**United StatesSecurities 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 quarterly period ended  June 30, 2004** |
|                                                   |   |                                                                                                     |
| **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)       |

 

Indicateby check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports) and (2) has been subject to such filing requirements for the past 90days.

 

YES     ý     NO     o

 

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

 

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

 
| **Class**                               |   | **Shares  outstanding as of August 2, 2004** |
|-----------------------------------------|--------|---------------------------------------------------|
| Class A Common Stock ($.0001 par value) |   | 9,311,897                                         |
|                                    |   |                                              |
| Class B Common Stock ($.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 June 30, 2004  and December 31, 2003                  |   |
|       | Condensed  Consolidated Statements of Operations for the three  months ended June 30, 2004, and 2003 |   |
|       | Condensed Consolidated  Statements of Operations for the six  months ended June 30, 2004, and 2003   |   |
|       | Condensed  Consolidated Statement of Cash Flows for the six  months ended June 30, 2004 and 2003     |   |
|       | Notes  to Interim Condensed Consolidated Financial Statements                                             |   |
|       |                                                                                                      |   |
| Item  2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations               |   |
|       |                                                                                                      |   |
| Item  3.   | Quantitative and Qualitative Disclosures  About Market Risk                                               |   |
|       |                                                                                                      |   |
| Item 4.    | Controls and Procedures                                                                                   |   |
|       |                                                                                                      |   |
| PART II.   | OTHER INFORMATION                                                                                         |   |
|       |                                                                                                      |   |
| Item  1.   | Legal  Proceedings                                                                                        |   |
|       |                                                                                                      |   |
| Item 2.    | Changes in Securities and Use of  Proceeds                                                                |   |
|       |                                                                                                      |   |
| Item 3.    | Defaults Upon Senior Securities                                                                           |   |
|       |                                                                                                      |   |
| Item 4.    | Submission of Matters to a Vote  of Security Holders                                                      |   |
|       |                                                                                                      |   |
| Item 5.    | Other Information                                                                                         |   |
|       |                                                                                                      |   |
| Item 6.    | Exhibits and Reports on Form 8-K                                                                          |   |
|       |                                                                                                      |
| Signatures |                                                                                                      |

 

FORWARD-LOOKINGSTATEMENTS

 

This report may containforward-looking statements that involve risks and uncertainties.  When used in this discussion, the words“anticipate,” “believe,” “plan,” “estimate,” “expect,” “strive,” “future,”“intend” and similar expressions as they relate to Gaiam or its management areintended to identify such forward-looking statements.  Gaiam’s actual results could differ materially from the resultsanticipated in these forward-looking statements as a result of certain factorsset forth under “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” “Market Risk” and elsewhere in this report.  Risks and uncertainties that could causeactual results to differ include, without limitation, general economicconditions, competition, loss of key personnel, pricing, brand reputation,acquisitions, security and information systems, legal liability for websitecontent, merchandise supply problems, failure of third parties to provideadequate service, reliance on centralized customer service, overstocks andmerchandise returns, reliance on a centralized fulfillment center, increases inpostage and shipping costs, e-commerce trends, future Internet related taxes,control of Gaiam by its founder, fluctuations in quarterly operating results,consumer trends, 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

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GAIAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share information)

 
|                                                                                                                                                                                          |   | **June 30,  2004** |       | **December 31,  2003** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                          |   | **(Unaudited)**         |       |                        |       |
| **Assets**                                                                                                                                                                                    |   |                    |       |                        |       |
| Current  assets:                                                                                                                                                                              |   |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                     |   | $                       | 12,551     |                        | $          | 8,384 |   |
| Accounts receivable, net                                                                                                                                                                      |   | 7,031                   |       | 17,818                      |       |
| Income tax and other receivables                                                                                                                                                              |   | 3,641                   |       | 2,091                       |       |
| Inventory, less allowances                                                                                                                                                                    |   | 16,669                  |       | 16,629                      |       |
| Deferred advertising costs                                                                                                                                                                    |   | 1,749                   |       | 1,649                       |       |
| Other current assets                                                                                                                                                                          |   | 1,371                   |       | 1,280                       |       |
| Total current assets                                                                                                                                                                          |   | 43,012                  |       | 47,851                      |       |
|                                                                                                                                                                                          |   |                    |       |                        |       |
| Property and equipment, net                                                                                                                                                                   |   | 9,233                   |       | 10,314                      |       |
| Investments                                                                                                                                                                                   |   | 7,865                   |       | 7,865                       |       |
| Capitalized production costs, net                                                                                                                                                             |   | 5,893                   |       | 6,094                       |       |
| Media library, net                                                                                                                                                                            |   | 5,750                   |       | 6,084                       |       |
| Goodwill and other intangibles                                                                                                                                                                |   | 9,559              |       | 9,509                  |       |
| Deferred tax assets                                                                                                                                                                           |   | 3,312                   |       | 3,488                       |       |
| Other assets                                                                                                                                                                                  |   | 440                     |       | 655                         |       |
| Total assets                                                                                                                                                                                  |   | $                       | 85,064     |                        | $          | 91,860 |   |
|                                                                                                                                                                                          |   |                    |       |                        |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                 |   |                    |       |                        |       |
| Current liabilities:                                                                                                                                                                          |   |                    | ** ** |                        | ** ** |
| Accounts payable                                                                                                                                                                              |   | $                       | 8,061      |                        | $          | 12,459 |   |
| Accrued liabilities                                                                                                                                                                           |   | 4,067                   |       | 4,904                       |       |
| Income taxes payable                                                                                                                                                                          |   | 1,027                   |       | 902                         |       |
| Capital lease obligations, current                                                                                                                                                            |   | 18                      |       | 55                          |       |
| Total current liabilities                                                                                                                                                                     |   | 13,173                  |       | 18,320                      |       |
| Deferred tax liabilities                                                                                                                                                                      |   | 802                     |       | 735                         |       |
|                                                                                                                                                                                          |   |                    |       |                        |       |
| Total liabilities                                                                                                                                                                             |   | 13,975                  |       | 19,055                      |       |
|                                                                                                                                                                                          |   |                    |       |                        |       |
| Minority interest                                                                                                                                                                             |   | 3,492                   |       | 3,320                       |       |
|                                                                                                                                                                                          |   |                    |       |                        |       |
| Commitments and contingencies                                                                                                                                                                 |   |                    |       |                        |       |
|                                                                                                                                                                                          |   |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                    |   |                    |       |                        |       |
| Class A common stock, $.0001 par value,  150,000,000 shares authorized, 9,306,277 and 9,203,056 shares issued and  outstanding at June 30, 2004 and December 31, 2003, respectively |   | 1                       |       | 1                           |       |
| Class B common stock, $.0001 par value,  50,000,000 shares authorized, 5,400,000 issued and outstanding at  June 30, 2004 and December 31, 2003, respectively                       |   | 1                       |       | 1                           |       |
| Additional paid-in capital                                                                                                                                                                    |   | 54,366             |       | 53,831                 |       |
| Deferred compensation                                                                                                                                                                         |   | (36                     | )          | (72                         | )          |
| Accumulated other comprehensive income                                                                                                                                                        |   | 610                     |       | 525                         |       |
| Retained earnings                                                                                                                                                                             |   | 12,655                  |       | 15,199                      |       |
| Total stockholders’ equity                                                                                                                                                               |   | 67,597                  |       | 69,485                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                               |   | $                       | 85,064     |                        | $          | 91,860 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

3

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited)

(Inthousands, except per share amounts)

 
|                                                                             |   | **For the  Three Months Ended  June 30,** |   |
|----------------------------------------------------------------------------------|--------|------------------------------------------------|--------|
|                                                                             |   | **2004**                                       |   | **2003** |   |
|                                                                             |   |                                           |   |   |   |
| Net revenue                                                                      |   | $                                              | 17,031 |   | $ | 20,352 |   |
| Cost of goods sold                                                               |   | 8,491                                          |   | 9,536 |   |
| Gross profit                                                                     |   | 8,540                                          |   | 10,816 |   |
|                                                                             |   |                                           |   |   |   |
| Expenses:                                                                        |   |                                           |   |   |   |
| Selling and operating                                                            |   | 10,171                                         |   | 9,778 |   |
| Corporate, general and administration                                            |   | 2,003                                          |   | 2,123 |   |
| Total expenses                                                                   |   | 12,174                                         |   | 11,901 |   |
|                                                                             |   |                                           |   |   |   |
| Income (loss) from operations                                                    |   | (3,634                                         | )      | (1,085 | ) |
|                                                                             |   |                                           |   |   |   |
| Other income                                                                     |   | 28                                             |   | 5 |   |
| Interest income                                                                  |   | 48                                             |   | 12 |   |
| Total other income                                                               |   | 76                                             |   | 17 |   |
|                                                                             |   |                                           |   |   |   |
| Income (loss) before income taxes and  minority interest                         |   | (3,558                                         | )      | (1,068 | ) |
|                                                                             |   |                                           |   |   |   |
| Provision for income tax (benefit) expense                                       |   | (1,297                                         | )      | (406 | ) |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |   | 46                                             |   | (97 | ) |
| Net income (loss)                                                                |   | $                                              | (2,215 | ) | $ | (759 | ) |
|                                                                             |   |                                           |   |   |   |
| Net income (loss) per share:                                                     |   |                                           |   |   |   |
| Basic                                                                            |   | $                                              | (0.15  | ) | $ | (0.05 | ) |
| Diluted                                                                          |   | $                                              | (0.15  | ) | $ | (0.05 | ) |
| Shares used in computing net income (loss)  per share:                           |   |                                           |   |   |   |
| Basic                                                                            |   | 14,686                                         |   | 14,594 |   |
| Diluted                                                                          |   | 14,686                                         |   | 14,594 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

4

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited)

(Inthousands, except per share amounts)

 
|                                                                             |   | **For the  Six Months Ended  June 30,** |   |
|----------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                             |   | **2004**                                     |   | **2003** |   |
|                                                                             |   |                                         |   |   |   |
| Net revenue                                                                      |   | $                                            | 40,806 |   | $ | 43,324 |   |
| Cost of goods sold                                                               |   | 19,590                                       |   | 20,184 |   |
| Gross profit                                                                     |   | 21,216                                       |   | 23,140 |   |
|                                                                             |   |                                         |   |   |   |
| Expenses:                                                                        |   |                                         |   |   |   |
| Selling and operating                                                            |   | 21,128                                       |   | 20,330 |   |
| Corporate, general and administration                                            |   | 4,051                                        |   | 4,392 |   |
| Total expenses                                                                   |   | 25,179                                       |   | 24,722 |   |
|                                                                             |   |                                         |   |   |   |
| Income (loss) from operations                                                    |   | (3,963                                       | )      | (1,582 | ) |
|                                                                             |   |                                         |   |   |   |
| Other income (expense)                                                           |   | 52                                           |   | 16 |   |
| Interest income                                                                  |   | 80                                           |   | 27 |   |
| Total other income                                                               |   | 132                                          |   | 43 |   |
|                                                                             |   |                                         |   |   |   |
| Income (loss) before income taxes and  minority interest                         |   | (3,831                                       | )      | (1,539 | ) |
|                                                                             |   |                                         |   |   |   |
| Provision for income tax (benefit) expense                                       |   | (1,413                                       | )      | (604 | ) |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |   | (126                                         | )      | (177 | ) |
| Net income (loss)                                                                |   | $                                            | (2,544 | ) | $ | (1,112 | ) |
|                                                                             |   |                                         |   |   |   |
| Net income (loss) per share:                                                     |   |                                         |   |   |   |
| Basic                                                                            |   | $                                            | (0.17  | ) | $ | (0.08 | ) |
| Diluted                                                                          |   | $                                            | (0.17  | ) | $ | (0.08 | ) |
| Shares used in computing net income (loss)  per share:                           |   |                                         |   |   |   |
| Basic                                                                            |   | 14,650                                       |   | 14,587 |   |
| Diluted                                                                          |   | 14,650                                       |   | 14,587 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

5

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASHFLOWS

(Unaudited– In Thousands)

 
|                                                                                                |   | **For the  Six Months  Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                                |   | **2004**                                     |   | **2003** |   |
| **Operating activities**                                                                            |   |                                         |   |   |   |
| Net income (loss)                                                                                   |   | $                                            | (2,544 | ) | $ | (1,112 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                         |   |   |   |
| Depreciation                                                                                        |   | 1,472                                        |   | 1,288  |   |
| Amortization                                                                                        |   | 352                                          |   | 223 |   |
| Stock compensation                                                                                  |   | 36                                           |   | 36 |   |
| Minority interest in consolidated subsidiaries                                                 |   | 126                                     |   | 177  |   |
| Deferred tax expense                                                                                |   | 221                                          |   | — |   |
| Changes in operating assets and  liabilities, net of effects from acquisitions:                     |   |                                         |   |   |   |
| Accounts receivable                                                                                 |   | 9,279                                        |   | 10,197 |   |
| Inventory                                                                                           |   | (12                                          | )      | (8 | ) |
| Deferred advertising costs                                                                          |   | (100                                         | )      | 354 |   |
| Capitalized production costs                                                                        |   | 201                                          |   | (997 | ) |
| Other current assets                                                                                |   | (91                                          | )      | (594 | ) |
| Other assets                                                                                        |   | 205                                          |   | 121 |   |
| Accounts payable                                                                                    |   | (4,589                                       | )      | (4,465 | ) |
| Accrued liabilities                                                                                 |   | (602                                         | )      | (2,219 | ) |
| Income taxes payable                                                                                |   | 180                                          |   | (1,575 | ) |
| Net cash provided by operating activities                                                           |   | 4,134                                        |   | 1,426 |   |
|                                                                                                |   |                                         |   |   |   |
| **Investing activities**                                                                            |   |                                         |   |   |   |
| Purchase of property, equipment and media  rights                                                   |   | (369                                         | )      | (655 | ) |
| Payments for acquisitions, net of cash  acquired                                                    |   | —                                       |   | (3,787 | ) |
| Net cash used in investing activities                                                               |   | (369                                         | )      | (4,442 | ) |
|                                                                                                |   |                                         |   |   |   |
| **Financing activities**                                                                            |   |                                         |   |   |   |
| Principal payments on capital leases                                                                |   | (37                                          | )      | (170 | ) |
| Proceeds from issuance of common stock                                                              |   | 402                                          |   | 121 |   |
| Net cash (used in) provided by financing  activities                                                |   | 365                                          |   | (49 | ) |
|                                                                                                |   |                                         |   |   |   |
| Effects of exchange rates on cash and cash  equivalents                                             |   | 37                                           |   | — |   |
| Net change in cash and cash equivalents                                                             |   | 4,167                                        |   | (3,065 | ) |
| Cash and cash equivalents at beginning of  period                                                   |   | 8,384                                        |   | 11,422 |   |
| Cash and cash equivalents at end of period                                                          |   | $                                            | 12,551 |   | $ | 8,357 |   |
|                                                                                                |   |                                         |   |   |   |
| **Supplemental cash flow information**                                                              |   |                                         |   |   |   |
| Interest paid                                                                                       |   | $                                            | — |   | $ | 33 |   |
| Common stock issued for acquisitions                                                                |   | —                                       |   | 348 |   |
| Income taxes paid                                                                                   |   | —                                       |   | 1,033 |   |

 

*See accompanying notes to the condensed consolidated financialstatements.*

 

6

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Gaiam, Inc.

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

June 30, 2004

 

1.                                       Interim Condensed Consolidated FinancialStatements

 

###### Organization and 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, ecological lifestyles andresponsible media.  Gaiam wasincorporated under the laws of the State of Colorado on July 7, 1988.

 

The accompanying consolidated financial statementsinclude the accounts of Gaiam and its subsidiaries in which Gaiam’s ownershipis greater than 50% and the subsidiary is considered to be under Gaiam’scontrol.  All material intercompanyaccounts and transaction balances have been eliminated in consolidation.

 

Preparation of InterimCondensed 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 June 30, 2004, the interimresults of operations for the three and six months ended June 30, 2004 and2003, and cash flows for the six months ended June 30, 2004 and 2003.  These interim statements have not beenaudited.  The balance sheet as ofDecember 31, 2003 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 principles 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, 2003included in Gaiam’s annual report on Form 10-K.  The consolidated financial statements contained herein should beread in conjunction with Gaiam’s audited financial statements, including thenotes thereto, for the year ended December 31, 2003.

 

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

 

Use of Estimates

 

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

 

Reclassifications

 

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

 

7

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Adoption of AccountingStandards

 

In December 2003, the Financial AccountingStandards Board (“FASB”) issued a revised FASB Interpretation No. 46,“Consolidation of Variable Interest Entities,” (“FIN 46R”).  FIN 46R modifies FIN 46 to include (1) adeferral of the effective date of the provisions related to certain variableinterests, (2) additional scope exceptions for certain other variableinterests, (3) clarifications on the impact of troubled debt restructurings,and (4) additional guidance on what constitutes a variable interest.  Adoption of FIN 46R is required in thefinancial statements of public entities that have interests in special purposesentities (“SPEs”) for periods ending after December 15, 2003.  Adoption by public entities that haveinterests in all other types of variable interest entities (“VIEs”) is requiredin financial statements for periods ending after March 15, 2004.  Gaiam believes that it has no entitiesqualifying as SPEs or VIEs, therefore, the adoption of FIN 46R has had noeffect on Gaiam’s financial position, results of operations or cash flows.

 

Stock-Based Compensation

 

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

 

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

 
|                                                                                                                                        |   | **June 30,** |   | **June 30,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|-------------------|--------|
|                                                                                                                                        |   | **2004**          |   | **2003**          |   | **2004** |   | **2003** |   |
| Net income (loss) as reported                                                                                                               |   | $                 | (2,215 | )                 | $      | (759 | ) | $ | (2,544 | ) | $ | (1,112 | ) |
| Add:   Stock-based compensation expense included in reported net income  (loss), net of related tax effects                            |   | 18                |   | 18                |   | 36 |   | 36 |   |
| Deduct:   Total stock-based compensation expenses determined under fair value  based method for all awards, net of related tax effects |   | (164              | )      | (254              | )      | (329 | ) | (451 | ) |
| Pro forma                                                                                                                                   |   | $                 | (2,361 | )                 | $      | (995 | ) | $ | (2,837 | ) | $ | (1,527 | ) |
| Net income (loss) per common share                                                                                                          |   |              |   |              |   |   |   |   |   |
| As reported                                                                                                                                 |   | $                 | (0.15  | )                 | $      | (0.05 | ) | $ | (0.17 | ) | $ | (0.08 | ) |
| Pro forma                                                                                                                                   |   | $                 | (0.16  | )                 | $      | (0.07 | ) | $ | (0.19 | ) | $ | (0.10 | ) |
| Fully diluted net income (loss) per common  share                                                                                           |   |              |   |              |   |   |   |   |   |
| As reported                                                                                                                                 |   | $                 | (0.15  | )                 | $      | (0.05 | ) | $ | (0.17 | ) | $ | (0.08 | ) |
| Pro forma                                                                                                                                   |   | $                 | (0.16  | )                 | $      | (0.07 | ) | $ | (0.19 | ) | $ | (0.10 | ) |

 

8

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2.                                       Stockholders’ Equity

 

During the first quarter of 2004, Gaiam issued atotal of 11,251 shares of Class A common stock to Gaiam’s independentdirectors, in lieu of cash compensation, for services rendered in 2003. Inaddition, for the six months ended June 30, 2004, Gaiam issued 91,970shares of Class A common stock upon exercise of options granted under Gaiam’s1999 Long-Term Incentive Plan.

 

3.                                       Comprehensive Income (Loss)

 

Gaiam’s comprehensive income (loss) is comprised of net 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  June 30,** |   | **Six Months  Ended  June 30,** |   |
|-----------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                          |   | **2004**                               |   | **2003**                             |   | **2004** |   | **2003** |   |
| Net income (loss)                             |   | $                                      | (2,215 | )                                    | $      | (759 | ) | $ | (2,544 | ) | $ | (1,112 | ) |
| Foreign currency translation adjustment,  net |   | (83                                    | )      | —                               |   | 85 |   | — |   |
| Comprehensive income (loss), net of taxes     |   | $                                      | (2,298 | )                                    | $      | (759 | ) | $ | (2,459 | ) | $ | (1,112 | ) |

 

4.                                       Earnings (Loss) per Share

 

Basic earnings (loss) per share excludes any dilutiveeffects of options, warrants and dilutive securities.  Basic earnings (loss) per share is computed using the weightedaverage number of common shares outstanding during the period.  Diluted earnings per share is computed usingthe weighted average number of common and common stock equivalent sharesoutstanding during the period.  Commonequivalent shares are excluded from the computation of diluted earnings pershare for the three and six months ended June 30, 2004 and 2003 becausetheir effect is antidilutive.

 

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

 
|                                                          |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|---------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                          |   | **2004**                               |   | **2003**                             |   | **2004** |   | **2003** |   |
| Numerator for basic and diluted earnings  (loss) per share    |   | $                                      | (2,215 | )                                    | $      | (759 | ) | $ | (2,544 | ) | $ | (1,112 | ) |
| Denominator:                                                  |   |                                   |   |                                 |   |   |   |   |   |
| Weighted average shares for basis earnings  (loss) per share  |   | 14,686                                 |   | 14,594                               |   | 14,650 |   | 14,587 |   |
| Effect of dilutive securities:                                |   |                                   |   |                                 |   |   |   |   |   |
| Weighted average of common stock, stock  options and warrants |   | —                                 |   | —                               |   | — |   | — |   |
| Denominators for diluted earnings (loss)  per share           |   | 14,686                                 |   | 14,594                               |   | 14,650 |   | 14,587 |   |
|                                                          |   |                                   |   |                                 |   |   |   |   |   |
| Net income (loss) per share - basic                           |   | $                                      | (0.15  | )                                    | $      | (0.05 | ) | $ | (0.17 | ) | $ | (0.08 | ) |
| Net income (loss) per share - diluted                         |   | $                                      | (0.15  | )                                    | $      | (0.05 | ) | $ | (0.17 | ) | $ | (0.08 | ) |

 

5.                                       Segment Information

 

Gaiam manages itsbusiness and aggregates its operational and financial information in accordancewith two reportable segments.  Thedirect to consumer segment contains Gaiam’s catalog and Internet saleschannels, while the business segment comprises the retailer, media andcorporate account channels.

 

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Although Gaiam isable to track revenues by sales channel, management, allocation of resourcesand analysis and reporting of expenses is solely on a combined basis, at thereportable segment level.

 

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

 
|                                                                             |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                                             |   | **2004**                               |   | **2003**                             |   | **2004** |   | **2003** |   |
| Net revenue:                                                                     |   |                                   |   |                                 |   |   |   |   |   |
| Direct to consumer                                                               |   | $                                      | 10,291 |                                 | $      | 10,445 |   | $ | 22,429 |   | $ | 21,462 |   |
| Business                                                                         |   | 6,740                                  |   | 9,907                                |   | 18,377 |   | 21,862 |   |
| Consolidated net revenue                                                         |   | 17,031                                 |   | 20,352                               |   | 40,806 |   | 43,324 |   |
| Contribution margin:                                                             |   |                                   |   |                                 |   |   |   |   |   |
| Direct to consumer                                                               |   | (478                                   | )      | 144                                  |   | (502 | ) | 148 |   |
| Business                                                                         |   | (3,156                                 | )      | (1,229                               | )      | (3,461 | ) | (1,730 | ) |
| Consolidated contribution margin (loss)                                          |   | $                                      | (3,634 | )                                    | $      | (1,085 | ) | $ | (3,963 | ) | $ | (1,582 | ) |
| Reconciliation of contribution margin  (loss) to net income (loss):              |   |                                   |   |                                 |   |   |   |   |   |
| Other income (expense)                                                           |   | 76                                     |   | 17                                   |   | 132 |   | 43 |   |
| Income tax benefit (expense)                                                     |   | (1,297                                 | )      | (406                                 | )      | (1,413 | ) | (604 | ) |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |   | 46                                     |   | (97                                  | )      | (126 | ) | (177 | ) |
| Net income (loss)                                                                |   | $                                      | (2,215 | )                                    | $      | (759 | ) | $ | (2,544 | ) | $ | (1,112 | ) |

 

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

 

The following discussion and analysis of Gaiam’s financial conditionand results of operations should be read in conjunction with the condensedconsolidated financial statements and related notes included elsewhere in thisdocument.

 

Overview and Outlook

 

Gaiamis a multi-channel lifestyle company providing information, goods and servicesto customers who value personal development, healthy living, ecologicallifestyles and responsible media. Gaiam was incorporated in Boulder, Coloradoin 1988 to support “Conscious Commerce,” the practice of making purchasingdecisions based on lifestyle and personal values.   In 1995, Gaiam began to expand nationally.  In 1996, Gaiam made a large investment ininfrastructure and operating systems to support rapid growth. From 1997 to 2003,Gaiam’s revenues increased from $19.9 million to $102 million, representing acompound annual growth rate of 31.3%.

 

Thedirect to consumer segment continues to be an integral part of Gaiam’s outreachand a solid base of business.  Thissegment accounted for 49%, or approximately $50.5 million, of Gaiam’s revenuesduring 2003.  During the first sixmonths of 2004, revenues in this segment were $22.4 million, an increase of 5%over 2003, and representing 55% of total revenue.  Through its diverse media reach, the direct to consumer segmentprovides branding, a sounding board for new product testing, promotionalopportunities, consumer education and customer feedback on Gaiam’s and theLOHAS (Lifestyles of Health and Sustainability) industry’s focus and future.

 

Withthe inception of our business segment in 1998, Gaiam started to sell directlyto retailers, both domestically and abroad. As of the end of 2003, Gaiam products were available in over 30,000stores in North America, plus in retailers located in the U.K. andAustralia.  Gaiam introduced its“store-within-store” lifestyle presentations, which utilize custom fixturesdesigned and produced by Gaiam, in late 2000, and the placement of this conceptgrew to over 3,650 stores by the end of 2003. In 1998, revenues generated by the business segment were $3.8million.  In 2002, revenues in thissegment, which were generated primarily by sales to mass market retailers,topped $60 million, representing a compound annual growth rate in excess of100%, but became difficult to sustain without grass roots development.  Gaiam is diversifying its approach toinclude a grass roots rollout to the community-based retail and specialtymarkets, along with more outreach to professionals, including yoga and Pilates

 

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instructors,fitness clubs, chiropractors and other wellness professionals.  Gaiam believes this approach will provide asolid base for expansion and a spring board for new product launches.  Gaiam is also focusing on new media releasesand new product opportunities in soft goods and spa products, along with anexpansion in mass market retailers and bookstores, and new launches into thegrocery market.  During the thirdquarter of 2004, Gaiam will receive an additional eight feet of shelf space inTarget’s fall planagram set, which will triple our existing space.  Inventory for this expansion will startshipping in August 2004.

 

Gaiam’srevenues will continue to be heavily weighted to the second half of the calendaryear.  As expected, Gaiam posted a netloss for the first six months of 2004. Our second quarter performance was disappointing and generated higherlosses than anticipated on an overall decrease in revenue of 16.3% compared to2003.  Despite the net loss for thefirst six months of 2004, Gaiam generated cash from operating activities of$4.1 million for the six months ended June 30, 2004, as compared to $1.4million in cash generated for the same period in 2003.

 

#### Results of Operations

####  

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

 
|                                                                             |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                                             |   | **2004**                               |   | **2003**                             |   | **2004** |   | **2003** |   |
| Net revenue                                                                      |   | 100.0                                  | %      | 100.0                                | %      | 100.0 | % | 100.0 | % |
| Cost of goods sold                                                               |   | 49.9                                   | %      | 46.9                                 | %      | 48.0 | % | 46.6 | % |
| Gross profit                                                                     |   | 50.1                                   | %      | 53.1                                 | %      | 52.0 | % | 53.4 | % |
| Expenses:                                                                        |   |                                   |   |                                 |   |   |   |   |   |
| Selling and operating                                                            |   | 59.7                                   | %      | 48.0                                 | %      | 51.8 | % | 47.0 | % |
| Corporate, general and administration                                            |   | 11.7                                   | %      | 10.4                                 | %      | 9.9 | % | 10.1 | % |
| Total expenses                                                                   |   | 71.4                                   | %      | 58.4                                 | %      | 61.7 | % | 57.1 | % |
| Income (loss) from operations                                                    |   | -21.3                                  | %      | -5.3                                 | %      | -9.7 | % | -3.7 | % |
| Other income (expense), net                                                      |   | 0.4                                    | %      | 0.1                                  | %      | 0.3 | % | 0.1 | % |
| Income tax (benefit) expense                                                     |   | -7.6                                   | %      | -2.0                                 | %      | -3.5 | % | -1.4 | % |
| Minority intreest in net (income) loss of  consolidated subsidiaries, net of tax |   | 0.3                                    | %      | -0.5                                 | %      | -0.3 | % | -0.4 | % |
| Net income (loss)                                                                |   | -13.0                                  | %      | -3.7                                 | %      | -6.2 | % | -2.6 | % |

####  

#### Three months endedJune 30, 2004 versus June 30, 2003

####  

Revenues of $17 millionfor the three months ended June 30, 2004 decreased 16.3% from $20.4million for the three months ended June 30, 2003.  Gaiam’s decrease in revenues was due to adecrease in the business segment of $3.2 million, or 32% for the quarter.  This shortfall resulted from lower salesvolumes in the U.S. trade business, and an increase in markdowns and returnsassociated with the change out of VHS stock for DVDs.  Sales to Target decreased over $1 million as compared to the sameperiod in 2003, as Target sold through its current product array prior to thespace expansion and assortment reset to ship starting in August.  Additionally, two of our distributors whoservice the clubs (Costco, Sam’s) and Wal-Mart generated negative comparativesales of over $1.1 million from 2003, as these retailers move to convert theirmedia inventories from the VHS format.  Direct to consumer segment revenues were $10.3 million for the threemonths ended June 30, 2004, compared to $10.4 million for the same periodin 2003.  In 2004, Gaiam suspendeddistribution of one of its catalog titles for the Spring/Summer seasons.  This title generated $668 thousand inrevenue during the second quarter of 2003, as compared to $30 thousand in thecomparable 2004 period, which were generated from the run-out of orders fromthe holiday mailing.  Internal revenuegrowth in the Internet and catalog businesses was 18% and 5%, respectively, forthe second quarter.

 

Gross profit, whichconsists of revenues less cost of sales (primarily merchandise acquisitioncosts and in-bound freight), decreased to $8.5 million for the second quarterof 2004 from $10.8 million during the same period in 2003.  As a percentage of revenue, gross profitdeclined to 50.1% in 2004 from 53.1% in 2003. This was primarily attributable to declines in the business segmentgross margin associated with a change in product mix to

 

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accessories with lowergross profit margins, increased markdowns given to incent sell-through of VHSinventories, and the write-down of VHS inventory, components and packaging.

 

Selling and operatingexpenses (which consist primarily of sales and marketing costs, commission andfulfillment expenses) increased to $10.2 million for the three months endedJune 30, 2004 as compared to $9.8 million in the same period of 2003,primarily resulting from increased sales and marketing efforts in our businesssegment, both domestically and in our U.K. subsidiary.  As a percentage of revenues, selling andoperating expenses increased to 59.7% in 2004 from 48% in 2003.

 

Corporate, general andadministration expenses decreased to $2.0 million for the second quarter of2004 from $2.1 million in the comparable 2003 period, but increased to 11.7% ofrevenues in 2004 from 10.4% of revenues in 2003 due to the lower sales base in2004.  This expense reduction wasgenerally attributable to cost savings generated by the consolidation ofadministrative services into Gaiam’s Colorado headquarters and the resultantstaffing reductions implemented at the end of the first half of 2003.

 

Operating lossesincreased to $3.6 million for the three months ended June 30, 2004 from$1.1 million for the three months ended June 30, 2003, primarily due torevenue decreases and lower gross profit margins.

 

Gaiamrecorded $76 thousand and $17 thousand in other income, primarily from interestincome, for the three months ended June 30, 2004 and 2003,respectively.  The share of net lossesassociated with minority interest was $46 thousand during the second quarter of2004, compared to the share of net income of $97 thousand for the comparable2003 period.

 

Gaiamrecorded an income tax benefit of $1.3 million for the three months endedJune 30, 2004 compared to an income tax benefit of $405 thousand for thethree months ended June 30, 2003.

 

Asa result of the factors described above, Gaiam’s net loss was $2.2 million forthe three months ended June 30, 2004 compared to a net loss of $759thousand recorded for the three months ended June 30, 2003.  Despite these losses, Gaiam’s cash generatedby operations was $1.4 million for the second quarter 2004, compared to a useof cash for the same period in 2003 of $81 thousand, and Gaiam’s cash positionincreased to $12.6 million at June 30, 2004, from $11.0 million atMarch 31, 2004.

 

#### Six months endedJune 30, 2004 versus June 30, 2003

####  

Revenues of $40.8 millionfor the six months ended June 30, 2004 decreased 5.8% from $43.3 millionfor the six months ended June 30, 2003. Gaiam’s decrease in revenues was due to a decrease in the businesssegment of $3.5 million, or 16% for the first six months of 2004.  This shortfall resulted from lower salesvolumes in the U.S. trade business, and an increase in markdowns and returnsassociated with the change out of VHS stock for DVDs.  Sales to Target decreased over $2.5 million as compared to thesame period in 2003, as Target’s replenishment order dropped in the firstquarter while they sold through stock delivered in the fourth quarter of 2003for the cartwell promotion, and they sold through its current product arrayprior to the space expansion and assortment reset to ship starting inAugust.  Additionally, two of ourdistributors who service the clubs (Costco, Sam’s) and Wal-Mart generatednegative comparative sales of over $1.1 million from 2003, as these retailersmove to convert their media inventories from the VHS format.   Direct to consumer segment revenues were$22.4 million for the six months ended June 30, 2004, compared to $21.5million for the same period in 2003. Internal revenue growth in our Internet and catalog businesses was 10%and 6%, respectively, for the first six months of the year.

 

Gross profit decreased to$21.2 million for the first six months of 2004 from $23.1 million during thesame period in 2003.  As a percentage ofrevenue, gross profit declined to 52% in 2004 from 53.4% in 2002.  This was primarily attributable a decline of267 basis points in the business segment gross margin associated with a changein mix from media to accessories and expense incurred with the changeover fromVHS to DVD products.  This was partiallyoffset by a favorable change in sales mix from the business segment to thedirect to consumer segment, where Gaiam has better overall margins.

 

Selling and operatingexpenses increased to $21.1 million for the six months ended June 30, 2004as compared to $20.3 million in the same period of 2003, primarily resultingfrom increased sales and marketing efforts in our business segment, bothdomestically and in our U.K. subsidiary, and in our direct to consumer segmentto

 

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support the revenueincreases described above.  As apercentage of revenues, selling and operating expenses increased to 51.8% in2004 from 47% in 2003.

 

Corporate, general andadministration expenses decreased to $4.1 million for the six months endedJune 30, 2004 from $4.4 million in the comparable 2003 period, anddecreased to 9.9% of revenues in 2004 from 10.1% of revenues in 2003.  This expense reduction is generallyattributable to cost savings generated by the consolidation of administrativeservices into Gaiam’s Colorado headquarters and the resultant staffingreductions implemented during 2003.

 

Operating lossesincreased to $4 million for the six months ended June 30, 2004 from $1.6million for the six months ended June 30, 2003, primarily due to revenuesdecreases and lower gross profit margins.

 

Gaiamrecorded $132 thousand and $43 thousand in other income, primarily frominterest income, for the six months ended June 30, 2004 and 2003,respectively.  The share of net incomeassociated with minority interest was $126 thousand for the first six months of2004, compared to the share of net income of $177 thousand for the comparable2003 period.  This change was primarilythe result of lower 2004 minority interest expense associated with the U.K.subsidiary as compared to 2003.

 

Gaiamrecorded an income tax benefit of $1.4 million for the six months endedJune 30, 2004 compared to an income tax benefit of $604 thousand for thesix months ended June 30, 2003.

 

Asa result of the factors described above, Gaiam’s net loss was $2.5 million forthe six months ended June 30, 2004 compared to a net loss of $1.1millionrecorded for the six months ended June 30, 2003.  Despite these losses, Gaiam’s cash generated by operations was$4.1 million for the first six months of 2004, compared to cash generated byoperations of $1.4 million for the same period in 2003, and Gaiam’s cashposition increased to $12.6 million at June 30, 2004, from $8.4 million atDecember 31, 2003.

 

Liquidityand Capital Resources

 

Gaiam’s capital needs arise from working capital required to fund ouroperations, capital expenditures related to replacements, expansions andimprovements to Gaiam’s infrastructure, development of e-commerce, acquisitionsof new businesses, and future growth. These capital requirements depend on numerous factors, including therate of market acceptance of Gaiam’s product offerings, the ability to expandGaiam’s customer base, the cost of ongoing upgrades to Gaiam’s productofferings, the level of expenditures for sales and marketing, the level ofinvestment in distribution and other factors. The timing and amount of these capital requirements cannot accurately bepredicted.  Additionally, Gaiam willcontinue to evaluate possible investments in businesses, products and technologies,and increase its sales and marketing programs and brand promotions as needed.

 

Gaiam has a credit agreement with Wells Fargo, which expires during2005 and permits borrowings of up to $15 million based upon the collateralvalue of Gaiam’s accounts receivable, inventory and certain property andequipment.  Borrowings under the creditagreement bear interest at the lower of prime rate less 50 basis points orLIBOR plus 275 basis points.  Borrowingsare secured by a pledge of Gaiam’s assets, and the agreement contains variousfinancial covenants, including covenants prohibiting the payment of cashdividends to Gaiam shareholders and requiring compliance with certain financialratios.  At June 30, 2004, Gaiamhad no amounts outstanding under this agreement and complied with all of thefinancial covenants.

 

Gaiam’s operating activities generated net cash of $4.1 million and$1.4 million for the six months ended June 30, 2004 and 2003,respectively.  Gaiam’s net cashgenerated from operating activities for both periods is primarily attributableto a decrease in accounts receivable of $9.3 million in 2004 and $10.2 millionin 2003, which was partially offset by decreases in accounts payable of $4.6million in 2004 and $4.5 million in 2003. Additionally, during the second quarter of 2003, accrued expenses andincome taxes payable decreased a combined $3.8 million.  Non-cash charges to net income were $2.2million and $1.7 million for the six months ended June 30, 2004 and 2003,respectively.

 

Gaiam’s investing and acquisition activities used net cash of $369thousand and $4.4 million during the first six months of 2004 and 2003,respectively.  Expenditures forproperty, equipment and media rights were $369 thousand for the first sixmonths of 2004, as compared to $655 thousand for the same period in 2003.  In January

 

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2003,Gaiam acquired a 50.1% interest in Leisure Systems International, a distributorof wellness products based in the U.K. Total consideration for the acquisition was approximately $4.3 millionin cash and 50,000 shares of Gaiam Class A common stock.

 

Gaiam’s financing activities generated net cash of $365 thousand andused cash of $49 thousand for the six months ended June 30, 2004 and 2003,respectively.  The cash generated byfinancing activities results primarily from the exercise of stock options underGaiam’s 1999 Long Term Incentive Program. Cash is used to fund principal payments under capitalized leases.

 

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

 

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

 

Contractual Obligations

 

Gaiam has commitments pursuant to lease and debt agreements, but doesnot have any long-term debt obligations or purchase obligations.  The following table shows our commitments tomake future payments under operating and capital leases as of June 30,2004 (in thousands):

 
|                               |   | **Total** |   | **< 1  year** |   | **1-3 years** |   | **3-5 years** |   | **> 5 yrs** |   |
|------------------------------------|--------|-----------|--------|------------------|--------|---------------|--------|---------------|--------|----------------|--------|
| Operating lease obligations        |   | $         | 3,990  |             | $      | 1,504         |   | $             | 2,486  |           | $      | — |   | $ | — |   |
| Capital lease obligations          |   | 18        |   | 18               |   | —        |   | —        |   | —         |   |
| Total contractual cash obligations |   | $         | 4,008  |             | $      | 1,522         |   | $             | 2,486  |           | $      | — |   | $ | — |   |

 

Off-Balance Sheet Arrangements

 

Gaiam does not participate in transactions that generate relationshipswith unconsolidated entities or financial partnerships, such as special purposeentities (“SPEs”) or variable interest entities (“VIEs”) established for thepurpose of facilitating off-balance sheet arrangements or other limitedpurposes.  As of June 30, 2004,Gaiam was not involved with any unconsolidated SPEs or VIEs.

 

Critical Accounting Policies

 

Management believes thefollowing to be critical accounting policies whose application have 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.

 

*Provision for Doubtful Accounts*

 

Gaiamrecords a provision for doubtful accounts for all receivables not expected tobe collected.  Gaiam generally does notrequire collateral.  Gaiam evaluates thecollectibility of accounts receivable based on a combination of factors.  In circumstances when 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.

 

*Inventory*

 

Inventoryconsists primarily of finished goods held for sale and is stated at the lowerof cost (first-in, first-out method) or market. Gaiam identifies the inventoryitems to be written down for obsolescence based on the item’s

 

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currentsales status and condition.  If the itemis discontinued or slow moving, it is written down based on an estimate of themarkdown to retail price needed to sell through its current stock level of theitem.

 

*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 unitexceeds its carrying amount, goodwill of the reporting unit is considered notimpaired.

 

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

 

*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. Investments underthe cost method are included on the accompanying consolidated balance sheet in“Investments.”

 

*Capitalized Production Costs*

 

Capitalizedproduction costs include costs incurred to produce informational media productsmarketed by Gaiam to retail marketers and direct-mail customers.  These costs are deferred for financialreporting purposes until the media is released, then amortized over succeedingperiods on the basis of estimated sales. Historical sales statistics are the principal factor used in estimatingthe amortization rate.

 

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

 

Risk Factors

 

We wish to caution youthat there are risks and uncertainties that could cause our actual results tobe materially different from those indicated by forward-looking statements thatwe make from time to time in filings with the Securities and ExchangeCommission, news releases, proxy statements, annual reports, registrationstatements and other written communications, as well as oral forward-lookingstatements made from time to time by representatives of Gaiam.  These risks and uncertainties include, butare not limited to, those listed in Gaiam’s Annual Report on Form 10-K for theyear ended December 31, 2003. 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 Qualitative DisclosuresAbout Market Risk

##### ** **

Weare exposed to market risks, which include changes in U.S. interest rates andforeign exchange rates.  We do notengage in financial transactions for trading or speculative purposes.

 

Anyborrowings we might make under our bank credit facility would bear interest atthe lower of prime rate less 50 basis points or LIBOR plus 275 basispoints.  Gaiam does not have any amountsoutstanding under its credit line, so any

 

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unfavorablechange in interest rates would not have a material impact on Gaiam’s resultsfrom operations or cash flows unless Gaiam made borrowings in the future.

 

Gaiampurchases a significant amount of inventory from vendors outside of the U.S. intransactions that are primarily U.S. dollar transactions.  Because the percentage of our internationalpurchases denominated in currencies other than the U.S. dollar is small, 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.

 

In2003, Gaiam purchased a 50.1% interest in Leisure Systems InternationalLimited, a U.K. based distributor. Because Leisure Systems’ revenues are primarily denominated in foreigncurrencies, this investment exposes Gaiam to accounting risk associated withforeign currency exchange rate fluctuations. However, we have determined that there was no material market riskexposure to our consolidated financial position, results of operations or cashflows as of June 30, 2004.

 

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

 

EffectiveAugust 2002, the Securities and Exchange Commission adopted rulesrequiring reporting companies to maintain disclosure controls and procedures toprovide reasonable assurance that a registrant is able to record, process,summarize and report the information required in the registrant’s quarterly andannual reports under the Securities Exchange Act of 1934 (the “Exchange Act”).

 

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 15d-15(e) under the ExchangeAct.  Based upon their evaluation as ofJune 30, 2004, they have concluded that those disclosure controls andprocedures are effective.

 

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

 
| **PART II.** |   | **OTHER INFORMATION**                                                                                                                                                                                                                                                                      |
|--------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                                                       |
| **Item  1.** |   | **Legal Proceedings**                                                                                                                                                                                                                                                                      |
|         |   |                                                                                                                                                                                                                                                                                       |
|         |   | From time to time, Gaiam is involved in legal proceedings that we  consider to be in the normal course of business.  We do not believe that any of these proceedings will have a  material adverse effect on our business.                                                            |
|         |   |                                                                                                                                                                                                                                                                                       |
| **Item  2.** |   | **Changes in Securities and  Use of Proceeds**                                                                                                                                                                                                                                             |
|         |   |                                                                                                                                                                                                                                                                                       |
|         |   | None.                                                                                                                                                                                                                                                                                      |
|         |   |                                                                                                                                                                                                                                                                                       |
| **Item  3.** |   | **Defaults Upon Senior  Securities**                                                                                                                                                                                                                                                       |
|         |   |                                                                                                                                                                                                                                                                                       |
|         |   | None.                                                                                                                                                                                                                                                                                      |
|         |   |                                                                                                                                                                                                                                                                                       |
| **Item 4.**  |   | **Submission of Matters to a Vote of Security Holders.**                                                                                                                                                                                                                                   |
|         |   |                                                                                                                                                                                                                                                                                       |
|         |   | On  May 18, 2004, Gaiam held its Annual Meeting of Shareholders.  The shareholders elected six directors to  serve until the next annual meeting of shareholders to be held in 2005 or  until their successors are duly elected and qualified.  The results of this vote follow: |
|         |   |                                                                                                                                                                                                                                                                                       |
|         |   | Jirka  Rysavy                                                                                                                                                                                                                                                                              | For: |   | 61,009,054 |   | Withheld: |   | 1,011,824 |   |
|         |   | Lynn  Powers                                                                                                                                                                                                                                                                               | For: |   | 61,009,235 |   | Withheld: |   | 1,011,643 |   |
|         |   | James  Argyropoulous                                                                                                                                                                                                                                                                       | For: |   | 61,947,762 |   | Withheld: |   | 73,116 |   |
|         |   | Barnet  Feinblum                                                                                                                                                                                                                                                                           | For: |   | 61,945,968 |   | Withheld: |   | 74,910 |   |
|         |   | Barbara  Mowry                                                                                                                                                                                                                                                                             | For: |   | 61,947,588 |   | Withheld: |   | 73,290 |   |
|         |   | Paul  Ray                                                                                                                                                                                                                                                                                  | For: |   | 61,157,071 |   | Withheld: |   | 863,807 |   |

 

16

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| **Item 5.** |   | **Other Information.**                |
|-------------|--------|---------------------------------------|
|        |   |                                  |
|        |   | None.                                 |
|        |   |                                  |
| **Item 6.** |   | **Exhibits and Reports on Form 8-K.** |
|        |   |                                  |
|        |   | a)                                    | Exhibits |

 
|   |   |   | **Exhibit No.**                                                                                                                                                                                |   | **Description**                                                                                                                                                                         |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                           |
|   |   |   | 10.5                                                                                                                                                                                           |   | Lease dated May 28th, 2004, between Gaiam, Inc. and FUND  IX, FUND X, FUND XI AND REIT JOINT VENTURE (filed herewith)                                                                   |
|   |   |   | 31.1                                                                                                                                                                                           |   | Certification of the Chief Executive Officer pursuant to Rule  13a-14(a) under the Securities Exchange Act of 1934 (filed herewith).                                                    |
|   |   |   | 31.2                                                                                                                                                                                           |   | Certification of the Chief Financial Officer pursuant to Rule  13a-14(a) under the Securities Exchange Act of 1934 (filed herewith).                                                    |
|   |   |   | 32.1                                                                                                                                                                                           |   | Certification of the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (furnished herewith). |
|   |   |   | 32.2                                                                                                                                                                                           |   | Certification of the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (furnished herewith). |
|   |   |   |                                                                                                                                                                                           |   |                                                                                                                                                                                    |
|   |   | b)     | Reports  on Form 8-K.                                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                           |
|   |   |   | On  May 6, 2004, Gaiam filed a report on Form 8-K relating to its earnings press  release for the first quarter 2004.                                                                          |
|   |   |   | On  July 23, 2004, Gaiam filed a report on Form 8-K relating to its press  release concerning Gaiam’s outlook for the second quarter 2004.                                           |
|   |   |   | On  July 30, 2004, Gaiam filed a report on Form 8-K under Item 4, “Changes  in Registrant’s Accountant” announcing a change in Registrant’s independent  accountants. |
|   |   |   | On  August 2, 2004, Gaiam filed a report on Form 8-K relating to its  earnings press release for the second quarter 2004.                                                                 |

 

17

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**Signatures**

 

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

 

 
|   | Gaiam,  Inc.         |
|--------|----------------------|
|   | (Registrant)         |
|   | August 2,  2004 |
|   |                 |
|   |                 |
|   | By:                  | /s/ | Jirka  Rysavy |   |
|   |                 |   |   Jirka Rysavy |
|   |                 |   |   Chief  Executive Officer |
|   |                 |
|   |                 | /s/ | Janet  Mathews |   |
|   |                 |   |   Janet  Mathews |
|   |                 |   |   Chief  Financial Officer |
|        |                      |  |  |  |  |

 

18

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