**UnitedStatesSecurities 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 September 30,2005**

** **

**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 theSecurities and Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Exchange Act Rule 12b-2). Yes o  No ý

 

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 November 8, 2005** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|
| Class A  Common Stock  ($.0001 par value) |       | 14,846,485                                    |       |
|                                      |       |                                          |       |
| Class B Common Stock  ($.0001 par value)  |       | 5,400,000                                     |       |

 

 

----

 

**INDEX TO FORM 10-Q**

 
| PART  I.   | FINANCIAL  INFORMATION                                                                                  |   |
|------------|---------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                    |   |
| Item  1.   | Condensed Consolidated Financial Statements  (Unaudited)                                                |   |
|       | Condensed Consolidated Balance Sheets at September 30,  2005 and December 31, 2004                      |   |
|       | Condensed Consolidated Statements of Operations for  the three months ended September 30, 2005 and 2004 |   |
|       | Condensed Consolidated Statements of Operations for  the nine months ended September 30, 2005 and 2004  |   |
|       | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2005 and 2004  |   |
|       | 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.    | Unregistered Sales of Equity  Securities and Use of Proceeds                                            |   |
|       |                                                                                                    |   |
| Item 3.    | Defaults Upon Senior  Securities                                                                        |   |
|       |                                                                                                    |   |
| Item 4.    | Submission of Matters to a  Vote of Security Holders                                                    |   |
|       |                                                                                                    |   |
| Item 5.    | Other Information                                                                                       |   |
|       |                                                                                                    |   |
| Item 6.    | Exhibits                                                                                                |   |
|       |                                                                                                    |   |
| SIGNATURES |                                                                                                    |   |

 

FORWARD-LOOKINGSTATEMENTS

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 or its managementare 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 and Analysisof Financial Condition and Results of Operations,” “Market Risk” and elsewherein this report.  Risks and uncertaintiesthat could cause actual results to differ include, without limitation, generaleconomic conditions, competition, loss of key personnel, pricing, brandreputation, consumer trends, acquisitions, new initiatives undertaken by Gaiam,security and information systems, legal liability for website content,merchandise supply problems, failure of third parties to provide adequateservice, our reliance on centralized customer service, overstocks andmerchandise returns, our reliance on a centralized fulfillment center,increases in postage and shipping costs, E-commerce trends, future Internetrelated taxes, control of Gaiam by its founder, fluctuations in quarterlyoperating results, customer interest in our products, the effect of governmentregulation and other risks and uncertainties included in Gaiam’s filings withthe Securities and Exchange Commission. We caution you that no forward-looking statement is a guarantee offuture performance, and you should not place undue reliance on theseforward-looking statements which reflect our management’s view only as of thedate of this report.  We undertake noobligation to update any forward-looking information.

 

2

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share information)

 
| ** **                                                                                                                                                                                | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| **Assets**                                                                                                                                                                                |       |                    |       |                   |       |
| ** **                                                                                                                                                                                |       |                    |       |                   |       |
| Current assets:                                                                                                                                                                           |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                 |       | $                       | 10,247     |                   | $          | 10,439 |   |
| Accounts receivable, net                                                                                                                                                                  |       | 20,863                  |       | 13,914                 |       |
| Income tax and other receivables                                                                                                                                                          |       | 3,008                   |       | 3,000                  |       |
| Inventory, less allowances                                                                                                                                                                |       | 21,186                  |       | 16,503                 |       |
| Prepaid expenses                                                                                                                                                                          |       | 5,466                   |       | 1,324                  |       |
| Deferred advertising costs                                                                                                                                                                |       | 4,312                   |       | 2,635                  |       |
| Deferred tax assets                                                                                                                                                                       |       | 523                     |       | 1,145                  |       |
| Total current assets                                                                                                                                                                      |       | 65,605                  |       | 48,960                 |       |
|                                                                                                                                                                                      |       |                    |       |                   |       |
| Property and equipment, net                                                                                                                                                               |       | 7,683                   |       | 7,857                  |       |
| Investments                                                                                                                                                                               |       | 15,318                  |       | 7,865                  |       |
| Capitalized production costs, net                                                                                                                                                         |       | 5,161                   |       | 5,457                  |       |
| Media library, net                                                                                                                                                                        |       | 15,634                  |       | 5,427                  |       |
| Intangible assets and goodwill                                                                                                                                                            |       | 24,439                  |       | 9,757                  |       |
| Non-current deferred tax assets                                                                                                                                                           |       | 3,883                   |       | 2,657                  |       |
| Other assets                                                                                                                                                                              |       | 1,417                   |       | 307                    |       |
| Total assets                                                                                                                                                                              |       | $                       | 139,140    |                   | $          | 88,287 |   |
|                                                                                                                                                                                      |       |                    |       |                   |       |
| **Liabilities and stockholders’ equity**                                                                                                                                             |       |                    |       |                   |       |
| Current liabilities:                                                                                                                                                                      | ** ** | ** **              | ** ** | ** **             | ** ** |
| Accounts payable                                                                                                                                                                          |       | $                       | 11,539     |                   | $          | 12,910 |   |
| Accrued liabilities                                                                                                                                                                       |       | 7,673                   |       | 3,160                  |       |
| Accrued royalties                                                                                                                                                                         |       | 9,305                   |       | 538                    |       |
| Income taxes payable                                                                                                                                                                      |       | 397                     |       | 864                    |       |
| Total current liabilities                                                                                                                                                                 |       | 28,914                  |       | 17,472                 |       |
|                                                                                                                                                                                      |       |                    |       |                   |       |
| Long-term liabilities                                                                                                                                                                     |       | 989                     |       | —                 |       |
| Total liabilities                                                                                                                                                                         |       | 29,903                  |       | 17,472                 |       |
|                                                                                                                                                                                      |       |                    |       |                   |       |
| Minority interest                                                                                                                                                                         |       | 4,487                   |       | 4,469                  |       |
|                                                                                                                                                                                      |       |                    |       |                   |       |
| Commitments and contingencies                                                                                                                                                             |       |                    |       |                   |       |
|                                                                                                                                                                                      |       |                    |       |                   |       |
| Stockholders’ equity:                                                                                                                                                                |       |                    |       |                   |       |
| Class A common stock, $.0001 par value,  150,000,000 shares authorized, 14,833,555 and 9,411,897 shares issued and outstanding  at September 30, 2005 and December 31, 2004, respectively |       | 1                       |       | 1                      |       |
| Class B common stock, $.0001 par value,  50,000,000 shares authorized, 5,400,000 issued and outstanding at September 30,  2005 and December 31, 2004                            |       | 1                       |       | 1                      |       |
| Additional paid-in capital                                                                                                                                                                |       | 93,890                  |       | 54,933                 |       |
| Accumulated other comprehensive income                                                                                                                                                    |       | 442                     |       | 850                    |       |
| Retained earnings                                                                                                                                                                         |       | 10,416                  |       | 10,561                 |       |
| Total stockholders’ equity                                                                                                                                                           |       | 104,750                 |       | 66,346                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                           |       | $                       | 139,140    |                   | $          | 88,287 |   |

 

*See accompanying notes to the condensedconsolidated financial statements.*

 

3

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 
| ** **                                                                | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
|                                                                      |       |                                          |       |   |   |
| Net revenue                                                               |       | $                                             | 30,139     |   | $ | 21,023 |   |
| Cost of goods sold                                                        |       | 13,426                                        |       | 11,196 |   |
| Gross profit                                                              |       | 16,713                                        |       | 9,827 |   |
|                                                                      |       |                                          |       |   |   |
| Expenses:                                                                 |       |                                          |       |   |   |
| Selling and operating                                                     |       | 13,682                                        |       | 10,270 |   |
| Corporate, general and administration                                     |       | 2,153                                         |       | 1,881 |   |
| Total expenses                                                            |       | 15,835                                        |       | 12,151 |   |
|                                                                      |       |                                          |       |   |   |
| Income (loss) from operations                                             |       | 878                                           |       | (2,324 | ) |
|                                                                      |       |                                          |       |   |   |
| Other income (expense)                                                    |       | (1                                            | )          | 83 |   |
| Interest income                                                           |       | 202                                           |       | 55 |   |
| Total other income                                                        |       | 201                                           |       | 138 |   |
|                                                                      |       |                                          |       |   |   |
| Income (loss) before income taxes and minority  interest                  |       | 1,079                                         |       | (2,186 | ) |
|                                                                      |       |                                          |       |   |   |
| Income tax expense (benefit)                                              |       | 406                                           |       | (856 | ) |
| Minority interest in net income of consolidated  subsidiaries, net of tax |       | (168                                          | )          | (200 | ) |
| Net income (loss)                                                         |       | $                                             | 505        |   | $ | (1,530 | ) |
|                                                                      |       |                                          |       |   |   |
| Net income (loss) per share:                                              |       |                                          |       |   |   |
| Basic                                                                     |       | $                                             | 0.03       |   | $ | (0.10 | ) |
| Diluted                                                                   |       | $                                             | 0.03       |   | $ | (0.10 | ) |
| Shares used in computing net income (loss)  per share:                    |       |                                          |       |   |   |
| Basic                                                                     |       | 18,592                                        |       | 14,712 |   |
| Diluted                                                                   |       | 18,892                                        |       | 14,712 |   |

 

*See accompanying notes to the condensedconsolidated financial statements.*

 

4

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 
| ** **                                                                | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
|                                                                      |       |                                         |       |   |   |
| Net revenue                                                               |       | $                                            | 78,169     |   | $ | 61,829 |   |
| Cost of goods sold                                                        |       | 37,150                                       |       | 30,786 |   |
| Gross profit                                                              |       | 41,019                                       |       | 31,043 |   |
|                                                                      |       |                                         |       |   |   |
| Expenses:                                                                 |       |                                         |       |   |   |
| Selling and operating                                                     |       | 35,307                                       |       | 31,398 |   |
| Corporate, general and administration                                     |       | 5,818                                        |       | 5,932 |   |
| Total expenses                                                            |       | 41,125                                       |       | 37,330 |   |
|                                                                      |       |                                         |       |   |   |
| Loss from operations                                                      |       | (106                                         | )          | (6,287 | ) |
|                                                                      |       |                                         |       |   |   |
| Other income                                                              |       | 37                                           |       | 135 |   |
| Interest income                                                           |       | 272                                          |       | 135 |   |
| Total other income                                                        |       | 309                                          |       | 270 |   |
|                                                                      |       |                                         |       |   |   |
| Income (loss) before income taxes and minority  interest                  |       | 203                                          |       | (6,017 | ) |
|                                                                      |       |                                         |       |   |   |
| Income tax expense (benefit)                                              |       | 4                                            |       | (2,269 | ) |
| Minority interest in net income of consolidated  subsidiaries, net of tax |       | (344                                         | )          | (326 | ) |
| Net loss                                                                  |       | $                                            | (145       | ) | $ | (4,074 | ) |
|                                                                      |       |                                         |       |   |   |
| Net loss per share:                                                       |       |                                         |       |   |   |
| Basic                                                                     |       | $                                            | (0.01      | ) | $ | (0.28 | ) |
| Diluted                                                                   |       | $                                            | (0.01      | ) | $ | (0.28 | ) |
| Shares used in computing net loss per  share:                             |       |                                         |       |   |   |
| Basic                                                                     |       | 16,091                                       |       | 14,671 |   |
| Diluted                                                                   |       | 16,091                                       |       | 14,671 |   |

 

*See accompanying notes to the condensedconsolidated financial statements.*

 

5

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited – In thousands)

 
| ** **                                                                       | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| **Operating activities**                                                         |       |                                         |       |   |   |
| Net loss                                                                         |       | $                                            | (145       | ) | $ | (4,074 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |       |                                         |       |   |   |
| Depreciation                                                                     |       | 1,666                                        |       | 2,131 |   |
| Amortization                                                                     |       | 1,280                                        |       | 1,232 |   |
| Stock compensation                                                               |       | —                                       |       | 54 |   |
| Minority interest in consolidated  subsidiaries                                  |       | 343                                          |       | 326 |   |
| Deferred income tax expense                                                      |       | (469                                         | )          | 330 |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:  |       |                                         |       |   |   |
| Accounts receivable                                                              |       | 2,333                                        |       | 5,896 |   |
| Inventory                                                                        |       | 1,451                                        |       | (606 | ) |
| Deferred advertising costs                                                       |       | (1,676                                       | )          | (1,758 | ) |
| Prepaid expenses                                                                 |       | (2,587                                       | )          | 107 |   |
| Other assets                                                                     |       | (1,145                                       | )          | 254 |   |
| Accounts payable                                                                 |       | (1,290                                       | )          | (1,628 | ) |
| Accrued liabilities                                                              |       | 1,953                                        |       | 251 |   |
| Income taxes payable                                                             |       | (441                                         | )          | (271 | ) |
| Net cash provided by operating activities                                        |       | 1,273                                        |       | 2,244 |   |
|                                                                             |       |                                         |       |   |   |
| **Investing activities**                                                         |       |                                         |       |   |   |
| Purchase of property, equipment and media  rights                                |       | (928                                         | )          | (1,378 | ) |
| Payments for acquisitions and investments                                        |       | (38,739                                      | )          | — |   |
| Net cash used in investing activities                                            |       | (39,667                                      | )          | (1,378 | ) |
|                                                                             |       |                                         |       |   |   |
| **Financing activities**                                                         |       |                                         |       |   |   |
| Principal payments on capital leases                                             |       | —                                       |       | (48 | ) |
| Proceeds from issuance of common stock                                           |       | 38,468                                       |       | 427 |   |
| Net cash provided by financing activities                                        |       | 38,468                                       |       | 379 |   |
|                                                                             |       |                                         |       |   |   |
| Effects of exchange rates on cash and cash  equivalents                          |       | (266                                         | )          | 45 |   |
| Net change in cash and cash equivalents                                          |       | (192                                         | )          | 1,290 |   |
| Cash and cash equivalents at beginning of  period                                |       | 10,439                                       |       | 8,384 |   |
| Cash and cash equivalents at end of period                                       |       | $                                            | 10,247     |   | $ | 9,674 |   |
|                                                                             |       |                                         |       |   |   |
| **Supplemental cash flow information**                                           |       |                                         |       |   |   |
| Interest paid                                                                    |       | $                                            | —     |   | $ | — |   |
| Income taxes paid                                                                |       | 743                                          |       | 615 |   |
| Common stock issued for acquisitions                                             |       | 390                                          |       | — |   |

 

*See accompanying notes to the condensedconsolidated financial statements*

 

6

----

 

Gaiam, Inc.

Notes to Interim Condensed ConsolidatedFinancial Statements

(Unaudited)

September 30, 2005

 

1.               Interim Condensed Consolidated FinancialStatements

 

###### Organization and Nature of Operations

 

Gaiam, Inc. is a lifestyle media company providing abroad selection of content, information, and products to individuals who valuepersonal development, natural health, and inspirational media.  Gaiam was incorporated under the laws of theState of Colorado on July 7, 1988.

 

The accompanying condensed consolidated financialstatements include the accounts of Gaiam and its subsidiaries in which Gaiam’sownership is greater than 50% and the subsidiary is considered to be underGaiam’s control.  All materialintercompany accounts and transaction balances have been eliminated inconsolidation.

 

Preparation of Interim Condensed ConsolidatedFinancial 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 andExchange Commission, 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, 2005, the interimresults of operations for the three and nine months ended September 30, 2005and 2004, and cash flows for the nine months ended September 30, 2005 and 2004.  These interim statements have not beenaudited.  The balance sheet as ofDecember 31, 2004 was derived from Gaiam’s audited consolidated financialstatements included in Gaiam’s annual report on Form 10-K.

 

Certain information and footnote disclosuresnormally included in consolidated financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations.  Accounting policies followed by Gaiam aredescribed in Note 1 to the audited financial statements for the fiscal yearended December 31, 2004 included in Gaiam’s annual report on Form 10-K.  The consolidated financial statementscontained herein should be read in conjunction with Gaiam’s audited financialstatements, including the notes thereto, for the year ended December 31, 2004.

 

The consolidated financial position, results ofoperations and cash flows for the interim periods disclosed in this report arenot necessarily indicative of future financial results.

 

Reclassifications

 

Certain reclassifications have been made to priorperiod amounts to conform to the current period presentations.

 

New Accounting Pronouncements

 

In December 2004, the FASB issued SFAS No. 123(revised), *Share-Based Payment,*which supersedesAccounting Principles Board (“APB”) No. 25, *Accounting for StockIssued to Employees*(“APB No. 25”)*,*and its related implementation guidance. Under SFAS No. 123 (revised), all share-based payments would be treatedas other forms of compensation by recognizing the costs, generally measured asthe fair value at the date of grant, in the statement of operations.  Gaiam will adopt SFAS No. 123 (revised) forits fiscal year beginning January 1, 2006, in accordance with rules adopted bythe Securities and Exchange Commission on April 14, 2005.  Management expects that the impact of theadoption of

 

7

----

 

SFASNo. 123 (revised) will be that the share-based payment expense amountshistorically disclosed as required by SFAS No. 123 will now be recognized as anexpense on the statement of operations.

 

In May 2005, the FASB issued Statement No. 154, *Accounting Changes and Error Corrections — a replacement of APB OpinionNo. 20 and FASB Statement No. 3*(“SFAS 154”).  This Statement replaces APB Opinion No. 20, *Accounting Changes,*and FASB Statement No. 3, *Reporting Accounting Changes in Interim Financial Statements,*andchanges the requirements for the accounting for and reporting of a change inaccounting principle.  This Statementapplies to all voluntary changes in accounting principle.  It also applies to changes required by anaccounting pronouncement in the unusual instance that the pronouncement doesnot include specific transition provisions. When a pronouncement includes specific transition provisions, thoseprovisions should be followed.  SFAS 154is effective for accounting changes and corrections or error made in fiscalyears beginning after December 15, 2005. Consequently, Gaiam will adopt the provisions of SFAS 154 for its fiscalyear beginning on January 1, 2006. Management currently believes that adoption of the provisions of SFAS154 will not have a material impact on Gaiam’s consolidated financialstatements.

 

Use of Estimates

 

The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenue and expenses and disclosureof contingent assets and liabilities at the date of the consolidated financialstatements.  Actual results could differfrom those estimates.

 

Stock-Based Compensation

 

Gaiam accounts for its stock-based compensationarrangements under the provisions of APB No. 25 and related interpretations,including FASB Interpretation No. 44, *Accountingfor Certain Transactions Involving Stock Compensation*, rather thanthe alternative fair value accounting 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 for optionsgranted to employees is determined as the difference between the fair marketvalue of Gaiam’s common stock on the date options were granted and the exerciseprice.  For purposes of this pro-formadisclosure, the estimated fair value of options is assumed to be amortized to expenseover the options’ vesting periods.

 

Compensation expense for options granted tonon-employees has been determined in accordance with SFAS No. 123 as the fairvalue of the consideration received or the fair value of the equity instrumentsissued, whichever is more reliably measured. Compensation expense for options granted to non-employees wasperiodically re-measured, as the underlying options vested.  Had compensation cost for Gaiam’s stock-basedcompensation plan been determined under the fair value methodology under SFASNo. 123, Gaiam’s net income (loss) and income (loss) per share would have beenas follows (in thousands, except per share data):

 

8

----

 
| ** **                                                                                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                            | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss) as reported                                                                                                         |       | $                                     | 505        |                                 | $          | (1,530 | ) | $ | (145 | ) | $ | (4,074 | ) |
| Add: Stock-based compensation expense included  in reported net income (loss), net of related tax effects                             |       | —                                |       | 18                                   |       | — |   | 54 |   |
| Deduct: Total stock-based compensation expenses  determined under fair value based method for all awards, net of related tax  effects |       | (37                                   | )          | (125                                 | )          | (182 | ) | (454 | ) |
| Pro forma                                                                                                                             |       | $                                     | 468        |                                 | $          | (1,637 | ) | $ | (327 | ) | $ | (4,474 | ) |
| Net income (loss) per common share                                                                                                    |       |                                  |       |                                 |       |   |   |   |   |
| As reported                                                                                                                           |       | $                                     | 0.03       |                                 | $          | (0.10 | ) | $ | (0.01 | ) | $ | (0.28 | ) |
| Pro forma                                                                                                                             |       | $                                     | 0.03       |                                 | $          | (0.11 | ) | $ | (0.02 | ) | $ | (0.30 | ) |
| Fully diluted net income (loss) per common  share                                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| As reported                                                                                                                           |       | $                                     | 0.03       |                                 | $          | (0.10 | ) | $ | (0.01 | ) | $ | (0.28 | ) |
| Pro forma                                                                                                                             |       | $                                     | 0.03       |                                 | $          | (0.11 | ) | $ | (0.02 | ) | $ | (0.30 | ) |

 

2.               Mergers and Acquisitions

 

In the third quarter of 2005, Gaiam acquired a media catalog businessand its customer mailing list.  The totalconsideration given for these assets was 60,000 shares of Class A common stock,valued at $390 thousand.  The customermailing list was valued at approximately $160 thousand, and the balance of thepurchase price was allocated to goodwill. Management believes that this media catalog, which is alreadyestablished in the marketplace, will augment our Internet marketing in thedirect to consumer distribution of our own media titles and those purchasedfrom GoodTimes Entertainment.  Theoperating results of this catalog are included in the results of operationsfrom August 1, 2005.  These results werenot significant to the overall consolidated Gaiam operations.

 

On August 4, 2005, Gaiam and its Chairman and Chief Executive Officer,Jirka Rysavy, entered into a series of agreements with Revolution Living, LLC;its founder, Steve Case, and Revolution Living’s LIME Media (“LIME”) subsidiaryto establish a multi-faceted strategic relationship.  Under the terms of the Transaction Agreement,Gaiam acquired a minority interest in LIME for approximately $7.5 million.

 

On September 13, 2005, Gaiam acquired substantially all of the assetsof GoodTimes Entertainment and certain of its affiliates.  GoodTimes Entertainment’s assets includedentertainment programming and home video products distributed through variouschannels, including television, retailers and the Internet.  The total purchase price consisted of thefollowing (in thousands):

 
| Cash                                    |   | $   | 34,405 |   |
|-----------------------------------------|--------|-----|--------|--------|
| Acquisition, legal and accounting costs |   | 621 |   |
| Total purchase price                    |   | $   | 35,026 |   |

 

The following is a summary of the preliminary asset purchase priceallocation (in thousands):

 
| Tangible assets less liabilities    |   | $      | 9,658  |   |
|-------------------------------------|--------|--------|--------|--------|
| Media library and intangible assets |   | 14,400 |   |
| Goodwill                            |   | 10,968 |   |
| Total purchase price                |   | $      | 35,026 |   |

 

Thepreliminary allocation of the total purchase price of the assets acquired fromGoodTimes Entertainment was based on their estimated fair values as ofSeptember 13, 2005.  Adjustments to theseestimates will be included in the allocation of the purchase price, if the adjustmentis determined within

 

9

----

 

thepurchase price allocation period of up to twelve months.  The excess of the purchase price over theidentifiable intangible and net tangible assets was allocated to goodwill.

 

Gaiam commenced distribution of titles and content acquired in thisasset purchase on September 13, 2005, and the results of sales in both thedirect to consumer and business segments are included in the consolidatedfinancial statements of Gaiam from September 13, 2005.

 

3.               Stockholders’ Equity

 

During the first quarter of 2005, Gaiam issued atotal of 8,221 shares of Class A common stock to Gaiam’s independent directors,in lieu of cash compensation, for services rendered in 2004.  In addition, for the nine months endedSeptember 30, 2005, Gaiam issued 32,120 shares of Class A common stock uponexercise of options granted under Gaiam’s 1999 Long-Term Incentive Plan.

 

On July 7, 2005, Gaiamissued and sold 2,821,317 shares of unregistered Class A common stock for anaggregate purchase price of approximately $18.7 million to certain fundsadvised by Prentice Capital Management, LP.

 

On August 1, 2005, Gaiamissued 60,000 shares of Class A common stock as purchase consideration for amedia catalog business.

 

On August 22, 2005, Gaiamissued and sold 2,500,000 shares of unregistered Class A common stock for anaggregate purchase price of $20 million to Revolution Living, LLC.

 

4.               Comprehensive Income (Loss)

 

Gaiam’s comprehensive income (loss) is comprised ofnet income (loss) and foreign currency translation adjustment, net of income taxes.  Comprehensive income (loss), net of relatedtax effects, was as follows (in thousands):

 
| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)                             |       | $                                     | 505        |                                 | $          | (1,530 | ) | $ | (145 | ) | $ | (4,074 | ) |
| Foreign currency translation adjustment,  net |       | (80                                   | )          | (9                                   | )          | (408 | ) | 76 |   |
| Comprehensive income (loss), net of taxes     |       | $                                     | 425        |                                 | $          | (1,539 | ) | $ | (553 | ) | $ | (3,998 | ) |

 

5.               Earnings (Loss) per Share

 

Basic earnings (loss) per share exclude any dilutiveeffects of options, warrants and dilutive securities.  Basic earnings (loss) per share is computedusing the weighted average number of common shares outstanding during theperiod.  Diluted earnings per share iscomputed using the weighted average number of common and common stockequivalent shares outstanding during the period.  Common equivalent shares of 138 thousand areexcluded from the computation of diluted earnings per share for the threemonths ended September 30, 2004, and 172 and 134 thousand common equivalentshares are excluded from the computation for the nine months ended September30, 2005 and 2004, respectively, because their effect is anti-dilutive.

 

The following table sets forth the computation ofbasic and diluted earnings per share (in thousands, except per share data):

 

10

----

 
| ** **                                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Numerator for basic and diluted earnings  (loss) per share    |       | $                                     | 505        |                                 | $          | (1,530 | ) | $ | (145 | ) | $ | (4,074 | ) |
| Denominator:                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average shares for basis earnings  (loss) per share  |       | 18,592                                |       | 14,712                               |       | 16,091 |   | 14,671 |   |
| Effect of dilutive securities:                                |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average of common stock, stock  options and warrants |       | 300                                   |       | —                               |       | — |   | — |   |
| Denominators for diluted earnings (loss)  per share           |       | 18,892                                |       | 14,712                               |       | 16,091 |   | 14,671 |   |
|                                                          |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss) per share - basic                           |       | $                                     | 0.03       |                                 | $          | (0.10 | ) | $ | (0.01 | ) | $ | (0.28 | ) |
| Net income (loss) per share - diluted                         |       | $                                     | 0.03       |                                 | $          | (0.10 | ) | $ | (0.01 | ) | $ | (0.28 | ) |

 

6.               Segment Information

 

Gaiam manages its business and aggregates itsoperational and financial information in accordance with two reportablesegments.  The direct to consumer segmentcontains Gaiam’s catalog and Internet sales channels, while the businesssegment comprises the retailer, media and corporate account channels.

 

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

 

Contribution margin is defined as net sales, lesscost of goods sold and direct expenses. Financial information for Gaiam’sbusiness segments was as follows (in thousands):

 
| ** **                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue:                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Direct to consumer                                                        |       | $                                     | 16,248     |                                 | $          | 11,347 |   | $ | 41,520 |   | $ | 33,776 |   |
| Business                                                                  |       | 13,891                                |       | 9,676                                |       | 36,649 |   | 28,053 |   |
| Consolidated net revenue                                                  |       | 30,139                                |       | 21,023                               |       | 78,169 |   | 61,829 |   |
| Contribution margin:                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Direct to consumer                                                        |       | 211                                   |       | 38                                   |       | (41 | ) | (464 | ) |
| Business                                                                  |       | 667                                   |       | (2,362                               | )          | (65 | ) | (5,823 | ) |
| Consolidated contribution margin (loss)                                   |       | $                                     | 878        |                                 | $          | (2,324 | ) | $ | (106 | ) | $ | (6,287 | ) |
| Reconciliation of contribution margin (loss)  to net income (loss):       |       |                                  |       |                                 |       |   |   |   |   |
| Other income                                                              |       | 201                                   |       | 138                                  |       | 309 |   | 270 |   |
| Income tax expense (benefit)                                              |       | 406                                   |       | (856                                 | )          | 4 |   | (2,269 | ) |
| Minority interest in net income of consolidated  subsidiaries, net of tax |       | (168                                  | )          | (200                                 | )          | (344 | ) | (326 | ) |
| Net income (loss)                                                         |       | $                                     | 505        |                                 | $          | (1,530 | ) | $ | (145 | ) | $ | (4,074 | ) |

 

7.               Related Party Transactions

 

On August 3, 2005, Gaiam andJirka Rysavy, Gaiam’s Chairman and Chief Executive Officer, entered into anInsurance and Stock Redemption Agreement pursuant to which Gaiam agreed to usethe proceeds of any life insurance Gaiam elects to obtain on Mr. Rysavy toacquire Gaiam shares from Mr. Rysavy’s estate. The purchase price for any shares will be determined by a nationalrecognized valuation expert.

 

11

----

 

**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 and related notes included elsewhere in this document.

 

#### Overviewand Outlook

 

Gaiamis a lifestyle media company providing content, information, and products tocustomers who value personal development, healthy living, and inspirationalmedia.

 

Withthe inception of our business segment in 1998, Gaiam started to sell directlyto retailers, both domestically and abroad. Gaiam products are available in over 40,000 stores.  Gaiam introduced its “store-within-store”lifestyle presentations, which utilize custom fixtures designed and produced byGaiam, in late 2000, and the placement of this concept has grown to over 4,300stores.  In 2004, revenue in this segmentwas $44.2 million.  During the first ninemonths of 2005, revenue generated by internal growth of 24% over the first ninemonths of 2004 in the business segment brought revenue to $32.2 million.  Gaiam continues to focus on the nationalretailer and media channels and plans to continue to build this segment througha combination of new media releases, store within store concept, and expansionsin mass market retailers, grocery, bookstores and other media outlets.

 

Thedirect to consumer segment continues to be an integral part of Gaiam’soutreach.  This segment accounted for54%, or approximately $52.4 million, of Gaiam’s revenue during 2004.  During the first nine months of 2005, revenuegenerated by internal growth of 17% in this segment brought revenue to $39.2million, and represented 55% of total revenue. Through its diverse media reach, the direct to consumer segment providesbranding, an opportunity to launch and support new media releases, a soundingboard for new product testing, promotional opportunities and customer feedbackon Gaiam’s and the LOHAS (Lifestyles of Health and Sustainability) industry’sfocus and future.

 

OnSeptember 13, 2005, Gaiam acquired substantially all of the assets of GoodTimesEntertainment and certain of its affiliates. GoodTimes Entertainment’s assets included entertainment programming andhome video products distributed through various channels, including television,theatres, retailers and the Internet. GoodTimes Entertainment’s library contained wellness franchises such asThe Firm and Tae Bo, children classics and theatrical releases.  The purchase price for the assets was $35million in cash plus the assumption of certain liabilities, and the acquisitionwas financed through cash on hand and cash raised in private equitytransactions completed in the third quarter of 2005.

 

Withthe completion of the GoodTimes asset acquisition, Gaiam expects to generateover $200 million in annual revenues. Gaiam’s home media is now carried by over 40,000 retail stores in UnitedStates. Gaiam also expects to distribute 20 million catalogs per year and haveapproximately 7 million direct customers. The volume increase will allow Gaiam to negotiate better inventory andservice pricing to improve margins, and more fully leverage its distributioncapacity and overhead to produce better overall financial results.

 

#### Resultsof Operations

 

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

 

12

----

 

| ** **                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue                                                               |       | 100.0                                 | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Cost of goods sold                                                        |       | 44.5                                  | %          | 53.3                                 | %          | 47.5 | % | 49.8 | % |
| Gross profit                                                              |       | 55.5                                  | %          | 46.7                                 | %          | 52.5 | % | 50.2 | % |
| Expenses:                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Selling and operating                                                     |       | 45.4                                  | %          | 48.9                                 | %          | 45.2 | % | 50.8 | % |
| Corporate, general and administration                                     |       | 7.1                                   | %          | 8.9                                  | %          | 7.4 | % | 9.6 | % |
| Total expenses                                                            |       | 52.5                                  | %          | 57.8                                 | %          | 52.6 | % | 60.4 | % |
| Income (loss) from operations                                             |       | 2.9                                   | %          | -11.1                                | %          | -0.1 | % | -10.2 | % |
| Other income                                                              |       | 0.7                                   | %          | 0.7                                  | %          | 0.4 | % | 0.4 | % |
| Income tax expense (benefit)                                              |       | 1.3                                   | %          | -4.1                                 | %          | 0.0 | % | -3.7 | % |
| Minority interest in net income of  consolidated subsidiaries, net of tax |       | -0.6                                  | %          | -1.0                                 | %          | -0.4 | % | -0.5 | % |
| Net income (loss)                                                         |       | 1.7                                   | %          | -7.3                                 | %          | -0.2 | % | -6.6 | % |

 

#### Threemonths ended September 30, 2005 versus September 30, 2004

 

Revenue of $30.1 million for the three months ended September 30, 2005increased 43.4% from $21 million for the three months ended September 30,2004.  Gaiam’s percentage increase inrevenue was contributed equally by the direct to consumer segment, in whichrevenue increased 43.2% to $16.2 million, and the business segment, in whichrevenue increased 43.5% to $13.9 million. Internal revenue growth was $1.8 million or 24.4% for the businesssegment, consisting primarily of increases in mass merchant retailers andbookstores.  Internal growth in thedirect to consumer segment was 23.4%, resulting in an increase in revenuegenerated by this segment of $2.6 million for the three months ended September30, 2005 as compared to same period in 2004. This was fueled by double digit growth in revenue generated by both ourInternet and renewable energy businesses. Revenue generated by media acquired from GoodTimes Entertainmentaccounted for the balance of the increase in revenues.

 

Gross profit, which consists of revenue less cost of sales (primarilymerchandise acquisition costs and in-bound freight), increased to $16.7 millionfor the third quarter of 2005 from $9.8 million during the same period in2004.  As a percentage of revenue, grossprofit for the third quarter of 2005 increased to 55.5% as compared to 46.7%generated in the comparable 2004 period. Virtually all of this improvement was generated by the business segment,where gross profit rose from 41.2% for the third quarter of 2004 to 59.6% inthe comparable 2005 period.  Thisimprovement is primarily due to higher sales of media and kits containingmedia, which have significantly higher gross profit margins than accessories.

 

Selling and operating expenses (which consist primarily of sales andmarketing costs, commission and fulfillment expenses) increased 33.2% to $13.7million for the three months ended September 30, 2005 as compared to $10.3million in the same period of 2004, due primarily to an increase revenue of43.4% and the additional cost of utilizing a temporary services agreement toutilize the GoodTimes warehousing and distribution center in New Jersey.  Inventory purchased from GoodTimes, which ishoused at the New Jersey site, is being transferred to Gaiam’s warehousing anddistribution center in Ohio.  Gaiamexpects to have transitioned all warehousing and distribution functions to Ohioduring the next 90 to 120 days.  As apercentage of revenue, selling and operating expenses decreased to 45.4% in2005 from 48.9% in 2004 as a result of the increase in the sales base.

 

Corporate, general and administration expenses increased to $2.2million for the third quarter of 2005 compared to $1.9 million for the same2004 period, primarily due to additional facility and infrastructure expensesassociated with establishment of our New York office.  As a percentage of revenue, corporate,general and administration expenses decreased to 7.1% in the third quarter of2005 from 8.9% in the comparable 2004 period, as a result of the aforementionedincrease in the sales base.

 

Gaiam generated operating income of $878 thousand for the third quarterof 2005 as compared to an operating loss of $2.3 million in the comparable 2004period.  This improvement is primarilythe result of revenue and gross margin increases across all of Gaiam’soperations.

 

13

----

 

Gaiamrecorded $201 and $138 thousand in other income for the three months endedSeptember 30, 2005 and 2004, respectively. The share of net income associated with minority interests was $168 and$200 thousand for the third quarters of 2005 and 2004, respectively.

 

Gaiamrecorded income tax expense of $406 thousand for the three months endedSeptember 30, 2005 compared to an income tax benefit of $856 thousand for thethree months ended September 30, 2004. Gaiam’s consolidated effective tax rate fluctuates based upon thedistribution of earnings/losses between its domestic and foreign operations.

 

Asa result of the factors described above, Gaiam’s net income was $505 thousand,or $0.03 per share, for the three months ended September 30, 2005, as comparedto a net loss of $1.5 million, or $0.10 per share, for the three months endedSeptember 30, 2004.

 

#### Ninemonths ended September 30, 2005 versus September 30, 2004

 

Revenues of $78.2 million for the nine months ended September 30, 2005increased 26.4% from $61.8 million for the nine months ended September 30,2004.  Gaiam’s increase in revenues wasdue primarily to an increase in the business segment of $8.6 million, or 30.6%for the first nine months of 2005.  Thisincrease resulted primarily from the efforts of the expanded sales force whichresulted in higher sales volumes with mass market retailers andbookstores.  Sales of media contentacquired in the GoodTimes asset acquisition, coupled with lower product returnsalso contributed to the increase in revenue. Direct to consumer segment revenues were $41.5 million for the ninemonths ended September 30, 2005, compared to $33.8 million for the same periodin 2004.  All components of the direct toconsumer segment experienced positive growth. For the nine months ended September 30, 2005, the internal growth ratesin the business and direct to consumer segments were 24% and 17%, respectively.

 

Gross profit increased to $41 million for the first nine months of 2005from $31 million during the same period in 2004.  As a percentage of revenue, gross profitincreased to 52.5% in 2005 from 50.2% in 2004. This was primarily attributable to improved margins in the businesssegment, where gross profit, as a percentage of revenue, increased from 46% forthe first nine months of 2004 to 52.9% for the same period in 2005.  This gross profit improvement stems primarilyfrom a increased sales of media and kits containing media, better margins withthose accounts that were transitioned to a direct relationship and a reductionin markdowns and product returns which eroded gross margin last year.

 

Selling and operating expenses increased to $35.3 million for the ninemonths ended September 30, 2005 as compared to $31.4 million in the same periodof 2004, primarily resulting from increased sales and marketing efforts whichproduced revenue increases of over 26% for the first nine months.  As a percentage of revenues, selling andoperating expenses decreased to 45.2% in 2005 from 50.8% in 2004.

 

Corporate, general and administration expenses decreased to $5.8million for the nine months ended September 30, 2005 from $5.9 million in thecomparable 2004 period, and decreased to 7.4% of revenues in 2005 from 9.6% ofrevenues in 2004.  This expense reductionwas generally attributable to cost savings generated by expense reductions inGaiam’s Colorado headquarters, which has been partially offset by the additionof infrastructure costs associated with the opening of office in New York Cityin September 2005.

 

Operating losses of $106 thousand for the nine months ended September30, 2005 were significantly lower than the $6.3 million operating loss for thenine months ended September 30, 2004, primarily due to the increase in revenueand gross margin.

 

Gaiamrecorded $309 thousand and $270 thousand in other income, primarily frominterest income, for the nine months ended September 30, 2005 and 2004,respectively.  The share of net incomeassociated with minority interest was $344 thousand for the first nine monthsof 2005, compared to the share of net income of $326 thousand for thecomparable 2004 period.

 

Gaiamrecorded income tax expense of $4 thousand for the nine months ended September30, 2005 compared to an income tax benefit of $2.3 million for the nine monthsended September 30, 2004.

 

14

----

 

Asa result of the factors described above, Gaiam’s net loss was $145 thousand forthe nine months ended September 30, 2005 compared to a net loss of $4.1 millionrecorded for the nine months ended September 30, 2004.

 

Liquidityand Capital Resources

 

Gaiam’s capital needs arisefrom working capital required to fund our operations, capital expendituresrelated to acquisition and development of media content, development of Internetand new products, acquisitions of new businesses, replacements, expansions andimprovements to Gaiam’s infrastructure, and future growth.  These capital requirements depend on numerousfactors, including the rate of market acceptance of Gaiam’s product offerings,our ability to expand Gaiam’s customer base, the cost of ongoing upgrades toGaiam’s product offerings, our level of expenditures for sales and marketing,our level of investment in distribution systems and facilities and otherfactors.  The timing and amount of thesecapital requirements are variable and cannot accurately be predicted.  Additionally, Gaiam will continue to pursueopportunities to expand our media libraries, evaluate possible investments inbusinesses, products and technologies, and increase our sales and marketingprograms and brand promotions as needed.

 

Gaiamhas a credit agreement with Wells Fargo, which permits borrowings of up to $15million based upon the collateral value of Gaiam’s accounts receivable andinventory.  At September 30, 2005, Gaiamhad no amounts outstanding under this agreement and complied with all of thefinancial covenants.     This creditagreement expires on July 31, 2007.  ShouldGaiam choose to borrow under the credit agreement, outstanding advances bearinterest at the lower of prime rate less 50 basis points or LIBO plus 275 basispoints.  Borrowings are secured by apledge of Gaiam’s assets, and the agreement contains various financialcovenants, including covenants prohibiting the payment of cash dividends toGaiam shareholders and requiring compliance with certain financial ratios.

 

Gaiam’soperating activities generated net cash of $1.3 million for the nine monthsended September 30, 2005, after a $2.6 million increase in prepaid expense inprimarily associated with transition services provided by GoodTimesEntertainment, and $2.2 million for the comparable 2004 period.  Gaiam’s net cash generated from operatingactivities for both periods is primarily attributable to a decrease in accountsreceivable of $2.3 million in 2005 and $5.9 million in 2004, and non-cashcharges to net income of $2.8 million in 2005 and $4.1 million in 2004.  These sources of funds were partially offsetby the use of funds for holiday catalog production costs of $1.7 million in2005 and $1.8 million in 2004, and reductions in accounts payable of $1.3million in 2005 and $1.6 million in 2004.

 

Gaiam’sinvesting and acquisition activities used net cash of $39.7 million and $1.4million during the first nine months of 2005 and 2004, respectively.  During 2005, Gaiam used cash to acquireassets from GoodTimes Entertainment and to fund its investment in LIMEMedia.   In 2005 and 2004, respectively,Gaiam used $928 thousand and $1.4 million for the purchase of property,equipment and media rights.

 

Gaiam’sfinancing activities provided net cash of $38 million and $379 thousand for thenine months ended September 30, 2005 and 2004, respectively.  On July 7, 2005, we issued and sold 2,821,317shares of unregistered Class A common stock for an aggregate purchase price ofapproximately $18.7 million to certain funds advised by Prentice CapitalManagement, LP.  On August 22, 2005,Gaiam issued and sold 2,500,000 shares of unregistered Class A common stock foran aggregate purchase price of $20 million to Revolution Living, LLC.

 

Webelieve our available cash, cash expected to be generated from operations, cashgenerated by the sale of unregistered Class A common stock, and borrowingcapabilities on our unused $15 million line of credit, should be sufficient tofund our operations on both a short-term and long-term basis.  However, our projected cash needs may changeas a result of acquisitions, product development, 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.

 

15

----

 

Contractual Obligations

 

Gaiam has commitmentspursuant to lease and debt agreements, but does not have any outstandingcommitments pursuant to long-term debt obligations, capital lease obligationsor purchase obligations.  The followingtable shows our commitments to make future payments under operating leases (inthousands):

 
| ** **                   | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 yrs** | ** ** |
|------------------------------|------------|-----------|------------|-----------------|------------|---------------|------------|---------------|------------|----------------|------------|
| Operating  lease obligations |       | $         | 3,336      |            | $          | 1,291         |       | $             | 1,424      |           | $          | 322 |   | $ | 299 |   |
|                              |            |           |            |                 |            |               |            |               |            |                |            |  |  |  |  |  |

 

Off-Balance Sheet Arrangements

 

Gaiamdoes not participate in transactions that generate relationships withunconsolidated entities or financial partnerships, such as special purposeentities (“SPEs”) or variable interest entities (“VIEs”), which have beenestablished for the purpose of facilitating off-balance sheet arrangements orother limited purposes.  As of September30, 2005, Gaiam is not involved in any unconsolidated SPEs or VIEs.

 

Critical Accounting Policies

##### ** **

The consolidated financialstatements are prepared in conformity with accounting principles generallyaccepted in the United States, which require management to make judgments,estimates and assumptions that affect the amounts reported in Gaiam’sconsolidated financial statements and accompanying notes.  Note 1 to the consolidated financialstatements in Item 8 of our Annual Report on Form 10-K summarizes thesignificant accounting policies and methods used in the preparation of Gaiam’sconsolidated financial statements.  Nochanges were made to our significant policies during the three months endedSeptember 30, 2005.

 

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.

 

*Provisionsfor Doubtful Accounts and Returns*

 

Gaiam records a provisionfor doubtful accounts for all receivables not expected to be collected.  Gaiam generally does not requirecollateral.  Gaiam evaluates thecollectibility of accounts receivable based on a combination of factors.  In circumstances in which we are aware of aspecific customer’s inability to meet its financial obligations (e.g.bankruptcy filings); Gaiam records a specific reserve for bad debts againstamounts due.  For all other instances,Gaiam recognizes reserves based on historical experience and review ofindividual accounts outstanding.

 

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

 

*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 the inventory items to be writtendown for obsolescence based on the item’s current sales status andcondition.  If the item is discontinuedor slow moving, it is written down based on an estimate of the markdown toretail price needed to sell through its current stock level of the item.

 

*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, on areporting unit level.  The fair value ofa 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 two reportingunits, and uses a market

 

16

----

 

value method for the purposesof testing for potential impairment.  Theannual review requires 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.

 

*Investments*

 

Investmentsin entities over which 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.”  Had Gaiamconcluded that it had the ability to exercise significant influence, its shareof the investee’s income or loss would have been reported in Gaiam’sconsolidated statement of operations.

 

*Capitalized Production Costs*

 

Capitalized production costsinclude costs incurred to produce informational media products marketed byGaiam to retail marketers and direct-mail and online customers.  These costs are deferred for financial reportingpurposes until the media is released, then amortized over succeeding periods onthe basis of estimated sales.  Historicalsales statistics are the principal factor used in estimating the amortizationrate.

 

Gaiam had nosignificant changes in its critical accounting policies from its Form 10-Kfiling for the fiscal year ended December 31, 2004.

 

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, 2004. These risks and uncertainties and additional risks and uncertainties notpresently known to us or that we currently deem 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. Gaiam does not undertake any obligation to update forward-lookingstatements except as required by law.

 

##### **Item3.    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 outstandingunder its credit facility, so any unfavorable change in interest rates wouldnot have a material impact on Gaiam’s results from operations or cash flowsunless Gaiam makes borrowings in the future.

 

Gaiam purchases asignificant amount of inventory from vendors outside of the U.S. intransactions that are primarily U.S. dollar denominated transactions.  Because the percentage of our internationalpurchases denominated in currencies other than the U.S. dollar is small, anycurrency risks 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’revenue is primarily denominated in foreign currencies, this investment exposesGaiam to accounting risk associated with foreign currency exchange ratefluctuations.  However, we havedetermined that no material

 

17

----

 

market risk exposure to ourconsolidated financial position, results of operations or cash flows existed asof September 30, 2005.

 

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

 

**Evaluation of Disclosure Controls and Procedures**

 

Gaiam’schief executive officer and chief financial officer conducted an evaluation ofthe effectiveness of the design and operation of Gaiam’s disclosure controlsand procedures, as defined in Rules 13a-15(e) and Rule 15d-15(e) under theExchange Act.  Based upon theirevaluation as of September 30, 2005, Gaiam’s chief executive officer and chieffinancial officer have concluded that those disclosure controls and proceduresare effective.

 

**Changesin Internal Control over Financial Reporting**

 

Nochanges in Gaiam’s internal control over financial reporting occurred duringthe quarter ended June 30, 2005 that have materially affected, or arereasonably likely to materially affect, Gaiam’s internal control over financialreporting.

 

## **PARTII.**                OTHER INFORMATION

 

##### **Item1.**                    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 theseproceedings will have a material adverse effect on our business.

##### ** **

##### **Item2.**                    Sales of Unregistered Securities and Use ofProceeds

 

None.

 

##### **Item3.**                    Defaults Upon Senior Securities

 

None.

 

**Item 4.****                   ****Submission of Matters to aVote of Security Holders.**

 

None.

 

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

 

None.

 

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

 

a)                                      Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1            |       | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934 (filed herewith).                                          |
| 31.2            |       | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934 (filed herewith).                                          |
| 32.1            |       | Certification  of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished  herewith). |
| 32.2            |       | Certification  of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished  herewith). |

 

18

----

 

### **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)            |
|   | November  9, 2005       |
|   |                    |
|   | By:                     | /s/  Jirka Rysavy |   |
|   | Jirka Rysavy            |
|   | Chief Executive Officer |
|   |                    |
|   | By:                     | /s/  Janet Mathews |   |
|   | Janet Mathews           |
|   | Chief Financial Officer |
|        |                         |  |  |  |

 

19

----