**United States**

**Securities and ExchangeCommission**

**Washington, D.C. 20549**

 

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

 
| **ý**                                              | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (d)  OF THE SECURITIES AND EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                    |       |                                                                                                     |   |   |
| **For the  quarterly period ended March 31, 2005** |
|                                                    |       |                                                                                                     |   |   |
| **OR**                                                  |
|                                                    |       |                                                                                                     |   |   |
| **o**                                                   | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15 (d)  OF THE SECURITIES AND EXCHANGE ACT OF 1934** |

 

**Commission File Number 0-27517**

 

**GAIAM, INC.**

(Exact name of registrant as specified in its charter)

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

 

**360 INTERLOCKEN BLVD.,**

**BROOMFIELD, COLORADO 80021**

(Address of principal executive offices)

 

**(303) 222-3600**

(Registrant’s telephone number, includingarea code)

 

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

 

YES  ý                       NO  o

 

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

 

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

 
| **Class**                                | ** ** | **Shares outstanding as of May 3,  2005** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|
| Class A Common Stock  ($.0001 par value) |       | 9,420,118                                 |       |
|                                     |       |                                      |       |
| Class B Common Stock  ($.0001 par value) |       | 5,400,000                                 |       |

 

 

----

 

**INDEXTO FORM 10-Q**

 
| PART I. FINANCIAL INFORMATION |                                                                                                      |
|-------------------------------|-----------------------------------------------------------------------------------------------------------|
|                          |                                                                                                      |   |
| Item 1.                       | Condensed Consolidated Financial Statements (Unaudited)                                                   |   |
|                          | Condensed  Consolidated Balance Sheets at March 31, 2005 and December 31, 2004                  |   |
|                          | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2005 and 2004 |   |
|                          | Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2005 and 2004 |   |
|                          |                                                                                                      |   |
|                          | Notes to Interim Condensed  Consolidated Financial Statements                                             |   |
|                          |                                                                                                      |   |
| Item 2.                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations               |   |
|                          |                                                                                                      |   |
| Item 3.                       | Quantitative and Qualitative Disclosures About  Market Risk                                               |   |
|                          |                                                                                                      |   |
| Item 4.                       | Controls and  Procedures                                                                                  |   |
|                          |                                                                                                      |   |
| PART II.                      | OTHER  INFORMATION                                                                                        |   |
|                          |                                                                                                      |   |
| Item 1.                       | Legal Proceedings                                                                                         |   |
|                          |                                                                                                      |   |
| Item 2.                       | Unregistered  Sales of Equity Securities and Use of Proceeds                                              |   |
|                          |                                                                                                      |   |
| Item 3.                       | Defaults Upon  Senior Securities                                                                          |   |
|                          |                                                                                                      |   |
| Item 4.                       | Submission of  Matters to a Vote of Security Holders                                                      |   |
|                          |                                                                                                      |   |
| Item 5.                       | Other  Information                                                                                        |   |
|                          |                                                                                                      |   |
| Item 6.                       | Exhibits                                                                                                  |   |
|                          |                                                                                                      |   |
| SIGNATURES                    |                                                                                                      |   |

 

FORWARD-LOOKING STATEMENTS

 

Thisreport may contain forward-looking statements that involve risks anduncertainties.  When used in thisdiscussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,”“strive,” “future,” “intend” and similar expressions as they relate to Gaiam orits management are intended to identify such forward-looking statements.  Gaiam’s actual results could differmaterially from the results anticipated in these forward-looking statements asa result of certain factors set forth under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” “Market Risk” andelsewhere in this report.  Risks anduncertainties that could cause actual results to differ include, withoutlimitation, general economic conditions, competition, loss of key personnel,pricing, brand reputation, consumer trends, acquisitions, new initiativesundertaken by Gaiam, security and information systems, legal liability forwebsite 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, control of Gaiam by its founder, fluctuations inquarterly operating results, customer interest in our products, the effect ofgovernment regulation and other risks and uncertainties included in Gaiam’sfilings with the Securities and Exchange Commission.  We caution you that no forward-lookingstatement is a guarantee of future performance, and you should not place unduereliance on these forward-looking statements which reflect our management’sview only as of the date of this report. We undertake no obligation to update any forward-looking information.

 

2

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except shareinformation)

 
| ** **                                                                                                                                                                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                                                                      | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                      |       |               |       |                  |       |
| Current assets:                                                                                                                                                                                 |       |               |       |                  |       |
| Cash and  cash equivalents                                                                                                                                                                      |       | $                  | 10,910     |                  | $          | 10,439 |   |
| Accounts  receivable, net                                                                                                                                                                       |       | 11,787             |       | 13,914                |       |
| Income tax  and other receivables                                                                                                                                                               |       | 3,137              |       | 3,000                 |       |
| Inventory,  less allowances                                                                                                                                                                     |       | 16,984             |       | 16,503                |       |
| Deferred  advertising costs                                                                                                                                                                     |       | 2,066              |       | 2,635                 |       |
| Deferred tax  assets                                                                                                                                                                            |       | 921                |       | 1,145                 |       |
| Other  current assets                                                                                                                                                                           |       | 1,391              |       | 1,324                 |       |
| Total  current assets                                                                                                                                                                           |       | 47,196             |       | 48,960                |       |
|                                                                                                                                                                                            |       |               |       |                  |       |
| Property and  equipment, net                                                                                                                                                                    |       | 7,333              |       | 7,857                 |       |
| Investments                                                                                                                                                                                     |       | 7,865              |       | 7,865                 |       |
| Capitalized  production costs, net                                                                                                                                                              |       | 5,147              |       | 5,457                 |       |
| Media library,  net                                                                                                                                                                             |       | 5,250              |       | 5,427                 |       |
| Goodwill and  other intangibles                                                                                                                                                                 |       | 9,708              |       | 9,757                 |       |
| Non-current  deferred tax assets                                                                                                                                                                |       | 2,714              |       | 2,657                 |       |
| Other assets                                                                                                                                                                                    |       | 349                |       | 307                   |       |
| Total assets                                                                                                                                                                                    |       | $                  | 85,562     |                  | $          | 88,287 |   |
|                                                                                                                                                                                            |       |               |       |                  |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                  |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                                           | ** ** | ** **         | ** ** | ** **            | ** ** |
| Accounts  payable                                                                                                                                                                               |       | $                  | 11,059     |                  | $          | 12,910 |   |
| Accrued  liabilities                                                                                                                                                                            |       | 2,695              |       | 3,698                 |       |
| Income taxes  payable                                                                                                                                                                           |       | 794                |       | 864                   |       |
| Total  current liabilities                                                                                                                                                                      |       | 14,548             |       | 17,472                |       |
|                                                                                                                                                                                            |       |               |       |                  |       |
| Minority  interest                                                                                                                                                                              |       | 4,568              |       | 4,469                 |       |
|                                                                                                                                                                                            |       |               |       |                  |       |
| Commitments  and contingencies                                                                                                                                                                  |       |               |       |                  |       |
|                                                                                                                                                                                            |       |               |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                     |       |               |       |                  |       |
| Class A  common stock, $.0001 par value, 150,000,000 shares authorized, 9,420,118 and  9,411,897 shares issued and outstanding at March 31, 2005 and December 31,  2004, respectively |       | 1                  |       | 1                     |       |
| Class B  common stock, $.0001 par value, 50,000,000 shares authorized, 5,400,000  issued and outstanding at March 31, 2005 and December 31, 2004                                      |       | 1                  |       | 1                     |       |
| Additional  paid-in capital                                                                                                                                                                     |       | 54,982             |       | 54,933                |       |
| Accumulated  other comprehensive income                                                                                                                                                         |       | 785                |       | 850                   |       |
| Retained  earnings                                                                                                                                                                              |       | 10,677             |       | 10,561                |       |
| Total  stockholders’ equity                                                                                                                                                                |       | 66,446             |       | 66,346                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                |       | $                  | 85,562     |                  | $          | 88,287 |   |

 

*Seeaccompanying notes to the condensed consolidated financial statements.*

 

3

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 (In thousands,except per share amounts)

 
| ** **                                                                | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
|                                                                      |       |                                           |       |   |   |
| Net revenue                                                               |       | $                                              | 26,324     |   | $ | 23,775 |   |
| Cost of  goods sold                                                       |       | 12,575                                         |       | 11,099 |   |
| Gross profit                                                              |       | 13,749                                         |       | 12,676 |   |
|                                                                      |       |                                           |       |   |   |
| Expenses:                                                                 |       |                                           |       |   |   |
| Selling and  operating                                                    |       | 11,690                                         |       | 10,957 |   |
| Corporate,  general and administration                                    |       | 1,772                                          |       | 2,048 |   |
| Total  expenses                                                           |       | 13,462                                         |       | 13,005 |   |
|                                                                      |       |                                           |       |   |   |
| Income  (loss) from operations                                            |       | 287                                            |       | (329 | ) |
|                                                                      |       |                                           |       |   |   |
| Other income                                                              |       | 91                                             |       | 24 |   |
| Interest  income                                                          |       | 25                                             |       | 32 |   |
| Total other  income                                                       |       | 116                                            |       | 56 |   |
|                                                                      |       |                                           |       |   |   |
| Income  (loss) before income taxes and minority interest                  |       | 403                                            |       | (273 | ) |
|                                                                      |       |                                           |       |   |   |
| Income tax  expense (benefit)                                             |       | 130                                            |       | (116 | ) |
| Minority  interest in net income of consolidated subsidiaries, net of tax |       | (157                                           | )          | (172 | ) |
| Net income  (loss)                                                        |       | $                                              | 116        |   | $ | (329 | ) |
|                                                                      |       |                                           |       |   |   |
| Net income  (loss) per share:                                             |       |                                           |       |   |   |
| Basic                                                                     |       | $                                              | 0.01       |   | $ | (0.02 | ) |
| Diluted                                                                   |       | $                                              | 0.01       |   | $ | (0.02 | ) |
| Shares used  in computing net income (loss) per share:                    |       |                                           |       |   |   |
| Basic                                                                     |       | 14,820                                         |       | 14,615 |   |
| Diluted                                                                   |       | 14,914                                         |       | 14,615 |   |

 

*Seeaccompanying notes to the condensed consolidated financial statements.*

 

4

----

 

GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited – In thousands)

 
| ** **                                                                                | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                       | ** ** | **2004** | ** ** |
| **Operating  activities**                                                                 |       |                                           |       |   |   |
| Net income  (loss)                                                                        |       | $                                              | 116        |   | $ | (329 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by operating activities: |       |                                           |       |   |   |
| Depreciation                                                                              |       | 574                                            |       | 749 |   |
| Amortization                                                                              |       | 523                                            |       | 464 |   |
| Stock  compensation                                                                       |       | —                                         |       | 18 |   |
| Minority  interest in consolidated subsidiaries                                           |       | 157                                            |       | 172 |   |
| Deferred tax  expense                                                                     |       | 191                                            |       | 119 |   |
| Changes in  operating assets and liabilities, net of effects from acquisitions:           |       |                                           |       |   |   |
| Accounts  receivable                                                                      |       | 1,947                                          |       | 5,716 |   |
| Inventory                                                                                 |       | (526                                           | )          | (184 | ) |
| Deferred  advertising costs                                                               |       | 569                                            |       | 746 |   |
| Other  current assets                                                                     |       | (72                                            | )          | 35 |   |
| Other assets                                                                              |       | (48                                            | )          | 106 |   |
| Accounts  payable                                                                         |       | (1,834                                         | )          | (4,495 | ) |
| Accrued  liabilities                                                                      |       | (938                                           | )          | (533 | ) |
| Income taxes  payable                                                                     |       | (61                                            | )          | 182 |   |
| Net cash  provided by operating activities                                                |       | 598                                            |       | 2,766 |   |
|                                                                                      |       |                                           |       |   |   |
| **Investing  activities**                                                                 |       |                                           |       |   |   |
| Purchase of  property, equipment and media rights                                         |       | (93                                            | )          | (254 | ) |
| Net cash  used in investing activities                                                    |       | (93                                            | )          | (254 | ) |
|                                                                                      |       |                                           |       |   |   |
| **Financing  activities**                                                                 |       |                                           |       |   |   |
| Principal  payments on capital leases                                                     |       | —                                         |       | (20 | ) |
| Proceeds  from issuance of common stock                                                   |       | —                                         |       | 8 |   |
| Net cash  provided by (used in) financing activities                                      |       | —                                         |       | (12 | ) |
|                                                                                      |       |                                           |       |   |   |
| Effects of  exchange rates on cash and cash equivalents                                   |       | (34                                            | )          | 110 |   |
| Net change  in cash and cash equivalents                                                  |       | 471                                            |       | 2,610 |   |
| Cash and  cash equivalents at beginning of period                                         |       | 10,439                                         |       | 8,384 |   |
| Cash and  cash equivalents at end of period                                               |       | $                                              | 10,910     |   | $ | 10,994 |   |
|                                                                                      |       |                                           |       |   |   |
| **Supplemental  cash flow information**                                                   |       |                                           |       |   |   |
| Interest  paid                                                                            |       | $                                              | —     |   | $ | — |   |
| Income taxes  paid                                                                        |       | 189                                            |       | — |   |

 

*Seeaccompanying notes to the condensed consolidated financial statements.*

 

5

----

 

Gaiam, Inc.

Notes to Interim Condensed ConsolidatedFinancial Statements

(Unaudited)

March 31, 2005

 

1.                                       Interim Condensed Consolidated FinancialStatements

 

###### Organization and Nature of Operations

 

  Gaiam, Inc. is a lifestyle media companyproviding a broad selection of content, information, and products to customerswho value personal development, natural health, ecological lifestyles andresponsible media.  Gaiam wasincorporated under the laws of the State of Colorado on July 7, 1988.

 

The accompanying condensed consolidatedfinancial statements include the accounts of Gaiam and its subsidiaries inwhich Gaiam’s ownership is greater than 50% and the subsidiary is considered tobe under Gaiam’s control.  All materialintercompany accounts and transaction balances have been eliminated inconsolidation.

 

Preparation of InterimCondensed Consolidated Financial Statements

 

The interim condensedconsolidated financial statements included herein have been prepared by themanagement of Gaiam pursuant to the rules and regulations of the United StatesSecurities and Exchange Commission, and, in the opinion of management, containall adjustments (consisting of only normal recurring adjustments) necessary topresent fairly Gaiam’s consolidated financial position as of March 31,2005, the interim results of operations for the three months ended March 31,2005 and 2004, and cash flows for the three months ended March 31, 2005and 2004.  These interim statements havenot been audited.  The balance sheet asof December 31, 2004 was derived from Gaiam’s audited consolidatedfinancial statements included in Gaiam’s annual report on Form 10-K.

 

Certain information andfootnote disclosures normally included in consolidated financial statementsprepared in accordance with accounting principles generally accepted in theUnited States have been condensed or omitted pursuant to such rules andregulations.  Accounting policiesfollowed by Gaiam are described in Note 1 to the audited financial statementsfor the fiscal year ended December 31, 2004 included in Gaiam’s annualreport on Form 10-K.  The consolidatedfinancial statements contained herein should be read in conjunction with Gaiam’saudited financial statements, including the notes thereto, for the year ended December 31,2004.

 

The consolidated financialposition, results of operations and cash flows for the interim periodsdisclosed in this report are not necessarily indicative of future financialresults.

 

Use of Estimates

 

The preparation of theconsolidated financial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenueand expenses and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements. Actual results could differ from those estimates.

 

Reclassifications

 

Certain reclassificationshave been made to prior period amounts to conform to the current periodpresentations.

 

6

----

 

New Accounting Pronouncements

 

In December 2004, theFASB issued SFAS No. 123 (revised), *Share-Based Payment,*whichsupersedes Accounting Principles Board (“APB”) No. 25, *Accountingfor Stock Issued to Employees,* and its related implementationguidance.  Under SFAS No. 123 (revised),all share-based payments would be treated as other forms of compensation byrecognizing the costs, generally measured as the fair value at the date ofgrant, in the income statement.  Gaiamwill adopt, in accordance with rules adopted by the Securities and ExchangeCommission on April 14, 2005, SFAS No. 123 (revised) for its fiscal yearbeginning January 1, 2006. Management expects that the impact of the adoption of SFAS No. 123(revised) will be that the share-based payment expense amounts historicallydisclosed as required by SFAS No. 123 will now be recognized as an expense onthe statement of operations.

 

Stock-Based Compensation

 

Gaiam accounts for itsstock-based compensation arrangements under the provisions of AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees* (“APB No. 25”) and related interpretations,including FASB Interpretation No. 44, *Accountingfor Certain Transactions Involving Stock Compensation*, rather thanthe alternative fair value accounting allowed by SFAS No. 123, *Accounting for Stock Based Compensation*.  Accordingly, no compensation expense isrecognized in Gaiam’s consolidated financial statements in connection withstock options granted to employees with exercise prices not less than fairvalue.  Deferred compensation for optionsgranted to employees is determined as the difference between the fair marketvalue of Gaiam’s common stock on the date options were granted and the exerciseprice.  For purposes of this pro-formadisclosure, the estimated fair value of options is assumed to be amortized toexpense over the options’ vesting periods.

 

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

 
| **For the Three Months Ended March 31,**                                                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                  |       |     |       |     |       |
| Net income  (loss) as reported                                                                                                        |       | $        | 116        |     | $          | (329 | ) |
| Add:  Stock-based compensation expense included in reported net income (loss), net  of related tax effects                            |       | —   |       | 18       |       |
| Deduct:  Total stock-based compensation expenses determined under fair value based  method for all awards, net of related tax effects |       | (80      | )          | (165     | )          |
| Pro forma  net income (loss)                                                                                                          |       | $        | 36         |     | $          | (476 | ) |
| Net income  (loss) per common share                                                                                                   |       |     |       |     |       |
| As reported                                                                                                                           |       | $        | 0.01       |     | $          | (0.02 | ) |
| Pro forma                                                                                                                             |       | $        | 0.00       |     | $          | (0.03 | ) |
| Fully  diluted net income (loss) per common share                                                                                     |       |     |       |     |       |
| As reported                                                                                                                           |       | $        | 0.01       |     | $          | (0.02 | ) |
| Pro forma                                                                                                                             |       | $        | 0.00       |     | $          | (0.03 | ) |

 

2.                                       Stockholders’ Equity

 

During the first quarter of2005, Gaiam issued a total of 8,221 shares of Class A common stock to Gaiam’sindependent directors, in lieu of cash compensation, for services rendered in 2004.

 

7

----

 

3.                                       Comprehensive Income (Loss)

 

Gaiam’s comprehensive income(loss) is comprised of net income (loss) and foreign currency translationadjustment, net of income taxes. Comprehensive income (loss), net of related tax effects, was as follows(in thousands):

 
| **For the Three Months Ended March 31,** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |
| Net income  (loss)                            |       | $        | 116        |     | $          | (329 | ) |
| Foreign  currency translation adjustment, net |       | (65      | )          | 168      |       |
| Comprehensive  income (loss), net of taxes    |       | $        | 51         |     | $          | (161 | ) |

 

4.                                       Earnings (Loss) per Share

 

Basic earnings (loss) pershare excludes any dilutive effects of options, warrants and dilutivesecurities.  Basic earnings (loss) pershare is computed using the weighted average number of common sharesoutstanding during the period.  Dilutedearnings per share is computed using the weighted average number of common andcommon stock equivalent shares outstanding during the period.  Common equivalent shares of 154 thousand areexcluded from the computation of diluted earnings per share for the three monthsended March 31, 2004, because their effect is antidilutive.

 

The following table setsforth the computation of basic and diluted earnings per share (in thousands,except per share data):

 
| **For the Three Months Ended March 31,**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                           |       |     |       |     |       |
| Numerator  for basic and diluted earnings (loss per share)     |       | $        | 116        |     | $          | (329 | ) |
| Denominator:                                                   |       |     |       |     |       |
| Weighted  average shares for basic earnings (loss) per share   |       | 14,820   |       | 14,615   |       |
| Effect of  dilutive securities:                                |       |     |       |     |       |
| Weighted  average of common stock, stock options, and warrants |       | 94       |       | —   |       |
| Denominators  for diluted earnings (loss) per share            |       | 14,914   |       | 14,615   |       |
|                                                           |       |     |       |     |       |
| Net income  (loss) per share—basic                        |       | $        | 0.01       |     | $          | (0.02 | ) |
| Net income  (loss) per share—diluted                      |       | $        | 0.01       |     | $          | (0.02 | ) |

 

5.                                       Segment Information

 

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

 

Although Gaiam is able to track revenue bysales channel, management, allocation of resources and analysis and reportingof expenses is solely on a combined basis, at the reportable segment level.

 

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

 

8

----

 
| **For the  Three Months Ended March 31,**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net revenue:                                                              |       |     |       |     |       |
| Direct to  consumer                                                       |       | $        | 13,313     |     | $          | 12,138 |   |
| Business                                                                  |       | 13,011   |       | 11,637   |       |
| Consolidated  net revenue                                                 |       | 26,324   |       | 23,775   |       |
| Contribution  margin:                                                     |       |     |       |     |       |
| Direct to  consumer                                                       |       | 166      |       | (24      | )          |
| Business                                                                  |       | 121      |       | (305     | )          |
| Consolidated  contribution margin (loss)                                  |       | 287      |       | (329     | )          |
| Reconciliation  of contribution margin (loss) to net income (loss):       |       |     |       |     |       |
| Other income  (expense)                                                   |       | 116      |       | 56       |       |
| Income tax  expense (benefit)                                             |       | 130      |       | (116     | )          |
| Minority  interest in net income of consolidated subsidiaries, net of tax |       | (157     | )          | (172     | )          |
| Net income  (loss)                                                        |       | $        | 116        |     | $          | (329 | ) |

 

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

 

The following discussion and analysis ofGaiam’s financial condition and results of operations should be read inconjunction with the condensed consolidated financial statements and relatednotes included elsewhere in this document.

 

#### Overview and Outlook

####  

Gaiam is a lifestyle media company providing content,information, and products to customers who value personal development, healthyliving, ecological lifestyles and responsible media. Gaiam was incorporated inBoulder, Colorado in 1988.

 

With the inception of our business segment in 1998,Gaiam started to sell directly to retailers, both domestically and abroad.  As of the end of 2004, Gaiam products wereavailable in over 25,000 stores.  Gaiamintroduced its “store-within-store” lifestyle presentations, which utilizecustom fixtures designed and produced by Gaiam, in late 2000, and the placementof this concept grew to over 4,200 stores by the end of 2004.  In 1998, revenue generated by the businesssegment was $3.8 million.  In 2004, revenuein this segment was $44.2 million. During the first three months of 2005, revenue in the business segmentwas $13 million, an increase of 12% over 2004. In the fourth quarter of 2004,Gaiam tripled its shelf space at Target and media was added to thestore-within-store displays in all 1,300 Target stores.  Gaiam will continue to focus on the nationalretailer and media channels and plans to continue to build this segment througha combination of new media releases, store within store concept, and expansionsin mass market retailers, grocery, bookstores and other media outlets.

 

The direct to consumer segment continues to be anintegral part of Gaiam’s outreach.  Thissegment accounted for 54%, or approximately $52.4 million, of Gaiam’s revenueduring 2004.  During the first threemonths of 2005, revenue in this segment was $13.3 million, an increase of 10%over 2004, and represented 51% of total revenue.  Through its diverse media reach, the directto consumer segment provides branding, an opportunity to launch and support newmedia releases, a sounding board for new product testing, promotionalopportunities and customer feedback on Gaiam’s and the LOHAS (Lifestyles ofHealth and Sustainability) industry’s focus and future.

 

The return to positive internal growth in bothoperating segments led to Gaiam’s achieving of an overall internal growth rateof 11% for the first quarter of 2005.

 

#### Results of Operations

####  

The following table sets forth certain financial data as a percentageof revenue for the periods indicated:

 

9

----

 
| **For the  Three Months Ended March 31,**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net revenue                                                               |       | 100.0    | %          | 100.0    | %          |
| Cost of  goods sold                                                       |       | 47.8     | %          | 46.7     | %          |
| Gross profit                                                              |       | 52.2     | %          | 53.3     | %          |
| Expenses:                                                                 |       |     |       |     |       |
| Selling and  operating                                                    |       | 44.4     | %          | 46.1     | %          |
| Corporate,  general and administrative                                    |       | 6.7      | %          | 8.6      | %          |
| Total  expenses                                                           |       | 51.1     | %          | 54.7     | %          |
| Income  (loss) from operations                                            |       | 1.1      | %          | -1.4     | %          |
| Other income                                                              |       | 0.4      | %          | 0.2      | %          |
| Income  (loss) before income taxes and minority interest                  |       | 1.5      | %          | -1.2     | %          |
| Income tax  expense (benefit)                                             |       | 0.5      | %          | -0.5     | %          |
| Minority  interest in net income of consolidated subsidiaries, net of tax |       | -0.6     | %          | -0.7     | %          |
| Net  income(loss)                                                         |       | 0.4      | %          | -1.4     | %          |

####  

#### Three months ended March 31, 2005 versus March 31,2004

####  

Revenueof $26.3 million for the three months ended March 31, 2005 increased 10.7%from $23.8 million for the three months ended March 31, 2004.  Gaiam’s increase in revenue was primarily dueto a $1.4 million, or 12%, increase in revenue generated by the businesssegment, largely as a result of increased volume generated by the shelf spaceexpansion and additional media placements in Target.  Direct to consumer segment revenue alsoincreased by 10%, fueled by continued strong growth in revenue generated by ourInternet business.

 

Grossprofit, which consists of revenue less cost of sales (primarily merchandiseacquisition costs and in-bound freight), increased to $13.7 million for the firstquarter of 2005 from $12.7 million during the same period in 2004.  As a percentage of revenue, gross profit forthe first quarter of 2005 declined to 52.2% in 2005 from 53.3% in the firstquarter of 2004, but increased over the fourth quarter 2004 rate of 48.7%.  As compared to first quarter of 2004, thelower 2005 gross profit percentage was primarily due to a sales/product mixchange, coupled with higher importation and inbound freight costs associated inpart with the rise in fuel costs.

 

Sellingand operating expenses (which consist primarily of sales and marketing costs,commission and fulfillment expenses) increased to $11.7 million for the threemonths ended March 31, 2005 as compared to $11 million in the same periodof 2004, primarily resulting from higher sales, marketing and fulfillmentexpenses associated with an overall increase in revenue of 10.7%.  As a percentage of revenue, selling and operatingexpenses decreased to 44.4% in 2005 from 46.1% in 2004 as a result of the increasein the sales base.

 

Corporate,general and administration expenses decreased to $1.8 million for the firstquarter of 2005 compared to $2 million for the same 2004 period, primarily dueto expense reductions in our Broomfield headquarters.  As a percentage of revenue, corporate,general and administration expenses decreased to 6.7% in the first quarter of2005 from 8.6% in the comparable 2004 period, as a result of the aforementionedexpense reductions and an increase in the sales base.

 

Operatingincome was $287 thousand for the three months ended March 31, 2005compared to an operating loss of $329 thousand for the three months ended March 31,2004, primarily due to a revenue increase in the first quarter of 2005 ascompared to the same period during 2004.

 

Gaiam recorded $116 thousand and $56 thousand inother income for the three months ended March 31, 2005 and 2004,respectively.  The share of net incomeassociated with minority interest was $157 thousand during the first quarter of2005, compared to the share of net income of $172 thousand for the comparable2004 period.

 

Gaiam recorded income tax expense of $130 thousandfor the three months ended March 31, 2005 compared to an income taxbenefit of $116 thousand for the three months ended March 31, 2004.  Gaiam’s consolidated effective tax ratefluctuates based upon the distribution of earnings/losses between its domesticand foreign operations.

 

10

----

 

As a result of the factors described above, Gaiam’snet income was $116 thousand, or $0.01 per share, for the three months ended March 31,2005, as compared to a net loss of $329 thousand, or $0.02 per share, for the threemonths ended March 31, 2004.

 

Gaiam generated cash from operating activities of$598 thousand for the three months ended March 31, 2005, and ended thequarter with $10.9 million in cash, up from $10.4 million at December 31,2004, no debt and an unused $15 million line of credit.

 

Liquidity and Capital Resources

 

Gaiam’s capital needs arise from working capital required to fund ouroperations, capital expenditures related to acquisition and development ofmedia content, development of E-commerce and new products, acquisitions of newbusinesses, replacements, expansions and improvements to Gaiam’sinfrastructure, and future growth.  Thesecapital requirements depend on numerous factors, including the rate of marketacceptance of Gaiam’s product offerings, our ability to expand Gaiam’s customerbase, the cost of ongoing upgrades to Gaiam’s product offerings, our level ofexpenditures for sales and marketing, our level of investment in distributionsystems and facilities and other factors. The timing and amount of these capital requirements are variable andcannot accurately be predicted. Additionally, Gaiam will continue to pursue opportunities to expand ourmedia libraries, evaluate possible investments in businesses, products and technologies,and increase our sales and marketing programs and brand promotions as needed.

 

Gaiam has a credit agreement with Wells Fargo, which permits borrowingsof up to $15 million based upon the collateral value of Gaiam’s accountsreceivable, inventory and certain property and equipment.  At March 31, 2005, Gaiam had no amountsoutstanding under this agreement and complied with all of the financialcovenants. This credit agreement expires on May 31, 2005, and Gaiam is negotiatinga renewal of this agreement.  ShouldGaiam choose to borrow under the credit agreement, outstanding advances bearinterest at the lower of prime rate less 50 basis points or LIBOR plus 275basis points.  Borrowings are secured bya pledge of Gaiam’s assets, and the agreement contains various financialcovenants, including covenants prohibiting the payment of cash dividends toGaiam shareholders and requiring compliance with certain financial ratios.

 

Gaiam’s operating activities generated net cash of $598 thousand and $2.8million for the three months ended March 31, 2005 and 2004,respectively.  Gaiam’s net cash generatedfrom operating activities for both periods is primarily attributable to adecrease in accounts receivable of $1.9 million in 2005 and $5.7 million in 2004,and non-cash charges to net income of $1.4 million in 2005 and $1.5 million in2004.  These sources of funds werepartially offset by the use of funds to reduce accounts payable $1.8 million in2005 and $4.5 million in 2004.

 

Gaiam’s investing and acquisition activities used net cash of $93thousand and $254 thousand during the first three months of 2005 and 2004,respectively, for the purchase of property, equipment and media rights.

 

Gaiam’s financing activities used net cash of $12 thousand for thethree months ended March 31, 2004, primarily to fund principal paymentsunder capitalized leases.

 

We believe our available cash, cash expected to begenerated from operations, and borrowing capabilities on our unused $15 millionline of credit, which we expect to renew, should be sufficient to fund ouroperations on both a short-term and long-term basis.  However, our projected cash needs may changeas a result of acquisitions, product development, unforeseen operationaldifficulties or other factors.

 

In the normal course of our business, weinvestigate, evaluate and discuss acquisition, joint venture, minorityinvestment, strategic relationship and other business combination opportunitiesin the LOHAS market.  For any futureinvestment, acquisition or joint venture opportunities, we may consider usingthen-available liquidity, issuing equity securities or incurring additionalindebtedness.

 

Contractual Obligations

 

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

 

11

----

 
| ** **                   | ** ** | **Total** | ** ** | **< 1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **> 5 yrs** | ** ** |
|------------------------------|------------|-----------|------------|-----------------|------------|---------------|------------|---------------|------------|----------------|------------|
| Operating  lease obligations |       | $         | 4,102      |            | $          | 1,670         |       | $             | 1,622      |           | $          | 430 |   | $ | 380 |   |
|                              |            |           |            |                 |            |               |            |               |            |                |            |  |  |  |  |  |

 

Off-Balance Sheet Arrangements

 

Gaiam does not participate in transactionsthat generate relationships with unconsolidated entities or financialpartnerships, such as special purpose entities (“SPEs”) or variable interestentities (“VIEs”), which have been established for the purpose of facilitatingoff-balance sheet arrangements or other limited purposes.  As of March 31, 2005, Gaiam is notinvolved in any unconsolidated SPEs or VIEs.

 

Critical Accounting Policies

 

Theconsolidated financial statements are prepared in conformity with accountingprinciples generally accepted in the United States, which require management tomake judgments, estimates and assumptions that affect the amounts reported in Gaiam’sconsolidated financial statements and accompanying notes.  Note 1 to the consolidated financialstatements in Item 8 of our Annual Report on Form 10-K summarizes thesignificant accounting policies and methods used in the preparation of Gaiam’sconsolidated financial statements.  No changeswere made to our significant policies during the three months ended March 31,2005.

 

Managementbelieves the following to be critical accounting policies whose application hasa material impact on Gaiam’s financial presentation, and involve a higherdegree of complexity, as they require management to make judgments andestimates about matters that are inherently uncertain.

 

*Provisions for Doubtful Accounts and Returns*

 

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

 

Gaiam records a provision for product returns to bereceived in future periods at the time the original sale is recognized.  The amount of the returns provision is basedupon historical experience and future expectations.

 

*Inventory*

 

Inventory consists primarily of finished goods heldfor sale and is stated at the lower of cost (first-in, first-out method) ormarket. Gaiam identifies the inventory items to be written down forobsolescence based on the item’s current sales status and condition.  If the item is discontinued or slow moving,it is written down based on an estimate of the markdown to retail price neededto sell through its current stock level of the item.

 

*Goodwill*

 

Goodwill represents the excess of the purchaseconsideration over the fair value of assets acquired less liabilities assumedin a business acquisition.  In accordancewith SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is nolonger amortized but is reviewed for impairment annually or more frequently ifimpairment indicators arise, on a reporting unit level.  The fair value of a reporting unit iscompared with its carrying amount, including goodwill.  If the fair value of a reporting unit exceedsits carrying amount, goodwill of the reporting unit is considered not impaired.

 

If the carrying amount of a reporting unit exceedsits fair value, the goodwill impairment test is performed to measure the amountof impairment loss.  Gaiam has allocatedgoodwill to two reporting units, and uses a market value method for thepurposes of testing for potential impairment. The annual review requires extensive use of financial judgment andestimates.  Application of alternativeassumptions and definitions, such as a change in the composition of a reportingunit, could yield significantly different results.

 

12

----

 

*Investments*

 

Investments in entities over which Gaiam does nothave the ability to exercise significant influence are accounted for under thecost method. Under the cost method of accounting, investments in privatecompanies are carried at cost and are adjusted only for other-than-temporarydeclines in fair value. Investments under the cost method are included on theaccompanying consolidated balance sheet in “Investments.”  Had Gaiam concluded that it had the abilityto exercise significant influence, its share of the investee’s income or losswould have been reported in Gaiam’s consolidated statement of operations.

 

*Capitalized Production Costs*

 

Capitalized production costs include costs incurredto produce informational media products marketed by Gaiam to retail marketersand direct-mail and online customers. These costs are deferred for financial reporting purposes until the mediais released, then amortized over succeeding periods on the basis of estimatedsales.  Historical sales statistics arethe principal factor used in estimating the amortization rate.

 

Gaiamhad no significant changes in its critical accounting policies from its Form10-K filing for the fiscal year ended December 31, 2004.

 

RiskFactors

 

Wewish to caution you that there are risks and uncertainties that could cause ouractual results to be materially different from those indicated byforward-looking statements that we make from time to time in filings with theSecurities and Exchange Commission, news releases, proxy statements, annualreports, registration statements and other written communications, as well asoral forward-looking statements made from time to time by representatives ofGaiam.  These risks and uncertaintiesinclude, but are not limited to, those listed in Gaiam’s Annual Report on Form10-K for the year ended December 31, 2004. These risks and uncertainties and additional risks and uncertainties notpresently known to us or that we currently deem immaterial may cause ourbusiness, financial condition, operating results and cash flows to bematerially adversely affected.  Exceptfor the historical information contained herein, the matters discussed in thisanalysis are forward-looking statements that involve risk and uncertainties,including, but not limited to, general economic and business conditions,competition, pricing, brand reputation, consumer trends, and other factorswhich are often beyond our control. Gaiam does not undertake any obligation to update forward-lookingstatements except as required by law.

 

##### **Item3**.           Quantitative and Qualitative Disclosures About Market Risk

#####  

We are exposed to market risks, which includechanges in U.S. interest rates and foreign exchange rates.  We do not engage in financial transactionsfor trading or speculative purposes.

 

Any borrowings we might make under our bank creditfacility would bear interest at the lower of prime rate less 50 basis points orLIBOR plus 275 basis points.  Gaiam does nothave any amounts outstanding under its credit facility, so any unfavorablechange in interest rates would not have a material impact on Gaiam’s resultsfrom operations or cash flows unless Gaiam makes borrowings in the future.

 

Gaiam purchases a significant amount of inventoryfrom vendors outside of the U.S. in transactions that are primarily U.S. dollardenominated transactions.  Because thepercentage of our international purchases denominated in currencies other thanthe U.S. dollar is small, any currency risks related to these transactions areimmaterial to Gaiam.  A decline in therelative value of the U.S. dollar to other foreign currencies could, however,lead to increased purchasing costs.  Inorder to mitigate this exposure, Gaiam makes virtually all of its purchasecommitments in U.S. dollars.

 

In 2003, Gaiam purchased a 50.1% interest in LeisureSystems International Limited, a U.K. based distributor.  Because Leisure Systems’ revenue is primarilydenominated in foreign currencies, this investment exposes Gaiam to accountingrisk associated with foreign currency exchange rate fluctuations.  However, we have determined that no materialmarket risk exposure to our consolidated financial position, results ofoperations or cash flows existed as of March 31, 2005.

 

13

----

 

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

 

**Evaluation of Disclosure Controls and Procedures**

 

Gaiam’s chief executive officer and chief financialofficer conducted an evaluation of the effectiveness of the design andoperation of Gaiam’s disclosure controls and procedures, as defined in Rules13a-15(e) and Rule 15d-15(e) under the Exchange Act.  Based upon their evaluation as of March 31,2005, Gaiam’s chief executive officer and chief financial officer haveconcluded that those disclosure controls and procedures are effective.

 

**Changes in Internal Control over Financial Reporting**

 

No changes in Gaiam’s internal control overfinancial reporting occurred during the quarter ended March 31, 2005 thathave materially affected, or are reasonably likely to materially affect, Gaiam’sinternal control over financial reporting.

 

## **PARTII**.                OTHER INFORMATION

##  

## **Item1**.                    Legal Proceedings

#####  

From time to time, Gaiam isinvolved in legal proceedings that we consider to be in the normal course ofbusiness.  We do not believe that any ofthese proceedings will have a material adverse effect on our business.

 

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

#####  

None.

 

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

#####  

None.

 

## **Item4**.                    Submission ofMatters to a Vote of Security Holders

 

None.

 

## **Item5**.                    Other Information

 

None.

 

## **Item6**.                    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). |

 

b)                                     Reports on Form 8-K.

 

On January 27, 2005,Gaiam filed a report on Form 8-K relating to a Change in Terms Agreemententered by Gaiam, Inc. and Wells Fargo Bank, National Association, whereby thematurity date of the $15,000,000 Promissory Note and Loan Agreement 

 

14

----

 

dated December 31, 2002, between the aforementionedparties, was extended to May 31, 2005.

 

On February 28, 2005,Gaiam filed a report on Form 8-K relating to its earnings press release for thefiscal year ended December 31, 2004.

 

On May 3, 2005, Gaiam fileda report on Form 8-K relating to its earnings press release for the firstquarter 2005.

 

15

----

 

### **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) |
|   | May 4, 2005  |
|   |         |
|   | By: /s/      | Jirka Rysavy |   |
|   |         |   Jirka Rysavy |
|   |         |   Chief Executive Officer |
|   |         |   |
|   | By: /s/      | Janet Mathews |   |
|   |         |   Janet Mathews |
|   |         |   Chief Financial Officer |
|        |              |  |  |  |

 

16

----