**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

 

**FORM 10-K**

 

| **(Mark  One)** |
|-----------------|
|            |   |   |
| **x**           | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|            |   |   |
|            |   | **For the  fiscal year ended December 31, 2007** |
|            |   |   |
|            |   | **or** |
|            |   |   |
| **o**           | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|            |   |   |
|            |   | **For the transition period from                     to                   .** |

** **

**Commission File 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 in Rule 405of the Securities Act.YES **o**  NO **x**

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or 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 orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  **o**

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer,” ,”accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

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

 

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

 

Theaggregate market value of the voting common equity held by non-affiliates ofthe registrant was approximately $323,787,569 as of June 30, 2007, basedupon the closing price on the NASDAQ Global Market on that date.  The registrant does not have non-votingcommon equity.

 

Asof March 13, 2008, 19,735,074 shares of the registrant’s Class Acommon stock and 5,400,000 shares of the registrant’s Class B common stockwere outstanding.

 

**DOCUMENTS INCORPORATED BYREFERENCE**

 

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 2008 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 on Form 10-K

 

For the Fiscal Year Ended December 31, 2007

 

INDEX

 
| ** **    | ** ** | ** **                                                                                                          | ** ** | **Page****Number** |
|---------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|--------------------|
| PART I   |       |                                                                                                                |       |               |
|          |       |                                                                                                                |       | 3                  |
| Item 1.       |       | Business                                                                                                            |       | 11                 |
| Item 1A.      |       | Risk Factors                                                                                                        |       | 15                 |
| Item 1B.      |       | Unresolved Staff  Comments                                                                                          |       | 15                 |
| Item 2.       |       | Properties                                                                                                          |       | 15                 |
| Item 3.       |       | Legal Proceedings                                                                                                   |       | 15                 |
| Item 4.       |       | Submission of  Matters to a Vote of Security Holders                                                                |       | 15                 |
|          |       |                                                                                                                |       |               |
| PART II  |       |                                                                                                                |       | 16                 |
| Item 5.       |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 16                 |
| Item 6.       |       | Selected Financial  Data                                                                                            |       | 17                 |
| Item 7.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 19                 |
| Item 7A.      |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       | 26                 |
| Item 8.       |       | Financial  Statements and Supplementary Data                                                                        |       | 27                 |
| Item 9.       |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               |       | 52                 |
| Item 9A.      |       | Controls and Procedures                                                                                             |       | 52                 |
| Item 9B.      |       | Other Information.                                                                                                  |       | 53                 |
|          |       |                                                                                                                |       |               |
| PART III |       |                                                                                                                |       | 54                 |
| Item 10.      |       | Directors,  Executive Officers and Corporate Governance                                                             |       | 54                 |
| Item 11.      |       | Executive  Compensation                                                                                             |       | 54                 |
| Item 12.      |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       | 54                 |
| Item 13.      |       | Certain  Relationships and Related Transactions, and Director Independence                                          |       | 54                 |
| Item 14.      |       | Principal  Accountant Fees and Services                                                                             |       | 54                 |
|          |       |                                                                                                                |       |               |
| PART IV  |       |                                                                                                                |       | 54                 |
| Item 15.      |       | Exhibits and  Financial Statement Schedules                                                                         |       | 54                 |
|          |       |                                                                                                                |       |               |
| SIGNATURES    |       | 58                                                                                                                  |

 

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**Item 1.  Business**

 

## **OurBusiness**

##  

We are a lifestyle media company providing abroad selection of information, media, products and services to customers whovalue personal development, wellness, ecological lifestyles, responsible mediaand conscious community. We offer our customers the ability to make purchasingdecisions and find responsible content based on these values while providingquality offerings at a price comparable to mainstream alternatives. We marketour content, media and products through a multi-channel approach includingtraditional media channels, direct to consumers via catalogs, the Internet,direct response television, broadband, subscriptions and communities. At theend of 2007, our home media was carried by approximately 70,000 retail storesin the United States alone, and we had approximately 8 million directcustomers.

 

We have established ourselves as a lifestylemedia brand, content producer and licensor, information resource and authorityin the Lifestyles of Health and Sustainability (“LOHAS”) market including theemerging Conscious Media market. We seek to become a unifying symbol of theseemerging media and lifestyle genres. Our lifestyle brand is built around ourability to develop and offer media content, products, lifestyle solutions andcommunity to consumers in the LOHAS and Conscious Media markets. Our contentforms the basis of our proprietary offerings, on which we realize our highestmargins, which then drive demand for parallel product and service offerings.Our operations are vertically integrated from content creation, through productdevelopment and sourcing, to customer service and distribution. We market ourproducts and services across two segments, business and direct-to-consumer. Wedistribute our products in each of these sales segments from a singlefulfillment center.

 

**The LOHAS Market**

 

TheLOHAS market, which represented $227 billion in sales according to the 2000Natural Business Communication study, consists of five main sectors:

 
| · | ***Sustainable Economy*.** Renewable energy, energy  conservation, recycled goods, environmental management services, sustainable  manufacturing processes and related information and services. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                             |
| · | ***Healthy Living*.** Natural and organic foods,  dietary supplements, personal care products and related information and services.                                                              |
|   | *** ***                                                                                                                                                                                     |
| · | ***Alternative Healthcare*.** Health and wellness  solutions and alternative health practices.                                                                                                   |
|   | *** ***                                                                                                                                                                                     |
| · | ***Personal Development*.**  Solutions, information, products and experiences relating to mind, body and  spiritual development.                                                                 |
|   | *** ***                                                                                                                                                                                     |
| · | ***Ecological Lifestyles*.** Environmentally friendly  cleaning and household products, organic cotton clothing and bedding, and  eco-tourism.                                                   |

 

Weparticipate in all five sectors of the LOHAS market with an emphasis onPersonal Development, Ecological Lifestyles and Alternative Healthcare.

 

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**TheConscious Media Market**

 

We consider the ConsciousMedia market to consist of five distinct sectors:

 

·                  ***Children’s.***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.

 

·                  ***Personal Development.*** Informativeand inspiring content that helps people to live a better life.

 

**Our Content**

 

Ourbusiness model revolves around content creation, which forms the basis for ourproprietary products. We have an “in house” production team that producesprogramming, which has won 71 Telly awards and several medals at theInternational New York Film Festival. We are fully high definition and 5.1surround sound capable and do the majority of our authoring and editing at ourColorado facility ensuring the quality standards that drives our awards. Wealso develop children’s programming, which have been the recipient of severalParent’s Choice and Kids First Awards recognizing new products that helpchildren grow imaginatively, physically, and mentally. During 2007, we producedover 100 new titles and added 150 titles to our DVD library through acquisitionsand remakes. We also develop and market music and audio CDs and publish printedcontent.

 

**OurProducts**

 

Ourvisual media programs represent an integral part of our proprietary productoffering. We currently stock approximately 10,000 stock keeping units, of whichapproximately 7,000 are branded proprietary offerings, including media,accessories and soft goods. In 2007, our proprietary products constituted over75% of our product sales.

 

**Our SalesChannels**

 

Weconduct our business across two segments. Our business segment customers areprimarily national retailers, corporate accounts and the media. We conduct ourdirect to consumer business through our catalogs, the Internet, direct responsetelevision, broadband, subscriptions and communities.

 

*Media*

 

Wedevelop, produce and license information and programming targeted to consumerswho value personal development, wellness, spirituality, inspirationalentertainment and conscious community. We have an award-winning library oftitles that we sell to retailers, license to selected distributors operatingoutside of the United States, and license or sublicense for broadcast anddownload. Some of our media partners include Google, Comcast, LodgeNet, andEntertainment One. All of our licensing arrangements require our branding to beprominent on the programming and are subject to royalty agreements with ourperforming artists. While our licensing of the rights to manufacture anddistribute certain of our media lowers recognized revenue, we improve contributionmargins and branding through this licensing. We intend to continue to seek newlicensees for our brand internationally and to move all of our currentdistribution agreements to licensing agreements.

 

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*DRTV*

 

We usedirect response television (“DRTV”) marketing to promote LOHAS products andservices, particularly those aimed at the fitness/wellness market. DRTVmarketing is a highly-scalable distribution channel for segments of our LOHASproduct suite, and also provides broad marketing support for our retailpartners, as well as creating new direct customers to which we cross-market awide range of LOHAS products and services via our catalog, Internet, andsubscription segments. We capitalize on both long-form DRTV shows as well asleading home shopping channels such as QVC. In 2006, we used the DRTV channelto launch our mass market brand “The Firm”.

 

*Retailers*

 

Sincethe inception of our retailer channel in 1998, we have increased our breadthand diversity. As of the end of 2007, our media titles could be found inapproximately 70,000 stores in the United States, up from 68,000 at the end of2006. We currently sell our media and other products across a variety ofleading retailers, including bookstores such as Barnes & Noble andBorders; media stores such as Best Buy and Blockbuster; beauty stores such asUlta; home furnishing stores such as Bed, Bath and Beyond and ABC Carpet andHome; natural food stores such as Whole Foods Market; sporting goods stores suchas Dick’s and REI; mass merchants such as WalMart and Target, our largestcustomer; e-tailers such as Amazon.com and Drugstore.com; and wholesale clubssuch as Costco and Sam’s Club. Many of these retailers display our products inbranded store-within-store lifestyle presentations that may include customfixtures that we design. We implemented our first store-within-store conceptlate in 2000 and the concept has grown to over 7,000 stores by the end of 2007,up from 6,000 stores at the end of 2006.

 

Throughdistributor arrangements, licensing agreements and acquisitions, our branded products are found in Canada, Japan, theUnited Kingdom and Australia. We sell our media products to internationalaccounts primarily under licensing agreements and we sell the remainingproducts through distributor relationships. Our intention is to focus onlicense arrangements in the future.

 

*Services*

 

We conduct operations as a solar energyintegrator through our wholly owned subsidiary Real Goods Solar, Inc.,offering turnkey services including the design, procurement, installation, gridconnection, monitoring, maintenance and referrals for third-party financing ofsolar energy systems.  We also sellrenewable energy products and sustainable living resources through Real Goods’nationally distributed catalog and website. On February 7, 2008, Real Goods filed a registration statement on Form S-1relating to the initial public offering of its Class A common stock.

 

*Catalogs*

 

Weoffer a variety of LOHAS products directly to the consumer through our catalogsand through some consumer lifestyle publications. We mailed approximately 19million catalogs in 2007. Our customer demographics are highly regarded withour customers having an average income over $85,000 and over 70% of them beingcollege educated.

 

*Internet*

 

We usethe Internet to sell our products and to provide information on the LOHASlifestyle.  We currently offerapproximately 10,000 stock keeping units on our website, www.gaiam.com.  We promote our website through our visualmedia, catalogs, print publications, product packaging and Internet links. Weprovide customer support for Internet sales from our in-house call center as akey component of our Internet approach.

 

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*Communityand Subscription Services*

 

Weoffer a variety of subscription paid services. These services include online communities under various brands andsubscription clubs.  During 2006, weacquired Spiritual Cinema Circle, a membership DVD club. During 2007, weacquired Zaadz, a leading social networking site for LOHAS consumers, ConsciousEnlightenment, an online and offline community that offers rewards cards andoperates several LOHAS magazines and Lime, a multichannel green lifestylecompany.  In the fourth quarter of 2007we also tested a beta site for our community development at gaia.com.

 

**OurOperations**

 

*SalesChannels, Product Development and Sourcing*

 

Wesell our branded products across various sales channels. Non-proprietaryproducts are only available through our catalogs and over the Internet. We useour catalog and Internet channels to test products before we develop productsunder our brand and distribute them through our other sales channels. Becausewe use a multi-channel approach to our business we are able to leverage our mediaand product development costs across all channels of our business.

 

Ourdevelopment team designs our proprietary offerings, our merchandisers sourcethese products both domestically and internationally and third party suppliersproduce these products to our specifications. We design our products to supplyinformation, enhance customers’ lifestyles and experiences and provide healthy,natural solutions while being eco-friendly and promoting a sustainable economy.We also screen the environmental and social responsibility of our suppliers. Inorder to minimize risk we often identify an alternate supplier for our productsin a separate location.

 

*CustomerService*

 

Wefocus on building and maintaining customer relationships that thrive on loyaltyand trust. We maintain a “no-risk guarantee” policy, whereby we provide acustomer a full refund for our products that are returned at any time, for anyreason. We have established a most valued customer program, which extends addedbenefits to our most loyal catalog and Internet customers. Our in-housecustomer service department includes product specialists who have specificproduct knowledge and assist customers in selecting products and solutions thatmeet their needs. We employ telephone routing software that directs each callto the appropriate representative. Our policy is to ship orders no later thanthe next business day, which we accomplish by stocking inventory that supportsover 85% of our orders. We believe that by offering exceptional customerservice we encourage repeat purchases by our customers, enhance our brandidentity and reputation and build stronger relationships with our customers.

 

*Established Infrastructure*

 

Weoperate a 283,000 square foot distribution center near Cincinnati, Ohio, whichprovides fulfillment for most of our current domestic business needs and hasthe capacity 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*

 

Proprietaryand authentic content lies at the core of our business model. Our mediaofferings introduce customers to us and help establish us as an authority inthe LOHAS market. Our primary focus is on leveraging our content with brandedlifestyle offerings through various media, catalogs, the Internet, and nationalretailers. We believe that the content-centric strategy is a competitiveadvantage and the multi-channel approach allows us the broadest possibleconsumer reach. It also provides the optimal “context” for us to market lifestyleproducts that are appropriate companions to the media.

 

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Wewill continue to develop authentic content that caters to the LOHAS lifestylein DVD, book and audio formats and also accelerate our efforts in the broadcastand online categories. To this end, we added wellness as a category to ourmedia library in 2007 by producing DVDs with the Mayo Clinic as a partner. Weintend to continue to expand our brand to the Conscious Media market, whichincorporates children’s, family, inspirational and edutainment media. Webelieve we can establish our brand as a leading brand in some of these mediacategories.

 

Wehave expanded our visual media offerings internationally and plan to continueto expand this opportunity. We also intend to broaden the variety of formats weoffer, from our traditional “physical media” (DVD, CD, etc), to making ourcontent available online to our consumers in both one-shot “purchase” format orsubscription services.

 

*Capitalize on our market sharepositioning*

 

We continue to grow ourmedia market share. Based on Nielsen’s Videoscan, we grew our U.S. DVD marketshare in the fitness/wellness category from 26% in 2005 (over 40% on a proforma basis, giving effect to our acquisition of the assets of GoodTimesEntertainment) to 45% in 2006 to 49% in 2007. With our market share nowapproaching 50%, we intend to sacrifice some of our market share in fitness inorder to assume a category management role bringing competitive product intothe mix to establish the most complete fitness assortment in the business. Webelieve by assuming this category management role, we can improve our revenuesand profitability. Based on the same Nielsen scanning, we ended 2007 sixth inthe non-theatrical U.S. DVD category with 6% market share. We intend tocontinue to grow our market share in the non-theatrical category through theproduction and acquisition of Conscious Media titles, focusing on children’sand family entertainment.  We also planto extend our line of offerings into wellness and green living with solutionbased programming and media based kits, building store within store wellnessofferings and continuing to grow our retail presence.

 

*Improve our Profit Margins*

 

We believe we can improveour profit margins with several distinct strategies. We will continue to focusour sales strategy on media that carries over 70% gross margins. We areestablishing ourselves as a brand in the Conscious Media and wellness/fitnessmedia market as well as in a genre we call edutainment. By continuing to growour market share in media, we believe we can attract more media producers towork with our brand instead of the traditional studio or distributor model.

 

We continue to improvemargins by our ability to serve the large retailers directly instead of goingthrough third party distributors, as a result of the increased sales volume ofour media. Since the GoodTimes transaction, we have been able to go directly toretailers like Wal-Mart and Kmart that were serviced by third partydistributors prior to the acquisition. During 2006 we implemented a new Vendor Manager Inventory Systemallowing us to improve store turns and reduce markdowns.

 

We launched a continuityand subscription business in second quarter of 2005 which we augmented withcertain assets we acquired from GoodTimes and with our acquisition of amajority of the equity of Spiritual Cinema in 2006. These businesses carry over85% gross margins and connect our media content directly to the consumer. Weexpect to continue to invest in this channel of business. We believe that withthe increase in broadband acceptance in the consumer marketplace, coupled withour specialized media library and loyal direct customer base, we have anopportunity for strong growth at high margins.

 

We expect to grow ourinternational business through licensing arrangements that carry low cost ofgoods. We have a valuable library of branded products, with only a smallportion monetizing outside North America.

 

*Strengthen our Lifestyle Brand*

 

Ourgoal is to maintain our brand as an authority in the LOHAS market (includingConscious Media) and to establish our brand as a unifying symbol of theemerging LOHAS lifestyle. We plan to strengthen our brand by growing our media,making our brand more prominent across our catalog efforts, focusing oncategory management initiatives, increasing our store-within-store presenceacross national retailers, increasing our marketing and public relationsefforts, and aggressively developing and marketing proprietary products whilemaintaining our high level of customer service. We initiated a branding studyin late 2006 that drove this initiative during 2007.

 

7

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*Launch aMass Market Brand in Fitness*

 

We launched mass marketmedia and products in fitness under “The Firm” brand in late 2006. We believethat the aging baby boomers at all income levels will be looking forfitness/wellness products. We do not market our brand except in media incertain mass market channels and believe there is growth opportunity for us inthose channels under a different brand with our same attention to quality. Wesupported The Firm brand through DRTV dollars during 2007 and ended the yearwith over 1,500 doors carrying The Firm brand through a store-within-storedisplay.

 

*Expandour Proprietary Products*

 

Ourproprietary products, which we introduced in 1997, represented over 75% of ourrevenues in fiscal year 2007. These products carry a higher margin, provide forbranding opportunity and distinguish us from our competitors. We currentlyoffer proprietary products that range from media products to sleep, stressrelief, yoga and Pilates accessories to organic cotton bedding and bathproducts. We have also expanded our exclusive media library to over 2,500titles through acquisitions and internal development. 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 theConscious Media market. We are strengthening our supply chain globally bysourcing a greater number of products offshore and leveraging our expandingmedia sales to acquire lower costs from our replicators. We leverage ourproduct development costs over all sales channels.

 

*Capitalize on our Multi-channel Approach*

 

Ourmulti-channel strategy affords us the broadest possible customer reach, as wellas the ability to allow our customers to buy from us “what they want, when theywant, where they want to.” This approach makes purchasing our lifestyleproducts convenient regardless of the channel that a customer prefers. It alsoallows us to migrate segments of our customer base across channels to developdeeper, longer-lasting relationships with them, and to convert them frompurchasers of individual media products into subscribers to our “continuityprograms,” whether those are DVD-based, or online access to communities andcontent on a continuity basis. Additionally, this diversified, strategicapproach should provide for continued operating and business stability as wehave the ability to cross-market lifestyle products and services regardless ofthe customer location or the channel to which we are marketing.

 

In our direct to consumerbusiness we are open 24 hours a day, offering approximately 10,000 stockkeeping units on our Internet site. As we increase the depth of media andcommunity functionality available to our consumers, our Internet presence willtransform from being merely a place to “order” product to a place to “consume”it, in real-time.

 

In ourbusiness segment, we continue to expand our presence in national retailers andcurrently have placements in approximately 70,000 retail points in the UnitedStates, up from 68,000 at the end of 2006 and 50,000 at the end of 2005. Wealso continue to expand our store-within-store concept in a variety of stores,including Whole Foods Market, Barnes & Noble Bookstores, Borders,Target, Ulta, Dick’s Sporting Goods, REI, ABC Carpet and Home and othernational retailers. We currently have over 7,000 store within store conceptsunder the Gaiam and The Firm brands.

 

*Complement our Existing Businesswith Selective Strategic Acquisitions*

 

Ourgrowth strategy is not dependent on acquisitions. However, we will considerthose strategic acquisitions in the LOHAS market that complement our existingbusiness, increase our media and related product offerings, expand ourgeographical reach, extend our channel distribution, and add to our directcustomer base. We especially focus on companies with media content, a strongbrand identity and customer and product information databases that augment ourexisting databases. We often allow some of the acquired company’s managementteam to retain responsibility for front-end business functions such as creativepresentation and marketing, while consolidating operational functions under ourexisting infrastructure when we can realize economies of scale.

 

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*Establisha lifestyle community*

 

In 2008, we plan toexpand our community and social networking efforts, with specific focus onsustainability, personal development, healthy living, spirituality, alternativehealthcare, and responsible media. We already work with leading experts inthese fields to produce our current suite of media offerings. During 2008, wewill continue to develop the online “space” for our customers to come togetherwith each other and with our cadre of experts in these core LOHAS areas, toshare ideas, discuss new trends and solutions, and allow our customers haveaccess to world-class resources to deepen their understanding of issues thatare central to how they choose to live their lives. During 2007, we launchedour new community site at gaia.com. We believe that by developing a communityof like-minded people, we can effect positive changes on the planet.

 

**OurBusiness Segments**

 

Weseparate our business into two business segments: the business segment whichincludes sales to businesses, retailers, international licenses, corporateaccounts and media outlets; and the direct to consumer segment, which includesDRTV, catalogs, E-commerce, and subscription community services.

 

Thebusiness segment represented 42.4% of 2007 net revenues, while the direct toconsumer segment represented 57.6% of net revenues. Our business segment isdependent upon a few major customers for a significant portion of its revenues.See Note 12 to our consolidated financial statements for further information onour segments.

 

**OurIntellectual Property**

 

Ourtradename Gaiam and various product and Internet domain names are subject totrademark or pending trademark applications of Gaiam or a Gaiam company. Webelieve these trademarks are significant assets to our business.

 

**OurCompetitive Position**

 

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

 

Ourbusiness is evolving and competitive. Larger and better-established entitiesmay acquire, invest in or form joint ventures with our competitors. Many ofthese entities have longer operating histories and have greater financial andmarketing resources than we have. Increased competition from these or othercompetitors could reduce our revenue and profits. In addition, the smallerbusinesses we compete against may be able to more effectively personalize theirrelationships with customers.

 

Becausewe use multi-channel distribution for our products, we compete with variousproducers of similar products and services. Our competitors include Warner,Disney, Paramount, Fox, Lions Gate, Liberty Media, Nike, Reebok, thousands ofsmall, local and regional businesses, and product lines or items offered bylarge retailers, manufacturers, publishers and media producers.

 

Webelieve the principal competitive factors in the LOHAS market are authenticityof information, unique content and distinctiveness of products and services,quality of product, brand recognition and price, and distribution capabilities.We believe we compete favorably on all these relevant factors.

 

Weexpect industry consolidation to increase competition. As our competitors grow,they may adopt aggressive pricing or inventory policies, which could result inreduced operating margins and loss of market share.

 

Oursuccess also depends upon the willingness of consumers to purchase media, goodsand services that promote the values we espouse. While we believe our businessplan and assumptions are reasonable, the demographic trends on which they arebased may change and the current consumption levels may not be sustained. Thedecrease of consumer interest in purchasing goods and services that promote thevalues we espouse would materially and adversely affect our customer base andrevenues and, accordingly, our financial prospects.

 

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**Our Employees**

 

As of February 20,2008, we employed approximately 454 individuals. None of our employees arecovered by a collective bargaining agreement.

 

**RegulatoryMatters**

 

Anumber of existing and proposed laws restrict disclosure of consumers’ personalinformation, which may make it more difficult for us to generate additionalnames for our direct marketing, and restrict our ability to send unsolicitedelectronic mail or printed materials. Although we believe we are generally incompliance with current laws and regulations and that these laws andregulations have not had a significant impact on our business to date, it ispossible that existing or future regulatory requirements will impose asignificant burden on us.

 

Wegenerally collect sales taxes only on sales to residents of states in which wehave locations.  Currently, we collectsales taxes on certain sales to residents of California, Colorado, New York andOhio. A number of legislative proposals have been made at the federal, stateand local level, and by foreign governments, that would impose additional taxeson the sale of goods and services over the Internet and certain states havetaken measures to tax Internet-related activities. If legislation is enactedthat requires us to collect sales taxes on sales to residents of other statesor jurisdictions, sales in our direct to consumer businesses may be adverselyaffected.

 

Ourbusiness is also subject to a number of other governmental regulations,including the Mail or Telephone Order Merchandise Rule and relatedregulations of the Federal Trade Commission. These regulations prohibit unfairmethods of competition and unfair or deceptive acts or practices in connectionwith mail and telephone order sales and require sellers of mail and telephoneorder merchandise to conform to certain rules of conduct with respect toshipping dates and shipping delays. We are also subject to regulations of theU.S. Postal Service and various state and local consumer protection agenciesrelating to matters such as advertising, order solicitation, shipment deadlinesand customer refunds and returns. In addition, merchandise that we import issubject to import and customs duties and, in some cases, import quotas.

 

**Seasonality**

 

Seethe “Quarterly and Seasonal Fluctuations” section of Item 7, Management’sDiscussion and Analysis of Financial Condition and Results of Operations, forinformation pertaining to the seasonal aspects of our business.

 

**AvailableInformation**

 

Ourcorporate website at www.gaiam.com/corporate provides information about us, ourhistory, goals and philosophy, as well as certain financial reports andcorporate press releases. Our www.gaiam.com website features a library ofinformation and articles on personal development, healthy lifestyles andenvironmental issues, along with an extensive offering of media, products andservices. We believe our website provides us with an opportunity to deepen ourrelationships with our customers and investors, educate them on a variety ofissues, and improve our service. As part of this commitment, we have added alink on our corporate website to our Securities and Exchange Commissionfilings, including our reports on Form 10-K, 10-Q and 8-K and allamendments to such reports. We make those reports available through ourwebsite, free of charge, as soon as reasonably practicable after these reportsare filed with the Securities and Exchange Commission.

 

Wehave included our website addresses only as inactive textual reference, and theinformation contained on our website is not incorporated by reference into the Form 10-K.

 

10

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**Item 1A.  Risk factors**

 

Wewish to caution you that there are risks and uncertainties that could cause ouractual results to be materially different from those indicated by forwardlooking statements that we make from time to time in filings with the Securitiesand Exchange Commission, news releases, reports, proxy statements, registrationstatements and other written communications as well as oral forward lookingstatements made from time to time by our representatives. These risks anduncertainties include, but are not limited to, those risks described below thatwe are presently aware of. Additional risks and uncertainties that we currentlydeem immaterial may also impair our business operations, and historical resultsare not necessarily an indication of the future results. The cautionarystatements below discuss important factors that could cause our business,financial condition, operating results and cash flows to be materiallyadversely affected.

 

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

 

Changesin overall economic conditions that impact consumer spending could also impactour results of operations. Future economic conditions affecting disposableincome such as employment levels, consumer confidence, business conditions,stock market volatility, weather conditions, acts of terrorism, threats of war,and interest and tax rates could reduce consumer spending or cause consumers toshift their spending away from our products. If the economic conditions andperformance of the retail and media environment worsen, we may experiencematerial adverse impacts on our business, operating results and financialcondition.

 

*Increasedcompetition could impact our financial results*

 

Webelieve that the LOHAS market includes thousands of small, local and regionalbusinesses. Some smaller businesses may be able to more effectively personalizetheir relationships with customers, thereby gaining a competitive advantage.Although we believe that we do not compete directly with any single companythat offers our entire range of merchandise and services, within each categorywe have competitors and we may face competition from new entrants. Some of ourcompetitors or our potential competitors may have greater financial andmarketing resources and greater brand recognition. In addition, larger,well-established and well-financed entities may acquire, invest in or formjoint ventures with our competitors. Increased competition from these or othercompetitors could negatively impact our business.

 

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

 

Wetarget our business at consumers who assign high value to personal development,healthy lifestyles, responsible media, renewable energy and the environment. Adecrease of consumer interest in purchasing goods and services that promote thevalues we espouse would materially and adversely affect our customer base andsales revenues and, accordingly, our financial prospects. Further, consumerpreferences and product trends are difficult to predict. Our future successdepends in part on our ability to anticipate and respond to changes in consumerpreferences and we may not respond in a timely or commercially appropriatemanner to such changes. Failure to anticipate and respond to changing consumerpreferences and product trends could lead to, among other things, lower salesof our products, increased merchandise returns and lower margins, which couldhave a material adverse effect on our business.

 

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

 

Animportant part of our strategy is to feature branded products. These productsare sold under our brand names and are manufactured to our specifications. Weexpect our reliance on branded merchandise to increase. The use of brandedmerchandise requires us to incur costs and risks relating to the design andpurchase of products, including submitting orders earlier and making longerinitial purchase commitments.

 

Inaddition, the use of branded merchandise limits our ability to return unsoldproducts to vendors, which can result in higher markdowns in order to sellexcess inventory. Our commitment to customer service typically results in uskeeping a high level of merchandise in stock so we can fill orders quickly.Consequently, we run the risk of having excess inventory, which may alsocontribute to higher markdowns. Our failure to successfully execute a brandedmerchandise strategy or to achieve anticipated profit margins on these goods,or a higher than anticipated level of overstocks, may materially adverselyaffect our revenues.

 

11

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Weoffer our customers liberal merchandise return policies. Our consolidatedfinancial statements include a reserve for anticipated merchandise returns,which is based on historical return rates. It is possible that actual returnsmay increase as a result of factors such as the introduction of newmerchandise, changes in merchandise mix or other factors. Any increase in ourmerchandise returns will correspondingly reduce our revenues.

 

*Acquisitionsmay harm our financial results*

 

Wehave historically expanded our operations in part through strategicacquisitions. We cannot accurately predict the timing, size and success of ouracquisition efforts. Our acquisition strategy involves significant risks thatcould inhibit our growth and negatively impact our operating results, includingthe following: our ability to identify suitable acquisition candidates atacceptable prices; our ability to complete successfully the acquisitions ofcandidates that we identify; our ability to compete effectively for availableacquisition opportunities; increases in asking prices by acquisition candidatesto levels beyond our financial capability or to levels that would not result inthe returns required by our acquisition criteria; diversion of management’sattention to expansion efforts; unanticipated costs and contingent liabilitiesassociated with acquisitions; failure of acquired businesses to achieveexpected results; our failure to retain key customers or personnel of acquiredbusinesses and difficulties entering markets in which we have no or limitedexperience. In addition, the size, timing and success of any futureacquisitions may cause substantial fluctuations in our operating results fromquarter to quarter. Consequently, our operating results for any quarter may notbe indicative of the results that may be achieved for any subsequent quarter orfor a full fiscal year. These fluctuations could adversely affect the marketprice of our Class A common stock.

 

*The lossof the services of our key personnel could disrupt our business*

 

Wedepend on the continued services and performance of our senior management andother key personnel, particularly Jirka Rysavy and Lynn Powers. Our strategy ofallowing the management teams of some acquired companies to continue toexercise significant management responsibility for those companies makes itimportant that we retain key employees, particularly the sales and creativeteams, of the companies we might acquire.

 

*Ourfounder and chief executive officer Jirka Rysavy controls us*

 

Mr. Rysavyholds 100% of our 5,400,000 outstanding shares of class B common stock and alsoowns 868,682 shares of Class A common stock. The shares of Class Bcommon stock are convertible into shares of Class A common stock at anytime. Each share of Class B common stock has ten votes per share, and eachshare of Class A common stock has one vote per share. Consequently, Mr. Rysavyis able to vote a majority of our stock, to exert substantial influence over usand to control matters requiring approval by our shareholders, including theelection of directors, increasing our authorized capital stock, or a merger orsale of our assets. As a result of Mr. Rysavy’s control, no change ofcontrol of us can occur without Mr. Rysavy’s consent.

 

*Oursuccess depends on the value of our brand*

 

Becauseof our reliance on sales of proprietary products, our success depends on ourbrand. Building and maintaining recognition of our brand are important toattracting and expanding our customer base. If the value of our brand wereadversely affected, we cannot be certain that we will be able to attract newcustomers, retain existing customers or encourage repeat purchases, and if thevalue of our brand were to diminish, our revenues, results of operations andprospects would be adversely affected.

 

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

 

Mostof our media content is subject to arrangements with third parties pursuant towhich we have licensed certain rights to use and distribute media content ownedby third parties or have licensed to third parties certain rights to use anddistribute media content that we own. In addition, we have a number ofagreements with third parties concerning the use of our media content andintellectual property, including agreements regarding royalties, distribution,duplication, etc. Allegations that we do not have rights to use media contentand other disputes arising from such arrangements can be costly and may have amaterial adverse impact on our results.

 

12

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*Product liability claims againstus could result in adverse publicity and potentially significant monetarydamages.*

 

As a seller of consumerproducts, we face an inherent risk of exposure to product liability claims inthe event that use of products we sell results in injuries. If such injuries orclaims of injuries were to occur, we could incur monetary damages and ourbusiness could be adversely affected by any resulting negative publicity. Thesuccessful assertion of product liability claims against us also could resultin potentially significant monetary damages and, if our insurance protection isinadequate to cover these claims, could require us to make significant paymentsfrom our own resources.

 

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

 

We aredependent on the success of our proprietary products, and we rely on a selectgroup of manufacturers to provide us with sufficient quantities to meet ourcustomers’ demands in a timely manner, produce these products in a humane andsafe environment for both their workers and the planet, maintain qualitystandards consistent with our brand, and meet certain pricing guarantees. Ouroverseas sourcing of these products continues to increase, and thesearrangements carry risks associated with relying on products manufacturedoutside of the U.S., including political unrest and trade restrictions,currency fluctuations, transportation difficulties, work stoppages, and otheruncertainties. In addition, a number of our suppliers are small companies, andsome of these vendors may not have sufficient capital, resources or personnelto increase their sales to us or to meet our needs for increased commitmentsfrom them. The failure of our suppliers to provide sufficient quantities of ourproprietary products could decrease our revenues, increase our costs, anddamage our customer service reputation.

 

*We relyon communications and shipping networks to deliver our products*

 

Givenour emphasis on customer service, the efficient and uninterrupted operation oforder-processing and fulfillment functions is critical to our business. Tomaintain a high level of customer service, we rely heavily on a number ofdifferent outside service providers, such as printers, telecommunicationscompanies and delivery companies. Any interruption in services from ourprincipal outside service providers, including delays or disruptions resultingfrom labor disputes, power outages, human error, adverse weather conditions ornatural disasters, could materially adversely affect our business. In addition,freight carriers must ship products that we source overseas to our distributioncenter, and a work stoppage or political unrest could adversely affect ourability to fulfill our customer orders.

 

*Informationsystems upgrades or integrations may disrupt our operations or financial reporting*

 

Wecontinually evaluate and upgrade our management information systems, which arecritical to our business. These systems assist in processing orders, managinginventory, purchasing and shipping merchandise on a timely basis, responding tocustomer service inquiries, and gathering and analyzing operating data bybusiness segment, customer, and stock keeping unit (a specific identifier foreach different product). We are required to continually update these systems.Furthermore, if we acquire other companies, we will need to integrate theacquired companies’ systems with ours, a process that could be time-consumingand costly. If our systems cannot accommodate our growth or if they fail, wecould incur substantial expenses and our business could be adversely affected.

 

Additionally,our success in E-commerce will depend upon our ability to provide a compellingand satisfying shopping experience. To remain competitive, we must continue toenhance and improve the responsiveness, functionality and features of ouronline technology, and if we are unable to do this, our business could beadversely affected.

 

*Amaterial security breach could cause us to lose sales, damage our reputation orresult in liability to us*

 

Ourcomputer servers may be vulnerable to computer viruses, physical or electronicbreak-ins and similar disruptions. We may need to expend significant additionalcapital and other resources to protect against a security breach or toalleviate problems caused by any breaches. Our relationships with our customersmay be adversely affected if the security measures that we use to protectpersonal information such as credit card numbers are ineffective. We currentlyrely on security and authentication technology that we license from thirdparties. We may not succeed in preventing all security breaches and our failureto do so could adversely affect our business.

 

13

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*Oursystems may fail or limit user traffic, which would cause us to lose sales*

 

Wesupport most of our business through our call center in Broomfield, Colorado.Even though we have back up arrangements, we are dependent on our ability tomaintain our computer and telecommunications equipment in this center ineffective working order and to protect against damage from fire, naturaldisaster, power loss, telecommunications failure or similar events. Inaddition, growth of our customer base may strain or exceed the capacity of ourcomputer and telecommunications systems and lead to degradations in performanceor systems failure. We have experienced capacity constraints and failure ofinformation systems in the past that have resulted in decreased levels ofservice delivery or interruptions in service to customers for limited periodsof time. Although we continually review and consider upgrades to our technicalinfrastructure and provide for system redundancies and backup power to limitthe likelihood of systems overload or failure, substantial damage to oursystems or a systems failure that causes interruptions for a number of dayscould adversely affect our business. Additionally, if we are unsuccessful inupdating and expanding our infrastructure, including our call center, ourability to grow may be constrained.

 

*Governmentregulation of the Internet and E-commerce is evolving and unfavorable changescould harm our business*

 

We aresubject to general business regulations and laws, as well as regulations andlaws specifically governing the Internet and E-commerce. Such existing andfuture laws and regulations may impede the growth of the Internet or otheronline services.  These regulations andlaws may cover taxation, user privacy, pricing, content, copyrights,distribution, consumer protection, the provision of online payment services andquality of products and services.  Thereis lack of clarity on how existing laws governing issues such as propertyownership, sales and other taxes and personal privacy apply to the Internet andE-commerce.  Unfavorable resolution ofthese issues may harm our business.

 

*We mayface legal liability for the content contained on our website*

 

Wecould face legal liability for defamation, negligence, copyright, patent ortrademark infringement, personal injury or other claims based on the nature andcontent of materials that we publish or distribute on our website. If we areheld liable for damages for the content on our website, our business maysuffer. 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.

 

*Relyingon our centralized fulfillment center could expose us to losing revenue*

 

Promptand efficient fulfillment of our customers’ orders is critical to our business.Our facility in Cincinnati, Ohio handles our fulfillment functions and somecustomer-service related operations, such as returns processing. A majority ofour orders are filled and shipped from the Cincinnati facility. The balance isshipped directly from suppliers. Because we rely on a centralized fulfillmentcenter, our fulfillment functions could be severely impaired in the event offire, extended adverse weather conditions, transportation difficulties ornatural disasters. Because we recognize revenue only when we ship orders,interruption of our shipping would diminish our revenues.

 

*We mayface quarterly and seasonal fluctuations that could harm our business*

 

Ourrevenue and results of operations have fluctuated and will continue tofluctuate on a quarterly basis as a result of a number of factors, includingthe timing of catalog offerings, timing of orders from retailers, recognitionof costs or net sales contributed by new merchandise, fluctuations in response rates,fluctuations in paper, production and postage costs and expenses, merchandisereturns, adverse weather conditions that affect distribution or shipping,shifts in the timing of holidays and changes in our merchandise mix. Inparticular, our net sales and profits have historically been higher during thefourth quarter holiday season. We believe that this seasonality will continuein the future.

 

*Postageand shipping costs may increase and therefore increase our expenses*

 

Weship our products, catalogs, and lifestyle publications to consumers and thecost of shipping is a material expenditure. Postage and shipping pricesincrease periodically and can be expected to increase in the future. Anyinability to secure suitable or commercially favorable prices or other termsfor the delivery of our merchandise and catalogs could have a material adverseeffect on our financial condition and results of operations.

 

14

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*Ourbusiness is subject to reporting requirements that continue to evolve andchange, which could continue to require significant compliance effort andresources.*

 

Becauseour common stock is publicly traded, we are subject to certain rules andregulations of federal, state and financial market exchange entities chargedwith the protection of investors and the oversight of companies whosesecurities are publicly traded. These entities, including the Public CompanyAccounting Oversight Board, the SEC and the NASDAQ, periodically issue newrequirements and regulations and legislative bodies also review and reviseapplicable laws such as the Sarbanes-Oxley Act of 2002. As interpretation andimplementation of these laws and rules and promulgation of new regulationscontinues, we will continue to be required to commit significant financial andmanagerial resources and incur additional expenses.

 

**Item 1B.   Unresolvedstaff comments**

 

NotApplicable.

 

### **Item 2.     Properties**

###  

Ourprincipal executive offices are located in Broomfield, Colorado. Ourfulfillment center is located in the Cincinnati, Ohio area. This facilityhouses most of our fulfillment functions. We selected the Cincinnati site afterconsidering the availability and cost of facilities and labor, proximity tomajor highways, air delivery hubs and support of local government of newbusinesses. We also believe that Cincinnati is ideal for providing the low costshipping available from a single central point to a customer base that conformsto the overall U.S. population.

 

Thefollowing table sets forth certain information relating to our primaryfacilities:

 
| **Primary  Locations** | ** ** | **Size**        | ** ** | **Use**                           | ** ** | **Lease  Expiration** | ** ** |
|------------------------|------------|-----------------|------------|-----------------------------------|------------|-----------------------|------------|
| ** **             | ** ** | ** **      | ** ** | ** **                        | ** ** | ** **            | ** ** |
| Broomfield, CO         |       | 36,000 sq. ft.  |       | Headquarters and customer service |       | May 2008         |       |
|                   |       |            |       |                              |       |                  |       |
| Cincinnati, OH         |       | 283,000 sq. ft. |       | Fulfillment center                |       | June 2010        |       |
|                   |       |            |       |                              |       |                  |       |
| New York, NY           |       | 18,400 sq. ft.  |       | Media office                      |       | April 2008       |       |
|                   |       |            |       |                              |       |                  |       |
| Hopland, CA            |       | 12 acres        |       | Renewable energy demo site        |       | Owned                 |       |

 

Wehave an option to renew the existing lease for our fulfillment center. We haveentered into a leasing arrangement, commencing April 1, 2008 and expiring March 31,2015, for a new 12,700 square foot New York media office, which we intend tooccupy when our current New York lease expires. On January 15, 2008, weentered into an option to purchase land, an office building, and improvementslocated in Colorado for approximately $13.2 million in cash, which we estimateto be well below its replacement value. It is our intention to purchase the property and relocate our corporateheadquarters and customer service to this newly acquired property during thesecond quarter of 2008 upon expiration of our existing lease. We believeour other facilities are adequate to meet our current needs and that suitableadditional facilities will be available for lease or purchase when, and as, weneed them.

 

### **Item 3.     Legalproceedings**

###  

From time to time, we are involved in legal proceedings that weconsider to be in the normal course of business. We do not believe that any ofthese proceedings will have a material adverse effect on our business.

 

##### **Item 4.     Submission of matters to a vote of security holders**

#####  

Nomatters were brought to a vote of our shareholders in the fourth quarter of thefiscal year ended December 31, 2007.

 

15

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**Part II**

 

###### **Item 5.     Market for registrant’s common equity, related stockholdermatters and issuer purchases of equity securities**

######  

**Stock Price History**

 

Our Class Acommon stock is listed on the NASDAQ Global Market under the symbol “GAIA”. On March 13,2008, we had 7,872 shareholders of record and 19,735,074 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.

 

Thefollowing table sets forth certain sales price and trading volume data for our Class Acommon stock for the period indicated:

 
| ** **     | ** ** | **High Bid** | ** ** | **Low Bid** | ** ** | **Close** | ** ** | **Average  Daily  Volume** | ** ** |
|----------------|------------|-------------------|------------|------------------|------------|-----------|------------|----------------------------|------------|
| Fiscal 2007:   |       |              |       |             |       |      |       |                       |       |
| Fourth Quarter |       | $                 | 30.73      |             | $          | 19.50     |       | $                          | 29.68      |   | 227,383 |   |
| Third Quarter  |       | $                 | 24.14      |             | $          | 14.67     |       | $                          | 24.03      |   | 213,300 |   |
| Second Quarter |       | $                 | 18.50      |             | $          | 14.15     |       | $                          | 18.23      |   | 200,805 |   |
| First Quarter  |       | $                 | 15.85      |             | $          | 11.65     |       | $                          | 15.74      |   | 195,993 |   |
|           |       |              |       |             |       |      |       |                       |       |
| 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 |   |

 

**IssuerPurchases of Equity Securities**

 

Thefollowing table summarizes purchases of our Class A common stock that wemade during the periods indicated:

 
| **Period**                | ** ** | **(a)  Total Number of Shares  Purchased** | ** ** | **(b)  Average Price Paid per  Share** | ** ** | **(c)  Total Number of Shares  Purchased as Part of  Publicly Announced Plans  or Programs** | ** ** | **(d)  Maximum Number (or  Approximate Dollar  Value) of Shares that May  Yet Be Purchased Under  the Plans or Programs** | ** ** |
|---------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| February 1-28,  2007 |       | 2.5 million                                               | (1)        | $                                                     | 13.14      |                                                                                                                                      | 0          |                                                                                                                                                                                       | 0          |   |
|                           |            |                                                           |            |                                                       |            |                                                                                                                                           |            |                                                                                                                                                                                            |            |  |

 

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(1)  Werepurchased 2.5 million shares from Revolution Living LLC in a negotiatedtransaction. See Note 10, Shareholders’ Equity.

 

**DividendPolicy**

 

Wehave never declared or paid any cash dividends on our capital stock. Our bankline of credit agreement permits, upon advance notification and maintaining ofcertain financial ratios, payment of dividends to our shareholders.

 

16

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**Sales ofUnregistered Securities**

 

During2007, we issued 80,795 shares of our Class A common stock to purchasecontrolling ownership interests in two businesses. These shares were issuedpursuant to an exemption from registration under Section 4(2) of theSecurities Act of 1933, as transactions by an issuer not involving a publicoffering.

 

**EquityCompensation Plan Information**

 

The following tablesummaries equity compensation plan information for our Class A commonstock:

 
| **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     |       | 883,670                                                                                                                                          |       | $                                                                                                                | 11.02      |                                                                                                                                    | 978,971    |   |
| Equity  compensation plans not approved by security holders |       | —                                                                                                                                           |       | —                                                                                                           |       | —                                                                                                                                  |       |
| Total                                                       |       | 883,670                                                                                                                                          |       | $                                                                                                                | 11.02      |                                                                                                                                    | 978,971    |   |

 

**Item 6. Selected financial data**

 

Wederived the selected consolidated statement of operations data for the yearsended December 31, 2007, 2006 and 2005 and consolidated balance sheet dataas of December 31, 2007 and 2006 set forth below from our auditedconsolidated financial statements which are included elsewhere in this Form 10-K.We derived the selected consolidated statement of operations data for the yearsended December 31, 2004 and 2003 and consolidated balance sheet data as ofDecember 31, 2005, 2004 and 2003 set forth below from our auditedconsolidated financial statements which are not included in this Form 10-K.The historical operating results are not necessarily indicative of the resultsto be expected for any other period. You should read the data set forth belowin conjunction with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and our consolidated financial statementsand related notes, included elsewhere in this Form 10-K.

 

17

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| ** **                                                               | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except per share data)**       | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| **Consolidated  Statements of Operations Data:**                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Net revenues                                                             |       | $                                           | 262,943    |   | $ | 219,480 |   | $ | 142,492 |   | $ | 96,657 |   | $ | 102,000 |   |
| Cost of goods  sold                                                      |       | 94,565                                      |       | 79,150 |   | 61,977 |   | 48,646 |   | 48,927 |   |
| Gross profit                                                             |       | 168,378                                     |       | 140,330 |   | 80,515 |   | 48,011 |   | 53,073 |   |
| Expenses:                                                                |       |                                        |       |   |   |   |   |   |   |   |   |
| Selling and  operating                                                   |       | 141,749                                     |       | 119,700 |   | 67,639 |   | 46,060 |   | 45,184 |   |
| Corporate,  general and administration                                   |       | 16,176                                      |       | 14,989 |   | 9,790 |   | 8,241 |   | 9,171 |   |
| Total expenses                                                           |       | 157,925                                     |       | 134,689 |   | 77,429 |   | 54,301 |   | 54,355 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Income from  operations                                                  |       | 10,453                                      |       | 5,641 |   | 3,086 |   | (6,290 | ) | (1,282 | ) |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Other income  (expense)                                                  |       | 256                                         |       | 645 |   | (533 | ) | (51 | ) | 472 |   |
| Interest income                                                          |       | 3,892                                       |       | 3,260 |   | 358 |   | 160 |   | 74 |   |
| Other income  (loss)                                                     |       | 4,148                                       |       | 3,905 |   | (175 | ) | 109 |   | 546 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Income (loss)  before income taxes and minority interest                 |       | 14,601                                      |       | 9,546 |   | 2,911 |   | (6,181 | ) | (736 | ) |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Income tax  expense (benefit)                                            |       | 5,767                                       |       | 3,774 |   | 974 |   | (2,440 | ) | (461 | ) |
| Minority  interest in net income of consolidated subsidiary,  net of tax |       | (310                                        | )          | (128 | ) | (601 | ) | (897 | ) | (697 | ) |
| Net income  (loss)                                                       |       | $                                           | 8,524      |   | $ | 5,644 |   | $ | 1,336 |   | $ | (4,638 | ) | $ | (972 | ) |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Net income  (loss) per share:                                            |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                                    |       | $                                           | 0.34       |   | $ | 0.23 |   | $ | 0.08 |   | $ | (0.32 | ) | $ | (0.07 | ) |
| Diluted                                                                  |       | $                                           | 0.34       |   | $ | 0.23 |   | $ | 0.08 |   | $ | (0.32 | ) | $ | (0.07 | ) |
| Shares  outstanding:                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Basic                                                                    |       | 24,962                                      |       | 24,349 |   | 17,140 |   | 14,684 |   | 14,594 |   |
| Diluted                                                                  |       | 25,214                                      |       | 24,617 |   | 17,354 |   | 14,684 |   | 14,594 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| ** **                                                               | ** ** | **As of December 31,**       | ** ** |
| **(in thousands)**                                                  | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| **Consolidated  Balance Sheet Data:**                                    |       |                                        |       |   |   |   |   |   |   |   |   |
| Cash                                                                     |       | $                                           | 66,258     |   | $ | 104,876 |   | $ | 15,028 |   | $ | 10,439 |   | $ | 8,384 |   |
| Working capital                                                          |       | 106,815                                     |       | 140,147 |   | 37,216 |   | 31,488 |   | 29,531 |   |
| Total assets                                                             |       | 240,712                                     |       | 250,968 |   | 156,101 |   | 88,287 |   | 91,860 |   |
| Total  liabilities                                                       |       | 34,251                                      |       | 26,700 |   | 40,716 |   | 17,472 |   | 18,347 |   |
| Shareholders’  equity                                               |       | 200,388                                     |       | 218,606 |   | 107,286 |   | 66,346 |   | 69,485 |   |
|                                                                          |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 7.     Management’sdiscussion and analysis of financial condition and results of operations**

 

**Forward-LookingStatements**

 

This report contains forward-looking statements that involve risks anduncertainties. When used in this discussion, we intend the words “anticipate,” “believe,”“plan,” “estimate,” “expect,” “strive,” “future,” “intend” and similarexpressions as they relate to us to identify such forward-looking statements.Our actual results could differ materially from the results anticipated inthese forward-looking statements as a result of certain factors set forth under“Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” “Market Risk” and elsewhere in this report. Risks anduncertainties that could cause actual results to differ include, withoutlimitation, general economic conditions, competition, loss of key personnel,pricing, brand reputation, acquisitions, new initiatives we undertake, securityand information systems, legal liability for website content, merchandisesupply problems, failure of third parties to provide adequate service, relianceon centralized customer service, overstocks and merchandise returns, ourreliance on a centralized fulfillment center, increases in postage and shippingcosts, E-commerce trends, future Internet related taxes, our founder’s controlof us, fluctuations in quarterly operating results, consumer trends, customerinterest in our products, the effect of government regulation and programs andother risks and uncertainties included in our filings with the Securities andExchange Commission. We caution you that no forward-looking statement is aguarantee of future performance, and you should not place undue reliance onthese forward-looking statements which reflect our views only as of the date ofthis report. We undertake no obligation to update any forward-lookinginformation.

 

Youshould read the following discussion and analysis of our financial conditionand results of operations in conjunction with the consolidated financialstatements and related notes included elsewhere in this document.**This section is designed to provide information thatwill assist readers in understanding our consolidated financial statements,changes in certain items in those statements from year to year, the primaryfactors that caused those changes and how certain accounting principles,policies and estimates affect the consolidated financial statements.

 

**Overviewand Outlook**

 

# We are a lifestylemedia company providing a broad selection of information, media, products andservices to customers who value personal development, wellness, ecologicallifestyles, responsible media and conscious community. Our media brand is built around our ability to develop and offer mediacontent, products, lifestyle solutions and community to consumers in the LOHASand the emerging Conscious Media markets.

#  

# We offer our customers the ability to make purchasing decisions and findresponsible content based on these values while providing quality offerings ata price comparable to mainstream alternatives. We market our media and productsthrough a multi-channel approach including traditional media channels, directto consumers via the Internet, direct response marketing, community,subscriptions, catalog, and through national retailers and corporate accounts.

#  

# Our content forms the basis of our proprietary offerings, which thendrive demand for parallel product and service offerings. Our operations arevertically integrated from content creations, through product development andsourcing, to customer service and distribution. We market our products andservices across two segments, business and direct to consumer. We distributeproducts in each of these sales segments from a single fulfillment center ordrop-ship products directly to customers.

#  

Ourbusiness segment sells directly to retailers, both domestically and abroad withour products now available in approximately 70,000 retail doors in the UnitedStates. During 2007, this segment generated revenues of $111.5 million, up from$93.8 million during 2006, reflecting an 18.9% increase. This increase reflectsour successful entrance into the international market and store within storeexpansion. During the year we expanded our store-within-store presence to over7,000 lifestyle presentations, which are custom fixtures that we design.

 

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Throughits diverse media reach, the direct to consumer segment provides an opportunityto launch and support new media releases, a sounding board for new producttesting, promotional opportunities, a growing community, and customer feedbackon us and the LOHAS industry’s focus and future. During 2007, this segmentgenerated revenues of $151.4 million, up from $125.7 million during 2006. Thisincrease reflects growth of 20.5% with the continued investment into brandeddirect response marketing, membership programs and solar energy integrations.

 

During 2007, wecompleted several acquisitions targeted towards expanding and enhancing ourmedia content and community reach. These acquisitions included Zaadz, a socialnetworking site in the LOHAS space; Lime, a multimedia lifestyle company; ConsciousEnlightenment, an on-line and off-line community; and a solar energyintegration company.

 

We believe our growthwill be driven by information, media content, products, and community deliveredto the consumer via broadcast, catalog, Internet, retailers, internationallicensing, electronic downloads and subscription systems. We have increased ourfocus on our media content creation and distribution, which strategicallyprovides increased branding opportunities, significantly higher operatingcontribution and greater mainstream penetration. We plan to invest in ourcommunity and membership businesses over the next two years to bettercapitalize on strong relationships with our loyal consumer audience and growingbroadband. This will allow us to focus on better leveraging our content.

 

We believe a number offactors are important to our long-term success, including building our brands,increasing international growth by expanding into new markets primarily throughlicense arrangements, extending our product lines into wellness and children’sprograms, and enhancing our multimedia platform community through new mediaopportunities, new membership programs, initiatives and acquisitions.

 

**CriticalAccounting Policies**

 

We prepare ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States, which requires us to make judgments,estimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes. Note 2 to the consolidatedfinancial statements in Item 8 of this Form 10-K summarizes thesignificant accounting policies and methods used in the preparation of ourconsolidated financial statements.

 

We believe the followingto be critical accounting policies whose application has a material impact onour financial presentation, and involve a higher degree of complexity, as theyrequire us to make judgments and estimates about matters that are inherentlyuncertain.

 

*Allowances for Doubtful Accounts and Product Returns*

 

Wemaintain allowances for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. We make estimates ofthe collectibility of our accounts receivable by analyzing historical baddebts, specific customer creditworthiness, and current economic trends. If thefinancial condition of our customers were to deteriorate such that theirability to make payments to us was impaired, additional allowances could berequired.

 

Werecord allowances for product returns to be received in future periods at thetime we recognize the original sale. We base the amounts of the returnsallowances upon historical experience and future expectations.

 

*Inventory*

 

Inventoryconsists primarily of finished goods held for sale and is stated at the lowerof cost (first-in, first-out method) or market. We identify the inventory itemsto be written down for obsolescence based on the item’s current sales statusand condition. We write down discontinued or slow moving inventories based onan estimate of the markdown to retail price needed to sell through our currentstock level of the inventories.

 

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*Goodwill and Other Intangibles*

 

Goodwillrepresents the excess of the purchase consideration over the estimated fairvalue of assets acquired less liabilities assumed in a business acquisition.Our other intangibles mainly consist of customer and marketing related assets.We no longer amortize goodwill, but instead we review it for impairmentannually or more frequently if impairment indicators arise, on a reporting unitlevel. We compare the estimated fair value of a reporting unit with itscarrying amount, including goodwill. If the estimated fair value of a reportingunit exceeds its carrying amount, we consider the goodwill of the reportingunit not impaired. If the carrying amount of a reporting unit exceeds itsestimated fair value, we perform the goodwill impairment test to measure theamount of impairment loss. We have allocated goodwill to two reporting units,and we use a market value method for the purposes of testing for potentialimpairment. The annual process of evaluating the potential impairment ofgoodwill is highly subjective and requires significant judgment at many pointsduring the analysis. Application of alternative assumptions and definitionscould yield significantly different results.

 

*Investments*

 

Weaccount for investments in limited liability companies in which we have theability to exercise significant influence or control, or in which we hold afive percent or more membership interest, under the equity method. We accountfor investments in corporations in which we have the ability to exercisesignificant influence or control, or in which we hold a twenty percent or moreownership, under the equity method. Under the equity method, we record ourshare of the income or losses of the investment by increasing or decreasing thecarrying value of our investment and recording the income or expense throughthe consolidated statement of operations. Under the cost method of accounting,we carry investments in private companies at cost and adjust them only forother-than-temporary declines in fair value. Determining whether we have theability to exercise significant influence or control over a company is highlysubjective and requires a high degree of judgment.

 

*Purchase Accounting*

 

Weaccount for the acquisition of a controlling interest in a business using thepurchase method. In determining the estimated fair value of certain acquiredassets and liabilities, we make assumptions based upon many difference factors,such as historical and other relevant information and analysis performed by independentparties. Assumptions may be incomplete, and unanticipated events andcircumstances may occur that could affect the validity of such assumptions,estimates, or actual results.

 

*Media Library*

 

The media library asset represents the fairvalue of the library of produced videos acquired through business combinations,the purchase price of media rights to both video and audio titles, and thecapitalized cost to produce media products, all of which we market to retailersand to direct-mail and online customers. We amortize the fair value of acquiredor purchased media titles and content on a straight-line basis over succeedingperiods on the basis of their estimated useful lives. We defer capitalizedproduction costs for financial reporting purposes until the media is releasedand, then, we amortize these costs over succeeding periods on the basis ofestimated sales. Historical sales statistics are the principal factor used inestimating the amortization rate.

 

*Share-Based Compensation*

 

As of January 1, 2006,we adopted the provisions of SFAS No. 123(R), *Share-Based Payment*, which requires companies to recognizecompensation cost for share-based awards based on the estimated fair value ofthe award on date of grant. We measure compensation cost at the grant datebased on the fair value of the award and recognize compensation cost upon theprobable attainment of a specified performance condition or over a serviceperiod. We use the Black-Scholes option valuation model to calculate the fairvalue disclosures under SFAS 123(R). In calculating this fair value, there arecertain assumptions that we use, as disclosed in Note 11, Share-BasedCompensation, consisting of the expected life of the option, risk-free interestrate, dividend yield, and volatility. The use of a different estimate for anyone of these components could have a material impact on the amount ofcalculated compensation expense.

 

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**Resultsof Operations**

 

The following table sets forth certain financial dataas a percentage of revenues for the periods indicated:

 
| ** **                                                              | ** ** | **For the Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2007**                                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net revenue**                                                         |       | 100.0                                                        | %          | 100.0 | % | 100.0 | % |
| Cost  of goods sold                                                     |       | 36.0                                                         | %          | 36.1 | % | 43.5 | % |
| **Gross profit**                                                        |       | 64.0                                                         | %          | 63.9 | % | 56.5 | % |
| Expenses:                                                               |       |                                                         |       |   |   |   |   |
| Selling  and operating                                                  |       | 53.9                                                         | %          | 54.6 | % | 47.6 | % |
| Corporate,  general and administration                                  |       | 6.1                                                          | %          | 6.8 | % | 6.9 | % |
| Total  expenses                                                         |       | 60.0                                                         | %          | 61.4 | % | 54.4 | % |
| Income  from operations                                                 |       | 4.0                                                          | %          | 2.5 | % | 2.1 | % |
| Other  income (expense), net                                            |       | 1.5                                                          | %          | 1.8 | % | -0.1 | % |
| Income  before income taxes and minority interest                       |       | 5.5                                                          | %          | 4.3 | % | 2.0 | % |
| Income  tax expense                                                     |       | 2.2                                                          | %          | 1.7 | % | 0.7 | % |
| Minority  interest in net income of consolidated subsidiary, net of tax |       | -0.1                                                         | %          | — | % | -0.4 | % |
| **Net income**                                                          |       | 3.2                                                          | %          | 2.6 | % | 0.9 | % |

 

***YearEnded December 31, 2007 Compared to Year Ended December 31, 2006***

 

*Net revenue*. Net revenue increased $43.5 million, or 19.8%, to $262.9million during 2007 from $219.5 million during 2006. During the year, we addeddistribution to over 2,000 new retail doors, bringing the total number of retaildoors in the United States to approximately 70,000. Net revenue in our directto consumer segment increased $25.8 million, or 20.5%, to $151.5 million during2007 from $125.7 million during 2006. This increase in the direct to consumersegment net revenue primarily reflects the continued success of our directresponse marketing revenues and increased revenues from businesses acquiredover the last year.  Net revenue in ourbusiness segment increased $17.7 million, or 18.9%, to $111.5 million during2007 from $93.8 million during 2006, primarily reflecting our success in theinternational market.

 

*Gross profit*. Gross profit increased $28.0 million, or 20.0%, to $168.4million during 2007 from $140.3 million during 2006. As a percentage of netrevenue, gross profit increased slightly to 64.0% during 2007 from 63.9% during2006. Gross profit in our direct to consumer segment increased $15.4 million,or 18.9%, to $97.1 million during 2007 from $81.7 million during 2006 and, as apercentage of net revenue, decreased to 64.1% during 2007 from 65.0% during2006, primarily reflecting increased revenues in our solar operations whichproduce lower margins.  Gross profit inour business segment increased $12.6 million, or 21.5%, to $71.2 million during2007 from $58.6 million during 2006 and, as a percentage of net revenue,increased to 63.9% during 2007 from 62.5% during 2006.

 

*Selling andoperating expenses*. Selling and operatingexpenses increased $22.0 million, or 18.4%, to $141.7 million during 2007 from$119.7 million during 2006, resulting primarily from increased sales andinvestments made in community, branding, personnel, advertising, and marketingprograms.  As a percentage of netrevenue, selling and operating expenses decreased to 53.9% during 2007 from 54.6%during 2006.

 

*Corporate,general and administration expenses*. Corporate, general and administration expensesincreased $1.2 million, or 7.9%, to $16.2 million during 2007 from $15.0million during 2006, primarily due to our planned investments to support theincreased revenue base.  As of percentageof net revenue, corporate, general and administration expenses decreased to6.1% during 2007 from 6.8% during 2006, primarily reflecting the leverage onthe higher revenue base.

 

*Other income*. Other income increased $0.2 million, or 6.2%, to $4.1million during 2007 from $3.9 million during 2006.  As a percentage of net revenue, other incomedeceased to 1.5% during 2007 from 1.8% during 2006. The increase reflects the interestearnings from proceeds of our sale of our Class A common stock in thesecondary offering during May 2006, partially offset by our use of cash torepurchase 2.5 million shares of our Class A common stock during 2007.

 

*Minorityinterest in net income of consolidated subsidiaries, net of income taxes*. Minority interest in net income of consolidatedsubsidiaries, net of income taxes, increased by $0.2 million, or 142.2%, to$0.3 million during 2007 from $0.1 million during 2006.

 

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*Net income*.  Net income increased$2.9 million, or 51.0%, to $8.5 million during 2007 from $5.6 million during2006. Earnings per share increased 47.8% to $0.34 per share during 2007 from$0.23 per share during 2006. The above factors improved our financial performanceover 2006.

 

***YearEnded December 31, 2006 Compared to Year Ended December 31, 2005***

 

*Net revenue*. Net revenue increased $77.0 million, or 54.0%, to $219.5million during 2006 from $142.5 million during 2005. Our increase in revenuereflects the sales of media titles acquired from GoodTimes, coupled with strongperformance in our direct marketing programs, continued penetration intoexisting retail stores, and the addition of new retail distribution outlets.During the year, we added distribution to over 18,000 new retail doors,bringing the total number of retail doors in the United States to 68,000. Netrevenue in our direct to consumer segment increased by $53.4 million, or 73.8%,to $125.7 million during 2006 from $72.3 million during 2005, primarily reflectingstrong performance in our direct marketing programs and revenue from theSpiritual Cinema acquisition in August 2006. Our direct response marketingprograms continue to be a strong revenue source for this segment whileproviding a test marketing platform for new brands and products. Net revenue inour business segment increased by $23.6 million, or 33.7%, to $93.8 millionduring 2006 from $70.2 million during 2005.

 

*Gross profit*. Gross profit increased by $59.8 million, or 74.3%, to$140.3 million during 2006 from $80.5 million during 2005. As a percentage ofnet revenue, gross profit increased 740 basis points to 63.9% during 2006 from56.5% during 2005. The increase in gross profit was primarily due to strongsales of media and direct marketing products which carry higher margins, butalso carry higher selling and operating expenses. The increased media saleshave allowed us to leverage our purchasing volume to receive improved buyingdiscounts. We also continued to benefit from the elimination of fees previouslypaid for third party distribution following the GoodTimes transaction.Additionally, our strong cash position allowed us to take advantage of promptpay vendor discounts.  The businesssegment’s gross profit increased to 62.5% in 2006 from 57.3% in 2005.  The direct to consumer segment’s gross profitincreased to 65.0% in 2006, up from 55.7% in 2005.

 

*Selling andoperating expenses*. Selling and operatingexpenses increased by $52.1 million, or 77.0%, to $119.7 million during 2006from $67.6 million during 2005, primarily resulting from increased sales andoperating expenses to support the revenue increases described above and theadditional amortization expense associated with our purchase of GoodTimes’media library.  As of percentage of netrevenue, selling and operating expenses increased to 54.6% during 2006 from47.6% during 2005, reflecting a change in revenue mix toward increased mediaand direct marketing products that carry higher selling and operating expenses,such as merchandising fees and advertising costs, along with higher grossmargins.

 

*Corporate,general and administration expenses*. Corporate, general and administration expensesincreased by $5.2 million, or 53.1%, to $15.0 million during 2006 from $9.8million during 2005, primarily due to planned investments in our business tosupport the increased revenue base. As a percentage of net revenue, corporate,general and administration expenses decreased slightly to 6.8% during 2006 from6.9% during 2005.

 

*Other income(expense)*. Other income increasedby $4.1 million to $3.9 million during 2006 from $0.2 million expense during2005. As a percentage of net revenue, other income increased to 1.8% during2006 from 0.1% expense during 2005. The increase in other income (expense) primarilyconsisted of interest on cash generated by the secondary offering of our Class Acommon stock and a gain of $0.5 million on the sale of a portion of our Series APreferred Units of Life Balance Media Holdings LLC. We acquired this investmentin August 2005 which originally represented a 19.9% ownership interest. In2005, we recorded a $0.6 million loss on this investment for the period from August 22,2005 through December 31, 2005, which was partially offset by interestincome of $0.4 million.

 

*Minorityinterest in net income of consolidated subsidiaries, net of income taxes*. Minority interest in net income of consolidatedsubsidiaries, net of income taxes, decreased by $0.5 million, or 78.7%, to $0.1million during 2006 from $0.6 million during 2005.

 

*Net income*.  Net income increased$4.3 million to $5.6 million during 2006 from $1.3 million during 2005.Earnings per share increased to $0.23 per share during 2006 from $0.08 pershare during 2005. The above factors improved our financial performance over2005.

 

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**Quarterly andSeasonal Fluctuations**

 

The followingtable sets forth our unaudited results of operations for each of the quartersin 2007 and 2006. In our opinion, this unaudited financial information includesall adjustments, consisting solely of normal recurring accruals andadjustments, necessary for a fair presentation of the results of operations forthe quarters presented. You should read this financial information 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.

 
| ** **                                                         | ** ** | **Fiscal Year 2007 Quarters Ended** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **March 31**                                       | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|                                                               |       |                                                    |       |   |   |   |   |   |   |
| Net revenue                                                        |       | $                                                       | 58,458     |   | $ | 52,361 |   | $ | 70,318 |   | $ | 81,806 |   |
| Gross profit                                                       |       | 37,476                                                  |       | 33,631 |   | 46,144 |   | 51,127 |   |
| Income (loss)  before income taxes and minority interests          |       | 2,828                                                   |       | (783 | ) | 5,224 |   | 7,332 |   |
| Net income  (loss)                                                 |       | 1,752                                                   |       | (346 | ) | 2,918 |   | 4,200 |   |
| Diluted net  income (loss) per share                               |       | $                                                       | 0.07       |   | $ | (0.01 | ) | $ | 0.12 |   | $ | 0.17 |   |
| Weighted average  shares outstanding-diluted                       |       | 25,813                                                  |       | 24,655 |   | 24,970 |   | 25,154 |   |

 
| ** **                                                         | ** ** | **Fiscal Year 2006 Quarters Ended** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **March 31**                                       | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|                                                               |       |                                                    |       |   |   |   |   |   |   |
| Net revenue                                                        |       | $                                                       | 51,752     |   | $ | 43,161 |   | $ | 51,786 |   | $ | 72,781 |   |
| Gross profit                                                       |       | 33,162                                                  |       | 26,891 |   | 32,629 |   | 47,648 |   |
| Income (loss)  before income taxes and minority interests          |       | 1,587                                                   |       | (2,125 | ) | 2,522 |   | 7,562 |   |
| 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 |   |

 

Quarterlyfluctuations in our revenues and operating results are due to a number offactors, including the timing of new product introductions and mailings tocustomers, advertising, acquisitions (including costs of acquisitions andexpenses related to integration of acquisitions), competition, pricing ofproducts by vendors and expenditures on our systems and infrastructure. Theimpact on revenue and operating results due to the timing and extent of thesefactors can be significant. Our sales are also affected by seasonal influences.On an aggregate basis, we generate our strongest revenues and net income in thefourth quarter due to increased holiday spending and retailer fitnesspurchases.

 

**Liquidityand Capital Resources**

 

Our capital needsarise from working capital required to fund operations, capital expendituresrelated to acquisition and development of media content, development of ourInternet and community platforms and new products, acquisitions of newbusinesses, replacements, expansions and improvements to our infrastructure,and future growth. These capital requirements depend on numerous factors,including the rate of market acceptance of our product offerings, the abilityto expand our customer base, the cost of ongoing upgrades to our 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 we cannot accuratelypredict them. Additionally, we will continue to pursue opportunities to expandour media libraries, evaluate possible investments in businesses, products andtechnologies, and increase our sales and marketing programs and brandpromotions as needed.

 

Wehave a revolving line of credit agreement with a financial institution thatexpires on October 22, 2009.  Thecredit agreement permits borrowings up to the lesser of $15 million or ourborrowing base which is calculated based upon the collateral value of ouraccounts receivable, inventory, and certain property and equipment. Borrowingsunder this agreement bear interest at the lower of prime rate less 75 basispoints or LIBO plus 275 basis points. Borrowings are secured by a pledge ofcertain of our assets, and the agreement contains various financial covenants,including those requiring compliance with certain financial ratios. At December 31,2007, we had no amounts outstanding under this agreement; however, $1.2 millionwas reserved for outstanding letters of credit. We believe we have complied with all of the financial covenants underthis credit agreement.

 

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***Cash Flows***

 

The following tablesummarizes our primary sources (uses) of cash during the periods presented:

 
| ** **                                              | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                                 | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net cash  provided by (used in):                        |       |                                        |       |   |   |   |   |
| Operating  activities                                   |       | $                                           | 13,445     |   | $ | (504 | ) | $ | 6,734 |   |
| Investing  activities                                   |       | (22,787                                     | )          | (9,742 | ) | (40,393 | ) |
| Financing  activities                                   |       | (29,432                                     | )          | 99,270 |   | 38,708 |   |
| Effects of  exchange rates on cash and cash equivalents |       | 156                                         |       | 824 |   | (460 | ) |
| Net (decrease)  increase in cash and cash equivalents   |       | $                                           | (38,618    | ) | $ | 89,848 |   | $ | 4,589 |   |

 

*Operatingactivities*. Our operating activities provided net cash of$13.4 million during 2007 and used cash of $0.5 million during 2006. Our netcash generated from operating activities during 2007 was primarily attributableto net income of $8.5 million, net non-cash expenses of $13.1 million, andincreases to accounts payable and accrued liabilities of $2.7 million,partially offset by uses of funds resulting from increased inventory, accountsreceivable, and deferred advertising costs of $5.5 million, $3.3 million, and$1.2 million, respectively. The increase in inventory reflects the additionalproducts necessary to support the increased sales levels. Our net cash used inoperating activities during 2006 was primarily attributable to an increase ininventory of $5.4 million, reduced payables and other liabilities of $10.8million, and net other uses of $1.8 million, partially offset by net income of$5.6 million, net non-cash expenses of $8.6 million and decreases to accountsreceivable of $3.3 million. The reduction in accounts payable of $6.9 millionreflects our decision to buy direct from overseas factories which requirepayment upon shipment versus going through distributors with paymentterms.  This change in buying strategy,coupled with other cost saving initiatives, increased our gross profit marginto 63.9% in 2006 from 56.5% in 2005.

 

*Investingactivities*. Our investing activities used net cash of $22.8million during 2007 and $9.7 million during 2006. The net cash used ininvesting activities during 2007 was used primarily to acquire businesses,property, equipment and other investments for $20.3 million and purchase mediafor $6.3 million, partially offset by proceeds from the sale of the LifeBalance Media Holdings LLC (“LIME”) investment for $1.4 million and prepaymentof a related promissory note of $2.4 million. We used our net cash in investingactivities during 2006 primarily to increase our ownership interest inConscious Media and Newmark Media and acquire an 85% ownership interest inSpiritual Cinema, resulting in net cash outlay of $7.0 million. Additionally,we acquired or produced additional media content and rights as well as soldother property and equipment for a net cash outlay of $2.7 million.

 

*Financingactivities*. Our financing activities used net cash of $29.4million during 2007 and provided net cash of $99.3 million during 2006. We usednet cash in financing activities during 2007 primarily to repurchase 2.5million shares of our Class A common stock for $32.9 million, which waspartially offset by net proceeds and income tax benefits of $3.5 million fromthe exercise of stock options under our 1999 Long Term Incentive Plan. Wegenerated our net cash provided by financing activities during 2006 primarilyfrom our sale of 5,000,000 shares of our Class A common stock on May 24,2006 and the sale of an additional 690,000 shares of our Class A commonstock on June 13, 2006. The remaining 2006 net cash provided by financingactivities resulted mainly from the exercise of stock options under our 1999Long Term Incentive Program.

 

On November 8,2007, we filed a shelf registration statement on Form S-3 with theSecurities and Exchange Commission for 5,000,000 shares of our Class Acommon stock.  As of December 31,2007, none of these shelf shares had been sold. On April 7, 2006, we fileda shelf registration statement on Form S-3 with the Securities andExchange Commission for our Class A common stock with a total offeringprice not to exceed $100,000,000.  On May 24,2006, we sold 5,000,000 shares of Class A common stock and on June 13,2006 we sold 690,000 shares of our Class A common stock in underwrittenofferings under the registration statement.  The combined stock sales in 2006 generatedgross proceeds of $99.6 million.

 

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We believe ouravailable cash, cash expected to be generated from operations, cash generatedby the sale of our Class A common stock, and borrowing capabilities shouldbe sufficient to fund our operations on both a short-term and long-term basis.However, our projected cash needs may change as a result of acquisitions,product development, unforeseen operational difficulties or other factors.

 

In the normal course of our business, we investigate,evaluate and discuss acquisition, joint venture, minority investment, strategicrelationship and other business combination opportunities in the LOHAS andConscious Media markets. For any future investment, acquisition or jointventure opportunities, we may consider using then-available liquidity, issuingequity securities or incurring additional indebtedness.

 

**Contractual Obligations**

 

We havecommitments pursuant to lease agreements, but do not have any outstandingcommitments pursuant to long-term debt obligations or purchase obligations. Thefollowing table shows our commitments to make future payments under operatingleases:

 
| **(in thousands)**      | ** ** | **Total**  | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 yrs** | ** ** |
|------------------------------|------------|------------|------------|-----------------|------------|--------------------|------------|--------------------|------------|--------------------------|------------|
| ** **                   | ** ** | ** ** | ** ** | ** **      | ** ** | ** **         | ** ** | ** **         | ** ** | ** **               | ** ** |
| Operating lease  obligations |       | $          | 12,336     |            | $          | 3,455              |       | $                  | 4,146      |                     | $          | 2,328 |   | $ | 2,407 |   |
|                              |            |            |            |                 |            |                    |            |                    |            |                          |            |  |  |  |  |  |

 

**Off-Balance Sheet Arrangements**

 

We do not participate in transactions that generate relationships withunconsolidated entities or financial partnerships, such as special purposeentities or variable interest entities, which have been established for thepurpose of facilitating off-balance sheet arrangements or other limited purposes.

 

**Item 7A.   Quantitativeand qualitative disclosures about market risk**

#####  

We areexposed to market risks, which include changes in U.S. interest rates andforeign exchange rates. We do not engage in financial transactions for tradingor speculative purposes.

 

Anyborrowings we might make under our bank credit facility would bear interest atthe lower of prime rate less 75 basis points or LIBOR plus 275 basis points. Wedo not have any amounts outstanding under our credit line, so any unfavorablechange in interest rates would not have a material impact on our results fromoperations or cash flows unless we make borrowings in the future.

 

Wepurchase a significant amount of inventory from vendors outside of the U.S. intransactions that are primarily U.S. dollar denominated transactions. Since thepercentage of our international purchases denominated in currencies other thanthe U.S. dollar is small, any currency risks related to these transactions areimmaterial to us. However, a decline in the relative value of the U.S. dollarto other foreign currencies could lead to increased purchasing costs.  In order to mitigate this exposure, we makevirtually all of our purchase commitments in U.S. dollars.

 

In2003, we purchased a 50.1% interest in Gaiam Limited, formerly known as LeisureSystems International Limited, a U.K. based distributor. Since Gaiam Limited’srevenues are primarily denominated in foreign currencies, this investmentexposes us to accounting risk associated with foreign currency exchange ratefluctuations. However, we have determined that there was no material marketrisk exposure to our consolidated financial position, results of operations orcash flows as of December 31, 2007 as a result of this investment.

 

26

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**Item 8.      Financialstatements and supplementary data**

 
| **Index to consolidated financial  statements**                         |   |   |
|-------------------------------------------------------------------------|--------|--------|
|                                                                    |   |   |
| Report of Independent Registered Public Accounting  Firm                |   | 28     |
|                                                                    |   |   |   |   |
|                                                                    |   |   |   |   |
| Gaiam, Inc. Consolidated Financial Statements:                     |   |   |   |   |
|                                                                    |   |   |   |   |
| Consolidated balance sheets                                             |   |   |   | 30 |
|                                                                    |   |   |   |   |
| Consolidated statements of operations                                   |   |   |   | 31 |
|                                                                    |   |   |   |   |
| Consolidated statement of shareholders’ equity                     |   |   |   | 32 |
|                                                                    |   |   |
| Consolidated statements of cash flows                                   |   | 33     |
|                                                                    |   |   |
| Notes to consolidated financial statements                              |   | 34     |
|                                                                    |   |   |
| **Financial Statement Schedule:**                                       |   |   |
| Schedule II  — Consolidated valuation and qualifying accounts |   | 52     |

 

27

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**Report of independent registered public accounting firm**

 

To the Board of Directorsand Shareholders of

Gaiam, Inc.

Broomfield, Colorado

 

We have audited theaccompanying consolidated balance sheets of Gaiam Inc. and subsidiaries (the “Company”)as of December 31, 2007 and 2006, and the related consolidated statementsof operations, shareholders’ equity and cash flows for each of the three yearsin the period ended December 31, 2007. Our audits also included thefinancial statement schedule II for each of the three years in the periodended December 31, 2007.  We alsohave audited the Company’s internal control over financial reporting as of December 31,2007, based on criteria established in *InternalControl-Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). The Company’s management isresponsible for these consolidated financial statements, for maintainingeffective internal control over financial reporting, and for its assessment ofthe effectiveness of internal control over financial reporting, included in theaccompanying Management’s Report on Internal Control over Financial Reportingincluded in Item 9A. Our responsibility is to express an opinion on theseconsolidated financial statements and an opinion on the Company’s internalcontrol over financial reporting based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudits to obtain reasonable assurance about whether the consolidated financialstatements are free of material misstatement and whether effective internalcontrol over financial reporting was maintained in all material respects. Ouraudits of the consolidated financial statements included examining, on a testbasis, evidence supporting the amounts and disclosures in the consolidatedfinancial statements, assessing the accounting principles used and significantestimates made by management, and evaluating the overall financial statementpresentation. Our audit of internal control over financial reporting includedobtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, and testing and evaluatingthe design and operating effectiveness of internal control based on theassessed risk. Our audits also included performing such other procedures as weconsidered necessary in the circumstances. We believe that our audits provide areasonable basis for our opinions.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with accountingprinciples generally accepted in the United States. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of theCompany’s assets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

As discussed in Note 2to the consolidated financial statements, in 2006, Gaiam, Inc. andsubsidiaries changed its method of accounting for share-based payments inaccordance with the guidance provided in Statement of Financial AccountingStandards No. 123(R), Share-Based Payment. As discussed in Note 9 tothe consolidated financial statements, in 2007, Gaiam, Inc. and subsidiariesadopted Financial Accounting Standards Board Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo.109.

 

28

----

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Gaiam Inc. and subsidiaries as of December 31,2007 and 2006, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2007 inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, the related financial statementschedule II for each of the three years in the period ended December 31,2007, when considered in relation to the basic financial statements taken as awhole, presents fairly in all material respects the information set forththerein. Also in our opinion, Gaiam Inc. and subsidiaries maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2007, based on criteria established in Internal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(“COSO”).

 
|                | /s/  Ehrhardt Keefe Steiner & Hottman PC |
|---------------------|---------------------------------------------------|
|                |                                              |
| March 12, 2008 |                                              |
| Denver, Colorado    |                                              |

 

29

----

 

**GAIAM, INC.**

**Consolidatedbalance sheets**

 
| ** **                                                                                                                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(in thousands, except share and per share data)**                                                                                                  | ** ** | **2007**              | ** ** | **2006** | ** ** |
| **ASSETS**                                                                                                                                                                              |       |                  |       |   |   |
| Current assets:                                                                                                                                                                         |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                              |       | $                     | 66,258     |   | $ | 104,876 |   |
| Accounts  receivable, net                                                                                                                                                               |       | 30,157                |       | 25,324 |   |
| Inventory, less  allowances                                                                                                                                                             |       | 29,839                |       | 24,313 |   |
| Deferred  advertising costs                                                                                                                                                             |       | 3,602                 |       | 3,965 |   |
| Deferred tax  assets                                                                                                                                                                    |       | 6,005                 |       | 3,404 |   |
| Other current  assets                                                                                                                                                                   |       | 5,205                 |       | 4,965 |   |
| Total current  assets                                                                                                                                                                   |       | 141,066               |       | 166,847 |   |
|                                                                                                                                                                                    |       |                  |       |   |   |
| Property and  equipment, net                                                                                                                                                            |       | 9,509                 |       | 7,784 |   |
| Media library,  net                                                                                                                                                                     |       | 37,566                |       | 37,201 |   |
| Deferred tax  assets, net                                                                                                                                                               |       | 4,057                 |       | 5,958 |   |
| Goodwill and  other intangibles, net                                                                                                                                                    |       | 44,410                |       | 28,879 |   |
| Notes receivable  and other assets                                                                                                                                                      |       | 4,104                 |       | 4,299 |   |
| Total assets                                                                                                                                                                            |       | $                     | 240,712    |   | $ | 250,968 |   |
| ** **                                                                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                           |       |                  |       |   |   |
| Current  liabilities:                                                                                                                                                                   |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                        |       | $                     | 23,620     |   | $ | 21,464 |   |
| Accrued  liabilities                                                                                                                                                                    |       | 10,631                |       | 5,236 |   |
| Total current  liabilities                                                                                                                                                              |       | 34,251                |       | 26,700 |   |
|                                                                                                                                                                                    |       |                  |       |   |   |
| Minority  interest                                                                                                                                                                      |       | 6,073                 |       | 5,662 |   |
|                                                                                                                                                                                    |       |                  |       |   |   |
| Commitments and  contingencies                                                                                                                                                          |       |                  |       |   |   |
|                                                                                                                                                                                    |       |                  |       |   |   |
| Shareholders’  equity:                                                                                                                                                             |       |                  |       |   |   |
| Class A  common stock, $.0001 par value, 150,000,000 shares authorized, 19,553,631 and  21,749,936 shares issued and outstanding at December 31, 2007 and 2006,  respectively |       | 2                     |       | 2 |   |
| Class B  common stock, $.0001 par value, 50,000,000 shares authorized, 5,400,000  shares  issued and outstanding at December 31, 2007 and 2006                                |       | 1                     |       | 1 |   |
| Additional paid-in  capital                                                                                                                                                             |       | 174,046               |       | 200,906 |   |
| Accumulated  other comprehensive income                                                                                                                                                 |       | 991                   |       | 873 |   |
| Retained  earnings                                                                                                                                                                      |       | 25,348                |       | 16,824 |   |
| Total  shareholders’ equity                                                                                                                                                        |       | 200,388               |       | 218,606 |   |
| Total  liabilities and shareholders’ equity                                                                                                                                        |       | $                     | 240,712    |   | $ | 250,968 |   |

 

See accompanying notes to the consolidated financial statements.

 

30

----

 

**GAIAM, INC.**

**Consolidated statements ofoperations**

 
| ** **                                                                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands, except per share data)**                 | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                                        |       | $                                           | 262,943    |   | $ | 219,480 |   | $ | 142,492 |   |
| Cost of goods  sold                                                                |       | 94,565                                      |       | 79,150 |   | 61,977 |   |
| Gross profit                                                                       |       | 168,378                                     |       | 140,330 |   | 80,515 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Expenses:                                                                          |       |                                        |       |   |   |   |   |
| Selling and  operating                                                             |       | 141,749                                     |       | 119,700 |   | 67,639 |   |
| Corporate,  general and administration                                             |       | 16,176                                      |       | 14,989 |   | 9,790 |   |
| Total expenses                                                                     |       | 157,925                                     |       | 134,689 |   | 77,429 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Income from  operations                                                            |       | 10,453                                      |       | 5,641 |   | 3,086 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Other income  (expense)                                                            |       | 256                                         |       | 645 |   | (533 | ) |
| Interest income                                                                    |       | 3,892                                       |       | 3,260 |   | 358 |   |
| Other income  (expense)                                                            |       | 4,148                                       |       | 3,905 |   | (175 | ) |
|                                                                               |       |                                        |       |   |   |   |   |
| Income before  income taxes and minority interest                                  |       | 14,601                                      |       | 9,546 |   | 2,911 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Income tax  expense                                                                |       | 5,767                                       |       | 3,774 |   | 974 |   |
| Minority  interest in net income of consolidated subsidiaries, net of income taxes |       | (310                                        | )          | (128 | ) | (601 | ) |
| Net income                                                                         |       | $                                           | 8,524      |   | $ | 5,644 |   | $ | 1,336 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Net income per  share:                                                             |       |                                        |       |   |   |   |   |
| Basic                                                                              |       | $                                           | 0.34       |   | $ | 0.23 |   | $ | 0.08 |   |
| Diluted                                                                            |       | $                                           | 0.34       |   | $ | 0.23 |   | $ | 0.08 |   |
|                                                                               |       |                                        |       |   |   |   |   |
| Weighted average  shares outstanding:                                              |       |                                        |       |   |   |   |   |
| Basic                                                                              |       | 24,962                                      |       | 24,349 |   | 17,140 |   |
| Diluted                                                                            |       | 25,214                                      |       | 24,617 |   | 17,354 |   |

 

See accompanying notes to consolidated financial statements.

 

31

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**GAIAM, INC.Consolidated statement of shareholders’ equity**

 
| ** **                                                                                                                                                       | ** ** | **Class A   Common  Stock** | ** ** | **Class B   Common  Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated  Other   Comprehensive** | ** ** | **Retained** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|-------------------------|------------|---------------------------------------------|------------|--------------|------------|------------|------------|
| **(in thousands, except share data)**                                                                                                        | ** ** | **Shares**                            | ** ** | **Amount**                            | ** ** | **Shares**              | ** ** | **Amount**                                  | ** ** | **Capital**  | ** ** | **Income** | ** ** | **Earnings** | ** ** | **Total** | ** ** |
|                                                                                                                                                             |       |                                  |       |                                  |       |                    |       |                                        |       |         |       |       |       |   |   |   |   |
| 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  loss:                                                                                                                                             |       |                                  |       |                                  |       |                    |       |                                        |       |         |       |       |       |   |   |   |   |
| 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 |   |
|                                                                                                                                                             |       |                                  |       |                                  |       |                    |       |                                        |       |         |       |       |       |   |   |   |   |
| Issuance of  common stock in conjunction with acquisitions and compensation                                                                                      |       | 303,695                               |       | —                                |       | —                  |       | —                                      |       | 6,047        |       | —     |       | — |   | 6,047 |   |
| Repurchase of  stock                                                                                                                                             |       | (2,500,000                            | )          | —                                |       | —                  |       | —                                      |       | (32,907      | )          | —     |       | — |   | (32,907 | ) |
| Comprehensive  income:                                                                                                                                           |       |                                  |       |                                  |       |                    |       |                                        |       |         |       |       |       |   |   |   |   |
| Net income                                                                                                                                                       |       | —                                |       | —                                |       | —                  |       | —                                      |       | —       |       | —     |       | 8,524 |   | 8,524 |   |
| Foreign currency  translation adjustment, net of income taxes of $77                                                                                             |       | —                                |       | —                                |       | —                  |       | —                                      |       | —       |       | 118        |       | — |   | 118 |   |
| Comprehensive  income                                                                                                                                            |       | —                                |       | —                                |       | —                  |       | —                                      |       | —       |       | —     |       | — |   | 8,642 |   |
|                                                                                                                                                             |       |                                  |       |                                  |       |                    |       |                                        |       |         |       |       |       |   |   |   |   |
| Balance at  December 31, 2007                                                                                                                               |       | 19,553,631                            |       | $                                     | 2          |                    | 5,400,000  |                                        | $          | 1            |       | $          | 174,046    |   | $ | 991 |   | $ | 25,348 |   | $ | 200,388 |   |

 

See accompanying notes to consolidated financial statements.

 

32

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**GAIAM, INC.Consolidated statements of cash flows**

** **
| ** **                                                                                   | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| **(in thousands)**                                                                      | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Operating  activities:                                                                       |       |                                        |       |   |   |   |   |
| Net income                                                                                   |       | $                                           | 8,524      |   | $ | 5,644 |   | $ | 1,336 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                                        |       |   |   |   |   |
| Depreciation                                                                                 |       | 2,120                                       |       | 1,926 |   | 2,146 |   |
| Amortization                                                                                 |       | 10,169                                      |       | 5,883 |   | 2,555 |   |
| Noncash  share-based compensation                                                            |       | 1,024                                       |       | 623 |   | — |   |
| Minority  interest in consolidated subsidiaries                                              |       | 310                                         |       | 128 |   | 601 |   |
| Noncash loss on  disposal of property                                                        |       | 265                                         |       | — |   | — |   |
| Noncash (gain)  loss from equity method investment                                           |       | (127                                        | )          | (680 | ) | 646 |   |
| Deferred and  stock option income tax (benefit) expense                                      |       | (701                                        | )          | 730 |   | 472 |   |
| Changes in  operating assets and liabilities, net of effects from acquisitions:              |       |                                        |       |   |   |   |   |
| Accounts  receivable, net                                                                    |       | (3,330                                      | )          | 3,319 |   | (11,066 | ) |
| Inventory, net                                                                               |       | (5,546                                      | )          | (5,373 | ) | 3,143 |   |
| Deferred  advertising costs                                                                  |       | (1,230                                      | )          | (531 | ) | (1,281 | ) |
| Other assets                                                                                 |       | (771                                        | )          | (1,413 | ) | (1,813 | ) |
| Accounts payable                                                                             |       | 345                                         |       | (6,859 | ) | 11,399 |   |
| Accrued  liabilities                                                                         |       | 2,393                                       |       | (3,901 | ) | (1,404 | ) |
| Net cash  provided by (used in) operating activities                                         |       | 13,445                                      |       | (504 | ) | 6,734 |   |
|                                                                                         |       |                                        |       |   |   |   |   |
| Investing  activities:                                                                       |       |                                        |       |   |   |   |   |
| Purchase of  property, equipment and media rights                                            |       | (9,536                                      | )          | (3,412 | ) | (1,589 | ) |
| Proceeds from  sale of property and equipment                                                |       | —                                      |       | 668 |   | — |   |
| Purchase of  acquisitions, investments, and note, net of cash acquired                       |       | (17,122                                     | )          | (6,998 | ) | (38,804 | ) |
| Proceeds from  sale of investments                                                           |       | 3,871                                       |       | — |   | — |   |
| Net cash used in  investing activities                                                       |       | (22,787                                     | )          | (9,742 | ) | (40,393 | ) |
|                                                                                         |       |                                        |       |   |   |   |   |
| Financing  activities:                                                                       |       |                                        |       |   |   |   |   |
| Repurchase of  Class A common stock, including related costs                            |       | (32,907                                     | )          | — |   | — |   |
| Net proceeds  from issuance of common stock and tax benefits from option exercises           |       | 3,475                                       |       | 99,270 |   | 38,708 |   |
| Net cash (used  in) provided by financing activities                                         |       | (29,432                                     | )          | 99,270 |   | 38,708 |   |
|                                                                                         |       |                                        |       |   |   |   |   |
| Effects of  exchange rates on cash and cash equivalents                                      |       | 156                                         |       | 824 |   | (460 | ) |
|                                                                                         |       |                                        |       |   |   |   |   |
| Net (decrease)  increase in cash and cash equivalents                                        |       | (38,618                                     | )          | 89,848 |   | 4,589 |   |
| Cash and cash  equivalents at beginning of year                                              |       | 104,876                                     |       | 15,028 |   | 10,439 |   |
| Cash and cash  equivalents at end of year                                                    |       | $                                           | 66,258     |   | $ | 104,876 |   | $ | 15,028 |   |
|                                                                                         |       |                                        |       |   |   |   |   |
| **Supplemental  cash flow information**                                                      |       |                                        |       |   |   |   |   |
| Interest paid                                                                                |       | $                                           | 174        |   | $ | 23 |   | $ | — |   |
| Income taxes  paid                                                                           |       | 6,746                                       |       | 949 |   | 1,196 |   |
| Common stock  issued for acquisitions                                                        |       | 1,504                                       |       | 4,943 |   | 2,150 |   |
|                                                                                              |            |                                             |            |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financial statements.

 

33

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**Notes to consolidated financial statements**

 

**1.Organization, Nature of Operations, and Principles of Consolidation**

 

Referencesin this report to “we”, “us”, “our” or “Gaiam” refer to Gaiam, Inc. andits consolidated subsidiaries, unless we indicate otherwise. We are a lifestylemedia company providing a broad selection of information, media, products andservices to customers who value personal development, wellness, ecologicallifestyles, responsible media and conscious community. We were incorporatedunder the laws of the State of Colorado on July 7, 1988.

 

Wehave prepared the accompanying consolidated financial statements in accordancewith accounting principles generally accepted in the United States, or GAAP, andthey include our accounts and those of our subsidiaries.  Intercompany transactions and balances havebeen eliminated.

 

**2.  Significant Accounting Policies**

 

*Cash and Cash Equivalents*

 

Cash and cash equivalentsinclude demand deposit accounts with financial institutions and highly liquidinvestments, which mature within three months of date of purchase. The fairvalue of the cash and cash equivalents approximates their carrying value due totheir short maturities.

 

*Concentration of Risk and Allowancesfor Doubtful Accounts*

 

We have potentialconcentration of credit risk in our accounts receivable in that two of our top customers,one of which is Target, accounted for 50.3% of accounts receivable, net as of December 31,2007.  These customers are major retailersin the United States to which we made significant sales during the calendaryear end holiday season.

 

We maintain allowancesfor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. We make estimates of the collectibility ofour accounts receivable by analyzing historical bad debts, specific customercreditworthiness, and current economic trends. The allowance for doubtfulaccounts was $1.3 million and $1.4 million as of December 31, 2007 and2006, respectively. If the financial condition of our customers were todeteriorate such that their ability to make payments to us was impaired,additional allowances could be required.

 

*Product Returns*

 

We record allowances forproduct returns to be received in future periods at the time we recognize theoriginal sale. We base the amounts of the returns allowances upon historicalexperience and future expectations.

 

*Inventory*

 

Inventoryconsists primarily of finished goods held for sale and is stated at the lowerof cost (first-in, first-out method) or market. We identify the inventory itemsto be written down for obsolescence based on the item’s current sales statusand condition. We write down discontinued or slow moving inventories based onan estimate of the markdown to retail price needed to sell through our currentstock level of the inventories. As of December 31, 2007 and 2006, weestimated obsolete or slow-moving inventory to be $3.5 million and $3.6million, respectively.

 

*AdvertisingCosts*

 

Deferred advertisingcosts relate to the preparation, printing, advertising and distribution ofinfomercials and catalogs. We defer such costs for financial reporting purposesuntil the catalogs and infomercials are distributed and advertised, then weamortize these costs over succeeding periods on the basis of estimated directrelationship sales. We amortize seasonal catalogs within seven months and ourannual catalogs within one year. Forecasted sales statistics are the principalfactor we use in estimating the amortization rate. We expense other advertisingand promotional costs as incurred. Amounts recorded as advertising expense were$39.9 million, $35.5 million, and $17.6 million for the years ended December 31,2007, 2006, and 2005, respectively, and we include these amounts in selling andoperating expense.

 

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Werecord sales discounts or other sales incentives as a reduction to revenues. Weidentify and record as expense those cooperative advertising expenses we pay,which are for advertisements meeting the separable benefit and fair valuetests, as part of selling and operating expense.

 

*Propertyand Equipment*

 

Westate property and equipment at cost less accumulated depreciation andamortization. We included in property and equipment the cost of internal-usesoftware, including software used in connection with our websites. We expenseall costs related to the development of internal-use software other than thoseincurred during the application development stage. We capitalize the costs weincur during the application development stage and amortize them over theestimated useful life of the software, which is typically three years. Wecompute depreciation of property and equipment on the straight-line method overestimated useful lives, generally three to ten years. We amortize leasehold andbuilding improvements over the shorter of the estimated useful lives of theassets or the remaining term of the lease or remaining life of the building,respectively.

 

*Investments*

 

Weaccount for investments in limited liability companies in which we have theability to exercise significant influence or control, or in which we hold afive percent or more membership interest, under the equity method. We accountfor investments in corporations in which we have the ability to exercisesignificant influence or control, or in which we hold a twenty percent or moreownership, under the equity method. Under the equity method, we record ourshare of the income or losses of the investment by increasing or decreasing thecarrying value of our investment and recording the income or expense throughthe consolidated statement of operations. Under the cost method of accounting,we carry investments in private companies at cost and adjust only forother-than-temporary declines in fair value. We include investments under thecost and equity methods in notes receivable and other assets.

 

Weevaluate our long-lived assets, including investments, on at least an annualbasis to test for impairment or valuation issues, and concluded that, as of December 31,2007 and 2006, no indicators of impairment were present.

 

*Purchase Accounting*

 

Weaccount for the acquisition of a controlling interest in a business using thepurchase method. In determining the estimated fair value of certain acquiredassets and liabilities, we make assumptions based upon many different factors,such as historical and other relevant information and analysis performed byindependent parties. Assumptions may be incomplete, and unanticipated eventsand circumstances may occur that could affect the validity of such assumptions,estimates, or actual results. The estimated fair value of assets andliabilities acquired in recent business combinations are preliminary as of December 31,2007. We expect to obtain information necessary to finalize the estimatedvalues during 2008.

 

*MediaLibrary*

 

Themedia library asset represents the fair value of our library of produced videosacquired through business combinations, the purchase price of media rights toboth video and audio titles, and the capitalized cost to produce mediaproducts, all of which we market to retailers and to direct-mail and onlinecustomers. We have presented the media library net of accumulated amortizationof approximately $23.2 million and $16.2 million at December 31, 2007 and2006, respectively, which is being amortized over the estimated useful life ofthe titles, which range from five to fifteen years. Additionally, we anticipateincurring during 2008 approximately $11.4 million in participation expenses,primarily royalties, related to acquired and produced media content.

 

Medialibrary costs to produce media content consist of costs incurred to produce themedia content, net of accumulated amortization. We recognize these costs, aswell as participation costs, as operating expenses on an individual film basisin the ratio that the current year’s gross revenues bear to our estimate oftotal ultimate gross revenues from all sources to be earned over a seven yearperiod. We state capitalized production costs at the lower of unamortized costor estimated fair value on an individual film basis. We continually reviewrevenue forecasts, based primarily on historical sales statistics, and revisethese forecasts when warranted by changing conditions. When estimates of totalrevenues and other events or changes in circumstances indicate that a film hasa fair value that is less than its unamortized cost, we recognize an impairmentloss in the current period for the amount by which the unamortized cost exceedsthe film’s fair value.

 

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During2007, capitalized production cost for released films was approximately $1.4million, and for those films not yet released was approximately $4.8 million.Additionally, as of December 31, 2007, we estimate that approximately $2.0million or 24.1% of the unamortized costs for released films will be amortizedduring 2008, and approximately 69.1% of the unamortized costs for releasedfilms will be amortized within the next three years. Accumulated amortizationfor produced media content at December 31, 2007 and 2006 was approximately$11.0 million and $8.1 million, respectively. Amortization expense for producedmedia content for the years ended December 31, 2007, 2006 and 2005 was$2.9 million, $1.4 million, and $1.0 million, respectively.

 

Theacquired media rights have $29.2 million of remaining unamortized costs as of December 31,2007 that will be amortized on a straight-line basis over 12 to 96 months.Amortization expense for acquired and purchased media rights for the yearsended December 31, 2007, 2006 and 2005 was $4.7 million, $4.1 million, and$1.5 million, respectively. Based upon the acquired media titles and rights at December 31,2007, we expect the annual amortization expense for the next five years toapproximate $5.8 million per annum. In 2005, we added $32.3 million in mediaassets from our acquisition of content and programming from GoodTimes.

 

Basedon total media library costs at December 31, 2007 and assuming nosubsequent impairment of the underlying assets or a material increase in thevideo productions or media acquired, we expect the amortization expense for thenext five years to be approximately $7.5 million per annum.

 

*Goodwilland Other Intangibles*

 

Goodwillrepresents the excess of the purchase consideration over the estimated fairvalue of assets acquired less liabilities assumed in a business acquisition.Our other intangibles mainly consist of customer and marketing related assets.We no longer amortize goodwill, but instead we review it for impairmentannually or more frequently if impairment indicators arise, on a reporting unitlevel. We compare the estimated fair value of a reporting unit with itscarrying amount, including goodwill. If the estimated fair value of a reportingunit exceeds its carrying amount, we consider the goodwill of the reportingunit not impaired. If the carrying amount of a reporting unit exceeds itsestimated fair value, we perform the goodwill impairment test to measure theamount of impairment loss. We have allocated goodwill to two reporting units,and we use a market value method for the purposes of testing for potentialimpairment. The annual process of evaluating the potential impairment ofgoodwill is highly subjective and requires significant judgment at many pointsduring the analysis. Application of alternative assumptions and definitionscould yield significantly different results.

 

Wehave allocated the entire goodwill balance of $42.9 million at December 31,2007 to our two segments, direct to consumer and business. The following tablesets forth the changes in goodwill for the period December 31, 2005through December 31, 2007 by reportable segment.

 
| **(in thousands)**                 | ** ** | **Direct to   Consumer  Segment** | ** ** | **Business  Segment** | ** ** | **Total**  | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                         | ** ** | ** **                                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| 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     |       |
| Additions                          |       | 10,568                                      |       | 3,871                 |       | 14,439     |       |
| Foreign currency  rate change      |       | —                                      |       | 68                    |       | 68         |       |
| Balance at  December 31, 2007 |       | $                                           | 21,882     |                  | $          | 20,974     |       | $ | 42,856 |   |

 

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Thegross carrying amount of our domain name intangibles, which are not subject toamortization, at December 31, 2007 was $0.3 million. The following tablerepresents our other intangibles subject to amortization by major class as of December 31,2007 and 2006:

 
| ** **                | ** ** | **As of December 31,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| **(in thousands)**   | ** ** | **2007**                              | ** ** | **2006** | ** ** |
|                      |       |                                  |       |   |   |
| Customer  related:        |       |                                  |       |   |   |
| Gross carrying  amount    |       | $                                     | 1,434      |   | $ | 664 |   |
| Accumulated  amortization |       | 727                                   |       | 134 |   |
|                      |       | $                                     | 707        |   | $ | 530 |   |
| Marketing  related:       |       |                                  |       |   |   |
| Gross carrying  amount    |       | $                                     | 638        |   | $ | — |   |
| Accumulated  amortization |       | 41                                    |       | — |   |
|                      |       | $                                     | 597        |   | $ | — |   |

 

Theamortization periods range from 6 to 84 months. Amortization expense for theyears ended December 31, 2007 and 2006 was $0.6 million and $0.1 million,respectively. Based on the December 31, 2007 balance of other intangibles,we estimate amortization expense to be $0.7 million in 2008, $0.2 million in2009 and 2010, $0.1 million in 2011 and 2012, and none thereafter.

 

*Long-LivedAssets*

 

Weevaluate the carrying value of long-lived assets held and used, other thangoodwill, when events or changes in circumstances indicate the carrying valuemay not be recoverable. We consider the carrying value of a long-lived assetimpaired when the total projected undiscounted cash flows from such asset areseparately identifiable and are less than the carrying value. We recognize aloss based on the amount by which the carrying value exceeds the estimated fairvalue of the long-lived asset. We determine the estimated fair value primarilyusing the projected cash flows from the asset discounted at a rate commensuratewith the risk involved.

 

*Income Taxes*

 

We provide for incometaxes pursuant to the liability method as prescribed in SFAS No. 109, *Accounting for Income Taxes*. The liabilitymethod requires recognition of deferred income taxes based on temporarydifferences between financial reporting and income tax bases of assets andliabilities, using current enacted income tax rates and regulations. Thesedifferences will result in taxable income or deductions in future years whenthe reported amount of the asset or liability is recovered or settled,respectively. Considerable judgment is required in determining when theseevents may occur and whether recovery of an asset is more likely than not. Oureffective tax rate remains fairly consistent.

 

*Revenues*

 

Revenueconsists of sales of products, media licensing, and solar energy integrationcontract fees. We recognize revenue from the sale of products and the licensingof media when the following four basic criteria are met: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or servicesrendered; (3) the seller’s price to the buyer is fixed and determinable;and (4) collectibility is reasonably assured. We recognize revenue fromfixed price contracts using either the completed contract or percentage-of-completionmethod, based on the energy size of the solar energy integration project. Wehad no contracts accounted for under the percentage-of-completion method for2007, 2006, and 2005. We present revenues net of taxes collected fromcustomers. We recognize amounts billed to customers for postage and handling asrevenue at the same time we recognize the revenues arising from the productsale. We include postage and handling costs, which were approximately $12.0million for 2007, $13.0 million for 2006, and $8.3 million for 2005, in sellingand operating expense along with other fulfillment costs.

 

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*Share-BasedCompensation*

 

As of January 1,2006, we adopted the provisions of SFAS No. 123(R), *Share-Based Payment*, which requirescompanies to recognize compensation cost for share-based awards based on theestimated fair value of the award on date of grant. We measure compensationcost at the grant date based on the fair value of the award and recognize compensationcost upon the probable attainment of a specified performance condition or overa service period. We use the Black-Scholes option valuation model to calculatethe fair value disclosures under SFAS 123(R). In calculating this fair value,we use certain assumptions, as disclosed in Note 11, Share-BasedCompensation, consisting of the expected life of the option, risk-free interestrate, dividend yield, and volatility. The use of a different estimate for anyone of these components could have a material impact on the amount ofcalculated compensation expense. We elected the modified-prospective method,under which prior periods are not revised for comparative purposes. Thevaluation provisions of SFAS 123R apply to new grants and to grants that wereoutstanding as of the effective date and are subsequently modified. We willrecognize estimated compensation for grants that were outstanding as of theeffective date over the remaining service periods using the compensation costestimated for the SFAS 123 pro forma disclosures.

 

The following table setsforth the pro forma amounts of net income and net income per share for the yearended December 31, 2005, that would have resulted if we had accounted forour share-based compensation plan under the fair value recognition provisionsof SFAS 123 and recorded share-based compensation expense.

 
| ** **                                                                                                                            | ** ** | **For the   Year Ended   December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| **(in thousands, except per share data)**                                                                    | ** ** | **2005**                                                         | ** ** |
|                                                                                                                                  |       |                                                             |       |
| Net income as  reported                                                                                                               |       | $                                                                | 1,336      |   |
| Add: Share-based  compensation expense included in reported net income, net of related tax  effects                                   |       | —                                                           |       |
| Deduct: Total  share-based compensation expenses determined under fair value based method  for all awards, net of related tax effects |       | (398                                                             | )          |
| Pro forma                                                                                                                             |       | $                                                                | 938        |   |
| Basic net income  per share:                                                                                                          |       |                                                             |       |
| As reported                                                                                                                           |       | $                                                                | 0.08       |   |
| Pro forma                                                                                                                             |       | $                                                                | 0.06       |   |
| Fully diluted  net income per share:                                                                                                  |       |                                                             |       |
| As reported                                                                                                                           |       | $                                                                | 0.08       |   |
| Pro forma                                                                                                                             |       | $                                                                | 0.05       |   |

 

*Use of Estimates andReclassifications*

 

The preparation offinancial statements in accordance with GAAP requires us to make estimates andassumptions that affect the amounts reported in the accompanying financialstatements and disclosures. Although we base these estimates on our bestknowledge of current events and actions that we may undertake in the future,actual results may be different from the estimates. We have made certainreclassifications to prior period amounts to conform to the current periodpresentations.

 

*DefinedContribution Plan*

 

In1999, we adopted a defined contribution retirement plan under Section 401(k) ofthe Internal Revenue Code, which covers substantially all employees. Eligibleemployees may contribute amounts to the plan, via payroll withholding, subjectto certain limitations. The 401(k) plan permits, but does not require, usto make additional matching contributions to the 401(k) plan on behalf ofall participants in the 401(k) plan. Effective June 1, 2007, we beganmatching 50% of an employee’s contribution, up to an annual maximum matchingcontribution of $1,500, and during the year ended December 31, 2007, wemade matching contributions of $0.2 million to the 401(k) plan.

 

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*ForeignCurrency Translation*

 

Ourforeign subsidiaries use their local currency as their functional currency. Wetranslate assets and liabilities into U.S. dollars at exchange rates in effectat the balance sheet date. We translate income and expense accounts at theaverage monthly exchange rates during the year. We record resulting translationadjustments, net of income taxes, as a separate component of accumulated othercomprehensive income.

 

*ComprehensiveIncome*

 

Ouraccumulated other comprehensive income consists only of foreign currencytranslation adjustments, net of income taxes.

 

*NetIncome Per Share*

 

Basicnet income per share excludes any dilutive effects of options. We compute basicnet income per share using the weighted average number of common sharesoutstanding during the period. We compute diluted net income per share usingthe weighted average number of common and common stock equivalent sharesoutstanding during the period. We excluded common equivalent shares of 186,000and 262,000 from the computation of diluted net income per share for 2007 and2006, respectively, because their effect was antidilutive.

 

Thefollowing table sets forth the computation of basic and diluted net income pershare:

 
| ** **                                                         | ** ** | **For the Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **(In thousands, except per share data)** | ** ** | **2007**                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Numerator for  basic and diluted net income per share              |       | $                                                             | 8,524      |   | $ | 5,644 |   | $ | 1,336 |   |
|                                                               |       |                                                          |       |   |   |   |   |
| Denominator:                                                       |       |                                                          |       |   |   |   |   |
| Weighted average  shares for basic net income per share            |       | 24,962                                                        |       | 24,349 |   | 17,140 |   |
|                                                               |       |                                                          |       |   |   |   |   |
| Effect of  dilutive securities:                                    |       |                                                          |       |   |   |   |   |
| Weighted average  of common stock and stock options                |       | 252                                                           |       | 268 |   | 214 |   |
|                                                               |       |                                                          |       |   |   |   |   |
| Denominators for  diluted net income per share                     |       | 25,214                                                        |       | 24,617 |   | 17,354 |   |
|                                                               |       |                                                          |       |   |   |   |   |
| Net income per  share—basic                                   |       | $                                                             | 0.34       |   | $ | 0.23 |   | $ | 0.08 |   |
| Net income per  share—diluted                                 |       | $                                                             | 0.34       |   | $ | 0.23 |   | $ | 0.08 |   |

 

*Recently Issued Accounting Pronouncements*

 

In December 2007,the FASB issued FASB Statement No. 141 (Revised 2007), *Business Combinations*. Under SFAS 141(R),an acquiring entity will be required to recognize all the assets acquired andliabilities assumed in a transaction at the acquisition-date fair value withlimited exceptions. SFAS 141(R) will change the accounting treatment forcertain specific items, including the following:

 
| · | acquisition costs will be generally  expensed as incurred;                                                                                                                                                                               |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                     |
| · | noncontrolling interests (formerly known  as “minority interests”—see SFAS 160 discussion below) will be valued at fair  value at the acquisition date;                                                                   |
|   |                                                                                                                                                                                                                                     |
| · | acquired contingent liabilities will be  recorded at fair value at the acquisition date and subsequently measured at  either the higher of such amount or the amount determined under existing  guidance for non-acquired contingencies; |
|   |                                                                                                                                                                                                                                     |
| · | in-process research and development will  be recorded at fair value as an indefinite-lived intangible asset at the  acquisition date;                                                                                                    |
|   |                                                                                                                                                                                                                                     |
| · | restructuring costs associated with a  business combination will be generally expensed subsequent to the acquisition  date and                                                                                                           |

 

 

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| · | changes in deferred tax asset valuation  allowances and income tax uncertainties after the acquisition date generally  will affect income tax expense. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Also included in SFAS141(R) are a substantial number of new disclosure requirements. SFAS 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. Earlier adoption is prohibited. Accordingly, a calendar year-end companyis required to record and disclose business combinations following existingGAAP until January 1, 2009. Consequently, we will adopt the provisions ofSFAS 141(R) for our fiscal year beginning January 1, 2009. We believethat SFAS 141(R) is applicable to us, but cannot yet reasonably estimatethe impact of the statement.

 

In December 2007,FASB issued FASB Statement No. 160, *NoncontrollingInterests in Consolidated Financial Statements—An Amendment of ARB No. 51*.SFAS 160 establishes new accounting and reporting standards for anoncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. Specifically, this statement requires the recognition of anoncontrolling interest (minority interest) as equity in the consolidatedfinancial statements and separate from the parent’s equity. The amount of netincome attributable to the noncontrolling interest will be included inconsolidated net income on the face of the income statement. SFAS 160 clarifiesthat changes in a parent’s ownership interest in a subsidiary that do notresult in deconsolidation are equity transactions if the parent retains itscontrolling financial interest. In addition, SFAS 160 requires that a parentrecognize a gain or loss in net income when a subsidiary is deconsolidated.Such gain or loss will be measured using the fair value of the noncontrollingequity investment on the deconsolidation date. SFAS 160 also includes expandeddisclosure requirements regarding the interests of the parent and itsnoncontrolling interest. SFAS 160 is effective for fiscal years, and interimperiods within those fiscal years, beginning on or after December 15,2008. Earlier adoption is prohibited. We will adopt SFAS 160 at the beginningof our fiscal year commencing January 1, 2009. We believe SFAS 160 will beapplicable to us in that minority interest will be listed separately inshareholders’ equity, but we cannot yet reasonably estimate the other impactsto our consolidated financial statements.

 

In September 2006,FASB issued FASB Statement No. 157, *Fair Value Measurements*.SFAS 157 defines fair value, establishes a framework for measuring fair value inGAAP, and expands disclosures about fair value measurements. SFAS 157 appliesunder other accounting pronouncements that require or permit fair valuemeasurements, the FASB having previously concluded in those accountingpronouncements that fair value is the relevant measurement attribute.Accordingly, SFAS 157 does not require any new fair value measurements. SFAS157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007, and interim periods within those fiscal years.Earlier application is encouraged, provided that the reporting entity has notyet issued financial statements for that fiscal year, including financialstatements for an interim period within that fiscal year. We will adopt theprovisions of SFAS 157 in our fiscal year commencing January 1, 2008. Wecurrently believe that adoption of the provisions of SFAS 157 will not have amaterial impact on our consolidated financial statements.

 

**3.****                  ****Notes Receivable and Other Assets**

 

As of December 31,2007, our notes receivable and other assets consisted of $2.7 million in notes,$0.3 million in investments, and $1.1 million in other long-term assets.  On November 7, 2007, we entered into acooperative business arrangement with Care2.com, Inc., whereby Care2 agreedthat we will become the e-commence provider for Care2 in return for apercentage of our revenue generated from such customer leads.  Additionally, Care2 agreed to promote Gaiamsubscriptions to Care2 customers and to not pursue subscription business.  We loaned Care2 $2.7 million, evidenced by a6% interest bearing senior secured promissory note due November 7, 2011,purchased 254,237 shares of Care2 Series D-1 Preferred Stock for cash of$300,000, and received warrants to subscribe for and purchase from Care2additional stock.  The warrants had noestimated fair value as of December 31, 2007.

 

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Notesreceivable and other assets as of December 31, 2006 consisted of $1.3million of investments, $2.4 million in notes and related interest receivable,and $0.6 million of other long-term assets. On January 5, 2006, we enteredinto an agreement with Alps Communications and Life Balance Media Holdings LLC,to sell 19,968 Series A Preferred Units of Life Balance Media Holdings toAlps, an investment that we previously accounted for using the equity method.The purchase price per unit was equal to the amount we paid for our investmentduring 2005. Alps assumed all unpaid Series A Capital Contributioncommitments from us and executed a 7.5% interest bearing promissory note due February 28,2009 in the principal amount of $2.3 million. After the closing of thistransaction, we owned 4,876 units, or less than 4%, of Life Balance MediaHoldings. This transaction resulted in a gain of $0.5 million which is includedin other income (expense) for the year ended December 31, 2006. On February 6,2007, we entered into a stock repurchase agreement with Revolution Living andAlps. As part of the stock repurchase agreement Alps prepaid its promissorynote principal plus accrued interest in the amount of $2.4 million and acquiredour investment in Life Balance Media Holdings for $1.4 million in cash.

 

On June 23,2006, we purchased, for $3.5 million, an approximate 34% ownership interest inCinema Circle, the parent company of Spiritual Cinema Circle, asubscription-based DVD film club. We accounted for this investment under theequity method and we recognized the excess of the cost of the investment overthe underlying equity in the net assets of Cinema Circle, $2.3 million, asgoodwill. During July 2006, we purchased an additional 29% interest inCinema Circle for $3.4 million. With the purchase of the additional interest,our ownership was approximately 63% and, therefore, commencing with theeffective dates of the additional share purchases, Cinema Circle met theaccounting criteria to be considered a business combination as outlined in SFASNo. 141, *Business Combinations*andwe began consolidating Cinema Circle’s results of operations effective July 31,2006.  On September 30, 2006, wereduced our investment in Cinema Circle to a 15% ownership interest and changedour accounting for Cinema Circle from the consolidation to cost method. SeeNote 4, Mergers and Acquisitions.

 

**4.            Mergersand Acquisitions**

 

Weinclude results from operations of acquired companies in our consolidatedfinancial statements from their respective effective acquisition dates. Weexpect that none of the goodwill resulting from acquisition of companies during2006 will be deductible for tax purposes.

 

In August 2005,we entered into agreements with Revolution Living, LLC, its founder, SteveCase, and Revolution Living’s Life Balance Media Holdings subsidiary. Under theterms of the Agreements, we acquired a minority interest in Life Balance MediaHoldings for approximately $7.5 million. We accounted for this investment usingthe equity method, so our share of the losses sustained by Life Balance MediaHoldings from the date of acquisition through December 31, 2005, totaling$0.6 million, have been reflected in our statement of operations for 2005.Effective in January 2006, we reduced our ownership in Life Balance MediaHoldings to less than 4%. On February 6, 2007, we sold the last part ofour interest in Life Balance Media Holdings for $1.4 million in cash.  See Note 3, Notes Receivable and OtherAssets.  On July 19, 2007, weacquired 100% ownership interest in Life Balance Media Holdings.  See our 2007 aggregated business acquisitionsdiscussion below.

 

In September 2005,we acquired a majority of the assets held by GoodTimes and certain of itsaffiliates for $34.4 million in cash plus $0.6 million in estimatedacquisition, legal and accounting costs. GoodTimes’ assets included entertainment programming and home videoproducts distributed through various channels, including television, retailersand the Internet. We commenced distribution of titles and content acquired inthis asset purchase on September 13, 2005. At December 31, 2005, weinitially allocated the $35.0 million purchase price as $29.1 million to medialibrary, $13.2 million to tangible assets, and $7.3 million to assumedliabilities. During 2006, we reduced the aggregate purchase price to $34.8million due to unrealized estimated acquisition costs and adjusted theestimated fair values by allocating $32.3 million to the media library, $9.4million to tangible assets, and $6.9 million to assumed liabilities. We basedthe adjustments primarily on additional facts about benefits and obligations asof the purchase date which were identified during the allocation period afterthe acquisition date. As a result of the adjustment to the media library, werecorded in September 2006 additional amortization expense of $0.3million.

 

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In October 2005,we acquired a 53.4% ownership interest in Newmark Media, a distribution companyspecializing in placing wellness media products in the grocery and drugstorechannels for an approximately $0.8 million cash contribution to Newmark. Weallocated the purchase price to the net tangible assets, and, as Newmark hadnegative net worth, we recorded $0.9 million in goodwill. On December 31,2006, we acquired the 46.6% minority ownership interest in Newmark for $0.3million cash and recorded an additional $0.2 million in goodwill. The stockpurchase agreement calls for additional consideration of up to $0.1 million contingentupon the achievement of certain distribution and product mix goals over thenext two years. During 2007 we recognized half of this contingent considerationas additional goodwill.  We have not yetrecognized the remainder of the contingent consideration because its amount isnot determinable beyond a reasonable doubt. We believe that Newmark’s expertisein product placement in these under-penetrated channels more than compensatesfor the goodwill recorded.

 

On December 30,2005, we increased our ownership percentage in Conscious Media, Inc., amultimedia company, to 51% for an additional investment of $3.5 million. Weacquired shares directly from the Conscious Media for its $1.5 million in notesreceivable and issued 146,667 shares of our Class A common stock andpromissory notes totaling $0.2 million to certain Conscious Media shareholders.We have recorded a reduction to retained earnings and our investment of $0.7million to reflect our share of the results from operations of Conscious Mediafrom the date of our original investment in 2002 to the end of 2005, when weacquired the majority ownership interest, and recognized $6.9 million ingoodwill.

 

On September 29,2006, we increased our ownership percentage in Conscious Media from 51% to 86%by issuing 149,698 shares of our Class A common stock valued at $1.9million and recognized additional goodwill of $1.4 million. During the fourthquarter of 2006, we invested another $3.2 million, comprised of 220,026 sharesof our Class A common stock, of which 85,526 shares were issued to two ofour outside board members, and cash of $0.2 million. As a result of thislatest investment, we effectively owned all of Conscious Media’s outstandingstock as of November 8, 2006 and recognized additional goodwill of $3.3million. We believe that Conscious Media’s expertise in media programming,development and post production will complement our current businesses andfuture growth, at a lower cost than we could develop on our own.

 

On September 30,2006, we, Cinema Circle, and Spiritual Cinema, one of our newly formedsubsidiaries, entered into a Share Exchange Agreement. Prior to our originalinvestment in Cinema Circle (see Note 3, Notes Receivable and Other Assets),Cinema Circle had two business segments, direct (primarily subscription clubs)and film production. Under the Exchange Agreement, Spiritual Cinema acquired100% of the equity and net assets of Cinema Circle’s direct segment from CinemaCircle in exchange for 76% of our interest in Cinema Circle and 15% ofSpiritual Cinema. Of the $6.9 million determined cost of our 85% ownershipin Spiritual Cinema, we allocated $5.6 million to goodwill, $0.5 millionto customer lists, and the remainder to net tangible assets and minorityinterest. We are amortizing the customer lists on a straight-line basis over 17months. We plan to invest in our community business over the next year tobetter capitalize on strong relationships with our loyal consumer audience andgrowing broadband subscription trends. This will allow us to focus on betterleveraging of our content through subscriptions and community. The filmsdistributed to Spiritual Cinema’s members are meaningful inspirational andspiritual family films that complement our product offerings.

 

During 2007, we acquiredvarying amounts of controlling ownership interest in several entities for atotal cost of approximately $17.9 million, including direct acquisition costsand other liabilities, of which $14.5 million was paid in cash, $1.5 million inshares of our Class A common stock, and $1.9 million in assumedliabilities.  Three of the acquisitionscall for additional consideration, payable in cash or shares of our Class Acommon stock (up to a maximum of 50,000 shares), contingent upon theachievement of a certain membership threshold within the next two years or oursale of the acquired business or its assets, the amount of revenue generatedfrom certain potential customers and the collection of certain rebates, or theattaining of a certain level of pre-tax profits in our community business overits first twelve months of operations. As additional consideration for the solar energy integrator, our whollyowned subsidiary, Real Goods Solar, granted to the sellers warrants to purchase40,000 shares of Real Goods’ Class A common stock at an exercise price of$3.20 per share.  The warrants commencevesting only upon an initial public offering of Real Goods’ Class A commonstock or our sale of 50% or more of the company.  We have not yet recognized any of thecontingent or additional consideration because the amounts are not determinablebeyond a reasonable doubt.  At the timeany of the contingent or additional consideration becomes probable and can beestimated, we will recognize it as additional purchase price and allocate it togoodwill and other intangibles, as appropriate.

 

42

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The acquired companies includeZaadz, a leading social networking site in the LOHAS space; Lime, a multimedialifestyle company; Conscious Enlightenment, an on-line and off-line community; anda solar system integration company. With regards to the acquisitions, weassumed liabilities for severance ($0.2 million) due to downsizing of theworkforce, facility lease obligations ($0.2 million) as a result of relocation,and a noncancellable contract ($0.6 million) which obligated us to performservices with no future benefit to the combined companies.  During 2007, we charged $0.1 million to theseverance liability, $0.1 million to the facility lease obligation liability,and $0.5 million to the noncancellable contract liability.  As of December 31, 2007, the remainingbalances were immaterial.  We anticipatecompleting the downsizing and relocation activities by the end of the secondquarter of 2008.

 

In connection with theacquisitions, we have preliminarily recognized $10.5 million and $3.8 millionof direct to consumer and business segment goodwill, respectively, of which weexpect $3.8 million to be deductible for tax purposes, $1.4 million of intangiblessubject to amortization (37 month weighted-average useful life), and $0.3million of indefinite life domain names. The amortizable intangibles are customer related of $0.8 million (23month weighted-average useful life) and marketing related of $0.6 million (53month weighted-average useful life).  Weare still in the process of finalizing our assessment of the estimated fairvalue of the net assets acquired and, thus, the amount of goodwill and otherintangibles is subject to refinement.

 

The following issupplemental unaudited pro forma information for the aggregated 2007acquisitions as if we had acquired the businesses on January 1, 2006. Thepro forma adjustments are based on currently available information and uponassumptions that we believe are reasonable in order to reflect, on a pro formabasis, the impact of these 2007 acquisitions on our historical financialinformation.  The unaudited pro formainformation should not be relied upon as being indicative of our results ofoperations had the acquisitions occurred on the dates assumed.  The unaudited pro forma financial informationalso does not project the results of operations for any future period or date.

 
| ** **                                                         | ** ** | ** **                                   | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|
| ** **                                                         | ** ** | **Pro Forma**                           | ** ** |
| ** **                                                         | ** ** | **Year ended   December 31,** | ** ** |
| ** **                                                         | ** ** | **2007**                                     | ** ** | **2006**   | ** ** |
| **(in thousands, except per share data)** | ** ** | **(unaudited)**                              | ** ** |
| Net revenue                                                        |       | $                                            | 273,835    |       | $          | 228,317 |   |
| Income before  income taxes and minority interest                  |       | $                                            | 12,225     |       |       | $ | 5,160 |   |
| Net income                                                         |       | $                                            | 7,079      |       | $          | 2,973 |   |
|                                                               |       |                                         |       |       |       |
| Net income per  share:                                             |       |                                         |       |       |       |
| Basic                                                              |       | $                                            | 0.28       |       | $          | 0.12 |   |
| Diluted                                                            |       | $                                            | 0.28       |       | $          | 0.12 |   |
|                                                                    |            |                                              |            |            |            |  |  |  |

 

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**5.             Property and Equipment**

 

Propertyand equipment, stated at lower of cost or fair value, consists of the followingas of December 31:

 
| **(in thousands)**                    | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Land                                       |       | $        | 3,100      |     | $          | 3,100 |   |
| Buildings                                  |       | 1,587    |       | 1,587    |       |
| Furniture,  fixtures and equipment         |       | 6,158    |       | 5,580    |       |
| Leasehold  improvements                    |       | 1,754    |       | 1,475    |       |
| Website  development costs                 |       | 5,962    |       | 4,763    |       |
| Studio, computer  and telephone equipment  |       | 8,842    |       | 7,864    |       |
| Warehouse and  distribution equipment      |       | 1,921    |       | 1,191    |       |
|                                       |       | 29,324   |       | 25,560   |       |
| Accumulated  depreciation and amortization |       | (19,815  | )          | (17,776  | )          |
|                                       |       | $        | 9,509      |     | $          | 7,784 |   |

 

**6.             Leases, Commitments andContingencies**

 

Welease office and warehouse space through operating leases. Some of the leaseshave renewal clauses, which range from 1 to 10 years. The following schedulerepresents the annual future minimum payments, as of December 31, 2007:

 
| **(in thousands)**       | ** ** | **Operating** | ** ** |
|-------------------------------|------------|---------------|------------|
| 2008                          |       | $             | 3,455      |   |
| 2009                          |       | 2,447         |       |
| 2010                          |       | 1,699         |       |
| 2011                          |       | 1,191         |       |
| 2012                          |       | 1,137         |       |
| 2013                          |       | 1,137         |       |
| 2014                          |       | 1,016         |       |
| 2015                          |       | 254           |       |
| Total minimum  lease payments |       | $             | 12,336     |   |

 

Weincurred rent expense of $4.2 million, $4.3 million and $2.7 million for theyears ended December 31, 2007, 2006 and 2005, respectively.

 

On January 15,2008, we entered into an option to purchase land, an office building, andimprovements located in Colorado for approximately $13.2 million in cash, whichwe estimate to be well below its replacement value.

 

**7.             Accrued Liabilities**

 

Accruedliabilities consist of the following as of December 31:

 
| **(in thousands)**    | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| Accrued  royalties         |       | $        | 3,242      |     | $          | 2,266 |   |
| Accrued  compensation      |       | 4,348    |       | 2,016    |       |
| Income taxes  payable      |       | 832      |       | 415      |       |
| Other accrued  liabilities |       | 2,209    |       | 539      |       |
|                       |       | $        | 10,631     |     | $          | 5,236 |   |

 

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**8.             Line of Credit**

 

Wehave a revolving line of credit agreement with a financial institution, whichexpires on October 22, 2009.  Thecredit agreement permits borrowings up to the lesser of $15 million or ourborrowing base which is calculated based upon the collateral value of ouraccounts receivable, inventory, and certain property and equipment. Borrowingsunder this agreement bear interest at the lower of prime rate less 75 basispoints or LIBO plus 275 basis points. Borrowings are secured by a pledge ofcertain of our assets, and the agreement contains various financial covenants,including those requiring compliance with certain financial ratios. At December 31,2007, we had no amounts outstanding under this agreement; however, $1.2 millionwas reserved for outstanding letters of credit. We believe we have complied with all of the financial covenants.

 

**9.             Income Taxes**

 

Ourprovision for income taxes is comprised of the following:

 
| ** **              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| **(in thousands)** | ** ** | **2007**                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Current:                |       |                                                          |       |   |   |   |   |
| Federal                 |       | $                                                             | 5,404      |   | $ | 2,115 |   | $ | 346 |   |
| State                   |       | 1,196                                                         |       | 474 |   | 48 |   |
| International           |       | (132                                                          | )          | (362 | ) | 301 |   |
|                    |       | 6,468                                                         |       | 2,227 |   | 695 |   |
| Deferred:               |       |                                                          |       |   |   |   |   |
| Federal                 |       | (624                                                          | )          | 916 |   | 232 |   |
| State                   |       | (138                                                          | )          | 207 |   | 47 |   |
| International           |       | 61                                                            |       | 424 |   | — |   |
|                    |       | (701                                                          | )          | 1,547 |   | 279 |   |
| Total                   |       | $                                                             | 5,767      |   | $ | 3,774 |   | $ | 974 |   |

 

Variations from thefederal statutory rate are as follows:

 
| **(in thousands)**                                                                 | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                    |       |     |       |     |       |     |       |
| Expected federal  income tax expense at statutory rate of 34%                           |       | $        | 4,944      |     | $          | 3,246    |       | $ | 978 |   |
| Effect of  permanent differences                                                        |       | 92       |       | 48       |       | 30       |       |
| State income tax  expense, net of federal benefit and utilization of net operating loss |       | 721      |       | 433      |       | 66       |       |
| Effect of  differences between U.S. taxation and foreign taxation                       |       | 10       |       | 47       |       | (100     | )          |
| Income tax  expense                                                                     |       | $        | 5,767      |     | $          | 3,774    |       | $ | 974 |   |

 

Deferred income taxesreflect net tax effects of temporary differences between the carrying amountsof assets and liabilities for financial reporting purposes and the amounts usedfor income tax purposes. The components of the net accumulated deferred incometax assets as of December 31, 2007 and 2006 are as follows:

 

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| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                        | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Deferred tax  assets (liabilities):            |       |                  |       |   |   |
| Current:                                       |       |                  |       |   |   |
| Provision for  doubtful accounts               |       | $                     | 491        |   | $ | 553 |   |
| Inventory-related  expense                     |       | 1,322                 |       | 456 |   |
| Accrued  liabilities                           |       | 4,365                 |       | 3,104 |   |
| Net operating  loss, or NOL, carryforward      |       | 337                   |       | — |   |
| Prepaid and  deferred catalog costs            |       | (584                  | )          | (709 | ) |
| Charitable  carryforward                       |       | 44                    |       | — |   |
| Foreign tax  credit                            |       | 30                    |       | — |   |
| Total current  deferred tax assets             |       | $                     | 6,005      |   | $ | 3,404 |   |
| Non-current:                                   |       |                  |       |   |   |
| Depreciation and  amortization                 |       | $                     | 420        |   | $ | (578 | ) |
| Section 181  qualified production expense |       | (2,770                | )          | — |   |
| NOL carryforward                               |       | 6,891                 |       | 7,026 |   |
| Foreign exchange  rate gain                    |       | (551                  | )          | (490 | ) |
| Other                                          |       | 67                    |       | — |   |
| Total  non-current deferred tax assets         |       | $                     | 4,057      |   | $ | 5,958 |   |
| Total net  deferred tax assets                 |       | $                     | 10,062     |   | $ | 9,362 |   |

 

At December 31,2007, we had made no provision for U.S. federal and state income taxes onapproximately $0.3 million of undistributed foreign earnings, which areexpected to remain outside of the U.S. indefinitely. Upon any futuredistribution of foreign earnings in the form of dividends or otherwise, wewould 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. Our foreign subsidiaries generated incomebefore minority interest and income taxes of approximately $0.2 million during2007 and 2006 and $1.2 million during 2005.

 

At December 31,2007 and 2006, we had NOL carryforwards of approximately $18.7 million and$18.0 million, respectively, associated with acquisitions completed in 2001,2002, 2005, 2006, and 2007, which may be used to offset future taxable income.These carryforwards expire between 2019 and 2027. The Internal Revenue Codecontains provisions that limit the NOL available for use in any given year uponthe occurrence of certain events, including significant changes in ownershipinterest. A change in ownership of a company of greater than 50% within athree-year period results in an annual limitation on the utilization of NOLcarryforwards from tax periods prior to the ownership changes. Our NOLcarryforwards as of December 31, 2007 are subject to annual limitationsdue to changes in****ownership.

 

Weexpect all the deferred tax assets at December 31, 2007 to be fullyrecoverable through the reversal of taxable temporary differences in futureyears as a result of normal business activities. We had no valuation allowanceas of December 31, 2007 or 2006.  Werealized $0.7 million and $2.2 million in tax benefits recorded to additionalpaid-in capital as a result of the exercise of stock options for the yearsended December 31, 2007 and 2006, respectively.

 

Effective January 1, 2007, we adopted the provisions ofthe Financial Accounting Standards Board (“FASB”) Interpretation No. 48, *Accounting of Uncertainty in Income Taxes—AnInterpretation of FASB Statement No. 109*. Under FIN 48, we mustrecognize the tax benefit from an uncertain tax position only if it is morelikely than not that the tax position will be sustained on examination by thetaxing authorities, based on the technical merits of the position. We measurethe tax benefits recognized in the consolidated financial statements from sucha position based on the largest benefit that has a greater than 50% likelihoodof being realized upon ultimate resolution. The application of income tax lawis inherently complex. Laws and regulations in this area are voluminous and areoften ambiguous. As such, we are required to make many subjective assumptionsand judgments regarding our income tax exposures. Interpretations of andguidance surrounding income tax law and regulations change over time and mayresult in changes to our subjective assumptions and judgments which canmaterially affect amounts recognized in our Consolidated balance sheets andConsolidated statements of operations. The result of the reassessment of ourtax positions in accordance with FIN 48 did not have a material impact on ourconsolidated financial statements. Our federal tax returns for all years after2003 and our state tax returns after 2002 are subject to future examination bytax authorities for all our tax jurisdictions. We recognize interest and penalties related to income tax matters inother income (expense) and corporate, general and administration expenses,respectively.

 

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**10.          Shareholders’ Equity**

 

During2005, we issued a total of 8,221 shares of our Class A common stock to ourindependent directors, in lieu of cash compensation, for services rendered in2004, and issued 62,634 shares of Class A common stock upon exercise ofoptions granted under our 1999 Long-Term Incentive Plan. On July 7, 2005,we issued and sold 2,821,317 unregistered shares of our Class A commonstock for an aggregate purchase price of approximately $18.7 million to certainfunds advised by Prentice Capital Management, LP. The holders of these shareshave certain registration rights. On August 22, 2005, we issued and sold2.5 million unregistered shares of our Class A common stock for anaggregate purchase price of $20 million to Revolution Living, LLC.Additionally, we issued 60,000 shares of our Class A common stock as purchaseconsideration for a media catalog business and issued 146,667 shares of Class Acommon stock to purchase shares of Conscious Media.

 

During2006, we issued a total of 7,692 shares of our Class A common stock to ourindependent directors, in lieu of cash compensation, for services rendered in2005 and 2006 and issued 671,784 shares of our Class A common stock uponexercise of options granted under our 1999 Long-Term Incentive Plan. On May 24,2006, we sold 5,000,000 shares of our Class A common stock and on June 13,2006 we sold 690,000 shares of our Class A common stock in an underwrittenoffering. The combined sale generated gross proceeds of $99.6 million. Weissued 149,698 and 220,026 shares of our Class A common stock on September 29,2006 and November 8, 2006, respectively, to acquire additional ownershipof Conscious Media. See Note 4, Mergers and Acquisitions.

 

During2007, we issued a total of 4,955 shares of our Class A common stock to ourindependent directors, in lieu of cash compensation, for services rendered in2006 and 2007; issued 1,875 restricted shares of our Class A common stockto two of our named executive officers as bonus compensation; issued 80,795shares of our Class A common stock as part of the consideration to acquirecontrolling ownership interests in two businesses (see Note 4, Mergers andAcquisitions); and issued 216,070 shares of our Class A common stock uponexercise of options under our 1999 Long-Term Incentive Plan.

 

On February 6, 2007,we entered into a stock repurchase agreement (the “Agreement”) with RevolutionLiving and Alps, whereby we repurchased 2.5 million of our Class A commonstock from Revolution Living for $13.14 per share or $32.8 million in cash,Alps prepaid its promissory note principal plus accrued interest in the amountof $2.4 million, Alps acquired our investment in Life Balance Media Holdingsfor $1.5 million in cash, and David Golden, Chief Financial Officer ofRevolution, resigned from the Board of Directors of Gaiam. Also as part of theAgreement, Jirka Rysavy, our Chairman and largest shareholder, purchased for$7.2 million Revolution Living’s option to acquire approximately 2.3 million ofhis Gaiam shares at $10 per share. The price to repurchase the option wascalculated as the spread between the negotiated $13.14 share price for ourpurchase of the shares from Revolution Living and the $10 option exerciseprice. The $13.14 per share price agreed to by the parties was the averageprice over the last 90 days of our shares prior to the closing. We accountedfor the re-acquired stock under the cost method. Since we have not yet decidedthe ultimate disposition of the re-acquired stock, we reflected its cost at December 31,2007 as a $32.9 million reduction to additional paid-in capital.

 

As of December 31,2007, we had the following Class A common shares reserved for futureissuance:

 
| Conversion of  Class B common shares                                                           |   | 5,400,000 |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------|--------|
| Awards under the  1999 Long-Term Incentive Plan:                                                    |   |      |   |
| Stock options  outstanding                                                                          |   | 883,670   |   |
| Shares reserved  for issuance to directors in lieu of cash compensation for 2007 services  rendered |   | 513       |   |
| Total shares  reserved for future issuance                                                          |   | 6,284,183 |   |

 

Each holder of shares ofour Class A common stock is entitled to one vote for each share held onall matters submitted to a vote of shareholders. Each share of our 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 ofour Class A common stock and shares of our Class B common stock voteas a single class on all matters that are submitted to the shareholders for avote. Accordingly, holders of a majority of the shares of our Class Acommon stock and shares of our Class B common stock entitled to vote inany election of directors may elect all of the directors who stand forelection. Shareholders may consent to an action in writing and without ameeting under certain circumstances.

 

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Shares of our Class Acommon stock and shares of our Class B common stock are entitled toreceive dividends, if any, as may be declared by the board of directors out oflegally available funds. In the event of a liquidation, dissolution or windingup of our Company, the shares of our Class A common stock and shares ofour Class B common stock are entitled to share ratably in our assetsremaining after the payment of all of our debts and other liabilities. Holdersof shares of our Class A common stock and shares of our Class Bcommon stock have no preemptive, subscription or redemption rights, and thereare no redemption or sinking fund provisions applicable to the shares of our Class Acommon stock and our Class B common stock.

 

Our Class Bcommon stock may not be transferred unless converted into shares of our Class Acommon stock, other than certain transfers to affiliates, family members, andcharitable organizations. The shares of our Class B common stock areconvertible one-for-one into shares of our Class A common stock, at theoption of the holder of the shares of our Class B common stock.

 

As part of additionalconsideration for the acquisition of a solar energy integrator, Real Goodsissued, on November 1, 2007, seven-year warrants to purchase 40,000 sharesof Real Goods’ Class A common stock at an exercise price of $3.20 pershare. See Note 4, Mergers and Acquisitions.

 

**11.          Share-Based Compensation**

 

Our share-basedcompensation program is a long-term retention program that is intended toattract, retain and provide incentives for talented employees, officers, anddirectors, and to align shareholder and employee interests. We grant optionsunder our 1999 Long-Term Incentive Plan, which provides for the granting ofoptions to purchase up to 3 million shares of our Class A common stock andterminates no later than June 1, 2009. We generally grant options underour Plan with an exercise price equal to the closing market price of our stockat the date of the grant and the options normally vest and become exercisableat 2% per month for the 50 months beginning in the eleventh month after date ofgrant. We recognize the compensation expense related to share-based paymentawards on a straight-line basis over the requisite service periods of theawards, which are generally five years for employees and two years for Boardmembers and named executive officers’ restricted stock wards. Grants typicallyexpire seven years from the date of grant.

 

Thedetermination of the fair value of share-based payment awards on the date ofgrant using the Black-Scholes option-pricing model is affected by our stockprice as well as assumptions regarding a number of complex and subjectivevariables. We derive the expected terms from the historical behavior ofparticipant groupings.  We base expectedvolatilities on the historically realized volatility of our stock over theexpected term. Our use of historically realized volatilities is based upon theexpectation that future volatility over the expected term is not likely todiffer from historical results. We base the risk-free interest rate used in theoption valuation model on U.S. Treasury zero-coupon issues with remaining termssimilar to the expected term on the options. We do not anticipate paying anycash dividends in the foreseeable future and, therefore, we use an expecteddividend yield of zero in the option valuation model. In accordance with SFAS No. 123R,we are required to estimate forfeitures at the time of grant and revise thoseestimates in subsequent periods if actual forfeitures differ from thoseestimates. We use historical data by participant groupings to estimate optionforfeitures and record share-based compensation expense only for those awardsthat are expected to vest.

 
| ** **                   | ** ** | **2007**       | ** ** | **2006**       | ** ** | **2005**     | ** ** |
|------------------------------|------------|----------------|------------|----------------|------------|--------------|------------|
|                         |       |           |       |           |       |         |       |
| Expected  volatility         |       | 49% - 59       | %          | 51% - 61       | %          | 38.4% - 46.9 | %          |
| Weighted-average  volatility |       | 57             | %          | 59             | %          | 42           | %          |
| Expected  dividends          |       | 0              | %          | 0              | %          | 0            | %          |
| Expected term  (in years)    |       | 2.0 – 5.8 |       | 1.5 – 5.9 |       | 5            |       |
| Risk-free rate               |       | 4.13% - 4.88   | %          | 4.27% - 5.13   | %          | 2.28% - 4.39 | %          |

 

Thetable below presents a summary of option activity under the Plan as of December 31,2007, and changes during the year then ended:

 

48

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| ** **                             | ** ** | **Shares** | ** ** | **Weighted-  Average   Exercise   Price** | ** ** | **Weighted- Average   Remaining   Contractual   Term** | ** ** | **Aggregate   Intrinsic   Value** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                                   |       |       |       |                                                |       |                                                                       |       |                                        |       |
| Outstanding at  January 1, 2007   |       | 1,027,740  |       | $                                                   | 10.59      |                                                                       |       |                                        |       |   |
| Granted                                |       | 333,000    |       | 15.64                                               |       |                                                                       |       |                                        |       |
| Exercised                              |       | (216,070   | )          | 12.59                                               |       |                                                                       |       |                                        |       |
| Forfeited or  expired                  |       | (261,000   | )          | 13.91                                               |       |                                                                       |       |                                        |       |
| Outstanding at  December 31, 2007 |       | 883,670    |       | $                                                   | 11.02      |                                                                       | 4.0        |                                        | $          | 15,692,126 |   |
| Exercisable at  December 31, 2007 |       | 403,200    |       | $                                                   | 8.18       |                                                                       | 2.2        |                                        | $          | 8,305,221 |   |

 

Weissue new shares upon the exercise of options. We received $2.7 million and$3.9 million in cash from stock options exercised during 2007 and 2006,respectively. The weighted-average grant-date fair value of options grantedduring the years 2007, 2006, and 2005 was $8.28, $8.06, and $4.37,respectively.  The total intrinsic valueof options exercised during the years ended December 31, 2007, 2006, and2005, was $2.1 million, $6.3 million, and $0.3 million, respectively. The totalfair value of shares vested during the years ended December 31, 2007,2006, and 2005 was $0.7 million, $0.4 million, and $1.4 million, respectively.

 

The share-basedcompensation cost charged against income was $1.1 million, $0.7 million, andnone during 2007, 2006, and 2005, respectively, and is shown in corporate,general and administration expenses. The total income tax benefit recognizedfor share-based compensation was $0.4 million, $0.3 million, and none for 2007,2006, and 2005, respectively.  As of December 31,2007, there was $3.0 million of unrecognized cost related to nonvestedshared-based compensation arrangements granted under the Plan.  We expect that cost to be recognized over aweighted-average period of 3.5 years.

 

During 2007, we extendedthe post-termination exercise grace period from 30 days to approximately sixmonths for vested options belonging to a former employee.  This modification had an immaterial effect oncompensation expense for the year ended December 31, 2007.

 

During 2007, oursubsidiary, Gaiam Energy Tech granted 300,000 options at $0.20 per share underits 2007 Long-Term Incentive Plan, which provides for the granting of up to1,000,000 common shares. Under this plan, options are typically granted with anexercise price equal to the estimated market price of Gaiam Energy Tech’s stockat the date of grant, vest based on performance or service conditions, andexpire seven years from the date of grant. Expected volatilities are based on avalue calculated using the historical volatility of comparable public companiesin Gaiam Energy Tech’s industry. Expected life is based on the specific vestingterms of the option, anticipated changes to market value and expected employeeexercise behavior.  The risk-freeinterest rate used in the option valuation model is based on U.S. Treasuryzero-coupon issues with remaining terms similar to the expected term on theoptions. Gaiam Energy Tech’s successor, Real Goods, assumed these options on January 31,2008, at an exercise price of $3.20 per share. We valued these options using anexpected volatility of 67%, expected term of 4.0 years, a risk-free interestrate of 4.875%, and no expected dividends. In determining the fair value ofReal Goods’ common stock at the date of grant of stock options, we set themarket value based on a combination of many different factors, such as anindependent offer to purchase a portion of Real Goods in exchange for preferredstock, the value of recent Gaiam Energy Tech acquisitions, and an evaluationperformed by an independent firm retained for that purpose. The options assumedare for Real Goods’ Class A common stock and vest only upon the initialpublic offering of Real Goods’ Class A common stock or our sale of 50% ormore of the company, (50% vest upon an initial public offering and thereaftervest approximately 2.0% per month during the 25-month period subsequent to thecompletion of Real Goods’ initial public offering).  The performance of this condition was notprobable as of December 31, 2007; therefore, we have recognized nocompensation expense related to these options. As of December 31, 2007, there was $0.5 million of unrecognizedcost related to these nonvested share-based compensation arrangements.  The ultimate recognition of compensationcost, if any, is dependent on the Real Goods initial public offering, theoccurrence or timing of which cannot accurately be predicted.

 

**12.          Segment and Geographic Information**

 

We manage our businessand aggregate our operational and financial information in accordance with tworeportable segments. The direct to consumer segment contains the directresponse marketing programs, catalog, Internet, solar, and subscriptioncommunity sales channels, while the business segment comprises the retailers,media and corporate account channels.

 

49

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Although we are able totrack revenues by sales channel, the management, allocation of resources andanalysis and reporting of expenses is solely on a combined basis, at thereportable segment level.

 

Contribution margin isdefined as net sales, less cost of goods sold and direct expenses. Financialinformation for our segments is as follows:

 

SegmentInformation

 
| ** **                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(in thousands)**                                                          | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenue:                                                                     |       |                                       |       |   |   |   |   |
| Direct to  consumer                                                              |       | $                                          | 151,462    |   | $ | 125,708 |   | $ | 72,337 |   |
| Business                                                                         |       | 111,481                                    |       | 93,772 |   | 70,155 |   |
| Consolidated net  revenue                                                        |       | 262,943                                    |       | 219,480 |   | 142,492 |   |
| Contribution  margin (loss):                                                     |       |                                       |       |   |   |   |   |
| Direct to  consumer                                                              |       | (2,904                                     | )          | (2,291 | ) | (781 | ) |
| Business                                                                         |       | 13,357                                     |       | 7,932 |   | 3,867 |   |
| Consolidated  contribution margin                                                |       | 10,453                                     |       | 5,641 |   | 3,086 |   |
| Reconciliation  of contribution margin to net income:                            |       |                                       |       |   |   |   |   |
| Other income  (expense)                                                          |       | 4,148                                      |       | 3,905 |   | (175 | ) |
| Income tax  expense                                                              |       | 5,767                                      |       | 3,774 |   | 974 |   |
| Minority  interest in net income of consolidated subsidiary, net of income taxes |       | (310                                       | )          | (128 | ) | (601 | ) |
| Net income                                                                       |       | $                                          | 8,524      |   | $ | 5,644 |   | $ | 1,336 |   |

 

 

The direct to consumerand business segments had total assets as follows:

 
| ** **              | ** ** | **As of December 31,** | ** ** |
|-------------------------|------------|---------------------------------------|------------|
| **(in thousands)** | ** ** | **2007**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Total assets:           |       |                                  |       |   |   |   |   |
| Direct to  consumer     |       | $                                     | 95,146     |   | $ | 89,507 |   | $ | 33,565 |   |
| Business                |       | 145,566                               |       | 161,461 |   | 122,536 |   |
|                    |       | $                                     | 240,712    |   | $ | 250,968 |   | $ | 156,101 |   |

 

Major Customer

 

Sales to our largestcustomer for 2007, 2006 and 2005 accounted for less than 10%, 10.1% and 12.1%of total revenue, respectively, during these periods and are reported in ourbusiness segment.

 

GeographicInformation

 

We sell and distributeessentially the same products in the United States and several foreigncountries. The major geographic territories are the U.S., Canada, Japan, andthe U.K. and are based on the location of the customer. The followingrepresents geographical data for our operations as of and for the year ended December 31:

 

50

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| **(in thousands)** | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------|------------|------------|------------|------------|------------|------------|------------|
| Revenue:                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States           |       | $          | 229,279    |       | $          | 206,584    |       | $ | 128,034 |   |
| International           |       | 33,664     |       | 12,896     |       | 14,458     |       |
|                    |       | $          | 262,943    |       | $          | 219,480    |       | $ | 142,492 |   |
| Long-Lived  Assets:     |       |       |       |       |       |       |       |
| United States           |       | $          | 47,794     |       | $          | 44,172     |       | $ | 46,466 |   |
| International           |       | 1,521      |       | 1,750      |       | 1,729      |       |
|                    |       | $          | 49,315     |       | $          | 45,922     |       | $ | 48,195 |   |

 
| ** **                            | ** ** | **As of December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|
| **(in thousands)**               | ** ** | **2007**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Components of  Long-Lived Assets (1): | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Property and  equipment, net          |       | $                                     | 9,509      |   | $ | 7,784 |   | $ | 9,428 |   |
| Media Library,  net                   |       | 37,566                                |       | 37,201 |   | 38,339 |   |
| Other  Intangibles, net               |       | 1,554                                 |       | 530 |   | 146 |   |
| Notes receivable  and other assets    |       | 686                                   |       | 407 |   | 282 |   |
|                                  |       | $                                     | 49,315     |   | $ | 45,922 |   | $ | 48,195 |   |

 

----

| (1) |   | Excludes other  non-current assets (non-current deferred tax assets, net, goodwill,  investments, notes receivable, and security deposits) of $50,331, $38,199,  and $31,637 for 2007, 2006, and 2005, respectively. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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

 

The following is asummary of the quarterly results of operations for the years ended December 31,2007 and 2006:

 
| ** **                                                         | ** ** | **Fiscal Year 2007 Quarters Ended** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **March 31**                                       | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
| ** **                                                         | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                        |       | $                                                       | 58,458     |   | $ | 52,361 |   | $ | 70,318 |   | $ | 81,806 |   |
| Gross profit                                                       |       | 37,476                                                  |       | 33,631 |   | 46,144 |   | 51,127 |   |
| Income (loss)  before income taxes and minority interests          |       | 2,828                                                   |       | (783 | ) | 5,224 |   | 7,332 |   |
| Net income  (loss)                                                 |       | 1,752                                                   |       | (346 | ) | 2,918 |   | 4,200 |   |
| Diluted net  income (loss) per share                               |       | $                                                       | 0.07       |   | $ | (0.01 | ) | $ | 0.12 |   | $ | 0.17 |   |
| Weighted average  shares outstanding-diluted                       |       | 25,813                                                  |       | 24,655 |   | 24,970 |   | 25,154 |   |

 
| ** **                                                         | ** ** | **Fiscal Year 2006 Quarters Ended** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in thousands, except per share data)** | ** ** | **March 31**                                       | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|                                                               |       |                                                    |       |   |   |   |   |   |   |
| Net revenue                                                        |       | $                                                       | 51,752     |   | $ | 43,161 |   | $ | 51,786 |   | $ | 72,781 |   |
| Gross profit                                                       |       | 33,162                                                  |       | 26,891 |   | 32,629 |   | 47,648 |   |
| Income (loss)  before income taxes and minority interests          |       | 1,587                                                   |       | (2,125 | ) | 2,522 |   | 7,562 |   |
| 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 |   |

 

51

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**14.          Subsequent Events**

 

On February 7, 2008, Real Goods filed apreliminary registration statement with the Securities and Exchange Commissionrelating to a proposed initial public offering of a minority interest of its Class Acommon stock.

 

On February 1, 2008, we sold our investment inthe non-LOHAS business newspapers that were previously acquired as part of theConscious Media acquisition.

 

On March 17, 2008, we re-acquired 75,800 sharesof our Class A common stock for an average price of $17.55 per share inthe open market.

 

**GAIAM, INC.**

 

**Financial StatementSchedule II**

 

**Consolidated valuation andqualifying accounts**

 
| **(in thousands)**           | ** ** | **Balance at  Beginning of  Year** | ** ** | **Additions  Charged to  Costs and  Expenses (1)** | ** ** | **Deductions** | ** ** | **Balance at  End of  Year (1)** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------------------|------------|----------------|------------|-------------------------------------------------|------------|
|                              |       |                                         |       |                                                              |       |           |       |                                            |       |
| Allowance for  Doubtful Accounts: |       |                                         |       |                                                              |       |           |       |                                            |       |
| 2007                              |       | $                                            | 1,443      |                                                              | $          | 312            |       | $                                               | 476        |   | $ | 1,279 |   |
| 2006                              |       | $                                            | 826        |                                                              | $          | 2,917          |       | $                                               | 2,300      |   | $ | 1,443 |   |
| 2005                              |       | $                                            | 642        |                                                              | $          | 952            |       | $                                               | 768        |   | $ | 826 |   |
|                              |       |                                         |       |                                                              |       |           |       |                                            |       |
| Allowance for  Product Returns:   |       |                                         |       |                                                              |       |           |       |                                            |       |
| 2007                              |       | $                                            | 6,891      |                                                              | $          | 30,216         |       | $                                               | 30,348     |   | $ | 6,759 |   |
| 2006                              |       | $                                            | 4,819      |                                                              | $          | 17,457         |       | $                                               | 15,385     |   | $ | 6,891 |   |
| 2005                              |       | $                                            | 1,814      |                                                              | $          | 6,350          |       | $                                               | 3,345      |   | $ | 4,819 |   |

 

----

(1)             Includesreserves associated with acquired assets/companies.

 

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

 

Not applicable.

 

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

 

**Evaluationof Disclosure Controls and Procedures**

 

Ourchief executive officer and chief financial officer conducted an evaluation ofthe effectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and Rule 15d-15(e) underthe Exchange Act. Based upon their evaluation as of December 31, 2007,they have concluded that those disclosure controls and procedures areeffective.

 

52

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**Changesin Internal Control over Financial Reporting**

 

Therehave been no changes in our internal control over financial reporting duringthe quarter ended December 31, 2007 that have materially affected, or arereasonably likely to affect, our internal control over financial reporting.

 

**Management’sReport on Internal Control over Financial Reporting**

 

We areresponsible for establishing and maintaining adequate internal control overfinancial reporting as defined in Rule 13a-15(f) under the ExchangeAct. Our 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 of America.Because of its inherent limitations, internal control over financial reportingmay not prevent 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.

 

Weassessed the effectiveness of our internal control over financial reporting asof December 31, 2007. In making the assessment, we used the criteria setforth by the Committee of Sponsoring Organizations of the Treadway Commissionin “*Internal Control-Integrated Framework*.”  Based on that assessment, we concluded that,as of December 31, 2007, our internal control over financial reporting iseffective based on those criteria.

 

Theoperating effectiveness of our internal control over financial reporting as of December 31,2007 has been audited by Ehrhardt Keefe Steiner & Hottman PC, anindependent registered public accounting firm, as stated in their report, whichis included herein.

 

**Item 9B.    Other Information**

 

Not applicable.

 

53

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**PART III**

 

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

 

We incorporate herein the information required by thisItem by reference to our Proxy Statement for our Annual Meeting ofShareholders, to be held on June 3, 2008, to be filed with the Commissionpursuant to Regulation 14A.

 

*Code ofEthics*

 

Wehave adopted a Code of Ethics applicable to our employees, including ourprincipal executive officer, principal financial officer, principal accountingofficer and persons performing similar functions. We have posted a copy of ourCode of Ethics on the corporate section of our Internet website atwww.gaiam.com/corporate. Our full Board of Directors must approve in advanceany waivers of the Code of Ethics. We will post any amendments or waivers fromour Code of Ethics that apply to our executive officers and directors on the “Codeof Ethics” section of our Internet website located at www.gaiam.com/corporate.

 

**Item 11.    Executive Compensation**

 

Weincorporate herein the information required by this Item by reference to ourProxy Statement for our Annual Meeting of Shareholders, to be held on June 3,2008, to be filed with the Commission pursuant to Regulation 14A.

 

**Item 12.    Security Ownership of Certain Beneficial Owners and Managementand Related Stockholder Matters**

 

Weincorporate  herein the informationrequired by this Item by reference to our Proxy Statement for our AnnualMeeting of Shareholders, to be held on June 3, 2008, to be filed with theCommission pursuant to Regulation 14A.

 

**Item 13.    Certain Relationships and Related Transactions, and DirectorIndependence**

 

Weincorporate herein the information required by this Item by reference to ourProxy Statement for our Annual Meeting of Shareholders, to be held on June 3,2008, to be filed with the Commission pursuant to Regulation 14A.

 

**Item 14.    Principal Accountant Fees and Services**

 

Weincorporate herein the information required by this Item by reference to ourProxy Statement for our Annual Meeting of  Shareholders, to be held on June 3, 2008,to be filed with the Commission pursuant to Regulation 14A.

 

**PART IV**

 

**Item 15.****   ****Exhibits and FinancialStatement Schedules**

 

Documents filed as part of this report are as follows:

 

1.     Consolidated Financial Statements.

 

See listing ofConsolidated Financial Statements included as part of this Form 10-K inItem 8 of Part II.

 

2.     Financial Statement Schedules.

 

Schedule II ConsolidatedValuation and Qualifying Accounts.

 

54

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|   | 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               |       | Amended and Restated Bylaws of Gaiam, Inc.  (incorporated by reference to Exhibit 3.1 of Gaiam’s current report on  Form 8-K dated November 29, 2007).                                                                                                                       |
|              |       |                                                                                                                                                                                                                                                                                                  |
| 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              |       | First Amendment to Credit Agreement executed  October 22, 2007 between Gaiam, Inc. (and other Gaiam subsidiaries  identified therein) and Wells Fargo Bank, N.A. (filed herewith).                                                                                                          |
|              |       |                                                                                                                                                                                                                                                                                                  |
| 10.3              |       | 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).*                                                                                                       |
|              |       |                                                                                                                                                                                                                                                                                                  |
| 10.4              |       | 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).                                                              |
|              |       |                                                                                                                                                                                                                                                                                                  |
| 10.5              |       | First Lease Amendment, dated April 12, 2000 and  effective 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). |

 

55

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| **Exhibit   No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                              |
|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.6              |       | Second Lease Amendment, dated October 5, 2005  and effective October 1, 2005, between Gaiam, Inc. and Dugan  Financing LLC (successor to Duke-Weeks Realty Limited Partnership)  (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              |       | Lease Agreement, dated October 5, 2005, between  Gaiam, Inc. and Dugan Realty L.L.C. (incorporated by reference to  Exhibit 10.6 of Gaiam’s annual report on Form 10-K for the year  ended December 31, 2005).                                                                                                 |
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.8              |       | 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).  |
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.9              |       | 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).                                  |
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.10             |       | 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).*                                                                                                                                  |
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.11             |       | 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).*                                                                                                                                   |
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.12             |       | 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).                                                                                                 |
|              |       |                                                                                                                                                                                                                                                                                                                                         |
| 10.13             |       | 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).*                                                                                                                                                |

 

56

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| **Exhibit   No.** | ** ** | **Description**                                                                                                                                                                                                                                         |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|              |       |                                                                                                                                                                                                                                                    |
| 10.14             |       | 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).*                  |
|              |       |                                                                                                                                                                                                                                                    |
| 10.15             |       | Lease Agreement dated December 18, 1997 by and  between Orix Prime West Broomfield Venture and Gaiam, Inc. (incorporated  by reference to Exhibit 10.4 of Gaiam’s registration statement on  Form S-1/A (No. 333-83283)). |
|              |       |                                                                                                                                                                                                                                                    |
| 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).                                                                                                |

 

----

* Indicates managementcontract or compensatory plan or arrangement.

 

57

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities andExchange Act of 1934, the Registrant has caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the City ofBroomfield, State of Colorado, on this 17th day of March, 2008.

 

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

** **

 
| **Signature**          | ** ** | **Title**                                              | ** ** | **Date**             |
|------------------------|------------|--------------------------------------------------------|------------|----------------------|
|                   |       |                                                   |       |                 |
| /s/ Jirka Rysavy       |       | Chairman of the Board  and                             |       | March 17,  2008 |
| Jirka Rysavy           |       | Chief Executive Officer  (Principal Executive Officer) |       |                 |
|                   |       |                                                   |       |                 |
| /s/ Lynn Powers        |       | President and                                          |       | March 17,  2008 |
| Lynn Powers            |       | Director                                               |       |                 |
|                   |       |                                                   |       |                 |
|                   |       | Director                                               |       |                 |
| James Argyropoulos     |       |                                                   |       |                 |
|                   |       |                                                   |       |                 |
| /s/ Barnet M. Feinblum |       | Director                                               |       | March 17, 2008  |
| Barnet M. Feinblum     |       |                                                   |       |                 |
|                   |       |                                                   |       |                 |
| /s/ Barbara Mowry      |       | Director                                               |       | March 17, 2008  |
| Barbara Mowry          |       |                                                   |       |                 |
|                   |       |                                                   |       |                 |
| /s/ Ted Nark           |       | Director                                               |       | March 17, 2008  |
| Ted Nark               |       |                                                   |       |                 |
|                   |       |                                                   |       |                 |
| /s/ Paul H. Ray        |       | Director                                               |       | March 17, 2008  |
| Paul H. Ray            |       |                                                   |       |                 |
|                   |       |                                                   |       |                 |
| /s/ Vilia Valentine    |       | Chief Financial Officer                                |       | March 17, 2008  |
| Vilia Valentine        |       | (Principal Accounting Officer)                         |       |                 |

 

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