GAIA, INC - Quarter Report: 2011 September (Form 10-Q)

Table of Contents

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2011

OR

Commission File Number 0-27517

GAIAM, INC.

(Exact name of registrant as specified in its charter)

833 WEST SOUTH BOULDER ROAD,

LOUISVILLE, COLORADO 80027

(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  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

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

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

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

Table of Contents

GAIAM, INC.

FORM 10-Q

INDEX

2

Table of Contents

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report may contain forward-looking statements that involve risks and uncertainties. The words “anticipate,” “believe,” “plan,” “estimate,” “expect,” “strive,” “future,” “intend” and similar expressions are intended to identify such forward-looking statements. Our 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,” “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in this report. Risks and uncertainties that could cause actual results to differ include, without limitation, general economic conditions, competition, loss of key personnel, pricing, brand reputation, consumer trends, acquisitions, new initiatives undertaken by us, security and information systems, legal liability for website content, merchandise supply problems, failure of third parties to provide adequate service, our reliance on centralized customer service, overstocks and merchandise returns, our reliance on a centralized fulfillment center, increases in postage and shipping costs, E-commerce trends, future Internet related taxes, our founder’s control of us, fluctuations in quarterly operating results, customer interest in our products, the effect of government regulation and other risks and uncertainties included in our 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 view only as of the date of this report. We undertake no obligation to update any forward-looking information.

PART I. FINANCIAL INFORMATION

Unaudited Interim Condensed Consolidated Financial Statements

We have prepared our unaudited interim condensed consolidated financial statements included herein pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to these rules and regulations, although we believe that the disclosures made are adequate to make the information not misleading. In our opinion, the unaudited interim condensed financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly, in all material respects, our consolidated financial position as of September 30, 2011, the interim results of operations for the three and nine months ended September 30, 2011 and 2010, and cash flows for the nine months ended September 30, 2011 and 2010. These interim statements have not been audited. The balance sheet as of December 31, 2010 was derived from our audited consolidated financial statements included in our annual report on Form 10-K. The interim condensed consolidated financial statements contained herein should be read in conjunction with our audited financial statements, including the notes thereto, for the year ended December 31, 2010. The unaudited condensed 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.

3

Table of Contents

GAIAM, INC.

Condensed consolidated balance sheets

See accompanying notes to the interim condensed consolidated financial statements.

4

Table of Contents

GAIAM, INC.

Condensed consolidated statements of operations

See accompanying notes to the interim condensed consolidated financial statements.

5

Table of Contents

GAIAM, INC.

Condensed consolidated statements of cash flows

See accompanying notes to the interim condensed consolidated financial statements

6

Table of Contents

Notes to interim condensed consolidated financial statements

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

References in this report to “we”, “us”, “our” or “Gaiam” refer to Gaiam, Inc. and its consolidated subsidiaries, unless we indicate otherwise. We are a lifestyle media company providing a broad selection of information, media, products and services to customers who value personal development, wellness, ecological lifestyles, responsible media and conscious community. We were incorporated under the laws of the State of Colorado on July 7, 1988.

Our consolidated financial statements include Real Goods Solar, Inc. (“Real Goods Solar”), our 55.7% owned publicly-traded solar business (NASDAQ: RSOL), that offers residential and small commercial solar energy integration services.

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States, or GAAP, and they include our accounts and those of our subsidiaries. Intercompany transactions and balances have been eliminated.

2. Significant Accounting Policies

Use of Estimates and Reclassifications

The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the amounts reported in the accompanying financial statements and disclosures. Although we base these estimates on our best knowledge of current events and actions that we may undertake in the future, actual results may be different from the estimates. We have made certain reclassifications to prior period amounts to conform to the current period presentations.

We have evaluated events subsequent to September 30, 2011 and concluded that no material event has occurred that would impact either the results reflected in this report or our results going forward.

No changes were made to our significant accounting policies during the three and nine months ended September 30, 2011, except for the following:

Cash

Cash represents demand deposit accounts with financial institutions that are denominated in U.S. dollars and foreign currencies. At each balance sheet date, cash on hand that is denominated in a foreign currency is adjusted to reflect the exchange rate that exists at the balance sheet date. The difference is reported as a gain or loss in our statement of operations each period. Historically, such gains or losses have been immaterial.

Restricted Cash

Restricted cash represents amounts reserved under our solar segment’s outstanding surety bonds.

Revenue Recognition

As a result of a recent business acquisition (see Note 3. Mergers and Acquisitions), we are slightly modifying our method of applying revenue recognition for fixed price contracts in that we will recognize revenue from energy system installations of less than 100 kilowatts when the installation is substantially complete and recognize revenue from energy installations greater than 100 kilowatts on a percentage-of-completion basis. The rest of our revenue recognition policy remains the same. This change in accounting principle was applied retrospectively, and did not have and is not expected to have in the future a material impact on our financial results.

Goodwill and Other Intangibles

Goodwill represents the excess of the purchase consideration over the estimated fair value of assets acquired less liabilities assumed in a business acquisition. Our other intangibles mainly consist of customer and marketing related assets. We review goodwill for impairment annually or more frequently if impairment indicators arise on a reporting unit level. We compare the estimated fair value of a reporting unit with its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, we consider the goodwill of the reporting unit not impaired. If the carrying amount of a reporting unit exceeds its estimated fair value, we perform the goodwill impairment test to measure the amount of impairment loss. We use either a comparable market approach, traditional present value method, or multiple of revenue or earnings approach to test for potential impairment. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis. Application of alternative assumptions and definitions could yield significantly different results.

As required by US GAAP, we tested our goodwill and other intangibles for potential impairment at the end of the quarter due to recent economic conditions and stock price volatility. We concluded that none of our goodwill or other intangibles were impaired as of September 30, 2011. The estimated fair value of our business goodwill reporting unit was 3% greater than its carrying value, including $22.4 million of goodwill. For the testing of the business goodwill reporting unit, we utilized a traditional discounted future cash flows

7

Table of Contents

model that employed certain key assumptions, including a discount factor, a terminal value, revenue growth projections, gross profit margins, and required working capital estimates, all of which were determined based on historical and projected market data and management’s judgment. A change in any one of the utilized assumptions could have yielded a different measurement of the estimated fair value for our business goodwill reporting unit.

3. Mergers and Acquisitions

Real Goods Solar (our 55.7% owned solar subsidiary)

Our subsidiary, Real Goods Solar, obtained financial control, through an Agreement and Plan of Merger, of 100% of the voting equity interests of Earth Friendly Energy Group Holdings, LLC d/b/a Alteris Renewables, Inc. (“Alteris”) on June 21, 2011 (the “acquisition date”). Alteris sells, designs, installs, and supports renewable energy systems, primarily solar, for both residential and commercial customers. Alteris has more than a dozen offices across seven states.

Real Goods Solar’s board of directors and the manager of Alteris each approved the Alteris transaction as of the acquisition date. On September 13, 2011, Real Goods Solar distributed an information statement to its shareholders with respect to our execution, as the holder of the majority of Real Goods Solar’s equity, of a written consent approving the Alteris transaction, and the transaction is expected to close in November 2011.

The total consideration to be transferred is approximately $21.7 million and will be comprised of 8.7 million shares, or $21.6 million worth based on Real Goods Solar’s Class A common stock closing market price of $2.48 per share on June 21, 2011, and $0.1 million worth of Real Goods Solar replacement share-based awards attributable to services rendered prior to the acquisition date. Of this amount, 0.7 million shares will be issued based on Alteris’ completion of a financing arrangement for commercial installation jobs, which we estimated, as of the acquisition date, would be completed. The consideration excludes $0.4 million and $2.4 million of costs that are reported as subsidiary’s acquisition-related costs in our condensed consolidated statements of operations for the three and nine months ended September 30, 2011, respectively. In addition, the transaction had remaining contingent equity consideration of 2.0 million shares of Real Goods Solar’s Class A common stock, which was contingent upon Alteris’ achievement of certain pre-tax income and cash flow performance targets for 2011, which Alteris’ shareholders and Real Goods Solar have agreed will not be earned. The fair value of the contingently issuable consideration shares was based on the closing price of Real Goods Solar’s Class A common stock on the acquisition date.

Real Goods Solar acquired Alteris, with its premier commercial customer experience, array of financing solutions, and strong in-house engineering expertise, to create a leading renewable energy provider with a strong presence on both coasts. Real Goods Solar plans to capitalize on Alteris’ east coast presence and realize synergies from this acquisition by leveraging its existing infrastructure as well as by taking advantage of Alteris’ expertise with commercial installations. These strategic benefits expected to be received were largely responsible for the goodwill resulting from the acquisition.

In connection with its acquisition of Alteris, Real Goods Solar recorded $0.6 million for customer-related intangibles (20 month weighted-average useful life). Goodwill is not expected to be deductible for tax purposes.

The following table summarizes the estimated fair values of Alteris’ net assets acquired at the acquisition date.

8

Table of Contents

We included the results of operations from Alteris in our consolidated financial statements from the acquisition date. Consequentially, $14.4 million and $15.5 million of revenue and $0.5 million and $0.7 million of net loss attributable to Alteris are included in our condensed consolidated statements of operations for the three and nine months ended September 30, 2011, respectively.

The following is supplemental unaudited interim pro forma information for the Alteris acquisition as if Real Goods Solar had issued 8.7 million of its Class A common shares to acquire this business on January 1, 2010. The pro forma net revenue and cost of goods sold were decreased by $1.3 million and $0.9 million, respectively, for the nine months ended September 30, 2011 to reflect Alteris’ adoption of Real Goods Solar’s method, cost to cost, of measuring progress towards completion for jobs accounted for under the percentage of completion method. Additionally, the pro forma net loss was adjusted to exclude $0.4 million and $2.4 million of nonrecurring expenses incurred during the three and nine months ended September 30, 2011, respectively, related to Real Goods Solar’s acquisition of Alteris. Finally, pro forma net income (loss) was adjusted by $0.2 million for the three months ended September 30, 2010 and by $0.1 million and $0.5 million for the nine months ended September 30, 2010 and 2011, respectively, to include amortization of intangible assets and share-based compensation expense related to replacement stock options, both resulting from Real Goods Solar’s acquisition of Alteris. All pro forma adjustments are based on currently available information and upon assumptions that we believe are reasonable in order to reflect, on a supplemental pro forma basis, the impact of this acquisition on our historical financial information.

4. Revolving Line of Credit

Real Goods Solar’s recently consolidated subsidiary, Alteris, has a revolving line of credit agreement which provides for advances not to exceed $7.0 million. All borrowings are collateralized by a security interest in substantially all assets of Alteris and bear interest at the bank’s prime rate plus 1.75% (total interest rate of 5.75% at September 30, 2011). The line of credit facility will mature on November 30, 2011 and prior to such date Real Goods Solar hopes to either amend the agreement or enter into a new line of credit. The line of credit has a facility fee of 0.5% per year of the average daily unused portion of the available line of credit during the applicable calendar quarter. Alteris may reserve up to $500,000 for stand-by letters of credit under the line of credit. As of September 30, 2011, there were no outstanding stand-by letters of credit under this facility.

5. Debt

Most of the following debt and subordinated debt, along with any unpaid accrued interest, have change of control provisions that required Real Goods Solar to pay the debt upon the consummation of its acquisition of Alteris (see Note 3. Mergers and Acquisitions). Real Goods Solar intends to pay the debt remaining after the consummation of the acquisition within the next twelve months and Real Goods Solar will fund such debt payments with a line of credit and/or with cash on hand.

The debt, all of which relates to Alteris, consisted of the following at September 30, 2011:

9

Table of Contents

Maturities of debt for each of the periods ended December 31st are as follows:

The notes are subject to both positive and negative restrictions and covenants, which include maintaining certain debt service and adjusted leverage ratios.

Alteris’ subordinated debt consisted of the following at September 30, 2011:

Accrued interest of $0.5 million related to these subordinated debt agreements is included in accrued liabilities on our condensed consolidated balance sheet at September 30, 2011.

6. Equity

During the nine months ended September 30, 2011, we issued 5,037 of our Class A common shares under our 2009 Long-Term Incentive Plan to our independent directors, in lieu of cash compensation, for services rendered in 2011 and issued 15,200 of our Class A common shares upon exercise of options under our 1999 Long-Term Incentive Plan.

During the third quarter of 2011, we repurchased 518,762 of our Class A common shares for a total cost of $1.9 million. We recorded this repurchase of our shares in accordance with the cost method of accounting for treasury stock. Because we have not decided the ultimate disposition of the re-acquired shares, their cost is reflected in our consolidated balance sheet at September 30, 2011 as a reduction to additional paid-in capital.

The following is a reconciliation from December 31, 2010 to September 30, 2011 of the carrying amount of total equity, equity attributable to Gaiam, Inc., and equity attributable to the noncontrolling interest.

10

Table of Contents

The following schedule reflects the effect of changes in Gaiam, Inc.’s ownership interest in Real Goods on Gaiam, Inc.’s equity.

Real Goods Solar (our 55.7% owned solar subsidiary)

Real Goods Solar, during the nine months ended September 30, 2011, issued 23,464 of its Class A common shares valued at $64 thousand to compensate independent board members for services rendered during 2011.

On June 30, 2011, Real Goods Solar repurchased 379,400 of its Class A common shares in a negotiated transaction for a total cost of $1.1 million. Real Goods Solar recorded this repurchase of its shares in accordance with the cost method of accounting for treasury stock. Real Goods Solar has not yet decided the ultimate disposition of the re-acquired shares.

Following these transactions, we owned 55.7% of Real Goods Solar’s shares and 78.7% of Real Goods Solar’s equity voting rights. Upon consummation of Real Goods Solar’s acquisition of Alteris, we will own approximately 38% of Real Goods Solar’s shares and 64% of Real Goods Solar’s equity voting rights.

11

Table of Contents

Gaiam and Real Goods Solar both valued the shares issued to their respective independent directors at estimated fair value based on the closing price of their respective stock on the date the shares were issued, which by policy is the last trading day of each quarter in which the services were rendered.

7. Comprehensive Income (Loss)

Our comprehensive income (loss), net of related tax effects, was as follows:

8. Share-Based Payments

During the nine months ended September 30, 2011, we granted 272,500 stock options under our 2009 Long-Term Incentive Plan, of which 200,000 were granted to our chief executive officer at an exercise price of $5.31 per share, and cancelled 74,800 stock options previously issued under our 1999 and 2009 Long-Term Incentive Plans. Total share-based compensation expense was $0.4 million for each of the three months ended September 30, 2011 and 2010, and $1.1 million and $1.2 million for the nine months ended September 30, 2011 and 2010, respectively, and is shown in corporate, general and administration expenses on our condensed consolidated statements of operations.

Real Goods Solar (our 55.7% owned solar subsidiary)

Also during the nine months ended September 30, 2011, Real Goods Solar granted 600,000 stock options to its new chief executive officer under the Real Goods Solar 2011 CEO Compensation Plan, and granted 34,000 stock options and cancelled 82,840 stock options under the Real Goods Solar 2008 Long-Term Incentive Plan. The new stock options vest 2% per month over 50 months commencing in the eleventh month following the date of grant. Additionally, during the second quarter of 2011, Real Goods Solar granted 3,000 restricted stock awards to each of its three non-employee board members serving at that time under its 2008 Long-Term Incentive Plan. The awards are restricted in that the awards vest 50% on each of the next two annual anniversaries of the grant date.

As specified under the terms of Real Goods Solar’s acquisition of Alteris (see Note 3. Mergers and Acquisitions), upon consummation of the acquisition, options for Alteris membership units will be replaced with equal-in-fair-value options to purchase Real Goods Solar stock. In this regard, 582,500 replacement options are expected to be granted by Real Goods Solar.

9. Net Income (Loss) Per Share Attributable To Gaiam, Inc. Common Shareholders

Basic net income (loss) per share attributable to Gaiam, Inc. common shareholders excludes any dilutive effects of options. We compute basic net income (loss) per share attributable to Gaiam, Inc. common shareholders using the weighted average number of common shares outstanding during the period. We compute diluted net income (loss) per share attributable to Gaiam, Inc. common shareholders using the weighted average number of common shares and common stock equivalents outstanding during the period. We excluded common stock equivalents of 1,307 and 628,000 for the three months ended September 30, 2011 and 2010, respectively, and 812,000 and 552,000 for the nine months ended September 30, 2011 and 2010, respectively, from the computation of diluted net income (loss) per share attributable to Gaiam, Inc. common shareholders because their effect was antidilutive.

12

Table of Contents

The following table sets forth the computation of basic and diluted net income (loss) per share attributable to Gaiam, Inc. common shareholders:

10. Segment Information

We manage our business and aggregate our operational and financial information in accordance with three reportable segments. The direct to consumer segment contains direct response marketing programs, catalogs, Internet, subscription community and retail store sales channels; the business segment comprises retailers, media and corporate account channels; and the solar segment reflects solar energy businesses.

Although we are able to track revenues by sales channel, the management, allocation of resources, and analysis and reporting of expenses is presented on a combined basis, at the reportable segment level. Contribution margin is defined as net revenue less cost of goods sold and total operating expenses.

Financial information for our segments is as follows:

Our solar segment’s total assets at September 30, 2011 changed materially from December 31, 2010 as a result of its acquisition of Alteris. (See Note 3. Mergers and Acquisitions).

13

Table of Contents

11. Income Taxes

Our income tax benefit for the three and nine months ended September 30, 2011 was reduced for certain nondeductible costs related to Real Goods Solar’s acquisition of Alteris that for tax purposes are capitalized into the basis of the stock investment.

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this document. This section is designed to provide information that will assist in understanding our condensed consolidated financial statements, changes in certain items in those statements from period to period, the primary factors that caused those changes and how certain accounting principles, policies and estimates affect the condensed consolidated financial statements.

Overview and Outlook

We are a lifestyle media company providing a broad selection of information, media, products and services to customers who value personal development, wellness, ecological lifestyles, and responsible media. We offer our customers the ability to make purchasing decisions and find responsible content based on these values by providing quality offerings at a price comparable to mainstream alternatives.

Our media brand is built around our ability to develop and offer media content, products, and lifestyle solutions to consumers in the LOHAS market. We market our media and products through a multi-channel approach including traditional media channels, direct to consumers via the Internet, direct response marketing, subscriptions, digital streaming through Gaiam TV and catalogs, and through national retailers, digital partners and corporate accounts. Our content forms the basis of our proprietary offerings, which then drive demand for parallel product and service offerings. Our operations are vertically integrated from content creation, through product development and sourcing, to customer service and distribution. We market our products and services across three segments: business, direct to consumer, and solar. We distribute the majority of our products in our business and direct to consumer segments from our fulfillment center or drop-ship products directly to customers. We also utilize a third party replication and fulfillment center for media distribution in our business segment.

Our business segment sells directly to retailers, with our products available in approximately 62,000 retail doors in the United States. During the third quarter of 2011, our store within store presentations, which include custom fixtures that we design, were in over 14,000 locations worldwide. In 2008, we launched a media category management role that is part of our long term strategy and a key step in securing shelf space for media. We have now expanded this strategy to approximately 6,000 doors, up from 4,600 at the end of the third quarter of 2010. Towards the end of the third quarter of 2011, we began to ship product under our recently announced role as entertainment media aggregator for a large retailer and we are in discussions with various independent studios to leverage and expand this distribution model to other retailers and digital partners.

In our business segment, during the third quarter we continued to experience events that not only reduced revenues, but also increased expenses. Our sales were reduced by the absence of Borders, who entered into bankruptcy liquidation during the second quarter of 2011. In late July, we ended an ineffective and costly third party fulfillment program and returned to a more favorable direct relationship with the entertainment media department of WalMart.

Through its diverse media reach, the direct to consumer segment provides an opportunity to launch and support new media releases, a sounding board for new product testing, promotional opportunities, a growing subscription base, and customer feedback on us and the LOHAS industry’s focus and future. During the third quarter of 2011, we launched our digital platform, GaiamTV.com, allowing us to further leverage our existing subscriber base and catalog and Internet consumer relationships to grow our digital sales through the delivery of mostly exclusive media content. Also, during the quarter, we launched The Firm Express, our first direct response television program under a repositioned business model designed to maintain brand alignment and grow revenue through our large distribution reach.

Critical Accounting Policies

Goodwill and Other Intangibles

Goodwill represents the excess of the purchase consideration over the estimated fair value of assets acquired less liabilities assumed in a business acquisition. Our other intangibles mainly consist of customer and marketing related assets. We review goodwill for impairment annually or more frequently if impairment indicators arise on a reporting unit level. We compare the estimated fair value of a reporting unit with its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, we consider the goodwill of the reporting unit not impaired. If the carrying amount of a reporting unit exceeds its estimated fair value, we perform the goodwill impairment test to measure the amount of impairment loss. We use either a comparable market

14

Table of Contents

approach, traditional present value method, or multiple of revenue or earnings approach to test for potential impairment. The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis. Application of alternative assumptions and definitions could yield significantly different results.

As required by US GAAP, we tested our goodwill and other intangibles for potential impairment at the end of the quarter due to recent economic conditions and stock price volatility. We concluded that none of our goodwill or other intangibles were impaired as of September 30, 2011. The estimated fair value of our business goodwill reporting unit was 3% greater than its carrying value, including $22.4 million of goodwill. For the testing of the business goodwill reporting unit, we utilized a traditional discounted future cash flows model that employed certain key assumptions, including a discount factor, a terminal value, revenue growth projections, gross profit margins, and required working capital estimates, all of which were determined based on historical and projected market data and management’s judgment. A change in any one of the utilized assumptions could have yielded a different measurement of the estimated fair value for our business goodwill reporting unit.

Results of Operations

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