**UnitedStatesSecurities and Exchange Commission****Washington,D.C. 20549**

#### **Form10-Q**

**x****           QUARTERLY REPORT PURSUANT TO SECTION13 OR 15 (d)OF THE SECURITIES AND EXCHANGE ACT OF 1934**

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

**OR**

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

**CommissionFile Number 0-27517**

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

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

 

**360 INTERLOCKEN BLVD.BROOMFIELD, COLORADO 80021**(Address of 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

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

| Large Accelerated  Filer  o |   | Accelerated  Filer  x |   | Non-Accelerated  Filer  o |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-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**                                |   | **Outstanding  at November 8, 2006** |
|------------------------------------------|--------|--------------------------------------|
| Class A Common  Stock ($.0001 par value) |   | 21,706,196                           |
| Class B Common  Stock ($.0001 par value) |   | 5,400,000                            |

 

 

----

 

**GAIAM,INC.**

**FORM10-Q**

**INDEX**

 
|                                   | ** **                                                                                                       | ** ** | ** ** |
|-----------------------------------|------------------------------------------------------------------------------------------------------------------|------------|------------|
| **PART I. FINANCIAL INFORMATION** | ** **                                                                                                       | ** ** |
| ** **                        | ** **                                                                                                       | ** ** |
| **Item 1.**                       | **Financial Statements (Unaudited):**                                                                            |       |       |
| ** **                        | Condensed Consolidated Balance Sheets at September 30,  2006 and December 31, 2005                               |       |       |
| ** **                        | Condensed Consolidated Statements of Operations for  the Three and Nine Months Ended September 30, 2006 and 2005 |       |       |
| ** **                        | Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended September 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                                                                                                       |       |       |

#  

2

----

**GAIAM, INC.CONDENSED CONSOLIDATED BALANCE SHEETS**(In thousands, except share information)
| ** **                                                                                                                                                                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                                 | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                 |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                            |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                 |       | $                      | 104,955    |                  | $          | 15,028 |   |
| Accounts receivable,  net                                                                                                                                                                  |       | 14,541                 |       | 28,067                |       |
| Inventory, less  allowances                                                                                                                                                                |       | 23,089                 |       | 20,792                |       |
| Deferred  advertising costs                                                                                                                                                                |       | 5,813                  |       | 3,917                 |       |
| Deferred tax  assets                                                                                                                                                                       |       | 2,807                  |       | 3,627                 |       |
| Other current  assets                                                                                                                                                                      |       | 4,769                  |       | 4,838                 |       |
| Total current  assets                                                                                                                                                                      |       | 155,974                |       | 76,269                |       |
|                                                                                                                                                                                       |       |                   |       |                  |       |
| Property and equipment,  net                                                                                                                                                               |       | 7,375                  |       | 9,428                 |       |
| Media library, net                                                                                                                                                                         |       | 38,389                 |       | 38,339                |       |
| Goodwill and other  intangibles                                                                                                                                                            |       | 25,339                 |       | 17,541                |       |
| Noncurrent deferred tax  assets                                                                                                                                                            |       | 9,311                  |       | 7,282                 |       |
| Notes receivable and  other assets                                                                                                                                                         |       | 4,243                  |       | 7,242                 |       |
| Total assets                                                                                                                                                                               |       | $                      | 240,631    |                  | $          | 156,101 |   |
|                                                                                                                                                                                       | ** ** | ** **             |       |                  |       |
| **Liabilities and stockholders’  equity**                                                                                                                                             |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                       |       |                   | ** ** | ** **            | ** ** |
| Accounts payable                                                                                                                                                                           |       | $                      | 18,300     |                  | $          | 25,843 |   |
| Accrued  liabilities                                                                                                                                                                       |       | 5,804                  |       | 13,210                |       |
| Total current  liabilities                                                                                                                                                                 |       | 24,104                 |       | 39,053                |       |
| Long-term liabilities                                                                                                                                                                      |       | —                 |       | 1,663                 |       |
| Total  liabilities                                                                                                                                                                         |       | 24,104                 |       | 40,716                |       |
| Minority interest                                                                                                                                                                          |       | 6,461                  |       | 8,099                 |       |
|                                                                                                                                                                                       |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                             |       |                   |       |                  |       |
|                                                                                                                                                                                       |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                 |       |                   |       |                  |       |
| Class A common stock, $.0001 par value, 150,000,000 shares  authorized, 21,467,420 and 15,010,736 shares issued and outstanding at  September 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 September 30, 2006 and December 31, 2005                                        |       | 1                      |       | 1                     |       |
| Additional  paid-in capital                                                                                                                                                                |       | 196,836                |       | 95,840                |       |
| Accumulated  other comprehensive income                                                                                                                                                    |       | 669                    |       | 264                   |       |
| Retained  earnings                                                                                                                                                                         |       | 12,558                 |       | 11,180                |       |
| Total  stockholders’ equity                                                                                                                                                           |       | 210,066                |       | 107,286               |       |
| Total liabilities and  stockholders’ equity                                                                                                                                           |       | $                      | 240,631    |                  | $          | 156,101 |   |

 

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

3

----

 

**GAIAM, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**(Unaudited)(In thousands, except per share amounts)
| ** **                                                                       | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                                               | ** ** | **2005**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net revenue                                                                      |       | $                                                                      | 51,786     |                                                                  | $          | 30,139 |   | $ | 146,699 |   | $ | 78,169 |   |
| Cost of goods  sold                                                              |       | 19,157                                                                 |       | 13,426                                                                |       | 54,017 |   | 37,150 |   |
| Gross profit                                                                     |       | 32,629                                                                 |       | 16,713                                                                |       | 92,682 |   | 41,019 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Expenses:                                                                        |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Selling and operating                                                            |       | 27,963                                                                 |       | 13,682                                                                |       | 82,885 |   | 35,307 |   |
| Corporate, general and administration                                            |       | 3,656                                                                  |       | 2,153                                                                 |       | 10,452 |   | 5,818 |   |
| Total expenses                                                                   |       | 31,619                                                                 |       | 15,835                                                                |       | 93,337 |   | 41,125 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Earnings (loss)  from operations                                                 |       | 1,010                                                                  |       | 878                                                                   |       | (655 | ) | (106 | ) |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Other income  (expense)                                                          |       | 65                                                                     |       | (1                                                                    | )          | 617 |   | 37 |   |
| Interest income                                                                  |       | 1,447                                                                  |       | 202                                                                   |       | 2,022 |   | 272 |   |
| Total other income                                                               |       | 1,512                                                                  |       | 201                                                                   |       | 2,639 |   | 309 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Earnings before  income taxes and minority interest                              |       | 2,522                                                                  |       | 1,079                                                                 |       | 1,984 |   | 203 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Income tax  expense                                                              |       | 977                                                                    |       | 406                                                                   |       | 784 |   | 4 |   |
| Minority  interest in net (income) loss of consolidated subsidiaries, net of tax |       | 108                                                                    |       | (168                                                                  | )          | 178 |   | (344 | ) |
| Net income  (loss)                                                               |       | $                                                                      | 1,653      |                                                                  | $          | 505 |   | $ | 1,378 |   | $ | (145 | ) |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net earnings  (loss) per share:                                                  |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic                                                                            |       | $                                                                      | 0.06       |                                                                  | $          | 0.03 |   | $ | 0.06 |   | $ | (0.01 | ) |
| Diluted                                                                          |       | $                                                                      | 0.06       |                                                                  | $          | 0.03 |   | $ | 0.06 |   | $ | (0.01 | ) |
| Shares used in  computing net earnings (loss) per share:                         |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic                                                                            |       | 26,705                                                                 |       | 18,592                                                                |       | 23,450 |   | 16,091 |   |
| Diluted                                                                          |       | 26,864                                                                 |       | 18,892                                                                |       | 23,697 |   | 16,091 |   |

 

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

4

----

 

**GAIAM, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**(Unaudited)(In thousands)
| ** **                                                                                | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| **Operating  activities**                                                                 |       |                                                                  |       |   |   |
| Net income  (loss)                                                                        |       | $                                                                     | 1,378      |   | $ | (145 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                                                  |       |   |   |
| Depreciation                                                                              |       | 1,593                                                                 |       | 1,666 |   |
| Amortization                                                                              |       | 3,948                                                                 |       | 1,280 |   |
| Minority interest in consolidated subsidiaries                                            |       | (178                                                                  | )          | 343 |   |
| Noncash gain from equity investment                                                       |       | (680                                                                  | )          | — |   |
| Noncash stock-based compensation                                                          |       | 365                                                                   |       | — |   |
| Deferred income tax expense                                                               |       | 644                                                                   |       | (469 | ) |
| Changes in operating assets and liabilities, net of  effects from acquisitions:           |       |                                                                  |       |   |   |
| Accounts receivable                                                                       |       | 14,074                                                                |       | 2,333 |   |
| Inventory                                                                                 |       | (4,089                                                                | )          | 1,451 |   |
| Deferred advertising costs                                                                |       | (2,436                                                                | )          | (1,676 | ) |
| Prepaid and other assets                                                                  |       | (1,111                                                                | )          | (3,732 | ) |
| Accounts payable                                                                          |       | (7,382                                                                | )          | (1,290 | ) |
| Accrued liabilities                                                                       |       | (5,549                                                                | )          | 1,512 |   |
| Net cash provided by operating activities                                                 |       | 577                                                                   |       | 1,273 |   |
|                                                                                      |       |                                                                  |       |   |   |
| **Investing  activities**                                                                 |       |                                                                  |       |   |   |
| Purchase of  property, equipment and media rights                                         |       | (1,854                                                                | )          | (928 | ) |
| Proceeds from  sale of property and equipment                                             |       | 637                                                                   |       | — |   |
| Purchase of  acquisitions and investments                                                 |       | (6,582                                                                | )          | (38,739 | ) |
| Net cash used in investing activities                                                     |       | (7,799                                                                | )          | (39,667 | ) |
|                                                                                      |       |                                                                  |       |   |   |
| **Financing  activities**                                                                 |       |                                                                  |       |   |   |
| Proceeds from  issuance of common stock, net                                              |       | 96,609                                                                |       | 38,468 |   |
| Net cash provided by financing activities                                                 |       | 96,609                                                                |       | 38,468 |   |
| Effects of  exchange rates on cash and cash equivalents                                   |       | 540                                                                   |       | (266 | ) |
|                                                                                      |       |                                                                  |       |   |   |
| Net change in  cash and cash equivalents                                                  |       | 89,927                                                                |       | (192 | ) |
| Cash and cash  equivalents at beginning of period                                         |       | 15,028                                                                |       | 10,439 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                                                     | 104,955    |   | $ | 10,247 |   |
|                                                                                      |       |                                                                  |       |   |   |
| **Supplemental  cash flow information**                                                   |       |                                                                  |       |   |   |
| Interest paid                                                                             |       | $                                                                     | —     |   | $ | — |   |
| Income taxes  paid                                                                        |       | $                                                                     | —     |   | $ | 743 |   |
| Common stock issued for  acquisitions                                                     |       | $                                                                     | 1,933      |   | $ | 390 |   |

 

*See accompanyingnotes to the interim condensed consolidated financial statements*

#  

5

----

** **

**Gaiam, Inc.Notes to Interim Condensed Consolidated Financial Statements(Unaudited)September 30, 2006**

**1.****              InterimCondensed Consolidated Financial Statements**

###### Organization and Nature ofOperations

Gaiam,Inc. (“Gaiam”) is a branded lifestyle media company providing a broad selectionof information, media, products and services to customers who value personaldevelopment, wellness, ecological lifestyles, and responsible media. Gaiam wasincorporated under the laws of the State of Colorado on July 7, 1988.

Theaccompanying interim condensed consolidated financial statements include theaccounts of Gaiam and its subsidiaries in which Gaiam’s ownership is greaterthan 50% and the subsidiary is considered to be under Gaiam’s control. Allmaterial intercompany accounts and transaction balances have been eliminated inconsolidation.

###### Preparation of InterimCondensed Consolidated Financial Statements

Theinterim condensed consolidated financial statements included herein have beenprepared by the management of Gaiam pursuant to the rules and regulations ofthe United States Securities and Exchange Commission, and, in the opinion ofmanagement, contain all adjustments (consisting of only normal recurringadjustments) necessary to present fairly Gaiam’s consolidated financialposition as of September 30, 2006, the interim results of operations for thethree and nine months ended September 30, 2006 and 2005, and cash flows for thenine months ended September 30, 2006 and 2005. These interim statements havenot been audited. The balance sheet as of December 31, 2005 was derived fromGaiam’s audited consolidated financial statements included in Gaiam’s annualreport on Form 10-K.

Theinterim condensed consolidated financial statements are prepared in conformitywith accounting principles generally accepted in the United States, whichrequire management to make judgments, estimates and assumptions that affect theamounts reported in Gaiam’s consolidated financial statements and accompanyingnotes. The interim condensed consolidated financial statements contained hereinshould be read in conjunction with Gaiam’s audited financial statements,including the notes thereto, for the year ended December 31, 2005. No changeswere made to our significant policies during the three and nine months endedSeptember 30, 2006, except for the adoption of Financial Accounting StandardsBoard’s (“FASB”) Statement No. 123 — revised 2004 (“SFAS 123R”), *Share-Based Payment*. See Summary of Significant AccountingPolicies discussed below.

Theconsolidated financial position, results of operations and cash flows for theinterim periods disclosed in this report are not necessarily indicative offuture financial 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 shortmaturities.

6

----

 

*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 forbad debts against amounts due. For all other instances, Gaiam recognizesreserves based on historical experience and review of individual accountsoutstanding.

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 amortized but is reviewed for impairment annually or morefrequently if impairment indicators arise, on a reporting unit level. The fairvalue of a reporting unit is compared with its carrying amount, includinggoodwill. If the fair value of a reporting unit exceeds its carrying amount,goodwill of the reporting unit is considered 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 exercise significantinfluence or control, or in which it holds a five percent or more membershipinterest, 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. Investments underthe cost and equity methods are included on the accompanying consolidatedbalance sheet in “Notes receivable and other assets”.

*Capitalized Production Costs and Media 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.

7

----

 

*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 nine months endedSeptember 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 nine months ended September 30, 2005 as ifGaiam had recorded stock-based compensation expense.

Contractual Obligations

Gaiam has commitmentspursuant to lease agreements, but does not have any outstanding commitmentspursuant to long-term debt, capital lease, or purchase obligations. Thefollowing table shows Gaiam’s commitments to make future payments underoperating leases (in thousands):

|                              | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 years** | ** ** | ** ** |
|------------------------------|------------|-----------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|----------------------------|------------|------------|
| Operating lease  obligations |       | $         | 4,950      |                      | $          | 2,962              |       | $                  | 1,522      |                       | $          | 314        |   | $ | 152 |   |   |
|                              |            |           |            |                           |            |                    |            |                    |            |                            |            |            |  |  |  |  |  |

 

Off-Balance Sheet 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 September 30, 2006, Gaiam is not involved in anyunconsolidated SPEs or VIEs.

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.

New AccountingPronouncements

During the quarter endedSeptember 30, 2006, the Financial Accounting Standards Board (“Board”) issuedInterpretation No. 48, *Accounting for Uncertaintyin Income Taxes — An Interpretation of FASB Statement No. 109*(“FIN48”). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with FASBStatement No. 109, *Accounting for IncomeTaxes.* The Interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. It alsoprovides guidance on derecognition, classification,

8

----

 

interest and penalties,accounting in interim periods, disclosure, and transition. This Interpretationis effective for fiscal years beginning after December 15, 2006. Earlierapplication of the provisions of this Interpretation is encouraged if theenterprise has not yet issued financial statements, including interim financialstatement, in the period this Interpretation is adopted. Consequently, Gaiamwill adopt the provisions of FIN 48 for its fiscal year beginning on January 1,2007. Management believes that FIN 48 is applicable to Gaiam, but can not yet reasonablyestimate the impact of the Interpretation.

In September 2006, theBoard issued Statement No. 157, Fair Value Measurements (“SFAS 157”). ThisStatement defines fair value, establishes a framework for measuring fair valuein generally accepted accounting principles (“GAAP”), and expands disclosuresabout fair value measurements. SFAS 157 applies under other accountingpronouncements that require or permit fair value measurements, the Board havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, this Statement does not requireany new fair value measurements. The Statement is effective for financialstatements issued for fiscal years beginning after November 15, 2007, and interimperiods within those fiscal years. Earlier application is encouraged, providedthat the reporting entity has not yet issued financial statements for thatfiscal year, including financial statements for an interim period within thatfiscal year. Gaiam will adopt the provisions of SFAS 157 in its fiscal yearcommencing January 1, 2008. Management currently believes that adoption of theprovisions of SFAS 157 will not have a material impact on Gaiam’s consolidatedfinancial statements.

**2.****              NotesReceivable and Other Assets**

Notes receivable andother assets as of September 30, 2006 consisted of $1.3 million of investments,$2.3 million in notes and related interest receivable, and $0.6 million ofother long-term assets. On January 5, 2006, Gaiam entered into an agreementwith Alps Communications LLC and Life Balance Media Holdings LLC (“LIME”), tosell 19,968 Series A Preferred Units of LIME, an investment previouslyaccounted for using the equity method. The purchase price per unit was equal tothe amount Gaiam paid for its investment during 2005. Alps Communicationsassumed all unpaid Series A Capital Contribution commitments from Gaiam andexecuted an interest bearing promissory note due February 28, 2009 in theprincipal amount of $2,250,000. After the closing of this transaction, Gaiamowns 4,876 units, or less than 4%, of LIME. This transaction resulted in a gainof $0.5 million which is included in Other Income on the Condensed ConsolidatedStatements of Operations for the nine months ended September 30, 2006. Notesreceivable and other assets as of December 31, 2005 consisted of $6.8 millionof investments and $0.4 million of other 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 was 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.Subsequent to June 30, 2006, Gaiam purchased an additional 29% interest inCCI for $3.4 million. With the purchase of the additional interest, Gaiam’sownership was approximately 63% and, therefore, commencing with the effectivedates of the additional share purchases, CCI met the accounting criteria to beconsidered a business combination as outlined in SFAS No. 141, *Business Combinations*and Gaiam began consolidating CCI’s resultsof operations effective July 31, 2006.

On September 30, 2006, aspart of a Share Exchange Agreement, Gaiam sold 76% of its CCI ownershipinterest directly to CCI in return for 85% ownership in a new entity, SpiritualCinema, Inc. (“SCI”), consisting primarily of CCI’s formerly owned subscriptionbased DVD club segment, thereby reducing Gaiam’s ownership interest in theremaining CCI film production segment to 15%. As a result of this reduction inthe CCI investment, Gaiam changed its accounting for its investment in CCI fromthe consolidation to cost method. SCI is consolidated into Gaiam’s balancesheet effective September 30, 2006. See Note 8 — Mergers and Acquisitions.

9

----

 

**3.****              Stockholders’Equity**

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. The combined stock sales generated gross proceeds of$99.6 million. During the first nine months of 2006, Gaiam issued a total of7,692 shares of Class A common stock to Gaiam’s independent directors, in lieuof cash compensation, for services rendered in 2005 and 2006. In addition, forthe nine months ended September 30, 2006, Gaiam issued 609,294 shares of ClassA common stock upon exercise of options granted under Gaiam’s 1999 Long-TermIncentive Plan. Furthermore, on September 29, 2006, Gaiam issued 149,698 sharesof Class A common stock to acquire additional ownership of Conscious Media,Inc. See Note 8 — Mergers and Acquisitions.

**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 nonqualified 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 theBlack-Scholes option pricing model to determine the fair value of stock optionsand shares issued under the Plan. The determination of fair value stock-basedpayment awards on the date of grant using an option-pricing model is affectedby Gaiam’s stock price as well as assumptions regarding a number of complex andsubjective variables. These variables include Gaiam’s expected stock pricevolatility over the term of the awards, actual and projected employee stockoption exercise behavior, risk-free interest rate and expected dividends.

Expected volatilities arebased on historical realized volatility of Gaiam’s stock. Gaiam’s use ofhistorical 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 areexpected to vest. All stock-based payment awards are amortized on astraight-line basis over the requisite service periods of the awards, which aregenerally the vesting periods.

Total stock-basedcompensation recognized was $0.2 million and $0.4 million and are shown incorporate, general, and administration expenses on Gaiam’s condensedconsolidated financial statements for the three and nine months ended September30, 2006, respectively.

The following table setsforth the pro forma amounts of net income and net income per share, for thethree and nine months ended September 30, 2005, that would have resulted ifGaiam had accounted for its stock-based compensation plan under the fair valuerecognition provisions of SFAS No. 123 (in thousands, except per share data).

#  

10

----

 
| ** **                                                                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                             | ** ** | **September 30, 2005** | ** ** | **September 30, 2005** | ** ** |
|                                                                                                   |       |                             |       |                             |       |
| Net income (loss) as  reported                                                                         |       | $                                | 505        |                             | $          | (145 | ) |
| Deduct: Total  stock-basedcompensationexpenses determined under fair value basedmethod for  all awards |       | (37                              | )          | (182                             | )          |
| Pro forma                                                                                              |       | $                                | 468        |                             | $          | (327 | ) |
|                                                                                                   |       |                             |       |                             |       |
| Net earnings (loss) per  common share                                                                  |       |                             |       |                             |       |
| As reported                                                                                            |       | $                                | 0.03       |                             | $          | (0.01 | ) |
| Pro forma                                                                                              |       | $                                | 0.03       |                             | $          | (0.02 | ) |
|                                                                                                   |       |                             |       |                             |       |
| Fully diluted net  earnings (loss) per common share                                                    |       |                             |       |                             |       |
| As reported                                                                                            |       | $                                | 0.03       |                             | $          | (0.01 | ) |
| Pro forma                                                                                              |       | $                                | 0.03       |                             | $          | (0.02 | ) |

 

**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  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss)                             |       | $                                                    | 1,653      |                                                | $          | 505 |   | $ | 1,378 |   | $ | (145 | ) |
| Foreign currency  translation adjustment, net |       | 6                                                    |       | (80                                                 | )          | 405 |   | (408 | ) |
| Comprehensive income (loss), net of taxes     |       | $                                                    | 1,659      |                                                | $          | 425 |   | $ | 1,783 |   | $ | (553 | ) |

 

**6.****              Earnings (Loss)Per Share**

Basicearnings (loss) per share excludes any dilutive effects of options, warrantsand dilutive securities. Basic earnings (loss) per share is computed using theweighted average number of common shares outstanding during the period. Dilutedloss per share is computed using the weighted average number of common andcommon stock equivalent shares outstanding during the period. Common equivalentshares of 172 are excluded from the computation of diluted loss per share forthe nine months ended September 30, 2005, because their effect is antidilutive.

Thefollowing table sets forth the computation of basic and diluted earnings (loss)per share (in thousands, except per share data):
| ** **                                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Numerator for  basic and diluted earnings (loss) per share    |       | $                                                    | 1,653      |                                                | $          | 505 |   | $ | 1,378 |   | $ | (145 | ) |
| Denominator:                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average share for basic earnings (loss) per  share   |       | 26,705                                               |       | 18,592                                              |       | 23,450 |   | 16,091 |   |
| Effect of  dilutive securities:                               |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average of common stock, stock options and  warrants |       | 159                                                  |       | 300                                                 |       | 247 |   | — |   |
| Denominators for  diluted earnings (loss) per share           |       | 26,864                                               |       | 18,892                                              |       | 23,697 |   | 16,091 |   |
|                                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Net earnings  (loss) per share - basic                        |       | $                                                    | 0.06       |                                                | $          | 0.03 |   | $ | 0.06 |   | $ | (0.01 | ) |
| Net earnings (loss) per  share - diluted                      |       | $                                                    | 0.06       |                                                | $          | 0.03 |   | $ | 0.06 |   | $ | (0.01 | ) |

 

11

----

 

**7.****              SegmentInformation**

Gaiam manages its business and aggregates itsoperational and financial information in accordance with two reportablesegments. The business segment comprises sales to businesses, retailers,corporate accounts, and media outlets, while the direct to consumer segmentincludes catalog, print advertising, direct response television (“DRTV’’),subscription, and e-commerce channels.

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

Contribution loss is defined as net sales, less costof goods sold and direct expenses. Financial information for Gaiam’s businesssegments was as follows (in thousands):
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenue:                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Direct to consumer                                                               |       | $                                                    | 32,624     |                                                | $          | 16,248 |   | $ | 85,741 |   | $ | 41,520 |   |
| Business                                                                         |       | 19,162                                               |       | 13,891                                              |       | 60,958 |   | 36,649 |   |
| Consolidated net revenue                                                         |       | 51,786                                               |       | 30,139                                              |       | 146,699 |   | 78,169 |   |
| Contribution  margin (loss):                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Direct to consumer                                                               |       | 587                                                  |       | 211                                                 |       | (723 | ) | (41 | ) |
| Business                                                                         |       | 423                                                  |       | 667                                                 |       | 68 |   | (65 | ) |
| Consolidated contribution margin (loss)                                          |       | 1,010                                                |       | 878                                                 |       | (655 | ) | (106 | ) |
| Reconciliation  of contribution margin (loss) to net income (loss):              |       |                                                 |       |                                                |       |   |   |   |   |
| Other income                                                                     |       | 1,512                                                |       | 201                                                 |       | 2,639 |   | 309 |   |
| Income tax expense                                                               |       | 977                                                  |       | 406                                                 |       | 784 |   | 4 |   |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |       | 108                                                  |       | (168                                                | )          | 178 |   | (344 | ) |
| Net income (loss)                                                                |       | $                                                    | 1,653      |                                                | $          | 505 |   | $ | 1,378 |   | $ | (145 | ) |

 

**8.****              Mergers andAcquisitions**

On September 29, 2006, Gaiam increased its ownershippercentage in Conscious Media, Inc. (“CMI”), a multimedia company, from 51% to86% for an additional investment of $1.9 million. Gaiam acquired stock directlyfrom certain CMI minority interest shareholders by issuing 149,698 shares ofGaiam Class A common stock. Also on September 29, 2006, CMI reacquired andretired 14.5 million of its outstanding Class A common stock from anotherminority shareholder in exchange for 100% of the common stock of a wholly-ownedsubsidiary of CMI. As a result of these two transactions, Gaiam re-valued thenet tangible assets of CMI, adjusted the portion assignable to minorityinterest and recorded a $1.4 million increase to goodwill. Gaiam is in theprocess obtaining valuations for certain tangible and intangible assets and,thus, the allocation of the purchase price is subject to refinement. Managementbelieves that CMI’s expertise in media programming, development and postproduction will complement Gaiam’s current businesses and future growth, at acost less than Gaiam could develop on its own. Subsequent to September 30,2006, CMI reacquired and retired 1.0 million of its outstandingClass A common stock from a minority shareholder in exchange for theforgiveness of $1.0 million worth of a note receivable from thatshareholder. As a result of this exchange and an additional Gaiam Class Acommon stock investment of approximately $3.0 million, of which 85,526shares were issued to two board directors of Gaiam, Gaiam owns substantiallyall of CMI’s outstanding stock as of November 8, 2006.

Cinema Circle, Inc. (“CCI”) had two business segments,direct (primarily subscription clubs) and film production. On September 30,2006, Gaiam, CCI, and Spiritual Cinema, Inc. (“SCI”), a newly formedwholly-owned subsidiary of Gaiam, entered into a Share Exchange Agreement (“Agreement”).Under the Agreement, 100% of the equity and net assets of CCI’s direct segmentwere acquired by SCI from CCI in exchange for 76% of Gaiam’s interest in CCI and15% of its SCI ownership. Of the $6.9 million determined cost of its 85%ownership in SCI, Gaiam allocated $6.1 million to goodwill and theremainder to net tangible assets and minority interest. The purchase priceallocation is preliminary

12

----

 

pending identificationand valuation of potentially separable intangibles, such as customerrelationships, trademarks, and media rights. SCI’s results of operations willbe included in Gaiam’s consolidated statement of operations commencing October1, 2006. Gaiam plans to invest in its online business over the next two yearsto better capitalize on growing broadband subscription trends as well as toestablish stronger relationships with its loyal consumer audience. This will beaccomplished through the direct-to-consumer business as Gaiam continues tofocus on better leveraging its content through subscription clubs andcommunity. The investment in SCI provides immediate content that can be offeredto Gaiam’s existing customer base. The films distributed to SCI’s members aremeaningful inspirational and spiritual family films that compliment Gaiam’sproduct offerings.

InSeptember 2005, Gaiam acquired the majority of the net assets held by GoodTimesEntertainment and certain of its affiliates. As of December 31, 2005, thepurchase price of $35.0 million was initially allocated $29.1M to medialibrary, $13.2 million to tangible assets, and $7.3 million to assumedliabilities. During September 2006, Gaiam reduced the aggregate purchase priceto $34.8 million due to unrealized estimated acquisition costs and adjusted theestimated fair values by allocating $32.4 million to the media library, $9.6million to tangible assets, and $7.2 million to assumed liabilities. Theadjustments were primarily based on additional facts about benefits andobligations as of the purchase date which were identified during the allocationperiod after the acquisition date. As a result of the adjustment to the medialibrary, Gaiam recorded in September 2006 additional amortization expense of$0.3 million.

# **Item 2.****           Management’s Discussionand Analysis of Financial Condition and Results of Operations**

**Forward-Looking Statements**

# This report maycontain forward-looking statements that involve risks and uncertainties. Whenused in this discussion, the words “anticipate,” “believe,” “plan,” “estimate,”“expect,” “strive,” “future,” “intend” and similar expressions as they relateto Gaiam or its management are intended to identify such forward-lookingstatements. 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 couldcause actual results to differ include, without limitation, general economicconditions, competition, loss of key personnel, pricing, brand reputation,consumer trends, acquisitions, new initiatives undertaken by Gaiam, securityand information systems, legal liability for website content, merchandisesupply problems, failure of third parties to provide adequate service, ourreliance on centralized customer service, overstocks and merchandise returns,our reliance on a centralized fulfillment center, increases in postage andshipping costs, E-commerce trends, future Internet related taxes, control ofGaiam by its founder, fluctuations in quarterly operating results, customerinterest in our products, the effect of government regulation and other risksand uncertainties included in Gaiam’s filings with the Securities and ExchangeCommission. We caution you that no forward-looking statement is a guarantee offuture performance, and you should not place undue reliance on theseforward-looking statements which reflect our management’s view only as of thedate of this report. We undertake no obligation to update any forward-lookinginformation.

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

#### Overview and Outlook

# Gaiam is a brandedlifestyle 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 is builtaround its ability to develop and offer media content, products and lifestylesolutions to consumers in the Lifestyle of Health and Sustainability (“LOHAS”)and the emerging Media that Matters (“MTM”) markets.

# Gaiam offers itscustomers the ability to make purchasing decisions based on these values whileproviding quality offerings at a price comparable to mainstream alternatives.Gaiam markets its media and products through a multi-channel approach includingtraditional media channels, direct to consumers via the Internet, DRTV,subscription clubs, catalog, and through national retailers and corporateaccounts. As of September 30, 2006, Gaiam’s media was carried by over 65,000retail stores in the United States alone, and it had approximately 7 milliondirect buyers.

13

----

 

# Gaiam’s contentforms the basis of its proprietary offerings, which then drive demand forparallel 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 2006, Gaiamexpanded and strengthened its management team. Jane Pemberton joined Gaiam asPresident of Worldwide Distribution, having previously served in seniormanagement roles at The Walt Disney Company, 20th Century FOX Home Entertainment and CEO of Mommy& Me. Vilia Valentine joined Gaiam from VERIO Inc. as the Chief FinancialOfficer.  Ms. Valentine replaced JanetMathews as CFO. Ms. Mathews assumed the position of Chief AdministrativeOfficer. Rob Sussman joined Gaiam as President of New Media.  Mr. Sussman was a founding member of theSundance Channel and its Executive Vice President and Chief Financial Officer.John Jackson joined Gaiam as Vice President of Corporate Development and willtake over acquisitions and legal affairs when Ms. Mathews leaves Gaiam at theend of November. Mr. Jackson has extensive experience in M&A transactions,business and legal affairs, including service as a partner at a national lawfirm and as the general counsel and an executive at two public companies.  Gaiam feels that the expertise and experienceof these new team members increases the depth and capabilities of an alreadystrong leadership group.

During the three monthsended September 30, 2006, both reportable segments experienced significantrevenue growth over the third quarter of 2005, with the business segmentgenerating revenue of $19.2 million, and the direct-to-consumer segmentgenerating revenue of $32.6 million. For the nine months ended September 30,2006, the business and direct-to-consumer segments generated revenue of $61.0million and $85.7 million, respectively. Gaiam expects to generate over $200million in annual revenues in 2006.

#### Results of Operations

The following table sets forth certain financial data as a percentageof revenue for the periods indicated:
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net revenue                                                                      |       | 100.0                                                | %          | 100.0                                               | %          | 100.0 | % | 100.0 | % |
| Cost of goods  sold                                                              |       | 37.0                                                 | %          | 44.5                                                | %          | 36.8 | % | 47.5 | % |
| Gross profit                                                                     |       | 63.0                                                 | %          | 55.5                                                | %          | 63.2 | % | 52.5 | % |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Expenses:                                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Selling and operating:                                                           |       | 54.0                                                 | %          | 45.4                                                | %          | 56.5 | % | 45.2 | % |
| Corporate, general and administration                                            |       | 7.0                                                  | %          | 7.2                                                 | %          | 7.1 | % | 7.4 | % |
| Total expenses                                                                   |       | 61.0                                                 | %          | 52.6                                                | %          | 63.6 | % | 52.6 | % |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  from operations                                                   |       | 2.0                                                  | %          | 2.9                                                 | %          | (0.4 | )% | (0.1 | )% |
| Other income                                                                     |       | 2.9                                                  | %          | 0.7                                                 | %          | 1.7 | % | 0.3 | % |
| Income tax  expense                                                              |       | 1.9                                                  | %          | 1.3                                                 | %          | 0.5 | % | 0.0 | % |
| Minority  interest in net (income) loss of consolidated subsidiaries, net of tax |       | 0.2                                                  | %          | (0.6                                                | )%         | 0.1 | % | (0.4 | )% |
| Net income  (loss)                                                               |       | 3.2                                                  | %          | 1.7                                                 | %          | 0.9 | % | (0.2 | )% |

 

#### Three Months Ended September30, 2006 Compared to September 30, 2005

For the three months ended September 30, 2006 revenues increased 71.8% to$51.8 million from $30.1 million for the three months ended September 30,2005. Gaiam’s increase in revenue was derived from the direct to consumersegment, in which revenue increased to $32.6 million, and the business segment,in which revenue increased to $19.2 million. The revenue increase reflects thesales of media titles acquired from GoodTimes Entertainment, coupled withstrong performance in our direct marketing programs, continued penetration intoexisting retail stores, and the addition of new retail distribution outlets.During the quarter, Gaiam added distribution to over 4,000 new retail doors,bringing the total number of doors in the United States to 65,000.

 

14

----

 

Gross profit, which consists of revenue less cost of sales (primarilymerchandise acquisition costs and in-bound freight), increased to $32.6 millionfor the third quarter of 2006 from $16.7 million during the same period in2005. As a percentage of revenue, gross profit for the third quarter of 2006increased 750 basis points to 63.0% in 2006 from 55.5% in the third quarter of2005 which in turn was an 880 basis point increase from 46.7% in the thirdquarter of 2004. The increase was primarily due to strong sales of media anddirect marketing products which carry higher margins, but also carry higherselling and 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 consist primarily of sales andmarketing costs, commission and fulfillment expenses) increased to $28.0million for the three months ended September 30, 2006 as compared to $13.7million in the same period of 2005, primarily resulting from the GoodTimestransaction. As a percentage of revenue, selling and operating expensesincreased to 54.0% in 2006 from 45.4% in 2005 reflecting additionalamortization expense associated with GoodTimes’ media library, and a change inrevenue mix toward increased media and direct marketing products which carryhigher selling and operating expenses, such as merchandising fees andadvertising costs.

Corporate, general and administration expenses increased to $3.7million for the third quarter of 2006 compared to $2.2 million for the same2005 period, primarily due to Gaiam’s planned investments in its business tosupport the increased revenue base. As a percentage of revenue, corporate,general and administration expenses decreased to 7.0% in the third quarter of2006 from 7.2% in the comparable 2005 period, as economies of scale areachieved on the increased revenue base.

Operating income was $1.0 million for the three months ended September30, 2006 compared to $0.9 million for the three months ended September 30,2005, primarily reflecting higher selling and operating expenses associatedwith media and direct marketing products, as well as redundant system andoperating costs as a result of the GoodTimes acquisition, partially offset byincreased gross profit margins.

Gaiam recorded $1.5 million in other income for the three months endedSeptember 30, 2006 compared to $0.2 million for the third 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 $0.1 million during the third quarter of 2006,compared to the share of net income of $0.02 million for the same 2005 period.

Gaiam recorded an income tax expense of $1.0 million for the threemonths ended September 30, 2006 compared to $0.4 million for the three monthsended September 30, 2005. Gaiam’s consolidated effective tax rate fluctuatesbased upon the distribution of earnings/losses between its domestic and foreignoperations.

As a result of the factors described above, Gaiam’s net income was $1.7million, or $0.06 per share, for the three months ended September 30, 2006, ascompared to a net income of $0.5 million, or $0.03 per share, for the threemonths ended September 30, 2005.

#### Nine Months Ended September30, 2006 Compared to September 30, 2005

For the nine months ended September 30, 2006 revenues increased 87.7% to$146.7 million from $78.2 million for the nine months ended September 30,2005. Gaiam’s increase in revenue was derived from the direct to consumersegment, in which revenue increased to $85.7 million, and the business segment,in which revenue increased to $61.0 million. The combination of strong internalrevenue growth in both segments coupled with sales of media titles acquiredfrom GoodTimes Entertainment primarily accounted for the increase in revenues.

Gross profit increased to $92.7 million for the first nine months of2006 from $41.0 million during the same period in 2005. As a percentage ofrevenue, gross profit for the first nine months of 2006 increased to 63.2% in2006 from 52.5% in the first nine months of 2005. The increase was primarilydue to strong sales of media and direct marketing products, which carry highermargins, but also carry higher selling and operating expenses. Also favorablyimpacting the gross margin were increased purchasing discounts associated withhigher DVD sales volume and the elimination of fees previously paid for thirdparty distribution.

15

----

 

Selling and operating expenses increased to $82.9 million for the ninemonths ended September 30, 2006 as compared to $35.3 million in the same periodof 2005, primarily resulting from the GoodTimes transaction. As a percentage ofrevenue, selling and operating expenses increased to 56.5% in 2006 from 45.2%in 2005 reflecting GoodTimes transition costs, distribution, management,systems, and additional amortization expense associated with its media library,and a change in revenue mix toward increased media and direct marketingproducts which carry higher selling and operating expenses, such asmerchandising fees and advertising costs.

Corporate, general and administration expenses increased to $10.5million for the first nine months of 2006 compared to $5.8 million for the same2005 period, primarily due to the Gaiam’s planned investments in its businessto support the increased revenue base. As a percentage of revenue, corporate,general and administration expenses decreased to 7.1% in the first nine monthsof 2006 from 7.4% in the comparable 2005 period, as economies of scale are achievedon the increased revenue base.

Operating loss was $0.7 million for the nine months ended September 30,2006 compared to an operating loss of $0.1 million for the nine months endedSeptember 30, 2005, primarily reflecting higher selling and operating expensesincluding costs associated with the GoodTimes transition and integration,partially offset by increased gross profit margins.

Gaiam recorded $2.6 million and $0.3 million in other income for thenine months ended September 30, 2006 and 2005, respectively. The increase in2006 primarily consisted of the $0.5 million gain from the LIME transaction,and interest earned on the investment of the stock offering net proceeds of$1.7 million. The share of net loss associated with minority interest was $0.2million during the first nine months of 2006, compared to the share of netincome of $0.3 million for the same 2005 period.

Gaiam recorded income tax expense of $0.8 million for the nine monthsended September 30, 2006 compared to $4,000 for the nine months ended September30, 2005. Gaiam’s consolidated effective tax rate fluctuates based upon thedistribution of earnings/losses between its domestic and foreign operations.

As a result of the factors described above, Gaiam’s net income was $1.4million, or $0.06 per share, for the nine months ended September 30, 2006, ascompared to a loss of $0.1 million, or $0.01 per share, for the nine monthsended September 30, 2005.

Seasonality

Gaiam’s sales areaffected by seasonal influences. On an aggregate basis, Gaiam generates itsstrongest revenues and net income in the fourth quarter due to increasedholiday spending.

Liquidity andCapital Resources

Gaiam’s capital needsarise 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 on numerousfactors, 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 September 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 provided net cash of $0.6 million for the nine months endedSeptember 30, 2006, primarily reflecting the use of funds to reduce accountspayable and accrued liabilities by $7.4 million and $5.6 million, respectively,and to increase inventory, advanced media production, and acquired mediaprogramming and other current assets by $4.1 million, $2.4 million and $1.1million, respectively. This use of funds was partially offset by cash providedfrom the decrease in accounts receivable of $14.1 million and noncash charges 

16

----

 

to net income of $5.7million. During the nine months ended September 30, 2005, Gaiam’s operatingactivities generated net cash of $1.3 million, primarily attributable todecreases in accounts receivable, inventory, and accrued liabilities of $2.3million, $1.5 million, and $2.0 million, respectively, and noncash charges tonet income of $2.8 million. These sources of funds were partially offset by anincrease in prepaid expense for transition services provided by GoodTimesEntertainment of $2.6 million, holiday catalog production costs of $1.7million, and reductions in accounts payable of $1.3 million.

Gaiam’s investingactivities for the nine months ended September 30, 2006 used net cash of $7.8million to purchase an interest in CCI for $6.6 million, net and to acquireproperty, equipment and media rights for $1.9 million, partially offset by cashprovided from the sale of property and equipment for $0.6 million. During thenine months ended September 30, 2005, Gaiam’s investing activities used cash of$0.9 million for the purchase of property, equipment, and media rights and$38.7 million to acquire assets from GoodTimes Entertainment and to fund itsinvestment in LIME Media.

On April 7, 2006, Gaiamfiled a shelf registration statement on Form S-3 with the Securities andExchange Commission for Class A common stock, par value $.0001, with a totaloffering price not to exceed $100,000,000. During May 2006, Gaiam filed anamended Form S-3 to register 5,000,000 shares of Class A common stock, plusadditional shares to cover over-allotments, if any. On May 24, 2006, Gaiam sold5,000,000 shares of Class A common stock and on June 13, 2006 sold 690,000shares of Class A common stock in underwritten offerings under the registrationstatement. The combined stock sales generated gross proceeds of $99.6 million.

Gaiam’s financingactivities provided net cash of $96.6 million for the nine months endedSeptember 30, 2006 reflecting net cash provided by the common stock offering of$93.0 million and the exercise of stock options for $3.5 million.

For the nine months endedSeptember 30, 2005, Gaiam’s financing activities provided net cash of $38.5million. On July 7, 2005, Gaiam issued and sold 2,821,317 shares ofunregistered Class A common stock for an aggregate purchase price ofapproximately $18.7 million to certain funds advised by Prentice Capital Management,LP. On August 22, 2005, Gaiam issued and sold 2,500,000 shares of unregisteredClass A common stock for an aggregate purchase price of $20.0 million toRevolution Living, LLC.

Gaiam believes itsavailable cash, cash expected to be generated from operations, cash generatedby the sale of Class A common stock, and borrowing capabilities should besufficient to fund its operations on both a short-term and long-term basis.However, Gaiam’s projected cash needs may change as a result of acquisitions,product development, unforeseen operational difficulties or other factors.

In the normal course ofour business, Gaiam investigates, evaluates and discusses acquisition, jointventure, minority investment, strategic relationship and other businesscombination opportunities in the LOHAS and MTM markets. For any futureinvestment, acquisition or joint venture opportunities, Gaiam may considerusing then-available liquidity, issuing equity securities or incurringadditional indebtedness.

RiskFactors

There are risks anduncertainties that could cause Gaiam’s actual results to be materiallydifferent from those indicated by forward-looking statements that it makes fromtime to time in filings with the Securities and Exchange Commission, newsreleases, proxy statements, annual reports, registration statements and otherwritten communications, as well as oral forward-looking statements made fromtime to time by representatives of Gaiam. These risks and uncertaintiesinclude, but are not limited to, those listed in Gaiam’s Annual Report on Form10-K for the year ended December 31, 2005. These risks and uncertainties andadditional risks and uncertainties not presently known to Gaiam or that arecurrently deemed immaterial may cause its business, financial condition, operatingresults and cash flows to be materially adversely affected.  Except for the historical informationcontained herein, the matters discussed in this analysis are forward-lookingstatements that involve risk and uncertainties, including, but not limited to,general economic and business conditions, competition, pricing, brandreputation, consumer trends, and other factors which are often beyond Gaiam’scontrol. Gaiam does not undertake any obligation to update forward-lookingstatements except as required by law.

17

----

 

##### **Item 3.    Quantitativeand Qualitative Disclosures 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 itsconsolidated financial position, results of operations or cash flows existed asof September 30, 2006.

**Item 4.    Controls and Procedures**

**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 September 30, 2006, Gaiam’schief executive officer and chief financial officer have concluded that thosedisclosure controls and procedures are effective.

**Changes in Internal Control overFinancial Reporting**

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

## **PART II.    OTHERINFORMATION**

**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. RiskFactors**

No material changes.

**Item 2.    Sales of Unregistered Securities and Use ofProceeds**

During the third quarter,Gaiam, Inc. issued 149,698 shares of Class A common stock to shareholders ofConscious Media, Inc. to purchase shares of Conscious Media. OnNovember 8, 2006, Gaiam, Inc. issued 220,026 shares of Class A commonstock to shareholders of Conscious Media, Inc. to purchase shares of ConsciousMedia. These shares were issued pursuant to an exemption from registrationunder Section 4(2) of the Securities Act of 1933 for sales not involving apublic offering.

18

----

 

**Item 3.    Defaults Upon Senior Securities**

None.

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

None.

**Item5.    Other Information**

None.

**Item6.    Exhibits**

a)     Exhibits.

| Exhibit No. | ** ** | **Description**                                                                                                                                                               |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                          |
| 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). |

 

19

----

 

### **Signatures**

In accordance with therequirements of the Securities and Exchange Act, the registrant caused thisreport to be signed on its behalf, by the undersigned, thereunto dulyauthorized.
|   | Gaiam, Inc.      |
|--------|------------------|
|   | (Registrant)     |
|   | November 9, 2006 |
|   |             |   |
|   | By:              | /s/ Jirka Rysavy |
|   |             | Jirka Rysavy |
|   |             | Chief Executive  Officer |
|   |             |   |
|   | By:              | /s/ Vilia Valentine |
|   |             | Vilia Valentine |
|   |             | Chief Financial  Officer |
|   |             | (principal  accounting officer) |

#  

20

----