Gaiam Q3 2007 Earnings Call Transcript

Nov. 7.07 | About: Gaiam, Inc. (GAIA)

Gaiam, Inc. (NASDAQ:GAIA)

Q3 2007 Earnings Call

November 7, 2007 4:30 pm ET

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

Operator

Welcome and thank you for standing by. At this time all participantsare in a listen-only mode. We would like to thank you for joining us for the ThirdQuarter 2007 Financial Results. (Operator Instructions) Today's conference isbeing recorded, if you have any objections you may disconnect at this time. NowI 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'sthird quarter 2007 Earnings Call. The following constitutes the Safe Harborstatement under the Private Securities Litigation Reform Act of 1995. Exceptfor historical information contained herein, the matters discussed in this callare 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 otherrisks detailed from time-to-time in the company's SEC reports.

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

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

Jirka Rysavy

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

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

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

Depreciation and amortization for the quarter was $3.3million. 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 pointingto the increasing shift in our seasonal revenue flow. We estimate thatapproximately $6 million to $8 million of revenue were received early ascompared to the last year. So I think to normalize the kind of internal growth thatit comes for the third and fourth quarters for this year should be probablyviewed together.

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

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

During the third quarter, as we announced previously we haveacquired 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 ofpaid subscribers is increasing at a pace above our expectations. You can see thebetter side of our community navigation and Gaia.com or at Gaiam.comat the subscription tab. Beside we'll continue to evolve as we integrate ouracquisition, we expect this part of the process to be completed by the end ofthe year conference call and on the conference call we also start to providesome performance data for the subscriptions. We currently expect that for fullyear 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 comparedto 2007 and it will be closer to 50%, even if this is our plan to continueinvesting in our community and subscription business.

Gaiam is also entering in a strategicrelationship with Care2, a social networking site with 7.5 million members wereamong other things, Gaiam will become an exclusive provider of paidsubscription services and e-commerce for Care2. And they will promote our subscriptionservices and pre-agreed number of newsletters and [other places]. Also as we informedyou earlier during the quarter our Board of Directors authorized a sharerepurchase program up to 5 million shares of our common stock and also filingof shelf registration statement for the amount of shares. As we saidshareholders of some of these potential acquisition they request Gaiam sharesas the acquisition consideration where we obviously prefer to use cash on hand.We intent to file the shelf shortly.

The repurchase program will give usflexibility to deal with this all the situations as they appear and we canaccommodate the tax rate. So now Vilia will give you some details on ournumbers and then Lynnwill give you the business overview. So Vilia.

Vilia Valentine

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

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

Revenues from our business segment of $30.1 million reflectour success in the international markets, particularly in Japan. For the third quarter, weexperienced solid growth in our overall gross margins, of 260 basis points fromthe same quarter in 2006. As a percentage of revenue, selling and operatingexpenses 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 decreasedto 5.8% of revenue for the third quarter of 2007, compared to 7.1% in the sameperiod last year, reflecting improved leverage of our corporate resourcesacross all divisions. Our improved operations resulted in significant increaseto consolidated net income for the third quarter.

Net income increased 76.5% to $2.9 million compared to $1.7million in the same period last year. Our earnings per share doubled to $0.12per share for the quarter from $0.06 per share in the third quarter 2006. Thedecrease in other income reflects less interest earned on our lower averagecash balances as a result of our stock repurchase in the first quarter of 2007and 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 marginremains solid at over 64%. The improved performance that we have experienced during the first threequarters of 2007 have contributed to a net income for the year of $4.3 millioncompared 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 comparedto $3.6 million in the third quarter of 2006.Strong international revenueperformance contributed to the quarter-over-quarter improvement in operatingcash flow.

Our cash balance of $81.6 million remained strong at the endof the third quarter even after the repurchase of 2.5 million shares of the Gaiamstock 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 2007improved 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 nationalsales.

Inventory turns for the third quarter of 2007 increased to3.7 times from 3.3 times in the prior year quarter. On hand inventory reflectsincremental purchases for the launch of several new software programs in ourdirect segment for holidays as well the safety stock position taken during thequarter to protect against the potential port strike in India where many of our soft goodsuppliers are located.

Deprecation and amortization was $3.3 million and ourcapital expenditures totaled $1.2 million for the third quarter of 2007. Duringthe quarter we continued many ongoing capital driven projects and initiatedseveral new ones.

These ongoing projects include the upgrade of our webplatform to take advantage of new customer navigation technology and upgrade ofour direct-to-consumer order management system and hardware purchases tosupport our new online community infrastructure. As a company, we continue toinvestment on infrastructure as we build the vital step towards ensuring thatwe [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 resultsby operating segment and outline our strategy for the reminder of 2007 and2008. Our third quarter was highlighted by a 34% overall internal growth rate,a 77% increase in net income quarter-over-quarter, and the successful executionof our acquisition growth strategy that is further positioning Gaiam as theleader in LOHAS.

The business segment, which primarily produces anddistributes to media and other proprietary media based products to retailersgenerated growth of $10.9 million or 57% and revenues of $30.1 million for thethird quarter of 2007 compared to $19.2 million for the same period in theprior year. The increase in revenues was bolstered by continued success of ourdirect response programs in international markets, particularly in Japanas well as solid growth in certain key accounts including Target. We continueto expand our media and media based product distribution and are currently anapproximately 70,000 retail doors in the US, up from 65,000 in the thirdquarter of 2006.

Our broad distribution of media in the US retail market is the largestpenetration of any visual media company and continues to be a key factor in ourgrowth strategy. Our expertise on authentic media content continues to anchorour position in the market. At the end of September, according to Nielsen'sVideoScan, Gaiam ranked fifth in overall US non-theatrical DVD sales, aheadof Twentieth Century Fox, Universal and Sony.

Our market share for the fitness/wellness category increasedto 49% at the end of September compared to 45% for the same nine months periodin 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 bestselling fitness DVDs, year-to-date and 66 of the top 100 titles. We lead the fitness/wellnesscategory with over four times, greater market share than our nearestcompetitor.

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

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

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

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

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

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

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

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

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

Our e-commerce business continues to grow at an impressivepace, as revenues from the web grew over 40% from the same quarter of 2006. Webmarketing remained a primary growth driver for us in the third quarter. We arecontinuing to invest in this business as we believe more opportunities existfor optimizing customer shopping and affiliate revenue streams. Our recentstrategic partnership with Care2 is an example of the opportunities we see inthis 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 themedia, Gaiam has historically been recognized as one of the authentic layers inthis industry. We continue to implement corporate initiatives that conform toour [mission] and beliefs. As noted in previous releases we were the first tooffer the Go Zero program as a part of our order fulfillment process. We are currentlytransitioning our retail packaging to innovative eco-conscious packaging. Weare also looking to increase the post consumer recycle paper content for adirect mail marketing and we are working with the Forest Stewardship Council toensure that the non-recycle paper product we use for the catalog business hastheir stamp of approval.

We are seeing an emerging force in the consumer market forproducts and lifestyle choices that are designed to reduce the carbonfootprint. As you are aware Al Gore recently celebrated a Nobel Prize for hisinvolvement with an Inconvenient Truth. John Schaeffer, our President of ourReal Goods Division, was recently awarded the 2007 Green Power Pioneer Awardfrom the Center for Resource Solutions for helping bring renewable energy productsto a much wider mainstream market. Real Goods sold the first PV solar panel inthe USat retail in 1978.

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

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

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

Question-and-AnswerSession

Operator

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

Gordon Hodge - ThomasWeisel Partners

Yeah, good afternoon. Just a couple of questions: I know youwould – mentioned you were going to give some metrics on the subscriptionbusiness later and I guess next quarter, but I was curious if you could justgive us the number of subscribers that you have as you have also given in thepast and then also it sounds like you have some orders for The FIRM forholiday? 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 isgoing 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 differentprograms that go along with The FIRM. One is our stores-in-store concept, whichcurrently above a 1,000 doors and the other is individual product more or lessyou 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 prettyoutsourcing throughout the year primarily in third quarter index.

Jirka Rysavy

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

Gordon Hodge - ThomasWeisel Partners

Perfect. Thanks.

Operator

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

Mark Argento -Craig-Hallum Capital

Hi, Lynn, hi, Jirka. Question for just going off of thefocusing on the subscriber model a little bit more, assuming that you are goingto give us an update next quarter in terms of metrics, I would assume thatmeans that you are actively marketing their products and are up on your newgaia.com site. But could you talk a little bit about how you're going to reachout 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 tryto draw people under these subscriptions?

Jirka Rysavy

Well, right now, we still pretty limit this to up sell toour existing customers and they will pretty much continue to probably next firstquarter. Whenever we launch the site, which is will be the kind of we tick itout of a data incorporate and all these other acquisitions and so this sitewill get more robust and that time we will start to generally market it. So Ithink 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 fileof customers that you built up over the years or are you still, it's just kindof 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 pasthistories to the different clubs to different people, which has recently launcheda new club called Earth Cinema Circle, which is another DVD kind ofenvironmental and green film club and but it still pretty much mostly up sellto our base. I think our overall cost acquiring new customer converting them isstill 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 bebasically beginning in Q1, Q2?

Vilia Valentine

Well we are doing it in two phases, Mark. First we launchthe 10 Mayo DVDs, which have a street date of January 1st, kind of New Year NewEve 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 ofthe stores-in-store?

Vilia Valentine

I can only tell you the channels that are very interested init, 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 thetimetable 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 continuebuild out but where are we in terms of the reinvestment cycle because clearlyour big gross margin expansion, you continue to spend to build out some of theseother programs can you guess kind of at a high level give us a little bit idea onyour thoughts there?

Jirka Rysavy

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

Mark Argento -Craig-Hallum Capital

Okay. And then last question. You had mentioned in yourprepared remarks that you are potentially further down the path on theacquisition front what type of companies you are looking at, more of the socialnetworking media type companies or you are looking at content companies or anyhints 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 WeiselPartners. Thank you, your line is open.

Lloyd Warmsley -Thomas Weisel Partners

Yes, thank you. I was wondering if you could just tell uslittle 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 yearsout how you see that business developing is it more of an effort to up sell intopaid subscriptions versus an advertising model and how you see that? That wouldbe helpful.

Jirka Rysavy

All right. So the Care2 deal is not closed yet so I need to limitmy comments on it, but effectively from our point what we really want from thedeal is that they would not sell any paid subscription and will promoteexclusively ours, and we become the exclusive e-commerce partner that means weprovide the e-commerce and paying them a fees, and they generate most of theirrevenue 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 futurepromotion for our subscription business. What's the other question?

Lynn Powers

Subscription versus advertising?

Jirka Rysavy

Subscription is definitely our core model. We [require] acouple of companies with some advertising on it and we would plan to do theadvertising however to subscribe you have a choice to undo all ads so if yousubscriber pin basically disallows all the ads what you see even on the freesite. 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 performthe 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 andhopefully you will be with us on one of the next quarter and hopefully we havegood news as well. So, thank you very much.

Operator

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

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