Gaia Inc (GAIA) 2006 Q3 法說會逐字稿

Accented speaker(s) causing [inaudibles]; transcript is best product.

Welcome and thank you for standing by. [Operator Instructions.]

Now I will turn the meeting over to Mr. John Mills. Sir, you may begin.

Thank you. Good afternoon everyone and welcome to Gaiam's Third Quarter 2006 Earnings Conference Call. 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 risk and uncertainties including, but not limited to, general business conditions, the integration of acquisitions, the timely development of new businesses, the impact of competition, and other risk detailed from time to time in the Company's SEC reports. The Company does not undertake any obligation to update forward-looking statements.

On the call today, representing Gaiam are Mr. Jirka Rysavy, Chairman and CEO, Lynn Powers, President, and Vilia Valentine, CFO.

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

Thank you John, and welcome everybody to our third quarter call. I'm very pleased to say again it was another good quarter.

For the third Q ending September 30, Gaiam generated revenue of $51.8 million, which is 72% increase over $30.1 million in the third quarter of the last year.

The strong revenue performance was due to a combination of internal growth in both business and direct to consumer segments, as well as the contribution from media titles we acquired from GoodTime Entertainment in last September.

And as we said last quarter, because of integration of GoodTime's assets into Gaiam infrastructure, it's not really possible for us to report internal grow accurately in this quarter. However, if you would exclude revenue related to GoodTime's from third Q of the last year revenues, the revenue increase you would be over 100% which would be higher than 97% we reported in the first Q or 99% we reported in the second Q.

The best part of our report quarter's story is again our gross margin. Gross margin improved 750-basis points to 63% from 55.5% in the third Q last year. And this 750-basis point increase came on the top of 80-basis point increase we had achieved during the third Q of the previous year.

The increase was primarily due to strong media sale and elimination of the third party distribution fees after the GoodTime acquisitions.

Net income for the quarter increased to $1.7 million or $0.06 per share compared to $0.5 million or $0.03 a share a year ago.

For the nine months, revenue were $146.7 million, 87.7% increase from $78.2 million in the same period of last year.

Net income increased to $1.4 million, or $0.06 per share, from a loss of $145,000 or a $0.01 a share.

During this quarter we have increased our ownership in both Conscious Media and Spiritual Cinema to approximately 85%.

We continue to strengthen our balance sheet and as of September 30 we had $105 million in cash or equivalent, which is about same as the end of the previous quarter even after the cash we spend on these acquisitions. And this is up from $15 million we have at the end of the '05.

Depreciation, amortization expense for the quarter was $2.4 million.

During the quarter we increased our distribution network for additional 4000 stores to over 65,000 doors and expanded our branded presence to 5500 store-within-store.

At the end of September, according to Nielson VideoScan, Gaiam DVD market share in fitness and wellness category increased 330-basis points to 44.7% year-to-date and it was 47.2% in September.

And now I'm going to ask Vilia to discuss in more details the financial results and then Lynn will talk about the business. So Vilia, go ahead.

Thank you Jirka. As Jirka already mentioned, in the third quarter we generated revenue of $51.8 million, an increase of 71.8% over revenue of $30.1 million recorded in the same quarter last year.

Both of our business segments, particularly the direct-to-consumer segment, made solid contribution to the top line performance during the quarter.

Our growth was also fueled by overall strong sales including media titles acquired from GoodTimes Entertainment in September of 2005.

Beginning the fourth quarter we will be able to report our segment revenues on a comparable quarter-over-quarter basis as the revenues from the acquired media titles from the GoodTimes acquisition become part of our comp base.

During the quarter, revenues generated by the direct-to-consumer segment exceeded our expectations and increased to $32.6 million, primarily reflecting the GoodTimes acquisition coupled with our successful direct marketing program.

Revenues generated by the business segment increased to $19.2 million, reflecting a continued increase in number of retail doors and Gaiam branded store-within-store presentations.

We added 4000 new retail doors during the quarter, bringing our total number of retail doors to over 65,000, up from the 61,000 doors at the end of second quarter. The total number of stores and store presentations increased by 200 to 5500, compared to 5300 at the end of the second quarter.

Our gross margin increased 750-basis points to 63% in the third quarter, compared to 55.5% in the third quarter last year. The improvement in gross margin was primarily due to increased sales of media and direct marketing products, which carry higher margin and also carry higher selling and operating expenses.

Our increased media sales have allowed us to leverage our purchasing volume to receive improved buying discounts. We also continue to benefit from the reduction of fees previously paid for third party distribution.

As a result of the GoodTimes acquisition we provide vendor-managed inventory direct to several of our mass-market merchants. This direct distribution method provides improved gross margins that are partially offset by higher operating expenses.

Our operating expenses increased to 61% of net revenue in the third quarter of 2006, from 52.6% in the comparable quarter last year. This increase reflects the change in revenue mix towards media and direct marketing products, which carry higher at selling and operating expenses including merchandising fees and advertising costs.

Additionally, we continue to incur redundant distributions, systems and management costs associated with the GoodTimes acquisition. Our selling and operating expenses improved 630-basis points sequentially from the second quarter to 54% from 60.3% of revenue.

As we are able to retire the redundant intranet infrastructure and associated cost of maintenance and upkeep, we expect to realize additional cost savings in future periods.

Operating expenses in 2006 also reflect the additional amortization expense associated with the GoodTimes media library.

Our operating income for the third quarter totaled $1 million or 2% of net revenues, compared to $878,000 or 2.9% of net revenue in the same quarter last year.

We reported net income for the third quarter of $1.7 million, or $0.06 per share, compared to net income of approximately $505,000 or $0.03 per share for the third quarter of 2005.

For the nine months ended September 30, 2006, net revenues increased 87.7% to $146.7 million compared to $78.2 million for the comparable period of 2005.

Net income totaled $1.4 million, or $0.06 per share, compared to a net loss of $145,000 or $0.01 per share for the nine months ended September 30, 2005.

Turning to the balance sheet, at September 30, 2006, our working capital was $131.9 million, up from $37.2 million at December 31, 2005. We also ended the quarter with $105 million of cash and $210 million of shareholders' equity due to the completion of our secondary offering of 5.69 million shares of common stock last quarter.

Our days sales outstanding for the third quarter of 2006 were 26 days compared to 43 days in the third quarter of 2005.

Our inventory turns, calculated on a quarterly basis, were 3.3 times compared to 2.9 times in the third quarter of 2005.

Depreciation and amortization expense was $2.4 million for the third quarter of 2006, and our capital expenditures totaled approximately $750,000.

Now I'd like to turn the call over to Lynn for the business overview. Lynn.

Thanks Vilia. I will now talk more about the operational milestones we accomplished during the quarter and review our financial performance by business segment, as well as briefly touch on our go-forward strategy.

We're pleased to report that both of our business segments continued to perform well during the quarter, elevating our growth initiatives and emphasizing the strength of our brand.

We exceeded our revenue goals for the quarter. However, we're not yet able to assess if some of the increase may be early fourth quarter holiday sales.

Our retail trade segment, which primarily produces and distributes media and other proprietary media-based products to retailers, generated revenues of $19.2 million. This growth was due to a combination of increased demand for Gaiam's media and media-based products from our existing retailers, continued expansion of our brand in traditional and non-traditional retail environments, as well as strong sales of media products acquired in the GoodTimes transaction.

At the end of third quarter, Gaiam was distributing media to over 65,000 doors in the U.S., up from 61,000 at the end of second quarter.

Gaiam's media products can be found in a wide range of leading retailers including Target, Whole Foods, Barnes & Noble, Borders, Dicks, Jennie Craig, and REI who continue to rollout new doors with the store-within-store concept.

At the end of third quarter, we had 5500 store-within-store presentations, up 200 from the previous quarter. In the last 12 months we've added over 1000 store-within-store concepts.

Additionally, while our store-within-store performance remains strong in all classes of trade, it is particularly strong in the natural grocery, sporting goods and bookstore channels where we both are exceeding our expectations.

This quarter we rolled out several new product initiatives with great success. Under our flagship Gaiam brand we launched a new line of eco-conscious fitness products, which included yoga mats made from jute fibers and natural rubber, cork yoga blocks, and organic cotton yoga straps. These products represent an important statement by Gaiam that is squarely on mission since they are not only effective fitness tools but also good for the planet.

Our existing retail customers have responded well by ordering and selling this new product line, including natural grocery retailers such as Wild Oats and Whole Foods as well as traditional sporting goods retailers such as REI. To date, sales are strong and exceeding our expectations.

We also successfully refreshed and transformed The firm, a brand we required in the GoodTimes transaction from an infomercial brand with only an in and out presence at mass retail, into a brand capable of sustaining a consistent presence at mass and mid-tier specialty retailers.

We did this by creating and launching a complete line of fitness DVDs and media-based kits specifically targeted to women shopping in mass and mid-tier retailers. This initiative enabled us to open new doors and store-within-store in a variety of retailers including Ulta, a beauty supply superstore, and a variety of drug and mid-tier retailers such as Longs Drug. To date, sales are strong with sell through higher than expected.

Our media sales continued to be strong this quarter. At the end of September, according to Nielsen's VideoScan, Gaiam ranks sixth in overall non-theatrical U.S. DVD sales.

Gaiam's year-to-date DVD market share for the fitness wellness category increased from 41.5% in the same period in 2005 to about 45% year-to-date, and was 47% in September, which was more than four times greater than our nearest competitor.

Currently, we have five titles in the top ten best selling fitness DVDs year-to-date. And as I previously stated, Gaiam's media products are now sold in over 65,000 doors giving us what we believe is one of the largest retail penetrations of any media company.

Our direct-to-consumer business segment continues to attract a loyal following and increased to $32.6 million in revenue for the third quarter.

The growth in this segment was driven by direct marketing efforts around brands such as The Firm, as well as strong consumer sales in our solar division.

As previously announced, we're making significant investments in the direct-to-consumer segment and are now prepared to begin to capitalize on many of our offerings, including the recent Spiritual Cinema Circle acquisition. We are looking forward to offering our new subscription services to our existing customers, and to move from transactional to relationship selling including subscription and continuity models. We will begin test marketing these products to our direct customers in our upcoming holiday catalogs

We currently have approximately 7 million buyers and will circulate about 20 million catalogs in 2006.

To expand our customer base and improve our brand recognition we're reviewing new media distribution partners. Next month we'll be launching four Gaiam branded channels with Blackberry's new audio service. These channels will include yoga, meditation, weight loss, and guided solutions for stress relief.

Gaiam will be in a package of services with other top tier media companies such as ABC, Accuweather, Clear Channel, Wall Street Journal, and Westwood One.

Additionally, we launched a broad offering of titles on Google Video at the end of October, which are available for download or rental.

Our partnerships with Blackberry and Google are a good statement for Gaiam as they validate our market leadership in the health and fitness space, and provide us with additional branding opportunities.

On the DR-TV side we experienced greater than expected demand for our Tae-Bo and The Firm properties. During the quarter we were able to run additional advertising for The Firm in support of the launch of the brand at retailers across the country at the end of September. DR-TV is a good brand builder and carries high margins along with high operating expenses.

We are continuing to invest in online content and community and expect to launch our first Gaiam community site in the next 90 days.

Our Go Zero partnership with the Conservation Fund continued to exceed all expectations during the quarter. In less than four months into the program our customers helped plant over 10,000 trees, demonstrating, again, their true commitment to Gaiam in our efforts to improve the health of the planet. This program is another testament to our customer loyalty and their growing environmental awareness.

Gaiam has also calculated the emission rate for two of its largest facilities, the corporate office and our distribution center, and donated money to plant trees to have both facilities Go Zero this year.

Our selling and operating expenses decreased by 630-basis points from second to third quarter as we completed the GoodTimes integration. However, we are still being impacted by certain costs associated with operating and system redundancies as a result of the GoodTimes Entertainment acquisition. We expect to see improved leverage by the end of 2006, as additional cost reductions are realized.

In summary, we're excited about the future and believe that we have a proven strategy and infrastructure in place to continue to expand our overall offering. During the next few quarters we'll see the launch of several more online clubs and services capitalizing on the early successes we're having in this emerging market.

We've begun to leverage our newly completed in-house production studio to create high quality content for our new media efforts with modest production costs.

With our current high quality media assets and our loyal customer base we're well positioned for growth as the premier brand in the low cost media space.

And we're confident with our previous 2006 guidance of over $200 million in revenues and gross margins over 60%.

I would now like to open the call up for questions. Operator.

[Operator Instructions.] Gordon Hodge with Thomas Weisel Partners.

Great. A couple of questions. One, just wondering direct response television, could you give a sense for how big or what percentage of the direct-to-consumer revenues that represents versus last year? Just roughly. And then, I don't know if you will be willing to give us a sense or an update on the subscriber numbers that you have but obviously you've pulled it in Spiritual Cinema Circle, just wondering between your current offering and then where you are now with subs.

And then last question. Wal-Mart as a percentage of revenues I think is relatively small, I think they buy about a third of the DVDs in the country. Just wondering what your plans might be to tap them as a customer as we move into next year. Thanks.

We'll try to break the questions and you may have to ask some again. But first, the subscription I'll that on. We said we would not-- we would announce it where we at 100, we not quite at 100 but we close.

The second one was the television stuff. Lynn, do we have numbers here? We try to figure it out if we can break it out, we can report it as separate numbers so we try to figure out if we can do it. So give us some little time.

And Wal-Mart is for Lynn.

Yes. On Wal-Mart, yes, they're a small portion of our business right now and we see that as a tremendous opportunity, particularly as we begin to capitalize on having some of these mass brands like The Firm.

So we think there's a tremendous opportunity both in the media space and in the media-based products space for additional expansion in Wal-Mart.

But we shouldn't expect Wal-Mart to be-- or The Firm brand to show up in Wal-Mart in a meaningful way until next year sometime?

Yes, we do not have any firm orders for them except some of the media titles at this time.

Thank you.

We try to figure the overall impact of the infomercial stuff but we have-- we tried to figure out it was going to be probably somewhere in like low mid-digits, single digits as a percent. But Vilia tried to figure it out but we might have to call you back on that one.

We don't report that number so we have to start different pieces to try to get a good number. So why don't we just follow up on this and call you.

That'd be fine. Thanks.

Mark Argento with Craig-Hallum Capital.

Good afternoon. Had a couple of quick questions for you. Jirka, I know when you guys are in the midst of a significant reinvestment period for the business in terms of some of the community, the subscriptions, sending out incremental catalogs to build up the customer list, could you provide us with just a little bit of color on the magnitude of these investments relative to kind of the run rate operating expenses that you would normally incur in the business either in dollar terms or margin terms. Just give us some way to quantify some of the investment that you're putting back in and hopefully that we can see some leverage from going forward into '07 and '08.

Let's just try to take a shot but we don't want to talk about this investment as we said all year specifically what they are, they're just part of our operating expenses. But let's try to help so, Lynn, why don't you take a shot at that.

Yes, Mark, a couple of things. First of all, some of the operating leverage you're going to see is as we migrate to one web platform to build all of the subscription and continuity plugs on it. Right now, we're on four different systems. You'll see leverage as we build one system and we hope to have that complete by the end of first quarter.

You'll also see some improvement in the operating margin as we migrate away from some third party customer service and operating expenses.

So both of those are underway. As far as the investment, we are investing in systems; we're investing in content. We don't really want to publish any of those numbers right now but I think you'll see over the next 90 days as we launch the community, you'll see the kinds of investments we've made.

Yes, since the last time on the call we have been testing different clubs and they will actually increase as the different products as we develop them and test them until we decide which products are truly going to mass market and we have a lot of costs [inaudible] revenues which will start reversing end of the next year.

So then we just kind of run it through-- we delete, we have in our leverage, on our operating from what Lynn talked about, so you know, we said that's our big things for next year to keep inventing these clubs and subscription. And I think we delivering numbers ahead what we even thought. So we pretty happy and we want to really take our leverage away from really building these clubs because I think we are the first out there and we now really have a strong offering when we are next year.

I'm just trying to get my hands around some of the costs. I mean it sounds like you're building content and using that to test various offerings of your content costs. If you could throw it into some buckets where are some of the different spending items that you guys are incurring right now?

Mark, we don't want to really start on the discussion. Those are our operating expenses right now. Until we get our revenues we will keep it there.

But is it content cost generation? I mean, are you guys spending a lot to build your database up? I mean any color there?

There is the content, there are systems, there are new products what has to be developed and tested which will mean we have meaningful revenues and we expending the customer some of that side.

And customer acquisition costs.

Talking about, in particular, the employee headcount right now. Where are you guys at right now versus say a quarter ago and a year ago if you have those numbers handy?

I don't have those numbers handy but what I can tell you is as we told you we were going to be at 100 employees left from the GoodTimes which originally started with 750 and we're there.

And then a little bit about Spiritual Cinema Circle. Is that fully integrated? And I saw in the press release you mentioned that you took up your ownership in that business a little bit. What was the thought there and what's the opportunity to roll this out in mass? I know you said you're going to start to do it in some of the catalogs but is that something you're going to get more aggressive with here going forward or is that still going to be in beta mode?

I'll take a couple of those questions Mark. First, as far as rolling that out aggressively we put it in our catalogs but we're testing a lot of different offers to see which one works. So, we're testing package inserts, different types of offers, and we want to make sure that our loyal Gaiam customer is pleased with the product before we really mass market it.

We also are just now starting the integration; we have not and don't expect to have an integration there finished until first quarter.

We have just increased that position. Effectively when we did that, we obviously like the club, it's a good margin, and when we bought the company there was like five different pieces to the company, the club, and they have different offerings and they also have investments and some production company, which we didn't particularly care about, so we traded some ownerships and made some money so we basically decreased our ownership in the production company because we don't want to be in a business of financing clubs and we just get the clubs.

So basically we separated and we increased our ownership in the clubs and direct offerings to distribution and subscription and divest ourself pretty much from any financial exposure on the production side.

Lynn, you had mentioned in your prepared remarks about you made some enhancements to your production facility. Can you talk a little bit about that? Specifically what type of enhancements and what the production facility and all looks like.

Yes, we have an in-house studio and what we did is we just redid the studio so that we can use it to shoot for web offerings and be able to shoot and have it up on the web within 48 hours. And we have it set up now where it can be more like a demonstration area and interview area, so we can, again, have current content on our website very quickly at a reasonable rate.

Any plans to put that into production and start using that quick turnaround?

That's absolutely part of our investment in communities and continuities.

Is that a stay tuned for the next 90 days?

That's a stay tuned.

All right, fair enough.

It's a part of as we talking about our community. The community in the web is just primarily done for that, part of our investment.

Just a couple of quick housekeeping questions. In terms of the amortization expense in the quarter related to the catalog, I don't know if you have that handy, I think you said in the aggregate it was $2.4 million.

$2.4 million was on depreciation amortization total. If you want to get to EBIT that number so that would be added to the income.

Right. Is the majority of that the amortization of the catalog relative to the GoodTimes deal?

Yes, media library.

Okay. And stock comp in the quarter, was that material?

It was not material but it did increase in the second quarter to a little over $100,000.

And then do you have an operating cash flow number handy or any type of cash flow number?

We, I think, generated about $3.7 million for the quarter on operating.

Right. And how much did you spend in terms of the acquisitions in the quarter? The Cinema Media Circle, what did you pay, was it $6 million cash or $3 million cash?

Well, in this quarter was roughly about same amount as the operating cash flow. That's why pretty much we have about same amount of cash as we have at the end of the second quarter because what we spend that's what we generated internally on the post-taxable basis.

Okay. And then in terms of the mix between the direct and the retail business or I think you call it the business business-- business segment and the direct-to-consumer. What should we look for in terms of the mix in Q4? Is it more flip back over into the retail channel or what's the thought there?

I think you'll still see it because the consumer channel is so strong for the holiday season. You'll still see a little bit more than we had in the past that the retail sector, it won't be quite as skewed as it is in third quarter.

Great, thanks for the time.

Robert Routh with Jefferies and Company.

Yes, good afternoon. A few quick questions that haven't been answered yet. First, I was wondering if you could comment a little bit on the GoodTimes library obviously has a lot of titles in it that don't fit with your model at all in terms of genre. I'm wondering if you guys are planning on doing any title swaps or sales and, if so, how close you might be doing that?

And as far as the catalog business goes that's obviously a very capital-intensive business. I was wondering whether you have any intention longer term to keep that or to possibly divest it and make your catalog 100% online to improve your margins?

Well, as far as, yes, we have still some titles which don't exactly-- we don't have such a good place there and we said that we would look at that when we finalized our position which is pretty much done right now. I think we done as of third quarter, we've done a- tidied up because of the 12 months from the deal everything. So we can pretty much right now look at those titles. We will try to-- obviously these titles are valuable to different people, probably more than us, so it will make sense that we do some swap.

As far as overall divestiture of the segment I don't think that's kind of in our plans however you never say never to offers we might get. But, for us is more looking-- our market share obviously increasing pretty nicely, we right now four times the next competitors and the order from mid-range between the studios on the non-theatrical and so with our internal assets of investing these titles we can have a title down for 100,000 when somebody else pay $5 million for same unit distribution. So we don't have any reason to really do that unless the offer is interesting.

Okay. And as far as the subscription clubs are concerned, I believe you have around six clubs now. Can you tell us what you're hoping the goal is in terms of how many total clubs you think you can have and then ultimately what you're going to do with them? Because obviously you can't have too many out there without rolling them out or rolling them together. And go over a little bit about the economics of how those clubs work because I don't think most people are aware of exactly how you make money on a subscription club basis at this point.

Well, from the money point of view, the average subscriber would pay like a the Spiritual Cinema-- the person would pay about $25 a month including the postage and the cost of the package is going to be more-- just everything bill at $5 probably. So it's a pretty good margin.

If you really the question, the content and how you deal with that part, and so the profit of it's pretty obvious. Is the question of the marketing and subscribers. We still, right now, the cost of our subscriber still it's single digits which is well below margin but we still testing it. But, it's more the question of when we roll it wide, how successful we have those conversion rates, not were they very high but it's limited.

You absolutely right, we cannot have so many of these clubs but we will pretty much want to offer some master plans will incur most of them together and as we expect to do that if you subscribe to one, for a small increments you can get all the others or some of the others.

Right now we have six or seven-- seven clubs right and we testing other different version of those so you might have different package, different way to do it, [inaudible] music free and different marketing packages what obviously costly but it's-- I don't know, we have a really planned how many clubs we would have. I know today, but we would try to tie them together in some kind of master plan but a lot of people will, I'm sure, subscribe just to specific club. But I don't think we have to have a lot of them, it's more find the best one and mass market them to our base.

Find the correct offer that works with the lowest customer acquisition cost and the highest picking at the customer, that's all the things we're testing right now.

Great. And just two more quick questions. I was wondering if you'd go over a little bit how you account for the store-within-store displays because you own them but I don't really see them on the balance sheet which would imply to me that you're expensing them now which would result in higher net income in the out years once you have fully built out that particular display model.

And then also if you could comment a little bit on the percentage of product now they're proprietary and what your ultimate goal is on that respect.

Well on the fixture expense, historically we have expensed those with the first order. And with the margin that we have we were always able to pay for that fixture with the margin from the first order.

So, yes, there's nothing on our books for them and so there's lots of opportunity in the future to improve margin because of that.

In regards to-- what was the question?

Can you repeat the second part?

The second part was what percentage of ultimate sales do you want to be proprietary going forward?

We always want to have at least 20% of our sales in third party products, Robert, so that we are constantly testing what's new in the market. And that'll always be on our direct side where we have the early adopter as a direct customer. And by testing there with third parties then we can know what's going to be successful prior to actually making it a proprietary product and taking it out to retail. So I think we can get to 80% of proprietary.

And we currently have--

About 65%.

Okay, great, thank you very much.

And pretty much you understand all our offerings through the third party are like to retailers, to the 65,000 distribution channel. That's all Gaiam products. The only place we would carry third party products are in a direct means catalog, actually even not on infomercial side, it would be only in catalog and--

On the web.

And we testing it because it's relatively easy to get out of it and we don't take inventories.

Thank you.

[John Pinto with Brightly Capital.]

Great, great quarter Jirka, Lynn. Had a couple of questions that maybe you can go quickly through. One is, can you give me any directional view on the gross margin of direct versus business? Especially as you grow out the media on the direct side around that 60% I'm assuming that direct is a fair amount higher than business is that fair to say?

Yes.

Is it 500-basis points, 1000-basis points, is it somewhere in that range? I mean it's a meaningful number right?

Yes. Direct is in different pieces so we have to kind of separate like the clubs. Yes, they have a very high margin in the high 70s. The catalog, when we sell third party products, will be more like 50. But the catalog overall will be more like 60. That's pretty much were the company average is.

So it really varies. On the retail side, the trade side, we have-- it's more-- if it's a media or it's majority, we still have very nice margins probably somewhere in 70%. But it depends still the retailer you would sell it because obviously people who buy more get better deal.

But we have some units like our solar unit and that margin will be more like 30% so that skew the margin a lot. And that's reported through our direct segment. So that lowers the margin so if you take all the reported margin, the difference not that big, but if you take the units then the answer is yes.

Okay, but all in all as you grow the club and as the direct-- I mean you're growing the direct business at a faster rate than you're growing the business business or the retail business?

That's correct.

But the clubs-- so both clubs and community margins will be very high, probably in 70s, high 70s.

Right, okay. I guess on the next one, just any ways for us to kind of understand what the fixed-- and other people were asking different ways at this, but what's the fixed and variable nature of the cost structure is at this point? You did a good job, generated operating income this quarter, but you still said you're having some redundant cost, you're growing the business, anyway to kind of look at how we should see the operating cost aspect of this in terms of what is variable, what is fixed?

Well, you have the expenses as we had in the press release [inaudible]. You take them, they'll be in a Q which we expect to file tomorrow.

You have the, what do you call, general or central expenses which is pretty much fixed and they came this quarter they from I think 7.2 down to 7. And they pretty much decrease quarter by quarter so I think we have the basics leverage you actually see that for several quarters because they [inaudible] fixed.

Then you have the marketing, the selling and operating which most of that is variable tied to specific sales expect the basic distribution and the sales force are relatively fixed.

But there is a lot of redundancies there, so we have 630-basis point improvement sequentially and we expect that you have additional improvement in fourth quarter.

So, but it's very different if you do something like infomercial, the expenses may run 80% of sales or if you run something-- if you sell a DVD to existing accounts that will be more in like 30% range. You got a big difference.

Yes okay. Well, I'll qualify some details and I'll follow up on that some other time. But the other one, you mentioned on the Q4 when I think Craig-Hallum analyst asked about revenue breakout between businesses and direct, I guess the way that I read it is that as in this quarter you would still expect the direct business to be higher than the retail business but not as broad a difference. Is that the right way to interpret?

Yes, that's correct.

Okay, so if I look at the retail business that you did last year and I grow it a little bit because obviously you've grown your distribution points, you've grown the amount of content that you're pushing through there…

It's growing pretty nice.

Excuse me?

It's growing pretty nice.

It's growing pretty nice and then if I say that the media or the direct business is bigger than that it's a big number. Am I missing something here nor not?

No, you don't.

The next is on this $200 million of guidance that you're giving, how much of that would you say is sales to the core Gaiam customer versus what you've tapped into the mass-- the kind of the wannabe or that next level of person that isn't your core but that is now understanding what you're doing? Or have you really tapped into that much at all yet?

Okay, let's try to furnish to the previous question what you ask on the-- I'm going to try answer it, what you were asking. But, the GoodTimes acquisition is going to be in the last quarter-- I mean fourth Q '05 we have a full GoodTimes, in the third Q '05 we have [inaudible] it a little. So that's really-- so you know that right?

Yes I do.

Okay. So this new question, how many of Gaiam core customers--?

I guess in the way that you described before the Gaiam core customer revenues versus as you're building out your retail points and you're building out your catalog base to approach more of a mass market interest in wellness, of your revenue base right now of this year, how would you describe how much of that revenue base is to core Gaiam customers versus you tapping into that less core customer? And I'm purposely being vague with the question just trying to see how you define your revenue base at this point.

I think for us pretty much you selling to existing customers. We should obviously get some new customers but it will be-- what you call core customers I think will be most of the sales. And new customers will come more from a DR-TV side and catalog prospecting; otherwise you pretty much sell to core customers. You might have some new doors for retailers but the core of sales come from the big accounts that we already have. Or the majority of sales come from the core customers.

I think you'll find that as we expand The Firm brand we'll start bringing a different customer-- appealing to a different customer than we currently have with the Gaiam brand.

Okay. And I assume by that you also mean a much larger market size.

Well at least the mass market.

Okay. Great, thanks guys.

[Karen Pane] with Pacific Edge Investment Management.

Thanks. I had several questions actually. First of all, the last caller mentioned a $200 million guidance number. I didn't know if you had actually said that in your earlier remarks. Can you clarify that though, is that for fiscal or calendar '06?

Yes, we said that in beginning of '06. Actually we said in end of '05 and so Lynn just confirmed that we still comfortable with that number. We expect to be for the year '06 ahead of the $200 million.

Ahead of $200 million. Okay. And then can you-- I know you don't break it out specifically but can you estimate what media sales represent as a percentage of total sales?

We kind of always say it's more than half and it's probably-- now it's kind of been growing, we kind of-- it's really a question of what media, how you count media, because we have-- a lot of our media sell in kits so they might be two DVDs but you might have yoga straps and something in it right? So, that's a big part of our sale.

So how do you allocate that so that's why we don't always [inaudible] just the DVDs but somewhere in the high 50s probably on media sales. Without being questions want to start-- how do you develop a [inaudible] cost of revenues kind of a question that you do these kits and kits sells really well for us so it's really important part of our offering

Okay. One of the analyst reports I read suggested it was as much as 80% of your total revenue.

That wouldn't be correct. I think-- and also depends, you have to look they report it by segment? Because it will be much more on the trade than it would be in direct.

Okay. Then you talked about migrating away from using some of the third party services that were related to GoodTimes. Can you tell us when we should expect to see the benefit from that?

Sometime in the first half of '07.

So not in Q4?

No.

Okay. Then did you have any revenue contribution in Q3 from Spiritual Cinema?

Yes.

Can you say what that was?

The revenue contribution was around $1 million in Q3.

$1 million?

Yes.

Okay, then two more questions. The first question's related to weeks of inventory in a typical store and I know that your store base is pretty diverse. But is there any kind of rule of thumb or what kind of assessment do you make to gauge what are weeks of inventory that are sitting on hand in stores?

Well, we kind of-- it really so varies by the store and size. But Vilia, can you comment on the inventory returns for the quarter?

I'm sure.

It's how we pretty much all look at that and we look at it by segments and stuff. So the less inventory out there so we support the sales.

3.3 times in this quarter ant that's up from the 2.9 a year ago.

Okay, but to be clear, let me make sure I understand, you're sales are recognized on sell in or sell through?

Sell into the retailers.

So what I'm after is your inventory turns are the inventory that's on your books. I'm after how much inventory is out there in the channel and how do you gauge that?

We really don't know.

You know, we don't have-- certain retailers we get that information from, others we don't. We certainly can't share proprietary information from our retailers.

But if the question is since we don't really use wholesalers, some people like stuffing the channel, is that what you're talking about? We don't have that opportunity to sell directly to retailers. Wholesalers you have more flexibility for how much they use. Being direct it's not really even a possibility for us. And we have our reports, really good ones for people like Target, but I don't think they've allowed us to share it.

No.

Okay. And then finally, so you reported 65,000 storefronts this year and as based on some analyst report it looks like you had about 40,000 a year ago. And so your doors are up about 63% year-over-year. Does that seem right? 65,000 this year compared to 40,000 a year ago.

I think that number is-- the number is probably right.

I think we ended last year around 50,000 doors a year ago.

At the GoodTime acquisition we had about 40.

So that's a pretty rapid growth rate and it's been part of your strategy for the last couple of years to build that, but at some point do you start to reach saturation in terms of I really can't open any more storefronts without overly saturating the market with my product? And where do you think that would be?

We expect to expand again in fourth quarter a number of doors but you have to look at it, it's not that from the revenue point of view, it's much more important to us to get extra store feet in Target than open additional couple of thousand doors. It's really number of media titles you can get into those doors.

And also remember, we are now expanding by having a second tier brand in The Firm -- an important differentiator.

Gordon Hodge with Thomas Weisel Partners.

Yes, just a couple of follow-ups. Just curious if you could give us an update on international sales, where they're trending?

And then you have $100 million of cash obviously on the books and a currency that's working again, and just curious if you can give us an update on what you see out there in terms of M&A opportunities? Is it a active market? Is there some interesting things out there you're looking at or is it you're just waiting for an opportunity? Thanks.

I'll address the international front, Gordon, and we are just in the process now of launching our international initiative. We shoed at [Netcom] recently and we had some-- a lot of interest in the product so I'll be able to tell you more about that at the end of fourth quarter, after we do some investigative work on the different partnerships we might have from Netcom.

I think one of the interesting parts, of course, with international is that we have [Martha Van Gelder] onboard who ran international for Sesame Street and built that brand and she came onboard about four months ago, four or five months ago, and so she'll be building that and Netcom was our first launch of it.

International is just about starting and obviously it's all 100% margin because we didn't do so it's all licensing deals mostly, pretty much all of that right now. And on the cash side, we said we would like to finish the GoodTimes, which we did, and then the [inaudible] we have to drop everything and hopefully everybody's right now ready to take on another deal because in a deal like this, which it kind of takes a lot from the people, I think everybody would have time to recoup. But we heading in a strongest quarter but that doesn't mean we cannot already start to do acquisition. So we have several deals in negotiation and various sizes.

We [inaudible] to increases what we want to do with my still [inaudible] one of those two in higher level and start to pick some more on primarily right now we would looking as a gain to club and also developments in the trade.

So, but the media is still obviously very attractive because of the leverage. So there are several deals out there and we'll see just to the right timing but so that's where we at.

Sounds good, thanks.

Thank you. At this time I'm showing no further questions.

We would like to thank everybody and hopefully we talk to you on our next call. Thank you very much.

Thank you. That concludes today's conference call. You may disconnect at this time.