Washington, D.C. 20549

 

Form 10-Q

 

 

Commission File Number 0-27517

 

GAIAM, INC.
(Exact name of registrant as specified in its charter)
COLORADO		84-1113527
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
360 INTERLOCKEN BLVD.,
BROOMFIELD, COLORADO 80021
(Address of principal executive offices)
(303) 222-3600
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to 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.

 

YES     ý     NO     o

 

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

 

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

 

Class		Shares outstanding as of August 2, 2004
Class A Common Stock ($.0001 par value)		9,311,897
Class B Common Stock ($.0001 par value)		5,400,000

 

 

INDEX TO FORM 10-Q

 

PART I. FINANCIAL INFORMATION

 

Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003
	Condensed Consolidated Statements of Operations for the three months ended June 30, 2004, and 2003
	Condensed Consolidated Statements of Operations for the six months ended June 30, 2004, and 2003
	Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2004 and 2003
	Notes to Interim Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

FORWARD-LOOKING STATEMENTS

 

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 Internet related taxes, 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

(In thousands, except share information)

 

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

 

See accompanying notes to the condensed consolidated financial statements.

 

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

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

 

See accompanying notes to the condensed consolidated financial statements.

 

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

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

 

See accompanying notes to the condensed consolidated financial statements.

 

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GAIAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited – In Thousands)

 

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

 

See accompanying notes to the condensed consolidated financial statements.

 

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Gaiam, Inc.

Notes to Interim Condensed Consolidated Financial Statements

(Unaudited)

June 30, 2004

 

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, ecological lifestyles and responsible media.  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 and its subsidiaries in which Gaiam’s ownership is greater than 50% and the subsidiary is considered to be under Gaiam’s control.  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, 2004, the interim results of operations for the three and six months ended June 30, 2004 and 2003, and cash flows for the six months ended June 30, 2004 and 2003.  These interim statements have not been audited.  The balance sheet as of December 31, 2003 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 principles 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, 2003 included in Gaiam’s annual report on Form 10-K.  The consolidated financial statements contained herein should be read in conjunction with Gaiam’s audited financial statements, including the notes thereto, for the year ended December 31, 2003.

 

The consolidated financial position, results of operations and cash flows for the interim periods disclosed in 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.

 

Reclassifications

 

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

 

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Adoption of Accounting Standards

 

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

 

Stock-Based Compensation

 

Gaiam accounts for its stock-based compensation arrangements under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”) and related interpretations, including FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, rather than the alternative fair value accounting allowed by SFAS No. 123, Accounting for Stock Based Compensation.  Accordingly, no compensation expense is recognized in Gaiam’s consolidated financial statements in connection with stock options granted to employees with exercise prices not less than fair value.  Deferred compensation for options granted to employees is determined as the difference between the deemed fair market value of Gaiam’s common stock on the date options were granted and the exercise price.  For purposes of this pro-forma disclosure, the estimated fair value of options is assumed to be amortized to expense over the options’ vesting periods.

 

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

 

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

 

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2.                                       Stockholders’ Equity

 

During the first quarter of 2004, Gaiam issued a total of 11,251 shares of Class A common stock to Gaiam’s independent directors, in lieu of cash compensation, for services rendered in 2003. In addition, for the six months ended June 30, 2004, Gaiam issued 91,970 shares of Class A common stock upon exercise of options granted under Gaiam’s 1999 Long-Term Incentive Plan.

 

3.                                       Comprehensive Income (Loss)

 

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

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Net income (loss)		$	(2,215	)	$	(759	)	$	(2,544	)	$	(1,112	)
Foreign currency translation adjustment, net		(83		)	—			85			—
Comprehensive income (loss), net of taxes		$	(2,298	)	$	(759	)	$	(2,459	)	$	(1,112	)

 

4.                                       Earnings (Loss) per Share

 

Basic earnings (loss) per share excludes any dilutive effects of options, warrants and dilutive securities.  Basic earnings (loss) 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 of diluted earnings per share for the three and six months ended June 30, 2004 and 2003 because their effect is antidilutive.

 

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

 

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

 

5.                                       Segment Information

 

Gaiam manages its business and aggregates its operational and financial information in accordance with two reportable segments.  The direct to consumer segment contains Gaiam’s catalog and Internet sales channels, while the business segment comprises the retailer, media and corporate account channels.

 

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Although Gaiam is able to track revenues by sales channel, 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 (in thousands):

 

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

 

Item 2.                                                           Management’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 and related notes included elsewhere in this document.

 

Overview and Outlook

 

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

 

The direct to consumer segment continues to be an integral part of Gaiam’s outreach and a solid base of business.  This segment accounted for 49%, or approximately $50.5 million, of Gaiam’s revenues during 2003.  During the first six months of 2004, revenues in this segment were $22.4 million, an increase of 5% over 2003, and representing 55% of total revenue.  Through its diverse media reach, the direct to consumer segment provides branding, a sounding board for new product testing, promotional opportunities, consumer education and customer feedback on Gaiam’s and the LOHAS (Lifestyles of Health and Sustainability) industry’s focus and future.

 

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 2003, Gaiam products were available in over 30,000 stores in North America, plus in retailers located in the U.K. and Australia.  Gaiam introduced its “store-within-store” lifestyle presentations, which utilize custom fixtures designed and produced by Gaiam, in late 2000, and the placement of this concept grew to over 3,650 stores by the end of 2003.  In 1998, revenues generated by the business segment were $3.8 million.  In 2002, revenues in this segment, which were generated primarily by sales to mass market retailers, topped $60 million, representing a compound annual growth rate in excess of 100%, but became difficult to sustain without grass roots development.  Gaiam is diversifying its approach to include a grass roots rollout to the community-based retail and specialty markets, along with more outreach to professionals, including yoga and Pilates

 

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

 

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

 

Results of Operations

 

The following table sets forth certain financial data as a percentage of revenues for the periods indicated:

 

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

 

Three months ended June 30, 2004 versus June 30, 2003

 

Revenues of $17 million for the three months ended June 30, 2004 decreased 16.3% from $20.4 million for the three months ended June 30, 2003.  Gaiam’s decrease in revenues was due to a decrease in the business segment of $3.2 million, or 32% for the quarter.  This shortfall resulted from lower sales volumes in the U.S. trade business, and an increase in markdowns and returns associated with the change out of VHS stock for DVDs.  Sales to Target decreased over $1 million as compared to the same period in 2003, as Target sold through its current product array prior to the space expansion and assortment reset to ship starting in August.  Additionally, two of our distributors who service the clubs (Costco, Sam’s) and Wal-Mart generated negative comparative sales of over $1.1 million from 2003, as these retailers move to convert their media inventories from the VHS format.   Direct to consumer segment revenues were $10.3 million for the three months ended June 30, 2004, compared to $10.4 million for the same period in 2003.  In 2004, Gaiam suspended distribution of one of its catalog titles for the Spring/Summer seasons.  This title generated $668 thousand in revenue during the second quarter of 2003, as compared to $30 thousand in the comparable 2004 period, which were generated from the run-out of orders from the holiday mailing.  Internal revenue growth in the Internet and catalog businesses was 18% and 5%, respectively, for the second quarter.

 

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

 

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

 

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

 

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

 

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

 

Gaiam recorded $76 thousand and $17 thousand in other income, primarily from interest income, for the three months ended June 30, 2004 and 2003, respectively.  The share of net losses associated with minority interest was $46 thousand during the second quarter of 2004, compared to the share of net income of $97 thousand for the comparable 2003 period.

 

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

 

As a result of the factors described above, Gaiam’s net loss was $2.2 million for the three months ended June 30, 2004 compared to a net loss of $759 thousand recorded for the three months ended June 30, 2003.  Despite these losses, Gaiam’s cash generated by operations was $1.4 million for the second quarter 2004, compared to a use of cash for the same period in 2003 of $81 thousand, and Gaiam’s cash position increased to $12.6 million at June 30, 2004, from $11.0 million at March 31, 2004.

 

Six months ended June 30, 2004 versus June 30, 2003

 

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

 

Gross profit decreased to $21.2 million for the first six months of 2004 from $23.1 million during the same period in 2003.  As a percentage of revenue, gross profit declined to 52% in 2004 from 53.4% in 2002.  This was primarily attributable a decline of 267 basis points in the business segment gross margin associated with a change in mix from media to accessories and expense incurred with the changeover from VHS to DVD products.  This was partially offset by a favorable change in sales mix from the business segment to the direct to consumer segment, where Gaiam has better overall margins.

 

Selling and operating expenses increased to $21.1 million for the six months ended June 30, 2004 as compared to $20.3 million in the same period of 2003, primarily resulting from increased sales and marketing efforts in our business segment, both domestically and in our U.K. subsidiary, and in our direct to consumer segment to

 

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support the revenue increases described above.  As a percentage of revenues, selling and operating expenses increased to 51.8% in 2004 from 47% in 2003.

 

Corporate, general and administration expenses decreased to $4.1 million for the six months ended June 30, 2004 from $4.4 million in the comparable 2003 period, and decreased to 9.9% of revenues in 2004 from 10.1% of revenues in 2003.  This expense reduction is generally attributable to cost savings generated by the consolidation of administrative services into Gaiam’s Colorado headquarters and the resultant staffing reductions implemented during 2003.

 

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

 

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

 

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

 

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

 

Liquidity and Capital Resources

 

Gaiam’s capital needs arise from working capital required to fund our operations, capital expenditures related to replacements, expansions and improvements to Gaiam’s infrastructure, development of e-commerce, acquisitions of new businesses, and 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 increase its sales and marketing programs and brand promotions as needed.

 

Gaiam has a credit agreement with Wells Fargo, which expires during 2005 and permits borrowings of up to $15 million based upon the collateral value of Gaiam’s accounts receivable, inventory and certain property and equipment.  Borrowings under the credit agreement bear interest at the lower of prime rate less 50 basis points or LIBOR plus 275 basis points.  Borrowings are secured by a pledge of Gaiam’s assets, and the agreement contains various financial covenants, including covenants prohibiting the payment of cash dividends to Gaiam shareholders and requiring compliance with certain financial ratios.  At June 30, 2004, Gaiam had no amounts outstanding under this agreement and complied with all of the financial covenants.

 

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

 

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

 

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

 

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

 

We believe our available cash, cash expected to be generated from operations, and borrowing capabilities on the unused $15 million line of credit should 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 market.  For any future investment, acquisition or joint venture opportunities, we may consider using then-available liquidity, issuing equity securities or incurring additional indebtedness.

 

Contractual Obligations

 

Gaiam has commitments pursuant to lease and debt agreements, but does not have any long-term debt obligations or purchase obligations.  The following table shows our commitments to make future payments under operating and capital leases as of June 30, 2004 (in thousands):

 

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

 

Off-Balance Sheet Arrangements

 

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

 

Critical Accounting Policies

 

Management believes the following to be critical accounting policies whose application have a material impact on Gaiam’s financial presentation and involve a higher degree of complexity, as they require management to make judgments and estimates about matters that are inherently uncertain.

 

Provision for Doubtful Accounts

 

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

 

Inventory

 

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

 

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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 needed to sell through its current stock level of the item.

 

Goodwill

 

Goodwill represents the excess of the purchase consideration over the fair value of assets acquired less liabilities assumed in a business acquisition.  In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is no longer amortized but is reviewed for impairment annually or more frequently if impairment indicators arise, on a reporting unit level.  The fair value of a reporting unit is compared with its carrying amount, including goodwill.  If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired.

 

If the carrying amount of a reporting unit exceeds its fair value, the goodwill impairment test is performed to measure the amount of impairment loss.  Gaiam has allocated goodwill to two reporting units, and uses a market value method for the purposes of testing for potential impairment.  The annual review requires extensive use of financial judgment and estimates.  Application of alternative assumptions and definitions, such as a change in the composition of a reporting unit, could yield significantly different results

 

Investments

 

Investments in entities over which Gaiam does not have the ability to exercise significant influence are accounted for under the cost method. Under the cost method of accounting, investments in private companies are carried at cost and are adjusted only for other-than-temporary declines in fair value. Investments under the cost method are included on the accompanying consolidated balance sheet in “Investments.”

 

Capitalized Production Costs

 

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

 

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

 

Risk Factors

 

We wish to caution you that there are risks and uncertainties that could cause our actual results to be materially different from those indicated by forward-looking statements that we make from time to time in filings with the Securities and Exchange Commission, news releases, proxy statements, annual reports, registration statements and other written communications, as well as oral forward-looking statements made from time to time by representatives of Gaiam.  These risks and uncertainties include, but are not limited to, those listed in Gaiam’s Annual Report on Form 10-K for the year ended December 31, 2003.  These risks and uncertainties and additional risks and uncertainties not presently known to us or that we currently deem immaterial may cause our business, financial condition, operating results and cash flows to be materially adversely affected.  Except for the historical information contained herein, the matters discussed in this analysis 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 factors which are often beyond our control.  Gaiam does not undertake any obligation to update forward-looking statements except as required by law.

 

Item 3.           Quantitative and Qualitative Disclosures About Market Risk

 

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

 

Any borrowings we might make under our bank credit facility would bear interest at the lower of prime rate less 50 basis points or LIBOR plus 275 basis points.  Gaiam does not have any amounts outstanding under its credit line, so any

 

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unfavorable change in interest rates would not have a material impact on Gaiam’s results from operations or cash flows unless Gaiam made borrowings in the future.

 

Gaiam purchases a significant amount of inventory from vendors outside of the U.S. in transactions that are primarily U.S. dollar transactions.  Because the percentage of our international purchases denominated in currencies other than the U.S. dollar is small, any currency risks related to these transactions are immaterial to Gaiam.  A decline in the relative value of the U.S. dollar to other foreign currencies could, however, lead to increased purchasing costs.  In order to mitigate this exposure, Gaiam makes virtually all of its purchase commitments in U.S. dollars.

 

In 2003, Gaiam purchased a 50.1% interest in Leisure Systems International Limited, a U.K. based distributor.  Because Leisure Systems’ revenues are primarily denominated in foreign currencies, this investment exposes Gaiam to accounting risk associated with foreign currency exchange rate fluctuations.  However, we have determined that there was no material market risk exposure to our consolidated financial position, results of operations or cash flows as of June 30, 2004.

 

Item 4.           Controls and Procedures

 

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

 

Gaiam’s chief executive officer and chief financial officer conducted an evaluation of the effectiveness of the design and operation of Gaiam’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.  Based upon their evaluation as of June 30, 2004, they have concluded that those disclosure controls and procedures are effective.

 

There have been no changes in Gaiam’s internal control over financial reporting that have materially affected, or are reasonably likely to affect, Gaiam’s internal control over financial reporting.

 

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

 

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

 

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

 

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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.

 

 

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

 

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