**                           | ** ** |
|                          |       |                                              |       |                        |       |      |       |
| Balance at  December 31, 2004 |       | $                                                 | 5,477      |                        | $          | 4,279     |       | $ | 9,756 |   |
| Additions                     |       | 231                                               |       | 7,759                       |       | 7,990     |       |
| Foreign currency rate change  |       | —                                            |       | (351                        | )          | (351      | )          |
| Balance at  December 31, 2005 |       | 5,708                                             |       | 11,687                      |       | 17,395    |       |
| Additions                     |       | 5,606                                             |       | 4,919                       |       | 10,525    |       |
| Foreign currency rate change  |       | —                                            |       | 429                         |       | 429       |       |
| Balance at December 31,  2006 |       | $                                                 | 11,314     |                        | $          | 17,035    |       | $ | 28,349 |   |

 

Gaiam’sother intangibles gross carrying amount, and related accumulated amortization,at December 31, 2006 and 2005 were $0.7 million and $0.2 million, and $0.1million and $13 thousand, respectively. The amortization periods range from 17to 60 months. Amortization expense for the years ended December 31, 2006 and2005 was $0.1 million and $13 thousand, respectively. Based on the December 31,2006 balance of other intangibles, the Company estimates amortization expenseto be $0.4 million in 2007, $0.1 million in 2008, $32 thousand in 2009, $19thousand in 2010, and none thereafter.

*Long-LivedAssets*

Gaiam evaluates impairment of its long-lived assets,other than goodwill, in accordance with SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets.*The carrying value of long-lived assets held andused, other than goodwill, is evaluated when events or changes in circumstancesindicate the carrying value may not be recoverable. The carrying value of along-lived asset is considered impaired when the total projected undiscountedcash flows from such asset are separately identifiable and are less than thecarrying value. In that event, a loss is recognized based on the amount bywhich the carrying value exceeds the estimated fair market value of thelong-lived asset. Estimated fair market value is determined primarily using theprojected cash flows from the asset discounted at a rate commensurate with therisk involved. Losses on long-lived assets held for sale, other than goodwill,are determined in a similar manner, except that fair market values are reducedfor disposal costs.

*IncomeTaxes*

Gaiam provides for income taxes pursuant to theliability method as prescribed in SFAS No. 109, *Accounting for Income Taxes*. The liability method requiresrecognition of deferred income taxes based on temporary differences betweenfinancial reporting and income tax bases of assets and liabilities, usingcurrently enacted income tax rates and regulations.

*Revenues*

Revenue from the sale of products is recognized at thetime merchandise is shipped to the customer. Revenue for services provided,such as design consultation for solar installations, is recognized whenservices are rendered. Licensing revenue is recognized upon delivery of themedia licensed. Amounts billed to customers for postage and handling arerecognized as revenue at the time that the revenues arising from the productbeing shipped are recognized. Postage and handling costs, which wereapproximately $13.0 million for 2006, $8.3 million for 2005 and $4.4 millionfor 2004, are included in selling and operating expense along with otherfulfillment costs incurred to warehouse, package and deliver products tocustomers. Gaiam provides a reserve for expected future returns at the time thesale is recorded based upon historical experience and future expectations.

*FairValue of Financial Instruments*

The carrying amounts of Gaiam’s financial instruments,including cash, cash equivalents and trade receivables and payables,approximate their fair values.

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*Use of Estimates*

The preparation of consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates requires management to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenue and expenses and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements. Actual results could differ from those estimates.

*Stock-BasedCompensation*

Priorto January 1, 2006, Gaiam accounted for its stock option program under therecognition and measurement provisions of APB Opinion No. 25 (“APB 25”), *Accounting for Stock Issued to Employees*,and related Interpretations, as permitted by FASB Statement No. 123 (“SFAS 123”),*Accounting for Stock-Based Compensation*.No stock-based compensation cost was recognized in the Statement of Operationsfor the year ended December 31, 2005, as all options granted under the plan hadan exercise price equal to the market value of the underlying common stock onthe date of grant.

Duringthe first quarter of fiscal 2006, Gaiam adopted the provisions of and accountedfor stock-based compensation in accordance with FASB Statement No. 123 (revised2004), *Share-Based Payment* (“SFAS 123R”), whichreplaced SFAS 123 and supersedes APB 25. Under the fair value recognitionprovisions of this statement, stock-based compensation cost is measured at thegrant date based on the fair value of the award and is recognized as expense ona straight-line basis over the requisite service period, which is from thegrant date through the end of the vesting period. Gaiam elected themodified-prospective method, under which prior periods are not revised forcomparative purposes. The valuation provisions of SFAS 123R apply to new grantsand to grants that were outstanding as of the effective date and aresubsequently modified. Estimated compensation for grants that were outstandingas of the effective date will be recognized over the remaining service periodsusing the compensation cost estimated for the SFAS 123 pro forma disclosures.The adoption of SFAS 123R reduced income from operations and income beforeincome taxes and minority interest by $0.6 million each, decreased net incomeby $0.4 million, and lowered both basic and diluted earnings per share by $0.01for the year ended December 31, 2006. The change to SFAS 123R had an immaterialeffect on cash flow from operations and cash flow from financing activities for2006. See Note 10 — Share-Based Payments for further information regardingstock option plan assumptions and expenses.

Thefollowing table sets forth the pro forma amounts of net income (loss) and netincome (loss) per share for the years ended December 31, 2005 and 2004, thatwould have resulted if Gaiam had accounted for its stock-based compensationplan under the fair value recognition provisions of SFAS 123 and recordedstock-based compensation expense (in thousands, except per share data).
| ** **                                                                                                                            | ** ** | **For the Years Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2005**                                                  | ** ** | **2004** | ** ** |
|                                                                                                                                  |       |                                                      |       |   |   |
| Net income  (loss) as reported                                                                                                        |       | $                                                         | 1,336      |   | $ | (4,638 | ) |
| Add: Stock-based compensation expense included in  reported net income (loss), net of related tax effects                             |       | —                                                    |       | 72 |   |
| Deduct: Total stock-based compensation expenses  determined under fair value based method for all awards, net of related tax  effects |       | (398                                                      | )          | (611 | ) |
| Pro forma                                                                                                                             |       | $                                                         | 938        |   | $ | (5,177 | ) |
| Net income  (loss) per common share:                                                                                                  |       |                                                      |       |   |   |
| As reported                                                                                                                           |       | $                                                         | 0.08       |   | $ | (0.32 | ) |
| Pro forma                                                                                                                             |       | $                                                         | 0.06       |   | $ | (0.35 | ) |
| Fully diluted  net income (loss) per common share:                                                                                    |       |                                                      |       |   |   |
| As reported                                                                                                                           |       | $                                                         | 0.08       |   | $ | (0.32 | ) |
| Pro forma                                                                                                                             |       | $                                                         | 0.05       |   | $ | (0.35 | ) |

 

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*NewAccounting Pronouncements*

In June 2006, the Financial Accounting Standards Board(“Board”) issued Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109*(“FIN48”). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with FASBStatement No. 109, *Accounting for IncomeTaxes.* The Interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. It alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. This Interpretationis effective for fiscal years beginning after December 15, 2006. Earlierapplication of the provisions of this Interpretation is encouraged if theenterprise has not yet issued financial statements, including interim financialstatement, in the period this Interpretation is adopted. Consequently, Gaiamwill adopt the provisions of FIN 48 for its fiscal year beginning on January 1,2007. Management believes that FIN 48 is applicable to Gaiam, but cannot yetreasonably estimate the impact of the Interpretation.

In September 2006, the Board issued Statement No. 157,Fair Value Measurements (“SFAS 157”). This Statement defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (“GAAP”), and expands disclosures about fair valuemeasurements. SFAS 157 applies under other accounting pronouncements thatrequire or permit fair value measurements, the Board having previouslyconcluded in those accounting pronouncements that fair value is the relevantmeasurement attribute. Accordingly, this Statement does not require any newfair value measurements. The Statement is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years. Earlier application is encouraged, provided that thereporting entity has not yet issued financial statements for that fiscal year,including financial statements for an interim period within that fiscal year.Gaiam will adopt the provisions of SFAS 157 in its fiscal year commencingJanuary 1, 2008. Management currently believes that adoption of the provisionsof SFAS 157 will not have a material impact on Gaiam’s consolidated financialstatements.

On February 16, 2006, the FASB issued SFAS No. 155, *Accounting  forCertain Hybrid Financial Instruments, an Amendment of FASB Statements No. 133and 140*(SFAS 155). SFAS 155 allows financial instruments that haveembedded derivatives that otherwise would require bifurcation from the host tobe accounted for as a whole, if the holder irrevocably elects to account forthe whole instrument on a fair value basis. Subsequent changes in the fairvalue of the instrument would be recognized in earnings. The standard also (i)clarifies which interest-only strips and principal-only strips are not subjectto the requirements of SFAS No. 133; (ii) establishes a requirement to evaluateinterests in securitized financial assets to determine whether interests arefreestanding derivatives or are hybrid financial instruments that contain anembedded derivative requiring bifurcation; (iii) clarifies that concentrationsof credit risk in the form of subordination are not embedded derivatives; and(iv) eliminates the prohibition on a qualifying special-purpose entity fromholding a derivative financial instrument that pertains to a beneficialinterest (that is itself a derivative financial instrument). SFAS 155 iseffective for all financial instruments acquired or issued after the beginningof an entity’s first fiscal year that begins after September 15, 2006. Earlieradoption is permitted as of the beginning of an entity’s fiscal year, providedthe entity has not yet issued financial statements, including financialstatements for any interim period for that fiscal year. Gaiam will adopt SFAS155 in its fiscal year commencing January 1, 2007. Management does not believethat SFAS 155 will have a material impact on Gaiam’s consolidated financialstatements.

*DefinedContribution Plan*

In 1999, Gaiam adopted a defined contributionretirement plan under Section 401(k) of the Internal Revenue Code, which coverssubstantially all employees. Eligible employees may contribute amounts to theplan, via payroll withholding, subject to certain limitations. The 401(k) planpermits, but does not require, additional matching contributions to the 401(k)plan by Gaiam on behalf of all participants in the 401(k) plan. To date, Gaiamhas not made any matching contributions to the 401(k) plan.

*ForeignCurrency Translation*

Our foreign subsidiaries use their local currency astheir functional currency. Assets and liabilities are translated into U.S.dollars at exchange rates in effect at the balance sheet date. Income andexpense accounts are translated at the average monthly exchange rates duringthe year. Resulting translation adjustments, net of income taxes, are recordedas a separate component of accumulated other comprehensive income.

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*ComprehensiveIncome*

SFAS No. 130, *Reportingon Comprehensive Income* establishes standards for reporting anddisplay of comprehensive income and its components in the consolidatedfinancial statements. Comprehensive income includes all changes in equityduring a period from non-owner sources. Gaiam’s accumulated other comprehensiveincome consists only of foreign currency translation adjustments, net of incometaxes.

*Reclassifications*

Certain reclassifications have been made to priorperiod amounts to conform to the current period presentations.

*Earnings(Loss) Per Share*

Basic earnings (loss) per share excludes any dilutiveeffects of options, warrants and dilutive securities. Basic earnings (loss) pershare is computed using the weighted average number of common shares outstandingduring the period. Diluted earnings per share is computed using the weightedaverage number of common and common stock equivalent shares outstanding duringthe period. Common equivalent shares of 119 thousand are excluded from thecomputation of diluted earnings per share for 2004 because their effect isantidilutive.

The following table sets forth the computation ofbasic and diluted earnings (loss) per share:
| ** **                                                     | ** ** | **For the Years Ended December 31,**         | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                     | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                                           |       |                                                                  |       |   |   |   |   |
| Numerator for  basic and diluted earnings (loss) per share     |       | $                                                                     | 5,644      |   | $ | 1,336 |   | $ | (4,638 | ) |
|                                                           |       |                                                                  |       |   |   |   |   |
| Denominator:                                                   |       |                                                                  |       |   |   |   |   |
| Weighted average shares for basic earnings (loss)  per share   |       | 24,349                                                                |       | 17,140 |   | 14,684 |   |
|                                                           |       |                                                                  |       |   |   |   |   |
| Effect of  dilutive securities:                                |       |                                                                  |       |   |   |   |   |
| Weighted average of common stock, stock options, and  warrants |       | 268                                                                   |       | 214 |   | — |   |
|                                                           |       |                                                                  |       |   |   |   |   |
| Denominators for  diluted earnings (loss) per share            |       | 24,617                                                                |       | 17,354 |   | 14,684 |   |
|                                                           |       |                                                                  |       |   |   |   |   |
| Net income  (loss) per share—basic                        |       | $                                                                     | 0.23       |   | $ | 0.08 |   | $ | (0.32 | ) |
| Net income (loss) per  share—diluted                      |       | $                                                                     | 0.23       |   | $ | 0.08 |   | $ | (0.32 | ) |

 

**2.****                                    ********Notes Receivable and Other Assets**

Notes receivable and other assets as of December 31,2006 consisted of $1.3 million of investments, $2.4 million in notes andrelated interest receivable, and $0.6 million of other long-term assets. OnJanuary 5, 2006, Gaiam entered into an agreement with Alps Communications LLC (“Alps”)and Life Balance Media Holdings LLC (“LIME”), to sell 19,968 Series A PreferredUnits of LIME to Alps, an investment previously accounted for using the equitymethod. The purchase price per unit was equal to the amount Gaiam paid for itsinvestment during 2005. Alps assumed all unpaid Series A Capital Contributioncommitments from Gaiam and executed a 7.5% interest bearing promissory note dueFebruary 28, 2009 in the principal amount of $2,250,000. After the closingof this transaction, Gaiam owned 4,876 units, or less than 4%, of LIME. Thistransaction resulted in a gain of $0.5 million which is included in Otherincome (expense) on the Consolidated Statements of Operations for the yearended December 31, 2006. On February 6, 2007, the Alps promissory note plusaccrued interest was prepaid as part of an agreement pursuant to which Gaiamrepurchased certain of its shares. See Note 13 — Subsequent Events. Notesreceivable and other assets as of December 31, 2005 consisted of $6.8 millionof investments and $0.4 million of other assets.

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On June 23, 2006, Gaiam purchased, for $3.5 million,an approximate 34% ownership interest in Cinema Circle, Inc. (“CCI”), theparent company of Spiritual Cinema Circle, a subscription-based DVD film club.This investment was accounted for under the equity method and the excess of thecost of the investment over the underlying equity in the net assets of CCI,$2.3 million, was recognized as goodwill. During July 2006, Gaiam purchased anadditional 29% interest in CCI for $3.4 million. With the purchase of theadditional interest, Gaiam’s ownership was approximately 63% and, therefore,commencing with the effective dates of the additional share purchases, CCI metthe accounting criteria to be considered a business combination as outlined inSFAS No. 141, *Business Combinations*andGaiam began consolidating CCI’s results of operations effective July 31, 2006.  On September 30, 2006, Gaiam reduced itsinvestment in CCI to a 15% ownership interest and changed its accounting forCCI from the consolidation to cost method. See Note 3 — Mergers andAcquisitions.

**3.            Mergersand Acquisitions**

Results from operations of acquired companies areincluded in the consolidated financial statements of Gaiam from the effectiveacquisition dates.  None of the goodwillresulting from acquisition of companies during 2006 is expected to bedeductible for tax purposes.

InAugust 2005, Gaiam entered into agreements with Revolution Living, LLC, itsfounder, Steve Case, and Revolution Living’s LIME subsidiary. Under the termsof the Agreements, Gaiam acquired a minority interest in LIME for approximately$7.5 million. This investment was accounted for using the equity method, soGaiam’s share of the losses sustained by LIME from the date of acquisitionthrough December 31, 2005, totaling $646 thousand, have been reflected in Gaiam’sstatement of operations for 2005, and the “Notes receivable and other assets”line on the balance sheet was reduced accordingly. Effective in January 2006,Gaiam reduced its ownership in LIME to less than 4%. See Note 2 — NotesReceivable and Other Assets. Additionally, on February 6, 2007, Gaiam sold this investment.  See Note 13 — Subsequent Events.

InSeptember 2005, Gaiam acquired a majority of the net assets held by GoodTimesand certain of its affiliates for $34.4 million in cash plus $0.6 million inestimated acquisition, legal and accounting costs.  GoodTimes’ assets included entertainmentprogramming and home video products distributed through various channels,including television, retailers and the Internet. Gaiam commenced distributionof titles and content acquired in this asset purchase on September 13, 2005,and the results of sales in both the direct to consumer and business segmentsare included in the consolidated financial statements of Gaiam from this date.At December 31, 2005, the purchase price of $35.0 million was initially allocated$29.1 million to media library, $13.2 million to tangible assets, and $7.3million to assumed liabilities.

During2006, Gaiam reduced the aggregate purchase price to $34.8 million due tounrealized estimated acquisition costs and adjusted the estimated fair valuesby allocating $32.3 million to the media library, $9.4 million to tangibleassets, and $6.9 million to assumed liabilities. The adjustments were primarilybased on additional facts about benefits and obligations as of the purchasedate which were identified during the allocation period after the acquisitiondate. As a result of the adjustment to the media library, Gaiam recorded inSeptember 2006 additional amortization expense of $0.3 million.

InOctober 2005, Gaiam acquired a 53.4% ownership interest in Newmark Media, Ltd.(“Newmark”), a distribution company specializing in placing wellness mediaproducts in the grocery and drugstore channels for an approximately $750thousand cash contribution to Newmark. Gaiam allocated the purchase price to thenet tangible assets, and, as Newmark had negative net worth, Gaiam recorded$869 thousand in goodwill. On December 31, 2006, Gaiam acquired the 46.6%minority ownership interest in Newmark for $250 thousand cash and recorded anadditional $222 thousand in goodwill. The stock purchase calls for additionalconsideration of up to $100 thousand contingent upon the achievement of certaindistribution and product mix goals over the next two years. Gaiam has not yetrecognized the contingent consideration because its amount is not determinablebeyond a reasonable doubt. The purchase price allocation is preliminary pendingthe identification and valuation of potentially separable intangibles andreorganization liabilities. Management believes that Newmark’s expertise inproduct placement in these under-penetrated channels more than compensates forthe goodwill recorded.

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OnDecember 30, 2005, Gaiam increased its ownership percentage in Conscious Media,Inc. (“CMI”), a multimedia company, to 51% for an additional investment of $3.5million. Gaiam acquired shares directly from the CMI for its $1.5 million innotes receivable and issued 146,667 shares of Gaiam Class A common stock andpromissory notes totaling $240 thousand to certain CMI shareholders. One ofthese shareholders, a non-profit corporation, who had received its shares as acontribution prior to Gaiam’s original investment, sold its shares to Gaiam ata discount. Gaiam has recorded a reduction to retained earnings and itsinvestment of $717 thousand to reflect its share of the results from operationsof CMI from the date of its original investment in 2002 to the end of 2005,when Gaiam acquired a majority interest. Gaiam valued the net tangible assetsof CMI at December 30, 2005, recorded the portion assignable to minorityinterest and recorded $6.9 million in goodwill.

On September 29, 2006, Gaiam increased its ownershippercentage in CMI from 51% to 86% for an additional investment of $1.9 million.Gaiam acquired stock directly from certain CMI minority interest shareholdersby issuing 149,698 shares of Gaiam Class A common stock. Also, on September 29,2006, CMI reacquired and retired 14.5 million of its outstanding Class A commonstock from another minority shareholder in exchange for 100% of the common stockof a wholly-owned subsidiary of CMI. As a result of the additional investment,Gaiam recorded a $1.4 million increase to goodwill.

Duringthe fourth quarter of 2006, CMI reacquired and retired 1.0 million of itsoutstanding Class A common stock from a minority shareholder in exchangefor the forgiveness of $1.0 million worth of a note receivable from thatshareholder. As a result of this exchange and an additional Gaiam investment of$3.2 million, comprised of 220,026 shares of Gaiam Class A common stock,of which 85,526 shares were issued to two outside board members of Gaiam, andcash of $0.2 million, Gaiam owned effectively all of CMI’s outstandingstock as of November 8, 2006 and recognized additional goodwill of $3.3million. Gaiam is still in the process of assessing the estimated fair value ofthe net assets acquired and, thus, the allocation of the purchase price issubject to refinement. Management believes that CMI’s expertise in mediaprogramming, development and post production will complement Gaiam’s currentbusinesses and future growth, at a cost less than Gaiam could develop on itsown.

OnSeptember 30, 2006, Gaiam, CCI, and Spiritual Cinema, Inc. (“SCI”), a newlyformed subsidiary of Gaiam, entered into a Share Exchange Agreement (“SCI Agreement”).Prior to Gaiam’s original investment in CCI (see Note 2 — Notes Receivable andOther Assets), CCI had two business segments, direct (primarily subscriptionclubs) and film production. Under the SCI Agreement, 100% of the equity and netassets of CCI’s direct segment were acquired by SCI from CCI in exchange for76% of Gaiam’s interest in CCI and 15% of SCI. Of the $6.9 milliondetermined cost of its 85% ownership in SCI, Gaiam allocated $5.6 millionto goodwill, $0.5 million to customer lists, and the remainder to net tangibleassets and minority interest. The customer lists are being amortized on astraight-line basis over 17 months. The purchase price allocation ispreliminary pending further identification and valuation of potentiallyseparable intangibles and reorganization liabilities. SCI’s results ofoperations were included in Gaiam’s consolidated statement of operationscommencing October 1, 2006. Gaiam plans to invest in its community businessover the next two years to better capitalize on strong relationships with itsloyal consumer audience and growing broadband subscription trends. This willallow Gaiam to focus on better leveraging its content through subscriptionclubs and community. The films distributed to SCI’s members are meaningfulinspirational and spiritual family films that compliment Gaiam’s productofferings.

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**4.             Property and Equipment**

Property and equipment, stated at lower of cost orfair value, consists of the following as of December 31 (in thousands):

 

|                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
|                                        |       |     |       |     |       |
| Land                                        |       | $        | 3,100      |     | $          | 3,100 |   |
| Buildings                                   |       | 1,587    |       | 1,545    |       |
| Furniture, fixtures and  equipment          |       | 5,580    |       | 4,670    |       |
| Leasehold improvements                      |       | 1,475    |       | 1,321    |       |
| Website development  costs                  |       | 4,763    |       | 4,094    |       |
| Studio, computer and  telephone equipment   |       | 7,864    |       | 10,890   |       |
| Vehicles                                    |       | —   |       | 636      |       |
| Warehouse equipment                         |       | 1,191    |       | 1,462    |       |
|                                        |       | 25,560   |       | 27,718   |       |
| Accumulated  depreciation and  amortization |       | (17,776  | )          | (18,290  | )          |
|                                        |       | $        | 7,784      |     | $          | 9,428 |   |

 

**5.             Leases**

Gaiam leases office and warehouse space throughoperating leases. Gaiam has renewal clauses in some of these leases, whichrange from 1 to 10 years. The following schedule represents the annual futureminimum payments, as of December 31, 2006 (in thousands):

 

|                              | ** ** | **Operating** | ** ** |
|------------------------------|------------|---------------|------------|
|                         |       |          |       |
| 2007                         |       | $             | 4,597      |   |
| 2008                         |       | 845           |       |
| 2009                         |       | 163           |       |
| 2010                         |       | 163           |       |
| 2011                         |       | 141           |       |
| 2012                         |       | 122           |       |
| 2013                         |       | 122           |       |
| Total minimum lease payments |       | $             | 6,153      |   |

 

Gaiam incurred rent expense of $4.3 million, $2.7million and $2.0 million for the years ended December 31, 2006, 2005 and2004, respectively.

**6.             Accrued Liabilities**

Accrued liabilities consist of the following as ofDecember 31 (in thousands):

 

|                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |
| Accrued royalties                                    |       | $        | 2,266      |     | $          | 6,596 |   |
| Deferred funding  obligation — LIME  investment |       | —   |       | 2,078    |       |
| Accrued compensation                                 |       | 2,169    |       | 1,395    |       |
| Other accrued  liabilities                           |       | 3,002    |       | 2,976    |       |
|                                                 |       | $        | 7,437      |     | $          | 13,045 |   |

 

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**7.             Line of Credit**

Gaiam is party to a revolving line of credit agreementwith a financial institution, which expires on July 31, 2007.  The credit agreement permits borrowings up tothe lesser of $15 million or Gaiam’s borrowing base which is calculated basedupon the collateral value of Gaiam’s accounts receivable, inventory, andcertain property and equipment. Borrowings under this agreement bear interestat the lower of prime rate less 50 basis points or LIBO plus 275 basis points.Borrowings are secured by a pledge of Gaiam’s cash and investments held at thefinancial institution, accounts receivable, inventory and certain property andequipment. The credit agreement contains various financial covenants, includingcovenants prohibiting the payment of cash dividends to Gaiam’s shareholders andrequiring the maintenance of certain financial ratios. At December 31, 2005,Gaiam had no amounts outstanding under this agreement; however, $3.0 millionwas reserved for outstanding letters of credit. Gaiam has complied with all the financial covenants.

**8.             Income Taxes**

Gaiam’sprovision for income taxes is comprised of the following (in thousands):

 

|               | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Current:      |       |                                                          |       |   |   |   |   |
| Federal       |       | $                                                             | 4,135      |   | $ | 346 |   | $ | (2,157 | ) |
| State         |       | 885                                                           |       | 48 |   | (381 | ) |
| International |       | 62                                                            |       | 301 |   | 662 |   |
|          |       | 5,082                                                         |       | 695 |   | (1,876 | ) |
| Deferred:     |       |                                                          |       |   |   |   |   |
| Federal       |       | (1,067                                                        | )          | 232 |   | (482 | ) |
| State         |       | (241                                                          | )          | 47 |   | (82 | ) |
|          |       | (1,308                                                        | )          | 279 |   | (564 | ) |
| Total         |       | $                                                             | 3,774      |   | $ | 974 |   | $ | (2,440 | ) |

 

Variationsfrom the federal statutory rate are as follows (in thousands):

 

|                                                                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                      |       |     |       |     |       |     |       |
| Expected federal income  tax expense at  statutory rate of 34%                            |       | $        | 3,246      |     | $          | 978      |       | $ | (2,079 | ) |
| Effect of permanent  differences                                                          |       | 48       |       | 30       |       | 28       |       |
| State income tax  expense, net of federal  benefit and utilization of net  operating loss |       | 433      |       | 66       |       | (301     | )          |
| Effect of differences  between U.S.  taxation and foreign taxation                        |       | 47       |       | (100     | )          | (88      | )          |
| Income tax expense                                                                        |       | $        | 3,774      |     | $          | 974      |       | $ | (2,440 | ) |

 

Deferredincome taxes reflect net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. The components of the net accumulateddeferred income tax asset as of December 31, 2006 and 2005 are as follows (inthousands):

42

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|                                        | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Deferred tax assets  (liabilities):    |       |                  |       |   |   |
| Current:                               |       |                  |       |   |   |
| Provision for  doubtful accounts       |       | $                     | 553        |   | $ | 130 |   |
| Inventory-related  expense             |       | 456                   |       | 560 |   |
| Accrued liabilities                    |       | 3,104                 |       | 1,090 |   |
| Prepaid and  deferred catalog costs    |       | (709                  | )          | (900 | ) |
| Net operating  loss carryback          |       | —                |       | 2,746 |   |
| Total current deferred  tax assets     |       | $                     | 3,404      |   | $ | 3,627 |   |
| Non-current:                           |       |                  |       |   |   |
| Depreciation and  amortization         |       | $                     | (578       | ) | $ | (267 | ) |
| Net operating  loss carryforward       |       | 7,026                 |       | 7,613 |   |
| Foreign exchange  rate gain            |       | (490                  | )          | (64 | ) |
| Total non-current  deferred tax assets |       | $                     | 5,958      |   | $ | 7,282 |   |
| Total net deferred tax assets          |       | $                     | 9,362      |   | $ | 10,909 |   |

 

AtDecember 31, 2006, no provision had been made for U.S. federal and state incometaxes on approximately $0.2million of undistributed foreign earnings,which are expected to be reinvested outside of the U.S. indefinitely. Upondistribution of those earnings in the form of dividends or otherwise, Gaiamwould be subject to U.S. income taxes (subject to an adjustment for foreign taxcredits), state income taxes, and withholding taxes payable to the variousforeign countries. Determination of the amount of unrecognized deferred U.S.income tax liability is not practicable because of the complexities associatedwith its hypothetical calculation. Gaiam’s foreign subsidiaries generatedincome before minority interest and income taxes of approximately $0.2 million,$1.2 million and $2.1 million in 2006, 2005 and 2004, respectively.

At December 31, 2006 Gaiam had net operating loss (“NOL”)carry forwards of approximately $18.0 million associated with acquisitionscompleted in 2001, 2002 and 2005, which may be used to offset future taxableincome. These carryforwards expire beginning in 2019. The Internal RevenueService Code contains provisions that limit the NOL available for use in anygiven year upon the occurrence of certain events, including significant changesin ownership interest. A change in ownership of a company of greater than 50%within a three-year period results in an annual limitation on the utilizationof NOL carryforwards from tax periods prior to the ownership changes. Gaiam’sNOL carryforwards as of December 31, 2006 are subject to annual limitations dueto changes in****ownership.

Gaiam expects the deferred tax assets at December 31,2006 to be fully recoverable through the reversal of taxable temporarydifferences in future years as a result of normal business activities.Accordingly, no valuation allowances for deferred tax items were considerednecessary as of December 31, 2006 or 2005.

**9.             Stockholders’ Equity**

In 2004, Gaiam issued 97,590 shares of Class A commonstock upon exercise of options granted under the 1999 Long-Term Incentive Plan,and 11,251 shares of Class A common stock to Gaiam’s independent directors inlieu of cash compensation for services rendered in 2003.

In 2005, Gaiam issued a total of 8,221 shares of ClassA common stock to Gaiam’s independent directors, in lieu of cash compensation,for services rendered in 2004, and issued 62,634 shares of Class A common stockupon exercise of options granted under Gaiam’s 1999 Long-Term Incentive Plan.On July 7, 2005, Gaiam issued and sold 2,821,317 shares of unregistered Class Acommon stock for an aggregate purchase price of approximately $18.7 million tocertain funds advised by Prentice Capital Management, LP. The holders of theseshares have certain registration rights. On August 22, 2005, Gaiam issued andsold 2,500,000 shares of unregistered Class A common stock for an aggregatepurchase price of $20 million to Revolution Living, LLC. Additionally, Gaiamissued 60,000 shares of Class A common stock as purchase consideration for amedia catalog business and issued 146,667 shares of Class A common stock topurchase shares of CMI.

43

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In2006, Gaiam issued a total of 7,692 shares of Class A common stock to Gaiam’sindependent directors, in lieu of cash compensation, for services rendered in2005 and 2006 and issued 671,784 shares of Class A common stock upon exerciseof options granted under Gaiam’s 1999 Long-Term Incentive Plan. On May 24,2006, Gaiam sold 5,000,000 shares of Class A common stock and on June 13, 2006sold 690,000 shares of Class A common stock in an underwritten offering. Thecombined sale generated gross proceeds of $99.6 million. Gaiam issued 149,698and 220,026 shares of Class A common stock on September 29, 2006 and November8, 2006, respectively, to acquire additional ownership of CMI. See Note 3 —Mergers and Acquisitions.

As ofDecember 31, 2006, Gaiam had the following Class A common shares reserved forfuture issuance:

 
| Conversion of Class B common shares                                                                 |   | 5,400,000 |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------|--------|
| Awards under the 1999 Long-Term Incentive Plan                                                      |   |      |   |
| Stock options  outstanding                                                                          |   | 1,027,740 |   |
| Shares reserved for  issuance to directors in lieu of cash  compensation for 2006 services rendered |   | 1,370     |   |
| Total shares reserved for future issuance                                                           |   | 6,429,110 |   |

 

Eachholder of shares of Class A common stock is entitled to one vote for each shareheld on all matters submitted to a vote of shareholders. Each share of Class Bcommon stock is entitled to ten votes on all matters submitted to a vote ofshareholders. There are no cumulative voting rights. All holders of shares ofClass A common stock and shares of Class B common stock vote as a single groupon all matters that are submitted to the shareholders for a vote. Accordingly,holders of a majority of the votes of the shares of Class A common stock andshares of Class B common stock entitled to vote in any election of directorsmay elect all of the directors who stand for election. As a result of votingrights described above, the holder of the Class B common stock has effectivecontrol of Gaiam. As of December 31, 2006 and 2005, all Class B common stockwas held by the Chairman and Chief Executive Officer of Gaiam.

Shares of Class A common stock and shares of Class Bcommon stock are entitled to equal dividends, if any, as may be declared by theBoard of Directors out of legally available funds. In the event of a liquidation,dissolution or winding up of Gaiam, the shares of Class A common stock andshares of Class B common stock would be entitled to share ratably in Gaiam’sassets remaining after the payment of all of Gaiam’s debts and otherliabilities. Holders of shares of Class A common stock and shares of Class Bcommon stock have no preemptive, subscription or redemption rights, and thereare no redemption or sinking fund provisions applicable to the shares of ClassA common stock and Class B common stock. The outstanding shares of Class Acommon stock and shares of Class B common stock are fully paid andnon-assessable.

The Class B common stock may not be transferred unlessconverted into shares of Class A common stock, other than certain transfers toaffiliates, family members, and charitable organizations. The shares of Class Bcommon stock are convertible one-for-one into shares of Class A common stock,at the option of the holder of the shares of Class B common stock.

**10.          Share-Based Payments**

Gaiam’s share-based compensation program is along-term retention program that is intended to attract, retain and provideincentives for talented employees, officers, and directors, and to alignstockholder and employee interests. Gaiam grants options under its 1999 Long-TermIncentive Plan (“the Plan”), which provides for the granting of options topurchase up to 3 million shares of Gaiam’s common stock. Both incentive stockoptions and nonqualified stock options may be issued under the provisions ofthe Plan. Employees of Gaiam and its affiliates, members of the Board ofDirectors, consultants and certain key advisors are eligible to participate inthe Plan, which terminates no later than June 1, 2009. Options under the Planare generally granted with an exercise price equal to the closing market priceof Gaiam’s stock at the date of the grant and normally vest and becomeexercisable at 2% per month for the 50 months beginning in the eleventh monthafter date of grant. Grants typically expire seven years from the date of grant.

The stock-based compensation cost charged againstincome was $0.6 million and $0.1 million in 2006 and 2004, respectively, withnone in 2005, and is shown in Corporate, general and administration expenses onGaiam’s consolidated statements of operations. The total income tax benefitrecognized in the consolidated statements of operations for stock-basedcompensation was $0.2 million and $28 thousand for 2006 and 2004,respectively.  As of December 31, 2006,there was $3.0 million of unrecognized cost related to nonvested shared-basedcompensation arrangements granted under the Plan.  That cost is expected to be recognized over aweighted-average period of 3.9 years.

44

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Gaiam uses the Black-Scholes option pricing model todetermine the estimated fair value of stock options and shares issued under thePlan. The determination of fair value stock-based payment awards on the date ofgrant using an option-pricing model is affected by Gaiam’s stock price as wellas assumptions regarding a number of complex and subjective variables. Thesevariables include Gaiam’s expected term of the awards, expected stock pricevolatility over the expected term of the awards, risk-free interest rate andexpected dividends. The Black-Scholes option valuation model was developed foruse in estimating the fair value of traded options which differ significantlyfrom our stock options as traded options have no vesting restrictions and arefully transferable.  In addition, optionvaluation models require the input of highly subjective assumptions,particularly for expected term and expected price volatility. Changes in theseassumptions can materially affect the fair value estimates.

The expected terms are derived from historicalbehavior of management versus non-management participant groupings.  Expected volatilities are based on thehistorically realized volatility of Gaiam’s stock over the expected term. Gaiam’suse of historical realized volatility is based upon the expectation that futurevolatility over the expected term is not likely to differ from historicalresults. The risk-free interest rate used in the option valuation model isbased on U.S. Treasury zero-coupon issues with remaining terms similar to theexpected term on the options. Gaiam does not anticipate paying any cashdividends in the foreseeable future and, therefore, an expected dividend yieldof zero is used in the option valuation model. In accordance with SFAS No.123R, Gaiam is required to estimate forfeitures at the time of grant and revisethose estimates in subsequent periods if actual forfeitures differ from thoseestimates. Historical data by participant groupings is used to estimatepre-vesting option forfeitures and record stock-based compensation expense onlyfor those awards that are expected to vest. All stock-based payment awards areamortized on a straight-line basis over the requisite service periods of theawards, which are generally five years for employees and two years for Boardmembers.

 

|                              | ** ** | **2006**     | ** ** | **2005**     | ** ** | **2004**     | ** ** |
|------------------------------|------------|--------------|------------|--------------|------------|--------------|------------|
|                         |       |         |       |         |       |         |       |
| Expected volatility          |       | 51% - 61     | %          | 38.4% - 46.9 | %          | 37.5% - 68.9 | %          |
| Weighted-average  volatility |       | 59           | %          | 42           | %          | 69           | %          |
| Expected dividends           |       | 0            | %          | 0            | %          | 0            | %          |
| Expected term (in  years)    |       | 1.5 - 5.9    |       | 5            |       | 5            |       |
| Risk-free rate               |       | 4.27% - 5.13 | %          | 2.28% - 4.39 | %          | 2.72% - 3.65 | %          |

 

A summary of option activity under the Plan as ofDecember 31, 2006, and changes during the year then ended is presented below:

 

|                                   | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
|                              |       |       |       |                                    |       |                                                 |       |                            |       |
| Outstanding at January  1, 2006   |       | 1,504,564  |       | $                                       | 7.74       |                                                 |       |                            |       |   |
| Granted                           |       | 364,400    |       | 13.24                                   |       |                                                 |       |                            |       |
| Exercised                         |       | (671,784   | )          | 5.81                                    |       |                                                 |       |                            |       |
| Forfeited or expired              |       | (169,440   | )          | 9.90                                    |       |                                                 |       |                            |       |
| Outstanding at December  31, 2006 |       | 1,027,740  |       | $                                       | 10.59      |                                                 | 4.1        |                            | ─    |   |
| Exercisable at December 31, 2006  |       | 483,250    |       | $                                       | 10.12      |                                                 | 2.4        |                            | ─    |   |

 

New shares are issued upon the exercise of options.Gaiam received $3.9 million in cash and realized a $2.5 million tax benefitfrom stock options exercised during 2006. The weighted-average grant-date fairvalue of options granted during the years 2006, 2005, and 2004 was $8.06,$4.37, and $3.48, respectively.  Thetotal intrinsic value of options exercised during the years ended December 31,2006, 2005, and 2004, was $6.3 million, $0.3 million, and $0.2 million,respectively. The total fair value of shares vested during the years endedDecember 31, 2006, 2005, and 2004 was $0.4 million, $1.4 million, and $1.3million, respectively.

On December 13, 2006, Gaiam’s Compensation Committee of the Board ofDirectors allowed  the vesting andexercise period to continue for 14,400 unvested share options held by a formeremployee who will continue to provide services to the Company on a consultingbasis. This modification had an immaterial effect on compensation expense forthe year ended December 31, 2006.

45

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**11.          Segment and Geographic Information**

Gaiammanages its business and aggregates its operational and financial informationin accordance with two reportable segments. The direct to consumer segment containsthe DRTV, catalog, Internet, and subscription community sales channels, whilethe business segment comprises the retailers, media and corporate accountchannels.

AlthoughGaiam is able to track revenues by sales channel, the management, allocation ofresources and analysis and reporting of expenses is solely on a combined basis,at the reportable segment level.

Contributionmargin is defined as net sales, less cost of goods sold and direct expenses.Financial information for Gaiam’s business segments is as follows (inthousands):

SegmentInformation

 

|                                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue:                                                                      |       |                                       |       |   |   |   |   |
| Direct to  consumer                                                               |       | $                                          | 125,708    |   | $ | 72,337 |   | $ | 52,428 |   |
| Business                                                                          |       | 93,772                                     |       | 70,155 |   | 44,229 |   |
| Consolidated net  revenue                                                         |       | 219,480                                    |       | 142,492 |   | 96,657 |   |
| Contribution margin  (loss):                                                      |       |                                       |       |   |   |   |   |
| Direct to  consumer                                                               |       | (2,291                                     | )          | (781 | ) | (82 | ) |
| Business                                                                          |       | 7,932                                      |       | 3,867 |   | (6,208 | ) |
| Consolidated  contribution margin (loss)                                          |       | 5,641                                      |       | 3,086 |   | (6,290 | ) |
| Reconciliation of  contribution margin (loss) to net income (loss):               |       |                                       |       |   |   |   |   |
| Other income (expense)                                                            |       | 3,905                                      |       | (175 | ) | 109 |   |
| Income tax expense  (benefit)                                                     |       | 3,774                                      |       | 974 |   | (2,440 | ) |
| Minority interest in  net income of consolidated subsidiary, net of  income taxes |       | (128                                       | )          | (601 | ) | (897 | ) |
| Net income (loss)                                                                 |       | $                                          | 5,644      |   | $ | 1,336 |   | $ | (4,638 | ) |

 

The direct toconsumer and business segments had total assets as follows (in thousands):

 

|                     | ** ** | **As of December 31,** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total Assets:       |       |                                  |       |   |   |   |   |
| Direct to  consumer |       | $                                     | 89,507     |   | $ | 33,565 |   | $ | 30,648 |   |
| Business            |       | 161,461                               |       | 122,536 |   | 57,639 |   |
|                |       | $                                     | 250,968    |   | $ | 156,101 |   | $ | 88,287 |   |

 

Major Customer

Salesto our largest customer for 2006, 2005 and 2004 accounted for approximately10.1%, 12.1% and 13.2% of total revenue, respectively, during these periods.

GeographicInformation

Gaiamsells and distributes essentially the same products in the United States andseveral foreign countries. The major geographic territories are the U.S.,Canada and the United Kingdom and are based on the location of the customer.The following represents geographical data for Gaiam’s operations as of and forthe year ended December 31 (in thousands):

46

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|                    | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenue:           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States      |       | $          | 206,584    |       | $          | 128,034    |       | $ | 79,392 |   |
| International      |       | 12,896     |       | 14,458     |       | 17,265     |       |
|               |       | $          | 219,480    |       | $          | 142,492    |       | $ | 96,657 |   |
| Long-Lived Assets: |       |       |       |       |       |       |       |
| United States      |       | $          | 44,172     |       | $          | 46,466     |       | $ | 17,117 |   |
| International      |       | 1,750      |       | 1,729      |       | 1,829      |       |
|               |       | $          | 45,922     |       | $          | 48,195     |       | $ | 18,946 |   |

 

 

|                                       | ** ** | **As of December 31,** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **2006**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Components of  Long-Lived Assets (1): | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Property and  equipment, net          |       | $                      | 7,784      |   | $ | 9,428 |   | $ | 7,857 |   |
| Media Library, net                    |       | 37,201                 |       | 38,339 |   | 10,884 |   |
| Other  Intangibles                    |       | 530                    |       | 146 |   | — |   |
| Notes receivable  and other assets    |       | 407                    |       | 282 |   | 205 |   |
|                                  |       | $                      | 45,922     |   | $ | 48,195 |   | $ | 18,946 |   |

 

----

(1)             Excludesother non-current assets (non-current deferred tax assets, goodwill,investments, notes receivable, and security deposits) of $38,199, $31,637, and$20,381 for 2006, 2005, and 2004, respectively.

**12.          Quarterly Results of Operations(Unaudited)**

The following is a summary of the quarterly results ofoperations for the years ended December 31, 2006 and 2005 (in thousands, exceptfor per share data):

 

|                                              | ** ** | **Fiscal 2006** | ** ** |
|----------------------------------------------|------------|----------------------|------------|
| ** **                                   | ** ** | **First**            | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **                                   | ** ** | **Quarter**          | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                         |       |                 |       |   |   |   |   |   |   |
| Net revenue                                  |       | $                    | 51,752     |   | $ | 43,161 |   | $ | 51,786 |   | $ | 72,781 |   |
| Gross profit                                 |       | 33,162               |       | 26,891 |   | 32,629 |   | 47,648 |   |
| Operating income (loss)                      |       | 1,010                |       | (2,676 | ) | 1,010 |   | 6,297 |   |
| Net income (loss)                            |       | 890                  |       | (1,166 | ) | 1,653 |   | 4,267 |   |
| Diluted net income  (loss) per share         |       | $                    | 0.04       |   | $ | (0.05 | ) | $ | 0.06 |   | $ | 0.16 |   |
| Weighted average shares  outstanding-diluted |       | 20,795               |       | 23,140 |   | 26,864 |   | 27,211 |   |
|                                         |       |                 |       |   |   |   |   |   |   |
|                                              | ** ** | **Fiscal 2005** | ** ** |
| ** **                                   | ** ** | **First**            | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **                                   | ** ** | **Quarter**          | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
|                                         |       |                 |       |   |   |   |   |   |   |
| Net revenue                                  |       | $                    | 26,324     |   | $ | 21,706 |   | $ | 30,139 |   | $ | 64,322 |   |
| Gross profit                                 |       | 13,749               |       | 10,557 |   | 16,713 |   | 39,496 |   |
| Operating income (loss)                      |       | 287                  |       | (1,271 | ) | 878 |   | 3,193 |   |
| Net income (loss)                            |       | 116                  |       | (766 | ) | 505 |   | 1,481 |   |
| Diluted net income  (loss) per share         |       | $                    | 0.01       |   | $ | (0.05 | ) | $ | 0.03 |   | $ | 0.07 |   |
| Weighted average shares  outstanding-diluted |       | 14914                |       | 14,820 |   | 18,892 |   | 20,595 |   |

 

47

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Note:                   The aggregateof certain of the above amounts differs from that reported for the full fiscalyear due to the effects of rounding.

**13.          Subsequent Events**

OnFebruary 6, 2007, Gaiam entered into a stock repurchase agreement (the “Agreement”)with Revolution Living LLC (“Revolution Living”) and Alps, whereby Gaiampurchased 2.5 million of its Class A common stock from Revolution Living for$13.14 per share or $32.8 million in cash, Alps prepaid its promissorynoteprincipal plus accrued interest in the amount of $2.4 million, Alpsacquired Gaiam’s investment in LIME for $1.5 million in cash, and David Golden,Chief Financial Officer of Revolution, resigned from the Board of Directors ofGaiam. Also as part of the Agreement, Jirka Rysavy, Gaiam’s Chairman andlargest shareholder, purchased for $7.2 million Revolution Living’s option toacquire approximately 2.3 million of his Gaiam shares at $10 per share. Theprice to repurchase the option was calculated as the spread between thenegotiated $13.14 share price for Gaiam’s purchase of the shares fromRevolution Living and the $10 option exercise price. The $13.14 per share priceagreed to by the parties was the average price over the last 90 days of Gaiam’sshares prior to the closing. As of the date of repurchase, the 2.5 millionshares are reflected as Treasury stock on Gaiam’s Consolidated Balance Sheet.

**Financial Statement Schedule II**

**Gaiam,Inc.**

**Schedule II - Consolidated Valuation and Qualifying Accounts**

**YearsEnded December 31, 2006, 2005 and 2004**

(in thousands)

 

|                                   | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Deductions** | ** ** | **Balance at  End of  Year (1)** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------|------------|----------------|------------|-------------------------------------------------|------------|
|                              |       |                                         |       |                                                     |       |           |       |                                            |       |
| Allowance for Doubtful  Accounts: |       |                                         |       |                                                     |       |           |       |                                            |       |
| 2006                              |       | $                                            | 761        |                                                     | $          | 1,230          |       | $                                               | 811        |   | $ | 1,180 |   |
| 2005                              |       | $                                            | 642        |                                                     | $          | 945            |       | $                                               | 826        |   | $ | 761 |   |
| 2004                              |       | $                                            | 801        |                                                     | $          | 892            |       | $                                               | 1,051      |   | $ | 642 |   |
|                              |       |                                         |       |                                                     |       |           |       |                                            |       |
| Reserve for Sales  Returns:       |       |                                         |       |                                                     |       |           |       |                                            |       |
| 2006                              |       | $                                            | 4,819      |                                                     | $          | 17,457         |       | $                                               | 15,385     |   | $ | 6,891 |   |
| 2005                              |       | $                                            | 1,814      |                                                     | $          | 6,350          |       | $                                               | 3,345      |   | $ | 4,819 |   |
| 2004                              |       | $                                            | 1,133      |                                                     | $          | 3,737          |       | $                                               | 3,056      |   | $ | 1,814 |   |

----

(1)             Includesreserves associated with acquired assets/companies

**Item 9.             Changes in and Disagreements with Accountants onAccounting and Financial Disclosure**

Not applicable.

**Item 9A.          Controls and Procedures.**

**Evaluationof Disclosure Controls and Procedures**

Gaiam’s chief executive officer and chief financialofficer conducted an evaluation of the effectiveness of the design andoperation of Gaiam’s disclosure controls and procedures, as defined in Rules13a-15(e) and Rule 15d-15(e) under the Exchange Act. Based upon theirevaluation as of December 31, 2006, they have concluded that those disclosurecontrols and procedures are effective.

48

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**Changes in Internal Control over Financial Reporting**

There have been no changes in Gaiam’s internal controlover financial reporting during the quarter ended December 31, 2006 thathave materially affected, or are reasonably likely to affect, Gaiam’s internalcontrol over financial reporting.

**Management’s Report on Internal Control over FinancialReporting**

Management of Gaiam is responsible for establishingand maintaining adequate internal control over financial reporting as definedin Rule 13a-15(f) under the Exchange Act. Our internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with accounting principles generallyaccepted in the United States of America. Because of its inherent limitations,internal control over financial reporting may not prevent or detectmisstatements. Also, projections of any evaluation of effectiveness to future periodsare subject to the risk that controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

Gaiam’s management assessed the effectiveness of Gaiam’sinternal control over financial reporting as of December 31, 2006. Inmaking the assessment, it used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in “*Internal Control-Integrated Framework*.”  Based on that assessment, managementconcluded that, as of December 31, 2006, Gaiam’s internal control overfinancial reporting is effective based on those criteria.

Gaiam’s assessment of the effectiveness of Gaiam’sinternal control over financial reporting as of December 31, 2006 has beenaudited by Ehrhardt Keefe Steiner & Hottman PC, an independent registeredpublic accounting firm, as stated in their report, which is included herein.

**Item 9B.          Other Information**

Not applicable.

**PART III**

**Item 10.           Directors, Executive Officers and Corporate Governance**

The information required by this Item is incorporatedherein by reference to Gaiam’s Proxy Statement for its Annual Meeting ofShareholders, to be held on May 17, 2007, to be filed with the Commissionpursuant to Regulation 14A.

Codeof Ethics

We have adopted a Code of Ethics applicable to ouremployees, including our principal executive officer, principal financialofficer, principal accounting officer and persons performing similar functions.We have posted a copy of our Code of Ethics on the corporate section of ourInternet website at www.gaiam.com/corporate. Any waivers of the Code of Ethicsmust be approved, in advance, by our full Board of Directors. Any amendments orwaivers from the Code of Ethics that apply to our executive officers anddirectors will be posted on the “Code of Ethics” section of our Internetwebsite located at www.gaiam.com/corporate.

**Item 11.           Executive Compensation**

The information required by this Item is incorporatedherein by reference to Gaiam’s Proxy Statement for its Annual Meeting ofShareholders, to be held on May 17, 2007, to be filed with the Commissionpursuant to Regulation 14A.

**Item 12.****                                 SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

The information required by this Item is incorporatedherein by reference to Gaiam’s Proxy Statement for its Annual Meeting ofShareholders to be held on May 17, 2007, to be filed with the Commissionpursuant to Regulation 14A.

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**Item 13.           Certain Relationships and Related Transactions,and Director Independence**

The information required by this Item is incorporatedherein by reference to Gaiam’s Proxy Statement for its Annual Meeting ofShareholders to be held on May 17, 2007, to be filed with the Commissionpursuant to Regulation 14A.

**Item 14.           Principal Accountant Fees andServices**

The information required by this Item is incorporatedherein by reference to Gaiam’s Proxy Statement for its Annual Meeting ofShareholders to be held on May 17, 2007, to be filed with the Commissionpursuant to Regulation 14A.

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**PART IV**

**Item 15.****          Exhibits and Financial Statement Schedules**

 

                         Documentsfiled as part of this report are as follows:
|        |   |   | 1.     | Consolidated Financial Statements.                                                                                   |   |   |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   |   |   |                                                                                                                 |   |   |
|   |   |   |   | See listing of Consolidated Financial Statements  included as part of this Form 10-K in Item 8 of Part II.           |
|   |   |   |   |                                                                                                                 |
|   |   |   | 2.     | Financial Statement Schedules.                                                                                       |   |   |
|   |   |   |   |                                                                                                                 |   |   |
|   |   |   |   | Schedule II Consolidated Valuation and Qualifying  Accounts.                                                         |
|   |   |   |   |                                                                                                                 |
|   |   |   | 3.     | Exhibits:                                                                                                            |   |   |
|   |   |   |   |                                                                                                                 |   |   |
|   |   |   |   | The following exhibits are incorporated by reference  or are filed or furnished with this report as indicated below: |

 

| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                             |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                        |
| 3.1          |       | Amended and Restated Articles of Incorporation of  Gaiam, Inc. (incorporated by

reference to Exhibit 3.1 of Gaiam’s Registration  Statement on Form S-1 (No. 333-  83283)).                                                                           |
|         |       |                                                                                                                                                                                                                                                        |
| 3.2          |       | Amendment to Amended and Restated Articles of  Incorporation of Gaiam, Inc.  (incorporated by reference to Exhibit 3.1 of Gaiam’s quarterly report on Form  10-Q for  the quarter ended June 30, 2006).                                                |
|         |       |                                                                                                                                                                                                                                                        |
| 3.3          |       | Bylaws of Gaiam, Inc. (incorporated by reference to  Exhibit 3.2 of Gaiam’s quarterly  report on Form 10-Q for the quarter ended June 30, 2006).                                                                                                       |
|         |       |                                                                                                                                                                                                                                                        |
| 4.1          |       | Form of Gaiam, Inc. Stock Certificate (incorporated  by reference to Exhibit 4.1 of  Gaiam’s Registration Statement on Form S-1 (No. 333-83283).                                                                                                       |
|         |       |                                                                                                                                                                                                                                                        |
| 10.1         |       | Amended and Restated Credit Agreement dated July 29,  2005 between Gaiam, Inc. and  Wells Fargo Bank, National Association (incorporated by reference to Exhibit  10.2 of  Gaiam’s quarterly report on Form 10-Q for the quarter ended June 30, 2005). |
|         |       |                                                                                                                                                                                                                                                        |
| 10.2         |       | Gaiam, Inc. 1999 Long-Term Incentive Plan  (incorporated by reference to Exhibit 10.1 of  Gaiam’s quarterly report on Form 10-Q for the quarter ended June 30, 2006).                                                                                  |
|         |       |                                                                                                                                                                                                                                                        |
| 10.3         |       | Lease, dated December 16, 1999, between Gaiam, Inc.  and Duke-Weeks Realty Limited  Partnership (incorporated by reference to Exhibit 10.2 of Gaiam’s  Registration Statement  on Form S-4 (No. 333-50560).                                            |
|         |       |                                                                                                                                                                                                                                                        |
| 10.4         |       | First Lease Amendment, dated March 1, 2000, between  Gaiam, Inc. and Duke-Weeks  Realty Limited Partnership (incorporated by reference to Exhibit 10.4 of  Gaiam’s annual  report on Form 10-K for the year ended December 31, 2002).                  |

 

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| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.5         |       | Second Lease Amendment, dated October 5, 2005,  between Gaiam, Inc. and Duke-  Weeks Realty (incorporated by reference to Exhibit 10.5 of Gaiam’s annual  report on  Form 10-K for the year ended December 31, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                 |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.6         |       | Lease Amendment, dated October 5, 2005, between  Gaiam, Inc. and Dugan Realty  (incorporated by reference to Exhibit 10.5 of Gaiam’s annual report on Form  10-K for  the year ended December 31, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                              |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.7         |       | Class A Stock Purchase Agreement, dated as of June  10, 2005, as amended and restated  June 16, 2005, among Gaiam, Inc. and the purchasers set for on the signature  pages to the  Agreement (incorporated by reference to Exhibit 10.1 of Gaiam’s current  report on Form  8-K dated June 10, 2005).                                                                                                                                                                                                                                                                                                                                 |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.8         |       | Asset Purchase Agreement, dated as of July 8, 2005,  among Gaiam, Inc., GT Brands  LLC, GT Merchandising & Licensing LLC, Gym Time, LLC, BSBP Productions LLC,  and GoodTimes Entertainment LLC (incorporated by reference to Exhibit 10.1 of  Gaiam’s current report on Form 8-K dated July 7, 2005), as amended by  Amendment  dated as of September 8, 2005 among Gaiam, Inc., GT Brands LLC, GT  Merchandising  & Licensing LLC, Gym Time, LLC, BSBP Productions LLC, and GoodTimes  Entertainment LLC (incorporated by reference to Exhibit 10.1 of Gaiam’s  current report  on Form 8-K dated September 13, 2005). |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.9         |       | Transaction Agreement dated as of August 4, 2005  among Gaiam, Inc., Revolution  Living, LLC and Life Balance Media Holdings, LLC (incorporated by reference  to  Exhibit 10.1 of Gaiam’s current report on Form 8-K dated August 3, 2005).                                                                                                                                                                                                                                                                                                                                                                                           |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.10        |       | Shareholders Agreement dated as of August 4, 2005  among Gaiam, Inc., Jirka Rysavy,  Revolution Living, LLC, and Stephen M. Case (incorporated by reference to  Exhibit 10.1  of Gaiam’s current report on Form 8-K dated August 3, 2005).                                                                                                                                                                                                                                                                                                                                                                                            |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.11        |       | Purchase Agreement and General Release and Settlement  dated as of February 6, 2007  among Gaiam, Inc., Revolution Living, LLC, Jirka Rysavy and Stephen M. Case  (incorporated by reference to Exhibit 10.1 of Gaiam’s current report on Form  8-K dated  February 12, 2007).                                                                                                                                                                                                                                                                                                                                                        |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.12        |       | Form of Employment Agreement between Gaiam, Inc. and  Jirka Rysavy (incorporated by reference to Exhibit 10.3 of Gaiam’s current  report on Form 8-K dated August 3, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.13        |       | Form of Employment Agreement between Gaiam, Inc. and  Lynn Powers (incorporated  by reference to Exhibit 10.4 of Gaiam’s current report on Form 8-K dated  August 3,  2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.14        |       | Insurance and Stock Redemption Agreement dated as of  August 4, 2005 between Gaiam,  Inc. and Jirka Rysavy (incorporated by reference to Exhibit 10.5 of Gaiam’s  current  report on Form 8-K dated August 3, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                  |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.15        |       | Gaiam, Inc. Executive Officer Salaries (filed  herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|         |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.16        |       | Gaiam, Inc. Nonemployee Director Compensation (incorporated  by reference to exhibit  10.15 of Gaiam’s annual report on Form 10-K for the year ended December 31,  2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                    |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                               |
|        |       |                                                                                                                                                                                                               |
| 10.17       |       | Form of Stock Option Agreement under Gaiam’s 1999  Long-Term Incentive Plan  (incorporated by reference to Exhibit 10.1 of Gaiam’s quarterly report on  Form 10-Q for  the quarter ended June 30, 2005). |
|        |       |                                                                                                                                                                                                               |
| 21.1        |       | List of Gaiam Subsidiaries (filed herewith).                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                               |
| 23.1        |       | Consent letter from Ehrhardt Keefe Steiner &  Hottman PC (filed herewith).                                                                                                                                     |
|        |       |                                                                                                                                                                                                               |
| 31.1        |       | Certification of the Chief Executive Officer pursuant  to Rule 13a-14(a) under the  Securities Exchange Act of 1934 (filed herewith).                                                                              |
|        |       |                                                                                                                                                                                                               |
| 31.2        |       | Certification of the Chief Financial Officer pursuant  to Rule 13a-14(a) under the  Securities Exchange Act of 1934 (filed herewith).                                                                              |
|        |       |                                                                                                                                                                                                               |
| 32.1        |       | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 (furnished herewith).                                                                     |
|        |       |                                                                                                                                                                                                               |
| 32.2        |       | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 (furnished herewith).                                                                     |

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities and Exchange Act of 1934, the Registrant has caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, inthe City of Broomfield, State of Colorado, on this 7th day of March, 2007.

 
|        | GAIAM, INC. |                    |   |
|--------|-------------|-------------------------|--------|
|   |        |                    |   |   |
|   |        |                    |   |   |
|   |        |                    |   |   |
|   | By:         | /s/ Jirka Rysavy        |
|   |        | Jirka Rysavy            |
|   |        | Chief Executive Officer |

** **
| Signature               | ** ** | **Title**                      | ** **                | **Date** | ** **    |
|-------------------------|------------|--------------------------------|---------------------------|----------|---------------|
|                    |       |                           |                      |     |          |
| /s/ Jirka Rysavy        |       |                           | Chairman of the Board and |     | March 7, 2007 |   |
| Jirka Rysavy            |       | Chief Executive Officer        |                      |     |          |
|                    |       | (Principal Executive Officer)  |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ Lynn Powers         |       |                           | President, Secretary and  |     | March 7, 2007 |   |
| Lynn Powers             |       | Director                       |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ James  Argyropoulos |       |                           | Director                  |     | March 7, 2007 |   |
| James  Argyropoulos     |       |                           |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ Barnet M.  Feinblum |       |                           | Director                  |     | March 7, 2007 |   |
| Barnet M.  Feinblum     |       |                           |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ Barbara  Mowry      |       |                           | Director                  |     | March 7, 2007 |   |
| Barbara Mowry           |       |                           |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ Ted Nark            |       |                           | Director                  |     | March 7, 2007 |   |
| Ted Nark                |       |                           |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ Paul H. Ray         |       |                           | Director                  |     | March 7, 2007 |   |
| Paul H. Ray             |       |                           |                      |     |          |
|                    |       |                           |                      |     |          |
| /s/ Vilia  Valentine    |       |                           | Chief Financial Officer   |     | March 7, 2007 |   |
| Vilia Valentine         |       | (Principal Accounting Officer) |                      |     |          |

 

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