**United StatesSecurities and Exchange Commission**

**Washington, D.C. 20549**

 

#### **Form 10-Q**

 

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

 

**For the quarterly period ended March 31, 2004**

 

**OR**

 

**o****                                ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d)OF THE SECURITIES 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, 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  ý         NO  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). YES  ý   NO  o

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

| **Class**            |   | **Shares  outstanding as of April 30, 2004** |   |
|----------------------|--------|----------------------------------------------|--------|
| Class A Common Stock |   | 9,296,477                                    |   |
| ($.0001 par value)   |   |                                         |   |
|                 |   |                                         |   |
| Class B Common Stock |   | 5,400,000                                    |   |
| ($.0001 par value)   |   |                                         |   |

 

 

----

 

**INDEX TO FORM 10-Q**

 
| PART  I.   | FINANCIAL  INFORMATION                                                                               |   |
|------------|------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                 |   |
| Item  1.   | Condensed Consolidated Financial Statements  (Unaudited)                                             |   |
|       | Condensed  Consolidated Balance Sheets at March 31, 2004 and December 31, 2003                       |   |
|       | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2004 and 2003 |   |
|       | Condensed  Consolidated Statement of Cash Flows for the three months ended March 31,  2004 and 2003  |   |
|       | 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                                                                    |   |
|       |                                                                                                 |   |
| Signatures |                                                                                                 |   |

 

FORWARD-LOOKINGSTATEMENTS

This report may contain forward-looking statements that involve risksand uncertainties.  When used in thisdiscussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,”“strive,” “future,” “intend” and similar expressions as they relate to Gaiam orits management are intended to identify such forward-looking statements.  Gaiam’s actual results could differmaterially from the results anticipated in these forward-looking statements asa result of certain factors set forth under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” “Market Risk” andelsewhere in this report.  Risks anduncertainties that could cause actual results to differ include, withoutlimitation, general economic conditions, competition, loss of key personnel,pricing, brand reputation, acquisitions, security and information systems,legal liability for website content, merchandise supply problems, failure ofthird parties to provide adequate service, reliance on centralized customerservice, overstocks and merchandise returns, reliance on a centralizedfulfillment center, increases in postage and shipping costs, e-commerce trends,future Internet related taxes, control of Gaiam by its founder, fluctuations inquarterly operating results, consumer trends, customer interest in ourproducts, the effect of government regulation and other risks and uncertaintiesincluded in Gaiam’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

(In thousands, except share information)

 
|                                                                                                                                                                                 |   | **March 31,  2004** |       | **December  31,  2003** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                                                                                                                                                                 |   | **(Unaudited)**     |       |                    |       |
| **Assets**                                                                                                                                                                           |   |                |       |                    |       |
| Current  assets:                                                                                                                                                                     |   |                |       |                    |       |
| Cash and cash equivalents                                                                                                                                                            |   | $                   | 10,994     |                    | $          | 8,384 |   |
| Accounts receivable, net                                                                                                                                                             |   | 11,950              |       | 17,818                  |       |
| Income tax and other receivables                                                                                                                                                     |   | 2,306               |       | 2,091                   |       |
| Inventory, less allowances                                                                                                                                                           |   | 16,871              |       | 16,629                  |       |
| Deferred advertising costs                                                                                                                                                           |   | 903                 |       | 1,649                   |       |
| Other current assets                                                                                                                                                                 |   | 1,248               |       | 1,280                   |       |
| Total current assets                                                                                                                                                                 |   | 44,272              |       | 47,851                  |       |
|                                                                                                                                                                                 |   |                |       |                    |       |
| Property and equipment, net                                                                                                                                                          |   | 9,810               |       | 10,314                  |       |
| Investments                                                                                                                                                                          |   | 7,865               |       | 7,865                   |       |
| Capitalized production costs, net                                                                                                                                                    |   | 5,852               |       | 6,094                   |       |
| Media library, net                                                                                                                                                                   |   | 5,927               |       | 6,084                   |       |
| Goodwill and other intangibles                                                                                                                                                       |   | 9,608               |       | 9,509                   |       |
| Deferred tax assets                                                                                                                                                                  |   | 3,380               |       | 3,488                   |       |
| Other assets                                                                                                                                                                         |   | 546                 |       | 655                     |       |
| Total assets                                                                                                                                                                         |   | $                   | 87,260     |                    | $          | 91,860 |   |
|                                                                                                                                                                                 |   |                |       |                    |       |
| **Liabilities and stockholders’ equity**                                                                                                                                        |   |                |       |                    |       |
| Current liabilities:                                                                                                                                                                 |   |                | ** ** |                    | ** ** |
| Accounts payable                                                                                                                                                                     |   | $                   | 8,174      |                    | $          | 12,459 |   |
| Accrued liabilities                                                                                                                                                                  |   | 4,149               |       | 4,904                   |       |
| Income taxes payable                                                                                                                                                                 |   | 1,104               |       | 902                     |       |
| Capital lease obligations, current                                                                                                                                                   |   | 35                  |       | 55                      |       |
| Total current liabilities                                                                                                                                                            |   | 13,462              |       | 18,320                  |       |
|                                                                                                                                                                                 |   |                |       |                    |       |
| Deferred tax liabilities                                                                                                                                                             |   | 791                 |       | 735                     |       |
| Total liabilities                                                                                                                                                                    |   | 14,253              |       | 19,055                  |       |
|                                                                                                                                                                                 |   |                |       |                    |       |
| Minority interest                                                                                                                                                                    |   | 3,589               |       | 3,320                   |       |
|                                                                                                                                                                                 |   |                |       |                    |       |
| Commitments and contingencies                                                                                                                                                        |   |                |       |                    |       |
|                                                                                                                                                                                 |   |                |       |                    |       |
| Stockholders’ equity:                                                                                                                                                           |   |                |       |                    |       |
| Class A common stock, $.0001 par value,  150,000,000 shares authorized, 9,216,027 and 9,203,056 shares issued and  outstanding at March 31, 2004 and December 31, 2003, respectively |   | 1                   |       | 1                       |       |
| Class B common stock, $.0001 par value,  50,000,000 shares authorized, 5,400,000 issued and outstanding at March 31,  2004 and December 31, 2003, respectively                       |   | 1                   |       | 1                       |       |
| Additional paid-in capital                                                                                                                                                           |   | 53,907              |       | 53,831                  |       |
| Deferred compensation                                                                                                                                                                |   | (54                 | )          | (72                     | )          |
| Accumulated other comprehensive income                                                                                                                                               |   | 693                 |       | 525                     |       |
| Retained earnings                                                                                                                                                                    |   | 14,870              |       | 15,199                  |       |
| Total stockholders’ equity                                                                                                                                                      |   | 69,418              |       | 69,485                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                      |   | $                   | 87,260     |                    | $          | 91,860 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

3

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 

(Unaudited)

(In thousands, except per share amounts)

 
|                                                                             |   | **For the Three Months Ended****March 31,** |   |
|----------------------------------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                                             |   | **2004**                                    |   | **2003** |   |
|                                                                             |   |                                        |   |   |   |
| Net revenue                                                                      |   | $                                           | 23,775 |   | $ | 22,972 |   |
| Cost of goods sold                                                               |   | 11,099                                      |   | 10,648 |   |
| Gross profit                                                                     |   | 12,676                                      |   | 12,324 |   |
|                                                                             |   |                                        |   |   |   |
| Expenses:                                                                        |   |                                        |   |   |   |
| Selling and operating                                                            |   | 10,957                                      |   | 10,552 |   |
| Corporate, general and administration                                            |   | 2,048                                       |   | 2,269 |   |
| Total expenses                                                                   |   | 13,005                                      |   | 12,821 |   |
|                                                                             |   |                                        |   |   |   |
| Income (loss) from operations                                                    |   | (329                                        | )      | (497 | ) |
|                                                                             |   |                                        |   |   |   |
| Other income                                                                     |   | 24                                          |   | 11 |   |
| Interest income                                                                  |   | 32                                          |   | 15 |   |
| Total other income                                                               |   | 56                                          |   | 26 |   |
|                                                                             |   |                                        |   |   |   |
| Income (loss) before income taxes and  minority interest                         |   | (273                                        | )      | (471 | ) |
|                                                                             |   |                                        |   |   |   |
| Provision for income tax (benefit) expense                                       |   | (116                                        | )      | (198 | ) |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |   | (172                                        | )      | (80 | ) |
| Net income (loss)                                                                |   | $                                           | (329   | ) | $ | (353 | ) |
|                                                                             |   |                                        |   |   |   |
| Net income (loss) per share:                                                     |   |                                        |   |   |   |
| Basic                                                                            |   | $                                           | (0.02  | ) | $ | (0.02 | ) |
| Diluted                                                                          |   | $                                           | (0.02  | ) | $ | (0.02 | ) |
|                                                                             |   |                                        |   |   |   |
| Shares used in computing net income (loss)  per share:                           |   |                                        |   |   |   |
| Basic                                                                            |   | 14,615                                      |   | 14,579 |   |
| Diluted                                                                          |   | 14,615                                      |   | 14,579 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

4

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited – In Thousands)

 
|                                                                                                |   | **For the  Three Months  Ended March 31,** |   |
|-----------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                                |   | **2004**                                   |   | **2003** |   |
| **Operating activities**                                                                            |   |                                       |   |   |   |
| Net income (loss)                                                                                   |   | $                                          | (329   | ) | $ | (353 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                       |   |   |   |
| Depreciation                                                                                        |   | 749                                        |   | 643 |   |
| Amortization                                                                                        |   | 174                                        |   | 112 |   |
| Stock compensation                                                                                  |   | 18                                         |   | 18 |   |
| Minority interest in consolidated  subsidiaries                                                     |   | 172                                        |   | 80 |   |
| Deferred tax expense                                                                                |   | 119                                        |   | — |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:                     |   |                                       |   |   |   |
| Accounts receivable                                                                                 |   | 5,716                                      |   | 8,040 |   |
| Inventory                                                                                           |   | (184                                       | )      | (270 | ) |
| Deferred advertising costs                                                                          |   | 746                                        |   | 754 |   |
| Capitalized production costs                                                                        |   | 242                                        |   | (657 | ) |
| Other current assets                                                                                |   | 35                                         |   | (465 | ) |
| Other assets                                                                                        |   | 106                                        |   | (266 | ) |
| Accounts payable                                                                                    |   | (4,495                                     | )      | (3,596 | ) |
| Accrued liabilities                                                                                 |   | (533                                       | )      | (1,300 | ) |
| Income taxes payable                                                                                |   | 182                                        |   | (1,233 | ) |
| Net cash provided by operating activities                                                           |   | 2,718                                      |   | 1,507 |   |
|                                                                                                |   |                                       |   |   |   |
| **Investing activities**                                                                            |   |                                       |   |   |   |
| Purchase of property, equipment and media  rights                                                   |   | (206                                       | )      | (797 | ) |
| Payments for acquisitions, net of cash  acquired                                                    |   | —                                     |   | (3,787 | ) |
| Net cash used in investing activities                                                               |   | (206                                       | )      | (4,584 | ) |
|                                                                                                |   |                                       |   |   |   |
| **Financing activities**                                                                            |   |                                       |   |   |   |
| Principal payments on capital leases                                                                |   | (20                                        | )      | (84 | ) |
| Proceeds from issuance of common stock                                                              |   | 8                                          |   | 87 |   |
| Net cash (used in) provided by financing  activities                                                |   | (12                                        | )      | 3 |   |
|                                                                                                |   |                                       |   |   |   |
| Effects of exchange rates on cash and cash  equivalents                                             |   | 110                                        |   | — |   |
| Net change in cash and cash equivalents                                                             |   | 2,610                                      |   | (3,074 | ) |
| Cash and cash equivalents at beginning of  period                                                   |   | 8,384                                      |   | 11,422 |   |
| Cash and cash equivalents at end of period                                                          |   | $                                          | 10,994 |   | $ | 8,348 |   |
|                                                                                                |   |                                       |   |   |   |
| **Supplemental cash flow information**                                                              |   |                                       |   |   |   |
| Interest paid                                                                                       |   | $                                          | — |   | $ | 19 |   |
| Common stock issued for acquisitions                                                                |   | —                                     |   | 348 |   |
| Income taxes paid                                                                                   |   | —                                     |   | 1,033 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

5

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Gaiam, Inc.

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

March 31, 2004

 

1.                                       InterimCondensed Consolidated Financial Statements

 

###### Organization andNature 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, ecological lifestyles and responsible media.  Gaiam was incorporated under the laws of theState of Colorado on July 7, 1988.

 

Theaccompanying consolidated financial statements include the accounts of Gaiamand its subsidiaries in which Gaiam’s ownership is greater than 50% and thesubsidiary is considered to be under Gaiam’s control.  All material intercompany accounts and transaction balances havebeen eliminated in consolidation.

 

Preparationof Interim Condensed 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 March 31, 2004, the interim results of operations for the threemonths ended March 31, 2004 and 2003, and cash flows for the three months endedMarch 31, 2004 and 2003.  These interimstatements have not been audited.  Thebalance sheet as of December 31, 2003 was derived from Gaiam’s auditedconsolidated financial statements included in Gaiam’s annual report on Form10-K.  

 

Certaininformation and footnote disclosures normally included in consolidatedfinancial statements prepared in accordance with generally accepted accountingprinciples 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, 2003 included in Gaiam’s annual reporton Form 10-K.  The consolidatedfinancial statements contained herein should be read in conjunction with theaudited financial statements, including the notes thereto, for the year endedDecember 31, 2003.

 

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

 

Reclassifications

 

Certainreclassifications have been made to prior period amounts to conform to thecurrent period presentations.

 

6

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Adoptionof Accounting Standards

 

InDecember 2003, the Financial Accounting Standards Board (“FASB”) issued arevised FASB Interpretation No. 46, “Consolidation of Variable InterestEntities,” (“FIN 46R”).  FIN 46Rmodifies FIN 46 to include (1) a deferral of the effective date of theprovisions related to certain variable interests, (2) additional scopeexceptions for certain other variable interests, (3) clarifications on theimpact of troubled debt restructurings, and (4) additional guidance on whatconstitutes a variable interest. Adoption of FIN 46R is required in the financial statements of publicentities that have interests in special purposes entities (“SPEs”) for periodsending after December 15, 2003. Adoption by public entities that have interests in all other types of variableinterest entities (“VIEs”) is required in financial statements for periodsending after March 15, 2004.  Gaiambelieves that there are no entities qualifying as SPEs or VIEs, therefore, theadoption of FIN 46R has not had any effect on Gaiam’s financial position,results of operations or cash flows. 

 

Stock-BasedCompensation

 

Gaiamaccounts for its stock-based compensation arrangements under the provisions ofAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*(“APB No. 25”) and related interpretations, including FASB Interpretation No.44, *Accounting for Certain TransactionsInvolving Stock Compensation*, rather than the alternative fair valueaccounting allowed by SFAS No. 123, *Accounting for Stock Based Compensation*.  Accordingly, no compensation expense isrecognized in Gaiam’s consolidated financial statements in connection withstock options granted to employees with exercise prices not less than fairvalue.  Deferred compensation foroptions granted to employees is determined as the difference between the deemedfair market value of Gaiam’s common stock on the date options were granted andthe exercise price.  For purposes ofthis pro-forma disclosure, the estimated fair value of options is assumed to beamortized to expense over the options’ vesting periods.

 

Compensationexpense for options granted to non-employees has been determined, in accordancewith SFAS No. 123, as the fair value of the consideration received or the fairvalue of the equity instruments issued, whichever is more reliably measured.  Compensation expense for options granted tonon-employees is periodically re-measured as the underlying options vest.  Had compensation cost for Gaiam’sstock-based compensation plan been determined under the fair value methodologyunder SFAS No. 123, Gaiam’s net income (loss) and income (loss) per share wouldhave been as follows (in thousands, except per share data):

 

| **For the  Three Months Ended March 31,**                                                                                                   |   | **2004** |   | **2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                                                                                                        |   |     |   |     |   |
| Net income (loss) as reported                                                                                                               |   | $        | (329   | )        | $      | (353 | ) |
| Add:   Stock-based compensation expense included in reported net income  (loss), net of related tax effects                            |   | 18       |   | 18       |   |
| Deduct:   Total stock-based compensation expenses determined under fair value  based method for all awards, net of related tax effects |   | (165     | )      | (196     | )      |
| Pro forma                                                                                                                                   |   | $        | (476   | )        | $      | (531 | ) |
| Net income (loss) per common share                                                                                                          |   |     |   |     |   |
| As reported                                                                                                                                 |   | $        | (0.02  | )        | $      | (0.02 | ) |
| Pro forma                                                                                                                                   |   | $        | (0.03  | )        | $      | (0.04 | ) |
| Fully diluted net income (loss) per common  share                                                                                           |   |     |   |     |   |
| As reported                                                                                                                                 |   | $        | (0.02  | )        | $      | (0.02 | ) |
| Pro forma                                                                                                                                   |   | $        | (0.03  | )        | $      | (0.04 | ) |

 

7

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2.                                       Stockholders’Equity

 

Duringthe first quarter of 2004, Gaiam issued a total of 11,251 shares of Class Acommon stock to Gaiam’s independent directors, in lieu of cash compensation,for services rendered in 2003. In addition, for the three months ended March31, 2004, Gaiam issued 1,720 shares of Class A common stock upon exercise ofoptions granted under Gaiam’s 1999 Long-Term Incentive Plan. 

 

3.                                       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 asfollows (in thousands):

 

| **For the  Three Months Ended March 31,**     |   | **2004** |   | **2003** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|
|                                          |   |     |   |     |   |
| Net income (loss)                             |   | $        | (329   | )        | $      | (353 | ) |
| Foreign currency translation adjustment,  net |   | 168      |   | —   |   |
| Comprehensive income (loss), net of taxes     |   | $        | (161   | )        | $      | (353 | ) |

 

4.                                       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 the weighted average number of common sharesoutstanding during the period.  Dilutedearnings per share is computed using the weighted average number of common andcommon stock equivalent shares outstanding during the period.  Common equivalent shares are excluded fromthe computation of diluted earnings per share for the three months ended March31, 2004 and 2003 because their effect is antidilutive.

 

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

 

| **For the  Three Months Ended March 31,**                      |   | **2004** |   | **2003** |   |
|----------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                           |   |     |   |     |   |
| Numerator for basic and diluted earnings  (loss) per share     |   | $        | (329   | )        | $      | (353 | ) |
| Denominator:                                                   |   |     |   |     |   |
| Weighted average shares for basic earnings  (loss) per share   |   | 14,615   |   | 14,579   |   |
| Effect of dilutive securities:                                 |   |     |   |     |   |
| Weighted average of common stock, stock  options, and warrants |   | —   |   | —   |   |
| Denominators for diluted earnings  (loss)  per share      |   | 14,615   |   | 14,579   |   |
|                                                           |   |     |   |     |   |
| Net income (loss) per share—basic                         |   | $        | (0.02  | )        | $      | (0.02 | ) |
| Net income (loss) per share—diluted                       |   | $        | (0.02  | )        | $      | (0.02 | ) |

 

5.                                       SegmentInformation

 

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 segment comprises the retailers, media andcorporate account channels.

 

8

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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 (inthousands):

 

| **For the Three Months Ended March 31,**                                         |   | **2004** |   | **2003** |   |
|----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Net revenue:                                                                     |   |     |   |     |   |
| Direct to consumer                                                               |   | $        | 12,138 |     | $      | 11,017 |   |
| Business                                                                         |   | 11,637   |   | 11,955   |   |
| Consolidated net revenue                                                         |   | 23,775   |   | $        | 22,972 |   |
| Contribution margin:                                                             |   |     |   |     |   |
| Direct to consumer                                                               |   | (24      | )      | 4        |   |
| Business                                                                         |   | (305     | )      | (501     | )      |
| Consolidated contribution margin (loss)                                          |   | (329     | )      | (497     | )      |
| Reconciliation of contribution margin  (loss) to net income (loss):              |   |     |   |     |   |
| Other income (expense)                                                           |   | 56       |   | 26       |   |
| Income tax (benefit) expense                                                     |   | (116     | )      | (198     | )      |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |   | (172     | )      | (80      | )      |
| Net income (loss)                                                                |   | $        | (329   | )        | $      | (353 | ) |

 

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

 

# Thefollowing discussion 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.

 

#### Overviewand Outlook

 

Gaiamis a multi-channel lifestyle company providing information, goods and servicesto customers who value personal development, healthy living, ecologicallifestyles and responsible media. Gaiam was incorporated in Boulder, Coloradoin 1988 to support “Conscious Commerce,” the practice of making purchasingdecisions based on lifestyle and personal values.   In 1995, Gaiam began to expand nationally.  In 1996, Gaiam made a large investment ininfrastructure and operating systems to support rapid growth. From 1997 to2003, Gaiam’s revenues increased from $19.9 million to $102 million,representing a compound annual growth rate of 31.3%.

 

Gaiam’srevenues declined 8.4% to $102 million in 2003, as compared to $111.4 millionin 2002.  The decline in revenues wasprimarily attributable to a decline of 34%, or $19 million, in sales toretailers.  These declines took place inour business segment, which has had higher operating contributions in prioryears than our direct to consumer segment. With a larger portion of Gaiam’s revenue contributed by operations withlower gross margins, the overall gross margin declined to 52%.  Gaiam used 2003 as a transition year inorder to make adjustments to our business strategy by doubling our sales force,adding new product categories, launching sales to additional retail chainswithin the business segment, and consolidating our operations and reducingexpenses in order to focus on profitability in all segments in the future.  Although Gaiam reported a net loss ofapproximately $972 thousand in 2003, its first net loss since becoming a publiccompany, Gaiam generated $3.7 million in cash provided by operations, comparedto $1 million cash provided by operations in 2002, when Gaiam had net income of$5.4 million.

 

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Gaiamhas increased its focus on its media and national retailer channels, whichstrategically provides increased branding opportunities, higher operatingcontribution and greater mainstream penetration.  In 2003, our business segment was 51% of total revenues, up from13% in 1998.  In 2004, Gaiam is focusingon selling directly to retailers, both domestically and abroad, through the“store-within-store” concept, and is concentrating on building this segmentthrough a combination of new media releases and new product opportunities insoft goods and spa products, along with an expansion in mass market retailersand bookstores, and new launches into the grocery and the professional markets.

 

Thedirect to consumer segment continues to be an integral part of Gaiam’soutreach.  This segment accounted for49%, or approximately $50.5 million, of Gaiam’s revenues during 2003.  Through its diverse media reach, the directto consumer segment provides branding, a sounding board for new producttesting, promotional opportunities and customer feedback on Gaiam’s and theLOHAS (Lifestyles of Health and Sustainability) industry’s focus and future.

 

The negative internal growthexperienced during 2003 has subsided, and, for the first quarter of 2004, Gaiamgenerated positive internal growth of approximately 5%.  Revenues in Gaiam’s direct to consumersegment increased to 51% of overall revenue and posted an internal growth rateof 12.8% for the first quarter of 2004. The business segment posted a modest decline in revenues of 2.7% for thefirst quarter, as compared to negative internal growth of 32.6% in the firstquarter of 2003.  As this segment’srevenues are heavily weighted in the second half of the calendar year, it isanticipated that this segment will return to positive internal growth in thattimeframe.  As Gaiam’s revenues willcontinue to be heavily weighted to the second half of the calendar year, themajority of our earnings will continue to be generated during the third andfourth quarters.  As expected, Gaiamposted a net loss in the first quarter of 2004 of $329 thousand, a 6.8%improvement over the same period in 2003. Additionally, Gaiam generated $2.7 million in cash provided by operatingactivities for the three months ended March 31, 2004, as compared to $1.5million for the same period in 2003.  

 

#### Resultsof Operations

 

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

 

| **For the Three Months Ended March 31,**                                         |   | **2004** |   | **2003** |   |
|----------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Net revenue                                                                      |   | 100.0    | %      | 100.0    | %      |
| Cost of goods sold                                                               |   | 46.7     | %      | 46.4     | %      |
| Gross profit                                                                     |   | 53.3     | %      | 53.6     | %      |
| Expenses:                                                                        |   |     |   |     |   |
| Selling and operating                                                            |   | 46.1     | %      | 45.9     | %      |
| Corporate, general and administrative                                            |   | 8.6      | %      | 9.9      | %      |
| Total expenses                                                                   |   | 54.7     | %      | 55.8     | %      |
| Income (loss) from operations                                                    |   | -1.4     | %      | -2.2     | %      |
| Other income (expense), net                                                      |   | 0.2      | %      | 0.1      | %      |
| Income (loss) before income taxes and  minority interest                         |   | -1.2     | %      | -2.1     | %      |
| Income tax (benefit) expense                                                     |   | -0.5     | %      | -0.9     | %      |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |   | -0.7     | %      | -0.3     | %      |
| Net income(loss)                                                                 |   | -1.4     | %      | -1.5     | %      |

####  

#### Threemonths ended March 31, 2004 versus March 31, 2003

 

Revenues of $23.8 million for the three months ended March 31, 2004increased 3.5% from $23 million for the three months ended March 31, 2003.  Gaiam’s increase in revenues was due torevenue increases in the direct to consumer segment of $1.1 million, or 10.2%for the quarter.  Business segmentrevenues were $11.6 million for the three months ended March 31, 2004, comparedto $11.9 million for the same period in

 

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2003.  While the business segment experienced negative growth of 2.7% in2004, this represents a significant improvement over 2003’s results, whennegative growth in this segment was 32.6%.

 

Gross profit, which consists of revenues less cost of sales (primarilymerchandise acquisition costs and in-bound freight), increased to $12.7 millionfor the first quarter of 2004 from $12.3 million during the same period in2003.  As a percentage of revenue, grossprofit declined to 53.3% in 2004 from 53.6% in 2002.  This was primarily attributable to increased sales contributionfrom certain of Gaiam’s lower margin endeavors within the direct to consumersegment, and was partially offset by improved gross margin in the businesssegment.

 

Selling and operating expenses (which consist primarily of sales andmarketing costs, commission and fulfillment expenses) increased to $11 millionfor the three months ended March 31, 2004 as compared to $10.6 million in thesame period of 2003, primarily resulting from increases associated with highersales volume.  During the second half of2003, Gaiam doubled its business sales force and increased other sales andmarketing expenditures in order to launch new sales strategies, includingexpansion in mass market retailers and bookstores, and new entries into thegrocery market.  New sales personnel arepaid under a minimum guarantee arrangement while training, so theircompensation will start to fluctuate with performance in the second half of2004.  As a percentage of revenues,selling and operating expenses increased to 46.1% in 2004 from 45.9% in 2003. 

 

Corporate, general and administration expenses decreased to $2.0million for the first quarter of 2004 from $2.3 million in the comparable 2003period, and decreased to 8.6% of revenues in 2004 from 9.9% of revenues in2003.  This expense reduction isgenerally attributable to cost savings generated by the consolidation ofadministrative services into Gaiam’s Colorado headquarters and the resultantstaffing reductions implemented during the first half of 2003. 

 

Operating losses decreased 33.8% to $329 thousand for the three months endedMarch 31, 2004 from $497 thousand for the three months ended March 31, 2003,primarily due to increased revenues and gross profit. 

 

Gaiamrecorded $56 thousand and $26 thousand in other income, primarily from interestincome, for the three months ended March 31, 2004 and 2003, respectively.  The share of net income associated withminority interest was $172 thousand during the first quarter of 2004, comparedto $80 thousand for the comparable 2003 period.  This increase was primarily due to the increased profitability ofour eco-travel subsidiary.

 

Gaiamrecorded an income tax benefit of $116 thousand for the three months endedMarch 31, 2004 compared to an income tax benefit of $198 thousand for the threemonths ended March 31, 2003. 

 

Asa result of the factors described above, Gaiam’s net loss was $329 thousand forthe three months ended March 31, 2004 compared to a net loss of $353 thousandrecorded for the three months ended March 31, 2003.  Despite these losses, Gaiam’s cash generated by operations grewto $2.7 million in 2004, from $1.5 million for the same period in 2003, whichincreased our cash position to $11million at March 31, 2004.

 

Liquidityand Capital Resources

 

Gaiam’s capital needs arisefrom working capital required to fund our operations, capital expendituresrelated to replacements, expansions and improvements to Gaiam’s infrastructure,development of e-commerce, acquisitions of new businesses, and anticipatedfuture growth.  These capital requirementsdepend on numerous factors, including the rate of market acceptance of Gaiam’sproduct offerings, the ability to expand Gaiam’s customer base, the cost ofongoing upgrades to Gaiam’s product offerings, the level of expenditures forsales and marketing, the level of investment in distribution and otherfactors.  The timing and amount of thesecapital requirements cannot accurately be predicted.  Additionally, Gaiam will continue to evaluate possible investmentsin businesses, products and technologies, and increase its sales and marketingprograms and brand promotions as needed.

 

In2002, Gaiam executed a new credit agreement with Wells Fargo, which expiresduring 2005, and permits borrowings of up to $15 million based upon thecollateral value of Gaiam’s accounts receivable, inventory and certain propertyand equipment.  Borrowings under thecredit agreement bear interest at the lower 

 

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of prime rate less 50 basis points or LIBORplus 275 basis points.  Borrowings aresecured by a pledge of Gaiam’s assets, and the agreement contains variousfinancial covenants, including covenants prohibiting the payment of cashdividends to Gaiam shareholders and requiring compliance with certain financialratios.  At March 31, 2004, Gaiam had noamounts outstanding under this agreement and complied with all of the financialcovenants.

 

Gaiam’soperating activities generated net cash of $2.7 million and $1.5 million forthe three months ended March 31, 2004 and 2003, respectively.  Gaiam’s net cash generated from operatingactivities for both periods is primarily attributable to a decrease in accountsreceivable of $5.7 million in 2004 and $8.0 million in 2003, which waspartially offset by decreases in accounts payable of $4.5 million in 2004 and $3.6million in 2003.  Additionally, duringthe first quarter of 2003, accrued expenses and income taxes payable decreaseda combined $2.5 million.  Non-cashcharges to net income were $1.2 million and $852 thousand for the three monthsended March 31, 2004 and 2003, respectively.

 

Gaiam’sinvesting and acquisition activities used net cash of $206 thousand and $4.6million during the first quarter of 2004 and 2003, respectively.  For the first quarter of 2004, Gaiam made$206 thousand in property and equipment purchases.  In January 2003, Gaiam acquired a 50.1% interest in LeisureSystems International, a distributor of wellness products based in theU.K.  Total consideration for theacquisition was approximately $4.3 million in cash and 50,000 shares of Gaiam ClassA common stock. 

 

Gaiam’s financing activitiesused net cash of $12 thousand and provided cash of $3 thousand during the firstquarter of 2004 and 2003, respectively. Cash is used to fund principal payments under capitalized leases, andfunds are generated by the exercise of stock options. 

 

Webelieve our available cash, cash expected to be generated from operations, andborrowing capabilities of $15 million (unused line of credit) should besufficient to fund our operations on both a short-term and long-termbasis.  However, our projected cashneeds may change as a result of acquisitions, unforeseen operationaldifficulties or other factors.

 

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

 

Contractual Obligations

 

Gaiam has commitmentspursuant to lease and debt agreements, but does not have any long-term debtobligations or purchase obligations. The following table shows our commitments to make future payments underoperating and capital leases as of March 31, 2004 (in thousands):

 
|                               |   | **Total** |   | **< 1  year** |   | **1-3 years** |   | **3-5 years** |   | **> 5 yrs** |   |
|------------------------------------|--------|-----------|--------|------------------|--------|---------------|--------|---------------|--------|----------------|--------|
| Operating lease obligations        |   | $         | 2,815  |             | $      | 1,824         |   | $             | 991    |           | $      | — |   | $ | — |   |
| Capital lease obligations          |   | 34        |   | 34               |   | —        |   | —        |   | —         |   |
| Total contractual cash obligations |   | $         | 2,849  |             | $      | 1,858         |   | $             | 991    |           | $      | — |   | $ | — |   |

 

Off-Balance Sheet Arrangements

 

Gaiamdoes not participate in transactions that generate relationships withunconsolidated entities or financial partnerships, such as special purpose entities(“SPEs”) or variable interest entities (“VIEs”), which have been establishedfor the purpose of facilitating off-balance sheet arrangements or other limitedpurposes.  As of March 31, 2004, Gaiamis not involved in any unconsolidated SPEs or VIEs.

 

CriticalAccounting Policies

##### ** **

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

 

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*Provision for Doubtful Accounts*

 

Gaiam records a provisionfor doubtful accounts for all receivables not expected to be collected.  Gaiam generally does not requirecollateral.  Gaiam evaluates thecollectibility of the accounts receivable based on a combination offactors.  In circumstances when we areaware of a specific customer’s inability to meet its financial obligations(e.g. bankruptcy filings), Gaiam records a specific reserve for bad debtsagainst amounts due.  For all otherinstances, Gaiam recognizes reserves based on historical experience and reviewof individual accounts outstanding.

 

*Inventory*

 

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

 

*Investments*

 

Investmentsin entities that Gaiam does not have the ability to exercise significantinfluence are accounted for under the cost method. Under the cost method ofaccounting, investments in private companies are carried at cost and areadjusted only for other-than-temporary declines in fair value. Investmentsunder the cost method are included on the accompanying consolidated balancesheet in “Investments.”

 

*Capitalized Production Costs*

 

Capitalized production costsinclude costs incurred to produce informational media products marketed byGaiam to retail marketers and direct-mail customers.  These costs are deferred for financial reporting purposes untilthe media is released, then amortized over succeeding periods on the basis ofestimated sales.  Historical salesstatistics are the principal factor used in estimating the amortization rate.

 

*Goodwill*

 

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

 

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

 

Gaiam has not had any significant changesin its critical accounting policies fromits Form 10-K filing for the fiscal year ended December 31, 2003.

 

Risk Factors

 

We wish tocaution you that there are risks and uncertainties that could cause our actualresults to be materially different from those indicated by forward-lookingstatements that we make from time to time in filings with the Securities andExchange Commission, news releases, proxy statements, annual reports,registration statements and other written communications, as well as oralforward-looking statements made from time to time by representatives ofGaiam.  These risks and uncertaintiesinclude, but are not limited to, those listed in Gaiam’s Annual Report on Form10-K for the year ended December 31, 2003. These risks and uncertainties and additional risks and uncertainties notpresently known to us or that we currently deem 

 

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immaterial may cause ourbusiness, financial condition, operating results and cash flows to bematerially adversely affected.  Exceptfor the historical information contained herein, the matters discussed in thisanalysis are forward-looking statements that involve risk and uncertainties,including, but not limited to, general economic and business conditions,competition, pricing, brand reputation, consumer trends, and other factorswhich are often beyond our control.  Gaiamdoes not undertake any obligation to update forward-looking statements exceptas required by law.

 

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

 

We are exposed to marketrisks, which include changes in U.S. interest rates and foreign exchangerates.  We do not engage in financialtransactions for trading or speculative purposes.

 

Any borrowings we might makeunder our bank credit facility would bear interest at the lower of prime rateless 50 basis points or LIBOR plus 275 basis points.  Gaiam does not have any amounts outstanding under its creditline, so any unfavorable change in interest rates would not have a materialimpact on Gaiam’s results from operations or cash flows unless Gaiam madeborrowings in the future.

 

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

 

In 2003, Gaiam purchased a50.1% interest in Leisure Systems International Limited, a U.K. baseddistributor.  Because Leisure Systems’revenues are primarily denominated in foreign currencies, this investmentexposes Gaiam to accounting risk associated with foreign currency exchange ratefluctuations.  However, we havedetermined that there was no material market risk exposure to our consolidatedfinancial position, results of operations or cash flows as of March 31, 2004.

 

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

 

Effective August 2002, theSecurities and Exchange Commission adopted rules requiring reporting companiesto maintain disclosure controls and procedures to provide reasonable assurancethat a registrant is able to record, process, summarize and report theinformation required in the registrant’s quarterly and annual reports under theSecurities Exchange Act of 1934 (the “Exchange Act”).

 

Gaiam’schief executive office 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 15d-15(e) under the ExchangeAct.  Based upon their evaluation as ofMarch 31, 2004, they have concluded that those disclosure controls andprocedures are effective.  

 

Therehave been no changes in Gaiam’s internal control over financial reporting thathave materially affected, or are reasonably likely to affect, Gaiam’s internalcontrol over financial reporting.   

 

## **PARTII**.                                                OTHER INFORMATION

 

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

 

From time to time, Gaiam is involved in legal proceedings that weconsider to be in the normal course of business.  We do not believe that any of these proceedings will have amaterial adverse effect on our business. 

##### ** **

##### **Item 2**.                    Changes in Securities and Use of Proceeds

 

None.

 

##### **Item 3.**                    Defaults Upon Senior Securities

 

None.

 

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**Item 4.****                   ****Submission****of Matters to a Vote ofSecurity Holders.**

 

None.

 

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

 

None.

 

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

 

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). |

 

b)            Reports on Form 8-K.

 

OnFebruary 26, 2004, Gaiam filed a report on Form 8-K relating to its earningspress release for the fourth quarter and fiscal year 2003.

 

OnMay 6, 2004, Gaiam filed a report on Form 8-K relating to its earnings pressrelease for the first quarter 2004.

 

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### **Signatures**

 

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

 

 
|   | Gaiam,  Inc.            |
|--------|-------------------------|
|   | (Registrant)            |
|   | May  7, 2004            |
|   |                    |
|   |                    |
|   | By:                     | /s/ | Jirka  Rysavy |   |
|   | Jirka Rysavy            |
|   | Chief Executive Officer |
|   |                    |
|   |                    | /s/ | Janet  Mathews |   |
|   | Janet Mathews           |
|   | Chief Financial Officer |
|        |                         |  |  |  |  |

 

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