Gaia Inc (GAIA) 2004 Q2 法說會逐字稿

Hello, and welcome to the Gaiam second-quarter earnings release conference. All lines will be in listen-only until the formal question-and-answer session. At that time, instructions will be given. At the request of Gaiam, today's conferences being recorded; if you have any objections, you may disconnect at this time. I'd like to introduce Mr. Jirka Rysavy, CEO, Janet Mathews, CFO, and Lynn Powers, President. Ms. Mathews, you may begin.

Thank you. Good afternoon, everyone, and welcome to Gaiam's second-quarter 2004 earnings conference call.

First to the legalities -- the following constitutes a Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Except for the 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, the integration of acquisition, 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. I would now like to turn the call over to Jirka Rysavy, Chairman and CEO.

Again, welcome to our call, which we are going to cover the results for the second quarter, which ended June 30. And even though we expected and communicated that second quarter would be a pretty good for us and then we expected a loss, our domestic business segment ended up worse than planned.

For the second quarter, revenue were 17 million, which was 3.3 million lower than anticipated and for the same period of last year. The shortfall came in Gaiam's domestic business segment. Internal revenue growth in Gaiam other businesses were solid, Internet was 18 percent; catalog, 5; and international, 8 percent.

Mostly because of the revenue shortfall, we have reported a loss for a quarter of 2.2 million -- net loss for 2.2 million -- or 15 (ph) cents a share compared to a net loss of 0.8 million or 5 cents a share during the same period of last year. However, during the second quarter, Gaiam again generated positive cash contribution of 1.4 million from its operation compared to a cash use of 0.1 million in the second quarter '03. And even though during -- cash was an important focus during Gaiam consolidation, generating any positive cash contribution in the second quarter was definitely above our expectation.

Depreciation and amortization for the quarter was 900,000. For the 6 months, our sales were 40.8 million compared to 43.3 million for the same period in '03; net loss of 2.5 million and 17 cents to a net loss of 1.1 million or 8 cents for 6 months ending June 30, 2003. For the 6 months, Gaiam generated 4.1 million cash contribution from operations compared to 1.4 million generated in the first half '03.

Gaiam improved its cash position for 4.2 million and ended the second quarter with 12.6 million in cash, up from 11 million at the end of the first quarter and 9.4 million at the December 31, '03. Gaiam still has no debt and has unused 15 million line of credit. Gaiam also expects to generate positive operating cash flow as well as free cash flow for its full fiscal year. Now Janet will give you some more details on numbers and then Lynn, business overview as usually.

Thank you, Jirka; now let me provide some additional details. For the second quarter, sales were 17 million, representing a decrease of 16.3 percent from prior-year sales of 20.4 million. Gaiam's decrease in revenues was due to a decrease in the business segment of 3.2 million or 32 percent for the quarter. This shortfall resulted from lower sales volumes in the U.S. trade business, particularly to mass-market retailers and an increase in markdowns and returns associated with the change-out of VHS stock for DVD's. In contrast, the internal growth rate in the international business was 8 percent for the quarter.

Revenue from our direct-to-consumer segment, which includes our catalog, Internet, solar installation programs and service units, was 10.3 million or relatively flat in total as compared to the same period in 2003. The internal growth rate in the Internet and catalog businesses was 18 and 5 percent, respectively, for the second quarter.

Gross margin for the second quarter of 2004 was 50.1 percent, down from 53.1 percent for the comparable prior year period. This was primarily attributable to increased costs associated with the transition from VHS to DVD formatted products. These costs included markdowns given to incent sell-through of current VHS inventories and the write-down of certain on-hand VHS inventory components and packaging.

Total operating expenses increased to 12.2 million for the second quarter of 2004 as compared to 11.9 million during the second quarter of 2003. Selling and operating expense increased to 10.2 million from 9.8 million in the second quarter of 2003. The year-on-year expense increase was primarily the result of increased sales and marketing efforts in our business segment, both domestically and in our UK subsidiary, and in the direct-to-consumer segment where the combined internal growth rate for the catalog and Internet businesses was 10 percent.

General and administrative expense decreased to $2 million in the second quarter of 2004 as compared to 2.1 million in the comparable 2003 period. This expense reduction is generally attributable to cost savings generated by the consolidation of administrative services into Gaiam's Colorado headquarters and the resultant staffing reductions implemented during the first half of 2003.

Operating losses increased to 3.6 million for the 3 months ended June 30th, 2004 from 1.1 million for the comparable 2003 period. The net loss for the second quarter of 2004 was 2.2 million or 15 cents per share compared to a net loss of 759,000 or 5 cents per share during the same period of 2003.

For the 6 months ended June 30th, 2004, sales were 40.8 million or 5.8 percent lower than the comparable period in 2003. Net losses for the 6 months ended June 30th, 2004 were 2.5 million or 17 cents a share compared to net losses of 1.1 million or 8 cents for the 6 months ended June 30th, 2003. Depreciation, amortization and other non-cash charges were 2.2 million for the 6 months ended June 30th, 2004.

Cash generated by operations for the second quarter of 2004 was 1.4 million as compared to use of funds of 81,000 in the second quarter of 2003. Gaiam generated 4.1 million in cash from operations for the 6 months ended June 30th, 2004 as compared to 1.4 million during the first 6 months of 2003. Gaiam ended the second quarter with 12.6 million in cash, up from 11 million in cash at the end of the first quarter and up from 8.4 million at December 31th, 2003. Gaiam has no debt and an unused credit line of 15 million.

DSO improved to an average of 50 days for the second quarter of 2004 as compared to an average of 64 days during the second quarter of 2003. Inventory turns for 2004 were 2.9 times as compared to 3 times for the same period in 2003.

Gaiam's audit committee has refused to accept our Ernst & Young's proposal to act as Gaiam's independent accountant for fiscal 2004 due to the sizable increase in the fees being sought. In December of 2003, Gaiam's audit committee received a proposal from Ernst & Young for accounting services to be rendered in conjunction with the 2004 quarterly reviews and annual audit. Due to the size of the fee increase, it was not accepted and Ernst & Young was asked to redo their proposal.

For our 2003 audit, which was completed in February of this year, Ernst & Young utilized an entirely new audit and tax management team, and we were asked to pay substantially higher costs than their agreed-upon fees for the 2003 audit. In June, Ernst & Young submitted a revised proposal for their 2004 services. Our audit committee reviewed their revised proposal and told Ernst & Young that the audit committee will seek bids from other firms. Ernst & Young was engaged to perform only the review of our second-quarter results and 10-Q filing, which they have completed and they have resigned as our independent accountants.

There have been no disagreements with Ernst & Young on any accounting principles of practices, financial statement disclosures or auditing scope or procedure. Gaiam is in the process selecting new independent accountants and we will have a new firm on board for the review of our third-quarter results.

Before turning it over to Lynn, I would like to announce our schedule for our net earnings call. The third-quarter earnings will be announced on Wednesday, October 27th at 4;30 PM Eastern or 2;30 PM Mountain time. Lynn.

Thanks, Janet. As Janet indicated, our second-quarter results were disappointing and generated higher losses than anticipated. Overall, revenues were 17 million for the 3 months ended June 30th, 2004. The 3.3 million shortfall was primarily the result of a 32 percent decline in the domestic business segment. Internal revenue growth for the other business segments was solid. Internet business was up 18 percent; catalog business, 5 percent; and the international business, 8 percent. The decline in the business segment can be attributed to lower sales in the mass-market channel, as well as an increase in markdowns and returns associated with the transition of media formats from VHS to DVD. The majority of the decrease came from distributors selling to mass-market retailers and the expected decline at Target.

Distributors generated negative comps of over 1.1 million, as these retailers returned VHS and moved to convert their media inventories from VHS format. Since DVD went mainstream in 2001, most of our retailers have supported both VHS and DVD formats from Gaiam if available.

The penetration of DVD players went from 30 percent of the homes in the U.S. to 50 percent of the homes in 3 years, but has grown to 70 percent penetration in the past 6 months. Because of this acceleration, retailers are trying to catch up. During the first part of 2004, many of our retailers decided to discontinue the VHS format from their assortment. We expect more retailers to make that decision during the balance of the year. Gaiam already converted its main titles and is now converting the remaining titles in its immediate library to DVD, and expects to launch these titles in DVD format in Q3 and Q4 this year. In light of the industry's conversion acceleration, we decided to discontinue VHS format and will not take additional VHS orders except for special cases for the balance of the year. We are also converting all of our kits to DVD format by the fourth quarter and are adding a DVD to already existing VHS format kits where warranted. While this has been an expensive and time-consuming endeavor, we believe going to DVD is a positive trend for Gaiam and Gaiam will emerge with the most expensive DVD library of mind/body products in the industry.

The sales decline in our business segment was further compounded by health issues with our VP of sales. He will be taking an extended leave of absence to undergo additional surgery for a serious condition that surfaced last December.

In recent weeks, we have made some significant changes to this division. We've added 2 national sales managers to our sales to retailers team. Our national sales manager of sporting goods and soft goods comes to us with 14 years of sales management experience; he has managed large national accounts with substantial product assortments, and is skilled in developing business relationships and creating an energetic and highly motivated work environment. We have also added an individual with approximately 10 years of sales management experience to oversee the remainder of our retailer channels. His experience includes developing and implementing sales and marketing strategies by channel, creating and implementing national sales training programs, building successful sales structures and launching new products.

As stated in our first-quarter conference call, we anticipated that business from Target in the second quarter would be below last year. We expected minimum reorders while they reduced their current inventory on certain products in anticipation of the expansion into new products in third quarter. For second quarter 2004, sales to Target were down 1 million from the same period in 2003. However, we've already received the orders from Target for the new 12-foot section reset, which will begin to ship in August. As previously announced, this will triple our current space in most Target stores. We developed innovative products and new color stories that we feel will bring some excitement to the expansion. In addition, we feel that the expansion of our media in all doors of Target will round out the full lifestyle presentation for this retailer and give Gaiam a great branding opportunity.

While business with our mass distributors was in Q2, we recently received orders on 2 new media titles to go into the September reset at Wal-Mart. This is particularly exciting for us as one of the titles is from our new children's media launch and the talent for this title was featured in the Parade magazine on Sunday, August 1st.

We also experienced negative growth in our audio segment of over 100,000 for the quarter based on discontinuing our distribution agreement with a third party in order to launch our own music label. We anticipate launching our new audio business in fourth quarter and are excited about the possibilities for growth in that arena.

The sporting goods channel was down approximately 200,000 in the second quarters and compared to prior year. It was announced during this quarter that Dick's Sporting Goods will acquire Galyan's. Over the past year, we've developed a strong relationship with management at Dick's. We feel that this acquisition will have a positive effect on our business as we work together over the next few months to expand our presence. We're anticipating store-within-store reset at Dicks' to take place in third quarter.

In the domestic business segment, the bookstore channel was our top performer for the second quarter of '04 with approximately 1 million in revenue or 63 percent growth over second quarter 2003. We're really pleased with our partnerships with the 2 largest players in this channel. We plan to continue to reset the balance at the Border's stores and the store-within-store presentation during the balance of '04. And for the remainder of '04, we expect the comp growth in this channel to slow down a bit as we approach the anniversary of the store-within-store concept rollout to Barnes & Noble. In third quarter '03, Barnes & Noble rollout contributed 1.6 million to revenue.

During the second quarter, we transitioned the majority of our direct business with Whole Foods to a grocery distributor relationship with UNFI. Gaiam continues to be involved on a daily basis with Whole Foods in regards to store design, product assortment and strategy discussions. Helped by this new relationship, our business with this channel was up 25 percent for the quarter. We expect to have the transition to UNFI completed by the end of third quarter.

We continue to introduce new products into the traditional grocery channel under the Healing Arts brand. During the quarter, we expanded into additional doors in both Bosch's (ph) and Hannaford. Our national sales manager for grocery has developed a fitness corrugate promotion for distribution into 1000 stores. This promotion will provide a substantial boost to our penetration in the grocery channel.

In support of our efforts to launch a grass-roots marketing effort for our soft goods, we've contracted 3 independent manufacturer's reps to begin our Gaiam Organix apparel launch. Our current plan is to launch to retail in fourth quarter '04. We have expanded our discussions at upscale hotels and spas, including Kimpton Hotels, Triton Hotel and W Hotel, who all now offer Gaiam media and products as part of their guest services. We have again partnered with Stonyfield Farms as a sponsor of their strong woman summit to celebrate, educate and motivate women about good health. The summit is scheduled for November.

During the quarter, Gaiam entered into a licensing agreement with Warner Bros. to use the Scooby Doo image on fitness products. We are excited about the opportunity to create a line of products and marketing campaigns with Warner Bros. around Do Yoga. Warner Bros. has committed to launching Scooby doing yoga on the cartoon network this fall. We plan to launch the full Scooby line in first quarter of '05.

The direct business segment, that includes our service units, was flat, at slightly above 10 million. In early '04, we made the decision to suspend a spring/summer distribution of one of our small catalog titles. The catalog business experienced an increase in comp revenue of 5 percent for the second quarter '04, and margin for this division was over 61 percent.

Our website delivered solid performance with approximately 18 percent comps over second Q '03. Margin continued to remain strong at 65 percent. We achieved an overall 14 percent increase in Web marketing revenue from second quarter '03 with affiliate programs growing 45 percent and search engines, 21 percent.

Fill rate improved approximately 94 percent compared to 90 percent for first quarter '04. We feel that we have implemented processes to correct the fill-rate problem that we saw over the last 2 quarters and do not anticipate a problem going forward in '04. For the second quarter 2004, average order size was $113 compared to 110 for the second quarter of '03.

In closing, we were not pleased with the results of this quarter. We have made some significant changes in the domestic business division's structure, put plans in place to stay on top of the shift in media formats, and feel that we are putting the people and strategies in place to retain our leadership position in the sales to retailer market.

I would now like to open the call for questions. Valerie?

(Operator Instructions). Mark Rupe, Adams, Harkness & Hill.

Hi, guys. Just a quick question. With the conversion to DVD from VHS, do you see any cost benefit from that? I'm not sure what the margin implications are from both formats right now?

The VHS -- overall, this acceleration happened a little unexpectedly because you know too because Lynn said you know 3 years to go from 30 to 50 percent penetration to DVD's. Now it took 6 months to go to 70, so a lot of retailers kind of changing the game, which actually is beneficial for us long-term because the DVD's are much cheaper to produce, so you actually get a little better margins. And it's also better for us because the smaller players have a disadvantage in this game. So it's kind of a better format for us. It also allows us to do a lot of things on the DVDs, which you know, our quality is always better. So it helps us (indiscernible) long-term because it's easier to ship it and too, the margins will be beneficial.

However, in short-term, we plan to still ship; because a lot of people are still taking orders, like Wal-Mart is doing a lot of volume from discontinued VHS in discount bins. But it's very hard to ship it because we expect to get everything back at December or in January, because today, everybody is saying they will exit then. So we've made a decision to forfeit a lot of revenues and basically not take those orders because we believe we will get them back to this inventory which we cannot discard anyhow. So that's kind of what's impacted. We took a big returns on DVD's already in the second quarter -- VHS sorry.

Right.

So it has really changed both margins and sales. And we expect that to continue. So we kind of made a decision to exit it by end of the year. So we will kind of go through our -- (indiscernible) we would forfeit some revenues and also probably take some cleanups faster; even some people will continue VHS's. But I think especially with people like Wal-Mart, it is very difficult to never can negotiate a final sale. They always want a right to return and it's industry standard. And we really don't want to get there, because we might end up -- that was still probably about 40 percent or so last year. (multiple speakers) VHS -- 40 percent of media sales, so it was a big chunk so it's a big shift. And why we like the shift, it's really changing the game for this year, which nobody could really pursue that till even first quarter because the proliferation of the DVD players. And so I think, I'm not sure I answered the question. But it was probably the biggest impact of the second quarter, what we expect over -- especially next quarter because we would actually try to kind of totally get out by September, October if we can, but definitely by Christmas.

So it is an issue that will be largely behind you at the end of this year?

Yes. We basically want to be out of business with VHS's before the end of the year and have virtually no inventory except -- there will always be some special orders, but they will be only done as a special order, as a final sale. So we wouldn't take a risk on inventories. Because that's the biggest thing. The VHS's are more expensive than DVD to put together, and you can also -- and it's pretty much, if you get them back, while it's easy to reship them, if it's a return because somebody else want to reorder. But except the special stores, not many people stock the VHS's. However, a lot of people, a lot of customers still have VHS machines in their fitting rooms; but they're actually still looking for VHS's, but the retailers are changing the game, obviously, which we kind of expect.

And the 2 sales managers that you've recently hired -- how fast do you think they will be up the curve and, obviously, helping out?

They've been onboard for a couple weeks now and they're getting up to speed very fast. We're having an off-site sales meeting next week and I expect them to really be up to speed at the end of the sales meeting.

And then, obviously, the Target reset is happening -- one of your bigger customers if not the biggest one. What thoughts on -- I know it may be too early -- but just on as far as your tripling the space at Target. What are the thoughts on growth for next year possibly coming from Target?

It's early to say, but it's obviously a big space and we are glad we already have the order because obviously even if we expect a slowdown in second Q, we cannot start this thing and be changing their minds. So we were glad that we saw that all the orders expected actually was a little bigger -- the reset order -- than we expected, I think. So I think it's going well. It's hard to say how fast they will put it out there when it gets on the shelf and whether there will be a sell-through. And there's a lot of new products. There's like 3 dozen of products we have not experienced in Target yet. So we need to see how they will work, but it's definitely positive. How much, we don't know. But we kind of expect that, you know, next year will be revenue-wise much better than this year because a lot of this VHS reset and the Target and a few other thing would happen.

I think the other good thing about the Target reset Mark, is of course it allows us to put media in all stores and create a full-lifestyle presentation. We have no idea what impact this will have on the revenues yet. But, obviously, we all believe that it is going to have a very positive impact for us going forward.

Perfect. Thank you.

Eva Martin (ph), BDP (ph).

Hi. I'm just wondering when you mentioned earlier about the -- you went to 3 independent grass roots companies. Have you started doing any grass root campaigning? And have you noticed increase in sales or has that strategy been successful -- showing any success yet?

We just contracted with the sales reps. And so we're planning to launch that in fourth quarter. And again, it will be with small independent retailers.

I see, okay, because I did notice that you did. I'm on your mailing list, so I noticed that you sent out a focus group type survey. Have you done any sort of mailing list grass-roots things without the independent company that you've contracted?

We've done just a catalog to the professionals market, yes.

I see. Okay. And has that brought back any successful feedback that you have wanted (multiple speakers)?

Yes, we have. We have gotten some very successful feedback from that.

We also put together a new that's kind of lot (ph) customer kind of can (indiscernible) kind of participate in our research and we have that group growing dramatically; there's several thousand of them right now. So we get much more rapid growth, that we try to capture the loyalty of our customers.

So you're doing focus groups amongst your customers?

We call it a Gaiam panel, yes.

We really felt that our sales were not satisfactory for first 6 months, so we tried to get a lot of feedback that way, as well; (multiple speakers) customers big efforts right now because we kind of started; we have the sales force in a place; but with our VP health issues and the VHS's, we are still far less -- we're not even close where we want to be. We're spending some additional dollars (indiscernible) second quarter, which will hopefully see a benefit. But it is really targeted -- I'd expect we don't see full benefit from it until the next year.

I see. And regards to your clothing that you sell direct to retail, do you sell your organic clothing anywhere else other than direct retail?

At this time, the only place you can get our clothing is in a few small boutiques and of course on the Internet or through our catalogs. But as we contract these independent sales reps, we hope to get it out into more independent boutique-type environments for fourth quarter.

I see. Okay. And then Marshall Fields going with the spa relaxation products?

They're mostly bedding products and certain stores are doing excellent with them. And so we are really trying to expand the presentation in those stores that are doing well.

So you do plan on expanding in Marshall Fields (multiple speakers) in stores. (multiple speakers) they will be giving you more space to expand?

In certain stores, yes.

I see. I have a question about Eco products. I noticed your Eco mat, the premium benefits mat, does that mat sell well? And are you seeing more demand for products that are more environmental?

That's all we sell; so everything it's what we do in the scope, so -- I mean on the clothing part.

Right. What about as far as fitness products or (multiple speakers) you know in yoga or Pilates?

In certain environments, our Eco products do very well. Particularly in like professional environments or in environments where the attention of the salespeople can be given on an individual basis with the customers.

Okay. So this yoga mat in particular, do you now how -- if that's being taken well by consumers, whether it's professionals or regular direct retail consumers?

I know that it's doing well in our direct business. I don't have any information on an individual product in an individual store.

I see. Okay.

We can look at it, but really don't want to provide probably individual SKU's information (indiscernible).

Right. Okay. Well, thank you very much.

Ben Morefield (ph), Wellington Partners.

Thank you. Just a couple of quick questions. In connection with the new sales managers that are going to be working the business segment, is there going to be any change in strategy in terms of which accounts you take direct? Like right now, I noticed that Bed Bath & Beyond is now direct, and Whole Foods, you are going through UNFI. What's the criteria you're using to determine who is direct and who isn't?

Lynn maybe should answer that part. But it's like there are basically 2 -- there are accounts where we can send (ph) centrally. And people at Whole Foods, we have to sell at every store. So it's maybe Lynn can talk.

All right.

On most companies where they are centrally bought, we try to go direct with them because we can do that. In excepting cases like a Wal-Mart, where you must go through their appointed distributor for media. So our strategy has been to go direct where possible.

How is the success of going direct with Bed Bath & Beyond been?

It's been fine.

(multiple speakers). We pretty much would like to go direct with (multiple speakers) --

(multiple speakers) will there be any change in approach on taking more or less direct? Or is it --

It all depends on the type of account. And again, once the sales managers get through our sales meeting next week, maybe after the third-quarter conference call, I can update you if there is a change in strategy.

It also depends on performance and distributors distributing -- who is doing well, we typically don't address the issue.

Okay, great. Earlier you mentioned something on a fitness promotion within the grocery sector?

That's correct.

What was the detail on that?

It's a specially designed in-and-out corrugate for the grocery stores for their fitness season.

And how is the success of the new grocery division manager? I think in quarter one, you appointed a new national grocery -- a natural foods chain manager?

It's been excellent. We've expanded in all of the chains where we have been testing Healing Arts in the grocery channel. And as you saw from the comps in the natural foods area in that channel, we're up about 25 percent.

That's probably our definitely better part of the business -- actually grew. But have in mind that we don't provide short (ph) of the Whole Foods to Gaiam brand. Because we treat Whole Foods as specialty stores, that all the other groceries will get Healing Arts.

All natural.

They are all natural food stores, yes.

Right. And then just one final question, like with the increasing competition, how is Gaiam positioning themselves differently to differentiate themselves from competitors in the market?

Gaiam, certainly from its authenticity, has always been positioned as the leader in the market. And yes, there may be people who copy our packaging and copy our products, but I think one of the key indicators is that someone who's bought 1 piece of our media has come back and bought 6 pieces of our media in our direct business. So they buy it once, they understand the quality and they keep coming back.

However, our sales definitely were under-performing for the last 6 months, so we need to evaluate all the things; we've been hearing specific competitive issues on the street, but there's definitely much more copying and stuff so we need to be coming with different innovative stuff to address it. But the DVD change is really playing right in our hands.

On the international front, how's things been working out with the United Kingdom? And is there any other change other than -- was it Selfrages (ph) that you are working with?

That's correct. We continue to roll out to some of the smaller retails in the UK. The UK is just -- their retail environment is a little bit challenging right now, although we have been able to -- in the second quarter, increase our sales year-on-year 8 percent. And we're continuing to pursue expanding our distribution of our entire Gaiam Lifestyles presentation in the UK market.

The UK grew 7 percent first quarter (multiple speakers). Sorry. (multiple speakers). 8 in second. And so we hope actually for bigger growth from UK than we so far delivered.

And then continental Europe?

We don't plan any continental Europe expansion right now. I think we have so much opportunity in the U.S. and we did not really deliver there. So we would want to stay in English-speaking countries, for right now at least. I'm sure there will be a time; but for right now, we have so much opportunity here.

Okay. Great, thanks a lot for your time.

(Operator Instructions). There are no further questions.

So we would like to thank everybody. And as Janet said, our next conference call will be October 27th at 4;30 Eastern. Thank you very much.

Thank you.