**United States****Securities and ExchangeCommission****Washington, D.C. 20549**

 

**Form 10-Q**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES AND EXCHANGE ACT OF 1934**

**For the FiscalQuarter Ended June 30, 2003**

 

**OR**

 

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

 

**Commission File Number 0-27517**

 

**GAIAM, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

**360 INTERLOCKEN BLVD.,**

**BROOMFIELD, COLORADO 80021**

(Address of principal executive offices)

 

**(303) 222-3600**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15 (d) of the Securities and Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

 

| YES |   | ý |   |   | NO |   | o |   |
|-----|--------|--------|--------|--------|----|--------|---|--------|

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

| YES |   | ý |   |   | NO |   | o |   |
|-----|--------|--------|--------|--------|----|--------|---|--------|

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

| **Class**            |   | **Shares outstanding as of July 29, 2003** |
|----------------------|--------|--------------------------------------------|
| Class A Common Stock |   |                                       |
| ($.0001 par value)   |   | 9,201,136                                  |
|                 |   |                                       |
| Class B Common Stock |   | 5,400,000                                  |
| ($.0001 par value)   |   |                                       |

 

 

----

 

**INDEX TO FORM 10-Q**

 
| PART I.   |   | FINANCIAL  INFORMATION                                                                          |
|-----------|--------|-------------------------------------------------------------------------------------------------|
|      |   |                                                                                            |
| Item 1.   |   | Condensed  Consolidated Financial Statements (Unaudited)                                        |
|      |   | Condensed  Consolidated Balance Sheets at June 30, 2003 and December 31, 2002                   |
|      |   | Condensed Consolidated Statements of Income  for the three months ended June 30, 2003 and 2002  |
|      |   | Condensed Consolidated Statements of Income for the six months ended  June 30, 2003 and 2002    |
|      |   | Condensed Consolidated Statement of Cash  Flows for the six months ended June 30, 2003 and 2002 |
|      |   | Notes to Interim Condensed Consolidated Financial Statements                                    |
|      |   |                                                                                            |   |   |   |
| Item 2.   |   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations     |
|      |   |                                                                                            |   |   |   |
| Item 3.   |   | Quantitative and Qualitative Disclosures  About Market Risk                                     |
|      |   |                                                                                            |   |   |   |
| Item 4.   |   | Controls and Procedures                                                                         |
|      |   |                                                                                            |   |   |   |
| PART  II. |   | OTHER INFORMATION                                                                               |
|      |   |                                                                                            |   |   |   |
| Item 1.   |   | Legal  Proceedings                                                                              |
|      |   |                                                                                            |   |   |   |
| Item 2.   |   | Changes in 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 and Reports on Form 8-K                                                                |

 

This report may contain forward-lookingstatements that involve risks and uncertainties.  When used in this discussion, the words “anticipate,” “believe,”“plan,” “estimate,” “expect,” “strive,” “future,” “intend” and similarexpressions as they relate to Gaiam or its management are intended to identifysuch forward-looking statements. Gaiam’s actual results could differ materially from the resultsanticipated in these forward-looking statements as a result of certain factorsset forth under “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” “Market Risk” and elsewhere in this report.  Risks and uncertainties that could causeactual results to differ include, without limitation, general economicconditions, competition, loss of key personnel, pricing, brand reputation,acquisitions, security and information systems, legal liability for websitecontent, merchandise supply problems, failure of third parties to provideadequate service, reliance on centralized customer service, overstocks andmerchandise returns, reliance on a centralized fulfillment center, increases inpostage and shipping costs, e-commerce trends, future taxes on internet orcatalog sales, control of Gaiam by its founder, fluctuations in quarterlyoperating results, consumer trends, customer interest in our products, theeffect of government regulation and other risks and uncertainties included inGaiam’s filings with the Securities and Exchange Commission.  We caution you that no forward-lookingstatement is a guarantee of future performance, and you should not place unduereliance on these forward-looking statements which reflect our management’sview only as of the date of this report. We undertake no obligation to update any forward-looking information.

 

2

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GAIAM, INC.CONDENSED CONSOLIDATED BALANCE SHEETS

 
|                                                                                                                                                                                       |   | **June 30,  2003** |       | **December 31,  2002** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                                                                                       |   | **(Unaudited)**    |       |                   |       |
| **Assets**                                                                                                                                                                                 |   |               |       |                   |       |
|                                                                                                                                                                                       |   |               |       |                   |       |
| Current assets:                                                                                                                                                                            |   |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                  |   | $                  | 8,357,175  |                   | $          | 11,422,435 |   |
| Accounts receivable, net                                                                                                                                                                   |   | 13,925,040         |       | 21,455,744             |       |
| Accounts and notes receivable, other                                                                                                                                                       |   | 977,998            |       | 1,949,832              |       |
| Inventory, less allowances                                                                                                                                                                 |   | 16,045,468         |       | 14,768,045             |       |
| Deferred advertising costs                                                                                                                                                                 |   | 2,063,281          |       | 2,417,211              |       |
| Other current assets                                                                                                                                                                       |   | 2,356,028          |       | 1,194,484              |       |
| Total current assets                                                                                                                                                                       |   | 43,724,990         |       | 53,207,751             |       |
|                                                                                                                                                                                       |   |               |       |                   |       |
| Property and equipment, net                                                                                                                                                                |   | 10,354,178         |       | 9,543,231              |       |
| Investments                                                                                                                                                                                |   | 7,865,192          |       | 7,865,192              |       |
| Capitalized production costs, net                                                                                                                                                          |   | 5,981,144          |       | 4,983,824              |       |
| Video library, net                                                                                                                                                                         |   | 5,335,735          |       | 5,262,586              |       |
| Goodwill, net                                                                                                                                                                              |   | 10,288,251         |       | 7,522,495              |       |
| Deferred tax assets                                                                                                                                                                        |   | 2,519,244          |       | 2,519,244              |       |
| Other assets                                                                                                                                                                               |   | 646,665            |       | 768,043                |       |
| Total assets                                                                                                                                                                               |   | $                  | 86,715,399 |                   | $          | 91,672,366 |   |
|                                                                                                                                                                                       |   |               |       |                   |       |
| **Liabilities and stockholders’ equity**                                                                                                                                              |   |               |       |                   |       |
| Current liabilities:                                                                                                                                                                       |   |               | ** ** |                   | ** ** |
| Accounts payable                                                                                                                                                                           |   | $                  | 8,044,759  |                   | $          | 11,998,087 |   |
| Accrued liabilities                                                                                                                                                                        |   | 4,058,672          |       | 5,709,788              |       |
| Income taxes payable                                                                                                                                                                       |   | 173,392            |       | 1,286,558              |       |
| Capital lease obligations, current                                                                                                                                                         |   | 182,755            |       | 269,290                |       |
| Total current liabilities                                                                                                                                                                  |   | 12,459,578         |       | 19,263,723             |       |
|                                                                                                                                                                                       |   |               |       |                   |       |
| Capital lease obligations, long-term                                                                                                                                                       |   | 19,054             |       | 54,529                 |       |
| Deferred tax liability                                                                                                                                                                     |   | 848,653            |       | 848,653                |       |
| Other liabilities                                                                                                                                                                          |   | 1,962,000          |       | 1,962,000              |       |
| Total liabilities                                                                                                                                                                          |   | 15,289,285         |       | 22,128,905             |       |
|                                                                                                                                                                                       |   |               |       |                   |       |
| Minority interest                                                                                                                                                                          |   | 2,651,994          |       | 172,481                |       |
|                                                                                                                                                                                       |   |               |       |                   |       |
| Stockholders’ equity:                                                                                                                                                                 |   |               |       |                   |       |
| Class A common stock, $.0001 par value,  150,000,000 shares authorized,  9,200,980  and 9,134,098 shares issued and outstanding at June 30, 2003 and December 31,  2002, respectively |   | 920                |       | 913                    |       |
| Class B common stock, $.0001 par value,  50,000,000 shares authorized, 5,400,000 issued and outstanding at June 30,  2003 and December 31, 2002, respectively                              |   | 540                |       | 540                    |       |
| Additional paid-in capital                                                                                                                                                                 |   | 53,821,911         |       | 53,343,046             |       |
| Deferred compensation                                                                                                                                                                      |   | (107,865           | )          | (143,865               | )          |
| Retained earnings                                                                                                                                                                          |   | 15,058,614         |       | 16,170,346             |       |
| Total stockholders’ equity                                                                                                                                                            |   | 68,774,120         |       | 69,370,980             |       |
| Total liabilities and stockholders’ equity                                                                                                                                            |   | $                  | 86,715,399 |                   | $          | 91,672,366 |   |

 

*See accompanying notes.*

 

3

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GAIAM, INC.CONDENSED CONSOLIDATED STATEMENTS OF INCOME(Unaudited)

 
|                                                                           |   | **For the Three Months Ended  June 30,** |       |
|--------------------------------------------------------------------------------|--------|------------------------------------------|------------|
|                                                                           |   | **2003**                                 |       | **2002** |   |
|                                                                           |   |                                     |       |   |   |
| Net revenue                                                                    |   | $                                        | 20,351,828 |   | $ | 24,067,426 |   |
| Cost of goods sold                                                             |   | 9,536,355                                |       | 9,885,211 |   |
| Gross profit                                                                   |   | 10,815,473                               |       | 14,182,215 |   |
|                                                                           |   |                                     |       |   |   |
| Expenses:                                                                      |   |                                     |       |   |   |
| Selling and operating                                                          |   | 9,518,831                                |       | 10,439,462 |   |
| Corporate, general and administration                                          |   | 2,285,938                                |       | 2,065,565 |   |
| Total expenses                                                                 |   | 11,804,769                               |       | 12,505,027 |   |
|                                                                           |   |                                     |       |   |   |
| Income (loss) from operations                                                  |   | (989,296                                 | )          | 1,677,188 |   |
|                                                                           |   |                                     |       |   |   |
| Other income (expense)                                                         |   | (90,920                                  | )          | (166,419 | ) |
| Interest income                                                                |   | 11,770                                   |       | 57,516 |   |
| Total other income (expense)                                                   |   | (79,150                                  | )          | (108,903 | ) |
|                                                                           |   |                                     |       |   |   |
| Income (loss) before income taxes and  minority interest                       |   | (1,068,446                               | )          | 1,568,285 |   |
|                                                                           |   |                                     |       |   |   |
| Provision for income tax (benefit) expense                                     |   | (405,491                                 | )          | 556,741 |   |
| Minority interest in net (income) loss of  consolidated subsidiary, net of tax |   | (96,228                                  | )          | (8,135 | ) |
| Net income (loss)                                                              |   | $                                        | (759,183   | ) | $ | 1,003,409 |   |
|                                                                           |   |                                     |       |   |   |
| Net income (loss) per share:                                                   |   |                                     |       |   |   |
| Basic                                                                          |   | $                                        | (0.05      | ) | $ | 0.07 |   |
| Diluted                                                                        |   | $                                        | (0.05      | ) | $ | 0.07 |   |
|                                                                           |   |                                     |       |   |   |
| Shares used in computing net income (loss)  per share:                         |   |                                     |       |   |   |
| Basic                                                                          |   | 14,594,413                               |       | 14,022,326 |   |
| Diluted                                                                        |   | 14,594,413                               |       | 14,468,424 |   |

 

*See accompanying notes.*

 

4

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GAIAM, INC.CONDENSED CONSOLIDATED STATEMENTS OF INCOME(Unaudited)

 
|                                                                           |   | **For the  Six Months Ended  June 30,** |       |
|--------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                           |   | **2003**                                |       | **2002** | ** ** |
|                                                                           |   |                                    |       |   |   |
| Net revenue                                                                    |   | $                                       | 43,720,066 |   | $ | 48,350,966 |   |
| Cost of goods sold                                                             |   | 20,283,855                              |       | 19,899,839 |   |
| Gross profit                                                                   |   | 23,436,211                              |       | 28,451,127 |   |
|                                                                           |   |                                    |       |   |   |
| Expenses:                                                                      |   |                                    |       |   |   |
| Selling and operating                                                          |   | 20,125,004                              |       | 21,030,713 |   |
| Corporate, general and administration                                          |   | 4,700,548                               |       | 4,568,011 |   |
| Total expenses                                                                 |   | 24,825,552                              |       | 25,598,724 |   |
|                                                                           |   |                                    |       |   |   |
| Income (loss) from operations                                                  |   | (1,389,341                              | )          | 2,852,403 |   |
|                                                                           |   |                                    |       |   |   |
| Other income (expense)                                                         |   | (176,378                                | )          | (252,941 | ) |
| Interest income (expense)                                                      |   | 26,445                                  |       | 113,480 |   |
| Total other income (expense)                                                   |   | (149,933                                | )          | (139,461 | ) |
|                                                                           |   |                                    |       |   |   |
| Income (loss) before income taxes and  minority interest                       |   | (1,539,274                              | )          | 2,712,942 |   |
|                                                                           |   |                                    |       |   |   |
| Provision for income tax (benefit) expense                                     |   | (604,048                                | )          | 963,095 |   |
| Minority interest in net (income) loss of  consolidated subsidiary, net of tax |   | (176,506                                | )          | (10,797 | ) |
| Net income (loss)                                                              |   | $                                       | (1,111,732 | ) | $ | 1,739,050 |   |
|                                                                           |   |                                    |       |   |   |
| Net income (loss) per share:                                                   |   |                                    |       |   |   |
| Basic                                                                          |   | $                                       | (0.08      | ) | $ | 0.12 |   |
| Diluted                                                                        |   | $                                       | (0.08      | ) | $ | 0.12 |   |
|                                                                           |   |                                    |       |   |   |
| Shares used in computing net income (loss)  per share:                         |   |                                    |       |   |   |
| Basic                                                                          |   | 14,586,501                              |       | 14,013,949 |   |
| Diluted                                                                        |   | 14,586,501                              |       | 14,500,285 |   |

 

*See accompanying notes.*

 

5

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GAIAM, INC.CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS(Unaudited)

 
|                                                                                                |   | **For the  Six Months  Ended June 30,** |       |
|-----------------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                                                |   | **2003**                                |       | **2002** | ** ** |
| **Operating activities**                                                                            |   |                                    |       |   |   |
| Net income (loss)                                                                                   |   | $                                       | (1,111,732 | ) | $ | 1,739,050 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                    |       |   |   |
| Depreciation                                                                                        |   | 1,288,310                               |       | 865,251 |   |
| Amortization                                                                                        |   | 323,452                                 |       | 172,596 |   |
| Stock compensation                                                                                  |   | 36,000                                  |       | 36,000 |   |
| Minority interest in consolidated  subsidiary                                                       |   | 176,506                                 |       | 26,883 |   |
|                                                                                                |   |                                    |       |   |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:                     |   |                                    |       |   |   |
| Accounts receivable                                                                                 |   | 10,196,505                              |       | (3,031,969 | ) |
| Inventory                                                                                           |   | (8,610                                  | )          | 1,688,133 |   |
| Deferred advertising costs                                                                          |   | 353,930                                 |       | (250,158 | ) |
| Capitalized production costs                                                                        |   | (997,319                                | )          | (1,038,096 | ) |
| Other current assets                                                                                |   | (593,893                                | )          | 12,616 |   |
| Other assets                                                                                        |   | 121,378                                 |       | (100,109 | ) |
| Accounts payable                                                                                    |   | (4,464,713                              | )          | (1,635,883 | ) |
| Accrued liabilities                                                                                 |   | (2,218,781                              | )          | (2,156,926 | ) |
| Income taxes payable                                                                                |   | (1,574,742                              | )          | (942,892 | ) |
| Net cash (used in) provided by operating  activities                                                |   | 1,526,291                               |       | (4,615,504 | ) |
|                                                                                                |   |                                    |       |   |   |
| **Investing activities**                                                                            |   |                                    |       |   |   |
| Purchase of property and equipment, and  media rights                                               |   | (755,182                                | )          | (1,188,560 | ) |
| Proceeds from sale of property and  equipment                                                       |   | —                                  |       |  2,748,292 |   |
| Payments for acquisitions, net of cash  acquired                                                    |   | (3,787,301                              | )          | — |   |
| Net cash (used in) provided by investing  activities                                                |   | (4,542,483                              | )          | 1,559,732 |   |
|                                                                                                |   |                                    |       |   |   |
| **Financing activities**                                                                            |   |                                    |       |   |   |
| Principal payments on capital leases                                                                |   | (169,600                                | )          | (106,116 | ) |
| Proceeds from issuance of common stock                                                              |   | 120,532                                 |       | 161,410 |   |
| Net cash (used in) provided by financing  activities                                                |   | (49,068                                 | )          | 55,294 |   |
|                                                                                                |   |                                    |       |   |   |
| Net change in cash and cash equivalents                                                             |   | (3,065,260                              | )          | (3,000,478 | ) |
| Cash and cash equivalents at beginning of  period                                                   |   | 11,422,435                              |       | 22,243,647 |   |
| Cash and cash equivalents at end of period                                                          |   | $                                       | 8,357,175  |   | $ | 19,243,169 |   |
|                                                                                                |   |                                    |       |   |   |
| **Supplemental cash flow information**                                                              |   |                                    |       |   |   |
| Interest paid                                                                                       |   | $                                       | 32,809     |   | $ | 24,648 |   |
| Common stock issued for acquisitions                                                                |   | 347,500                                 |       | 2,367,469 |   |
| Income taxes paid                                                                                   |   | 1,033,400                               |       | — |   |

 

*See accompanying notes.*

 

6

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Gaiam, Inc.Notes to Interim Condensed Consolidated FinancialStatements(Unaudited)June 30, 2003

 

1.                                       Interim Condensed Consolidated FinancialStatements

 

###### Organization and Nature of Operations

 

Gaiam,Inc., is a multi-channel lifestyle company providing a broad selection ofinformation, products and services to customers who value natural health,personal development, and renewable energy. Gaiam was incorporated under the laws of the State of Colorado on July7, 1988.

 

Theaccompanying consolidated financial statements include the accounts of Gaiam,its subsidiaries and partnerships in which ownership is greater than 50% andconsidered to be under the control of Gaiam. All material intercompany accounts and transaction balances have beeneliminated in consolidation.

 

Preparation of Interim Condensed ConsolidatedFinancial 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 June 30, 2003, the interim results of operations for the threeand six months ended June 30, 2003 and 2002, and cash flows for the sixmonths ended June 30, 2003 and 2002. These interim statements have not been audited.  The balance sheet as of December 31, 2002was derived from Gaiam’s audited consolidated financial statements included inGaiam’s annual report on Form 10-K.

 

Certaininformation and footnote disclosures normally included in consolidatedfinancial statements prepared in accordance with generally accepted accountingprincipals have been condensed or omitted pursuant to such rules andregulations.  Accounting policiesfollowed by Gaiam are described in Note 1 to the audited financial statementsfor the fiscal year ended December 31, 2002 included in Gaiam’s annual reporton Form 10-K.  The consolidated financialstatements contained herein should be read in conjunction with the auditedfinancial statements, including the notes thereto, for the year ended December31, 2002.

 

Theconsolidated financial position, results of operations and cash flows for the interimperiods disclosed within this report are not necessarily indicative of futurefinancial results.

 

Useof Estimates

 

Thepreparation of the consolidated financial statements in conformity withgenerally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues and expenses and disclosure of contingent assets and liabilities atthe date of the consolidated financial statements.  Actual results could differ from those estimates.

 

7

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Adoption of Accounting Standards

 

InJune 2001, the FASB issued statement No. 143, “Accounting for Asset RetirementObligations” (“SFAS No. 143”), which sets forth the financial accounting andreporting to be followed for obligations associated with the retirement oftangible long-lived assets and the associated asset retirement costs.  SFAS No. 143 requires that the fair value ofa liability for an asset retirement obligation be recorded in the period inwhich it is incurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs mustbe capitalized as part of the carrying amount of the long-lived asset.  Subsequently, the recorded liability will beaccreted to its present value and the capitalized costs will bedepreciated.  Gaiam adopted SFAS No. 143in its consolidated financial statements for the first quarter of 2003. Theadoption of SFAS No. 143 did not have a material impact on Gaiam’s consolidatedfinancial statements.

 

InMay 2002, the FASB issued statement No. 145, “Rescission of FASB Statements No.4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections”(“SFAS No. 145”).  The statementrescinds FASB No. 4, “Reporting Gains and Losses from Extinguishment of Debt,and an amendment of that statement, FASB No. 64, “Extinguishments of Debt Madeto Satisfy Sinking Fund Requirements.” As a result, gains and losses from extinguishments of debt will nolonger be aggregated and classified as an extraordinary item, net of relatedincome tax effect, on the statement of earnings.  SFAS No. 145 is effective for fiscal years beginning after May15, 2002, with earlier application encouraged. Gaiam has adopted SFAS No. 145, as required, in its consolidatedfinancial statements effective the first quarter of 2003.  The adoption of SFAS No. 145 did not have amaterial impact on Gaiam’s consolidated financial statements.

 

InJuly 2002, the FASB issued statement No. 146, “Accounting for Costs Associatedwith Exit or Disposal Activities” (“SFAS No. 146”).  SFAS No. 146 requires that a liability for a cost associated withan exit or disposal activity is recognized at fair value when the liability isincurred rather than at the date of a commitment to an exit or disposalplan.  SFAS No. 146 is effective forexit or disposal activities initiated after December 31, 2002.  Gaiam has adopted SFAS No. 146effective the first quarter of 2003. The adoption of SFAS No. 146 did not havea material impact on Gaiam’s consolidated financial statements.

 

InDecember 2002, the FASB issued statement No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure, an Amendment of FASB Statement No.123” (“SFAS No. 148”).  SFAS No. 148amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”(“Statement 123’) to provide alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  Gaiam has elected to usethe intrinsic value method of accounting for stock compensation for optionsgranted to employees and directors in accordance with APB 25.  In addition, SFAS No. 148 amends thedisclosure requirements of Statement 123 to require prominent disclosure inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method of accountingused on reported

 

8

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results. Gaiam has adopted SFAS No. 148 in its fiscal year reportingeffective December 31, 2002 and its interim reporting as of the first quarterof 2003.

 

InApril 2003, the FASB issued statement No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities” (“SFAS No. 149”).  SFAS No. 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts and for hedging activitiesunder FASB Statement No. 133, *Accounting forDerivative Instruments and Hedging Activities*.  SFAS No. 149 is effective for contractsentered into or modified after June 30, 2003, and for hedging relationshipsdesignated after June 30, 2003.  Gaiamdoes not currently have any derivative instruments, nor does Gaiam currentlyparticipate in hedging activities. Therefore, Gaiam’s adoption of SFAS No. 149, as required, is notexpected to have a material impact on Gaiam’s consolidated financialstatements.

 

InMay 2003, the FASB issued statement No. 150, “Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity” (“SFAS No.150”).  SFAS No. 150 establishesstandards for classification and measurement of certain financial instrumentswith characteristics of both liabilities and equity.  SFAS No. 150 is effective for financial instruments entered intoor modified after May 31, 2003, and otherwise is effective at the beginning ofthe first interim period beginning after June 15, 2003.  Gaiam will adopt SFAS No. 150 in its interimreporting as of the third quarter of 2003, and adoption of this statement isnot expected to have a material impact on Gaiam’s consolidated financialstatements.

 

2.                                       Mergers and Acquisitions

 

In January 2003, Gaiam acquired a 50.1% interest inLeisure Systems International Ltd., a U.K. based distributor and marketer oflifestyle products for approximately $4.3 million in cash and 50,000 shares ofGaiam Class A common stock.  Thisacquisition was accounted for using the purchase method and approximately $2.8million of goodwill was recorded.  Theresults of operations of Leisure Systems International are included in theconsolidated financial statements of Gaiam from the effective acquisition dateof January 1, 2003.  The revenuegenerated by this acquisition during the second quarter totaled approximately$3.2 million.

 

3.                                       Stockholders’ Equity

 

During the first quarter of 2003, Gaiamissued 50,000 shares of Class A common stock in conjunction with theacquisition of 50.1% of Leisure Systems International and 3,750 shares of ClassA common stock to four directors in lieu of cash compensation. In addition, forthe six months ended June 30, 2003, Gaiam issued 13,132 shares of Class Acommon stock upon exercise of options granted under Gaiam’s 1999 Long-Term IncentivePlan.

 

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4.                                       Earnings per Share

 

Basicearnings per share exclude any dilutive effects of options and dilutivesecurities.  Basic earnings per share iscomputed using the weighted average number of common shares outstanding duringthe period.  Diluted earnings per shareis computed using the weighted average number of common and common stockequivalent shares outstanding during the period.  Common equivalent shares are excluded from the computation if theireffect is antidilutive.  All earningsper share amounts for all periods have been presented and conform to theStatement No. 128 requirements.

 

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

 
|                                                          |   | **Three  Months Ended  June 30,** |     | **Six Months  Ended  June 30,** |       |
|---------------------------------------------------------------|--------|-----------------------------------|----------|---------------------------------|------------|
|                                                          |   | **2003**                          |     | **2002**                        | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                          |   |                              |     |                            |       |   |   |   |   |
| Net income (loss)                                             |   | $                                 | (759,183 | )                               | $          | 1,003,409 |   | $ | (1,111,732 | ) | $ | 1,739,050 |   |
|                                                          |   |                              |     |                            |       |   |   |   |   |
| Denominator:                                                  |   |                              |     |                            |       |   |   |   |   |
| Weighted average shares for basic earnings per  share         |   | 14,594,413                        |     | 14,022,326                      |       | 14,586,501 |   | 14,013,949 |   |
|                                                          |   |                              |     |                            |       |   |   |   |   |
| Effect of Dilutive Securities:                                |   |                              |     |                            |       |   |   |   |   |
| Weighted average of common stock, stock options  and warrants |   | —                            |     | 446,098                         |       | — |   | 486,336 |   |
|                                                          |   |                              |     |                            |       |   |   |   |   |
| Denominator for diluted earnings per share                    |   | 14,594,413                        |     | 14,468,424                      |       | 14,586,501 |   | 14,500,285 |   |
|                                                          |   |                              |     |                            |       |   |   |   |   |
| Net income (loss) per share – basic                      |   | $                                 | (0.05    | )                               | $          | 0.07 |   | $ | (0.08 | ) | $ | 0.12 |   |
| Net income (loss) per share – diluted                    |   | $                                 | (0.05    | )                               | $          | 0.07 |   | $ | (0.08 | ) | $ | 0.12 |   |

 

5.                                       Stock Based Compensation

 

Asrequired by Statement of Financial Accounting Standards (“SFAS”) Nos. 123 and148, we have determined pro forma net income and net income per common share asif compensation costs had been determined based on the fair value of theoptions granted and then recognized ratably over the vesting period. The fairvalue of stock option grants has been estimated at the date of grant using theBlack-Scholes option pricing model.  Hadcompensation cost for Gaiam’s stock-based compensation plan been determinedunder the fair value methodology for determining compensation cost under SFASNo. 123, Gaiam’s net income (loss) and income (loss) per share would havebeen as follows:

 

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|                                                                                                                                         |   | **Three  Months Ended****June 30,** | ** ** | **Six Months  Ended****June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|-----------------------------------|------------|
|                                                                                                                                         |   | **2003**                            |       | **2002**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss) as reported                                                                                                                |   | $                                   | (759,183   | )                                 | $          | 1,003,409 |   | $ | (1,111,732 | ) | $ | 1,739,050 |   |
| Deduct:   Total stock-basedcompensation  expenses determined under fair  value based method for all  awards net of related tax  effects |   | 235,554                             |       | 213,063                           |       | 415,114 |   | 407,315 |   |
| Pro forma                                                                                                                                    |   | $                                   | (994,737   | )                                 | $          | 790,346 |   | $ | (1,526,846 | ) | $ | 1,331,735 |   |
| Net income (loss) per common share                                                                                                           |   |                                |       |                              |       |   |   |   |   |
| As reported                                                                                                                                  |   | $                                   | (0.05      | )                                 | $          | 0.07 |   | $ | (0.08 | ) | $ | 0.12 |   |
| Pro forma                                                                                                                                    |   | $                                   | (0.07      | )                                 | $          | 0.06 |   | $ | (0.10 | ) | $ | 0.10 |   |
|                                                                                                                                         |   |                                |       |                              |       |   |   |   |   |
| Fully diluted net income (loss)per common share:                                                                                             |   |                                |       |                              |       |   |   |   |   |
| As reported                                                                                                                                  |   | $                                   | (0.05      | )                                 | $          | 0.07 |   | $ | (0.08 | ) | $ | 0.12 |   |
| Pro forma                                                                                                                                    |   | $                                   | (0.07      | )                                 | $          | 0.05 |   | $ | (0.10 | ) | $ | 0.09 |   |

 

 

6.                                       Segment Information

 

Gaiammanages its business and aggregates its operational and financial informationin accordance with two reportable segments. The Direct to Consumer segment contains the Catalog and Internet saleschannels, while the Business to Business segment comprises the Retailers, Mediaand Corporate Account sales channels.

 

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

 

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

 

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|                                                                |   | **For the  Three Months  Ended June 30,** |       | **For the  Six Months  Ended June 30,** |       |
|---------------------------------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------|------------|
|                                                                |   | **2003**                                  |       | **2002**                                | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net revenue:                                                        |   |                                      |       |                                    |       |   |   |   |   |
| Direct to consumer                                                  |   | $                                         | 10,445,164 |                                    | $          | 11,299,964 |   | $ | 21,462,308 |   | $ | 22,682,900 |   |
| Business to business                                                |   | 9,906,664                                 |       | 12,767,461                              |       | 22,257,758 |   | 25,668,066 |   |
| Consolidated net revenue                                            |   | 20,351,828                                |       | 24,067,426                              |       | 43,720,066 |   | 48,350,966 |   |
| Contribution margin:                                                |   |                                      |       |                                    |       |   |   |   |   |
| Direct to consumer                                                  |   | 144,088                                   |       | 190,285                                 |       | 148,673 |   | 316,988 |   |
| Business to business                                                |   | (1,133,384                                | )          | 1,486,903                               |       | (1,538,014 | ) | 2,535,415 |   |
| Consolidated contribution margin (loss)                             |   | (989,296                                  | )          | 1,677,188                               |       | (1,389,341 | ) | 2,852,403 |   |
| Reconciliation of contribution margin (loss) to  net income (loss): |   |                                      |       |                                    |       |   |   |   |   |
| Other income (expense)                                              |   | (79,150                                   | )          | (108,903                                | )          | (149,933 | ) | (139,461 | ) |
| Income tax (benefit) expense                                        |   | (405,491                                  | )          | 556,741                                 |       | (604,048 | ) | 963,095 |   |
| Minority interest expense                                           |   | 96,228                                    |       | 8,135                                   |       | 176,506 |   | 10,797 |   |
| Net income (loss)                                                   |   | $                                         | (759,183   | )                                       | $          | 1,003,409 |   | $ | (1,111,732 | ) | $ | 1,739,050 |   |

 

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

 

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

 

Three monthsended June 30, 2003 compared to three months ended June 30, 2002

 

Revenuesof $20.4 million for the three months ended June 30, 2003 declined 15% from$24.1 million for the three months ended June 30, 2002.  Gaiam’s decrease in revenues was primarilydue to lower sales in our retailer channel, where we experienced a weakness inour sales to department stores, distributors and mall-based specialty stores.

 

Grossprofit, which consists of revenues less cost of sales (primarily merchandiseacquisition costs and in-bound freight), decreased to $10.8 million for thesecond quarter of 2003 from $14.2 million during the same period in 2002.  As a percentage of revenue, gross profitdeclined to 53.1% in 2003 from 58.9% in 2002. This was primarily attributable to increased sales contribution from ourlower margin divisions, and from margin contraction in our retailer channel dueto a product shift to accessories.

 

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Inresponse to the current economic environment and Gaiam’s revenue decrease,Gaiam has undertaken new sales initiatives, new product development, andexpense reduction measures. Gaiam has doubled its sales force, added newproduct categories for distribution to retailers, consolidated its operationsinto its Colorado headquarters, restructured its management organization andreduced its labor costs, and is in the process of consolidating itsdistribution operations into one centralized facility.  As part of Gaiam’s restructuring, Janet Mathews,Vice President of Business Development, resumed her previous role as CFO.  In addition, Ms. Mathews and Eva Williams,Gaiam’s Vice President of Sales, were promoted to executive officers effectiveJuly 1, 2003. Eva Williams joined Gaiam in the fourth quarter of 2002 after along career as head of sales for U.S. Leasing, and more recently as CEO of RedZeppelin, a visual media company.  Costsavings initiatives, after deducting the increased sales force costs, areanticipated to be approximately $2.5 to $3.5 million annually.  The benefit of this expense reduction isexpected to commence in the third quarter of 2003, and be fully realized byJanuary 2004.

 

Sellingand operating expenses (which consist primarily of sales and marketing costs,commission and fulfillment expenses) decreased to $9.5 million for the threemonths ended June 30, 2003 as compared to $10.4 million in the same period of2002, primarily resulting from cost reductions gained through the consolidationof certain operations into the Colorado headquarters and other cost reductionmeasures.  As a percentage of revenues,selling and operating expenses increased to 46.8% in 2003 from 43.4% in 2002due to the lower sales base.

 

Corporate,general and administrative expenses increased to $2.3 million during the secondquarter of 2003, from $2.1 million during 2002, primarily due to increasesresulting from the consolidation of acquisitions and severance costs associatedwith its cost reduction initiatives.

 

Operatingloss, as a result of the factors described above, was $989,296 for the threemonths ended June 30, 2003 compared to an operating profit of $1,677,188 forthe three months ended June 30, 2002 primarily due to lower sales and grossprofit.

 

Gaiam recorded $79,150 inother expense for the three months ended June 30, 2003 compared to $108,903recorded in the prior year period. The share of net income associated withminority interest was $96,228 during the second quarter of 2003, compared to$8,135 during the second quarter of 2002. Minority interest changed year-over-year primarily due to Gaiam’spurchase of a majority interest in Leisure Systems International, a distributorof wellness products based in the U.K, during the first quarter of 2003.

 

Gaiam recorded an income taxbenefit of $405,491 for the three months ended June 30, 2003 compared to anincome tax provision of $556,741 for the three months ended June 30, 2002.

 

Gaiam’s net loss was$759,183 for the three month ended June 30, 2003 as a result of the factorsdescribed above compared to net income of $1,003,409 recorded for the threemonths ended June 30, 2002.

 

# Six months ended June 30, 2003 compared to sixmonths ended June 30, 2002

 

Revenues decreased to $43.7 million for the six months ended June 30,2003 from $48.4 million during the six months ended June 30, 2002, primarilydue to an economic slowdown in the U.S. retail sector, which resulted in adecrease in sales primarily in Gaiam’s business-to-business segment.  Additionally, Gaiam’s business-to-businesssegment was adversely impacted by mergers involving its customers, whichresulted in a contraction in orders placed.

 

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Grossprofit decreased to $23.4 million for the six months ended June 30, 2003 from$28.5 million during the same period in 2002. As a percentage of revenue, gross profit declined to 53.6% in 2003 from58.8% in 2002.  This was primarilyattributable to narrowing margins from the business-to-business channel, and achange in sales mix associated with Gaiam’s acquisition activity.

 

Sellingand operating expenses decreased to $20.1 million for the six months ended June30, 2003 from $21.0 million for the same period in 2002, resulting from plannedcost reduction measures, net of severance costs.  As a percentage of revenues, selling and operating expensesincreased to 46.0% in 2003 from 43.5% in 2002, primarily due to the reductionin the sales base.

 

Corporate,general and administrative expenses increased to $4.7 million for the sixmonths ended June 30, 2003, compared to $4.6 million for the correspondingperiod in 2002.  As a percentage ofrevenues, general and administrative expenses increased to 10.8% in 2003 from9.4% in 2002.

 

Operatingloss, as a result of the factors described above, was $1.4 million for the sixmonths ended June 30, 2003 as compared to operating income of $2.9 million forthe same period in 2002.

 

Gaiam recorded $149,933 inother expense during the six months ended June 30, 2003, compared to $139,461for the comparable period in 2002.  Forthe six months ended June 30, 2003, minority interest income of $176,506 wasrecorded as compared to $10,797 for the comparable period in 2002.  Minority interest income increasedyear-over-year due to Gaiam’s purchase of a majority interest in LeisureSystems International, a distributor of wellness products based in the U.K.,during the first quarter of 2003.

 

Gaiamrecorded an income tax benefit of $604,048 for the six months ended June 30,2003, as compared to an income tax provision of $963,095 in the same period2002.

 

Netloss, as a result of the factors described above, was $1,111,732 for the sixmonths ended June 30, 2003 as compared to net income of $1,739,050 for the sameperiod in 2002.

 

Liquidity and Capital Resources

 

Gaiam’s capital needs arisefrom working capital required to fund our operations, capital expendituresrelated to expansions and improvements to Gaiam’s infrastructure and e-commercecapabilities, capital transactions including stock repurchases, and fundsrequired in connection with the acquisitions of new businesses and Gaiam’santicipated future growth.  Thesecapital requirements depend on numerous factors, including the rate of marketacceptance of Gaiam’s product offerings, the ability to expand Gaiam’s customerbase, the cost of ongoing upgrades to Gaiam’s product offerings, the level ofexpenditures for sales and marketing, the level of investment in distributionand other factors.  The timing andamount of these capital requirements cannot accurately be predicted.  Additionally, Gaiam will continue to evaluatepossible investments in businesses, products and technologies, and plans toexpand sales and marketing programs and conduct more aggressive brandpromotions.

 

Gaiam’s operating activities provided net cash of $1.5 million for thesix months ended June 30, 2003 compared to cash usage of $4.6 million for thesix months ended June 30, 2002.  Gaiam’snet cash provided by operating activities in 2003 was primarily due to asignificant reduction in accounts receivable. Gaiam’s net cash used by operating activities in the first six months of2002 was primarily due to a payment of income taxes for the prior year and anincrease in accounts receivable.

 

Gaiam’s investing and acquisition activities used cash of $4,542,483and provided cash of $1,559,732 for the six months ended June 30, 2003 and2002, respectively.  In January 2003,Gaiam

 

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acquired a 50.1% interest in Leisure Systems International, adistributor of wellness products based in the U.K.  Total consideration for the acquisition was approximately$4,300,000 in cash and 50,000 shares of Gaiam Class A common stock.  Cash provided by investing activities during2002 arose primarily from the sale of the Gaiam Yoga Center during the secondquarter.

 

Gaiam’s financing activitiesused cash of $49,068 and provided cash of $55,294 for the six months ended June30, 2003 and 2002, respectively.

 

We believe our availablecash, cash expected to be generated from operations, and borrowing capabilitiesof $15 million (unused line of credit) will be sufficient to fund ouroperations on both a short-term and long-term basis.  However, our projected cash needs may change as a result ofacquisitions, unforeseen operational difficulties or other factors.

 

In the normal course of ourbusiness, we investigate, evaluate and discuss acquisition, joint venture,minority investment, strategic relationship and other business combinationopportunities in the LOHAS (Lifestyles of Health and Sustainability) market.  In the event of any future investment,acquisition or joint venture opportunities, we may consider usingthen-available liquidity, issuing equity securities or incurring additionalindebtedness.

 

Critical Accounting Policies

##### ** **

We have nothad any significant change in our critical accounting policies from thepreviously reported 10K.

 

##### **Item 3**.                                                           Quantitative and Qualitative DisclosuresAbout Market Risk

 

Wedo not believe that any of our financial instruments have significant riskassociated with market sensitivity.  Weare not exposed to material financial market risks from changes in foreignexchange rates and are only minimally impacted by changes in interest rates.

 

Inthe future, we may enter into transactions denominated in non-U.S. currencies,which could increase our exposure to these market risks.  We have not used, and currently do notcontemplate using, any derivative financial instruments.

##### ** **

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

 

Basedon their evaluation of our disclosure controls and procedures (as defined inRule 13a-14(c) under the Securities Exchange Act of 1934) as of adate within 90 days of the filing date of this quarterly report, our ChiefExecutive Officer and Chief Financial Officer have concluded that thesedisclosure controls and procedures are effective. There were no significantchanges in our internal controls or in other factors that could significantlyaffect these controls subsequent to the date of their evaluation.

## ** **

## **PART II**.                                                OTHER INFORMATION

 

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

 

Nolegal proceedings became reportable during the second quarter of 2003 and therewere no material developments in any previously reported legal proceedings.

 

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##### **Item 2.**                                                           Changesin Securities and Use of Proceeds

 

None.

 

##### **Item 3.**                                                           DefaultsUpon Senior Securities

 

None.

 

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

 

On May 23, 2003, Gaiam held its Annual Meeting of Shareholders.  The shareholders elected six directors ofGaiam to serve until the next annual meeting of shareholders to be held in 2004or until their successors are duly elected and qualified.  The results of this vote follow:

 
| Jirka Rysavy        |   | For: |   | 60,867,733 |   | Withheld: |   | 1,033,503 |
|---------------------|--------|------|--------|------------|--------|-----------|--------|-----------|
| Lynn Powers         |   | For: |   | 60,867,784 |   | Withheld: |   | 1,033,452 |
| James Argyropoulous |   | For: |   | 61,766,854 |   | Withheld: |   | 134,382   |
| Barnet Feinblum     |   | For: |   | 61,811,509 |   | Withheld: |   | 89,727    |
| Barbara Mowry       |   | For: |   | 61,766,830 |   | Withheld: |   | 134,406   |
| Paul Ray            |   | For: |   | 61,811,513 |   | Withheld: |   | 89,723    |

** **

##### **Item 5.**                                                           Other Information.

 

None.

 

##### **Item 6.**                                                           Exhibits and Reports on Form 8-K.

 

a)                                      Exhibits

 
| **Exhibit No.** |   | **Description**                                                                                      |
|-----------------|--------|------------------------------------------------------------------------------------------------------|
| 31.1            |   | Certification  pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002                          |
| 31.2            |   | Certification  pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002                          |
| 32.1            |   | Certification  of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002 |
| 32.2            |   | Certification  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002 |

 

b)                                     Reports on Form 8-K.

 

OnJuly 29, 2003, Gaiam filed a report on Form 8-K relating to its earnings pressrelease for second quarter 2003.

 

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**Signatures**

 

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

 

 

|   | Gaiam, Inc.   |
|--------|---------------|
|   | (Registrant)  |
|   | July 29, 2003 |
|   |          |
|   |          |
|   | By:           | /s/ Jirka  Rysavy |   |
|   |          | Jirka Rysavy |
|   |          | Chief  Executive Officer |
|   |          |
|   |          | /s/ Janet  Mathews |   |
|   |          | Janet  Mathews |
|   |          | Chief  Financial Officer |
|        |               |  |  |  |

 

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