**United StatesSecurities and Exchange Commission****Washington, D.C. 20549**

 

**Form 10-Q**

 

**ý****          ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES ANDEXCHANGE ACT OF 1934**

 

**For the quarterly period endedJune 30, 2005**

 

**OR**

 

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

 

**Commission FileNumber 0-27517**

 

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

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

 

**360 INTERLOCKENBLVD.,BROOMFIELD, COLORADO 80021**(Address of principal executive offices)

 

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

 

Indicate by check mark whether the registrant: (1) has filedall reports required to be filed by Section 13 or 15 (d) of the Securities andExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has been subjectto such filing requirements for the past 90 days.

 

YES  ý             NO  o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).YES  ý             NO  o

 

Indicate the number of shares outstanding of each of theissuer’s classes of common stock, as of the latest practicable date:

 
| **Class**                                 | ** ** | **Shares outstanding as of August 8, 2005** |
|-------------------------------------------|------------|---------------------------------------------|
| Class A Common Stock  ($.0001 par value)  |       | 12,301,435                                  |
|                                      |       |                                        |
| Class B Common Stock   ($.0001 par value) |       | 5,400,000                                   |

 

 

----

 

**INDEX TO FORM 10-Q**

 
| PART  I.   FINANCIAL INFORMATION |                                                                                               |
|--------------------------------------------|----------------------------------------------------------------------------------------------------|
|                                       |                                                                                               |   |
|                                       | Condensed  Consolidated Financial Statements (Unaudited)                                           |   |
|                                       | Condensed Consolidated  Balance Sheets at June 30, 2005 and December 31, 2004                      |   |
|                                       | Condensed Consolidated  Statements of Operations for the three months ended June 30, 2005 and 2004 |   |
|                                       | Condensed Consolidated  Statements of Operations for the six months ended June 30, 2005 and 2004   |   |
|                                       | Condensed Consolidated Statements of Cash Flows for the six months  ended June 30, 2005 and 2004   |   |
|                                       | Notes to Interim Condensed  Consolidated Financial Statements                                      |   |
|                                       |                                                                                               |   |
| Item 2.                                    | Management’s Discussion and Analysis  of Financial Condition and Results of Operations        |   |
|                                       |                                                                                               |   |
| Item 3.                                    | Quantitative and Qualitative  Disclosures About Market Risk                                        |   |
|                                       |                                                                                               |   |
| Item 4.                                    | Controls and Procedures                                                                            |   |
|                                       |                                                                                               |   |
| PART II.                                   | OTHER INFORMATION                                                                                  |   |
|                                       |                                                                                               |   |
| Item 1.                                    | Legal Proceedings                                                                                  |   |
|                                       |                                                                                               |   |
| Item 2.                                    | Unregistered Sales of Equity  Securities and Use of Proceeds                                       |   |
|                                       |                                                                                               |   |
| Item 3.                                    | Defaults Upon Senior  Securities                                                                   |   |
|                                       |                                                                                               |   |
| Item 4.                                    | Submission of Matters to a  Vote of Security Holders                                               |   |
|                                       |                                                                                               |   |
| Item 5.                                    | Other Information                                                                                  |   |
|                                       |                                                                                               |   |
| Item 6.                                    | Exhibits                                                                                           |   |
|                                       |                                                                                               |   |
| SIGNATURES                                 |                                                                                               |   |

 

FORWARD-LOOKINGSTATEMENTS

 

Thisreport may contain forward-looking statements that involve risks anduncertainties.  When used in thisdiscussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,” “strive,”“future,” “intend” and similar expressions as they relate to Gaiam or itsmanagement are intended to identify such forward-looking statements.  Gaiam’s actual results could differmaterially from the results anticipated in these forward-looking statements asa result of certain factors set forth under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” “Market Risk” andelsewhere 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, consumer trends, acquisitions, new initiativesundertaken by Gaiam, security and information systems, legal liability forwebsite content, merchandise supply problems, failure of third parties toprovide adequate service, our reliance on centralized customer service,overstocks and merchandise returns, our reliance on a centralized fulfillmentcenter, increases in postage and shipping costs, E-commerce trends, futureInternet related taxes, control of Gaiam by its founder, fluctuations inquarterly operating results, customer interest in our products, the effect ofgovernment regulation and other risks and uncertainties included in Gaiam’sfilings with the Securities and Exchange Commission.  We caution you that no forward-lookingstatement is a guarantee of future performance, and you should not place unduereliance on these forward-looking statements which reflect our management’sview only as of the date of this report. We undertake no obligation to update any forward-looking information.

 

2

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GAIAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share information)

 
| ** **                                                                                                                                                                          | ** ** | **June 30,**    | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2005**        | ** ** | **2004**         | ** ** |
| ** **                                                                                                                                                                          | ** ** | **(Unaudited)** | ** ** | ** **       | ** ** |
| **Assets**                                                                                                                                                                          |       |            |       |             |       |
| Current  assets:                                                                                                                                                                    |       |            |       |             |       |
| Cash and cash equivalents                                                                                                                                                           |       | $               | 12,259     |             | $          | 10,439 |   |
| Accounts receivable, net                                                                                                                                                            |       | 8,129           |       | 13,914           |       |
| Income tax and other receivables                                                                                                                                                    |       | 3,023           |       | 3,000            |       |
| Inventory, less allowances                                                                                                                                                          |       | 15,594          |       | 16,503           |       |
| Deferred advertising costs                                                                                                                                                          |       | 1,994           |       | 2,635            |       |
| Deferred tax assets                                                                                                                                                                 |       | 715             |       | 1,145            |       |
| Other current assets                                                                                                                                                                |       | 1,462           |       | 1,324            |       |
| Total current assets                                                                                                                                                                |       | 43,176          |       | 48,960           |       |
|                                                                                                                                                                                |       |            |       |             |       |
| Property and equipment, net                                                                                                                                                         |       | 7,128           |       | 7,857            |       |
| Investments                                                                                                                                                                         |       | 7,865           |       | 7,865            |       |
| Capitalized production costs, net                                                                                                                                                   |       | 5,326           |       | 5,457            |       |
| Media library, net                                                                                                                                                                  |       | 5,060           |       | 5,427            |       |
| Goodwill and other intangibles                                                                                                                                                      |       | 9,537           |       | 9,757            |       |
| Non-current deferred tax assets                                                                                                                                                     |       | 3,685           |       | 2,657            |       |
| Other assets                                                                                                                                                                        |       | 431             |       | 307              |       |
| Total assets                                                                                                                                                                        |       | $               | 82,208     |             | $          | 88,287 |   |
|                                                                                                                                                                                |       |            |       |             |       |
| **Liabilities and stockholders’ equity**                                                                                                                                       |       |            |       |             |       |
| Current liabilities:                                                                                                                                                                | ** ** | ** **      | ** ** | ** **       | ** ** |
| Accounts payable                                                                                                                                                                    |       | $               | 8,948      |             | $          | 12,910 |   |
| Accrued liabilities                                                                                                                                                                 |       | 3,080           |       | 3,698            |       |
| Income taxes payable                                                                                                                                                                |       | 390             |       | 864              |       |
| Total current liabilities                                                                                                                                                           |       | 12,418          |       | 17,472           |       |
|                                                                                                                                                                                |       |            |       |             |       |
| Minority interest                                                                                                                                                                   |       | 4,373           |       | 4,469            |       |
|                                                                                                                                                                                |       |            |       |             |       |
| Commitments and contingencies                                                                                                                                                       |       |            |       |             |       |
|                                                                                                                                                                                |       |            |       |             |       |
| Stockholders’ equity:                                                                                                                                                          |       |            |       |             |       |
| Class A common stock, $.0001 par value, 150,000,000  shares authorized, 9,420,118 and 9,411,897 shares issued and outstanding at  June 30, 2005 and December 31, 2004, respectively |       | 1               |       | 1                |       |
| Class B common stock, $.0001 par value, 50,000,000  shares authorized, 5,400,000 issued and outstanding at June 30, 2005 and  December 31, 2004                                     |       | 1               |       | 1                |       |
| Additional paid-in capital                                                                                                                                                          |       | 54,982          |       | 54,933           |       |
| Accumulated other comprehensive income                                                                                                                                              |       | 522             |       | 850              |       |
| Retained earnings                                                                                                                                                                   |       | 9,911           |       | 10,561           |       |
| Total stockholders’ equity                                                                                                                                                     |       | 65,417          |       | 66,346           |       |
| Total liabilities and stockholders’ equity                                                                                                                                     |       | $               | 82,208     |             | $          | 88,287 |   |

 

*See accompanying notes to the condensedconsolidated financial statements.*

 

3

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 
| ** **                                                                       | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                   | ** ** |
| ** **                                                                       | ** ** | **2005**                       | ** ** | **2004** | ** ** |
|                                                                             |       |                           |       |   |   |
| Net revenue                                                                      |       | $                              | 21,706     |   | $ | 17,031 |   |
| Cost of goods sold                                                               |       | 11,149                         |       | 8,491 |   |
| Gross profit                                                                     |       | 10,557                         |       | 8,540 |   |
|                                                                             |       |                           |       |   |   |
| Expenses:                                                                        |       |                           |       |   |   |
| Selling and operating                                                            |       | 9,935                          |       | 10,171 |   |
| Corporate, general and administration                                            |       | 1,893                          |       | 2,003 |   |
| Total expenses                                                                   |       | 11,828                         |       | 12,174 |   |
|                                                                             |       |                           |       |   |   |
| Loss from operations                                                             |       | (1,271                         | )          | (3,634 | ) |
|                                                                             |       |                           |       |   |   |
| Other income (expense)                                                           |       | (53                            | )          | 28 |   |
| Interest income                                                                  |       | 45                             |       | 48 |   |
| Total other income (expense)                                                     |       | (8                             | )          | 76 |   |
|                                                                             |       |                           |       |   |   |
| Loss before income taxes and minority  interest                                  |       | (1,279                         | )          | (3,558 | ) |
|                                                                             |       |                           |       |   |   |
| Income tax benefit                                                               |       | (532                           | )          | (1,297 | ) |
| Minority interest in net (income) loss of consolidated  subsidiaries, net of tax |       | (19                            | )          | 46 |   |
| Net loss                                                                         |       | $                              | (766       | ) | $ | (2,215 | ) |
|                                                                             |       |                           |       |   |   |
| Net loss per share:                                                              |       |                           |       |   |   |
| Basic                                                                            |       | $                              | (0.05      | ) | $ | (0.15 | ) |
| Diluted                                                                          |       | $                              | (0.05      | ) | $ | (0.15 | ) |
| Shares used in computing net loss per share:                                     |       |                           |       |   |   |
| Basic                                                                            |       | 14,820                         |       | 14,686 |   |
| Diluted                                                                          |       | 14,820                         |       | 14,686 |   |

 

*See accompanying notes to the condensedconsolidated financial statements.*

 

4

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OFOPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 
| ** **                                                                | ** ** | **For the Six Months Ended** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                | ** ** | **June 30,**                 | ** ** |
| ** **                                                                | ** ** | **2005**                     | ** ** | **2004** | ** ** |
|                                                                      |       |                         |       |   |   |
| Net revenue                                                               |       | $                            | 48,030     |   | $ | 40,806 |   |
| Cost of goods sold                                                        |       | 23,724                       |       | 19,590 |   |
| Gross profit                                                              |       | 24,306                       |       | 21,216 |   |
|                                                                      |       |                         |       |   |   |
| Expenses:                                                                 |       |                         |       |   |   |
| Selling and operating                                                     |       | 21,625                       |       | 21,128 |   |
| Corporate, general and administration                                     |       | 3,665                        |       | 4,051 |   |
| Total expenses                                                            |       | 25,290                       |       | 25,179 |   |
|                                                                      |       |                         |       |   |   |
| Loss from operations                                                      |       | (984                         | )          | (3,963 | ) |
|                                                                      |       |                         |       |   |   |
| Other income                                                              |       | 38                           |       | 52 |   |
| Interest income                                                           |       | 70                           |       | 80 |   |
| Total other income                                                        |       | 108                          |       | 132 |   |
|                                                                      |       |                         |       |   |   |
| Loss before income taxes and minority  interest                           |       | (876                         | )          | (3,831 | ) |
|                                                                      |       |                         |       |   |   |
| Income tax benefit                                                        |       | (402                         | )          | (1,413 | ) |
| Minority interest in net income of consolidated  subsidiaries, net of tax |       | (176                         | )          | (126 | ) |
| Net loss                                                                  |       | $                            | (650       | ) | $ | (2,544 | ) |
|                                                                      |       |                         |       |   |   |
| Net loss per share:                                                       |       |                         |       |   |   |
| Basic                                                                     |       | $                            | (0.04      | ) | $ | (0.17 | ) |
| Diluted                                                                   |       | $                            | (0.04      | ) | $ | (0.17 | ) |
| Shares used in computing net loss per  share:                             |       |                         |       |   |   |
| Basic                                                                     |       | 14,820                       |       | 14,650 |   |
| Diluted                                                                   |       | 14,820                       |       | 14,650 |   |

 

*See accompanying notes to the condensedconsolidated financial statements.*

 

5

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS

(Unaudited – In thousands)

 
| ** **                                                                       | ** ** | **For the Six Months  Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| **Operating activities**                                                         |       |                                   |       |   |   |
| Net loss                                                                         |       | $                                      | (650       | ) | $ | (2,544 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |       |                                   |       |   |   |
| Depreciation                                                                     |       | 1,145                                  |       | 1,472 |   |
| Amortization                                                                     |       | 802                                    |       | 835 |   |
| Stock compensation                                                               |       | —                                 |       | 36 |   |
| Minority interest in consolidated  subsidiaries                                  |       | 176                                    |       | 126 |   |
| Deferred income tax expense                                                      |       | 382                                    |       | 221 |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:  |       |                                   |       |   |   |
| Accounts receivable                                                              |       | 5,620                                  |       | 9,279 |   |
| Inventory                                                                        |       | 663                                    |       | (12 | ) |
| Deferred advertising costs                                                       |       | 641                                    |       | (100 | ) |
| Other current assets                                                             |       | (150                                   | )          | (91 | ) |
| Other assets                                                                     |       | (145                                   | )          | 205 |   |
| Accounts payable                                                                 |       | (3,882                                 | )          | (4,589 | ) |
| Accrued liabilities                                                              |       | (504                                   | )          | (602 | ) |
| Income taxes payable                                                             |       | (1,312                                 | )          | 180 |   |
| Net cash provided by operating activities                                        |       | 2,786                                  |       | 4,416 |   |
|                                                                             |       |                                   |       |   |   |
| **Investing activities**                                                         |       |                                   |       |   |   |
| Purchase of property, equipment and media  rights                                |       | (767                                   | )          | (651 | ) |
| Net cash used in investing activities                                            |       | (767                                   | )          | (651 | ) |
|                                                                             |       |                                   |       |   |   |
| **Financing activities**                                                         |       |                                   |       |   |   |
| Principal payments on capital leases                                             |       | —                                 |       | (37 | ) |
| Proceeds from issuance of common stock                                           |       | —                                 |       | 402 |   |
| Net cash provided by financing activities                                        |       | —                                 |       | 365 |   |
|                                                                             |       |                                   |       |   |   |
| Effects of exchange rates on cash and cash  equivalents                          |       | (199                                   | )          | 37 |   |
| Net change in cash and cash equivalents                                          |       | 1,820                                  |       | 4,167 |   |
| Cash and cash equivalents at beginning of  period                                |       | 10,439                                 |       | 8,384 |   |
| Cash and cash equivalents at end of period                                       |       | $                                      | 12,259     |   | $ | 12,551 |   |
|                                                                             |       |                                   |       |   |   |
| **Supplemental cash flow information**                                           |       |                                   |       |   |   |
| Interest paid                                                                    |       | $                                      | —     |   | $ | — |   |
| Income taxes paid                                                                |       | 560                                    |       | — |   |

 

*See accompanying notes to the condensedconsolidated financial statements*

 

6

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Gaiam, Inc.

Notes to Interim Condensed ConsolidatedFinancial Statements

(Unaudited)

June 30, 2005

 

1.             Interim Condensed Consolidated FinancialStatements

 

###### Organization and Nature of Operations

 

Gaiam, Inc. is a lifestyle media company providing abroad selection of content, information, and products to individuals who valuepersonal development, natural health, ecological lifestyles and responsible,inspirational media.  Gaiam wasincorporated under the laws of the State of Colorado on July 7, 1988.

 

The accompanying condensed consolidated financialstatements include the accounts of Gaiam and its subsidiaries in which Gaiam’sownership is greater than 50% and the subsidiary is considered to be underGaiam’s control.  All materialintercompany accounts and transaction balances have been eliminated inconsolidation.

 

###### Preparation of Interim Condensed Consolidated Financial Statements

 

The interim condensed consolidated financialstatements included herein have been prepared by the management of Gaiampursuant to the rules and regulations of the United States Securities andExchange Commission, and, in the opinion of management, contain all adjustments(consisting of only normal recurring adjustments) necessary to present fairlyGaiam’s consolidated financial position as of June 30, 2005, the interimresults of operations for the three and six months ended June 30, 2005 and2004, and cash flows for the six months ended June 30, 2005 and 2004.  These interim statements have not beenaudited.  The balance sheet as ofDecember 31, 2004 was derived from Gaiam’s audited consolidated financialstatements included in Gaiam’s annual report on Form 10-K.

 

Certain information and footnote disclosuresnormally included in consolidated financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  Accounting policies followed by Gaiam aredescribed in Note 1 to the audited financial statements for the fiscal yearended December 31, 2004 included in Gaiam’s annual report on Form 10-K.  The consolidated financial statementscontained herein should be read in conjunction with Gaiam’s audited financialstatements, including the notes thereto, for the year ended December 31, 2004.

 

The consolidated financial position, results ofoperations and cash flows for the interim periods disclosed in this report arenot necessarily indicative of future financial results.

 

###### Use of Estimates

 

The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenue and expenses anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements.  Actual resultscould differ from those estimates.

 

###### Reclassifications

 

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

 

7

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###### New Accounting Pronouncements

 

In December 2004, the FASB issued SFAS No. 123(revised), *Share-Based Payment,*which supersedesAccounting Principles Board (“APB”) No. 25, *Accounting for StockIssued to Employees*(“APB No. 25”)*,*and its related implementation guidance. Under SFAS No. 123 (revised), all share-based payments would be treatedas other forms of compensation by recognizing the costs, generally measured asthe fair value at the date of grant, in the statement of operations.  Gaiam will adopt SFAS No. 123 (revised) forits fiscal year beginning January 1, 2006, in accordance with rules adopted bythe Securities and Exchange Commission on April 14, 2005.  Management expects that the impact of theadoption of SFAS No. 123 (revised) will be that the share-based payment expenseamounts historically disclosed as required by SFAS No. 123 will now berecognized as an expense on the statement of operations.

 

###### Stock-Based Compensation

 

Gaiam accounts for its stock-based compensationarrangements under the provisions of APB No. 25 and related interpretations,including FASB Interpretation No. 44, *Accountingfor Certain Transactions Involving Stock Compensation*, rather thanthe alternative fair value accounting allowed by SFAS No. 123, *Accounting for Stock Based Compensation*.  Accordingly, no compensation expense isrecognized in Gaiam’s consolidated financial statements in connection withstock options granted to employees with exercise prices not less than fairvalue.  Deferred compensation for optionsgranted to employees is determined as the difference between the fair marketvalue of Gaiam’s common stock on the date options were granted and the exerciseprice.  For purposes of this pro-formadisclosure, the estimated fair value of options is assumed to be amortized toexpense over the options’ vesting periods.

 

Compensation expense for options granted tonon-employees has been determined in accordance with SFAS No. 123 as the fairvalue of the consideration received or the fair value of the equity instrumentsissued, whichever is more reliably measured. Compensation expense for options granted to non-employees was periodicallyre-measured, as the underlying options vested. Had compensation cost for Gaiam’s stock-based compensation plan beendetermined under the fair value methodology under SFAS No. 123, Gaiam’s netincome (loss) and income (loss) per share would have been as follows (inthousands, except per share data):

 
| ** **                                                                                                                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                            | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                                                                                                            | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss as reported                                                                                                                  |       | $                      | (766       | )                    | $          | (2,215 | ) | $ | (650 | ) | $ | (2,544 | ) |
| Add: Stock-based compensation expense included  in reported net income (loss), net of related tax effects                             |       | —                 |       | 18                   |       | — |   | 36 |   |
| Deduct: Total stock-based compensation expenses  determined under fair value based method for all awards, net of related tax  effects |       | (65                    | )          | (164                 | )          | (145 | ) | (329 | ) |
| Pro forma                                                                                                                             |       | $                      | (831       | )                    | $          | (2,361 | ) | $ | (795 | ) | $ | (2,837 | ) |
| Net loss per common share                                                                                                             |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                                           |       | $                      | (0.05      | )                    | $          | (0.15 | ) | $ | (0.04 | ) | $ | (0.17 | ) |
| Pro forma                                                                                                                             |       | $                      | (0.06      | )                    | $          | (0.16 | ) | $ | (0.05 | ) | $ | (0.19 | ) |
| Fully diluted net loss per common share                                                                                               |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                                           |       | $                      | (0.05      | )                    | $          | (0.15 | ) | $ | (0.04 | ) | $ | (0.17 | ) |
| Pro forma                                                                                                                             |       | $                      | (0.06      | )                    | $          | (0.16 | ) | $ | (0.05 | ) | $ | (0.19 | ) |

 

2.             Stockholders’ Equity

 

During the first quarter of 2005, Gaiam issued atotal of 8,221 shares of Class A common stock to Gaiam’s independent directors,in lieu of cash compensation, for services rendered in 2004.

 

8

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3.             Comprehensive Income (Loss)

 

Gaiam’s comprehensive income (loss) is comprised ofnet income (loss) and foreign currency translation adjustment, net of incometaxes.  Comprehensive income (loss), netof related tax effects, was as follows (in thousands):

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                    | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)                             |       | $                      | (766       | )                    | $          | (2,215 | ) | $ | (650 | ) | $ | (2,544 | ) |
| Foreign currency translation adjustment,  net |       | (263                   | )          | (83                  | )          | (328 | ) | 85 |   |
| Comprehensive income (loss), net of taxes     |       | $                      | (1,029     | )                    | $          | (2,298 | ) | $ | (978 | ) | $ | (2,459 | ) |

 

4.             Earnings (Loss) per Share

 

Basic earnings (loss) per share excludes anydilutive effects of options, warrants and dilutive securities.  Basic earnings (loss) per share is computedusing the weighted average number of common shares outstanding during theperiod.  Diluted earnings per share iscomputed using the weighted average number of common and common stockequivalent shares outstanding during the period.  Common equivalent shares of 121 thousand and110 thousand are excluded from the computation of diluted earnings per sharefor the three months ended June 30, 2005 and 2004, respectively, and 108 and 132thousand common equivalent shares are excluded from the computation for the sixmonths ended June 30, 2005 and 2004, respectively, because their effect isantidilutive.

 

The following table sets forth the computation ofbasic and diluted earnings per share (in thousands, except per share data):

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                    | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                                    | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Numerator for basic and diluted earnings  (loss) per share    |       | $                      | (766       | )                    | $          | (2,215 | ) | $ | (650 | ) | $ | (2,544 | ) |
| Denominator:                                                  |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares for basis earnings  (loss) per share  |       | 14,820                 |       | 14,686               |       | 14,820 |   | 14,650 |   |
| Effect of dilutive securities:                                |       |                   |       |                 |       |   |   |   |   |
| Weighted average of common stock, stock  options and warrants |       | —                 |       | —               |       | — |   | — |   |
|                                                          |       |                   |       |                 |       |   |   |   |   |
| Denominators for diluted earnings (loss)  per share           |       | 14,820                 |       | 14,686               |       | 14,820 |   | 14,650 |   |
|                                                          |       |                   |       |                 |       |   |   |   |   |
| Net income (loss) per share - basic                           |       | $                      | (0.05      | )                    | $          | (0.15 | ) | $ | (0.04 | ) | $ | (0.17 | ) |
|                                                          |       |                   |       |                 |       |   |   |   |   |   |   |   |   |
| Net income (loss) per share - diluted                         |       | $                      | (0.05      | )                    | $          | (0.15 | ) | $ | (0.04 | ) | $ | (0.17 | ) |

 

5.             Segment Information

 

Gaiam manages its business and aggregates itsoperational and financial information in accordance with two reportablesegments.  The direct to consumer segmentcontains Gaiam’s catalog and Internet sales channels, while the businesssegment comprises the retailer, media and corporate account channels.

 

9

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Although Gaiam is able to track revenue by saleschannel, management, allocation of resources and analysis and reporting ofexpenses is solely on a combined basis, at the reportable segment level.

 

Contribution margin is defined as net sales, lesscost of goods sold and direct expenses. Financial information for Gaiam’sbusiness segments was as follows (in thousands):

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                                                       | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue:                                                                     |       |                   |       |                 |       |   |   |   |   |
| Direct to consumer                                                               |       | $                      | 11,959     |                 | $          | 10,291 |   | $ | 25,272 |   | $ | 22,429 |   |
| Business                                                                         |       | 9,747                  |       | 6,740                |       | 22,758 |   | 18,377 |   |
| Consolidated net revenue                                                         |       | 21,706                 |       | 17,031               |       | 48,030 |   | 40,806 |   |
| Contribution margin:                                                             |       |                   |       |                 |       |   |   |   |   |
| Direct to consumer                                                               |       | (418                   | )          | (478                 | )          | (252 | ) | (502 | ) |
| Business                                                                         |       | (853                   | )          | (3,156               | )          | (732 | ) | (3,461 | ) |
| Consolidated contribution loss                                                   |       | $                      | (1,271     | )                    | $          | (3,634 | ) | $ | (984 | ) | $ | (3,963 | ) |
| Reconciliation of contribution loss to net  loss:                                |       |                   |       |                 |       |   |   |   |   |
| Other income (expense)                                                           |       | (8                     | )          | 76                   |       | 108 |   | 132 |   |
| Income tax benefit                                                               |       | (532                   | )          | (1,297               | )          | (402 | ) | (1,413 | ) |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |       | (19                    | )          | 46                   |       | (176 | ) | (126 | ) |
| Net loss                                                                         |       | $                      | (766       | )                    | $          | (2,215 | ) | $ | (650 | ) | $ | (2,544 | ) |

 

6.             Subsequent Events

 

On July 7, 2005, Gaiam issued and sold 2,821,317shares of unregistered Class A common stock for an aggregate purchase price ofapproximately $18.7 million to certain funds advised by Prentice CapitalManagement, LP.

 

On July 8, 2005, Gaiam entered into an assetpurchase agreement (the “Purchase Agreement”) with GT Brands LLC, GTMerchandising & Licensing LLC, Gym Time, LLC, BSBP Productions LLC, andGoodTimes Entertainment LLC (collectively “GoodTimes”) pursuant to which Gaiamagreed to purchase substantially all of the assets of GoodTimes relating toGoodTimes’ independent home video entertainment business.  In addition, Gaiam agreed to assume certainspecified liabilities in connection with the acquisition.  Under the Purchase Agreement, the purchaseprice for the assets is $40 million, subject to certain adjustments relating tochanges in working capital and other matters, and subject to approval of thefederal bankruptcy court.  Ifconsummated, the sale is expected to close by the end of the third quarter2005.

 

On July 29, 2005, Gaiam extended its revolving lineof credit agreement with Wells Fargo Bank, N.A. to July 31, 2007.

 

On August 1, 2005, Gaiam issued 60,000 shares ofClass A common stock as purchase consideration for a media catalog business.

 

On August 3, 2005, Gaiam and Jirka Rysavy, Gaiam'sChairman and Chief Executive Officer, entered into an Insurance and StockRedemption Agreement pursuant to which Gaiam agreed to use the proceeds of anylife insurance Gaiam elects to obtain on Mr. Rysavy to acquire Gaiam sharesfrom Mr. Rysavy's estate. The purchase price for any shares will be determinedby a national recognized valuation expert.

 

On August 4, 2005, Gaiam entered into a series ofagreements with Revolution Living, LLC; its founder, Steve Case; and RevolutionLiving's subsidiary, LIME Media. Under the terms of the Transaction Agreement,Revolution Living will acquire 2,500,000 shares of Gaiam Class A common stockat a price of $8.00 per share, and Gaiam will purchase newly issued preferredequity in LIME at a price of approximately $7.5 million. On August 4, 2005,Gaiam, Revolution Living, Rysavy and Case also entered into a ShareholdersAgreement, and, as a condition to these transactions, Gaiam agreed to enterinto four-year employment agreements with Jirka Rysavy and Lynn Powers, Gaiam'sPresident.

 

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

 

The followingdiscussion and analysis of Gaiam’s financial condition and results ofoperations should be read in conjunction with the condensed consolidatedfinancial statements and related notes included elsewhere in this document.

 

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#### Overviewand Outlook

####  

Gaiamis a lifestyle media company providing content, information, and products tocustomers who value personal development, healthy living, ecological lifestylesand responsible, inspirational media. Gaiam was incorporated in Boulder,Colorado in 1988.

 

Withthe inception of our business segment in 1998, Gaiam started to sell directlyto retailers, both domestically and abroad. As of June 30, 2005, Gaiam products were available in over 25,000stores.  Gaiam introduced its “store-within-store”lifestyle presentations, which utilize custom fixtures designed and produced byGaiam, in late 2000, and the placement of this concept grew to over 4,300stores by the end of June 2005.  In 1998,revenue generated by the business segment was $3.8 million.  In 2004, revenue in this segment was $44.2million.  During the first six months of2005, revenue in the business segment was $22.8 million, an increase of 24%over the first six months of 2004. Gaiam will continue to focus on the nationalretailer and media channels and plans to continue to build this segment througha combination of new media releases, store within store concept, and expansionsin mass market retailers, grocery, bookstores and other media outlets.

 

Thedirect to consumer segment continues to be an integral part of Gaiam’s outreach.  This segment accounted for 54%, orapproximately $52.4 million, of Gaiam’s revenue during 2004.  During the first six months of 2005, revenuein this segment was $25.3 million, an increase of 13% over 2004, andrepresented 53% of total revenue.  Throughits diverse media reach, the direct to consumer segment provides branding, anopportunity to launch and support new media releases, a sounding board for newproduct testing, promotional opportunities and customer feedback on Gaiam’s andthe LOHAS (Lifestyles of Health and Sustainability) industry’s focus andfuture.

 

In June 2005, Gaiam enteredinto a stock purchase agreement with certain funds advised by Prentice CapitalManagement, LP in which Gaiam agreed to sell 2,821,317 shares of unregisteredClass A common stock for an aggregate purchase price of $18.7 million.  This transaction closed on July 7, 2005.

 

On July 8, 2005, Gaiamentered into a definitive agreement to acquire substantially all of the assetsof various companies operating as GoodTimes Entertainment.  GoodTimes Entertainment is a media companythat creates and distributes entertainment programming and home video productsthrough various channels, including television, theaters, retailers and the Internet.GoodTimes Entertainment’s library contains approximately 2,000 titles,including wellness franchises such as The Firm and Tae Bo, children classicssuch as Benji and numerous theatrical releases. The agreement is subject to a number of conditions, including approvalof the federal bankruptcy court.

 

If the acquisition ofGoodTimes Entertainment is consummated, Gaiam expects to generate over $200million in annual revenues and, in addition to its television and theatricaldistribution, Gaiam’s home media will be carried by over 40,000 retail storesin U.S., which will be the widest direct distribution coverage in the countryfor any content provider. Gaiam also expects to distribute 20 million catalogsper year and have approximately 7 million direct customers.

 

Gaiam’s agreement to acquiresubstantially all of GoodTimes Entertainment’s assets for $40 million in cash(subject to certain adjustments) and assumption of certain liabilities isexpected to close the transaction by the end of the third quarter. Theacquisition will be financed by existing cash and, if necessary, borrowingsunder Gaiam’s credit facility.

 

#### Resultsof Operations

####  

Thefollowing table sets forth certain financial data as a percentage of revenuefor the periods indicated:

 

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| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                                                                       | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue                                                                      |       | 100.0                  | %          | 100.0                | %          | 100.0 | % | 100.0 | % |
| Cost of goods sold                                                               |       | 51.4                   | %          | 49.9                 | %          | 49.4 | % | 48.0 | % |
| Gross profit                                                                     |       | 48.6                   | %          | 50.1                 | %          | 50.6 | % | 52.0 | % |
| Expenses:                                                                        |       |                   |       |                 |       |   |   |   |   |
| Selling and operating                                                            |       | 45.8                   | %          | 59.7                 | %          | 45.0 | % | 51.8 | % |
| Corporate, general and administration                                            |       | 8.7                    | %          | 11.7                 | %          | 7.6 | % | 9.9 | % |
| Total expenses                                                                   |       | 54.5                   | %          | 71.4                 | %          | 52.6 | % | 61.7 | % |
| Loss from operations                                                             |       | -5.9                   | %          | -21.3                | %          | -2.0 | % | -9.7 | % |
| Other income                                                                     |       | 0.0                    | %          | 0.4                  | %          | 0.2 | % | 0.3 | % |
| Income tax benefit                                                               |       | -2.5                   | %          | -7.6                 | %          | -0.8 | % | -3.5 | % |
| Minority intreest in net (income) loss of  consolidated subsidiaries, net of tax |       | -0.1                   | %          | 0.3                  | %          | -0.4 | % | -0.3 | % |
| Net loss                                                                         |       | -3.5                   | %          | -13.0                | %          | -1.4 | % | -6.2 | % |

 

#### Threemonths ended June 30, 2005 versus June 30, 2004

####  

Revenue of $21.7million for the three months ended June 30, 2005 increased 27.4% from $17million for the three months ended June 30, 2004.  Gaiam’s increase in revenue was primarily dueto a $3 million, or 45%, increase in revenue generated by the business segment,largely as a result of increased volume generated in the mass market segment,additional media placements in Target, and lower product returns.  Direct to consumer segment revenue alsoincreased by 16%, fueled by continued strong growth in revenue generated by ourInternet business.

 

Gross profit,which consists of revenue less cost of sales (primarily merchandise acquisitioncosts and in-bound freight), increased to $10.6 million for the second quarterof 2005 from $8.5 million during the same period in 2004.  As a percentage of revenue, gross profit of48.6% for the second quarter of 2005 was approximately the same as thatgenerated during the fourth quarter of 2004, but declined from the 50.1% grossprofit generated in the second quarter of 2004. As compared to second quarter of 2004, the lower 2005 gross profitpercentage was primarily due to a sales/product mix shift, increasedpromotional programs in the direct segment during the 2005 period, and higher importationand inbound freight costs associated in part with the rise in fuel costs.

 

Selling andoperating expenses (which consist primarily of sales and marketing costs,commission and fulfillment expenses) decreased to $9.9 million for the threemonths ended June 30, 2005 as compared to $10.2 million in the same period of2004, even with an overall increase in the sales, due to lower outboundfulfillment costs and bad debt expense. As a percentage of revenue, selling and operating expenses decreased to45.8% in 2005 from 59.7% in 2004 as a result of the increase in the sales base.

 

Corporate, generaland administration expenses decreased to $1.9 million for the second quarter of2005 compared to $2 million for the same 2004 period, primarily due to expensereductions in our Broomfield headquarters. As a percentage of revenue, corporate, general and administrationexpenses decreased to 8.7% in the second quarter of 2005 from 11.7% in thecomparable 2004 period, as a result of the aforementioned expense reductionsand an increase in the sales base.

 

The operating losswas $1.3 million for the three months ended June 30, 2005 compared to anoperating loss of $3.6 million for the three months ended June 30, 2004,primarily due to a revenue increase in the second quarter of 2005 as comparedto the same period during 2004.

 

Gaiamrecorded $8 thousand in other expense and $76 thousand in other income for thethree months ended June 30, 2005 and 2004, respectively.  The share of net income associated withminority interest was $19 thousand during the second quarter of 2005, comparedto the share of net loss of $46 thousand for the comparable 2004 period.

 

Gaiamrecorded an income tax benefit of $532 thousand for the three months ended June30, 2005 compared to an income tax benefit of $1.3 million for the three monthsended June 30, 2004.  Gaiam’sconsolidated 

 

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effective tax rate fluctuates based upon thedistribution of earnings/losses between its domestic and foreign operations.

 

Asa result of the factors described above, Gaiam’s net loss was $766 thousand, or$0.05 per share, for the three months ended June 30, 2005, as compared to a netloss of $2.2 million, or $0.15 per share, for the three months ended June 30,2004.

 

Gaiamgenerated cash from operating activities of $2.2 million for the three monthsended June 30, 2005, and ended the quarter with $12.3 million in cash, up from$10.9 million at March 31, 2005.

 

#### Sixmonths ended June 30, 2005 versus June 30, 2004

####  

Revenues of $48million for the six months ended June 30, 2005 increased 17.7% from $40.8million for the six months ended June 30, 2004. Gaiam’s increase in revenues was due primarily to an increase in thebusiness segment of $4.4 million, or 24% for the first six months of 2005.  This increase resulted primarily from highersales volumes with mass market retailers, coupled with lower productreturns.  Direct to consumer segmentrevenues were $25.3 million for the six months ended June 30, 2005, compared to$22.4 million for the same period in 2004. The internal growth rate for this segment was 14% for the first sixmonths of 2005, largely due to increases in Internet performance.

 

Gross profitincreased to $24.3 million for the first six months of 2005 from $21.2 millionduring the same period in 2004.  As apercentage of revenue, gross profit declined from 52% in 2004 to 50.6% in2005.  This was primarily attributable toa decline in the direct to consumer segment gross margin associated with achange in sales mix to divisions with lower gross margins and more promotionalprograms during the first six months of 2005. Gross margin in the business segment improved slightly during the firstsix months of 2005 as compared to the same 2004 period.

 

Selling andoperating expenses increased to $21.6 million for the six months ended June 30,2005 as compared to $21.1 million in the same period of 2004, primarilyresulting from increased sales and marketing efforts in our business segment,both domestically and in our U.K. subsidiary, and in our direct to consumersegment to support the revenue increases described above.  As a percentage of revenues, selling andoperating expenses decreased to 45% in 2005 from 51.8% in 2004.

 

Corporate, generaland administration expenses decreased to $3.7 million for the six months endedJune 30, 2005 from $4.1 million in the comparable 2004 period, and decreased to7.6% of revenues in 2005 from 9.9% of revenues in 2004.  This expense reduction was generallyattributable to cost savings generated by expense reductions in Gaiam’sColorado headquarters.

 

Operating lossesdecreased to $650 thousand for the six months ended June 30, 2005 from $2.5million for the six months ended June 30, 2004, primarily due to the increasein revenue and expense reductions.

 

Gaiamrecorded $108 thousand and $132 thousand in other income, primarily frominterest income, for the six months ended June 30, 2005 and 2004,respectively.  The share of net incomeassociated with minority interest was $176 thousand for the first six months of2005, compared to the share of net income of $126 thousand for the comparable2004 period.  This change was primarilythe result of higher 2005 minority interest expense associated with the U.K.subsidiary as compared to 2004.

 

Gaiamrecorded an income tax benefit of $402 thousand for the six months ended June30, 2005 compared to an income tax benefit of $1.4 million for the six monthsended June 30, 2004.

 

Asa result of the factors described above, Gaiam’s net loss was $650 thousand forthe six months ended June 30, 2005 compared to a net loss of $2.5 millionrecorded for the six months ended June 30, 2004.

 

Liquidityand Capital Resources

 

Gaiam’s capital needs arise from working capital required to fund ouroperations, capital expenditures related to acquisition and development ofmedia content, development of Internet and new products, acquisitions of

 

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new businesses, replacements,expansions and improvements to Gaiam’s infrastructure, and future growth.  These capital requirements depend on numerousfactors, including the rate of market acceptance of Gaiam’s product offerings,our ability to expand Gaiam’s customer base, the cost of ongoing upgrades toGaiam’s product offerings, our level of expenditures for sales and marketing,our level of investment in distribution systems and facilities and otherfactors.  The timing and amount of thesecapital requirements are variable and cannot accurately be predicted.  Additionally, Gaiam will continue to pursue opportunitiesto expand our media libraries, evaluate possible investments in businesses,products and technologies, and increase our sales and marketing programs andbrand promotions as needed.

 

Gaiam has a credit agreement with Wells Fargo, which permits borrowingsof up to $15 million based upon the collateral value of Gaiam’s accountsreceivable and inventory.  At June 30,2005, Gaiam had no amounts outstanding under this agreement and complied withall of the financial covenants.  Thiscredit agreement expires on July 31, 2007. Should Gaiam choose to borrow under the credit agreement, outstandingadvances bear interest at the lower of prime rate less 50 basis points or LIBOplus 275 basis points.  Borrowings aresecured by a pledge of Gaiam’s assets, and the agreement contains variousfinancial covenants, including covenants prohibiting the payment of cashdividends to Gaiam shareholders and requiring compliance with certain financialratios.

 

Gaiam’s operating activities generated net cash of $2.8 million and$4.4 million for the six months ended June 30, 2005 and 2004,respectively.  Gaiam’s net cash generatedfrom operating activities for both periods is primarily attributable to adecrease in accounts receivable of $5.6 million in 2005 and $9.3 million in2004, and non-cash charges to net income of $2.5 million in 2005 and $2.7million in 2004.  These sources of fundswere partially offset by the use of funds to reduce accounts payable $3.9million in 2005 and $4.6 million in 2004.

 

Gaiam’s investing and acquisition activities used net cash of $767thousand and $651 thousand during the first six months of 2005 and 2004,respectively, for the purchase of property, equipment and media rights.

 

Gaiam’s financing activities used net cash of $37 thousand for the sixmonths ended June 30, 2004, primarily to fund principal payments undercapitalized leases, and provided net cash of $402 thousand from the exercise ofstock options.

 

On July 7, 2005, we issued and sold 2,821,317 shares of unregisteredClass A common stock for an aggregate purchase price of approximately $18.7million to certain funds advised by Prentice Capital Management, LP.

 

On July 8, 2005, we entered into a purchase agreement with GoodTimespursuant to which we agreed to purchase substantially all of the assets ofGoodTimes relating to GoodTimes’ independent home video entertainmentbusiness.  In addition, we agreed toassume certain specified liabilities in connection with the acquisition.  Under the purchase agreement, the purchaseprice for the assets is $40 million, subject to certain adjustments relating tochanges in working capital and other matters, and subject to approval of thefederal bankruptcy court.  Ifconsummated, the sale is expected to close by the end of the third quarter 2005.  The acquisition will be financed by existingcash and, if necessary, borrowings under our credit facility.

 

Webelieve our available cash, cash expected to be generated from operations, cashgenerated by the sale of unregistered Class A common stock, and borrowingcapabilities on our unused $15 million line of credit, should be sufficient tofund our operations on both a short-term and long-term basis.  However, our projected cash needs may changeas a result of acquisitions, product development, unforeseen operationaldifficulties or other factors.

 

Inthe normal course of our business, we investigate, evaluate and discussacquisition, joint venture, minority investment, strategic relationship andother business combination opportunities in the LOHAS market.  For any future investment, acquisition orjoint venture opportunities, we may consider using then-available liquidity,issuing equity securities or incurring additional indebtedness.

 

Contractual Obligations

 

Gaiam has commitments pursuant to lease and debt agreements, but doesnot have any outstanding commitments pursuant to long-term debt obligations,capital lease obligations or purchase obligations.  The following table shows our commitments tomake future payments under operating leases (in thousands):

 

14

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| ** **                  | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 yrs** | ** ** |
|-----------------------------|------------|-----------|------------|-----------------|------------|---------------|------------|---------------|------------|----------------|------------|
| Operating lease obligations |       | $         | 3,762      |            | $          | 1,495         |       | $             | 1,606      |           | $          | 322 |   | $ | 339 |   |
|                             |            |           |            |                 |            |               |            |               |            |                |            |  |  |  |  |  |

 

Off-Balance Sheet Arrangements

 

Gaiam does not participate in transactionsthat generate relationships with unconsolidated entities or financialpartnerships, such as special purpose entities (“SPEs”) or variable interestentities (“VIEs”), which have been established for the purpose of facilitatingoff-balance sheet arrangements or other limited purposes.  As of June 30, 2005, Gaiam is not involved inany unconsolidated SPEs or VIEs.

 

Critical Accounting Policies

 

The consolidated financialstatements are prepared in conformity with accounting principles generallyaccepted in the United States, which require management to make judgments,estimates and assumptions that affect the amounts reported in Gaiam’sconsolidated financial statements and accompanying notes.  Note 1 to the consolidated financialstatements in Item 8 of our Annual Report on Form 10-K summarizes thesignificant accounting policies and methods used in the preparation of Gaiam’sconsolidated financial statements.  Nochanges were made to our significant policies during the three months endedJune 30, 2005.

 

Management believes thefollowing to be critical accounting policies whose application has a materialimpact on Gaiam’s financial presentation, and involve a higher degree ofcomplexity, as they require management to make judgments and estimates about mattersthat are inherently uncertain.

 

*Provisionsfor Doubtful Accounts and Returns*

 

Gaiamrecords a provision for doubtful accounts for all receivables not expected tobe collected.  Gaiam generally does notrequire collateral.  Gaiam evaluates thecollectibility of accounts receivable based on a combination of factors.  In circumstances in which we are aware of aspecific customer’s inability to meet its financial obligations (e.g.bankruptcy filings), Gaiam records a specific reserve for bad debts againstamounts due.  For all other instances,Gaiam recognizes reserves based on historical experience and review ofindividual accounts outstanding.

 

Gaiamrecords a provision for product returns to be received in future periods at thetime the original sale is recognized. The amount of the returns provision is based upon historical experienceand 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. Gaiam identifies the inventoryitems to be written down for obsolescence based on the item’s current salesstatus and condition.  If the item isdiscontinued or slow moving, it is written down based on an estimate of themarkdown to retail price needed to sell through its current stock level of theitem.

 

*Goodwill*

 

Goodwillrepresents the excess of the purchase consideration over the fair value ofassets acquired less liabilities assumed in a business acquisition.  In accordance with SFAS No. 142, “Goodwilland Other Intangible Assets,” goodwill is no longer amortized but is reviewedfor impairment annually, or more frequently if impairment indicators arise, ona reporting unit level.  The fair valueof a reporting unit is compared with its carrying amount, includinggoodwill.  If the fair value of areporting unit exceeds its carrying amount, goodwill of the reporting unit isconsidered not impaired.

 

Ifthe carrying amount of a reporting unit exceeds its fair value, the goodwillimpairment test is performed to measure the amount of impairment loss.  Gaiam has allocated goodwill to two reportingunits, and uses a market value method for the purposes of testing for potentialimpairment.  The annual review requiresextensive use of financial judgment and estimates.  Application of alternative assumptions anddefinitions, such as a change in the composition of a reporting unit, couldyield significantly different results.

 

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*Investments*

 

Investmentsin entities over which Gaiam does not have the ability to exercise significantinfluence are accounted for under the cost method. Under the cost method ofaccounting, investments in private companies are carried at cost and areadjusted only for other-than-temporary declines in fair value. Investmentsunder the cost method are included on the accompanying consolidated balancesheet in “Investments.”  Had Gaiamconcluded that it had the ability to exercise significant influence, its shareof the investee’s income or loss would have been reported in Gaiam’sconsolidated statement of operations.

 

*Capitalized Production Costs*

 

Capitalizedproduction costs include costs incurred to produce informational media productsmarketed by Gaiam to retail marketers and direct-mail and onlinecustomers.  These costs are deferred forfinancial reporting purposes until the media is released, then amortized oversucceeding periods on the basis of estimated sales.  Historical sales statistics are the principalfactor used in estimating the amortization rate.

 

Gaiamhad no significant changes in its critical accounting policies from its Form10-K filing for the fiscal year ended December 31, 2004.

 

RiskFactors

 

Wewish to caution you that there are risks and uncertainties that could cause ouractual results to be materially different from those indicated byforward-looking statements that we make from time to time in filings with theSecurities and Exchange Commission, news releases, proxy statements, annualreports, registration statements and other written communications, as well asoral forward-looking statements made from time to time by representatives ofGaiam.  These risks and uncertaintiesinclude, but are not limited to, those listed in Gaiam’s Annual Report on Form10-K for the year ended December 31, 2004. These risks and uncertainties and additional risks and uncertainties notpresently known to us or that we currently deem immaterial may cause ourbusiness, financial condition, operating results and cash flows to bematerially adversely affected.  Exceptfor the historical information contained herein, the matters discussed in thisanalysis are forward-looking statements that involve risk and uncertainties,including, but not limited to, general economic and business conditions, competition,pricing, brand reputation, consumer trends, and other factors which are oftenbeyond our control.  Gaiam does notundertake any obligation to update forward-looking statements except asrequired by law.

 

##### **Item3.**    Quantitative and Qualitative Disclosures About Market Risk

##### ** **

Weare exposed to market risks, which include changes in U.S. interest rates andforeign exchange rates.  We do not engagein financial transactions for trading or speculative purposes.

 

Anyborrowings we might make under our bank credit facility would bear interest atthe lower of prime rate less 50 basis points or LIBOR plus 275 basispoints.  Gaiam does not have any amountsoutstanding under its credit facility, so any unfavorable change in interestrates would not have a material impact on Gaiam’s results from operations orcash flows unless Gaiam makes borrowings in the future.

 

Gaiampurchases a significant amount of inventory from vendors outside of the U.S. intransactions that are primarily U.S. dollar denominated transactions.  Because the percentage of our internationalpurchases denominated in currencies other than the U.S. dollar is small, anycurrency risks related to these transactions are immaterial to Gaiam.  A decline in the relative value of the U.S.dollar to other foreign currencies could, however, lead to increased purchasingcosts.  In order to mitigate thisexposure, Gaiam makes virtually all of its purchase commitments in U.S.dollars.

 

In2003, Gaiam purchased a 50.1% interest in Leisure Systems InternationalLimited, a U.K. based distributor. Because Leisure Systems’ revenue is primarily denominated in foreigncurrencies, this investment exposes Gaiam to accounting risk associated withforeign currency exchange rate fluctuations. However, we have determined that no material market risk exposure to ourconsolidated financial position, results of operations or cash flows existed asof June 30, 2005.

 

16

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**Item 4.****   ****Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

Gaiam’schief executive officer and chief financial officer conducted an evaluation ofthe effectiveness of the design and operation of Gaiam’s disclosure controlsand procedures, as defined in Rules 13a-15(e) and Rule 15d-15(e) under theExchange Act.  Based upon theirevaluation as of June 30, 2005, Gaiam’s chief executive officer and chieffinancial officer have concluded that those disclosure controls and proceduresare effective.

 

**Changesin Internal Control over Financial Reporting**

 

Nochanges in Gaiam’s internal control over financial reporting occurred duringthe quarter ended June 30, 2005 that have materially affected, or arereasonably likely to materially affect, Gaiam’s internal control over financialreporting.

 
| **PART  II.** | ** ** | **OTHER INFORMATION**                                                                                                                                                                                                                                                                                                      | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
|---------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **    | ** ** | ** **                                                                                                                                                                                                                                                                                                                 | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
| **Item  1.**  | ** ** | **Legal Proceedings**                                                                                                                                                                                                                                                                                                      | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
| ** **    | ** ** | ** **                                                                                                                                                                                                                                                                                                                 | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
|          |       | From time to time, Gaiam is involved in legal proceedings that we  consider to be in the normal course of business. We do not believe that any  of these proceedings will have a material adverse effect on our business.                                                                                                  |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
| **Item  2.**  | ** ** | **Sales of Unregistered Securities and Use of Proceeds**                                                                                                                                                                                                                                                                   | ** ** | ** **      | ** ** | ** **                                                                                                                       |
| ** **    | ** ** | ** **                                                                                                                                                                                                                                                                                                                 | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
|          |       | On  August 1, 2005, Gaiam issued 60,000 shares of unregistered Class A common  stock, valued at $9.20 per share, to Conscious Wave, Inc., as purchase  consideration for a media catalog business. These shares were issued pursuant  to an exemption from registration under Section 4(2) of the Securities Act of  1933. |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
| **Item  3.**  | ** ** | **Defaults Upon Senior Securities**                                                                                                                                                                                                                                                                                        | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
| ** **    | ** ** | ** **                                                                                                                                                                                                                                                                                                                 | ** ** | ** **      | ** ** | ** **                                                                                                                       | ** ** | ** ** |
|          |       | None.                                                                                                                                                                                                                                                                                                                      |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
| **Item 4.**   | ** ** | **Submission of Matters to a Vote of Security Holders.**                                                                                                                                                                                                                                                                   |       |            |       |                                                                                                                             |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
|          |       | On  May 19, 2005, Gaiam held its Annual Meeting of Shareholders. The shareholders  elected seven directors to serve until the next annual meeting of shareholders  to be held in 2006 or until their successors are duly elected and qualified.  The results of this vote follow:                                          |
|          |       |                                                                                                                                                                                                                                                                                                                       |
|          |       | Jirka  Rysavy                                                                                                                                                                                                                                                                                                              |       | For:            |       | 60,970,492                                                                                                                       |       | Withheld:  |   | 1,469,655 |   |   |
|          |       | Lynn  Powers                                                                                                                                                                                                                                                                                                               |       | For:            |       | 60,970,511                                                                                                                       |       | Withheld:  |   | 1,469,636 |   |   |
|          |       | James  Argyropoulos                                                                                                                                                                                                                                                                                                        |       | For:            |       | 62,384,610                                                                                                                       |       | Withheld:  |   | 55,537 |   |   |
|          |       | Barnet  Feinblum                                                                                                                                                                                                                                                                                                           |       | For:            |       | 62,362,929                                                                                                                       |       | Withheld:  |   | 77,218 |   |   |
|          |       | Barbara  Mowry                                                                                                                                                                                                                                                                                                             |       | For:            |       | 62,384,594                                                                                                                       |       | Withheld:  |   | 55,553 |   |   |
|          |       | Ted  Nark                                                                                                                                                                                                                                                                                                                  |       | For:            |       | 62,384,478                                                                                                                       |       | Withheld:  |   | 55,669 |   |   |
|          |       | Paul  Ray                                                                                                                                                                                                                                                                                                                  |       | For:            |       | 62,132,802                                                                                                                       |       | Withheld:  |   | 307,345 |   |   |
| ** **    | ** ** | ** **                                                                                                                                                                                                                                                                                                                 |       |            |       |                                                                                                                             |       |       |
| **Item 5.**   | ** ** | **Other Information**                                                                                                                                                                                                                                                                                                      |       |            |       |                                                                                                                             |       |       |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
|          |       | None.                                                                                                                                                                                                                                                                                                                      |       |            |       |                                                                                                                             |       |       |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
| **Item 6.**   | ** ** | **Exhibits**                                                                                                                                                                                                                                                                                                               |       |            |       |                                                                                                                             |       |       |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
|          |       | a)                                                                                                                                                                                                                                                                                                                         |       | Exhibits        |       |                                                                                                                             |       |       |
|          |       |                                                                                                                                                                                                                                                                                                                       |       |            |       |                                                                                                                             |       |       |
| ** **    | ** ** | ** **                                                                                                                                                                                                                                                                                                                 | ** ** | **Exhibit No.** | ** ** | **Description**                                                                                                                  | ** ** | ** ** |
|          |       |                                                                                                                                                                                                                                                                                                                       |       | 10.1            |       | Form  of Stock Option Agreement under Gaiam’s 1999 Long-Term Incentive Plan.                                                |
|          |       |                                                                                                                                                                                                                                                                                                                       |       | 10.2            |       | Amended  and Restated Credit Agreement dated July 29, 2005 between Gaiam, Inc.  and Wells Fargo Bank, National Association. |
|               |            |                                                                                                                                                                                                                                                                                                                            |            |                 |            |                                                                                                                                  |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

17

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|   |   |   |   | 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 of the Chief Executive Officer 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 of the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 (furnished herewith). |

 

18

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### **Signatures**

 

Inaccordance with the requirements of the Securities and Exchange Act, theregistrant caused this report to be signed on its behalf, by the undersigned,thereunto duly authorized.

 

 
|   | Gaiam,  Inc.    |
|--------|-----------------|
|   | (Registrant)    |
|   | August  9, 2005 |
|   |            |
|   | By:             | /s/  Jirka Rysavy |   |
|   |            |        Jirka  Rysavy |
|   |            |        Chief  Executive Officer |
|   |            |   |
|   | By:             | /s/  Janet Mathews |   |
|   |            |        Janet  Mathews |
|   |            |        Chief  Financial Officer |
|        |                 |  |  |  |

 

19

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