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Executives

John Mills - Integrated Corporate Relations, Inc., IR

Jirka Rysavy - Chairman and CEO

Vilia Valentine - CFO

Lynn Powers - President

Analysts

Gordon Hodge - Thomas Weisel Partners

Mark Argento - Craig-Hallum Capital

Lloyd Warmsley - Thomas Weisel Partners

Gaiam, Inc. (GAIA) Q3 2007 Earnings Call November 7, 2007 4:30 PM ET

Operator

Welcome and thank you for standing by. At this time all participants are in a listen-only mode. We would like to thank you for joining us for the Third Quarter 2007 Financial Results. (Operator Instructions) Today's conference is being recorded, if you have any objections you may disconnect at this time. Now I will turn the meeting over to Mr. John Mills. Thank you sir, you may begin.

John Mills

Thank you. Good afternoon everyone and welcome to Gaiam's third quarter 2007 Earnings Call. The following constitutes the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Except for historical information contained herein, the matters discussed in this call are forward-looking statements that involve risks and uncertainties, including, but not limited to, general business conditions, integration of acquisitions, the timely development of new businesses, the impact of competition, and other risks detailed from time-to-time in the company's SEC reports.

The company does not undertake any obligation to update forward-looking statements. On the call today representing Gaiam, Mr. Jirka Rysavy, Chairman and CEO; Lynn Powers, President; and Vilia Valentine, CFO.

Now I'd like to turn the call over to the company's Chairman and CEO, Jirka Rysavy.

Jirka Rysavy

Thank you John, and welcome everyone to our third quarter call. And I'm very pleased again it was another very good quarter. Revenue for the quarter ended September 30, 2007 increased 36% to $70.3 million from $51.8 million in the same period of last year. This strong performance reflects internal growth rate of 34%.

Gross margin increased 260 basis points to 65.6% from 63% in the 3Q of 2006, which was on top of a 750 basis point increase from 55.5% in the third quarter of 2005. Operating expenses as a percentage of revenue decreased to 59.7% from 61.0% even this increase in expenses relates to our expanding of community business.

Net income for the third quarter increased 77% to $2.9 million from $1.7 million and with the share buyback we did early this year we have doubled EPS for the quarter to $0.12 from $0.06 in a same quarter of 2006.

Depreciation and amortization for the quarter was $3.3 million. For the nine months Gaiam revenue increased 24% to $181.1 million from $146.7 million and net income tripled to $4.3 million, or $0.17 per share, compared to $1.4 million, or $0.06 per share, for the nine months in 2006.

The record 34% internal growth for the quarter is pointing to the increasing shift in our seasonal revenue flow. We estimate that approximately $6 million to $8 million of revenue were received early as compared to the last year. So I think to normalize the kind of internal growth that it comes for the third and fourth quarters for this year should be probably viewed together.

According to Nielsen's VideoScan, Gaiam's market share in the fitness/wellness DVD category increased to 49% year-to-date from 45% in the same nine months in last year and for the third quarter Gaiam’s market share increased further to 53% up from 46% during the third quarter of last year.

And we have currently 66 titles in the top 100. During the third quarter, which is historically the most demanding period for our cash flow, we have generated $4.1 million in cash from the operations, bringing the year-to-date cash from operations to $20.6 million which is $20 million ahead of $0.6 million generated during the nine months of last year.

During the third quarter, as we announced previously we have acquired Zaadz, LIME Media, and majority ownership in Conscious Enlightenment, to strengthen our community division and create a unified solution for LOHAS.

We are also in later state with several other acquisitions. We continue to invest in our community and subscription costs. The number of paid subscribers is increasing at a pace above our expectations. You can see the better side of our community navigation and Gaia.com or at Gaiam.com at the subscription tab. Beside we'll continue to evolve as we integrate our acquisition, we expect this part of the process to be completed by the end of the year conference call and on the conference call we also start to provide some performance data for the subscriptions. We currently expect that for full year of 2007 over a 40% increase in our earnings per share as compared to 2006. We also expect that earnings per share growth will increase in 2008 as compared to 2007 and it will be closer to 50%, even if this is our plan to continue investing in our community and subscription business.

Gaiam is also entering in a strategic relationship with Care2, a social networking site with 7.5 million members were among other things, Gaiam will become an exclusive provider of paid subscription services and e-commerce for Care2. And they will promote our subscription services and pre-agreed number of newsletters and [other places]. Also as we informed you earlier during the quarter our Board of Directors authorized a share repurchase program up to 5 million shares of our common stock and also filing of shelf registration statement for the amount of shares. As we said shareholders of some of these potential acquisition they request Gaiam shares as the acquisition consideration where we obviously prefer to use cash on hand. We intent to file the shelf shortly.

The repurchase program will give us flexibility to deal with this all the situations as they appear and we can accommodate the tax rate. So now Vilia will give you some details on our numbers and then Lynn will give you the business overview. So Vilia.

Vilia Valentine

Thank you Jirka. We are pleased to report successful results for the third quarter including double-digit revenue growth, improved operating leverage and positive operating cash even after seasonal outlays for inventory and preparation for the upcoming holiday season.

We generated revenues of $70.3 million in the third quarter of 2007,a net increase of 35.8% from $55.8 million in the third quarter of last year. Revenues produced by the direct-to-consumer segment of $40.2 million reflect the strong performance by our e-commerce and community divisions.

Revenues from our business segment of $30.1 million reflect our success in the international markets, particularly in Japan. For the third quarter, we experienced solid growth in our overall gross margins, of 260 basis points from the same quarter in 2006. As a percentage of revenue, selling and operating expenses were consistent at 53.9% of third quarter of 2007 compared to 54% during the quarter ended September 30, 2006.

Our corporate, general and administration expenses decreased to 5.8% of revenue for the third quarter of 2007, compared to 7.1% in the same period last year, reflecting improved leverage of our corporate resources across all divisions. Our improved operations resulted in significant increase to consolidated net income for the third quarter.

Net income increased 76.5% to $2.9 million compared to $1.7 million in the same period last year. Our earnings per share doubled to $0.12 per share for the quarter from $0.06 per share in the third quarter 2006. The decrease in other income reflects less interest earned on our lower average cash balances as a result of our stock repurchase in the first quarter of 2007 and acquisitions.

Year-to-date revenues of $181.1 million were up 23.5% from $146.7 million for the same nine month period in 2006. Overall gross margin remains solid at over 64%. The improved performance that we have experienced during the first three quarters of 2007 have contributed to a net income for the year of $4.3 million compared to $1.4 million for the same nine month period in 2006.

Earnings per share for the first nine months of the year were $0.17 per share compared to $0.06 per share for the same nine months in 2006. We generated $4.1 million of cash from operations in the third quarter compared to $3.6 million in the third quarter of 2006.Strong international revenue performance contributed to the quarter-over-quarter improvement in operating cash flow.

Our cash balance of $81.6 million remained strong at the end of the third quarter even after the repurchase of 2.5 million shares of the Gaiam stock for $32.9 million and $10.8 million paid year-to-date for acquisitions. We ended the quarter with 24.8 million shares of common stock outstanding, $192.7 million in shareholder's equity and no debt.

Our day sales outstanding for the third quarter of 2007 improved to 13.8 days compared to 26.1 days in the same period of 2006, reflecting the growth in the direct-to-consumer segment and increase in our national sales.

Inventory turns for the third quarter of 2007 increased to 3.7 times from 3.3 times in the prior year quarter. On hand inventory reflects incremental purchases for the launch of several new software programs in our direct segment for holidays as well the safety stock position taken during the quarter to protect against the potential port strike in India where many of our soft good suppliers are located.

Deprecation and amortization was $3.3 million and our capital expenditures totaled $1.2 million for the third quarter of 2007. During the quarter we continued many ongoing capital driven projects and initiated several new ones.

These ongoing projects include the upgrade of our web platform to take advantage of new customer navigation technology and upgrade of our direct-to-consumer order management system and hardware purchases to support our new online community infrastructure. As a company, we continue to investment on infrastructure as we build the vital step towards ensuring that we [build] a solid foundation for future growth.

Now, I would like to turn the call over to Lynn for the business overview. Lynn?

Lynn Powers

Thanks, Vilia. I will now review our third quarter results by operating segment and outline our strategy for the reminder of 2007 and 2008. Our third quarter was highlighted by a 34% overall internal growth rate, a 77% increase in net income quarter-over-quarter, and the successful execution of our acquisition growth strategy that is further positioning Gaiam as the leader in LOHAS.

The business segment, which primarily produces and distributes to media and other proprietary media based products to retailers generated growth of $10.9 million or 57% and revenues of $30.1 million for the third quarter of 2007 compared to $19.2 million for the same period in the prior year. The increase in revenues was bolstered by continued success of our direct response programs in international markets, particularly in Japan as well as solid growth in certain key accounts including Target. We continue to expand our media and media based product distribution and are currently an approximately 70,000 retail doors in the US, up from 65,000 in the third quarter of 2006.

Our broad distribution of media in the US retail market is the largest penetration of any visual media company and continues to be a key factor in our growth strategy. Our expertise on authentic media content continues to anchor our position in the market. At the end of September, according to Nielsen's VideoScan, Gaiam ranked fifth in overall US non-theatrical DVD sales, ahead of Twentieth Century Fox, Universal and Sony.

Our market share for the fitness/wellness category increased to 49% at the end of September compared to 45% for the same nine months period in 2006. For the quarter, which ended September 30, 2007, our market share increased to 53%, compared to 46% for the third quarter of '06.

At the end of September, we had six of the top 10 best selling fitness DVDs, year-to-date and 66 of the top 100 titles. We lead the fitness/wellness category with over four times, greater market share than our nearest competitor.

As a testament to our commitment to authentic high quality programming and production we were awarded an additional four Aegis awards bringing the total overall Aegis awards to [66] to complement our 71 Telly awards. Our stores-in-store concept remains a strong part of our strategy in retail, by showcasing Gaiam products in a branded lifestyle presentation, including fixtures and signage.

Since 2000, we have grown this concept to approximately 6,500 doors up from 5,500, in third quarter of 2006 and expect to further expand this concept as we launch wellness. After the launch of wellness in the first half of 2008, we will have three complete and distinct stores-in-store concepts to offer retailers including Gaiam's fitness, Gaiam's wellness and The FIRM.

Additionally with the upcoming launch of wellness we intend to broaden our reach within the doors we already occupy and secure space in non-traditional retail. We expect our last year's acquisition of Newmark Media a natural grocery and pharmacy store racker will enhance our ability to leverage wellness in channels that do not currently carry our product.

Our upcoming wellness initiative has received a very positive response from many of our customers. We believe that the best opportunity for early success with wellness lies within the natural grocery, pharmacy and book channels, each of which reach the target customers demographic best suited to this initiative. As a concept of healthy living and wellness tips through mainstream media, many of our retail partners and other channels are also expressing strong interest in this genre.

Gaiam is well positioned to be the first to market with a comprehensive stores-in-store wellness concept, which will offer customers a complete shopping experience. This concept will include a series of media productions co-branded with the Mayo Clinic and specifically targeted to help in wellness topics such as [cholesterol], high blood pressure, diabetes and insomnia.

A partnership with the Mayo Clinic will also provide other marketing opportunities such as our plans to market the line to their 700,000 newsletters subscribers. As with our Gaiam in The FIRM branded stores-in-store concept, the wellness initiative will include both media and media based products capable of occupying a branded four foot section, to create a well-rounded buying experience.

In anticipation of the shift away from the fitness category and the Target media department we began to explore other opportunities by working closely with [Target]. This partnership has enabled us to secure an opportunity to category manage, a four foot fitness media [enclave] in the Sporting goods department for a 13 week test beginning January 1st for fitness season. We are extremely encouraged by this initiative because we believe the fitness media category can be closely tied to the other products in the sporting goods department to enhance the stores-in-store concept and achieve overall higher performance. It's a great opportunity to employ a category management model to one of our key accounts. The test will feature both Gaiam and comparative fitness programs, category managed and fully fulfilled exclusively through Gaiam. Our partnership with Target on this new opportunity is the direct result of Gaiam's recognition as the industry leader in fitness media and mind-body health.

We continue to expand our distribution of our children's programs as we have secured seasonal placement of four of our children's titles in Walgreens and over [40] media titles including children's programs and fitness for new moms at (inaudible) and placement in the K-Mart media department for the fourth quarter. Our All About series and animated graphic titles have sold over 1 million copies in the past three years, and we are looking to extend these franchises further to continue to grow our share as the children's non-theatrical market. Our international business continued to drive in the quarter again driven by the success of our direct response products in the Japanese markets. We expect the impact of direct response sales in Japan to diminish moving forward as our market penetration matures. As we move towards 2008 we are focused on building the foundation for sustainable revenue based internationally within key markets. We've identified partners in many of these markets are now in the process of expanding our international infrastructure.

Our direct-to-consumer business segment, which include, results from direct [mail], internet sales, subscriptions and our direct response campaign has seen continued success in particular with web marketing, the latest release of The FIRM and direct response, our [solar] division as well as our eco-travel division. For the quarter the direct segment generated revenue growth of 23.3% on revenue of $40.2 million compared to $32.6 million in the third quarter of 2006. Our latest launch of The FIRM information program has nearly outperformed the most successful FIRM program to-date. We are ready to launch the latest FIRM line into retail channels in time for the holiday season and anticipate it will make an attractive gift purchase.

Our e-commerce business continues to grow at an impressive pace, as revenues from the web grew over 40% from the same quarter of 2006. Web marketing remained a primary growth driver for us in the third quarter. We are continuing to invest in this business as we believe more opportunities exist for optimizing customer shopping and affiliate revenue streams. Our recent strategic partnership with Care2 is an example of the opportunities we see in this channel.

Within direct operation average order size remains strong at $103 for catalog and $93 for e-commerce.

These days green living is getting a lot of exposure in the media, Gaiam has historically been recognized as one of the authentic layers in this industry. We continue to implement corporate initiatives that conform to our [mission] and beliefs. As noted in previous releases we were the first to offer the Go Zero program as a part of our order fulfillment process. We are currently transitioning our retail packaging to innovative eco-conscious packaging. We are also looking to increase the post consumer recycle paper content for a direct mail marketing and we are working with the Forest Stewardship Council to ensure that the non-recycle paper product we use for the catalog business has their stamp of approval.

We are seeing an emerging force in the consumer market for products and lifestyle choices that are designed to reduce the carbon footprint. As you are aware Al Gore recently celebrated a Nobel Prize for his involvement with an Inconvenient Truth. John Schaeffer, our President of our Real Goods Division, was recently awarded the 2007 Green Power Pioneer Award from the Center for Resource Solutions for helping bring renewable energy products to a much wider mainstream market. Real Goods sold the first PV solar panel in the US at retail in 1978.

For the past 30 years John has continued to sell solar and renewable energy supplies for the now Gaiam Real Goods. So we continue to capitalize on this new green movement, we will be expanding our green living products selection in our direct channel, initiating a retail line of green living products, launching a new subscription model called Earth Cinema Circle and looking for additional acquisitions and expansion for our Real Goods solar business.

Our recent acquisitions of Zaadz and Conscious Enlightenment are helping to lay the foundation for a network of community websites based on subscribers, whose value closely follow the Gaiam brand and mission. We are in data testing on our new gaia.com online community. As we head into the holiday and fitness seasons we continue to be very excited about the opportunities that lay ahead.

With the widest DVD distribution in the US of any visual media company, a growing international market, the launch of wellness and new channels of distribution our solar and green living expansion and our strong base of direct buyers for a new subscription model, we look forward to an exciting and opportunistic 2008. I would now like to open the call up for questions. Jimmy?

Question-and-Answer Session

Operator

(Operator Instructions). First question today comes from Gordon Hodge with Thomas Weisel Partners. Thank you, sir, your line is open.

Gordon Hodge - Thomas Weisel Partners

Yeah, good afternoon. Just a couple of questions: I know you would – mentioned you were going to give some metrics on the subscription business later and I guess next quarter, but I was curious if you could just give us the number of subscribers that you have as you have also given in the past and then also it sounds like you have some orders for The FIRM for holiday? I'm just curious: how many doors do you expect that to go into and --- were those orders fourth quarter orders and would not to get the business is going to be pretty strong in the fourth quarter as well? Thanks

Lynn Powers

Gordan, this is Lynn. I'll talk a little bit about: The FIRM. First of all: there are two different programs that go along with The FIRM. One is our stores-in-store concept, which currently above a 1,000 doors and the other is individual product more or less you have seen on TV type product that we launch periodically out to retail. That we will see in fourth quarter, but the stores-in-store we've been pretty outsourcing throughout the year primarily in third quarter index.

Jirka Rysavy

And for the subscribers, we don't do it quarterly, so we will not do it. But it does increase at an accelerating pace.

Gordon Hodge - Thomas Weisel Partners

Perfect. Thanks.

Operator

Next question comes from Mark Argento with Craig-Hallum Captial. Thank you, your line is open.

Mark Argento - Craig-Hallum Capital

Hi, Lynn, hi, Jirka. Question for just going off of the focusing on the subscriber model a little bit more, assuming that you are going to give us an update next quarter in terms of metrics, I would assume that means that you are actively marketing their products and are up on your new gaia.com site. But could you talk a little bit about how you're going to reach out to your customer base is it going to be predominantly e-commerce, e-mail, what different types of way that you are going to reach out to be able to try to draw people under these subscriptions?

Jirka Rysavy

Well, right now, we still pretty limit this to up sell to our existing customers and they will pretty much continue to probably next first quarter. Whenever we launch the site, which is will be the kind of we tick it out of a data incorporate and all these other acquisitions and so this site will get more robust and that time we will start to generally market it. So I think in the next call, we wouldn't really do any marketing to speak of yet, except internal.

Mark Argento - Craig-Hallum Capital

So, have you actually gone into your kind of big flat file of customers that you built up over the years or are you still, it's just kind of more of active customer kind of touch right now you are not really going in and [minding] the data base?

Jirka Rysavy

No, we pretty much up selling is based on customer past histories to the different clubs to different people, which has recently launched a new club called Earth Cinema Circle, which is another DVD kind of environmental and green film club and but it still pretty much mostly up sell to our base. I think our overall cost acquiring new customer converting them is still below $5.

Mark Argento - Craig-Hallum Capital

Okay. And then in terms of the Mayo launch will that be -- is there going to be the soft launch this year yet? Or is it going to be basically beginning in Q1, Q2?

Vilia Valentine

Well we are doing it in two phases, Mark. First we launch the 10 Mayo DVDs, which have a street date of January 1st, kind of New Year New Eve launch. But we'll launch the full four foot wellness section late March, early April so it will be first, second quarter kind of launch on that.

Mark Argento - Craig-Hallum Capital

And what type of commitment did you say you had in terms of the stores-in-store?

Vilia Valentine

I can only tell you the channels that are very interested in it, they are the book channel natural grocery and pharmacy.

Mark Argento - Craig-Hallum Capital

Sure. And then Jirka, a little bit about the kind of the timetable in terms of reinvestment where are you in enough you had to say 50% through kind of the build out of these new businesses, I know this continue build out but where are we in terms of the reinvestment cycle because clearly our big gross margin expansion, you continue to spend to build out some of these other programs can you guess kind of at a high level give us a little bit idea on your thoughts there?

Jirka Rysavy

Yeah, I mean, it's kind of going pretty much at the plan we spend a little bit more because our results were a little more so we took the liberty to spend a little more. And it will probably continue through mid next year as this goes. However, when we kind of launch the sites and have the test done, it will probably start to slowdown. But it will continue for at least the first part of ’08. But we've kind of -- the results getting very, very encouraging so we wanted to make sure that we don't miss anything, leave anything on the table.

Mark Argento - Craig-Hallum Capital

Okay. And then last question. You had mentioned in your prepared remarks that you are potentially further down the path on the acquisition front what type of companies you are looking at, more of the social networking media type companies or you are looking at content companies or any hints you want to give us there?

Jirka Rysavy

Yes, yes, yes.

Mark Argento - Craig-Hallum Capital

Fair enough, better try.

Jirka Rysavy

I meant like all of them.

Mark Argento - Craig-Hallum Capital

Okay.

Jirka Rysavy

It's pretty much what you said it's kind of what we are.

Mark Argento - Craig-Hallum Capital

I should know better. Thank you.

Jirka Rysavy

Thank your.

Operator

Next question comes from [Lloyd Warmsley] from Thomas Weisel Partners. Thank you, your line is open.

Lloyd Warmsley - Thomas Weisel Partners

Yes, thank you. I was wondering if you could just tell us little bit more about the Care2 social networking deal if that is exclusive? And then just taking step back if you could give us your broader view two years out how you see that business developing is it more of an effort to up sell into paid subscriptions versus an advertising model and how you see that? That would be helpful.

Jirka Rysavy

All right. So the Care2 deal is not closed yet so I need to limit my comments on it, but effectively from our point what we really want from the deal is that they would not sell any paid subscription and will promote exclusively ours, and we become the exclusive e-commerce partner that means we provide the e-commerce and paying them a fees, and they generate most of their revenue from selling risk to non-profits and we agree obviously not to do that. We don't do that in our regular business. So this is the kind of the basics, our interest as I said mostly that was to do obviously have a big future promotion for our subscription business. What's the other question?

Lynn Powers

Subscription versus advertising?

Jirka Rysavy

Subscription is definitely our core model. We [require] a couple of companies with some advertising on it and we would plan to do the advertising however to subscribe you have a choice to undo all ads so if you subscriber pin basically disallows all the ads what you see even on the free site. But it's how we intend to do that but nothing will really be down [until] first quarter.

Lloyd Warmsley - Thomas Weisel Partners

Thanks.

Jirka Rysavy

Thank you that subscription revenues will well out perform the advertising as we go forward.

Lloyd Warmsley - Thomas Weisel Partners

That's great. Thank you.

Operator

Excuse me at this time I show no other questions.

Jirka Rysavy

Thank you very much. Thank you everybody for being with us and hopefully you will be with us on one of the next quarter and hopefully we have good news as well. So, thank you very much.

Operator

At this time I conclude today's conference call, I would like to thank you for your participation you may disconnect at this time.

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