Gaia, Inc. (GAIA) Q4 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Gaiam Incorporated Fourth Quarter Conference Call. [Operator Instructions] A quick reminder, this conference is being recorded, Monday, March 18, 2013. It is now my pleasure to turn the conference over to Norberto Aja, Investor Relations. Please go ahead.

Thank you, operator, and good afternoon, everyone. Thank you for participating in Gaiam's 2012 fourth quarter and full-year conference call. Joining me today on the call are Gaiam's Chairman, Jirka Rysavy; Gaiam's CEO, Lynn Powers; and Steve Thomas, Gaiam's CFO. Before we get started however, I would like to take a minute to read our Safe Harbor language. The following constitutes the Safe Harbor statement of the Private Securities Litigation Reform Act of 1995. Except for historical information contained herein, the matters discussed on 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 risk details 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 take the turn to introduce Gaiam's Chairman, Jirka Rysavy. Please go ahead.

Thank you, Norberto, and good afternoon, everyone. So revenue for the fiscal year ending December 31 increased 22% to $202.5 million from $165.5 million in 2011. Internal revenue growth was 10%. Gross profit increased $27.1 million to $116.1 million and gross margin improved 350 basis points to 57.3%. Operating income grew $7.2 million and net income improved $4.5 million to $0.6 million or $0.03 per share from a loss of $3.9 million or a loss of $0.17 per share in prior year. EBITDA for the year grew to $12.8 million from a breakeven in 2011. The cash flow from operation increased $14.9 million to $16.9 million and free cash flow improved $14.8 million to $12.9 million. Revenue for fourth quarter increased 20% to $66.7 million from $55.6 million in the same quarter of the last year. Gross profit for the quarter increased $10 million to $36.9 million and gross margin improved 700 basis points to 55.3%. Operating income improved $2.7 million to $4 million and net income increased to $2.1 million or $0.09 a share from $1.3 million or $0.06 per share in prior year. EBITDA for the quarter increased $4.2 million to $7.6 million. These numbers exclude all impacts from deconsolidated Real Goods Solar and also one time Vivendi acquisition cost of $1.7 million. Integration of Vivendi is now complete and we are pleased with its operating results. Gaiam Yoga Fitness brand has expanded to additional doors and improved its U.S. video market share to 42%. Our subscription business, a platform distributing media over the Internet and across mobile devices, is progressing very nicely with over 5,000 videos exclusively available for digital streaming. The conversion rate from the free-trial to subscription continues to go and be well [ph] in our expectation, running still at approximately 70%. The current revenue from the unit is about $350,000 per month. During in the last few weeks, we completed hiring of our marketing team, are now performing some marketing audits. We plan to start marketing campaign in late April. For the year, we expect to have about $5.7 million loss from the unit and then contribution into operating coming 2014. And I'd like to turn it over to Steve to give you some more color on financials. Steve?

Thank you, Jirka. I will spend a few minutes reviewing the financial results in greater detail and offering additional perspective on our performance for the quarter and for the full year beginning with the income statement. As a reminder, all the comparisons discussed are as if Real Goods Solar was deconsolidated from Gaiam as of the beginning of 2011. Starting with the fourth quarter of 2012, net revenue rose 19.9% to $66.7 million compared to $55.6 million for the fourth quarter of 2011. Net revenue from our business segment, which is comprised of sales to retailers, increased 40.7% to $48.8 million as we continue to grow our role across some of the largest U.S.-based retailers by offering the media content, fitness and wellness products consumers are looking for. And of course, the Gaiam-Vivendi Entertainment acquisition is playing a vital role in the success of this segment by providing us with a growing library of sought-after content and digital relationships that have helped us to grow the business in line with our expectations when we acquired Vivendi Entertainment at the end of the first quarter of 2012. While we're pleased with the contribution from Gaiam-Vivendi Entertainment, internal revenue growth for our business segment without the acquisition was over 14% for the quarter, showing the strength of our brand. As for our direct-to-consumer segment, revenue declined by 14.6% or $3.1 million to $17.9 million as our direct-response TV business experienced a $2.6 million or 22.9% decline in revenue due to our previously discussed strategic decision to optimize profitability by holding key programming and content in light of significantly higher costs associated with securing television time during the fall political campaign season. For the full year 2012, revenue rose to $202.5 million compared to $165.5 million in 2011, representing a 22.3% increase. Net revenue from our business segment increased 47.5% to $130.2 million in 2012 while our direct-to-consumer segment's revenue declined by 6.4% or $5 million to $72.3 million. Gross profit for the 2012 fourth quarter increased 37.4% to $36.9 million or 55.3% of net revenue compared to gross profit of $26.9 million or 48.3% of net revenue in the fourth quarter of 2011. The increase in gross margin primarily reflects the 100% margin net fee revenue of the Gaiam Vivendi Entertainment business, which was partially offset by lower net revenue in what is typically high margin direct-response television marketing business. Gross profit for the full-year 2012 improved to 57.3% of net revenue or $116.1 million compared to $89 million or 53% of net revenue in 2011. Operating expenses represented 49.3% of net revenue or $32.9 million in the 2012 fourth quarter period compared to 45.8% of net revenue or $25.5 million in the prior year period. Please note these operating expense and income comparisons exclude the $22.5 million non-cash goodwill impairment charge incurred in the 2011 fourth quarter. However, Q4 2012 includes $3.2 million or 4.8% of net revenue of non-cash amortization expense related to the Gaiam Vivendi Entertainment acquisition in the 2012 fourth quarter that we did not incur in the fourth quarter of 2011. Operating expenses for the full year represented 57% of net revenue or $115.5 million for 2012 compared to 57.7% of net revenue or $95.6 million in the prior year period. Operating income for the fourth quarter of 2012 was $4 million compared to $1.4 million in the fourth quarter of 2011. On a full year basis, operating income rose $7.1 million to $0.6 million compared to an operating loss of $6.6 million in 2011. Adjusted EBITDA improved significantly from $3.4 million in the prior year period to $7.6 million in the fourth quarter of 2012, reflecting the progress we are making in both growing our top line and leveraging our operations. On a full-year basis, adjusted EBITDA was $12.8 million compared to breakeven adjusted EBITDA for 2011. Improved operating income and EBITDA results include operating losses of $2 million and $5.9 million for the quarter and year respectively from our start-up digital subscription businesses, a key part of our long-term digital media delivery strategy. Moving down the income statement, net income for the 2012 fourth quarter, excluding non-cash equity method investment losses from Real Goods, net of any related tax benefit, was $2.1 million or $0.09 per diluted share compared to $1.3 million or $0.06 per diluted share in the prior year period, again excluding the 2011 non-cash goodwill impairment charge. On a GAAP reporting basis, net income was $1.6 million or $0.07 per diluted share for the 2012 fourth quarter. We had a full-year net loss of $12.9 million including the $18.4 million loss from our equity investment in Real Goods compared to a loss of $27.1 million for the previous year, which included a $22.5 million goodwill impairment. Before moving to the balance sheet, I want to quickly review our investment in Real Goods Solar. As a reminder, we converted our Real Goods Solar Class B shares to 10 million Class A shares on December 31, 2011, reducing our voting ownership to approximately 38%. For 2012 comparison reporting purposes, Real Goods Solar results are deconsolidated and shown as an equity investment line in our financials, as if Real Goods Solar had been deconsolidated as of the beginning of 2011. Looking at the balance sheet, we ended the fourth quarter with $9.9 million in cash versus $14.5 million on December 31 of 2011. This leaves our current ratio at approximately 1.7, a metric that underscores the health of our balance sheet and our ability to fund our current operations. Inventory turns for the fourth quarter of 2012 were 3.5x. Regarding our credit facility, at December 31, we had outstanding borrowings of $16.2 million and outstanding letters of credit and other reserves of $12.6 million under the 3-year $35 million asset-based facility. Taking a look at our cash flow statement, we're pleased to report a $14.9 million improvement to our cash from operations, highlighting the impact of our sales and operating income growth. In summary, our fourth quarter and full-year results reflect both the benefits that Gaiam Vivendi Entertainment acquisition is providing to our businesses as well as the overall strength in the Gaiam brand. The fundamentals across our revenue streams remain healthy and we continue to prudently manage our balance sheet, our investments around important growth prospects such as e-commerce and digital media, and we will continue to focus on balancing our long-term growth and near-term execution to create the best possible outcome for our shareholders. With that, I will 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. Echoing Jirka's and Steve's comments, I'm also pleased with both our fourth quarter and full-year results. We're continuing to build and broaden our brand, grow our media business, achieving double-digit organic revenue growth for the full year 2012 while also significantly improving our margin and adjusted EBITDA. We're successfully executing on our stated goals and that is demonstrated in our results and in our confidence going forward. Included within our significantly improved margin and adjusted EBITDA is our $5.9 million investment in Gaiam TV which we believe will be one of the key drivers of our future earnings growth as digital media channel moves to the living room. Without this investment, our adjusted EBITDA would have been $18.7 million for the year. We continue to improve our financial performance through increased revenue, better efficiencies from larger volumes and media sales, and expansion of our core retail partnerships, while continuing to invest in our future growth. We recently hired IDEO, a world-renowned design and innovation consulting firm, to complete a brand positioning study to review opportunities for category and channel expansion for the Gaiam brand. We look forward to a discussion of those opportunities on a future call. Looking at our business segment, the performance over the past year continues to be strong, with internal revenue growth of 14% and 25% compared to the fourth quarter and full year of 2011 respectively. And with total revenue growth including the Vivendi Entertainment acquisition of 41% and 48% compared to the fourth quarter and full year of 2011. Much of the success of this business segment stems from the quick integration we were able to achieve between Gaiam and Vivendi Entertainment and how our team has been able to leverage the additional sales volume of approximately 20 million units or $200 million in gross billings and driven that to meet our annualized net revenue and gross margin targets of approximately $25 million. There are significant economies of scale and operational efficiencies totaling approximately $4 million that we've been able to achieve through reduction of third-party distribution costs and the elimination of redundant overhead. As we expected, our larger scale has provided us with a greater ability to win important new content distribution deals and further solidify our position as the largest independent distributor of non-theatrical media content in the U.S. For example, we closed on a multi-year distribution agreement with Crown Media to distribute the highly visible and unique Hallmark Channel content library as well as a licensing deal with The Jim Henson Company which has a large children's content library, including Fraggle Rock, Doozer, and many other familiar titles. In terms of market share, Nielsen's VideoScan continues to rank Gaiam at the top of the chart in fitness with 42% market share, up from 38% last year. We maintain our #3 position in market share in non-theatrical content, topped only by Warner and Disney. We are now the largest independent distributor of non-theatrical content and the only independent with direct relationships with Target, Wal-Mart, and all meaningful digital players. In terms of the overall home entertainment market, 2012 marked the arrest of a 7-year slide in sales of home entertainment, with total home entertainment spending in the U.S. inching up 0.2% to $18 billion according to Digital Entertainment Group. We also continue to expand our media category management role with over 5,000 doors under management in the U.S., including being 1 of only 2 independent aggregators for media and the sole aggregator for fitness media with the second-largest mass retailer in the U.S. I also want to highlight our initiative to convert the remainder of our current agreements from an aggregator role to distribution model. Though this may lead to lower GAAP recognized revenues to more attractive business model as it results in higher margins and improved cash flow. With our Gaiam branded fitness business, we continue to focus much of our efforts in our store-within-store concept, which is now in place at over 15,000 doors, and expect to utilize this strategy across our new categories as we look to further grow our percentage of the fitness and wellness market. We're excited with the third quarter and fourth quarter launch of both our Gaiam Yoga and SPRI professional fitness equipment at Sports Authority, one of the largest sporting goods retailers in the United States with more than 460 stores across 45 states. We're pleased with the sell-through and the potential expansion opportunities for both of these brands. We're also excited about the expansion of the SPRI brand into 450 Sears stores during the latter half of 2012. These placements are helping to significantly expand the market for our SPRI line of products and we're in the advanced stages of discussions to further expand this line with other major retailers. We also continue to see great success from our Gaiam Restore line of at-home rehabilitative and restorative accessories, as well as with our Gaiam Sol line of premium yoga products. 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. Revenue from our Restore line, which includes foam rollers and other accessories and is targeted at the growing segment of active consumers seeking self-care devices for improving flexibility and mobility, more than tripled from 2011. We're investing in product development and expanding our proprietary products to fill this consumer and market need. We're expanding our assortment as well as bringing on new retailers in the coming months. Turning now to the direct-to-consumer segment, we brought down the media spend in our direct-response television business in order to remain profitable when media costs skyrocketed during the fall political campaign season. The full-year DRTV business was also impacted by the Olympics during the summer, when we also strategically avoided higher media rates. We expect DRTV revenues to grow in 2013 as long as media costs maintain their traditional levels. We plan to follow up on the success of The FIRM Express with new fitness content that will allow for continued growth from this branded business, including a new line of Richard Simmons content which is already being favorably received. We also are very excited about continuing our award-winning DRTV program featuring Jillian Michaels, titled Jillian Michaels Body Revolution, currently in mass retail which was relaunched by DRTV in January to coincide with Jillian's return to the hit television show, The Biggest Loser. We have an important addition to our direct-to-consumer segment with the recent appointment of Andrew Davison as President of Gaiam Brand. Andrew, who joined us following his time as Chief Marketing Officer at Crocs, is an accomplished industry veteran with a deep understanding of consumer behavior and how to exploit brands to maximize their visibility and profitability. Last year, while he was at Crocs, Andrew and his team were honored by the American Business Awards with a Stevie for Marketing Executive of the Year for their success they achieved in elevating and evolving their marketing strategy and programs. We expect Andrew to have a big impact on our direct-to-consumer strategy in the coming months as he becomes more involved with the formulation of the IDEO research into our brand strategy going forward. In October, we migrated our website to a more flexible demand-ware platform. As we implemented and optimized this site, we experienced a short-term negative impact on our Q4 e-commerce revenue. This investment in e-commerce provides us with the best-in-class tools and functionalities that will improve our online customer experience, support interactive content, enhance product pages, and improve testing and analytics. In 2013, we will invest in additional core technology efforts around CRM and loyalty and the enhancement of our mobile and tablet efforts. 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 to bring added visibility and help with both customer acquisition and retention. 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 capability, should make Gaiam TV a very appealing offering. As media consumption evolves to the Internet, and consumers have the ability to select the type of content they desire to view, we believe we are in a unique position to curate and create content for the [indiscernible] consumer. Gaiam TV currently streams on all PC and Mac platforms and all browsers. Mobile availability includes the iPhone and iPad. Over-the-top availability includes Roku and Apple TV using Apple's AirPlay. Gaiam TV will continue to expand its big-screen presence in Q2 of 2013 with the focus on connected TV application. Releases in the second quarter include devices and connected TVs from Sony, LG, Panasonic, and Samsung, as well as Google TV enabled devices. As we invest in this business through technology and content, and now marketing, it impacts operating income, including the $2 million loss for the quarter and $5.9 million loss for the full year of 2013. 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 the year. With digital distribution accounting for nearly 30% of the domestic home entertainment market in 2012, up from 19% in 2011, Gaiam TV and our other digital content distribution initiatives should resonate with consumers interested in learning more about the world of fitness, health, wellness, personal development, and family entertainment, be it through their TVs, computers, mobile devices, or tablets. Our key initiatives in 2012 were to successfully integrate the business of Vivendi Entertainment and leverage our larger scale to sign more and larger distribution agreements with studio partners that have attractive content; to leverage our digital infrastructure to offer digital distribution to our studio partners; to release branded direct response products with mass retail potential; to invest in a new e-commerce platform; to seek broader placement of Gaiam branded products with the release of the Restore, SPRI and Sol lines; to move out of beta on Gaiam TV; to return to double-digit organic revenue growth; and most importantly, to significantly improve our operating margin, EBITDA, and cash flow from operations. I'm pleased to report that we've accomplished all of these goals. In closing, our focus remains on the future and on reaching our full potential. Gaiam has the right brand, financial resources, infrastructure, and people to make that happen. So I am confident about what we're doing and our focus on expanding our product assortment and improving the customer experience at every touch point, from our website to our store-within-store presentation. We have the ability to develop our Gaiam brand halo across more product lines and channels, including apparel and physical locations, 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. This concludes our prepared remarks for today and now I'd like to turn the call back to the operator for questions.

[Operator Instructions] First question from the line of George Kelly.

Couple of questions, just to start on the TV business. I was wondering, first of all, is breakeven still 90,000 subscribers there? And then I think you said that you expect for 2013, it will be a $5.9 million loss -- or a $5 million loss? I'm just wondering if you could go through the quarterly expectations, and if you still expect the fourth quarter to be breakeven or close to it?

Yes, we still expect to breakeven in December, not the fourth quarter. The breakeven is probably on the run rate of where we ended up about 85,000 subscribers, and the $5.9 million was last year. We expect a little better, about $5.7 million. It's obviously a question of marketing, that includes about $6.3 million marketing budget.

Okay, and just the comment that you gave, I think it was 350,000 per month, is that right now or was that in the fourth quarter?

No, that's about what it's right now.

Okay, and so then, just so far this year, when you put more marketing dollars behind that initiative, can you talk about just how that's -- what channels have been effective and how your -- just anymore sort of dialogue about what's happened since you've been spending more?

Well, we didn't spend that much more, we didn't do marketing at all until like Thanksgiving, and so we kind of want to hold it pretty much till we finalize the product and test it. We hired our marketing team actually over last 3 weeks, so we have a new both VP and Director of Marketing to run the team. Before, it was kind of everybody from the team was pitching in. So, the campaign start pretty much in late April. So, most of the budget will be spent between April and end of the year.

Okay. Then, on the e-commerce transition to the new platform in the quarter, you mentioned that it was weak initially. How is that trended now since the quarter ended?

We've come back in the first quarter to having a much stronger first quarter. We have a slight comp going on, on our direct side, but we lost probably about 30 days where we weren't converting as we were implementing the new platform, but the new platform will give us so much more flexibility in the future, we'll make it interactive, we'll be able to add video, and we believe that that will have final implementation of all the things that we want to do with the platform by the third quarter of 2013.

Okay. So then, I think you had also said that the direct business should be positive for the full year in 2013, and is that part that you have to work through the difficult part is the e-commerce side where comps are more harder?

Yes, that's correct.

Is there anything else impacting that?

No, we do expect to have double-digit comps in our direct business for 2013.

Then, your stake in Real Goods Solar, any news there? The stock has been up quite a bit here recently, any update there?

Not really. I think -- we would say the stock move is because of activity of Sol [ph] City [ph], and so there's not really any update on that.

Okay, and then just one last one, the transition with the Vivendi business into the aggregator model, can you talk through what kind of impact that will have in 2013, just as far as revenue growth and was it just a few -- is it going to be able to...?

Yes, it's a few contracts that we still had where we were doing aggregator versus distribution and depending on when and how many of those contracts we converted, it could be somewhere around $5 million to $6 million in revenue. But again, it won't affect -- it will have a positive effect on the bottom line and cash flow.

[Operator Instructions] Next question from the line of Mark Argento.

Couple of questions. First off, interesting hire with Andrew Davison in terms of some of the branding. Can you talk a little bit about more specifically what his responsibilities will be in terms of the brand? Will it be the brand across all kind of different divisions or how do you think about some of the things he'll be doing?

First of all, Andrew will be responsible for the direct-to-consumer business for making sure that our web presence and every place where we touch the consumer directly has one brand positioning, and also will be looking at opportunities for licensing on the brand and for additional categories where we see -- which we can see the Gaiam brand on, such as apparel.

And will he have direct oversight over, you said all the direct-to-consumer, so will that be the catalog and the web, versus the retail part of the business?

Catalog, web, and our single retail store, but not on the retailer DRTV side.

Got you, that's helpful. Then, when does he start, is he there now?

Yes, he is. He started beginning of January.

Great. Shifting over to the retail channel a little bit, could you talk about unit trends? I know you mentioned the overall shift in activity in the media segment has really seen a big pickup in digital distribution. What are you seeing with activity when it comes to fitness DVDs and some of the areas that you focus on? You're seeing as pronounced a move to digital or is it lagging some of the overall trends?

Fitness is lagging the overall trends right now because once again on fitness, you watch it over and over again, versus a single viewing which you might use for a theatrical release, where people only want it -- it's not ownable, whereas fitness is ownable, so our DVD sales still continue strong and at our largest retailer we're actually up in DVD sales for the year.

On a unit basis?

Yes, and the Gaiam brand.

Got you. Alright. Then, thinking through the Gaiam TV business, how do you see that? Do you see that more as a kind of unifying property where you can ultimately have a lot of your ecommerce functionality built into Gaiam TV as well, or do you see Gaiam TV as almost more of a standalone, almost like a Netflix for the LOHAS marketplace, how do you see that property playing out over time within all the other brands and all the other kind of products that you have under the umbrella?

We don't really see the Gaiam TV as the Netflix model. Gaiam TV is more like curated, exclusive viewing. So, it means none of the titles are on Netflix or anywhere else, and then consumers, they pick, they have more kind of the selective choice than currently exists in existing media channels. As far as -- the first goal is obviously to make the business breakeven. Services like Amazon, they successfully combined a subscription business with a e-commerce business in form of Amazon Prime. So, there is definitely potential for something like that. But I think the first focus is to get the business to start contributing.

And Mark [ph], there is also opportunity for consumers to see the Gaiam products in action on the fitness and wellness portion of Gaiam TV, and I think that will give a brand halo over those products and certainly the ability to then go to our ecommerce site and buy those products.

Earlier in your comments, you had talked about some of the other opportunities on the product side of the business, apparel was one, and then you mentioned something about physical location. So, does physical locations mean more retail outlets or store-in-a-stores or what were you alluding to there?

We're, all of the above. Certainly with the expansion into Sports Authority, with the Gaiam store-within-store, and 460 doors, that was pretty exciting. And we believe there's lots of opportunity to expand into its own 2-to-4 foot section for the Restore brand with the pretty dramatic sales results we've had there. So we think on the retail side, more door expansion. We also believe in, whether it's in a studio environment or a retail environment, there is an opportunity for standalone Gaiam presence.

And any thoughts in terms of trying to get apparel into retail stores or physical stores versus just online or the catalog?

I think, if anything, we'd start first with some of the online partners like an Amazon, versus trying to go into a retail environment at this time. But I think we have plans and Andrew is working on additional apparel line extensions that then we could take out to retail.

Great, it looks like recently you pushed into almost kind of a higher-end line of yoga, probably a little more of lifestyle clothing, yoga clothing, is that an area you tend to focus a little bit more on as the upscale part of the market or where should we see you position yourself?

No, we see ourselves in a good, better, best strategy as the better line. We think there's lots of opportunity of price level or so below where lululemon is.

There are no further questions registered. I would like to turn the call back to you for any closing remarks.

I'd like to thank everybody and our first quarter call is going to be somewhere in early May. Thank you very much.

So, ladies and gentlemen, that will conclude our conference call for today. We thank you for your participation and you may now disconnect your lines.