Table of Contents

 

 

 

**UnitedStatesSecurities and Exchange Commission**

**Washington,D.C. 20549**

 

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

#### ** **

| **x**                                                       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE  ACT OF 1934**  |
|-------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                        |
| **For the  quarterly period ended September 30, 2008** |
|                                                        |
| **OR**                                                      |
|                                                        |                                                                                                     |
| **o**                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE  ACT OF 1934** |

 

**CommissionFile Number 0-27517**

 

**GAIAM, INC.**

(Exact name of registrant as specified in itscharter)

 

| **COLORADO**                     | ** ** | **84-1113527**      |
|----------------------------------|------------|---------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer    |
| incorporation or  organization)  |       | Identification No.) |

 

**833 W.SOUTH BOULDER ROAD**

**LOUISVILLE,COLORADO 80027-2452**

(Address of principal executive offices)

 

**(303)222-3600**(Registrant’stelephone number, including area code)

 

Indicateby check mark whether the registrant:  (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities andExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has beensubject to such filing requirements for the past 90days.  YES  x    NO  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

| Large  accelerated filer o                     |   | Accelerated  filer x         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                       |   | Smaller  reporting company o |
| (Do  not check if a smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).   YES  o    NO  x

 

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

 

| **Class**                                     | ** ** | **Outstanding at November 7, 2008** |
|-----------------------------------------------|------------|---------------------------------------------------------|
| Class A Common Stock  ($.0001 par value) |       | 18,625,855                                              |   |
| Class B Common Stock  ($.0001 par value) |       | 5,400,000                                               |   |

 

 

 

----

Table of Contents

 

**GAIAM, INC.**

 

**FORM 10-Q**

 

**INDEX**

 
| **PART I.  FINANCIAL INFORMATION** | 3                                                                                                                               |
|-----------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|
| ** **                              | ** **                                                                                                                      |   |
| **Item  1.**                            | **Financial  Statements (Unaudited):**                                                                                          | 3 |
|                                    | Condensed consolidated balance sheets at September 30,  2008 and December 31, 2007                                    | 4 |
|                                    | Condensed consolidated statements of operations for  the Three and Nine Months Ended September 30, 2008 and 2007 | 5 |
|                                    | Condensed consolidated statements of cash flows for  the Nine Months Ended September 30, 2008 and 2007                | 6 |
|                                    | Notes to interim condensed consolidated financial  statements                                                                   | 7 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 2.**                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                     | 11 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 3.**                             | Quantitative  and Qualitative Disclosures About Market Risk                                                                     | 17 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 4.**                             | Controls  and Procedures                                                                                                        | 17 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **PART II.  OTHER INFORMATION**    | 18                                                                                                                              |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 1.**                             | Legal Proceedings                                                                                                               | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item  1A.**                           | Risk Factors                                                                                                                    | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 2.**                             | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                    | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 3**                              | Defaults  Upon Senior Securities                                                                                                | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 4.**                             | Submission  of Matters to a Vote of Security Holders                                                                            | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item 5.**                             | Other Information                                                                                                               | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
| **Item  6.**                            | Exhibits                                                                                                                        | 18 |
| ** **                              | ** **                                                                                                                      | ** ** |
|                                    | SIGNATURES                                                                                                                      | 19 |

 

2

----

Table of Contents

 

**CAUTIONARY STATEMENT REGARDING FORWARD-LOOKINGSTATEMENTS**

 

# **Thisreport may contain forward-looking statements that involve risks anduncertainties. When used in discussion, the words “anticipate,” “believe,” “plan,”“estimate,” “expect,” “strive,” “future,” “intend” and similar expressions asthey relate to us are intended to identify such forward-looking statements. Ouractual results could differ materially from the results anticipated in theseforward-looking statements as a result of certain factors set forth under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” “Quantitativeand Qualitative Disclosures about Market Risk” and elsewhere in this report.Risks and uncertainties that could cause actual results to differ include,without limitation, general economic conditions, competition, loss of keypersonnel, pricing, brand reputation, consumer trends, acquisitions, newinitiatives undertaken by us, security and information systems, legal liabilityfor website content, merchandise supply problems, failure of third parties toprovide adequate service, our reliance on centralized customer service,overstocks and merchandise returns, our reliance on a centralized fulfillmentcenter, increases in postage and shipping costs, E-commerce trends, futureInternet related taxes, our founder’s control of us, fluctuations in quarterly operatingresults, customer interest in our products, the effect of government regulationand other risks and uncertainties included in our filings with the Securitiesand Exchange Commission. We caution you that no forward-looking statement is aguarantee of future performance, and you should not place undue reliance onthese forward-looking statements which reflect our view only as of the date ofthis report. We undertake no obligation to update any forward-lookinginformation.**

# ** **

# **PART I.  FINANCIAL INFORMATION**

# ** **

**Item 1.     Financial Statements (Unaudited)**

 

# **Unaudited InterimCondensed Consolidated Financial Statements**

# ** **

Wehave prepared our unaudited interim condensed consolidated financial statementsincluded herein pursuant to the rules and regulations of the United StatesSecurities and Exchange Commission. Certain information and note disclosuresnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted in the United States have beencondensed or omitted pursuant to these rules and regulations, although webelieve that the disclosures made are adequate to make the information notmisleading. In our opinion, the unaudited interim condensed financialstatements contain all adjustments (consisting of only normal recurringadjustments) necessary to present fairly, in all material respects, ourconsolidated financial position as of September 30, 2008, the interimresults of operations for the three and nine months ended September 30,2008 and 2007, and cash flows for the nine months ended September 30, 2008and 2007. These interim statements have not been audited. The balance sheet asof December 31, 2007 was derived from our audited consolidated financialstatements included in our annual report on Form 10-K. The interimcondensed consolidated financial statements contained herein should be read inconjunction with our audited financial statements, including the notes thereto,for the year ended December 31, 2007.

 

3

----

Table of Contents

 

**GAIAM, INC.**

**Condensed consolidated balancesheets**

 
| ** **                                                                                                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(in thousands, except share and per share data)**                                                                                                                                              | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                          | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                          |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                                                     |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                           |       | $                      | 50,317     |                  | $          | 66,258 |   |
| Accounts receivable, net                                                                                                                                                                                                            |       | 26,641                 |       | 30,157                |       |
| Inventory, less allowances                                                                                                                                                                                                          |       | 32,950                 |       | 29,839                |       |
| Deferred advertising costs                                                                                                                                                                                                          |       | 3,475                  |       | 3,602                 |       |
| Deferred tax assets                                                                                                                                                                                                                 |       | 12,837                 |       | 6,005                 |       |
| Other current assets                                                                                                                                                                                                                |       | 7,223                  |       | 5,205                 |       |
| Total current assets                                                                                                                                                                                                                |       | 133,443                |       | 141,066               |       |
|                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Property and equipment, net                                                                                                                                                                                                         |       | 25,635                 |       | 9,509                 |       |
| Media library, net                                                                                                                                                                                                                  |       | 12,086                 |       | 37,566                |       |
| Deferred tax assets, net                                                                                                                                                                                                            |       | 978                    |       | 4,057                 |       |
| Goodwill and other intangibles, net                                                                                                                                                                                                 |       | 52,197                 |       | 44,410                |       |
| Notes receivable and other assets                                                                                                                                                                                                   |       | 3,401                  |       | 4,104                 |       |
| Total assets                                                                                                                                                                                                                        |       | $                      | 227,740    |                  | $          | 240,712 |   |
|                                                                                                                                                                                                                                |       |                   |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                       |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                                                    |       | $                      | 18,645     |                  | $          | 23,620 |   |
| Accrued liabilities                                                                                                                                                                                                                 |       | 5,999                  |       | 10,631                |       |
| Total current liabilities                                                                                                                                                                                                           |       | 24,644                 |       | 34,251                |       |
|                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Minority interest                                                                                                                                                                                                                   |       | 19,432                 |       | 6,073                 |       |
|                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Commitments and contingencies                                                                                                                                                                                                       |       |                   |       |                  |       |
|                                                                                                                                                                                                                                |       |                   |       |                  |       |
| Shareholders’ equity:                                                                                                                                                                                                          |       |                   |       |                  |       |
| Class A common stock, $.0001 par  value, 150,000,000 shares authorized, 18,625,855 and 19,553,631  shares issued and outstanding at September 30, 2008 and December 31,  2007, respectively |       | 2                      |       | 2                     |       |
| Class B common stock, $.0001 par  value, 50,000,000 shares authorized, 5,400,000 issued and outstanding at  September 30, 2008 and December 31, 2007                                                            |       | 1                      |       | 1                     |       |
| Additional paid-in capital                                                                                                                                                                                                          |       | 163,541                |       | 174,046               |       |
| Accumulated other comprehensive income                                                                                                                                                                                              |       | 93                     |       | 991                   |       |
| Retained earnings                                                                                                                                                                                                                   |       | 20,027                 |       | 25,348                |       |
| Total shareholders’ equity                                                                                                                                                                                                     |       | 183,664                |       | 200,388               |       |
| Total liabilities and shareholders’ equity                                                                                                                                                                                     |       | $                      | 227,740    |                  | $          | 240,712 |   |

 

See accompanyingnotes to the interim condensed consolidated financial statements.

 

4

----

Table of Contents

 

**GAIAM, INC.**

**Condensed consolidated statementsof operations**

 
| ** **                                                                       | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **(in thousands, except per share data)**               | ** ** | **2008**                                                               | ** ** | **2007**                                                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                       | ** ** | **(unaudited)**                                                        | ** ** | **(unaudited)**                                                       | ** ** |
| Net revenue                                                                      |       | $                                                                      | 60,285     |                                                                  | $          | 70,318 |   | $ | 182,675 |   | $ | 181,137 |   |
| Cost of goods sold                                                               |       | 26,440                                                                 |       | 24,174                                                                |       | 71,699 |   | 63,886 |   |
| Gross profit                                                                     |       | 33,845                                                                 |       | 46,144                                                                |       | 110,976 |   | 117,251 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Expenses:                                                                        |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Selling and operating                                                            |       | 34,049                                                                 |       | 38,634                                                                |       | 102,686 |   | 103,533 |   |
| Corporate, general and administration                                            |       | 3,126                                                                  |       | 3,314                                                                 |       | 9,601 |   | 9,824 |   |
| Other general income and expense                                                 |       | 13,947                                                                 |       | —                                                                |       | 40,655 |   | — |   |
| Total expenses                                                                   |       | 51,122                                                                 |       | 41,948                                                                |       | 152,942 |   | 113,357 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Income (loss) from operations                                                    |       | (17,277                                                                | )          | 4,196                                                                 |       | (41,966 | ) | 3,894 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Gain from issuance of subsidiary stock                                           |       | 98                                                                     |       | —                                                                |       | 31,368 |   | — |   |
| Interest and other income                                                        |       | 257                                                                    |       | 1,028                                                                 |       | 995 |   | 3,375 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Income (loss) before income taxes and  minority interest                         |       | (16,922)                                                               |       | 5,224                                                                 |       | (9,603) |   | 7,269 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Income tax expense (benefit)                                                     |       | (6,922)                                                                |       | 2,060                                                                 |       | (4,031) |   | 2,868 |   |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |       | (115)                                                                  |       | (246                                                                  | )          | 251 |   | (77 | ) |
| Net income (loss)                                                                |       | $                                                                      | (10,115)   |                                                                  | $          | 2,918 |   | $ | (5,321) |   | $ | 4,324 |   |
|                                                                             |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net income (loss) per share:                                                     |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic                                                                            |       | $                                                                      | (0.42)     |                                                                  | $          | 0.12 |   | $ | (0.22) |   | $ | 0.17 |   |
| Diluted                                                                          |       | $                                                                      | (0.42)     |                                                                  | $          | 0.12 |   | $ | (0.22) |   | $ | 0.17 |   |
| Shares used in computing net income (loss)  per share:                           |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Basic                                                                            |       | 24,020                                                                 |       | 24,705                                                                |       | 24,611 |   | 25,000 |   |
| Diluted                                                                          |       | 24,020                                                                 |       | 24,970                                                                |       | 24,611 |   | 25,222 |   |

 

See accompanyingnotes to the interim condensed consolidated financial statements.

 

5

----

Table of Contents

 

**GAIAM, INC.**

**Condensed consolidated statementsof cash flows**

 
| ** **                                                                                          | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **(in thousands)**                                                                                  | ** ** | **2008**                                     | ** ** | **2007** | ** ** |
| ** **                                                                                          | ** ** | **(unaudited)**                              | ** ** |
| **Operating  activities**                                                                           | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       | $                                            | (5,321)    |   | $ | 4,324 |   |
| Adjustments to reconcile net income (loss) to  net cash (used in) provided by operating activities: |       |                                         |       |   |   |
| Depreciation                                                                                        |       | 2,373                                        |       | 1,395 |   |
| Amortization                                                                                        |       | 4,601                                        |       | 7,215 |   |
| Minority interest in consolidated subsidiaries,  net of tax                                         |       | (251                                         | )          | 77 |   |
| Net (gain) loss on investments and property                                                         |       | (579                                         | )          | 138 |   |
| Share-based compensation expense                                                                    |       | 1,063                                        |       | 832 |   |
| Noncurrent deferred income tax expense (benefit)                                                    |       | (8,115                                       | )          | 677 |   |
| Gain on issuance of subsidiary stock, net  of tax                                                   |       | (19,254                                      | )          | — |   |
| Impairment loss                                                                                     |       | 37,785                                       |       | — |   |
| Changes in operating assets and liabilities,  net of effects from acquisitions and dispositions:    |       |                                         |       |   |   |
| Accounts receivable, net                                                                            |       | 4,637                                        |       | 13,233 |   |
| Inventory, net                                                                                      |       | (1,976                                       | )          | (3,097 | ) |
| Deferred advertising costs                                                                          |       | (2,368                                       | )          | (2,256 | ) |
| Current income tax receivable                                                                       |       | (12,109                                      | )          | — |   |
| Other current assets                                                                                |       | 1,438                                        |       | (1,757 | ) |
| Accounts payable                                                                                    |       | (7,232                                       | )          | (2,983 | ) |
| Accrued liabilities                                                                                 |       | (4,549                                       | )          | 2,773 |   |
| Net cash (used in) provided by operating activities                                                 |       | (9,857                                       | )          | 20,571 |   |
|                                                                                                |       |                                         |       |   |   |
| **Investing  activities**                                                                           |       |                                         |       |   |   |
| Purchase of property, equipment and media rights                                                    |       | (26,285                                      | )          | (5,133 | ) |
| Purchase of acquisitions, net of cash acquired                                                      |       | (10,029                                      | )          | (10,801 | ) |
| Disposition of investments, net                                                                     |       | (1,381                                       | )          | 3,871 |   |
| Net cash used in investing activities                                                               |       | (37,695                                      | )          | (12,063 | ) |
|                                                                                                |       |                                         |       |   |   |
| **Financing  activities**                                                                           |       |                                         |       |   |   |
| Proceeds from Real Goods stock issuances, net                                                       |       | 48,154                                       |       | — |   |
| Repurchase of Class A common stock, net                                                             |       | (18,086                                      | )          | (32,907 | ) |
| Proceeds from issuance of common stock                                                              |       | 1,556                                        |       | 753 |   |
| Net cash provided by (used in) financing activities                                                 |       | 31,624                                       |       | (32,154 | ) |
|                                                                                                |       |                                         |       |   |   |
| Effects of exchange rates on cash and cash equivalents                                              |       | (13                                          | )          | 335 |   |
|                                                                                                |       |                                         |       |   |   |
| Net change in cash and cash equivalents                                                             |       | (15,941                                      | )          | (23,311 | ) |
| Cash and cash equivalents at beginning of period                                                    |       | 66,258                                       |       | 104,876 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                            | 50,317     |   | $ | 81,565 |   |
|                                                                                                |       |                                         |       |   |   |
| **Supplemental  cash flow information**                                                             |       |                                         |       |   |   |
| Interest paid                                                                                       |       | $                                            | 42         |   | $ | — |   |
| Income taxes paid                                                                                   |       | $                                            | 2,902      |   | $ | 3,042 |   |
| Common stock issued for acquisitions                                                                |       | $                                            | 7,281      |   | $ | 491 |   |

 

See accompanyingnotes to the interim condensed consolidated financial statements

 

6

----

Table of Contents

 

**Notes to interim condensedconsolidated financial statements**

 

**1. Organization, Nature of Operations, and Principles of Consolidation**

 

Referencesin this report to “we”, “us”, “our” or “Gaiam” refer to Gaiam, Inc. and itsconsolidated subsidiaries, unless we indicate otherwise. We are a lifestylemedia company providing a broad selection of information, media, products andservices to customers who value personal development, wellness, ecologicallifestyles, responsible media and conscious community. We were incorporatedunder the laws of the State of Colorado on July 7, 1988.

 

Wehave prepared the accompanying unaudited interim condensed consolidatedfinancial statements in accordance with accounting principles generallyaccepted in the United States, or GAAP, and they include our accounts and thoseof our subsidiaries.  Intercompanytransactions and balances have been eliminated.

 

Theunaudited condensed consolidated financial position, results of operations andcash flows for the interim periods disclosed in this report are not necessarilyindicative of future financial results.

 

**2. Significant Accounting Policies**

 

Nochanges were made to our significant accounting policies during the three andnine months ended September 30, 2008, except for the adoption of FinancialAccounting Standards Board, or FASB, Statement No. 157, *Fair ValueMeasurement* and the adoption of Staff Accounting Bulletin No. 51, *Accounting for Sales of Stock by a Subsidiary*, whereby weelected the income statement approach for the recognition of gains and lossesresulting from the issuance of subsidiary stock.  SFAS 157 defines fair value, establishes aframework for measuring fair value in GAAP, and expands disclosures about fairvalue measurements. The implementation of SFAS 157 did not have a materialimpact on our unaudited interim condensed consolidated financial statements forthe three and nine months ended September 30, 2008.

 

*Use ofEstimates and Reclassifications*

 

Thepreparation of financial statements in accordance with GAAP requires us to makeestimates and assumptions that affect the amounts reported in the accompanyingfinancial statements and disclosures. Although we base these estimates on ourbest knowledge of current events and actions that we may undertake in the future,actual results may be different from the estimates. We have made certainreclassifications to prior period amounts to conform to the current periodpresentations.

 

*RecentlyIssued Accounting Pronouncements*

 

On March 19, 2008, the FASB issued FASB Statement No.161, *Disclosures about Derivative Instruments andHedging Activities – an Amendment of FASB Statement 133*.  SFAS 161 enhances required disclosuresregarding derivatives and hedging activities, including enhanced disclosuresregarding how: (a) an entity uses derivative instruments; (b) derivativeinstruments and related hedge items are accounted for under FASB Statement No. 133,*Accounting for Derivative Instruments and HedgingActivities*; and (c) derivative instruments and related hedged itemsaffect an entity’s financial position, financial performance, and cashflows.  Specifically, SFAS 161 requires:

 

·                  disclosureof the objectives for using derivative instruments be disclosed in terms ofunderlying risk and accounting designation;

·                  disclosureof the fair values of derivative instruments and their gains and losses in atabular format;

·                  disclosureof information about credit-risk-related contingent features; and

·                  cross-referencefrom the derivative footnote to other footnotes in which derivative-relatedinformation is disclosed.

 

SFAS161 is effective for fiscal years and interim periods beginning after November 15,2008.  We will adopt the provisions ofSFAS 161 in our fiscal year commencing January 1, 2009. We currently believethat adoption of the provisions of SFAS 161 will not have a material impact onour consolidated financial statements.

 

**3.****             ****Property and Equipment**

 

On April 3, 2008, we purchased land, an officebuilding, and improvements located in Colorado for a total cost ofapproximately $15.7 million in cash. We consolidated our Colorado operations tothis property during the second and third quarters of 2008 upon expiration ofour existing facility leases.

 

7

----

Table of Contents

 

**4.****             ****Impairment of Assets**

 

As a result of changes in the retail businessclimate, we impaired a portion of our acquired media libraries, LIME goodwilland other intangibles, tangible assets primarily related to web sitedevelopment, and related assets during the nine months ended September 30,2008.  These noncash, tax deductibleimpairments reduced the business and direct to consumer total assets by $33.7million and $4.1 million, respectively.  Wedetermined the estimated fair value of these asset groups using variousvaluation techniques, such as estimated future sales, internal budgets andprojections, and judgment about existing brand potential.  The resulting impairment losses of $11.9million and $37.8 million are reported in other general income and expense onour condensed consolidated statements of operations for the three and ninemonths ended September 30, 2008, respectively.

 

**5.****             ****Shareholders’ Equity**

 

During the nine months ended September 30, 2008, we issued a total of2,800 shares of our Class A common stock to our independent directors, in lieuof cash compensation, for services rendered in 2007 and 2008; issued 221,152shares of our Class A common stock as part of the consideration to acquire theremaining and controlling ownership interests in two businesses (see Note 10,Mergers and Acquisitions); and issued 133,360 shares of our Class A commonstock upon exercise of options under our 1999 Long-Term Incentive Plan,including 110,000 shares exercised and held by our President.

 

Additionally,during the nine months of 2008, we repurchased 1,285,088 shares of our Class Acommon stock for a total cost of $19.0 million. See also Note 10, Mergers and Acquisitions.  We recorded these repurchases of our sharesin accordance with the cost method of accounting for treasury stock.  Since we have not yet decided the ultimatedisposition of the re-acquired shares, their combined cost is reflected in thecondensed consolidated balance sheet at September 30, 2008 as a $19.0 millionreduction to additional paid-in capital.

 

Duringthe nine months ended September 30, 2008, our subsidiary, Real Goods Solar, Inc.(“Real Goods”), completed an initial public offering (“IPO”) of 5.5 millionshares resulting in net proceeds of $48.2 million to Real Goods, issued 280,000shares valued at $1.9 million to acquire a minority interest in one of itssubsidiaries and issued 47,423 shares valued at $0.3 million as partialconsideration to acquire 100% ownership of a business (see Note 10, Mergers andAcquisitions), issued an additional 13,448 shares valued at $87,000, and madeother non-stock related equity transactions, for a net gain of $32.1 million tous.  Following these transactions weowned 63.1% of Real Goods.  The portionof our gain resulting from Real Goods selling new shares, $31.4 million, isreflected in gain from issuance of subsidiary stock on our condensedconsolidated statements of operations for the three and nine months ended September30, 2008 and has been tax affected.  Theremaining net gain resulting from other Real Goods non-stock related equitytransactions, which was not tax affected, is recorded as an increase toadditional paid-in capital on our condensed consolidated balance sheet at September30, 2008.

 

During2007, we issued a total of 4,955 shares of our Class A common stock to ourindependent directors, in lieu of cash compensation, for services rendered in2006 and 2007; issued 1,875 restricted shares of our Class A common stock totwo of our named executive officers as bonus compensation; issued 80,795 sharesof our Class A common stock as part of the consideration to acquire controllingownership interests in two businesses; issued 216,070 shares of our Class Acommon stock upon exercise of options under our 1999 Long-Term Incentive Plan;and repurchased 2.5 million shares of our Class A common stock.

 

**6.****              ****Comprehensive Income (Loss)**

 

Ourcomprehensive income (loss) is comprised of net income (loss) and foreigncurrency translation adjustments, net of income taxes. Comprehensive income(loss), net of related tax effects, was as follows:

 
| ** **                                                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(in thousands)**                                                                | ** ** | **2008**                              | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss)                                                                 |       | $                                     | (10,115    | )                                    | $          | 2,918 |   | $ | (5,321 | ) | $ | 4,324 |   |
| Foreign currency translation adjustment,  net of reclassification and related tax |       | —                                |       | 174                                  |       | (898 | ) | 258 |   |
| Comprehensive income (loss), net of taxes                                         |       | $                                     | (10,115    | )                                    | $          | 3,092 |   | $ | (6,219 | ) | $ | 4,582 |   |

 

8

----

Table of Contents

 

The disposition of our investment in our UKoperations during the quarter ended March 31, 2008 resulted in a net loss whichlowered our net income.  The foreigncurrency translation amount attributable to that entity and accumulated in thetranslation adjustment component of equity was removed from the othercomprehensive income component of equity and reported as part of the loss onthe sale of the investment.

 

**7.****              ****Share-Based****Payments**

 

During the nine months ended September 30,2008, we granted 170,500 stock options to employees and cancelled 22,020 stockoptions. Total share-based compensation recognized was $0.4 million and $0.3million for the three months ended September 30, 2008 and 2007, respectively,and $1.1 million and $0.8 million for the nine months ended September 30, 2008and 2007, respectively, and is shown in corporate, general and administrationexpenses on our condensed consolidated statements of operations.

 

**8.****              ****Net****Income****(Loss) Per Share**

 

Basicnet income (loss) per share excludes any dilutive effects of options. Wecompute basic net income (loss) per share using the weighted average number ofcommon shares outstanding during the period. We compute diluted net income(loss) per share using the weighted average number of common and common stockequivalent shares outstanding during the period. We excluded from thecomputation of diluted net income (loss) per share common equivalent shares of715,000 and 152,000 for the three months ended September 30, 2008 and 2007,respectively, and 482,000 and 391,000 for the nine months ended September 30,2008 and 2007, respectively, because their effect was antidilutive.

 

Thefollowing table sets forth the computation of basic and diluted net income(loss) per share:

 
| ** **                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(in thousands, except per share data)**                      | ** ** | **2008**                              | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Numerator for basic and diluted net income  (loss) per share   |       | $                                     | (10,115    | )                                    | $          | 2,918 |   | $ | (5,321 | ) | $ | 4,324 |   |
| Denominator:                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average shares for basic net  income (loss) per share |       | 24,020                                |       | 24,705                               |       | 24,611 |   | 25,000 |   |
| Effect of dilutive securities:                                 |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average of common stock and stock  options            |       | —                                |       | 265                                  |       | — |   | 222 |   |
| Denominators for diluted net income (loss)  per share          |       | 24,020                                |       | 24,970                               |       | 24,611 |   | 25,222 |   |
|                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss) per share – basic                       |       | $                                     | (0.42      | )                                    | $          | 0.12 |   | $ | (0.22 | ) | $ | 0.17 |   |
| Net income (loss) per share – diluted                     |       | $                                     | (0.42      | )                                    | $          | 0.12 |   | $ | (0.22 | ) | $ | 0.17 |   |

 

**9.****              ****Segment Information**

 

Wemanage our business and aggregate our operational and financial information inaccordance with three reportable segments. The direct to consumer segmentcontains direct response marketing programs, catalogs, Internet, andsubscription community sales channels, the business segment comprisesretailers, media and corporate account channels, and the solar segment reflectssolar energy businesses.

 

Althoughwe are able to track revenues by sales channel, the management, allocation ofresources and analysis and reporting of expenses is presented on a combinedbasis, at the reportable segment level. Contribution margin is defined as netsales, less cost of goods sold and direct expenses.  Prior period amounts have been restated toreflect the addition of our solar reporting segment.

 

9

----

Table of Contents

 

Financial information for our segments is as follows:

 
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(in thousands)**                                                               | ** ** | **2008**                              | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net revenue:                                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Direct to  consumer                                                              |       | $                                     | 34,231     |                                 | $          | 35,960 |   | $ | 95,383 |   | $ | 91,499 |   |
| Business                                                                         |       | 16,514                                |       | 30,079                               |       | 62,343 |   | 76,481 |   |
| Solar                                                                            |       | 9,540                                 |       | 4,279                                |       | 24,949 |   | 13,157 |   |
| Consolidated  net revenue                                                        |       | 60,285                                |       | 70,318                               |       | 182,675 |   | 181,137 |   |
| Contribution margin (loss):                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Direct to  consumer                                                              |       | (6,155                                | )          | 776                                  |       | (10,799 | ) | (2,200 | ) |
| Business                                                                         |       | (10,447                               | )          | 3,626                                |       | (29,871 | ) | 5,953 |   |
| Solar                                                                            |       | (675                                  | )          | (206                                 | )          | (1,296 | ) | 141 |   |
| Consolidated  contribution margin (loss)                                         |       | (17,277                               | )          | 4,196                                |       | (41,966 | ) | 3,894 |   |
| Reconciliation of contribution margin  (loss) to net income (loss):              |       |                                  |       |                                 |       |   |   |   |   |
| Gain from  issuance of subsidiary stock                                          |       | 98                                    |       | —                               |       | 31,368 |   | — |   |
| Interest and  other income                                                       |       | 257                                   |       | 1,028                                |       | 995 |   | 3,375 |   |
| Income tax  expense (benefit)                                                    |       | (6,922                                | )          | 2,060                                |       | (4,031 | ) | 2,868 |   |
| Minority  interest in net (income) loss of consolidated subsidiaries, net of tax |       | (115                                  | )          | (246                                 | )          | 251 |   | (77 | ) |
| Net income  (loss)                                                               |       | $                                     | (10,115    | )                                    | $          | 2,918 |   | $ | (5,321 | ) | $ | 4,324 |   |

 

# **Ourbusiness segment includes international revenues in 2007 which amounted to $13.3million in the third quarter and $28.5 million for the nine months.  In the first quarter of 2008, we made thedecision to shift our international business to license arrangements ratherthan traditional product sales. Excluding international revenues, which were affected by thistransition, the business segment revenue decreased 4.3% for the third quarterof 2008 and increased 21.6% for the nine months ended September 30, 2008.**

# ** **

Ourcontribution margin includes other general income and expense of $11.9 millionfor the three months and $37.8 million for the nine months ended September 30,2008 reflecting a****non-cash, tax-deductableimpairment charge related to our acquired media libraries, web site developmentcosts, and related assets. These charges impacted the direct to consumersegment by $3.2 million and $4.1 million for the three and nine months ended September30, 2008, respectively, and the business segment by $8.7 million and $33.7million for the three and nine months ended September 30, 2008, respectively.

 

Ourgoodwill balance of $50.4 million at September 30, 2008 was allocated $16.8million, $19.9 million, and $13.7 million to the direct to consumer, business,and solar segments, respectively.  Ourbalance of $42.9 million at December 31, 2007 was allocated $16.0 million,$21.0 million, and $5.9 million to the direct to consumer, business, and solarsegments, respectively.

 

# **10.**            Mergers and Acquisitions

# ** **

Duringthe first quarter of 2008, Real Goods’ subsidiary, Real Goods Carlson, Inc.,acquired certain assets of Carlson Solar, Inc., and we acquired 100% ownershipinterest of SPRI Products, Inc. and the remaining 49.9% ownership interest ofConscious Enlightenment.  On May 23,2008, Real Goods exchanged 280,000 shares of its Class A common stock for RealGoods’ current President’s 11.6% ownership in Real Goods Carlson, Inc.  Consideration paid for the minority interestof Real Goods Carlson was the same relative fair value as the equityreceived.  The assets acquired fromCarlson Solar were determined to have all inputs and processes necessary for thetransferred assets to continue to conduct normal operations after acquisition;accordingly, the purchase was treated as a business combination.  During the third quarter of 2008, Real Goodsacquired 100% ownership of Independent Energy Systems.  The total cost of these business acquisitionswas $18.8 million, including direct acquisition costs, consisting of $10.8million in cash, $5.1 million in our Class A common stock, $2.2 million in RealGoods Class A common stock, and $0.7 million in assumed liabilities. For theseacquisitions, we have preliminarily recognized $7.7 million, $6.4 million, and$1.1 million of solar, business, and direct to consumer segment goodwill,respectively, of which $2.5 million is expected to be deductible for taxpurposes, and $1.2 million of intangibles subject to amortization (50 monthweighted-average useful life).  Themarketing related intangibles were $1.0 million (48 month weighted-averageuseful life) and the customer related intangibles were $0.2 million (60 monthweighted-average useful life).

 

10

----

Table of Contents

 

Also during the quarter ended March 31, 2008, wesold our investment in the non-LOHAS business newspapers that were acquired aspart of a previous acquisition and sold our 51% ownership interest in GaiamLimited, our UK subsidiary.  We received50,000 shares of Gaiam Class A common stock, valued at $0.9 million, as part ofthe consideration for our UK subsidiary.

 

In2007, we acquired varying amounts of controlling ownership interest in severalentities. Three of the acquisitions call for additional consideration, payablein cash or shares of our Class A common stock (up to a maximum of 50,000shares), contingent upon the achievement of a certain membership thresholdwithin the next two years or our sale of the acquired business or its assets,the amount of revenue generated from certain potential customers and thecollection of certain rebates, or the attaining of a certain level of pre-taxprofits in our community business over its first twelve months ofoperations.  At the time any of thiscontingent consideration can be estimated beyond a reasonable doubt, we willrecognize it as additional purchase price and allocate it to goodwill and otherintangibles, as appropriate.

 

Weare finalizing our assessment of the estimated fair value of the net assetsacquired during the fourth quarter of 2007 and to date in 2008 and, thus, theamount of goodwill and other intangibles previously recorded is subject torefinement. We have included results from operations of these acquiredcompanies in our condensed consolidated financial statements from theirrespective effective acquisition dates.

 

# **11.**            Income Taxes

# ** **

Duringthe nine months ended September 30, 2008, we recognized an increase in ourdeferred tax assets of $15.9 million, primarily reflecting the financialimpairment of certain assets (see Note 4, Impairment of Assets), partiallyoffset by a deferred tax liability of approximately $12.1 million on afinancial gain from the issuance of Real Goods stock (see Note 5, Shareholders’Equity).  The impairment chargeaccelerates approximately $5.5 million of tax receivables in the third quarter,bringing our total tax refund and benefit to over $12 million, which we expectto receive in early 2009.

 

# **12.**       Subsequent Events

# ** **

# **Effective October 1, 2008, through mergers, RealGoods acquired Regrid Power, Inc. (“Regrid Power”), a northern Californiaprivate designer and installer of residential and commercial solar electricsystems.  Pursuant to the mergeragreement, Real Goods’ subsidiary acquired all of the outstanding shares ofRegrid Power for an aggregate of $3.8 million in cash and 2,047,256 shares ofReal Goods’ Class A common stock, plus the assumption of certain liabilities,subject to post closing adjustments.  Thetotal share consideration could be increased up to a maximum of 800,000 sharesof Real Goods Solar stock, based on Regrid Power’s revenue and earningsperformance over the next 12 months, but in no event more than one timestrailing twelve months revenues.**

# ** **

# **Item 2.**                                   Management’s discussion and analysis offinancial condition and results of operations

# ** **

Youshould read the following discussion and analysis of our financial conditionand results of operations in conjunction with the condensed consolidatedfinancial statements and related notes included elsewhere in this document.**This section is designed to provide information that willassist in understanding our condensed consolidated financial statements,changes in certain items in those statements from period to period, the primaryfactors that caused those changes and how certain accounting principles,policies and estimates affect the condensed consolidated financial statements.

 

# **Overview andOutlook**

# ** **

# **We are alifestyle media company providing a broad selection of information, media,products and services to customers who value personal development, wellness,ecological lifestyles, responsible media and conscious community.**Our media brand isbuilt around our ability to develop and offer media content, products,lifestyle solutions and community to consumers in the LOHAS market.

# ** **

# **Weoffer our customers the ability to make purchasing decisions and findresponsible content based on these values while providing quality offerings ata price comparable to mainstream alternatives. We market our media and productsthrough a multi-channel approach including traditional media channels, directto consumers via the Internet, direct response marketing, community,subscriptions, catalog, and through national retailers and corporate accounts.**

 

11

----

Table of Contents

 

# **Ourcontent forms the basis of our proprietary offerings, which then drive demandfor parallel product and service offerings. Our operations are verticallyintegrated from content creation, through product development and sourcing, tocustomer service and distribution. We market our products and services acrossthree segments: business, direct to consumer, and solar. We distribute themajority of our products in our business and direct to consumer segments fromour fulfillment center or drop-ship products directly to customers.  We also utilize a third party replication andfulfillment center for media distribution in our business segment.**

# ** **

# **Ourbusiness segment sells directly to retailers, with our products available inapproximately 73,000 retail doors in the United States. During the thirdquarter of 2008, this segment generated revenues of $16.5 million, down from$30.1 million during the third quarter of 2007. Excluding internationalrevenues, which were affected by the transition from product sales to licensingarrangements, the business segment revenue decrease for the quarter wasapproximately 4.3%. During the quarter we expanded our store-within-storepresence to over 9,000 lifestyle presentations, up from 6,500 at the end of September2007, which are custom fixtures that we design.**

# ** **

Throughits diverse media reach, the direct to consumer segment provides an opportunityto launch and support new media releases, a sounding board for new producttesting, promotional opportunities, a growing online and off-line community,and customer feedback on us and the LOHAS industry’s focus and future. Duringthe third quarter of 2008, this segment generated revenues of $34.2 million,down from $36.0 million during the third quarter of 2007.  This decrease reflects planned lower catalogcirculation and direct response marketing, and the overall economicenvironment.

 

DuringMay 2008, our solar energy business consummated an initial public offering andhas since been managed as a separate segment. Through recent acquisitions, this business has grown its sales andexpanded its market territories.  Duringthe third quarter of 2008, this segment generated revenues of $10.3 million, upfrom $4.3 million during the third quarter of 2007.  We have and will continue to use the IPOproceeds to fund this segment’s working capital needs and general corporatepurposes, which may include future acquisitions of businesses.

 

Duringthe nine months ended September 30, 2008, we completed acquisitions targetedtowards expanding and enhancing our solar market, community reach, and mediacontent. The solar acquisitions were Carlson Solar, Inc. and Independent EnergySystems, Inc., solar energy integrators located in southern and northernCalifornia, respectively.  We alsopurchased the remaining 49.9% ownership interest in Conscious Enlightenment, anon-line and off-line community and SPRI Products, Inc., a leading marketer ofresistance exercise products for the professional health and fitness industry.

 

Given the current and projected economic and market conditions, weevaluated the recoverability of certain assets assuming that additional mediaand marketing investments would be limited. As a result of this evaluation, we revised our business plans for theseassets and impaired $37.8 million of the acquired media libraries, LIMEgoodwill and other intangibles, tangible assets primarily related to web sitedevelopment, certain deferred advertising costs, and related assets during thesecond and third quarters of 2008.

 

Webelieve our growth will be driven by information, media content, products, andcommunity delivered to the consumer via Internet, retailers, internationallicensing, electronic downloads and subscription systems. We have increased ourfocus on our media content creation and distribution, which strategicallyprovides increased branding opportunities, higher operating contribution andgreater mainstream penetration.

 

12

----

Table of Contents

 

**Results of Operations**

 

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

 
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                              | ** ** | **2007**                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Net revenue                                                                      |       | 100.0                                 | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Cost of goods sold                                                               |       | 43.9                                  | %          | 34.4                                 | %          | 39.2 | % | 35.3 | % |
| Gross profit                                                                     |       | 56.1                                  | %          | 65.6                                 | %          | 60.8 | % | 64.7 | % |
|                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Expenses:                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Selling and operating                                                            |       | 56.5                                  | %          | 55.0                                 | %          | 56.2 | % | 57.2 | % |
| Corporate, general and administration                                            |       | 5.2                                   | %          | 4.7                                  | %          | 5.3 | % | 5.4 | % |
| Other general income and expense                                                 |       | 23.1                                  | %          | —                               | %          | 22.2 | % | — | % |
| Total expenses                                                                   |       | 84.8                                  | %          | 59.7                                 | %          | 83.7 | % | 62.6 | % |
|                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Income (loss) from operations                                                    |       | (28.7                                 | )%         | 5.9                                  | %          | (22.9 | )% | 2.1 | % |
|                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Gain from issuance of subsidiary stock                                           |       | 0.2                                   | %          | —                               | %          | 17.2 | % | — | % |
| Interest and other income                                                        |       | 0.4                                   | %          | 1.5                                  | %          | 0.5 | % | 1.9 | % |
| Income tax expense (benefit)                                                     |       | (11.5                                 | )%         | 2.9                                  | %          | (2.2 | )% | 1.6 | % |
| Minority interest in net (income) loss of  consolidated subsidiaries, net of tax |       | (0.2                                  | )%         | (0.4                                 | )%         | 0.1 | % | 0.0 | % |
| Net income (loss)                                                                |       | (16.8                                 | )%         | 4.1                                  | %          | (2.9 | )% | 2.4 | % |

 

*Three Months Ended September 30, 2008 Compared to Three Months Ended September30, 2007*

 

*Net revenue*.Net revenue decreased $10.0 million, or 14.3%, to $60.3 million during thethird quarter of 2008 from $70.3 million during the third quarter of 2007.  Excluding international revenues,which were affected by the transition from product sales to licensingarrangements, the revenue growth for the quarter was approximately 2%.  Netrevenue in our direct to consumer segment decreased $1.7 million to $34.2million during the third quarter of 2008 from $36.0 million during the thirdquarter of 2007. This decrease in the direct to consumer segment net revenueprimarily reflects decreased catalog prospecting, lower response rates from ourfirst holiday catalog drop which coincided with weather related impacts ofhurricane Ike, and overall slower consumer spending.  Net revenue in our business segment decreased$13.6 million to $16.5 million during the third quarter of 2008 from $30.1million during the third quarter of 2007. This decrease primarily reflects the decision in the first quarter of 2008to shift our international business to licensing arrangements rather thantraditional product sales and precautionary holiday buying trends from ourretailers.  Net revenue in our solarsegment increased $6.1 million to $10.3 million during the third quarter of2008 from $4.3 million during the third quarter of 2007, primarily reflectingthe acquisitions of Marin Solar in the fourth quarter of 2007, Carlson Solar inthe first quarter of 2008, and Independent Energy Systems in the third quarterof 2008.

 

*Grossprofit*. Gross profitdecreased $12.3 million, or 26.7%, to $33.8 million during the third quarter of2008 from $46.1 million during the third quarter of 2007. As a percentage ofnet revenue, gross profit decreased to 56.1% during the third quarter of 2008from 65.6% during the third quarter of 2007. The change in gross marginreflects our investment in the lower margin solar business and additional storewithin store presentations.  The marginwas also impacted by the decision to expand our distribution footprint bymaintaining retail prices while absorbing cost increases from higher freightcharges and the dollar decline. Our strategy to aggressively pursuestore-within-store and media category management expansion will continue toimpact the margin through fourth quarter.

 

*Selling and operating expenses*. Selling and operating expenses decreased $4.6 million, or 11.9%, to$34.0 million during the third quarter of 2008 from $38.6 million during thethird quarter of 2007, primarily from reduced catalog circulation, payroll andincentive reductions, and synergies realized from business acquisitionintegrations.  As a percentage of netrevenue, selling and operating expenses increased to 56.5% during the thirdquarter of 2008 from 55.0% during the third quarter of 2007.

 

13

----

Tableof Contents

 

*Corporate, general and administration expenses*. Corporate, general and administrationexpenses decreased $0.2 million, or 5.7%, to $3.1 million during the thirdquarter of 2008 from $3.3 million during the third quarter of 2007.  As of percentage of net revenue, corporate,general and administration expenses increased to 5.2% during the third quarterof 2008 from 4.7% during the third quarter of 2007, primarily reflecting lowerrevenues.

 

*Other general income and expense.* Other general income and expense was $13.9million during the third quarter of 2008 and was comprised of impairments ofour acquired media libraries, tangible assets primarily related to web sitedevelopment, and related assets, as well as expected losses on futurecontractual commitments and reduction in force costs.

 

*Interest and other income*. Interest and other income decreased $0.8 million to $0.3 millionduring the third quarter of 2008 from $1.0 million during the third quarter of2007.  The decrease reflects lowerinterest earnings as we used cash to fund our operations, acquire businessesand assets, and repurchase 1.3 million shares of our Class A common stock for$19.0 million, and the decline of average interest rates received on our cashinvestments from 5.24% as of September 30, 2007 to 2.65% at September 30, 2008.

 

*Minority interest in net income of consolidated subsidiaries, net ofincome taxes*.Minority interest in net income of consolidated subsidiaries, net of incometaxes, decreased to $0.1 million during the third quarter of 2008 from $0.2million during the third quarter of 2007.

 

*Net income*.  As a result of the above factors, net incomedecreased $13.0 million to a net loss of $10.1 million during the third quarterof 2008 from net income of $2.9 million during the third quarter of 2007. Netincome per share decreased to a loss of $0.42 per share during the thirdquarter of 2008 from net income of $0.12 per share during the third quarter of2007.

 

*Nine Months Ended September 30, 2008 Compared to Nine Months Ended September30, 2007*

 

*Net revenue*.Net revenue increased $1.5 million, or 0.8%, to $182.7 million during the ninemonths ended September 30, 2008 from $181.1 million during the nine monthsended September 30, 2007. Net revenue in our direct to consumer segmentincreased $3.9 million to $95.4 million during the nine months ended September 30,2008 from $91.5 million during the nine months ended September 30, 2007. Thisincrease in the direct to consumer segment net revenue primarily reflects thesuccess of our ecommerce and increased revenues from businesses acquired,partially offset by declining revenue from catalog prospecting and overallslower consumer spending.    Net revenuein our business segment decreased $14.1 million to $62.3 million during thenine months ended September 30, 2008 from $76.5 million during the nine monthsended September 30, 2007, primarily reflecting lower international productsales, which includes the shift to licensing arrangements and the dispositionof our UK operations. Net revenue in our solar segment increased $12.6 millionto $25.7 million during the nine months ended September 30, 2008 from $13.2million during the nine months ended September 30, 2007, primarily due to theacquisition of Marin Solar in the fourth quarter of 2007, Carlson Solar in thefirst quarter of 2008, and Independent Energy Systems in the third quarter of2008.

 

*Grossprofit*. Gross profitdecreased $6.3 million, or 5.4%, to $111.0 million during the nine months endedSeptember 30, 2008 from $117.3 million during the nine months ended September 30,2007. As a percentage of net revenue, gross profit decreased to 60.8% duringthe nine months ended September 30, 2008 from 64.7% during the nine monthsended September 30, 2007.  Thechange in gross margin primarily reflects our investment in the lower marginsolar business and additional store within store presentations.  The margin was also impacted by the decisionto expand our distribution footprint by maintaining retail prices whileabsorbing cost increases from higher freight charges and the dollar decline.

 

*Selling and operating expenses*. Selling and operating expenses decreased $0.8 million, or 0.8%, to$102.7 million during the nine months ended September 30, 2008 from $103.5million during the nine months ended September 30, 2007, resulting primarilyfrom reduced catalog circulation, lower payroll incentives, and businessdispositions in the first quarter of 2008, partially offset by investments madein community, advertising, and marketing programs.  As a percentage of net revenue, selling andoperating expenses decreased to 56.2% during the nine months ended September 30,2008 from 57.2% during the nine months ended September 30, 2007.

 

*Corporate, general and administration expenses*. Corporate, general and administrationexpenses decreased $0.2 million, or 2.3%, to $9.6 million during the ninemonths ended September 30, 2008 from $9.8 million during the nine months ended September30, 2007.  As of percentage of netrevenue, corporate, general and administration expenses decreased to 5.3%during the nine months ended September 30, 2008 from 5.4% during the ninemonths ended September 30, 2007, primarily reflecting the continued focus onleveraging corporate resources across all segments.

 

14

----

Table of Contents

 

*Other general income and expense.* Other general income and expense was $40.7million during the nine months ended September 30, 2008 and was comprised ofimpairments of our media library, LIME goodwill and other intangibles, tangibleassets primarily related to web site development, certain deferred advertisingcosts, and related assets, as well as incremental operating expenses related tothe consummation of the Real Goods initial public offering, expected losses onfuture contractual commitments, and reduction in force costs, partially offsetby the recovery in value of a loan receivable.

 

*Gain from issuance of subsidiary stock*.  Gainfrom issuance of subsidiary stock was $31.4 million during the nine monthsended September 30, 2008 and represented the increase in carrying value of ourinvestment in Real Goods as a result of their issuance of new stock.

 

*Interest and other income*. Interest and other income decreased $2.4 million to $1.0 millionduring the nine months ended September 30, 2008 from $3.4 million during thenine months ended September 30, 2007. The decrease reflects lower interest earnings as we used cash to fundour operations, acquire businesses and assets and repurchase 1.3 million sharesof our Class A common stock for $19.0 million, and the decline of averageinterest rates received on our cash investments from 5.24% as of September 30,2007 to 2.65% at September 30, 2008.

 

*Minority interest in net (income) loss of consolidated subsidiaries,net of income taxes*.Minority interest in net loss of consolidated subsidiaries, net of incometaxes, increased to $0.3 million during the nine months ended September 30,2008 from minority interest net income of $0.1 million during the nine monthsended September 30, 2007.

 

*Net income*.  As a result of the above factors, net incomedecreased $9.6 million to a net loss of $5.3 million during the nine monthsended September 30, 2008 from net income of $4.3 million during the nine monthsended September 30, 2007. Net income per share decreased to a net loss of $0.22per share during the nine months ended September 30, 2008 from net income of$0.17 per share during the nine months ended September 30, 2007.

 

**Seasonality**

 

Our sales areaffected by seasonal influences. On an aggregate basis, we generate ourstrongest revenues and net income in the fourth quarter due to increasedholiday spending and retailer fitness purchases.

 

**Liquidityand Capital Resources**

 

Our capital needsarise from working capital required to fund operations, capital expendituresrelated to acquisition and development of media content, development of ourInternet and community platforms and new products, acquisitions of newbusinesses, replacements, expansions and improvements to our infrastructure,and future growth. These capital requirements depend on numerous factors,including the rate of market acceptance of our product offerings, the abilityto expand our customer base, the cost of ongoing upgrades to our productofferings, the level of expenditures for sales and marketing, the level ofinvestment in distribution systems and facilities and other factors. The timingand amount of these capital requirements are variable and we cannot accuratelypredict them. Additionally, we will continue to pursue opportunities to expandour media libraries, evaluate possible investments in businesses, products andtechnologies, and increase our sales and marketing programs and brandpromotions as needed.

 

Wehave a revolving line of credit agreement with a financial institution thatexpires on October 22, 2009.  The creditagreement permits borrowings up to the lesser of $15 million or our borrowingbase which is calculated based upon the collateral value of our accountsreceivable, inventory, and certain property and equipment. Borrowings underthis agreement bear interest at the lower of prime rate less 75 basis points orLIBOR plus 275 basis points. Borrowings are secured by a pledge of certain ofour assets, and the agreement contains various financial covenants, includingthose requiring compliance with certain financial ratios. At September 30,2008, we had no amounts outstanding under this agreement; however, $1.2 millionwas reserved for outstanding letters of credit. We believe we have complied with all of the financial covenants underthis credit agreement.

 

15

----

Table of Contents

 

***Cash Flows***

 

Thefollowing table summarizes our primary sources (uses) of cash during theperiods presented:

 
| ** **                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|
| **(in thousands)**                                      | ** ** | **2008**                             | ** ** | **2007** | ** ** |
| Net cash (used in) provided by:                         |       |                                 |       |   |   |
| Operating activities                                    |       | $                                    | (9,857     | ) | $ | 20,571 |   |
| Investing activities                                    |       | (37,695                              | )          | (12,063 | ) |
| Financing activities                                    |       | 31,624                               |       | (32,154 | ) |
| Effects of exchange rates on cash and cash  equivalents |       | (13                                  | )          | 335 |   |
| Net decrease in cash and cash equivalents               |       | $                                    | (15,941    | ) | $ | (23,311 | ) |

 

*Operatingactivities*. Our operating activities used net cash of $9.9million during the nine months ended September 30, 2008 and provided net cashof $20.6 million during the nine months ended September 30, 2007. Our net cashused in operating activities during the nine months ended September 30, 2008was primarily attributable to decreased accounts payable and accruedliabilities of $11.8 million, a net loss of $5.3 million, increased current taxreceivable of $12.1 million, and increased deferred advertising costs andinventory of $2.4 million and $2.0 million, respectively, partially offset bythe noncash adjustments to the net loss of $17.6 million and reductions inaccounts receivable of $4.6 million. The reduction in accounts payable reflectspayments for inventory purchases of holiday and fitness season shipments andour decision to lower accounts payable as interest rates declined.  Our net cash provided by operating activitiesduring the nine months ended September 30, 2007 was primarily attributable tocash provided from net income of $4.3 million, noncash adjustments to netincome of $10.3 million, and improved accounts receivable collections of $13.2million, partially offset by the use of funds from increased inventory inpreparation for the 2007 holiday season of $3.1 million, reduced accountspayable of $3.0 million, and increased deferred advertising of $2.2 million.

 

*Investingactivities*. Our investing activities used net cash of $37.7million and $12.1 million during the nine months ended September 30, 2008 and2007, respectively. The net cash used in investing activities during the ninemonths ended September 30, 2008 was used primarily to acquire our new corporateheadquarters property, businesses, equipment and other investments for $30.9million and purchase and produce media rights for $5.4 million. Our net cashprovided by our investing activities during the nine months ended September 30,2007 primarily reflected the acquisition of businesses for $10.8 million, netof acquired funds, and the purchase of property, equipment and media rights for$5.1 million, partially offset by proceeds from the sale of an investment for$1.4 million and prepayment of a promissory note principal and interest for$2.4 million.

 

*Financingactivities*. Our financing activities provided net cash of$31.6 million during the nine months ended September 30, 2008 and used net cashof $32.2 million during the nine months ended September 30, 2007. Our net cashprovided by financing activities during the nine months ended September 30,2008 primarily reflected net proceeds from Real Goods’ IPO of $48.2 million andissuances of our common stock and related tax benefits of $1.5 million,partially offset by the use of funds to repurchase approximately 1.3 millionshares of our Class A common stock for $18.1 million. We used net cash in ourfinancing activities during the nine months ended September 30, 2007 primarilyto repurchase 2.5 million shares of our Class A common stock for $32.9 million,partially offset by net proceeds from the exercise of stock options of $0.8million.

 

On November 8,2007, we filed a shelf registration statement on Form S-3 with the Securitiesand Exchange Commission for 5,000,000 shares of our Class A common stock.  During the nine months ended September 30,2008, we issued 221,152 of these shares to acquire business ownershipinterests.

 

We believe ouravailable cash, cash expected to be generated from operations, cash generatedby the sale of our stock, and borrowing capabilities should be sufficient tofund our operations on both a short-term and long-term basis. However, ourprojected cash needs may change as a result of acquisitions, productdevelopment, unforeseen operational difficulties or other factors.

 

In the normalcourse of our business, we investigate, evaluate and discuss acquisition, jointventure, minority investment, strategic relationship and other businesscombination opportunities in the LOHAS market. For any future investment,acquisition or joint venture opportunities, we may consider usingthen-available liquidity, issuing equity securities or incurring additionalindebtedness.

 

16

----

Table of Contents

 

**Contractual Obligations**

 

We have commitments pursuant to leaseagreements, but have no outstanding commitments pursuant to long-term debt,capital lease, or purchase obligations. The following table shows ourcommitments to make future payments under operating leases:

 
| **(in thousands)**          | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 years** | ** ** |
|-----------------------------|------------|-----------|------------|-----------------|------------|---------------|------------|---------------|------------|------------------|------------|
| Operating lease obligations |       | $         | 9,155      |            | $          | 2,503         |       | $             | 3,095      |             | $          | 2,034 |   | $ | 1,523 |   |
|                             |            |           |            |                 |            |               |            |               |            |                  |            |  |  |  |  |  |

 

**Risk Factors**

 

We wish to caution you that there are risksand uncertainties that could cause our actual results to be materiallydifferent from those indicated by forward looking statements that we make fromtime to time in filings with the Securities and Exchange Commission, newsreleases, reports, proxy statements, registration statements and other writtencommunications as well as oral forward looking statements made from time totime by our representatives. These risks and uncertainties include, but are notlimited to, those risks listed in our Annual Report on Form 10-K for the yearended December 31, 2007. Additional risks and uncertainties that we currentlydeem immaterial may also impair our business operations, and historical resultsare not necessarily an indication of the future results. Except for thehistorical information contained herein, the matters discussed in this analysisare 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 factors which are oftenbeyond our control. We do not undertake any obligation to updateforward-looking statements except as required by law.

 

**Item 3.    Quantitative and Qualitative Disclosures AboutMarket Risk**

 

Weare exposed to market risks, which include changes in U.S. interest rates andforeign exchange rates. We do not engage in financial transactions for tradingor speculative purposes.

 

Anyborrowings we might make under our bank credit facility would bear interest atthe lower of prime rate less 75 basis points or LIBOR plus 275 basis points. Wedo not have any amounts outstanding under our credit line, so any unfavorablechange in interest rates would not have a material impact on our results fromoperations or cash flows unless we make borrowings in the future.

 

Wepurchase a significant amount of inventory from vendors outside of the U.S. intransactions that are primarily U.S. dollar denominated transactions. A declinein the relative value of the U.S. dollar to other foreign currencies has andmay continue to lead to increased purchasing costs.

 

**Item 4.    Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

Ourchief executive officer and chief financial officer conducted an evaluation ofthe effectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rule 13a-15(e) and Rule 15d-15(e) under the ExchangeAct. Based upon their evaluation as of September 30, 2008, our chief executiveofficer and chief financial officer have concluded that those disclosurecontrols and procedures are effective.

 

**Changes in Internal Control over Financial Reporting**

 

Nochanges in our internal control over financial reporting occurred during thethree and nine months ended September 30, 2008 that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

17

----

Table of Contents

 

## **PART II.    OTHERINFORMATION**

## ** **

**Item 1.    LegalProceedings**

 

From time to time, we are involved in legalproceedings that we consider to be in the normal course of business. We do notbelieve that any of these proceedings will have a material adverse effect onour business.

 

**Item 1A. Risk Factors**

 

No material changes.

 

**Item 2.    Salesof Unregistered Securities and Use of Proceeds**

 

None.

 

**Item 3.    DefaultsUpon Senior Securities**

 

None.

 

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

 

None.

 

**Item 5.    OtherInformation**

 

None.

 

**Item 6.    Exhibits**

 

a)     Exhibits.

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

 

18

----

Table of Contents

 

### **Signatures**

### ** **

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

 
|   | Gaiam,  Inc.       |
|--------|--------------------|
|   | (Registrant)       |
|   | November  10, 2008 |
|   |               |
|   | By:           | /s/  Jirka Rysavy |
|   |               | Jirka  Rysavy |
|   |               | Chief  Executive Officer |
|   |               |   |
|   | By:                | /s/  Vilia Valentine |
|   |               | Vilia  Valentine |
|   |               | Chief  Financial Officer |
|   |               | (principal  accounting officer) |

 

19

----