**United StatesSecurities and Exchange Commission**

**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 Fiscal Quarter EndedSeptember 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, including  area 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 1934during the preceding 12 months (or for such shorter period that the registrantwas required 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 October 30, 2003** |
|----------------------|--------|----------------------------------------------------|
| Class A Common Stock |   |                                               |
| ($.0001 par value)   |   | 9,201,296                                          |
|                 |   |                                               |
| Class B Common Stock |   | 5,400,000                                          |
| ($.0001 par value)   |   |                                               |

 

 

----

 

**INDEX TO FORM 10-Q**

 
| PART I.  | FINANCIAL INFORMATION                                                                                      |
|----------|------------------------------------------------------------------------------------------------------------|
|     |                                                                                                       |
| Item 1.  | Condensed Consolidated Financial Statements  (Unaudited)                                                   |
|     | Condensed Consolidated Balance Sheets at  September 30, 2003 and December 31, 2002               |
|     | Condensed Consolidated Statements of Income  for the three months ended September 30, 2003 and 2002   |
|     | Condensed Consolidated Statements of Income  for the nine months ended September 30, 2003 and 2002    |
|     | Condensed Consolidated Statement of Cash  Flows for the nine months ended September 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                                                                           |

 

Thisreport may contain forward-looking statements that involve risks anduncertainties.  When used in thisdiscussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,”“strive,” “future,” “intend” and similar expressions as they relate to Gaiam 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 taxes on internet or catalog sales, control of Gaiam by its founder,fluctuations in quarterly operating results, consumer trends, customer interestin our products, the effect of government regulation and other risks anduncertainties included in Gaiam’s filings with the Securities and ExchangeCommission.  We caution you that noforward-looking statement is a guarantee of future performance, and you shouldnot place undue reliance on these forward-looking statements which reflect ourmanagement’s view only as of the date of this report.  We undertake no obligation to update any forward-lookinginformation.

 

2

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 
|                                                                                                                                                                                                |   | **September 30,  2003** |       | **December 31,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                                |   | **(Unaudited)**              |       |                        |       |
| **Assets**                                                                                                                                                                                          |   |                         |       |                        |       |
| Current assets:                                                                                                                                                                                     |   |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                           |   | $                            | 7,852,489  |                        | $          | 11,422,435 |   |
| Accounts receivable, net                                                                                                                                                                            |   | 15,866,172                   |       | 21,455,744                  |       |
| Accounts and notes receivable, other                                                                                                                                                                |   | 964,076                      |       | 1,949,832                   |       |
| Inventory, less allowances                                                                                                                                                                          |   | 16,820,313                   |       | 14,768,045                  |       |
| Deferred advertising costs                                                                                                                                                                          |   | 3,232,035                    |       | 2,417,211                   |       |
| Other current assets                                                                                                                                                                                |   | 2,123,408                    |       | 1,194,484                   |       |
| Total current assets                                                                                                                                                                                |   | 46,858,493                   |       | 53,207,751                  |       |
|                                                                                                                                                                                                |   |                         |       |                        |       |
| Property and equipment, net                                                                                                                                                                         |   | 10,155,773                   |       | 9,543,231                   |       |
| Investments                                                                                                                                                                                         |   | 7,865,192                    |       | 7,865,192                   |       |
| Capitalized production costs, net                                                                                                                                                                   |   | 6,154,916                    |       | 4,983,824                   |       |
| Video library, net                                                                                                                                                                                  |   | 5,224,010                    |       | 5,262,586                   |       |
| Goodwill, net                                                                                                                                                                                       |   | 10,288,251                   |       | 7,522,495                   |       |
| Deferred tax assets                                                                                                                                                                                 |   | 2,514,257                    |       | 2,519,244                   |       |
| Other assets                                                                                                                                                                                        |   | 616,693                      |       | 768,043                     |       |
| Total assets                                                                                                                                                                                        |   | $                            | 89,677,585 |                        | $          | 91,672,366 |   |
|                                                                                                                                                                                                |   |                         |       |                        |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                       |   |                         |       |                        |       |
| Current liabilities:                                                                                                                                                                                |   |                         | ** ** |                        | ** ** |
| Accounts payable                                                                                                                                                                                    |   | $                            | 10,802,010 |                        | $          | 11,998,087 |   |
| Accrued liabilities                                                                                                                                                                                 |   | 4,399,734                    |       | 5,709,788                   |       |
| Income taxes payable                                                                                                                                                                                |   | 29,982                       |       | 1,286,558                   |       |
| Capital lease obligations, current                                                                                                                                                                  |   | 118,256                      |       | 269,290                     |       |
| Total current liabilities                                                                                                                                                                           |   | 15,349,982                   |       | 19,263,723                  |       |
|                                                                                                                                                                                                |   |                         |       |                        |       |
| Capital lease obligations, long-term                                                                                                                                                                |   | 9,349                        |       | 54,529                      |       |
| Deferred tax liability                                                                                                                                                                              |   | 943,286                      |       | 848,653                     |       |
| Other liabilities                                                                                                                                                                                   |   | 1,962,000                    |       | 1,962,000                   |       |
| Total liabilities                                                                                                                                                                                   |   | 18,264,617                   |       | 22,128,905                  |       |
|                                                                                                                                                                                                |   |                         |       |                        |       |
| Minority interest                                                                                                                                                                                   |   | 2,820,465                    |       | 172,481                     |       |
|                                                                                                                                                                                                |   |                         |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                          |   |                         |       |                        |       |
| Class A common stock, $.0001 par value,  150,000,000 shares authorized, 9,201,296 and 9,134,098 shares issued and  outstanding at September 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  September 30, 2003 and December 31, 2002, respectively                        |   | 540                          |       | 540                         |       |
| Additional paid-in capital                                                                                                                                                                          |   | 53,823,504                   |       | 53,343,046                  |       |
| Deferred compensation                                                                                                                                                                               |   | (89,865                      | )          | (143,865                    | )          |
| Retained earnings                                                                                                                                                                                   |   | 14,857,404                   |       | 16,170,346                  |       |
| Total stockholders’ equity                                                                                                                                                                     |   | 68,592,503                   |       | 69,370,980                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                     |   | $                            | 89,677,585 |                        | $          | 91,672,366 |   |

 

*See accompanying notes.*

 

3

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 
|                                                                           |   | **For the  Three Months Ended  September 30,** |       |
|--------------------------------------------------------------------------------|--------|-----------------------------------------------------|------------|
|                                                                           |   | **2003**                                            |       | **2002** |   |
|                                                                           |   |                                                |       |   |   |
| Net revenue                                                                    |   | $                                                   | 23,533,439 |   | $ | 25,793,600 |   |
| Cost of goods sold                                                             |   | 11,263,145                                          |       | 10,763,823 |   |
| Gross profit                                                                   |   | 12,270,294                                          |       | 15,029,777 |   |
|                                                                           |   |                                                |       |   |   |
| Expenses:                                                                      |   |                                                |       |   |   |
| Selling and operating                                                          |   | 10,177,799                                          |       | 10,700,319 |   |
| Corporate, general and administration                                          |   | 2,076,380                                           |       | 2,083,780 |   |
| Total expenses                                                                 |   | 12,254,179                                          |       | 12,784,099 |   |
|                                                                           |   |                                                |       |   |   |
| Income from operations                                                         |   | 16,115                                              |       | 2,245,678 |   |
|                                                                           |   |                                                |       |   |   |
| Other income (expense)                                                         |   | (110,281                                            | )          | (161,677 | ) |
| Interest income                                                                |   | 17,637                                              |       | 41,654 |   |
| Total other income (expense)                                                   |   | (92,644                                             | )          | (120,023 | ) |
|                                                                           |   |                                                |       |   |   |
|                                                                           |   |                                                |       |   |   |
| Income (loss) before income taxes and  minority interest                       |   | (76,529                                             | )          | 2,125,655 |   |
|                                                                           |   |                                                |       |   |   |
| Provision for income tax (benefit) expense                                     |   | (43,790                                             | )          | 754,607 |   |
| Minority interest in net (income) loss of  consolidated subsidiary, net of tax |   | (168,471                                            | )          | 23,744 |   |
| Net income (loss)                                                              |   | $                                                   | (201,210   | ) | $ | 1,394,792 |   |
|                                                                           |   |                                                |       |   |   |
| Net income (loss) per share:                                                   |   |                                                |       |   |   |
| Basic                                                                          |   | $                                                   | (0.01      | ) | $ | 0.10 |   |
| Diluted                                                                        |   | $                                                   | (0.01      | ) | $ | 0.10 |   |
|                                                                           |   |                                                |       |   |   |   |   |
| Shares used in computing net income (loss)  per share:                         |   |                                                |       |   |   |
| Basic                                                                          |   | 14,601,121                                          |       | 14,033,066 |   |
| Diluted                                                                        |   | 14,601,121                                          |       | 14,376,074 |   |

 

*See accompanying notes.*

 

4

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 
|                                                                           |   | **For the  Nine Months Ended  September 30,** |       |
|--------------------------------------------------------------------------------|--------|----------------------------------------------------|------------|
|                                                                           |   | **2003**                                           |       | **2002** |   |
|                                                                           |   |                                               |       |   |   |
| Net revenue                                                                    |   | $                                                  | 67,253,505 |   | $ | 74,144,566 |   |
| Cost of goods sold                                                             |   | 31,547,000                                         |       | 30,663,662 |   |
| Gross profit                                                                   |   | 35,706,505                                         |       | 43,480,904 |   |
|                                                                           |   |                                               |       |   |   |
| Expenses:                                                                      |   |                                               |       |   |   |
| Selling and operating                                                          |   | 30,302,803                                         |       | 31,731,033 |   |
| Corporate, general and administration                                          |   | 6,776,928                                          |       | 6,651,791 |   |
| Total expenses                                                                 |   | 37,079,731                                         |       | 38,382,824 |   |
|                                                                           |   |                                               |       |   |   |
| Income (loss) from operations                                                  |   | (1,373,226                                         | )          | 5,098,080 |   |
|                                                                           |   |                                               |       |   |   |
| Other income (expense)                                                         |   | (286,659                                           | )          | (414,618 | ) |
| Interest income                                                                |   | 44,082                                             |       | 155,134 |   |
| Total other income (expense)                                                   |   | (242,577                                           | )          | (259,484 | ) |
|                                                                           |   |                                               |       |   |   |
| Income (loss) before income taxes and  minority interest                       |   | (1,615,803                                         | )          | 4,838,596 |   |
|                                                                           |   |                                               |       |   |   |
| Provision for income tax (benefit) expense                                     |   | (647,838                                           | )          | 1,717,701 |   |
| Minority interest in net (income) loss of  consolidated subsidiary, net of tax |   | (344,977                                           | )          | 12,947 |   |
| Net income (loss)                                                              |   | $                                                  | (1,312,942 | ) | $ | 3,133,842 |   |
|                                                                           |   |                                               |       |   |   |
| Net income (loss) per share:                                                   |   |                                               |       |   |   |
| Basic                                                                          |   | $                                                  | (0.09      | ) | $ | 0.22 |   |
| Diluted                                                                        |   | $                                                  | (0.09      | ) | $ | 0.22 |   |
|                                                                           |   |                                               |       |   |   |
| Shares used in computing net income (loss)  per share:                         |   |                                               |       |   |   |
| Basic                                                                          |   | 14,591,428                                         |       | 14,020,392 |   |
| Diluted                                                                        |   | 14,591,428                                         |       | 14,458,952 |   |

 

*See accompanying notes.*

 

5

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 
|                                                                                                |   | **For the Nine Months  Ended September 30,** |       |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------------------|------------|
|                                                                                                |   | **2003**                                          |       | **2002** |   |
| **Operating activities**                                                                            |   |                                              |       |   |   |
| Net income (loss)                                                                                   |   | $                                                 | (1,312,942 | ) | $ | 3,133,843 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                              |       |   |   |
| Depreciation                                                                                        |   | 1,965,979                                         |       | 1,478,232 |   |
| Amortization                                                                                        |   | 435,177                                           |       | 258,893 |   |
| Stock compensation                                                                                  |   | 54,000                                            |       | 54,000 |   |
| Minority interest in consolidated  subsidiary                                                       |   | 344,977                                           |       | 3,139 |   |
| Deferred tax expense                                                                                |   | 99,620                                            |       | — |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:                     |   |                                              |       |   |   |
| Accounts receivable                                                                                 |   | 8,269,294                                         |       | (4,029,332 | ) |
| Inventory                                                                                           |   | (783,455                                          | )          | 612,138 |   |
| Deferred advertising costs                                                                          |   | (814,824                                          | )          | (1,151,569 | ) |
| Capitalized production costs                                                                        |   | (1,171,092                                        | )          | (1,231,385 | ) |
| Other current assets                                                                                |   | (361,273                                          | )          | (453,081 | ) |
| Other assets                                                                                        |   | 151,350                                           |       | (53,015 | ) |
| Accounts payable                                                                                    |   | (1,707,461                                        | )          | (1,009,910 | ) |
| Accrued liabilities                                                                                 |   | (1,877,715                                        | )          | (3,498,962 | ) |
| Income taxes payable                                                                                |   | (1,718,042                                        | )          | (101,475 | ) |
| Net cash (used in) provided by operating  activities                                                |   | 1,573,593                                         |       | (5,988,484 | ) |
|                                                                                                |   |                                              |       |   |   |
| **Investing activities**                                                                            |   |                                              |       |   |   |
| Purchase of property and equipment, and  media rights                                               |   | (1,234,447                                        | )          | (2,142,644 | ) |
| Proceeds from sale of property and  equipment                                                       |   | —                                            |       | 2,748,292 |   |
| Payments for acquisitions, net of cash  acquired                                                    |   | (3,787,301                                        | )          | 255,230 |   |
| Net cash (used in) provided by investing  activities                                                |   | (5,021,748                                        | )          | 860,878 |   |
|                                                                                                |   |                                              |       |   |   |
| **Financing activities**                                                                            |   |                                              |       |   |   |
| Principal payments on capital leases                                                                |   | (243,806                                          | )          | (156,176 | ) |
| Proceeds from issuance of common stock                                                              |   | 122,015                                           |       | 176,841 |   |
| Net cash (used in) provided by financing  activities                                                |   | (121,791                                          | )          | 20,665 |   |
|                                                                                                |   |                                              |       |   |   |
| Net change in cash and cash equivalents                                                             |   | (3,569,946                                        | )          | (5,106,941 | ) |
| Cash and cash equivalents at beginning of  period                                                   |   | 11,422,435                                        |       | 22,243,647 |   |
| Cash and cash equivalents at end of period                                                          |   | $                                                 | 7,852,489  |   | $ | 17,136,706 |   |
|                                                                                                |   |                                              |       |   |   |
| **Supplemental cash flow information**                                                              |   |                                              |       |   |   |
| Interest paid                                                                                       |   | $                                                 | 40,221     |   | $ | 45,115 |   |
| Common stock issued for acquisitions                                                                |   | 347,500                                           |       | — |   |
| Income taxes paid                                                                                   |   | 1,033,400                                         |       | 2,367,737 |   |

* *

*See accompanying notes.*

 

6

----

 

Gaiam, Inc.

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

September 30, 2003

 

1.                                       Interim Condensed Consolidated FinancialStatements

 

###### Organizationand Nature of Operations

 

Gaiam, Inc. is a multi-channel lifestyle companyproviding a broad selection of information, products and services to customerswho value natural health, personal development, and renewable energy.  Gaiam was incorporated under the laws of theState of Colorado on July 7, 1988.

 

The accompanying consolidated financial statementsinclude the accounts of Gaiam, its subsidiaries and partnerships in whichownership is greater than 50% and considered to be under the control ofGaiam.  All material intercompanyaccounts and transaction balances have been eliminated in consolidation.

 

Preparation of Interim Condensed Consolidated Financial Statements

 

The interim condensed consolidated financialstatements included herein have been prepared by the management of Gaiampursuant to the rules and regulations of the United States Securities and ExchangeCommission, and, in the opinion of management, contain all adjustments(consisting of only normal recurring adjustments) necessary to present fairlyGaiam’s consolidated financial position as of September 30, 2003, theinterim results of operations for the three and nine months endedSeptember 30, 2003 and 2002, and cash flows for the nine months endedSeptember 30, 2003 and 2002.  Theseinterim statements have not been audited. The balance sheet as of December 31, 2002 was derived from Gaiam’saudited consolidated financial statements included in Gaiam’s annual report onForm 10-K.

 

Certain information and footnote disclosuresnormally included in consolidated financial statements prepared in accordancewith generally accepted accounting principals have been condensed or omittedpursuant to such rules and regulations. Accounting policies followed by Gaiam are described in Note 1 to theaudited financial statements for the fiscal year ended December 31, 2002included in Gaiam’s annual report on Form 10-K.  The consolidated financial statements contained herein should beread in conjunction with the audited financial statements, including the notesthereto, for the year ended December 31, 2002.

 

The consolidated financial position, results ofoperations and cash flows for the interim periods disclosed within this reportare not necessarily indicative of future financial results.

 

Use of Estimates

 

The preparation of the consolidated financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses and disclosure of contingentassets and liabilities at the date of the consolidated financial statements.  Actual results could differ from thoseestimates.

 

7

----

 

Adoption of Accounting Standards

 

In June 2001, the FASBissued Statement of Financial Accounting Standards (“SFAS”) No. 143,“Accounting for Asset Retirement Obligations” (“SFAS No. 143”), which setsforth the financial accounting and reporting to be followed for obligationsassociated with the retirement of tangible long-lived assets and the associatedasset retirement costs.  SFAS No. 143requires that the fair value of a liability for an asset retirement obligationbe recorded in the period in which it is incurred if a reasonable estimate offair value can be made.  The associatedasset retirement costs must be capitalized as part of the carrying amount ofthe long-lived asset.  Subsequently, therecorded liability will be accreted to its present value and the capitalizedcosts will be depreciated.  Gaiamadopted SFAS No. 143 in its consolidated financial statements for the firstquarter of 2003. The adoption of SFAS No. 143 did not have a material impact onGaiam’s consolidated financial statements.

 

In May 2002, the FASBissued 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 statement rescinds FASB No.4, “Reporting Gains and Losses from Extinguishment of Debt, and an amendment ofthat statement, FASB No. 64, “Extinguishments of Debt Made to Satisfy SinkingFund Requirements.”  As a result, gainsand losses from extinguishments of debt will no longer be aggregated andclassified as an extraordinary item, net of related income tax effect, on thestatement of earnings.  SFAS No. 145 iseffective for fiscal years beginning after May 15, 2002, with earlierapplication encouraged.  Gaiam hasadopted SFAS No. 145, as required, in its consolidated financial statementseffective the first quarter of 2003. The adoption of SFAS No. 145 did not have a material impact on Gaiam’sconsolidated financial statements.

 

In July 2002, the FASBissued statement No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (“SFAS No. 146”). SFAS No. 146 requires that a liability for a cost associated with anexit 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. 146 effective thefirst quarter of 2003. The adoption of SFAS No. 146 did not have a materialimpact on Gaiam’s consolidated financial statements.

 

In December 2002, theFASB issued statement No. 148, “Accounting for Stock-Based Compensation –Transition and Disclosure, an Amendment of FASB Statement No. 123” (“SFAS No.148”).  SFAS No. 148 amends FASBstatement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123’)to provide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  Gaiam has elected to use the intrinsic valuemethod of accounting for stock compensation for options granted to employeesand directors in accordance with APB 25. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No.123 to require prominent disclosure in both annual and interim financialstatements about the method of accounting for stock-based employee compensationand the effect of the method of accounting used on reported results. Gaiam hasadopted SFAS No. 148 in its fiscal year reporting effective December 31,2002 and its interim reporting as of the first quarter of 2003.

 

8

----

 

In April 2003, the FASBissued statement No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities” (“SFAS No. 149”). SFAS No. 149 amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under FASB Statement No. 133, *Accounting for Derivative Instruments and HedgingActivities*.  SFAS No. 149 iseffective for contracts entered into or modified after June 30, 2003, andfor hedging relationships designated after June 30, 2003.  Gaiam does not currently have any derivativeinstruments, nor does Gaiam currently participate in hedging activities.  Therefore, Gaiam’s adoption of SFAS No. 149,as required, did not have a material impact on Gaiam’s consolidated financialstatements.

 

In May 2003, the FASBissued statement No. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity” (“SFAS No. 150”).  SFAS No. 150 establishes standards forclassification and measurement of certain financial instruments withcharacteristics 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 thebeginning of the first interim period beginning after June 15, 2003.  Gaiam adopted SFAS No. 150 in its interimreporting as of the third quarter of 2003, and adoption of this statement didnot have a material impact on Gaiam’s consolidated financial statements.

 

Stock Based Compensation

 

As required by SFAS Nos. 123and 148, Gaiam has determined pro forma net income (loss) and net income (loss)per common share as if compensation costs had been determined based on the fairvalue of the options granted and then recognized ratably over the vestingperiod. The fair value of stock option grants has been estimated at the date ofgrant using the Black-Scholes option pricing model.  Had compensation cost for Gaiam’s stock-based compensation planbeen determined under the fair value methodology for determining compensationcost under SFAS No. 123, Gaiam’s net income (loss) and income (loss) per sharewould have been as follows:

 
|                                                                                                                                         |   | **Three  Months Ended  September 30,** |     | **Nine  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|----------|--------------------------------------------|--------|
|                                                                                                                                         |   | **2003**                                    |     | **2002**                                   |   | **2003** |   | **2002** |   |
| Net income (loss) as reported                                                                                                                |   | $                                           | (201,210 | )                                          | $      | 1,394,792 |   | $ | (1,312,942 | ) | $ | 3,133,842 |   |
| Deduct:   Total stock-basedcompensation  expenses determined under fair  value based method for all  awards net of related tax  effects |   | (142,912                                    | )        | 225,365                                    |   | 248,135 |   | 609,532 |   |
| Pro forma                                                                                                                                    |   | $                                           | (58,298  | )                                          | $      | 1,169,427 |   | $ | (1,561,077 | ) | $ | 2,524,310 |   |
| Net income (loss) per common share                                                                                                           |   |                                        |     |                                       |   |   |   |   |   |
| As reported                                                                                                                                  |   | $                                           | (0.01    | )                                          | $      | 0.10 |   | $ | (0.09 | ) | $ | 0.22 |   |
| Pro forma                                                                                                                                    |   | $                                           | (0.00    | )                                          | $      | 0.08 |   | $ | (0.11 | ) | $ | 0.18 |   |
|                                                                                                                                         |   |                                        |     |                                       |   |   |   |   |   |
| Fully diluted net income (loss)per common share:                                                                                             |   |                                        |     |                                       |   |   |   |   |   |
| As reported                                                                                                                                  |   | $                                           | (0.01    | )                                          | $      | 0.10 |   | $ | (0.09 | ) | $ | 0.22 |   |
| Pro forma                                                                                                                                    |   | $                                           | (0.00    | )                                          | $      | 0.08 |   | $ | (0.11 | ) | $ | 0.17 |   |

 

9

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2.                                       Mergers and Acquisitions

 

InJanuary 2003, Gaiam acquired a 50.1% interest in Leisure Systems InternationalLtd., a U.K. based distributor and marketer of lifestyle products, forapproximately $4.3 million in cash and 50,000 shares of Gaiam Class A commonstock.  This acquisition was accountedfor using the purchase method and approximately $2.8 million of goodwill wasrecorded.  The results of operations ofLeisure Systems International are included in the consolidated financialstatements of Gaiam from the effective acquisition date of January 1,2003.  The revenue generated by thisacquisition for the three and nine months ended September 30, 2003 wasapproximately $3.3 million and $10.2 million, respectively.

 

3.                                       Stockholders’ Equity

 

Duringthe first quarter of 2003, Gaiam issued 50,000 shares of Class A common stockin conjunction with the acquisition of 50.1% of Leisure Systems Internationaland 3,750 shares of Class A common stock to four directors in lieu of cashcompensation. In addition, for the nine months ended September 30, 2003,Gaiam issued 13,448 shares of Class A common stock upon exercise of optionsgranted under Gaiam’s 1999 Long-Term Incentive Plan.

 

4.                                       Earnings per Share

 

Basic earnings per share exclude any dilutive effects of options anddilutive securities.  Basic earnings pershare 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 if their effect is antidilutive.  All earnings per share amounts for all periods have beenpresented and conform to the requirements of SFAS No. 128.

 

The following table sets forth the computation of basic and dilutedearnings per share:

 
|                                                          |   | **Three  Months Ended  September 30,** |     | **Nine  Months Ended  September 30,** |   |
|---------------------------------------------------------------|--------|---------------------------------------------|----------|--------------------------------------------|--------|
|                                                          |   | **2003**                                    |     | **2002**                                   |   | **2003** |   | **2002** |   |
|                                                          |   |                                        |     |                                       |   |   |   |   |   |
| Net income (loss)                                             |   | $                                           | (201,210 | )                                          | $      | 1,394,792 |   | $ | (1,312,942 | ) | $ | 3,133,842 |   |
|                                                          |   |                                        |     |                                       |   |   |   |   |   |
| Denominator:                                                  |   |                                        |     |                                       |   |   |   |   |   |
| Weighted average shares for basic earnings per share          |   | 14,601,121                                  |     | 14,033,066                                 |   | 14,591,428 |   | 14,020,392 |   |
|                                                          |   |                                        |     |                                       |   |   |   |   |   |
| Effect of Dilutive Securities:                                |   |                                        |     |                                       |   |   |   |   |   |
| Weighted average of common stock, stock options  and warrants |   | —                                      |     | 343,008                                    |   | — |   | 438,560 |   |
|                                                          |   |                                        |     |                                       |   |   |   |   |   |
| Denominator for diluted earnings per share                    |   | 14,601,121                                  |     | 14,376,074                                 |   | 14,591,428 |   | 14,458,952 |   |
|                                                          |   |                                        |     |                                       |   |   |   |   |   |
| Net income (loss) per share – basic                      |   | $                                           | (0.01    | )                                          | $      | 0.10 |   | $ | (0.09 | ) | $ | 0.22 |   |
| Net income (loss) per share – diluted                    |   | $                                           | (0.01    | )                                          | $      | 0.10 |   | $ | (0.09 | ) | $ | 0.22 |   |

 

10

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5.                                       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:

 
|                                                               |   | **For the  Three Months  Ended September 30,** |       | **For the  Nine Months  Ended September 30,** |   |
|--------------------------------------------------------------------|--------|------------------------------------------------|------------|-----------------------------------------------|--------|
|                                                               |   | **2003**                                       |       | **2002**                                      |   | **2003** |   | **2002** |   |
| Net revenue:                                                       |   |                                           |       |                                          |   |   |   |   |   |
| Direct to consumer                                                 |   | $                                              | 11,579,062 |                                          | $      | 12,772,864 |   | $ | 33,041,370 |   | $ | 35,455,764 |   |
| Business to business                                               |   | 11,954,377                                     |       | 13,020,736                                    |   | 34,212,135 |   | 38,688,802 |   |
| Consolidated net revenue                                           |   | 23,533,439                                     |       | 25,793,600                                    |   | 67,253,505 |   | 74,144,566 |   |
| Contribution margin:                                               |   |                                           |       |                                          |   |   |   |   |   |
| Direct to consumer                                                 |   | 194,735                                        |       | 452,020                                       |   | 343,408 |   | 769,007 |   |
| Business to business                                               |   | (178,620                                       | )          | 1,793,658                                     |   | (1,716,634 | ) | 4,329,073 |   |
| Consolidated contribution margin (loss)                            |   | 16,115                                         |       | 2,245,678                                     |   | (1,373,226 | ) | 5,098,080 |   |
| Reconciliation of contribution margin (loss) to net income (loss): |   |                                           |       |                                          |   |   |   |   |   |
| Other income (expense)                                             |   | (92,644                                        | )          | (120,023                                      | )      | (242,577 | ) | (259,484 | ) |
| Income tax (benefit) expense                                       |   | (43,790                                        | )          | 754,607                                       |   | (647,838 | ) | 1,717,701 |   |
| Minority interest income (expense)                                 |   | (168,471                                       | )          | 23,744                                        |   | (344,977 | ) | 12,947 |   |
| Net income (loss)                                                  |   | $                                              | (201,210   | )                                             | $      | 1,394,792 |   | $ | (1,312,942 | ) | $ | 3,133,842 |   |

 

**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 September 30, 2003 compared to three months ended September 30, 2002

 

Revenues of $23.5 millionfor the three months ended September 30, 2003 declined 9% from $25.8 millionfor the three months ended September 30, 2002. Gaiam’s decrease in revenues was primarily due to lower sales in Gaiam’sbusiness to business retailer channel, as Gaiam continued to experienceweakness in sales made into retail channels through outside distributors,mall-based specialty stores and sporting goods outlets.

 

11

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Gross profit, which consistsof revenues less cost of sales (primarily merchandise acquisition costs andin-bound freight), decreased to $12.3 million for the third quarter of 2003from $15 million during the same period in 2002.  As a percentage of revenue, gross profit declined to 52.1% in2003 from 58.3% in 2002.  This wasprimarily attributable to increased sales contribution from Gaiam’s lowermargin divisions, and from margin contraction in the retailer channel due to aproduct shift to accessories.

 

Selling and operatingexpenses (which consist primarily of sales and marketing costs, commission andfulfillment expenses) decreased to $10.2 million for the three months endedSeptember 30, 2003 as compared to $10.7 million in the same period of 2002,primarily resulting from cost reductions gained through the consolidation ofcertain operations into Gaiam’s Colorado headquarters and other cost reductionmeasures.   As a percentage of revenues,selling and operating expenses increased to 43.2% in 2003 from 41.5% in 2002due to the lower sales base.

 

Corporate, general andadministration expenses were flat at $2.1 million for the third quarter of 2003and 2002, but increased in 2003 to 8.8% of revenues from 8.1% of revenues in2002, due to the 9% reduction in the sales base.

 

Operating income, as aresult of the factors described above, declined to $16,115 for the three monthsended September 30, 2003 compared to an operating profit of $2,245,678 for thethree months ended September 30, 2002 primarily due to lower sales and grossprofit.

 

Gaiam recorded $92,644 inother expense for the three months ended September 30, 2003 compared to$120,023 recorded in the prior year period. The share of net income associatedwith minority interest was $168,471 during the third quarter of 2003, comparedto a net loss of $23,744 associated with minority interest during the thirdquarter of 2002.   Minority interestchanged year-over-year primarily due to Gaiam’s purchase of a majority interestin Leisure Systems International, a distributor of wellness products based inthe U.K, during the first quarter of 2003.

 

Gaiam recorded an income taxbenefit of $43,790 for the three months ended September 30, 2003 compared to anincome tax provision of $754,607 for the three months ended September 30, 2002.

 

As a result of the factorsdescribed above, Gaiam’s net loss was $201,210 for the three month endedSeptember 30, 2003 compared to net income of $1,394,792 recorded for the threemonths ended September 30, 2002.

 

Nine monthsended September 30, 2003 compared to nine months ended September 30, 2002

 

Revenues decreased to $67.3million for the nine months ended September 30, 2003 from $74.1 million duringthe nine months ended September 30, 2002, primarily due to a decrease ofapproximately 37% in 2003 revenues generated in Gaiam’s domestic business tobusiness segment as compared to 2002. Sales to department stores, mall-based specialty stores, and salesthrough distributors into retail chains all were lower during the first ninemonths of 2003.

 

Gross profit decreased to$35.7 million for the nine months ended September 30, 2003 from $43.5 millionduring the same period in 2002.  As apercentage of revenue, gross profit declined to 53.1% in 2003 from 58.6% in2002.  This was primarily attributableto narrowing margins from Gaiam’s business-to-business channel as Gaiam’sproduct mix shifted from media to accessories, and Gaiam’s revenue compositionshifted to lower margins divisions, including those associated with Gaiam’sacquisition activity.

 

12

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Selling and operatingexpenses decreased to $30.3 million for the nine months ended September 30,2003 from $31.7 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 45.1% in 2003 from 42.8% in 2002, primarily due to the reductionin the sales base.

 

Corporate, general andadministration expenses increased to $6.8 million for the nine months endedSeptember 30, 2003, compared to $6.7 million for the corresponding period in2002, primarily due to an increase in expenses associated with the inclusion ofLeisure Systems International in 2003, which was partially offset by costreduction measures enacted during the first half of 2003.  As a percentage of revenues, general andadministrative expenses increased to 10.1% in 2003 from 9.0% in 2002, primarilydue to a reduction in the sales base.

 

Operating loss, as a resultof the factors described above, was $1.4 million for the nine months endedSeptember 30, 2003 as compared to operating income of $5.1 million for the sameperiod in 2002.

 

Gaiam recorded $242,577 inother expense during the nine months ended September 30, 2003, compared to$259,484 for the comparable period in 2002. For the nine months ended September 30, 2003, the minority interestshare of net income was $344,977, as compared to a $12,947 minority interestshare of net losses in the comparable 2002 period.  Minority interest income increased year-over-year due to Gaiam’spurchase of a majority interest in Leisure Systems International, during thefirst quarter of 2003.

 

Gaiam recorded an income taxbenefit of $647,838 for the nine months ended September 30, 2003, as comparedto an income tax provision of $1.7 million in the same period 2002.

 

Net loss, as a result of thefactors described above, was $1.3 million for the nine months ended September30, 2003 as compared to net income of $3.1 million for the same period in 2002.

 

Liquidity andCapital Resources

 

Gaiam’s capital needs arisefrom working capital required to fund operations, capital expenditures relatedto 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 toevaluate possible investments in businesses, products and technologies, andplans to expand sales and marketing programs and conduct more aggressive brandpromotions.

 

Gaiam’s operating activitiesprovided net cash of $1.6 million for the nine months ended September 30, 2003compared to cash usage of $6 million for the nine months ended September 30,2002.  Gaiam’s net cash provided byoperating activities in 2003 was primarily due to a significant reduction inaccounts receivable of $8.3 million, which was partially offset by a reductionin the level of payables.  Gaiam’s netcash used by operating activities in the first nine months of 2002 wasprimarily due to an increase in accounts receivable of $4.0 million.

 

13

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Gaiam’s investing andacquisition activities used cash of $5.0 million and provided cash of $860,878for the nine months ended September 30, 2003 and 2002, respectively.  In January 2003, Gaiam acquired a 50.1%interest in Leisure Systems International, Ltd.  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 $121,791 for the nine months ended September 30, 2003, primarilyfor principal payments on capital leases, and provided cash of $20,665 for thenine months ended September 30, 2002, primarily from the exercise of stockoptions.

 

Gaiam believes its availablecash, cash generated from operations, and borrowing capabilities of $15 million(unused line of credit) will be sufficient to fund Gaiam’s operations on both ashort-term and long-term basis. However, Gaiam’s projected cash needs may change as a result ofacquisitions, unforeseen operational difficulties or other factors.

 

In the normal course of itsbusiness, Gaiam investigates, evaluates and discusses acquisition, jointventure, minority investment, strategic relationship and other businesscombination opportunities in the LOHAS (Lifestyles of Health andSustainability) market.  In the event ofany future investment, acquisition or joint venture opportunities, Gaiam mayconsider using then-available liquidity, issuing equity securities or incurringadditional indebtedness.

 

CriticalAccounting Policies

 

Gaiam has not had any significant changesin its critical accounting policies fromits Form 10-K filing for the fiscal year ended December 31, 2002.

 

**Item 3.****                    Quantitative****and Qualitative Disclosures About Market Risk**

 

Gaiam does not believe thatany of its financial instruments have significant risk associated with marketsensitivity.  Gaiam is not exposed tomaterial financial market risks from changes in foreign exchange rates and areonly minimally impacted by changes in interest rates.

 

 In the future, Gaiam may enter into transactions denominated innon-U.S. currencies, which could increase its exposure to these marketrisks.  Gaiam has not used, and currentlydo not contemplate using, any derivative financial instruments.

 

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

 

Based on their evaluation ofGaiam’s 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, Gaiam’s ChiefExecutive Officer and Chief Financial Officer have concluded that thesedisclosure controls and procedures are effective. There were no significantchanges in Gaiam’s internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation.

 

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

 

**Item 1.****                    LegalProceedings**

 

No legalproceedings became reportable during the third quarter of 2003 and there wereno material developments in any previously reported legal proceedings.

 

14

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| **Item 2.** | **Changes in Securities and Use of Proceeds**             |
|-------------|-----------------------------------------------------------|
|        |                                                      |   |
|        | None.                                                     |
|        |                                                      |   |
| **Item 3.** | **Defaults Upon Senior Securities**                       |
|        |                                                      |   |
|        | None.                                                     |
|        |                                                      |   |
| **Item 4.** | **Submission of Matters to a Vote of Security  Holders.** |
|        |                                                      |   |
|        | None.                                                     |
|        |                                                      |   |
| **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.                                                                                                        |
|   |                                                                                                                        |
|   | On October 29, 2003,  Gaiam filed a report on Form 8-K relating to its earnings press release for  third quarter 2003. |

 

15

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**Signatures**

 

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

 

 
|   | Gaiam, Inc.  (Registrant)  October 30, 2003 |
|--------|---------------------------------------------|
|   |                                        |
|   |                                        |
|   | By:                                         | /s/ | Jirka Rysavy |   |
|   |                                        | Jirka Rysavy  Chief Executive Officer |
|   |                                        |   |
|   |                                        | /s/ | Janet  Mathews |   |
|   |                                        | Janet  Mathews  Chief Financial Officer |

 

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