**United States**

**Securities and Exchange Commission**

**Washington, D.C. 20549**

 

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

 
| **ý**                                      |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES AND EXCHANGE ACT OF 1934**  |
|-------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                                            |   |                                                                                                |
| **For the Fiscal Quarter Ended March 31, 2003** |
|                                            |   |                                                                                                |
| **OR**                                          |
|                                            |   |                                                                                                |
| **o**                                           |   | **TRANSITION  REPORT 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)      |

 

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

 

YES   ý                  NO   o

 

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

 

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

 

| **Class**                                |   | **Shares outstanding as of May 7, 2003** |
|------------------------------------------|--------|------------------------------------------|
| Class A Common Stock  ($.0001 par value) |   | 9,193,562                                |
|                                     |   |                                     |
|                                     |   |                                     |
| Class B Common Stock  ($.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  March 31, 2003  and December 31, 2002               |
|      | Condensed Consolidated Statements of Income  for the three months ended March 31, 2003 and 2002    |
|      | Condensed Consolidated Statement of Cash  Flows for the three months ended March 31, 2003 and 2002 |
|      | Notes to Interim Condensed Consolidated  Financial Statements                                      |
|      |                                                                                               |
| Item 2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations        |
|      |                                                                                               |
| Item 3.   | Critical  Accounting Policies                                                                      |
|      |                                                                                               |
| Item 4.   | Quantitative  and Qualitative Disclosures About Market Risk                                        |
|      |                                                                                               |
| Item 5.   | Controls  and Procedures                                                                           |
|      |                                                                                               |
| PART  II. | OTHER  INFORMATION                                                                                 |
|      |                                                                                               |
| Item 1.   | Legal Proceedings                                                                                  |
|      |                                                                                               |
| Item 2.   | Changes in Securities and Use of Proceeds                                                          |
|      |                                                                                               |
| Item 3.   | Defaults Upon Senior Securities                                                                    |
|      |                                                                                               |
| Item 4.   | Submission of Matters to a Vote of Security  Holders                                               |
|      |                                                                                               |
| Item 5.   | Other Information                                                                                  |
|      |                                                                                               |
| Item 6.   | Exhibits and Reports on Form 8-K                                                                   |

 

Thisreport may contain forward-looking statements that involve risks anduncertainties.  When used in thisdiscussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,”“strive,” “future,” “intend” and similar expressions as they relate to Gaiam orits management are intended to identify such forward-looking statements.  Gaiam’s actual results could differmaterially from the results anticipated in these forward-looking statements asa result of certain factors set forth under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” “Market Risk” andelsewhere in this report.  Risks and uncertaintiesthat could cause actual results to differ include, without limitation, generaleconomic conditions, competition, loss of key personnel, pricing, brandreputation, acquisitions, security and information systems, legal liability forwebsite content, merchandise supply problems, failure of third parties toprovide adequate service, reliance on centralized customer service, overstocksand merchandise returns, 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, consumer trends, customer interest in our products, theeffect of government regulation and other risks and uncertainties included inGaiam’s filings with the Securities and Exchange Commission.  We caution you that no forward-lookingstatement is a guarantee of future performance, and you should not place unduereliance on these forward-looking statements which reflect our management’sview only as of the date of this report. We undertake no obligation to update any forward-looking information.

 

2

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 
|                                                                                                                                                                                        |   | **March 31,  2003** |       | **December 31,  2002** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------------|------------|
|                                                                                                                                                                                        |   | **(Unaudited)**     |       |                   |       |
| **Assets**                                                                                                                                                                                  |   |                |       |                   |       |
| Current assets:                                                                                                                                                                             |   |                |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                   |   | $                   | 8,347,681  |                   | $          | 11,422,435 |   |
| Accounts receivable, net                                                                                                                                                                    |   | 15,643,384          |       | 21,455,744             |       |
| Accounts and notes receivable, other                                                                                                                                                        |   | 1,416,112           |       | 1,949,833              |       |
| Inventory, less allowances                                                                                                                                                                  |   | 16,307,540          |       | 14,768,045             |       |
| Deferred advertising costs                                                                                                                                                                  |   | 1,663,240           |       | 2,417,211              |       |
| Other current assets                                                                                                                                                                        |   | 1,755,281           |       | 1,194,484              |       |
| Total current assets                                                                                                                                                                        |   | 45,133,238          |       | 53,207,751             |       |
|                                                                                                                                                                                        |   |                |       |                   |       |
| Property and equipment, net                                                                                                                                                                 |   | 11,141,631          |       | 9,543,231              |       |
| Investments                                                                                                                                                                                 |   | 7,865,192           |       | 7,865,192              |       |
| Capitalized production costs, net                                                                                                                                                           |   | 5,640,460           |       | 4,983,824              |       |
| Video library, net                                                                                                                                                                          |   | 5,447,461           |       | 5,262,586              |       |
| Goodwill, net                                                                                                                                                                               |   | 10,288,251     |       | 7,522,495         |       |
| Deferred tax assets                                                                                                                                                                         |   | 2,519,244           |       | 2,519,244              |       |
| Other assets                                                                                                                                                                                |   | 1,033,615           |       | 768,043                |       |
| Total assets                                                                                                                                                                                |   | $                   | 89,069,092 |                   | $          | 91,672,366 |   |
|                                                                                                                                                                                        |   |                |       |                   |       |
| **Liabilities and stockholders’ equity**                                                                                                                                               |   |                |       |                   |       |
| Current liabilities:                                                                                                                                                                        |   |                | ** ** |                   | ** ** |
| Accounts payable                                                                                                                                                                            |   | $                   | 8,913,140  |                   | $          | 11,998,087 |   |
| Accrued liabilities                                                                                                                                                                         |   | 4,977,594           |       | 5,709,788              |       |
| Income taxes payable                                                                                                                                                                        |   | 47,335              |       | 1,286,558              |       |
| Capital lease obligations, current                                                                                                                                                          |   | 250,583             |       | 269,290                |       |
| Total current liabilities                                                                                                                                                                   |   | 14,188,652          |       | 19,263,723             |       |
|                                                                                                                                                                                        |   |                |       |                   |       |
| Capital lease obligations, long-term                                                                                                                                                        |   | 36,351              |       | 54,529                 |       |
| Deferred tax liability                                                                                                                                                                      |   | 848,653             |       | 848,653                |       |
| Other liabilities                                                                                                                                                                           |   | 1,962,000           |       | 1,962,000              |       |
| Total liabilities                                                                                                                                                                           |   | 17,035,656          |       | 22,128,905             |       |
|                                                                                                                                                                                        |   |                |       |                   |       |
| Minority interest                                                                                                                                                                           |   | 2,555,766           |       | 172,481                |       |
|                                                                                                                                                                                        |   |                |       |                   |       |
| Stockholders’ equity:                                                                                                                                                                  |   |                |       |                   |       |
| Class A common stock, $.0001 par value,  150,000,000 shares authorized,   9,193,380 and 9,134,098 shares issued and outstanding at March 31,  2003 and December 31, 2002, respectively |   | 919                 |       | 913                    |       |
| Class B common stock, $.0001 par value,  50,000,000 shares authorized, 5,400,000 issued and outstanding at March 31,  2003 and December 31, 2002, respectively                              |   | 540                 |       | 540                    |       |
| Additional paid-in capital                                                                                                                                                                  |   | 53,784,277          |       | 53,343,046             |       |
| Deferred compensation                                                                                                                                                                       |   | (125,865            | )          | (143,865               | )          |
| Retained earnings                                                                                                                                                                           |   | 15,817,799          |       | 16,170,346             |       |
| Total stockholders’ equity                                                                                                                                                             |   | 69,477,670          |       | 69,370,980             |       |
| Total liabilities and stockholders’ equity                                                                                                                                             |   | $                   | 89,069,092 |                   | $          | 91,672,366 |   |

 

*See accompanying notes.*

 

3

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 
|                                                                           |   | **For the  Three Months Ended   March 31,** |       |
|--------------------------------------------------------------------------------|--------|---------------------------------------------|------------|
|                                                                           |   | **2003**                                    |       | **2002** |   |
|                                                                           |   |                                        |       |   |   |
| Net revenue                                                                    |   | $                                           | 23,368,238 |   | $ | 24,283,540 |   |
| Cost of goods sold                                                             |   | 10,747,500                                  |       | 10,014,628 |   |
| Gross profit                                                                   |   | 12,620,738                                  |       | 14,268,912 |   |
|                                                                           |   |                                        |       |   |   |
| Expenses:                                                                      |   |                                        |       |   |   |
| Selling and operating                                                          |   | 10,606,173                                  |       | 10,591,253 |   |
| Corporate, general and administration                                          |   | 2,414,610                                   |       | 2,502,445 |   |
| Total expenses                                                                 |   | 13,020,783                                  |       | 13,093,698 |   |
|                                                                           |   |                                        |       |   |   |
| Income (loss) from operations                                                  |   | (400,045                                    | )          | 1,175,214 |   |
|                                                                           |   |                                        |       |   |   |
| Other income (expense)                                                         |   | (85,459                                     | )          | (86,522 | ) |
| Interest income                                                                |   | 14,676                                      |       | 55,965 |   |
| Total other income (expense)                                                   |   | (70,783                                     | )          | (30,557 | ) |
|                                                                           |   |                                        |       |   |   |
| Income (loss) before income taxes and  minority Interest                       |   | (470,828                                    | )          | 1,144,657 |   |
|                                                                           |   |                                        |       |   |   |
| Provision for income taxes                                                     |   | (198,558                                    | )          | 406,353 |   |
| Minority interest in net (income) loss of  consolidated subsidiary, net of tax |   | (80,278                                     | )          | (2,662 | ) |
| Net income (loss)                                                              |   | $                                           | (352,548   | ) | $ | 735,642 |   |
|                                                                           |   |                                        |       |   |   |
| Net income (loss) per share:                                                   |   |                                        |       |   |   |
| Basic                                                                          |   | $                                           | (0.02      | ) | $ | 0.05 |   |
| Diluted                                                                        |   | $                                           | (0.02      | ) | $ | 0.05 |   |
| Shares used in computing net income (loss)  per share:                         |   |                                        |       |   |   |
| Basic                                                                          |   | 14,578,501                                  |       | 14,005,480 |   |
| Diluted                                                                        |   | 14,578,501                                  |       | 14,532,351 |   |

 

*See accompanying notes.*

 

4

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 
|                                                                                                |   | **For the Three Months****Ended March 31,** |      |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------------|-----------|
|                                                                                                |   | **2003**                                    |      | **2002** |   |
| **Operating activities**                                                                            |   |                                        |      |   |   |
| Net income (loss)                                                                                   |   | $                                           | (352,548  | ) | $ | 735,642 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                        |      |   |   |
| Depreciation                                                                                        |   | 642,174                                     |      | 447,594 |   |
| Amortization                                                                                        |   | 211,726                                     |      | 86,298 |   |
| Stock compensation                                                                                  |   | 18,000                                      |      | 18,000 |   |
| Minority interest in consolidated  subsidiary                                                       |   | 80,278                                      |      | 2,662 |   |
|                                                                                                |   |                                        |      |   |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:                     |   |                                        |      |   |   |
| Accounts receivable                                                                                 |   | 8,040,047                                   |      | (2,924,621 | ) |
| Inventory                                                                                           |   | (270,681                                    | )         | 938,222 |   |
| Deferred advertising costs                                                                          |   | 753,971                                     |      | 211,742 |   |
| Capitalized production costs                                                                        |   | (656,637                                    | )         | (545,723 | ) |
| Other current assets                                                                                |   | (465,562                                    | )         | (602,040 | ) |
| Other assets                                                                                        |   | (265,573                                    | )         | (53,896 | ) |
| Accounts payable                                                                                    |   | (3,596,330                                  | )         | (1,765,387 | ) |
| Accrued liabilities                                                                                 |   | (1,299,856                                  | )         | (142,680 | ) |
| Income taxes payable                                                                                |   | (1,232,768                                  | )         | (1,291,028 | ) |
| Net cash (used in) provided by operating  activities                                                |   | 1,606,241                                   |      | (4,885,215 | ) |
|                                                                                                |   |                                        |      |   |   |
| **Investing activities**                                                                            |   |                                        |      |   |   |
| Purchase of property and equipment, and  media rights                                               |   | (896,500                                    | )         | (430,513 | ) |
| Payments for acquisitions, net of cash  acquired                                                    |   | (3,787,301                                  | )         |   |   |
| Net cash (used in) by investing activities                                                          |   | (4,683,801                                  | )         | (430,513 | ) |
|                                                                                                |   |                                        |      |   |   |
| **Financing activities**                                                                            |   |                                        |      |   |   |
| Principal payments on capital leases                                                                |   | (84,476                                     | )         | (50,490 | ) |
| Proceeds from issuance of common stock                                                              |   | 87,282                                      |      | 108,913 |   |
| Net proceeds from borrowings                                                                        |   | **—**                                  |      | — |   |
| Net cash provided by financing activities                                                           |   | 2,806                                       |      | 58,423 |   |
|                                                                                                |   |                                        |      |   |   |
| Net change in cash and cash equivalents                                                             |   | (3,074,754                                  | )         | (5,257,305 | ) |
| Cash and cash equivalents at beginning of  period                                                   |   | 11,422,435                                  |      | 22,243,647 |   |
| Cash and cash equivalents at end of period                                                          |   | $                                           | 8,347,681 |   | $ | 16,986,342 |   |
|                                                                                                |   |                                        |      |   |   |
| **Supplemental cash flow information**                                                              |   |                                        |      |   |   |
| Interest paid                                                                                       |   | $                                           | 18,501    |   | $ | 12,829 |   |
| Common stock issued for acquisitions                                                                |   | 347,500                                     |      | — |   |
| Income taxes paid                                                                                   |   | 1,033,400                                   |      | 2,367,469 |   |

*See accompanying notes.*

 

5

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Gaiam, Inc.

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

March 31, 2003

 

1.             Interim Condensed Consolidated FinancialStatements

 

###### Organizationand Nature of Operations

 

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

 

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

 

Preparation of Interim Condensed Consolidated Financial Statements

 

The interim condensed consolidated financialstatements included herein have been prepared by the management of Gaiampursuant to the rules and regulations of the United States Securities 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 March 31, 2003, the interimresults of operations for the three months ended March 31, 2003 and 2002, andcash flows for the three months ended March 31, 2003 and 2002.  These interim statements have not beenaudited.  The balance sheet as ofDecember 31, 2002 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 generally accepted accounting principals have been condensed or omittedpursuant to such rules and regulations. Accounting policies followed by Gaiam are described in Note 1 to theaudited financial statements for the fiscal year ended December 31, 2002included in Gaiam’s annual report on Form 10-K.  The consolidated financial statements contained herein should beread in conjunction with the audited financial statements, including the notesthereto, for the year ended December 31, 2002.

 

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

 

Use of Estimates

 

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

 

6

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Adoption of Accounting Standards

 

In June 2001, the FASBissued statement No. 143, “Accounting for Asset Retirement Obligations” (“SFASNo. 143”), which sets forth the financial accounting and reporting to befollowed for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs.  SFAS No. 143 requires entities to record the fair value of aliability for an asset retirement obligation in the period in which it isincurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs are tobe capitalized as part of the carrying amount of the long-lived asset.  Subsequently, the recorded liability will beaccreted to its present value and the capitalized costs will bedepreciated.  Gaiam adopted SFAS No. 143in its consolidated financial statements for the first quarter of 2003.  The adoption of SFAS No. 143 did not have amaterial impact on Gaiam's consolidated financial statements.

 

In May 2002, the FASB issuedstatement No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendmentof FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”).  The statement rescinds FASB No. 4,“Reporting Gains and Losses from Extinguishment of Debt, and an amendment ofthat statement, FASB No. 64, “Extinguishments of Debt Made to Satisfy SinkingFund Requirements.”  As a result, gainsand losses from extinguishments of debt will no longer be aggregated andclassified as an extraordinary item, net of related income tax effect, on thestatement of earnings.  SFAS No. 145 iseffective for fiscal years beginning after May 15, 2002, with earlierapplication encouraged.  Gaiam hasadopted SFAS No. 145, as required, in its consolidated financial statementseffective the first quarter of 2003. The adoption of SFAS No. 145 did not have a material impact on Gaiam'sconsolidated financial statements.

 

 

In July 2002, the FASBissued statement No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (“SFAS No. 146”). SFAS No. 146 requires that a liability for a cost associated with anexit or disposal activity is recognized at fair value when the liability isincurred rather than at the date of a commitment to an exit or disposalplan.  SFAS No. 146 is effective forexit or disposal activities, which are initiated after December 31, 2002.  Gaiam has adopted SFAS No. 146 effective thefirst quarter of 2003.  The adoption ofSFAS No. 146 did not have a material impact on Gaiam's consolidated financialstatements.

 

 

In December 2002, the FASBissued statement No. 148, “Accounting for Stock-Based Compensation – Transitionand Disclosure, an Amendment of FASB Statement No. 123” (“SFAS No. 148”).  SFAS No. 148 amends FASB Statement No. 123,“Accounting for Stock-Based Compensation” (“Statement 123’) to providealternative methods of transition for a voluntary change to the fair value basedmethod of accounting for stock-based employee compensation.  Gaiam has elected to use the intrinsic valuemethod of accounting for stock compensation for options granted to employeesand directors in accordance with APB 25. In addition, SFAS No. 148 amends the disclosure requirements ofStatement 123 to require prominent disclosure in both annual and interim March31, 2003 financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method of accounting used onreported results. Gaiam has adopted SFAS No. 148 in its fiscal year reportingeffective December 31, 2002 and its interim reporting as of the first quarterof 2003.

 

7

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2.             Mergers and Acquisitions

 

InJanuary 2003, Gaiam acquired a 50.1% interest in Leisure Systems InternationalLtd., a U.K. based distributor and marketer of lifestyle products forapproximately $4.3 million in cash and 50,000 shares of Gaiam Class A commonstock.  This acquisition was accountedfor using the purchase method and approximately $2.8 million of goodwill wasrecorded.  The results of operations ofLeisure Systems International are included in the consolidated financialstatements of Gaiam from the effective acquisition date of January 1,2003.  The revenue generated by thisacquisition during the first quarter (which is historically a strong quarter)totaled approximately $3.69 million.

 

3.             Stockholders’ Equity

 

Duringthe first quarter of 2003, Gaiam issued 50,000 shares of Class A common stockin conjunction with the acquisition of 50.1% of Leisure Systems International3,750 shares of Class A common stock to four directors in lieu of cashcompensation, and 5,532 shares of Class A common stock upon exercise of optionsgranted under the 1999 Long-Term Incentive Plan.

 

4.             Earnings per Share

 

Basic earnings per share exclude any dilutive effects of options anddilutive securities.  Basic earnings pershare is computed using the weighted average number of common shares outstandingduring the period.  Diluted earnings pershare is computed using the weighted average number of common and common stockequivalent shares outstanding during the period.  Common equivalent shares are excluded from the computation iftheir effect is antidilutive.  Allearnings per share amounts for all periods have been presented and conform tothe Statement No. 128 requirements.

 

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

 
|                                                  |   | **Three  Months Ended  March 31,** |     |
|-------------------------------------------------------|--------|------------------------------------|----------|
|                                                  |   | **2003**                           |     | **2002** | ** ** |
|                                                  |   |                               |     |   |   |
| Net income (loss)                                     |   | $                                  | (352,548 | ) | $ | 735,642 |   |
|                                                  |   |                               |     |   |   |
| Denominator:                                          |   |                               |     |   |   |
| Weighted average shares for basic earnings per  share |   | 14,578,501                         |     | 14,005,480 |   |
|                                                  |   |                               |     |   |   |
| Effect of Dilutive Securities:                        |   |                               |     |   |   |
| Weighted average of common stock and stock options    |   | —                             |     | 526,871 |   |
| Denominator for diluted earnings per share            |   | 14,578,501                         |     | 14,532,351 |   |
| Net income (loss) per share – basic              |   | $                                  | (0.02    | ) | $ | 0.05 |   |
| Net income (loss) per share – diluted            |   | $                                  | (0.02    | ) | $ | 0.05 |   |

 

8

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5.             Stock Based Compensation

 

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

 
|                                                                                                                                       |   | **For the  Months Ended   March 31,** |     |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|----------|
|                                                                                                                                       |   | **2003**                              |     | **2002** |   |
| Net income  (loss) as reported                                                                                                             |   | $                                     | (352,548 | ) | $ | 735,642 |   |
| Deduct:  Total stock-based compensation expenses  determined under fair value based method for all awards net of related tax  effects |   | (179,382                              | )        | (194,252 | ) |
| Pro forma                                                                                                                                  |   | $                                     | (531,930 | ) | $ | 541,390 |   |
| Net income (loss) per common share                                                                                                         |   |                                  |     |   |   |
| As reported                                                                                                                                |   | $                                     | (0.02    | ) | $ | 0.05 |   |
| Pro forma                                                                                                                                  |   | $                                     | (0.04    | ) | $ | 0.04 |   |
| Fully diluted net income (loss) per common  share:                                                                                         |   |                                  |     |   |   |
| As reported                                                                                                                                |   | $                                     | (0.02    | ) | $ | 0.05 |   |
| Pro forma                                                                                                                                  |   | $                                     | (0.04    | ) | $ | 0.04 |   |

 

9

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6.             Segment Information

 

Gaiam has two business segments: Direct to Consumer and Business. Both segments sell products, servicesand information produced or purchased from other suppliers.  Although the customer bases do not overlapto any significant extent, the production, purchase and delivery processesoverlap in some areas.  Gaiam does notaccumulate the balance sheet by segment for purposes of management review.

 

Each of the two segments qualifies as such because each accounts formore than 10% of combined revenue. Contribution margin is defined as net sales, less cost of goods sold anddirect expenses. Financial information for Gaiam’s business segments was asfollows:

 
|                                                                |   | **For the  Three Months   Ended March 31,** |       |
|---------------------------------------------------------------------|--------|---------------------------------------------|------------|
|                                                                |   | **2003**                                    |       | **2002** |   |
| Net revenue:                                                        |   |                                        |       |   |   |
| Direct to consumer                                                  |   | $                                           | 11,017,144 |   | $ | 11,382,935 |   |
| Business                                                            |   | 12,351,094                                  |       | 12,900,605 |   |
| Consolidated net revenue                                            |   | 23,368,238                                  |       | 24,283,540 |   |
| Contribution margin:                                                |   |                                        |       |   |   |
| Direct to consumer                                                  |   | 4,585                                       |       | 126,703 |   |
| Business                                                            |   | (404,630                                    | )          | 1,048,511 |   |
| Consolidated contribution margin (loss)                             |   | (400,045                                    | )          | 1,175,214 |   |
| Reconciliation of contribution margin (loss) to  net income (loss): |   |                                        |       |   |   |
| Other income (expense)                                              |   | (70,783                                     | )          | (30,557 | ) |
| Income tax (benefit) expense                                        |   | (198,558                                    | )          | 406,353 |   |
| Minority interest expense                                           |   | 80,278                                      |       | 2,662 |   |
| Net income (loss)                                                   |   | $                                           | (352,548   | ) | $ | 735,642 |   |

 

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**Item2.****            Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

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

 

#### Three months ended March 31, 2003 compared to threemonths ended March 31, 2002

 

Revenues of $23.4 million for the three months ended March 31, 2003declined 3.8% from $24.3 million for the three months ended March 31,2002.  Gaiam’s internal growth rate wasa negative 20.2% primarily due to lower sales into our retailer channel.  We were also negatively impacted by theretail merger of The Sports Authority with Gart Sports and our transition ofBed Bath and Beyond from a distributor relationship to direct sales.

 

Gross profit,which consists of revenues less cost of sales (primarily merchandiseacquisition costs and in-bound freight) decreased 11.6% to $12.6 million forthe first quarter of 2003 from $14.3 million during the same period in2002.  As a percentage of revenue, grossprofit declined to 54% in 2003 from 58.8% in 2002.  This was primarily attributable to increased sales contributionfrom our acquisitions which carry lower margins and from margin contraction inour retailer channel.  Strategically,Gaiam continues to pursue growth of its proprietary product offerings and toincrease its focus on media products, on which Gaiam has better margins.

 

Selling andoperating expenses (which consist primarily of sales and marketing costs,commission and fulfillment expenses) of $10.6 million for the three monthsended March 31, 2003 were flat when compared to the same period of 2002.  As a percentage of revenues, selling andoperating expenses increased to 45.4% in 2003 from 43.6% in 2002 due to lowersales.

 

Corporate,general and administrative expenses decreased to $2.4 million during the firstquarter of 2003, from $2.5 million during 2002.  As a percentage of revenues, general and administrative expenseswere 10.3% for the comparable periods in both 2003 and 2002.

 

Operatingloss, as a result of the factors described above, was $400,045 for the threemonths ended March 31, 2003 compared to an operating profit of $1,175,214 forthe three months ended March 31, 2002 primarily due to lower sales and grossprofit.

 

Gaiamrecorded $70,783 in other expense for the three months ended March 31, 2003compared to $30,557 recorded in the prior year period. The share of net incomeassociated with minority interest was $80,278 during the first quarter of 2003,compared to $2,662 during the first quarter of 2002.   Minority interest changed year-over-year primarily due toGaiam’s purchase in first quarter 2003 of a majority interest in LeisureSystems International, a distributor of wellness products based in the U.K.

 

Gaiamrecorded an income tax benefit of $198,558 for the three months ended March 31,2003 compared to an income tax provision of $406,353 for the three months endedMarch 31, 2002.

 

Gaiamreported a net loss of $352,548 for the three month ended March 31, 2003 as aresult of the factors described above compared to net income of $735,642recorded for the three months ended March 31, 2002.

 

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Liquidity and Capital Resources

 

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

 

Gaiam’soperating activities provided net cash of $1.6 million for the three monthsended March 31, 2003 compared to cash usage of $4.9 million for the threemonths ended March 31, 2002.  Gaiam’snet cash provided by operating activities in 2003 was primarily due to asignificant reduction in accounts receivables during the first quarter.   Gaiam’s net cash used by operatingactivities in the first quarter of 2002 was primarily caused by a decrease inaccounts payable as we took advantage of early payment terms with our vendors,an increase in accounts receivable associated with the growth in our businesssegment and the payment of income taxes for the prior year.

 

Gaiam’sinvesting and acquisition activities used cash of $4,683,801 and $430,513 forthe three months ended March 31, 2003 and 2002, respectively.  In January 2003 Gaiam acquired a 50.1%interest in Leisure Systems International, a distributor of wellness productsbased in the U.K.  Total considerationfor the acquisition was approximately $4,300,000 in cash and 50,000 shares ofGaiam Class A common stock.

 

Gaiam’sfinancing activities provided cash of $2,806 and $58,423 for the three monthsended March 31, 2003 and 2002, respectively.

 

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

 

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

 

**Item3.****            Critical AccountingPolicies**

 

We have not had anysignificant change in our critical accounting policies from the previouslyreported 10K.

 

**Item 4.****           ****Quantitative and QualitativeDisclosures About Market Risk**

 

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

 

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

 

**Item 5.****         ****Controls and Procedures**

 

Based on their evaluation of our disclosurecontrols and procedures (as defined in Rule 13a-14(c) under theSecurities Exchange Act of 1934) as of a date within 90 days of the filingdate of this quarterly report, our Chief Executive Officer and Chief FinancialOfficer have concluded that these disclosure controls and procedures areeffective. There were no significant changes in our internal controls or inother factors that could significantly affect these controls subsequent to thedate of their evaluation.

 

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

 

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

 

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

 

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

 

None.

 

**Item 3.****           ****Defaults Upon SeniorSecurities**

 

None.

 

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

 

None.

 

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

 

None.

 

**Item 6.****           ****Exhibits and Reports on Form8-K.**

 

a)         Exhibits

 
| **Exhibit No.** |   | **Description**                                                                                                          |
|-----------------|--------|--------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                     |
| 99.1            |   | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|            |   |                                                                                                                     |
| 99.2            |   | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

b)          Reports on Form 8-K.

 

             On May 6, 2003, Gaiam filed a report on Form 8-Krelating to itsearnings press release for first quarter 2003.

 

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### **Signatures**

 

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

 
|   | Gaiam, Inc.  |                          |
|--------|--------------|-------------------------------|
|   | (Registrant) |                          |
|   | May 9, 2003  |                          |
|   |         |                          |   |
|   |         |                          |   |
|   |         |                          |   |
|   | By:          | /s/ Jirka Rysavy              |   |
|   |         |  Jirka Rysavy            |   |
|   |         |  Chief Executive Officer |   |
|   |         |                          |   |
|   |         | /s/ Yudhister Bahl            |   |
|   |         |  Yudhister Bahl          |   |
|   |         |  Chief Financial Officer |   |

 

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### **CERTIFICATIONS**

 

### **I, JirkaRysavy, certify that:**

 

### **1.  I have reviewed this quarterly report onForm 10-Q of Gaiam, Inc.;**

 

### **2.  Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;**

 

### **3.  Based on my knowledge, the financial statements,and other financial information included in this quarterly report, fairlypresent in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;**

 

### **4.  The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:**

 

### **a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is being prepared;**

 

### **b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and**

 

### **c) presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;**

 

### **5.  The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):**

 

### **a) all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and**

 

### **b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and**

 

### **6.  The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent**

 

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### **evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.**

 

 

### **Date: May9, 2003**

 

 
| **/s/ Jirka Rysavy**                 |   |   |
|--------------------------------------|--------|--------|
| **Jirka Rysavy**                     |   |   |
| Chairman and Chief Executive Officer |   |

 

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### **CERTIFICATIONS**

 

### **I,Yudhister Bahl, certify that:**

 

### **1. I havereviewed this quarterly report on Form 10-Q of Gaiam, Inc.;**

 

### **2. Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;**

 

### **3. Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;**

 

### **4. Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:**

 

### **a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;**

 

### **b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and**

 

### **c) presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;**

 

### **5. Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):**

 

### **a) all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and**

 

### **b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and**

 

### **6. Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent**

 

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### **evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.**

 

 
| **Date: May 9, 2003**         |   |   |
|-------------------------------|--------|--------|
|                          |   |   |
|                          |   |   |
| **/s/  Yudhister  Bahl** |   |   |
| **Yudhister Bahl**            |   |   |
| **Chief Financial Officer**   |   |   |

 

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