United States
Securities and Exchange Commission
Washington, D.C. 20549

Form 10-Q

ý                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934

For the Fiscal Quarter Ended June 30, 2003

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934

Commission File Number 0-27517

GAIAM, INC.

(Exact name of registrant as specified in its charter)

360 INTERLOCKEN BLVD.,

BROOMFIELD, COLORADO 80021

(Address of principal executive offices)

(303) 222-3600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant:  (1) has filed all reports required to 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 such reports) and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

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

INDEX TO FORM 10-Q

This report may contain forward-looking statements that involve risks and uncertainties.  When used in this discussion, the words “anticipate,” “believe,” “plan,” “estimate,” “expect,” “strive,” “future,” “intend” and similar expressions as they relate to Gaiam or its management are intended to identify such forward-looking statements.  Gaiam’s actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain factors set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “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 key personnel, pricing, brand reputation, acquisitions, security and information systems, legal liability for website content, merchandise supply problems, failure of third parties to provide adequate service, reliance on centralized customer service, overstocks and merchandise returns, reliance on a centralized fulfillment center, increases in postage and shipping costs, e-commerce trends, future taxes on internet or catalog sales, control of Gaiam by its founder, fluctuations in quarterly operating results, consumer trends, customer interest in our products, the effect of government regulation and other risks and uncertainties included in Gaiam’s filings with the Securities and Exchange Commission.  We caution you that no forward-looking statement is a guarantee of future performance, and you should not place undue reliance on these forward-looking statements which reflect our management’s view only as of the date of this report.  We undertake no obligation to update any forward-looking information.

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GAIAM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes.

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GAIAM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes.

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GAIAM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

See accompanying notes.

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GAIAM, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

See accompanying notes.

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Gaiam, Inc.
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
June 30, 2003

1.                                       Interim Condensed Consolidated Financial Statements

Organization and Nature of Operations

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

The accompanying consolidated financial statements include the accounts of Gaiam, its subsidiaries and partnerships in which ownership is greater than 50% and considered to be under the control of Gaiam.  All material intercompany accounts and transaction balances have been eliminated in consolidation.

Preparation of Interim Condensed Consolidated Financial Statements

The interim condensed consolidated financial statements included herein have been prepared by the management of Gaiam pursuant to the rules and regulations of the United States Securities and Exchange Commission, and, in the opinion of management, contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly Gaiam’s consolidated financial position as of June 30, 2003, the interim results of operations for the three and six months ended June 30, 2003 and 2002, and cash flows for the six months ended June 30, 2003 and 2002.  These interim statements have not been audited.  The balance sheet as of December 31, 2002 was derived from Gaiam’s audited consolidated financial statements included in Gaiam’s annual report on Form 10-K.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principals have been condensed or omitted pursuant to such rules and regulations.  Accounting policies followed by Gaiam are described in Note 1 to the audited financial statements for the fiscal year ended December 31, 2002 included in Gaiam’s annual report on Form 10-K.  The consolidated financial statements contained herein should be read in conjunction with the audited financial statements, including the notes thereto, for the year ended December 31, 2002.

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

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities at the date of the consolidated financial statements.  Actual results could differ from those estimates.

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Adoption of Accounting Standards

In June 2001, the FASB issued statement No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”), which sets forth the financial accounting and reporting to be followed for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recorded in the period in which it is incurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs must be capitalized as part of the carrying amount of the long-lived asset.  Subsequently, the recorded liability will be accreted to its present value and the capitalized costs will be depreciated.  Gaiam adopted SFAS No. 143 in its consolidated financial statements for the first quarter of 2003. The adoption of SFAS No. 143 did not have a material impact on Gaiam’s consolidated financial statements.

In May 2002, the FASB issued statement No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”).  The statement rescinds FASB No. 4, “Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that statement, FASB No. 64, “Extinguishments of Debt Made to Satisfy Sinking Fund Requirements.”  As a result, gains and losses from extinguishments of debt will no longer be aggregated and classified as an extraordinary item, net of related income tax effect, on the statement of earnings.  SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with earlier application encouraged.  Gaiam has adopted SFAS No. 145, as required, in its consolidated financial statements effective the first quarter of 2003.  The adoption of SFAS No. 145 did not have a material impact on Gaiam’s consolidated financial statements.

In July 2002, the FASB issued statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”).  SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity is recognized at fair value when the liability is incurred rather than at the date of a commitment to an exit or disposal plan.  SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002.  Gaiam has adopted SFAS No. 146 effective the first quarter of 2003. The adoption of SFAS No. 146 did not have a material impact on Gaiam’s consolidated financial statements.

In December 2002, the FASB issued statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123” (“SFAS No. 148”).  SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“Statement 123’) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  Gaiam has elected to use the intrinsic value method of accounting for stock compensation for options granted to employees and directors in accordance with APB 25.  In addition, SFAS No. 148 amends the disclosure requirements of Statement 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method of accounting used on reported

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results. Gaiam has adopted SFAS No. 148 in its fiscal year reporting effective December 31, 2002 and its interim reporting as of the first quarter of 2003.

In April 2003, the FASB issued statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”).  SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.  SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003.  Gaiam does not currently have any derivative instruments, nor does Gaiam currently participate in hedging activities.  Therefore, Gaiam’s adoption of SFAS No. 149, as required, is not expected to have a material impact on Gaiam’s consolidated financial statements.

In May 2003, the FASB issued statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS No. 150”).  SFAS No. 150 establishes standards for classification and measurement of certain financial instruments with characteristics of both liabilities and equity.  SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  Gaiam will adopt SFAS No. 150 in its interim reporting as of the third quarter of 2003, and adoption of this statement is not expected to have a material impact on Gaiam’s consolidated financial statements.

2.                                       Mergers and Acquisitions

In January 2003, Gaiam acquired a 50.1% interest in Leisure Systems International Ltd., a U.K. based distributor and marketer of lifestyle products for approximately $4.3 million in cash and 50,000 shares of Gaiam Class A common stock.  This acquisition was accounted for using the purchase method and approximately $2.8 million of goodwill was recorded.  The results of operations of Leisure Systems International are included in the consolidated financial statements of Gaiam from the effective acquisition date of January 1, 2003.  The revenue generated by this acquisition during the second quarter totaled approximately $3.2 million.

3.                                       Stockholders’ Equity

During the first quarter of 2003, Gaiam issued 50,000 shares of Class A common stock in conjunction with the acquisition of 50.1% of Leisure Systems International and 3,750 shares of Class A common stock to four directors in lieu of cash compensation. In addition, for the six months ended June 30, 2003, Gaiam issued 13,132 shares of Class A common stock upon exercise of options granted under Gaiam’s 1999 Long-Term Incentive Plan.

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4.                                       Earnings per Share

Basic earnings per share exclude any dilutive effects of options and dilutive securities.  Basic earnings per share is computed using the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed using the weighted average number of common and common stock equivalent shares outstanding during the period.  Common equivalent shares are excluded from the computation if their effect is antidilutive.  All earnings per share amounts for all periods have been presented and conform to the Statement No. 128 requirements.

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

5.                                       Stock Based Compensation

As required by Statement of Financial Accounting Standards (“SFAS”) Nos. 123 and 148, we have determined pro forma net income and net income per common share as if compensation costs had been determined based on the fair value of the options granted and then recognized ratably over the vesting period. The fair value of stock option grants has been estimated at the date of grant using the Black-Scholes option pricing model.  Had compensation cost for Gaiam’s stock-based compensation plan been determined under the fair value methodology for determining compensation cost under SFAS No. 123, Gaiam’s net income (loss) and income (loss) per share would have been as follows:

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6.                                       Segment Information

Gaiam manages its business and aggregates its operational and financial information in accordance with two reportable segments.  The Direct to Consumer segment contains the Catalog and Internet sales channels, while the Business to Business segment comprises the Retailers, Media and Corporate Account sales channels.

Although Gaiam is able to track revenues by sales channel, the management, allocation of resources and analysis and reporting of 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’s business segments was as follows:

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Item 2.                                                           Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Three months ended June 30, 2003 compared to three months ended June 30, 2002

Revenues of $20.4 million for the three months ended June 30, 2003 declined 15% from $24.1 million for the three months ended June 30, 2002.  Gaiam’s decrease in revenues was primarily due to lower sales in our retailer channel, where we experienced a weakness in our sales to department stores, distributors and mall-based specialty stores.

Gross profit, which consists of revenues less cost of sales (primarily merchandise acquisition costs and in-bound freight), decreased to $10.8 million for the second quarter of 2003 from $14.2 million during the same period in 2002.  As a percentage of revenue, gross profit declined to 53.1% in 2003 from 58.9% in 2002.  This was primarily attributable to increased sales contribution from our lower margin divisions, and from margin contraction in our retailer channel due to a product shift to accessories.

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In response to the current economic environment and Gaiam’s revenue decrease, Gaiam has undertaken new sales initiatives, new product development, and expense reduction measures. Gaiam has doubled its sales force, added new product categories for distribution to retailers, consolidated its operations into its Colorado headquarters, restructured its management organization and reduced its labor costs, and is in the process of consolidating its distribution operations into one centralized facility.  As part of Gaiam’s restructuring, Janet Mathews, Vice President of Business Development, resumed her previous role as CFO.  In addition, Ms. Mathews and Eva Williams, Gaiam’s Vice President of Sales, were promoted to executive officers effective July 1, 2003. Eva Williams joined Gaiam in the fourth quarter of 2002 after a long career as head of sales for U.S. Leasing, and more recently as CEO of Red Zeppelin, a visual media company.  Cost savings initiatives, after deducting the increased sales force costs, are anticipated to be approximately $2.5 to $3.5 million annually.  The benefit of this expense reduction is expected to commence in the third quarter of 2003, and be fully realized by January 2004.

Selling and operating expenses (which consist primarily of sales and marketing costs, commission and fulfillment expenses) decreased to $9.5 million for the three months ended June 30, 2003 as compared to $10.4 million in the same period of 2002, primarily resulting from cost reductions gained through the consolidation of certain operations into the Colorado headquarters and other cost reduction measures.  As a percentage of revenues, selling and operating expenses increased to 46.8% in 2003 from 43.4% in 2002 due to the lower sales base.

Corporate, general and administrative expenses increased to $2.3 million during the second quarter of 2003, from $2.1 million during 2002, primarily due to increases resulting from the consolidation of acquisitions and severance costs associated with its cost reduction initiatives.

Operating loss, as a result of the factors described above, was $989,296 for the three months ended June 30, 2003 compared to an operating profit of $1,677,188 for the three months ended June 30, 2002 primarily due to lower sales and gross profit.

Gaiam recorded $79,150 in other expense for the three months ended June 30, 2003 compared to $108,903 recorded in the prior year period. The share of net income associated with minority interest was $96,228 during the second quarter of 2003, compared to $8,135 during the second quarter of 2002.  Minority interest changed year-over-year primarily due to Gaiam’s purchase of a majority interest in Leisure Systems International, a distributor of wellness products based in the U.K, during the first quarter of 2003.

Gaiam recorded an income tax benefit of $405,491 for the three months ended June 30, 2003 compared to an income tax provision of $556,741 for the three months ended June 30, 2002.

Gaiam’s net loss was $759,183 for the three month ended June 30, 2003 as a result of the factors described above compared to net income of $1,003,409 recorded for the three months ended June 30, 2002.

Six months ended June 30, 2003 compared to six months ended June 30, 2002

Revenues decreased to $43.7 million for the six months ended June 30, 2003 from $48.4 million during the six months ended June 30, 2002, primarily due to an economic slowdown in the U.S. retail sector, which resulted in a decrease in sales primarily in Gaiam’s business-to-business segment.  Additionally, Gaiam’s business-to-business segment was adversely impacted by mergers involving its customers, which resulted in a contraction in orders placed.

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Gross profit decreased to $23.4 million for the six months ended June 30, 2003 from $28.5 million during the same period in 2002.  As a percentage of revenue, gross profit declined to 53.6% in 2003 from 58.8% in 2002.  This was primarily attributable to narrowing margins from the business-to-business channel, and a change in sales mix associated with Gaiam’s acquisition activity.

Selling and operating expenses decreased to $20.1 million for the six months ended June 30, 2003 from $21.0 million for the same period in 2002, resulting from planned cost reduction measures, net of severance costs.  As a percentage of revenues, selling and operating expenses increased to 46.0% in 2003 from 43.5% in 2002, primarily due to the reduction in the sales base.

Corporate, general and administrative expenses increased to $4.7 million for the six months ended June 30, 2003, compared to $4.6 million for the corresponding period in 2002.  As a percentage of revenues, general and administrative expenses increased to 10.8% in 2003 from 9.4% in 2002.

Operating loss, as a result of the factors described above, was $1.4 million for the six months ended June 30, 2003 as compared to operating income of $2.9 million for the same period in 2002.

Gaiam recorded $149,933 in other expense during the six months ended June 30, 2003, compared to $139,461 for the comparable period in 2002.  For the six months ended June 30, 2003, minority interest income of $176,506 was recorded as compared to $10,797 for the comparable period in 2002.  Minority interest income increased year-over-year due to Gaiam’s purchase of a majority interest in Leisure Systems International, a distributor of wellness products based in the U.K., during the first quarter of 2003.

Gaiam recorded an income tax benefit of $604,048 for the six months ended June 30, 2003, as compared to an income tax provision of $963,095 in the same period 2002.

Net loss, as a result of the factors described above, was $1,111,732 for the six months ended June 30, 2003 as compared to net income of $1,739,050 for the same period in 2002.

Liquidity and Capital Resources

Gaiam’s capital needs arise from working capital required to fund our operations, capital expenditures related to expansions and improvements to Gaiam’s infrastructure and e-commerce capabilities, capital transactions including stock repurchases, and funds required in connection with the acquisitions of new businesses and Gaiam’s anticipated future growth.  These capital requirements depend on numerous factors, including the rate of market acceptance of Gaiam’s product offerings, the ability to expand Gaiam’s customer base, the cost of ongoing upgrades to Gaiam’s product offerings, the level of expenditures for sales and marketing, the level of investment in distribution and other factors.  The timing and amount of these capital requirements cannot accurately be predicted.  Additionally, Gaiam will continue to evaluate possible investments in businesses, products and technologies, and plans to expand sales and marketing programs and conduct more aggressive brand promotions.

Gaiam’s operating activities provided net cash of $1.5 million for the six months ended June 30, 2003 compared to cash usage of $4.6 million for the six months ended June 30, 2002.  Gaiam’s net cash provided by operating activities in 2003 was primarily due to a significant reduction in accounts receivable.  Gaiam’s net cash used by operating activities in the first six months of 2002 was primarily due to a payment of income taxes for the prior year and an increase in accounts receivable.

Gaiam’s investing and acquisition activities used cash of $4,542,483 and provided cash of $1,559,732 for the six months ended June 30, 2003 and 2002, respectively.  In January 2003, Gaiam

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acquired a 50.1% interest in Leisure Systems International, a distributor of wellness products based in the U.K.  Total consideration for the acquisition was approximately $4,300,000 in cash and 50,000 shares of Gaiam Class A common stock.  Cash provided by investing activities during 2002 arose primarily from the sale of the Gaiam Yoga Center during the second quarter.

Gaiam’s financing activities used cash of $49,068 and provided cash of $55,294 for the six months ended June 30, 2003 and 2002, respectively.

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

In the normal course of our business, we investigate, evaluate and discuss acquisition, joint venture, minority investment, strategic relationship and other business combination opportunities in the LOHAS (Lifestyles of Health and Sustainability) market.  In the event of any future investment, acquisition or joint venture opportunities, we may consider using then-available liquidity, issuing equity securities or incurring additional indebtedness.

Critical Accounting Policies

We have not had any significant change in our critical accounting policies from the previously reported 10K.

Item 3.                                                           Quantitative and Qualitative Disclosures About Market Risk

We do not believe that any of our financial instruments have significant risk associated with market sensitivity.  We are not exposed to material financial market risks from changes in foreign exchange rates and are only minimally impacted by changes in interest rates.

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

Item 4.                                                           Controls and Procedures

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

PART II.                                                OTHER INFORMATION

Item 1.                                                           Legal Proceedings

No legal proceedings became reportable during the second quarter of 2003 and there were no material developments in any previously reported legal proceedings.

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Item 2.                                                           Changes in Securities and Use of Proceeds

None.

Item 3.                                                           Defaults Upon Senior Securities

None.

Item 4.                                                           Submission of Matters to a Vote of Security Holders.

On May 23, 2003, Gaiam held its Annual Meeting of Shareholders.  The shareholders elected six directors of Gaiam to serve until the next annual meeting of shareholders to be held in 2004 or until their successors are duly elected and qualified.  The results of this vote follow:

Item 5.                                                           Other Information.

None.

Item 6.                                                           Exhibits and Reports on Form 8-K.

a)                                      Exhibits

b)                                     Reports on Form 8-K.

On July 29, 2003, Gaiam filed a report on Form 8-K relating to its earnings press release for second quarter 2003.

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Signatures

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

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