**United States**

**Securities and Exchange Commission**

**Washington,D.C. 20549**

**Form 10-Q**

**x****        QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d)OF THE SECURITIES AND EXCHANGE ACT OF 1934**

**For thequarterly period ended June 30, 2006**

**OR**

**o****        TRANSITION REPORT PURSUANTTO SECTION 13 OR 15 (d)OF THE SECURITIES AND EXCHANGE ACT OF 1934**

**Commission File Number 0-27517**

**GAIAM, INC.**

(Exactname of registrant as specified in its charter)

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

 

**360INTERLOCKEN BLVD.,**

**BROOMFIELD,COLORADO 80021**

(Addressof principal executive offices)

 

**(303)222-3600**

(Registrant’s telephone number, including area code)

Indicateby check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d)of the Securities and Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports)and (2) has been subject to such filing requirements for the past 90 days.    YES  x                  NO  o

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer or a non-acceleratedfiler.  See definition of “accelerated filer”and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

LargeAccelerated Filer   o              AcceleratedFiler x

Non-AcceleratedFiler     o

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).YES  o                  NO  x

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:
| Class                 | ** ** | **Shares outstanding as of August 4, 2006** | ** ** |
|-----------------------|------------|---------------------------------------------------------------------------|------------|
| Class A Common  Stock |       | 21,304,030                                                                |       |
| ($.0001 par  value)   |       |                                                                      |       |
|                  |       |                                                                      |       |
| Class B Common  Stock |       | 5,400,000                                                                 |       |
| ($.0001 par value)    |       |                                                                      |       |

 

 

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**INDEXTO FORM 10-Q**
| PART I. FINANCIAL INFORMATION |   |
|-------------------------------|--------|
|                          |   |   |   |
| Item 1.                       |   | Condensed Consolidated Financial Statements  (Unaudited) |   |
|                          |   |   |   |
|                          |   | Condensed  Consolidated Balance Sheets at June 30, 2006 and December 31, 2005 |   |
|                          |   |   |   |
|                          |   | Condensed  Consolidated Statements of Operations for the three months ended June 30,  2006 and 2005 |   |
|                          |   |   |   |
|                          |   | Condensed Consolidated Statements of Operations for  the six months ended June 30, 2006 and 2005 |   |
|                          |   |   |   |
|                          |   | Condensed  Consolidated Statements of Cash Flows for the six months ended June 30, 2006  and 2005 |   |
|                          |   |   |   |
|                          |   | 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  1A.                     |   | Risk  Factors |   |
|                          |   |   |   |
| Item 2.                       |   | Sales of  Unregistered 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

This report maycontain forward-looking statements that involve risks and uncertainties.  When used in this discussion, the words “anticipate,”“believe,” “plan,” “estimate,” “expect,” “strive,” “future,” “intend” andsimilar expressions as they relate to Gaiam or its management are intended toidentify such forward-looking statements. Gaiam’s actual results could differ materially from the resultsanticipated in these forward-looking statements as a result of certain factorsset forth under “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” “Quantitative and Qualitative Disclosures aboutMarket Risk” and elsewhere in this report. Risks and uncertainties that could cause actual results to differinclude, without limitation, general economic conditions, competition, loss ofkey personnel, pricing, brand reputation, consumer trends, acquisitions, newinitiatives undertaken by Gaiam, security and information systems, legalliability for website content, merchandise supply problems, failure of thirdparties to provide adequate service, our reliance on centralized customerservice, overstocks and merchandise returns, our reliance on a centralizedfulfillment center, increases in postage and shipping costs, E-commerce trends,future Internet 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-looking statementis a guarantee of future performance, and you should not place undue relianceon these forward-looking statements which reflect our management’s view only asof the date of this report.  We undertakeno obligation to update any forward-looking information.

2

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GAIAM, INC.

CONDENSEDCONSOLIDATED BALANCE SHEETS

(In thousands, exceptshare information)

 
| ** **                                                                                                                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                             | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                             |       |              |       |                  |       |
| ** **                                                                                                                                                                             |       |              |       |                  |       |
| Current assets:                                                                                                                                                                        |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                             |       | $                 | 105,335    |                  | $          | 15,028 |   |
| Accounts receivable,  net                                                                                                                                                              |       | 15,414            |       | 28,067                |       |
| Inventory, less  allowances                                                                                                                                                            |       | 24,020            |       | 20,792                |       |
| Deferred  advertising costs                                                                                                                                                            |       | 3,592             |       | 3,917                 |       |
| Deferred tax  assets                                                                                                                                                                   |       | 4,705             |       | 3,627                 |       |
| Other current  assets                                                                                                                                                                  |       | 5,726             |       | 4,838                 |       |
| Total current assets                                                                                                                                                                   |       | 158,792           |       | 76,269                |       |
|                                                                                                                                                                                   |       |              |       |                  |       |
| Property and equipment,  net                                                                                                                                                           |       | 8,778             |       | 9,428                 |       |
| Media library, net                                                                                                                                                                     |       | 36,373            |       | 38,339                |       |
| Goodwill and other  intangibles                                                                                                                                                        |       | 20,067            |       | 17,541                |       |
| Non-current deferred  tax assets                                                                                                                                                       |       | 8,201             |       | 7,282                 |       |
| Notes receivable and  other assets                                                                                                                                                     |       | 5,392             |       | 7,242                 |       |
| Total assets                                                                                                                                                                           |       | $                 | 237,603    |                  | $          | 156,101 |   |
|                                                                                                                                                                                   |       |              |       |                  |       |
| **Liabilities and stockholders’  equity**                                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                   |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                       |       | $                 | 15,868     |                  | $          | 25,843 |   |
| Accrued  liabilities                                                                                                                                                                   |       | 7,225             |       | 12,649                |       |
| Other current  liabilities                                                                                                                                                             |       | 46                |       | 561                   |       |
| Total current  liabilities                                                                                                                                                             |       | 23,139            |       | 39,053                |       |
|                                                                                                                                                                                   |       |              |       |                  |       |
| Long-term liabilities                                                                                                                                                                  |       | —            |       | 1,663                 |       |
| Total liabilities                                                                                                                                                                      |       | 23,139            |       | 40,716                |       |
|                                                                                                                                                                                   |       |              |       |                  |       |
| Minority interest                                                                                                                                                                      |       | 8,332             |       | 8,099                 |       |
|                                                                                                                                                                                   |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                                         |       |              |       |                  |       |
|                                                                                                                                                                                   |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                             |       |              |       |                  |       |
| Class A common  stock, $.0001 par value, 150,000,000 shares authorized, 21,294,030 and 15,010,736  shares issued and outstanding at June 30, 2006 and December 31, 2005,  respectively |       | 2                 |       | 1                     |       |
| Class B common  stock, $.0001 par value, 50,000,000 shares authorized, 5,400,000 issued and  outstanding at June 30, 2006 and December 31, 2005                                        |       | 1                 |       | 1                     |       |
| Additional  paid-in capital                                                                                                                                                            |       | 194,562           |       | 95,840                |       |
| Accumulated  other comprehensive income                                                                                                                                                |       | 663               |       | 264                   |       |
| Retained  earnings                                                                                                                                                                     |       | 10,904            |       | 11,180                |       |
| Total stockholders’  equity                                                                                                                                                       |       | 206,132           |       | 107,286               |       |
| Total liabilities and stockholders’ equity                                                                                                                                        |       | $                 | 237,603    |                  | $          | 156,101 |   |

 

*Seeaccompanying notes to the interim condensed consolidated financial statements.*

3

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GAIAM, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 
| ** **                                                                       | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                                  | ** ** |
| ** **                                                                       | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
|                                                                             |       |                                               |       |   |   |
| Net revenue                                                                      |       | $                                                  | 43,161     |   | $ | 21,706 |   |
| Cost of goods  sold                                                              |       | 16,270                                             |       | 11,149 |   |
| Gross profit                                                                     |       | 26,891                                             |       | 10,557 |   |
|                                                                             |       |                                               |       |   |   |
| Expenses:                                                                        |       |                                               |       |   |   |
| Selling and operating                                                            |       | 26,016                                             |       | 9,935 |   |
| Corporate, general and administration                                            |       | 3,551                                              |       | 1,893 |   |
| Total expenses                                                                   |       | 29,567                                             |       | 11,828 |   |
|                                                                             |       |                                               |       |   |   |
| Loss from  operations                                                            |       | (2,676                                             | )          | (1,271 | ) |
|                                                                             |       |                                               |       |   |   |
| Other income  (expense)                                                          |       | 19                                                 |       | (53 | ) |
| Interest income                                                                  |       | 532                                                |       | 45 |   |
| Total other  income (expense)                                                    |       | 551                                                |       | (8 | ) |
|                                                                             |       |                                               |       |   |   |
| Loss before  income taxes and minority interest                                  |       | (2,125                                             | )          | (1,279 | ) |
|                                                                             |       |                                               |       |   |   |
| Income tax  benefit                                                              |       | (804                                               | )          | (532 | ) |
| Minority  interest in net (income) loss of consolidated subsidiaries, net of tax |       | 155                                                |       | (19 | ) |
| Net loss                                                                         |       | $                                                  | (1,166     | ) | $ | (766 | ) |
|                                                                             |       |                                               |       |   |   |
| Net loss per  share:                                                             |       |                                               |       |   |   |
| Basic                                                                            |       | $                                                  | (0.05      | ) | $ | (0.05 | ) |
| Diluted                                                                          |       | $                                                  | (0.05      | ) | $ | (0.05 | ) |
| Shares used in  computing net loss per share:                                    |       |                                               |       |   |   |
| Basic                                                                            |       | 23,140                                             |       | 14,820 |   |
| Diluted                                                                          |       | 23,140                                             |       | 14,820 |   |

 

*Seeaccompanying notes to the interim condensed consolidated financial statements.*

4

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GAIAM, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except pershare amounts)

 
| ** **                                                                       | ** ** | **For the Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                                | ** ** |
| ** **                                                                       | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
|                                                                             |       |                                             |       |   |   |
| Net revenue                                                                      |       | $                                                | 94,913     |   | $ | 48,030 |   |
| Cost of goods  sold                                                              |       | 34,860                                           |       | 23,724 |   |
| Gross profit                                                                     |       | 60,053                                           |       | 24,306 |   |
|                                                                             |       |                                             |       |   |   |
| Expenses:                                                                        |       |                                             |       |   |   |
| Selling and operating                                                            |       | 54,922                                           |       | 21,625 |   |
| Corporate, general and administration                                            |       | 6,797                                            |       | 3,665 |   |
| Total expenses                                                                   |       | 61,719                                           |       | 25,290 |   |
|                                                                             |       |                                             |       |   |   |
| Loss from  operations                                                            |       | (1,666                                           | )          | (984 | ) |
|                                                                             |       |                                             |       |   |   |
| Other income                                                                     |       | 553                                              |       | 38 |   |
| Interest income                                                                  |       | 575                                              |       | 70 |   |
| Total other  income                                                              |       | 1,128                                            |       | 108 |   |
|                                                                             |       |                                             |       |   |   |
| Loss before  income taxes and minority interest                                  |       | (538                                             | )          | (876 | ) |
|                                                                             |       |                                             |       |   |   |
| Income tax  benefit                                                              |       | (192                                             | )          | (402 | ) |
| Minority  interest in net (income) loss of consolidated subsidiaries, net of tax |       | 70                                               |       | (176 | ) |
| Net loss                                                                         |       | $                                                | (276       | ) | $ | (650 | ) |
|                                                                             |       |                                             |       |   |   |
| Net loss per  share:                                                             |       |                                             |       |   |   |
| Basic                                                                            |       | $                                                | (0.01      | ) | $ | (0.04 | ) |
| Diluted                                                                          |       | $                                                | (0.01      | ) | $ | (0.04 | ) |
| Shares used in  computing net loss per share:                                    |       |                                             |       |   |   |
| Basic                                                                            |       | 21,795                                           |       | 14,820 |   |
| Diluted                                                                          |       | 21,795                                           |       | 14,820 |   |

 

*Seeaccompanying notes to the interim condensed consolidated financial statements.*

5

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GAIAM, INC.

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 
| ** **                                                                         | ** ** | **For the Six Months  Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                                        | ** ** | **2005** | ** ** |
| **Operating  activities**                                                          |       |                                                            |       |   |   |
| Net loss                                                                           |       | $                                                               | (276       | ) | $ | (650 | ) |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                            |       |   |   |
| Depreciation                                                                       |       | 1,064                                                           |       | 1,145 |   |
| Amortization                                                                       |       | 2,074                                                           |       | 802 |   |
| Minority interest in consolidated subsidiaries                                     |       | (70                                                             | )          | 176 |   |
| Non-cash gain from equity investment                                               |       | (519                                                            | )          | — |   |
| Non-cash stock-based compensation                                                  |       | 194                                                             |       | — |   |
| Deferred income tax expense                                                        |       | (211                                                            | )          | 382 |   |
| Changes in operating assets and liabilities, net of  effects from acquisitions:    |       |                                                            |       |   |   |
| Accounts receivable                                                                |       | 13,496                                                          |       | 5,620 |   |
| Inventory                                                                          |       | (3,026                                                          | )          | 663 |   |
| Deferred advertising costs                                                         |       | 325                                                             |       | 641 |   |
| Other current assets                                                               |       | (1,788                                                          | )          | (150 | ) |
| Other assets                                                                       |       | (141                                                            | )          | (145 | ) |
| Accounts payable                                                                   |       | (10,034                                                         | )          | (3,882 | ) |
| Accrued liabilities                                                                |       | (3,611                                                          | )          | (504 | ) |
| Other current liabilities                                                          |       | (460                                                            | )          | (1,312 | ) |
| Net cash (used  in) provided by operating activities                               |       | (2,983                                                          | )          | 2,786 |   |
|                                                                               |       |                                                            |       |   |   |
| **Investing  activities**                                                          |       |                                                            |       |   |   |
| Purchase of  property, equipment and media rights                                  |       | (379                                                            | )          | (767 | ) |
| Proceeds from  sale of property and equipment                                      |       | 297                                                             |       | — |   |
| Purchase of  investment                                                            |       | (3,548                                                          | )          | — |   |
| Net cash used in  investing activities                                             |       | (3,630                                                          | )          | (767 | ) |
|                                                                               |       |                                                            |       |   |   |
| **Financing  activities**                                                          |       |                                                            |       |   |   |
| Proceeds from  issuance of common stock, net                                       |       | 96,496                                                          |       | — |   |
| Net cash  provided by financing activities                                         |       | 96,496                                                          |       | — |   |
|                                                                               |       |                                                            |       |   |   |
| Effects of  exchange rates on cash and cash equivalents                            |       | 424                                                             |       | (199 | ) |
|                                                                               |       |                                                            |       |   |   |
| Net change in  cash and cash equivalents                                           |       | 90,307                                                          |       | 1,820 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 15,028                                                          |       | 10,439 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                               | 105,335    |   | $ | 12,259 |   |
|                                                                               |       |                                                            |       |   |   |
| **Supplemental  cash flow information**                                            |       |                                                            |       |   |   |
| Interest paid                                                                      |       | $                                                               | —     |   | $ | — |   |
| Income taxes paid                                                                  |       | $                                                               | 92         |   | $ | 560 |   |

 

*Seeaccompanying notes to the interim condensed consolidated financial statements*

6

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Gaiam, Inc.

Notes to Interim Condensed Consolidated FinancialStatements

(Unaudited)

June 30, 2006

 

1.               InterimCondensed Consolidated Financial Statements

###### Organizationand Nature of Operations

Gaiam, Inc. (“Gaiam”) isa branded lifestyle media company providing a broad selection of information,media, products and services to customers who value personal development,wellness, ecological lifestyles, and responsible media. Gaiam was incorporatedunder the laws of the State of Colorado on July 7, 1988.

The accompanying interimcondensed consolidated financial statements include the accounts of Gaiam andits subsidiaries in which Gaiam’s ownership is greater than 50% and thesubsidiary is considered to be under Gaiam’s control. All material intercompanyaccounts and transaction balances have been eliminated in consolidation.

Preparation of InterimCondensed Consolidated Financial Statements

The interim condensedconsolidated financial statements included herein have been prepared by themanagement of Gaiam pursuant to the rules and regulations of the United StatesSecurities and Exchange Commission, and, in the opinion of management, containall adjustments (consisting of only normal recurring adjustments) necessary topresent fairly Gaiam’s consolidated financial position as of June 30, 2006, theinterim results of operations for the three and six months ended June 30, 2006and 2005, and cash flows for the six months ended June 30, 2006 and 2005. Theseinterim statements have not been audited. The balance sheet as of December 31,2005 was derived from Gaiam’s audited consolidated financial statementsincluded in Gaiam’s annual report on Form 10-K.

The interim condensedconsolidated financial statements are prepared in conformity with accountingprinciples generally accepted in the United States, which require management tomake judgments, estimates and assumptions that affect the amounts reported inGaiam’s consolidated financial statements and accompanying notes. The interimcondensed consolidated financial statements contained herein should be read inconjunction with Gaiam’s audited financial statements, including the notesthereto, for the year ended December 31, 2005. No changes were made to oursignificant policies during the three and six months ended June 30, 2006,except for the adoption of Financial Accounting Standards Board’s (“FASB”)Statement No. 123 — revised 2004 (“SFAS 123R”), “Share-Based Payment”. See Summary of Significant AccountingPolicies discussed below.

The consolidatedfinancial position, results of operations and cash flows for the interimperiods disclosed in this report are not necessarily indicative of futurefinancial results.

Summary of SignificantAccounting Policies

Managementbelieves the following to be critical accounting policies whose application hasa material impact on Gaiam’s financial presentation, and involve a higherdegree of complexity, as they require management to make judgments andestimates about matters that are inherently uncertain.

*Cash and Cash Equivalents*

Cash and cash equivalentsinclude demand deposit accounts and highly liquid instruments, with maturitiesof three months or less at the date of purchase. The fair value of the cash andcash equivalents approximates their carrying value due to their short maturities.

7

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*Provisions for Doubtful Accounts and Returns*

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

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

*Inventory*

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

*Goodwill*

Goodwill represents theexcess of the purchase consideration over the fair value of assets acquiredless liabilities assumed in a business acquisition. In accordance with SFAS No.142, “Goodwill and Other Intangible Assets,” goodwill is no longer amortizedbut is reviewed for impairment annually or more frequently if impairmentindicators arise, on a reporting unit level. The fair value of a reporting unitis compared with its carrying amount, including goodwill. If the fair value ofa reporting unit exceeds its carrying amount, goodwill of the reporting unit isconsidered not impaired.

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

*Investments*

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

8

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*Capitalized Production Costs andMedia Library*

Capitalized productioncosts include costs incurred to produce media products marketed by Gaiam toretailers and direct-mail and online customers. These costs are deferred forfinancial reporting purposes until the media is released, then amortized oversucceeding periods on the basis of estimated sales. Historical sales statisticsare the principal factor used in estimating the amortization rate. Gaiam’smedia library consists of titles and content purchased or acquired. Atacquisition, the fair market value of the library is established and isamortized over succeeding periods on the basis of its estimated useful life.

*Stock-Based Compensation*

Prior to January 1, 2006,Gaiam accounted for its stock option program under the recognition andmeasurement provisions of APB Opinion No. 25 (“APB 25”), *Accountingfor Stock Issued to Employees*, and related Interpretations, aspermitted by FASB Statement No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation*. No stock based compensation cost wasrecognized in the Statement of Operations for the quarter or six months endedJune 30, 2005, as all options granted under the plan had an exercise priceequal to the market value of the underlying common stock on the date of grant.

During the first quarterof fiscal 2006, Gaiam adopted the provisions of and accounted for stock-basedcompensation in accordance with SFAS 123R, which replaced SFAS 123 andsupersedes APB 25. Under the fair value recognition provisions of thisstatement, stock-based compensation cost is measured at the grant date based onthe fair value of the award and is recognized as expense on a straight-linebasis over the requisite service period, which is the vesting period. Gaiamelected the modified-prospective method, under which prior periods are notrevised for comparative purposes. The valuation provisions of SFAS 123R applyto new grants and to grants that were outstanding as of the effective date andare subsequently modified. Estimated compensation for grants that wereoutstanding as of the effective date will be recognized over the remainingservice periods using the compensation cost estimated for the SFAS 123 proforma disclosures.

The adoption of SFAS 123Rdid not have a material impact on Gaiam’s consolidated financial position,results of operations and cash flows. See Note 4 for further informationregarding stock-based compensation assumptions and expenses, including proforma disclosures for the three and six months ended June 30, 2005 as if Gaiamhad recorded stock-based compensation expense.

ContractualObligations

Gaiam hascommitments pursuant to lease and debt agreements, but does not have anyoutstanding commitments pursuant to long-term debt, capital lease, or purchaseobligations. The following table shows Gaiam’s commitments to make futurepayments under operating leases (in thousands):

 
|                              | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 yrs** | ** ** |
|------------------------------|------------|-----------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|--------------------------|------------|
| Operating lease  obligations |       | $         | 5,693      |                      | $          | 2,990              |       | $                  | 2,203      |                     | $          | 320 |   | $ | 180 |   |
|                              |            |           |            |                           |            |                    |            |                    |            |                          |            |  |  |  |  |  |

 

Off-BalanceSheet Arrangements

Gaiam does notparticipate in transactions that generate relationships with unconsolidatedentities or financial partnerships, such as special purpose entities (“SPEs”)or variable interest entities (“VIEs”), which have been established for thepurpose of facilitating off-balance sheet arrangements or other limitedpurposes. As of June 30, 2006, Gaiam is not involved in any unconsolidated SPEsor VIEs.

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Use of Estimates

The preparation of theconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenue and expenses and disclosure of contingent assets and liabilities at thedate of the consolidated financial statements. Actual results could differ fromthose estimates.

2.               Notes Receivableand Other Assets

Notes receivable andother assets as of June 30, 2006 consisted of $2.7 million of investments, $2.2million in notes receivable, and $0.5 million of other long-term assets. OnJanuary 5, 2006, Gaiam entered into an agreement with Alps Communications LLCand Life Balance Media Holdings LLC (“LIME”), to sell 19,968 Series A PreferredUnits of LIME, an investment previously accounted for using the equity method. Thepurchase price per unit was equal to the amount Gaiam paid for its investment. AlpsCommunications assumed all unpaid Series A Capital Contribution commitmentsfrom Gaiam and executed a promissory note in the principal amount of $2,250,000.After the closing of this transaction, Gaiam owns 4,876 units, or less than 4%,of LIME. This transaction resulted in a gain of $0.5 million which is includedin Other Income on the Condensed Consolidated Statements of Operations for the threeand six months ended June 30, 2006. Notes receivable and other assets as ofDecember 31, 2005 consisted of $6.8 million of investments and $0.4 million ofother assets.

On June 23, 2006, Gaiampurchased, for $3.5 million, an approximate 34% ownership interest in CinemaCircle, Inc. (“CCI”), the parent company of Spiritual Cinema Circle, asubscription-based DVD film club. This investment is accounted for under theequity method and the excess of the cost of the investment over the underlyingequity in the net assets of CCI, $2.3 million, was recognized as goodwill. Subsequentto June 30, 2006, Gaiam purchased an additional 29% interest in CCI for $3.4million. With the purchase of the additional interest, Gaiam’s ownership isapproximately 63% and, therefore, commencing with the effective dates of theadditional share purchases, CCI met the accounting criteria to be considered a businesscombination as outlined in SFAS No. 141, *Business Combinations*.

Gaiam plans to invest inits online business over the next two years to better capitalize on growingbroadband subscription trends as well as to establish stronger relationshipswith its loyal consumer audience. This will be accomplished through thedirect-to-consumer business as Gaiam continues to focus on better leveragingits’ content through subscription clubs and community. The investment in CCIprovides immediate content that can be offered to Gaiam’s seven millioncustomer base. The films distributed to CCI’s members are meaningfulinspirational and spiritual family films that compliment Gaiam’s productofferings.

3.               Stockholders’Equity

On May 24,2006, Gaiam sold 5,000,000 sharesof Class A Common Stock and on June 13, 2006 sold 690,000 shares of Class ACommon Stock. The combined stock sales generated gross proceeds of $99.6million. During the first six months of 2006, Gaiam issued a total of 6,600shares of Class A common stock to Gaiam’s independent directors, in lieu ofcash compensation, for services rendered in 2005 and 2006. In addition, for thesix months ended June 30, 2006, Gaiam issued 586,694 shares of Class A commonstock upon exercise of options granted under Gaiam’s 1999 Long-Term IncentivePlan.

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4.               Stock-BasedCompensation

Gaiam’s stock optionprogram is a long-term retention program that is intended to attract, retainand provide incentives for talented employees, officers, and directors, and toalign stockholder and employee interests. Gaiam grants options under its 1999Long-Term Incentive Plan (“the Plan”), which provides for the granting ofoptions to purchase up to 3 million shares of Gaiam’s common stock. Bothincentive stock options and non-qualified stock options may be issued under theprovisions of the Plan. Employees of Gaiam and its affiliates, members of theBoard of Directors, consultants and certain key advisors are eligible toparticipate in the plan, which terminates no later than June 1, 2009. Optionsgranted under the Plan generally vest and become exercisable at 2% per monthfor the 50 months beginning in the eleventh month after date of grant. Grantsgenerally expire seven years from the date of grant.

 Gaiam uses the Black-Scholes option pricingmodel to determine the fair value of stock options and shares issued under thePlan. The determination of fair value stock-based payment awards on the date ofgrant using an option-pricing model is affected by Gaiam’s stock price as wellas assumptions regarding a number of complex and subjective variables. Thesevariables include Gaiam’s expected stock price volatility over the term of theawards, actual and projected employee stock option exercise behavior, risk-freeinterest rate and expected dividends.

Gaiam uses the actualvesting term of an option as the expected term of the option. Expectedvolatilities are based on historical realized volatility of Gaiam’s stock. Gaiam’suse of historical realized volatility is based upon the expectation that futurevolatility over the expected term is not likely to differ from historicalresults. The risk-free interest rate used in the option valuation model isbased on U.S. Treasury zero-coupon issues with remaining terms similar to theexpected term on the options. Gaiam does not anticipate paying any cashdividends in the foreseeable future and therefore an expected dividend yield ofzero is used in the option valuation model. In accordance with SFAS No. 123R,Gaiam is required to estimate forfeitures at the time of grant and revise thoseestimates in subsequent periods if actual forfeitures differ from thoseestimates. Historical data is used to estimate pre-vesting option forfeituresand record stock-based compensation expense only for those awards that are expectedto vest. All stock-based payment awards are amortized on a straight-line basisover the requisite service periods of the awards, which are generally thevesting periods.

Total stock-basedcompensation recognized was $0.1 million and $0.2 million and are shown incorporate, general, and administration expenses on Gaiam’s condensedconsolidated financial statements for the three and six months ended June 30,2006, respectively.

The following table setforth the proforma amounts of net income and net income per share, for thethree and six months ended June 30, 2005, that would have resulted if Gaiam hadaccounted for its stock-based compensation plan under the fair valuerecognition provisions of SFAS No. 123 (in thousands, except per share data):

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|                                                                                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                            | ** ** | **June 30, 2005**      | ** ** | **June 30, 2005**    | ** ** |
| Net loss as  reported                                                                                                                 |       | $                                | (766       | )                              | $          | (650 | ) |
| Deduct: Total  stock-based compensation expenses determined under fair value based method  for all awards, net of related tax effects |       | (65                              | )          | (145                           | )          |
| Pro forma                                                                                                                             |       | $                                | (831       | )                              | $          | (795 | ) |
| Net loss per  common share                                                                                                            |       |                             |       |                           |       |
| As reported                                                                                                                           |       | $                                | (0.05      | )                              | $          | (0.04 | ) |
| Pro forma                                                                                                                             |       | $                                | (0.06      | )                              | $          | (0.05 | ) |
| Fully diluted  net loss per common share                                                                                              |       |                             |       |                           |       |
| As reported                                                                                                                           |       | $                                | (0.05      | )                              | $          | (0.04 | ) |
| Pro forma                                                                                                                             |       | $                                | (0.06      | )                              | $          | (0.05 | ) |

 

5.               ComprehensiveIncome (Loss)

Gaiam’scomprehensive income (loss) is comprised of net income (loss) and foreigncurrency translation adjustment, net of income taxes. Comprehensive income(loss), net of related tax effects, was as follows (in thousands):

 
|                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                    | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  (loss)                            |       | $                                | (1,166     | )                              | $          | (766 | ) | $ | (276 | ) | $ | (650 | ) |
| Foreign currency  translation adjustment, net |       | 314                              |       | (263                           | )          | 399 |   | (328 | ) |
| Comprehensive income  (loss), net of taxes    |       | $                                | (852       | )                              | $          | (1,029 | ) | $ | 123 |   | $ | (978 | ) |

 

6.               Loss per Share

Basic loss per shareexcludes any dilutive effects of options, warrants and dilutive securities. Basicloss per share is computed using the weighted average number of common sharesoutstanding during the period. Diluted loss per share is computed using theweighted average number of common and common stock equivalent sharesoutstanding during the period. Common equivalent shares of 221 thousand and 121thousand are excluded from the computation of diluted loss per share for thethree months ended June 30, 2006 and 2005, respectively, and 290 thousand and108 thousand common equivalent shares are excluded from the computation for thesix months ended June 30, 2006 and 2005, respectively, because their effectsare antidilutive.

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Thefollowing table sets forth the computation of basic and diluted loss per share(in thousands, except per share data):

 
|                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                    | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Numerator for  basic and diluted loss per share               |       | $                                | (1,166     | )                              | $          | (766 | ) | $ | (276 | ) | $ | (650 | ) |
| Denominator:                                                  |       |                             |       |                           |       |   |   |   |   |
| Weighted average shares for basic loss per share              |       | 23,140                           |       | 14,820                         |       | 21,795 |   | 14,820 |   |
| Effect of dilutive  securities:                               |       |                             |       |                           |       |   |   |   |   |
| Weighted average of common stock, stock options and  warrants |       | —                           |       | —                         |       | — |   | — |   |
|                                                          |       |                             |       |                           |       |   |   |   |   |
| Denominators for  diluted loss per share                      |       | 23,140                           |       | 14,820                         |       | 21,795 |   | 14,820 |   |
|                                                          |       |                             |       |                           |       |   |   |   |   |
| Net loss per  share — basic                              |       | $                                | (0.05      | )                              | $          | (0.05 | ) | $ | (0.01 | ) | $ | (0.04 | ) |
| Net loss per share —  diluted                            |       | $                                | (0.05      | )                              | $          | (0.05 | ) | $ | (0.01 | ) | $ | (0.04 | ) |

 

7.               SegmentInformation

Gaiam manages itsbusiness and aggregates its operational and financial information in accordancewith two reportable segments. The business segment comprises sales tobusinesses, retailers, corporate accounts, and media outlets, while the directto consumer segment includes catalog, print advertising, DRTV subscription, ande-commerce channels.

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

Contribution lossis defined as net sales, less cost of goods sold and direct expenses. Financialinformation for Gaiam’s business segments was as follows (in thousands):

 
|                                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenue:                                                                     |       |                             |       |                           |       |   |   |   |   |
| Direct to consumer                                                               |       | $                                | 27,008     |                           | $          | 11,959 |   | $ | 53,118 |   | $ | 25,272 |   |
| Business                                                                         |       | 16,153                           |       | 9,747                          |       | 41,795 |   | 22,758 |   |
| Consolidated net revenue                                                         |       | 43,161                           |       | 21,706                         |       | 94,913 |   | 48,030 |   |
| Contribution  loss:                                                              |       |                             |       |                           |       |   |   |   |   |
| Direct to consumer                                                               |       | (693                             | )          | (418                           | )          | (1,312 | ) | (252 | ) |
| Business                                                                         |       | (1,983                           | )          | (853                           | )          | (354 | ) | (732 | ) |
| Consolidated contribution loss                                                   |       | (2,676                           | )          | (1,271                         | )          | (1,666 | ) | (984 | ) |
| Reconciliation  of contribution loss to net loss:                                |       |                             |       |                           |       |   |   |   |   |
| Other income (expense)                                                           |       | 551                              |       | (8                             | )          | 1,128 |   | 108 |   |
| Income tax benefit                                                               |       | (804                             | )          | (532                           | )          | (192 | ) | (402 | ) |
| Minority interest in net (income) loss of consolidated  subsidiaries, net of tax |       | 155                              |       | (19                            | )          | 70 |   | (176 | ) |
| Net loss                                                                         |       | $                                | (1,166     | )                              | $          | (766 | ) | $ | (276 | ) | $ | (650 | ) |

 

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# **Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations**

# The following discussion and analysis of Gaiam’sfinancial condition and results of operations should be read in conjunctionwith the condensed consolidated financial statements and related notes includedelsewhere in this document.

#### Overview and Outlook

Gaiamis a branded lifestyle media company providing a broad selection of information,media, products and services to customers who value personal development,wellness, ecological lifestyles and responsible media. Gaiam’s media brand isbuilt around its ability to develop and offer media content, products andlifestyle solutions to consumers in the Lifestyle of Health and Sustainability(“LOHAS”) and the emerging Media that Matters (“MTM”) markets.

Gaiamoffers its customers the ability to make purchasing decisions based on thesevalues while providing quality offerings at a price comparable to mainstreamalternatives. Gaiam markets its media and products through a multi-channelapproach including traditional media channels, direct to consumers via theInternet, DRTV, subscription clubs, catalog, and through national retailers andcorporate accounts. As of June 30, 2006, Gaiam’s media was carried by more than61,000 retail stores in the United States alone, and it had approximately 7million direct buyers.

Gaiam’scontent forms the basis of its proprietary offerings, which then drive demandfor parallel product and service offerings. Gaiam’s operations are verticallyintegrated from content creations, through product development and sourcing, tocustomer service and distribution. Gaiam markets its products and servicesacross two segments, business and direct-to-consumer. Products are distributedin each of these sales segments from a single fulfillment center.

On September 13, 2005,Gaiam acquired substantially all of the assets of GoodTimes Entertainment andcertain of its affiliates. GoodTimes Entertainment’s assets includedentertainment programming and home video products distributed through variouschannels, including television, theatres, retailers and the Internet. GoodTimesEntertainment’s library contained wellness franchises such as The Firm and TaeBo, children classics and theatrical releases.

During the three monthsended June 30, 2006, both reportable segments experienced significant revenuegrowth over the second quarter of 2005, with the business segment generatingrevenue of $16.2 million, and the direct-to-consumer segment generating revenueof $27.0 million. For the six months ended June 30, 2006, the business anddirect-to-consumer segments generated revenue of $41.8 million and $53.1million, respectively. Gaiam expects to generate over $200 million in annualrevenues in 2006.

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#### Results of Operations

The following table setsforth certain financial data as a percentage of revenue for the periodsindicated:

 

|                                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenue                                                                      |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                                              |       | 37.7                             | %          | 51.4                           | %          | 36.7 | % | 49.4 | % |
| Gross profit                                                                     |       | 62.3                             | %          | 48.6                           | %          | 63.3 | % | 50.6 | % |
| Expenses:                                                                        |       |                             |       |                           |       |   |   |   |   |
| Selling and operating                                                            |       | 60.3                             | %          | 45.8                           | %          | 57.9 | % | 45.0 | % |
| Corporate, general and administration                                            |       | 8.2                              | %          | 8.7                            | %          | 7.2 | % | 7.6 | % |
| Total expenses                                                                   |       | 68.5                             | %          | 54.5                           | %          | 65.1 | % | 52.6 | % |
| Loss from  operations                                                            |       | -6.2                             | %          | -5.9                           | %          | -1.8 | % | -2.0 | % |
| Other income                                                                     |       | 1.3                              | %          | 0.0                            | %          | 1.2 | % | 0.2 | % |
| Income tax  benefit                                                              |       | -1.9                             | %          | -2.5                           | %          | -0.2 | % | -0.8 | % |
| Minority  interest in net (income) loss of consolidated subsidiaries, net of tax |       | 0.3                              | %          | -0.1                           | %          | 0.1 | % | -0.4 | % |
| Net loss                                                                         |       | -2.7                             | %          | -3.5                           | %          | -0.3 | % | -1.4 | % |

 

#### Three months ended June 30, 2006 versus June 30, 2005

Revenue of $43.2 million for the three months ended June30, 2006 increased 98.8% from $21.7 million for the three months ended June 30,2005. Gaiam’s increase in revenue was derived from the direct to consumersegment, in which revenue increased 125.8% to $27.0 million, and the businesssegment, in which revenue increased 65.7% to $16.2 million. The revenueincrease reflects the sales of media titles acquired from GoodTimesEntertainment, coupled with strong performance in our direct marketingprograms, continued penetration into existing retail stores, and the additionof new retail distribution outlets. During the quarter, Gaiam addeddistribution to 3,000 new retail doors, bringing the total number of doors inthe United States to 61,000.

Gross profit, which consists of revenue less cost ofsales (primarily merchandise acquisition costs and in-bound freight), increasedto $26.9 million for the second quarter of 2006 from $10.6 million during thesame period in 2005. As a percentage of revenue, gross profit for the secondquarter of 2006 increased to 62.3% in 2006 from 48.6% in the second quarter of2005. The increase was primarily due to strong sales of media and directmarketing products which carry higher margins, but also carry higher sellingand operating expenses. The increased media sales have allowed Gaiam toleverage its purchasing volume to receive improved buying discounts. Gaiam alsocontinued to benefit from the elimination of fees previously paid for thirdparty distribution following the GoodTimes transaction.

Selling and operating expenses (which consistprimarily of sales and marketing costs, commission and fulfillment expenses)increased to $26.0 million for the three months ended June 30, 2006 as comparedto $9.9 million in the same period of 2005, primarily resulting from theGoodTimes transaction. As a percentage of revenue, selling and operatingexpenses increased to 60.3% in 2006 from 45.8% in 2005 reflecting GoodTimestransition costs, distribution, management, systems, and additionalamortization expense associated with its media library, and a change in revenuemix toward increased media and direct marketing products which carry higherselling and operating expenses, such as merchandising fees and advertisingcosts.

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Corporate, general and administration expensesincreased to $3.6 million for the second quarter of 2006 compared to $1.9million for the same 2005 period, primarily due to the Gaiam’s plannedinvestments in its business to support the increased revenue base. As apercentage of revenue, corporate, general and administration expenses decreasedto 8.2% in the second quarter of 2006 from 8.7% in the comparable 2005 period,as economies of scale are achieved on the increased revenue base.

Operating loss was $2.7 million for the three monthsended June 30, 2006 compared to a loss of $1.3 million for the three monthsended June 30, 2005, primarily reflecting higher selling and operatingexpenses, including transition costs associated with the GoodTimes transaction,partially offset by increased gross profit margins.

Gaiamrecorded $0.6 million in other income for the three months ended June 30, 2006compared to other expense of $0.01 million for the second quarter of 2005. Theincrease in other income in 2006 primarily consisted of interest earned on theinvestment of the stock offering net proceeds. The share of net loss associatedwith minority interest was $0.2 million during the second quarter of 2006,compared to the share of net income of $0.02 million for the same 2005 period.

Gaiamrecorded an income tax benefit of $0.8 million for the three months ended June30, 2006 compared to an income tax benefit of $0.5 million for the three monthsended June 30, 2005. Gaiam’s consolidated effective tax rate fluctuates basedupon the distribution of earnings/losses between its domestic and foreignoperations.

As aresult of the factors described above, Gaiam’s net loss was $1.2 million, or$0.05 per share, for the three months ended June 30, 2006, as compared to a netloss of $0.8 million, or $0.05 per share, for the three months ended June 30,2005.

#### Six months ended June 30, 2006 versus June 30, 2005

Revenue of $94.9 million for the six months ended June30, 2006 increased 97.6% from $48.0 million for the six months ended June 30,2005. Gaiam’s increase in revenue was derived from the direct to consumersegment, in which revenue increased 110.2% to $53.1 million, and the businesssegment, in which revenue increased 83.6% to $41.8 million. The combination ofstrong internal revenue growth in both segments coupled with sales of mediatitles acquired from GoodTimes Entertainment primarily accounted for theincrease in revenues.

Gross profit increased to $60.1 million for the firstsix months of 2006 from $24.3 million during the same period in 2005. As apercentage of revenue, gross profit for the first six months of 2006 increasedto 63.3% in 2006 from 50.6% in the first six months of 2005. The increase wasprimarily due to strong sales of media and direct marketing products, whichcarry higher margins, but also carry higher selling and operating expenses. Alsofavorably impacting the gross margin were increased purchasing discountsassociated with higher DVD sales volume and the elimination of fees previouslypaid for third party distribution.

Selling and operating expenses increased to $54.9 millionfor the six months ended June 30, 2006 as compared to $21.6 million in the sameperiod of 2005, primarily resulting from the GoodTimes transaction. As apercentage of revenue, selling and operating expenses increased to 57.9 % in2006 from 45.0% in 2005 reflecting GoodTimes transition costs, distribution,management, systems, and additional amortization expense associated with itsmedia library, and a change in revenue mix toward increased media and directmarketing products which carry higher selling and operating expenses, such asmerchandising fees and advertising costs.

Corporate, general and administration expensesincreased to $6.8 million for the first six months of 2006 compared to $3.7million for the same 2005 period, primarily due to the Gaiam’s plannedinvestments in its business to support the increased revenue base. As apercentage of revenue, corporate, general and administration expenses decreasedto 7.2% in the first six months of 2006 from 7.6% in the comparable 2005period, as economies of scale are achieved on the increased revenue base.

Operating loss was $1.7 million for the six monthsended June 30, 2006 compared to an operating loss of $1.0 million for the sixmonths ended June 30, 2005, primarily reflecting higher selling and operatingexpenses, partially offset by increased gross profit margins.

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Gaiamrecorded $1.1 million and $0.1 million in other income for the six months endedJune 30, 2006 and 2005, respectively. The increase in 2006 primarily consistedof the gain from the LIME transaction, $0.5 million, and interest earned on theinvestment of the stock offering net proceeds, $0.6 million. The share of netloss associated with minority interest was $0.1 million during the first sixmonths of 2006, compared to the share of net income of $0.2 million for thesame 2005 period.

Gaiamrecorded income tax benefit of $0.2 million for the six months ended June 30,2006 compared to an income tax benefit of $0.4 million for the six months endedJune 30, 2005. Gaiam’s consolidated effective tax rate fluctuates based uponthe distribution of earnings/losses between its domestic and foreignoperations.

As aresult of the factors described above, Gaiam’s net loss was $0.3 million, or$0.01 per share, for the six months ended June 30, 2006, as compared to a lossof $0.7 million, or $0.04 per share, for the six months ended June 30, 2005.

Liquidity andCapital Resources

Gaiam’s capitalneeds arise from working capital required to fund our operations, capitalexpenditures related to acquisition and development of media content,development of our Internet platform and new products, acquisitions of newbusinesses, replacements, expansions and improvements to Gaiam’sinfrastructure, and future growth. These capital requirements depend onnumerous factors, including the rate of market acceptance of Gaiam’s product offerings,the ability to expand Gaiam’s customer base, the cost of ongoing upgrades toGaiam’s product offerings, the level of expenditures for sales and marketing,the level of investment in distribution systems and facilities and otherfactors. The timing and amount of these capital requirements are variable andcannot accurately be predicted. Additionally, Gaiam will continue to pursueopportunities to expand its media libraries, evaluate possible investments inbusinesses, products and technologies, and increase its sales and marketingprograms and brand promotions as needed.

Gaiam has a creditagreement with Wells Fargo, which permits borrowings of up to $15 million basedupon the collateral value of Gaiam’s accounts receivable, inventory, andcertain property and equipment. At June 30, 2006, Gaiam had no amountsoutstanding under this agreement and complied with all of the financialcovenants. The credit agreement expires on July 31, 2007. Should Gaiam chooseto borrow under the credit agreement, outstanding advances would bear interestat the lower of prime rate less 50 basis points or LIBOR plus 275 basis points.Borrowings are secured by a pledge of Gaiam’s assets, and the agreementcontains various financial covenants, including covenants prohibiting thepayment of cash dividends to Gaiam shareholders and requiring compliance withcertain financial ratios.

Gaiam’s operatingactivities used net cash of $3.0 million for the six months ended June 30,2006, primarily reflecting the use of funds to reduce accounts payable andaccrued liabilities by $10.0 million and $3.6 million, respectively, increasesin inventory and other current assets, including advances in media productionand acquired media programming, by $3.0 million and $1.8 million, respectively,and other net uses of $0.6 million. This use of funds was partially offset bycash provided from the decrease in accounts receivable of $13.5 million anddecrease in deferred advertising costs of $0.3 million, and non-cash charges tonet income of $2.2 million. During the six months ended June 30, 2005, Gaiam’soperating activities generated $2.8 million reflecting a decrease in accountsreceivable of $5.6 million and non-cash charges to net income of $2.2 million,partially offset by the use of funds to reduce accounts payable of $3.9million.

Gaiam’s investingactivities for the six months ended June 30, 2006 used net cash of $3.6 millionto purchase an approximate 34% interest in Cinema Circle Inc. for $3.5 millionand to acquire property, equipment and media rights for $0.4 million, partiallyoffset by cash provided from the sale of property and equipment for $0.3million. During the six months ended June 30, 2005, Gaiam’s investingactivities used cash of $0.8 million for the purchase of property, equipment,and media rights.

Gaiam’s financingactivities provided net cash of $96.5 million for the six months ended June 30,2006 reflecting net cash provided by the common stock offering of $93.0 millionand the exercise of stock options during the first half of the year for $3.5million.

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OnApril 7, 2006, Gaiam filed a shelf registration statement on Form S-3 with theSecurities and Exchange Commission for Class A Common Stock, par value $.0001,with a total offering price not to exceed $100,000,000. During May 2006, Gaiamfiled an amended Form S-3 to register 5,000,000 shares of Class A Common Stock,plus additional shares to cover over-allotments, if any. On May 24,2006, Gaiam sold 5,000,000shares of Class A Common Stock and on June 13, 2006 sold 690,000 shares ofClass A Common Stock in underwritten offerings under the registration statement.The combined stock sales generated gross proceeds of $99.6 million.

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

In thenormal course of our business, Gaiam investigates, evaluates and discussesacquisition, joint venture, minority investment, strategic relationship andother business combination opportunities in the LOHAS market. For any futureinvestment, acquisition or joint venture opportunities, Gaiam may considerusing then-available liquidity, issuing equity securities or incurringadditional indebtedness.

RiskFactors

There are risks and uncertainties that couldcause Gaiam’s actual results to be materially different from those indicated byforward-looking statements that it makes 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 uncertainties include, but are not limited to, thoselisted in Gaiam’s Annual Report on Form 10-K for the year ended December 31,2005. These risks and uncertainties and additional risks and uncertainties notpresently known to Gaiam or that are currently deemed immaterial may cause itsbusiness, financial condition, operating results and cash flows to bematerially adversely affected. Except for the historical information containedherein, the matters discussed in this analysis are forward-looking statementsthat involve risk and uncertainties, including, but not limited to, generaleconomic and business conditions, competition, pricing, brand reputation,consumer trends, and other factors which are often beyond Gaiam’s control. Gaiamdoes not undertake any obligation to update forward-looking statements exceptas required by law.

##### **Item 3.****   ****Quantitative and QualitativeDisclosures About Market Risk**

Gaiamis exposed to market risks, which include changes in U.S. interest rates andforeign exchange rates. Gaiam does not engage in financial transactions fortrading or speculative purposes.

Anyborrowings Gaiam might make under its bank credit facility would bear interestat the lower of prime rate less 50 basis points or LIBOR plus 275 basis points.Gaiam does not have any amounts outstanding under its credit facility, so anychange in interest rates would not have a material impact on Gaiam’s resultsfrom operations or cash 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. Becausethe percentage of Gaiam’s international purchases denominated in currenciesother than the U.S. dollar is small, any currency risks related to thesetransactions are immaterial to Gaiam. A decline in the relative value of theU.S. dollar to other foreign currencies could, however, lead to increasedpurchasing costs. In order to mitigate this exposure, Gaiam makes virtually allof 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 isprimarily denominated in foreign currencies, this investment exposes Gaiam toaccounting risk associated with foreign currency exchange rate fluctuations. However,Gaiam has determined that no material market risk exposure to its consolidatedfinancial position, results of operations or cash flows existed as of June 30,2006.

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**Item 4.****                    Controls andProcedures**

**Evaluationof 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 their evaluation as of June 30, 2006, Gaiam’s chiefexecutive officer and chief financial officer have concluded that thosedisclosure controls and procedures are effective.

**Changesin Internal Control over Financial Reporting**

Nochanges in Gaiam’s internal control over financial reporting occurred duringthe quarter or first six months ended June 30, 2006 that have materiallyaffected, or are reasonably likely to materially affect, Gaiam’s internalcontrol over financial reporting.

## **PART II.****               ****OTHER INFORMATION**

##### **Item 1.****                                                          ****Legal Proceedings**

From time to time, Gaiamis involved in legal proceedings that it considers to be in the normal courseof business. Gaiam does not believe that any of these proceedings will have amaterial adverse effect on its business.

##### **Item 1A.****               ****Risk Factors**

Nomaterial changes.

##### **Item 2.****                                                          ****Sales of UnregisteredSecurities and Use of Proceeds**

On April 28, 2006, entities formed for thebenefit of certain Gaiam employees exercised options (which options were issuedby Gaiam in 1999 at an exercise price of $4.375 per share) to purchase 200,000shares of Gaiam’s Class A Common Stock. The shares were issued in relianceon the exemption from registration contained in Section 4(2) of the SecuritiesAct as a transaction by an issuer not involving any public offering. There wereno underwriters involved in connection with the sale of these securities.

##### **Item 3.****                                                          ****Defaults Upon SeniorSecurities**

None.

**Item 4.****                                                           Submissionof Matters to a Vote of Security Holders.**

On June 22, 2006, Gaiam held an annual and specialmeeting of shareholders. The shareholders elected eight directors to serveuntil the next annual meeting of shareholders to be held in 2007 or until theirsuccessors are duly elected and qualified. The results of this vote follow:
| Jirka Rysavy        |   | For: | 59,997,565 |   | Withheld: | 1,319,340 |   |
|---------------------|--------|------|------------|--------|-----------|-----------|--------|
| Lynn Powers         |   | For: | 59,955,627 |   | Withheld: | 1,361,278 |   |
| James  Argyropoulos |   | For: | 61,068,480 |   | Withheld: | 248,425   |   |
| Barnet M.  Feinblum |   | For: | 60,825,608 |   | Withheld: | 491,297   |   |
| David Golden        |   | For: | 61,297,482 |   | Withheld: | 19,423    |   |
| Barbara Mowry       |   | For: | 61,068,587 |   | Withheld: | 248,318   |   |
| Ted Nark            |   | For: | 59,449,438 |   | Withheld: | 1,867,467 |   |
| Paul H. Ray         |   | For: | 59,449,485 |   | Withheld: | 1,867,420 |   |

 

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In addition, the shareholders approved a motion toamend Gaiam’s 1999 Long-Term Incentive Plan in order to increase the number ofshares which may be issued pursuant to the Plan by a vote of 59,586,424 infavor, 1,651,434 opposed and 79,046 abstaining, and a motion to authorize anamendment to our Articles of Incorporation to provide that any action ofshareholders that would otherwise require a shareholders’ meeting may be takenby the written consent of the required minimum number of shareholders without ameeting, by a vote of 56,991,794 in favor, 2,758,124 opposed and 7,870abstaining.

**Item 5.****                                                           OtherInformation**

On August 4, 2006, Gaiam filed an amendment to itsAmended and Restated Articles of Incorporation with the Colorado Secretary ofState. The amendment was approved by Gaiam shareholders at Gaiam’s specialmeeting of shareholders described in Part II, Item 4 above. As a result of theamendment being filed, certain conforming changes in Gaiam’s bylaws that werepreviously approved by Gaiam’s Board of Directors became effective. The bylawchanges relate to the ability of Gaiam shareholders to take action by writtenconsent without a meeting as permitted by the amendment to Gaiam’s Amended andRestated Articles of Incorporation.

**Item 6.****                                                           Exhibits**

a)                                      Exhibits.
| Exhibit No. | ** ** | **Description** |
|-------------|------------|-----------------|
| 3.1         |       |            | Amendment to Amended and Restated Articles of  Incorporation of Gaiam, Inc. (filed herewith). |
| 3.2         |       |            | Bylaws of Gaiam, Inc. (filed herewith). |
| 10.1        |       |            | Gaiam Inc. 1999 Long-Term Incentive Plan (filed  herewith). |
| 31.1        |       |            | Certification of the Chief Executive Officer  pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 (filed  herewith). |
| 31.2        |       |            | Certification of the Chief Financial Officer  pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 (filed  herewith). |
| 32.1        |       |            | Certification 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). |

 

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**Signatures**

 

In accordance withthe requirements of the Securities and Exchange Act, the registrant caused thisreport to be signed on its behalf, by the undersigned, thereunto dulyauthorized.

 
|        | Gaiam, Inc.    |
|--------|----------------|
|   | (Registrant)   |
|   | August 7, 2006 |
|   |           |
|   | By:            | /s/ Jirka Rysavy |   |
|   |           | Jirka Rysavy |
|   |           | Chief Executive Officer |
|   |           |   |
|   | By:            | /s/ Vilia  Valentine |   |
|   |           | Vilia Valentine |
|   |           | Chief Financial Officer |
|   |           | (Principal Accounting Officer) |
|        |                |  |  |  |

 

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