Gaia, Inc. (GAIA) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Gaiam Incorporated Third Quarter 2012 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Monday, November 5, 2012. I would now like to turn the conference over to Mr. Norberto Aja, Investor Relations. Please go ahead.

Thank you, operator, and good afternoon everyone, and thank you for participating in Gaiam’s 2012 Third Quarter Conference Call. Joining me today on the call are Gaiam’s Chairman, Jirka Rysavy; Gaiam’s CEO, Lynn Powers; and Steve Thomas, Gaim’s CFO. Before we get started however, I would like to take a minute to read over the safe harbor language. The following constitutes the safe harbor statement of the Private Securities Litigation Reform Act of 1995. Except for historic information contained herein, the matters discussed in this call are forward-looking statements and involve risks and uncertainties including, but not limited to, general business conditions, integration of acquisitions, the timely development of new business, the impact of competition, and other risks detailed from time-to-time as described in the SEC reports. The Company does not undertake any obligation to update forward-looking statements. With that, I would now like to turn the call over to Gaiam’s Chairman, Jirka Rysavy. Please go ahead.

Thank you, Norberto, and good afternoon, everyone. Revenue for the third quarter which ended September 30 increased 3% to $43 million compared to $41.8 million in the same period over the last year. Revenue for business segment increased about $7.5 million or 38% to $27.1 million, and this internal growth rate of 15.2%. Revenue on our direct-to-consumer segment declined 6.3 million primarily due to our pull back in advertisement spending in our direct response television business because of the challenges of securing airtime at reasonable costs due to Olympics and Presidential campaign. EBITDA for the quarter increased $1.7 million. For 9 months, revenue increased 23% to $135.8 million with an internal growth of 13% and the benefit of acquisition of Vivendi Entertainment. Gross profit rose $17 million or 27% and gross margin improved by 180 basis points to 58.3% while operating expenses decreased 290 basis points. This drove a $4.5 million improvement in operating income, $8.7 million improvement in EBITDA and $19.8 million improvement in operating cash flow. $8.7 million improvement in EBITDA exclude $1.7 million acquisition costs from Vivendi. Gaiam has no dollar investment and virtually no tax basis in our holding of about 10 million shares of Real Goods Solar since Real Goods did the IPO in 2008. Because of Real Goods’ non-cash impairment charges of primarily goodwill and deferred taxes in this third quarter, Gaiam recognition of our lost portion of the loss also reduce our GAAP carrying value to 0, and therefore Gaiam will not be required to flow any future losses through its income statement. Excluding this loss from the equity investment, Gaiam reported about $0.01 a share loss in the quarter compared to a loss of $0.04 in the same quarter in last year. Including the loss from the Gaiam investment in Real Goods, our net loss was about 11.2 or $0.49 per share. Our subscription of United Gaiam TV as anticipated during our last call reached a mark of 5,000 exclusive titles for streaming meaning that you cannot get any of these title at Netflix, Amazon, Prime and whatever else. So marketing spend that have been kept pretty modest during the past few months can increase later this month as planned. Conversion rates from free trial subscription are still well above our expectation and are running about 70%. The $19.8 million improvement in operating cash flow in the first 9 months, this was $19 million on our balance sheet, about offsetting our trade units borrowing for the Vivendi acquisition, which on September 30 was about $20.9 million outstanding against the credit line in the unit. The company continues to expect that Vivendi Entertainment acquisition to contribute approximately $25 million in revenue, representing about $200 million in billing and the equal $25 million of gross profit over the first 12 months after the deal was closed. In summary, we are pleased with our performance year-to-date and our new Hallmark Channel and Henson Company licensees further securing Gaiam position as the second largest non-theatrical distributor in U.S. just behind Warner and with over 60,000 retail doors, our digital platforms and 15,000 store within stores. And with that, I’ll turn it over to Steve who will give you details over the financials. Steve?

Thank you, Jirka. I will spend a few minutes reviewing the final results in greater detail and offering some additional perspective on our performance in the quarter beginning with the income statement. As a reminder, all the comparisons discussed are as if Real Goods Solar was de-consolidated from Gaiam as at the beginning of the prior year. Overall 2012 third quarter net revenue was $43 million compared to $41.7 million in the third quarter of 2011, representing a 3% increase. Net revenue from our business segment which is comprised of sales to retailers increased 38.6% to $27.1 million compared to the year ago period as we continue to drive further growth in our aggregator role with some of the largest U.S. based retailers and showcase one of a kind media content and wellness products both from third parties as well as under the Gaiam brand. And of course, Gaiam Vivendi Entertainment is already playing a vital role in the success of this business by providing us with the growing library of desirable content and digital relationships. As for our direct-to-consumer segment, this segment saw revenue decline by 28.4% or $6.3 million as our direct response TV business experienced the $5.4 million or 50% decline in revenue due to our planned holdback of key programming and content in light of significantly higher cost associated with securing television time during the Summer Olympics and more recently with Presidential and local campaigns monopolizing nearly all affordable airtime. We'll begin support this business with the same quality and quantity of content as we have in the past, and fully expected to return to its historical trends. In addition, we expect a growing contribution from our e-commerce sales due to the recent completion of the redesign of our website as well as an expanding Gaiam TV subscription base given the increased visibility this segment will enjoy now that it has transitioned out of the beta stage. Gross profit was flat at $24.1 million for the third quarter of 2012 and 2011. Gross margin decreased to 56% from 57.6% during the same quarter last year due to sales mix given the decrease in typically higher margin DRTV sales. As I mentioned, and as Lynn will elaborate upon in a moment, we should see improved gross margins as we ramp up our programming and media spend for DRTV next year. Moving down the income statement, total operating expenses decreased in the quarter to $24.2 million from $25.1 million in Q3 of 2011. And as a percentage of revenues operating expenses were $56.4 in the third quarter of 2012 versus 60% during the same period last year. This 360 basis point improvement was despite the fact that we incurred approximately $1 million in non-cash amortization expense during the third quarter of 2012 related to our acquisition of Vivendi Entertainment earlier this year. As Jirka noted earlier, our investments to further develop the subscription business and our digital delivery strategies are now moving to the implementation phase to impact consumer tension and thus increase revenue. Such investments impacted the income statement by approximately $3.8 million over the last 3 quarters. Including $1 million of new amortization expense following Vivendi Entertainment acquisition, depreciation, amortization and stock compensation expenses totaled $2.4 million for the third quarter of 2012 compared to $2 million in the year-ago period. Capital expenditures were $0.7 million and media rights costs were $0.1 million compared to Q3 of 2011 when CapEx was $0.7 million and media rights were $0.3 million. Operating loss for the third quarter of 2012 totaled $0.2 million compared to an operating loss of $1 million during the same quarter of last year. Our core business continues to be healthy, and excluding the losses -- operating losses from our investment in the subscription business, our operating loss for the third quarter of 2012 would have changed to an operating income of $1.1 million, compared to an operating loss of approximately $0.5 million for 2011 excluding the investment in subscription. Including a non-cash equity investment loss of $15.9 million, net loss for the quarter was $11.2 million, compared to a loss of $1.1 million in Q3 of 2011. As a reminder, we converted our Real Goods Solar Class B shares to Class A shares on December 2011, reducing our ownership to approximately 38%. For 2012 comparison reporting purposes, Real Goods Solar results are de-consolidated and shown as an equity investment line in our financials as if Real Goods Solar have been de-consolidated as of the beginning of 2011. Before I move to the balance sheet, I wanted to draw your attention to our year-to-date performance. For the first 9 months of 2012, our revenue rose 23.5%, internal growth was 13%, cash flow from operations increased $19.8 million and EBITDA improved to $5.3 million versus a loss of $3.4 million in the first 9 months of 2011. These results reflect both the positive impact of Vivendi Entertainment acquisition is having, as well as the health of our businesses as a whole. Moving to the balance sheet, we ended the third quarter with $19.1 million in cash versus $14.5 million on December 31 of 2011. This leaves our current ratio at approximately $1.6 million, metric that underscores the health of our balance sheet and our continued ability to fund our current operations, as well as permit investment in value creating initiatives. Inventory turns for the third quarter of 2012 were 2.2x compared to 2.6x in the third quarter of 2011. Regarding our credit facility, at September 30, we had $20.9 million outstanding under the 3 year $35 million asset-based facility. This new facility with PNC Bank provides us with the working capital and financial flexibility to continue pursuing our strategies for increasing shareholder value at very competitive rates. With regard to Gaiam Vivendi Entertainment, we are at or above our expectations at this point with regard to its performance and contribution to our overall business. The last of the financial systems have been migrated and integrated and the business is operating seamlessly with the rest of our trade operations. Before turning the call over to Lynn, I wanted to reiterate that our business fundamentals, including our primary revenue streams remain healthy. We continue to prudently manage our balance sheet. Our investment areas, e-commerce and digital media represent an important growth prospects for us and we will continue to focus on balancing our long-term growth with near-term execution to create the best possible outcome for our shareholders. With that, I'll now turn the call over to Lynn who will provide more detail on the overall status of the industry and our growth initiatives. Lynn?

Thanks, Steve. Reaffirming Jirka’s and Steve's comments, I’m also pleased with our third quarter and year-to-date results, and we remain very confident that our performance in the fourth quarter will drive us to achieve our prior goals in regards to revenue and earnings. As we focus on our top 3 priorities, expanding the Gaiam brand, evolving and increasing our distribution and licensing business, and growing our digital subscription services, I remain optimistic and excited for the months ahead. Let me begin by reviewing our business segment. The segment that continues to perform very well for us with internal revenue growth of over 15% compared to the third quarter of 2011. Year-to-date the business segment has internal growth over 30% with growth including acquisition over 50%. I’m particularly pleased with the results of the integration between Gaiam and Vivendi Entertainment and how we are leveraging the additional sales volume of approximately 20 million units or $200 million in gross revenues and expected annualized net revenue and gross margin of approximately $25 million. There are significant economies of scale and operational efficiencies through reduction of third party distribution cost and the elimination of redundant overhead. Just as important as the financial synergies, our larger scale is affording us a greater ability to win important new content distribution deals, becoming the largest independent distributor of non-theatrical content in the U.S. To that end, I can think no better example than the 2 most recent agreements we secured. The first, the Hallmark Channel provides us with the highly visible and unique content library including new first run movies that we're confidently can leverage across multiple partners and via multiple platforms. The Hallmark brand will resonate well with Gaiam’s core values and core customers. The second agreement is with The Jim Henson Company. If there is one content library for children that we had to choose, this would be it. Whether it's Fraggle Rock or Doozer, the agreement with The Jim Henson Company is something that all of us at Gaiam are very proud and excited about. As I mentioned during our prior call, I am also very pleased with the recent renewal of our licensing agreement with Discovery, which includes all the Discovery Channel brands including TLC, Discovery and Animal Planet. I am also excited about our new agreement, where we distribute the highlights and collective stories of the Olympic games. First for digital purchase and rental on iTunes, Amazon, Xbox, Sony PlayStation, YouTube and Google Play. So as you can see, we're creating value from the integration beyond operational leverage by better positioning ourselves to win new business. These operational efficiencies and new business wins will help offset any top line DVD headwind and become a crucial competitive differentiator that will help further Gaiam Vivendi entertainment remain as the largest independent and the second largest overall media distributor in the U.S. for non-theatrical content in the physical and the digital world. We also continue to expand our media category management role that we started in 2009. We now have about 5,400 doors in the U.S. under management including being one of only 2 independent aggregators for media and the sole aggregator for fitness media in the second largest mass retailer in the U.S. In terms of market share, according to Nielson’s video scan, Gaiam remains at the top of the chart in fitness with 45.2% market share, up from 37.6% last year and double our nearest competitor. Additionally, as of the end of the third quarter, Gaiam Vivendi Entertainment is the #2 distributor in non-theatrical content with 14.1% market share, up from Gaiam’s 6.2% last year, leaving only Warner Studios ahead of us. Gaiam without Vivendi grew to over 8% share. We also have some encouraging news from IHS Screen Digest indicating that after several years of decline, total revenue from home entertainment content is projected to rise 8% in 2012 with the expansion of Blu-ray and digital offsetting DVD decline. With regards to efforts to continue to grow our business segment, we are seeing strong consumer demand across Gaiam branded accessories. Our top 25 retailers are up over 25% in the aggregate year-to-date with some retailers reaching as high as 50%. Sell through also continues to compare well. With regards to our fitness products, we continue to see great success from both our restore line as at-home rehabilitative and restorative accessories as well as with our Gaiam Sol premium yoga line. Our SPRI professional’s line of workout accessories which is already expanded to 500 Sears locations is fast becoming a recognized brand for the male lifestyle enthusiast audience. And just recently launched into the Sports Authority with several new products, including some restorative products designed for men. Our Gaiam restore line continues to do well with 2 of the top SKUs at our largest customer and is among the best performing at other store locations. We also continue to focus much of our efforts in our store within store concept, which is now in place over 15,000 doors. We expect to utilize this strategy across our new categories such as the Gaiam restore wellness and the SPRI brand as well as for our studio partners. Turning now to the direct to consumer segment, we brought down the media spend in our direct response business in order to remain profitable when media costs skyrocketed during the Olympics and the political campaigns. We experienced high media rates as well as being preempted during the quarter, reducing our revenues over $5 million from Q3 2011. We still remain excited about the prospects for direct response once we get through the political and holiday season. We plan to follow up on the success of The Firm Express with new fitness content that will allow for continued growth from this business, including a new line of Richard Simmons content. We are also very excited about continuing our successful award-winning DRTV program featuring Jillian Michaels that will re-launch in early 2013 with new footage to coincide with Jillian’s return to the hit television show, The Biggest Loser. On the e-commerce front, in October, we migrated our website to a more flexible platform and completed the shift towards proprietary branded products and apparel. Gaiam’s online customer will now have a greater assortment and an overall more engaging shopping experience. We expect to expand our offering to include video, interactivity and mobile devices in the coming months. These initiatives should begin to yield results at the fourth quarter of the year as we enter the holiday shopping season. Regarding Gaiam TV, as Jirka mentioned, the business is out of the beta stage and has entered the marketing phase with an increased marketing spend around the holiday. We have a library of 5,000 exclusive for streaming digital titles across fitness, health and wellness and personal development, which together with our in-house capabilities should create compelling content with low incremental cost should make Gaiam TV a very appealing offering to consumers interested in learning more about these areas and bringing the world of fitness, health, wellness and personal development closer to them through their TVs, computers, mobile devices and tablets. As we invest in this business through technology and content, it has a negative impact on operating income including a loss of $1.3 million for the quarter, and $3.8 million year-to-date, compared to a loss of $500,000 and $1 million in Q3, and first 9 months of 2011 respectively. We believe this is an exciting new initiative that will begin to contribute to our financial results as soon as we hit breakeven on the subscriber base by the end of next year. In closing, Q3 was a good quarter. However, our focus remains on the future and on reaching our full potential. We now have the financial resources, infrastructure and right people to make that happen. That’s why I feel so confident about what we are doing and our focus on expanding our product assortment and improving the customer experience at every touch point from a catalog, to our website, to our store within store presentation. We have the ability to develop our Gaiam brand halo across more product lines and channels to be an aggregator that packages and markets content across all distribution channels including digital and non-traditional retail and to leverage the unique proposition of Gaiam TV, so it becomes a key part of how we build our brand in the digital world. We look forward to be an active in our investor outreach over the coming months and hope to see many of you throughout the balance of the year. Thank you for your continued interest in Gaiam, and your participation today. With that, I would like to turn the call back to the operator and take an opportunity to answer some questions. Operator?

[Operator Instructions] Our first question is from the line of George Kelly from Craig-Hallum Capital Group.

Couple of questions for you. First, what are your plans for the solar stock now? Do you have any sort of goals with or how do you think about what to do with that?

As we said, we have no basis -- we never have GAAP basis, but it's really a question of the right opportunity to capitalize the stock now.

Okay. Secondly, on organic growth for the fourth quarter, is it fair -- the direct to consumer business clearly, there will be an impact in the first month of the quarter, how should we think about organic growth for the fourth quarter in total within that segment?

On the direct to consumer side, we will see high media cost through fourth quarter. We'll move from the political campaigns into heavy holiday advertising which does not work that well for DRTV. So you'll see a continued slowdown in that particular category during the fourth quarter. However, we plan to come back very strong and really look forward to launching the recut Jillian Michaels for New Year, New You starting in January, she goes back on The Biggest Loser. But we do expect to continue to see strong comps on the business segment side.

Okay, great. And then the TV segment, can you break out any other numbers that you have before? I think you may have given conversion was 70%, but what is the number of subs?

Yes, okay. So the conversion is actually, it's still running, kind of expected 30 was running at 70, it's still running 70 actually increased somewhat. So that's actually surprising and very promising. The number of subs we probably -- as we said last time we will start to run advertising kind of slow and soon we'll hit this benchmark when we mentioned last on 5,000 exclusive titles for streaming which we just hit that we'll start to market by Thanksgiving like kind of the regular campaign, be kind of looking for different way to launch it. It will happen between over next 30 days to 45 days and the -- I expect that right now before we start a campaign, we'll be about right now 20,000 subscribers and the biggest impact right now is our gross profit on the sub right now because most of this sub is fixed until you are high in numbers. It’s running maybe 65% by end of the next year when we expect to hit breakeven of run above 90%. So that's kind of the bottom line as far as the impact. So speaking it about contribution Lynn and Steve said, it cost us right now around $1.3 million a quarter, and we expect about equal number on the fourth and first because as we increasing revenue, increasing advertising spend. So we’re probably same kind of negative contribution for the fourth and first and then it will start to improve about $400,000, $500,000 a quarter to reach slight contribution by end of the year. On monthly basis.

[Operator Instructions] Our next question is from the line of Mark Argento [ph] with Lake Street Partners [ph].

Talking a little bit more about the Gaiam TV launch, can you talk a little bit about your launch strategy, is it going to be mostly all online marketing, do you have any partners that you are going to roll this out, with any thoughts around how you really start to build that sub base?

It's pretty much, mostly online, the biggest contributors right now is the search engine, both free and paid. And we very successfully launched second generation of Raku [ph] and so we doing a launch with Raku [ph] which proportionately actually let us people watching it on that. And our third part we just signed as a new host guy named George Noory, he is host in coast to coast which is second highest radio station. I mean he can be listen -- he get daily show for 4 hours with about 3 million listeners. And so he would do actually TV show on our thing will start in December. His promotion on his radio station and we have a couple of others like that that's coming online. So that's pretty much kind of on the first between now and Christmas and then we see the different responses to really tweak it. But it's hard with really helping that our retention almost doubled since beginning of the year, retention of the customers. So that’s obviously very good trend which kind of help us to breakeven.

Remember a number of years ago, you guys bought a company called I think it was The Spiritual Cinema Circle, is that still up and running and are you kind of doing any tie-in between the 2 entities?

Yes, we pretty much all the subscription it’s merged into a unit or will be by next few months as we totally incorporated. And we pretty much going to have one different offering -- I mean you can buy all of them together, you can do it separately but it's all subscription units. So it's like kind of look at it as you call the trade divisions of -- subscription unit which is incorporated all those parts?

It’s helpful and then shifting gears over to the retail side of the business side. Lynn it sounds like pretty good traction. Are you -- sell through at the rates that you are seeing growth at or you are replenishing lower inventories. What do you kind of seeing that the point of sale right now in terms of volume?

Well, certainly Mark in the first couple of quarters of the year, we did see a little bit of replenishing out of stocks which I think you were very familiar with seeing at retail. But right now we are seeing really strong sell through in the accounts where we get sell through, so it's keeping pace with our sell-in.

Okay. And when can you guys think about the DirecTV business, I know it’s a tough one because it's fairly lumpy depending upon when you have new products rolling out, you guys look at that business as a natural extension from distribution perspective to your general product set or what it make sense over time to maybe migrate more of that online and do less on the TV -- take some of the volatility out of the numbers, I guess the question is, are you getting the right return given the amount of volatility that you see in that business?

Couple of things, Mark. As you know, we used that channel really as our marketing channel. It creates a demand for a product or a category of merchandise, and we just have to always be cautious on the media spend side. It isn't so much that it is lumpy based on our offerings, but it does can be lumpy based on cost of media stand. And we were very cautious this quarter as a media spend went up to pullback. And yes it may be lumpy from a revenue standpoint, but we’re protecting the overall bottom line by pulling back, because we do use it to launch like I said, brands or categories like we’ve used with the firm, which we launched via DRTV, then we take it out to retail, and we also then have online communities and online sales. So I think that we’re going to continue to use it in that manner, since we can maintain the profitability. You may just see some contractions in revenue, when the cost of media goes up. And it certainly does at election times and the holiday times, so you’ll see that usually is our lowest time of the year for revenue for that division, but it didn’t hurt our profitability.

And just shifting back, I think you’d mentioned Lynn in regards to the Gaiam TV, offering that you expect to get that breakeven by the end of fiscal ’13. Do you guys have a total sub number that you’re targeting to get there, or it’s, how do you guys kind of model that out?

Yes, it’s exactly, it’s about, based on as we see today, and it really depends retention and some factors, but right now we kind of see is about 19,000 subs.

And there are no further questions at his time.

So we like to thank everybody for being with us and hopefully we see you in next quarter which should be in March probably, early March. Thank you very much.

Okay. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. And I say please disconnect your line. Have a great day, everyone.