Gaia Inc (GAIA) 2008 Q3 法說會逐字稿

Welcome to the third quarter 2008 financial results conference call. At this time, all participants will be in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, today's conference is being recorded. If you have any objections, you may disconnect at this time.

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

Thank you. Good afternoon, everyone, and welcome to Gaiam's third quarter 2008 earnings conference call.

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 in this call are forward-looking statements that involve risk and uncertainties, including but not limited to, general business conditions; integration of acquisitions; the timely development of new businesses; the impact of the 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, is Mr. Jirka Rysavy, Chairman and CEO; Lynn Powers, President; and Vilia Valentine, CFO.

And now I'd like to turn the call over to the Company's Chairman and CEO, Jirka Rysavy. Go ahead, Jirka.

Okay, John. And welcome, everybody in our third Q call. As we discussed on our second quarter, which was in early August, we did expect our retail customers to heighten their focus on inventory levels and take a conservative approach to holiday buying in the third quarter. However, obviously due to September financial loss, those factors had a more significant impact than we expected, especially in the month of September.

We believe currently that economy turn when September cost us during the quarter, mostly during September, about $10 million in revenues and about $0.10 to $0.11 in EPS line. And based on what we have seen in October, we currently expect that impact on our fourth quarter will be similar.

Revenue for the third quarter, which ended September 30, decreased 14.3% to $60.3 million from $70.3 million in the same period of last year. Results for the third quarter included -- third quarter in 2007 included accelerated holiday orders from retail customers of approximately $6 million to $8 million, as we said last year, and also much higher international revenue, which in this quarter of this year, were heavily affected by transition to licensing.

Excluding the international revenues and the quarter-over-quarter impact of the early holiday orders [of which were ships] in '07 during the third Q, the revenue gross over the quarter would be approximately 15% and internal growth approximately 8%, compared what we actually [plot] and recorded, which was negative 7%.

Gross margin increased -- sorry, decreased to 56.1% of revenues for the quarter from 65.6% in the third quarter of last year. The margin decrease was heavily impacted by first our expansion to our lower margin solo business and then by our decision to expand Gaiam distribution footprint by maintaining retail prices, while absorbing product cost increases from higher gas prices and the dollar decline.

The -- and on strategy to aggressively pursue the retail door and stores within the stores, as well as media category management expansion, will continue to impact the margin during the first quarter. We expect that our margins will return to mid-'60s ex-solar by the first quarter of 2009.

Including the charge of $0.36 per share, we recorded another expense line. Our net loss for the quarter was $10.1 million or $0.42 per share. That means about $0.06 per share loss, excluding the charge.

This $13.9 million or $0.36 per share impairment charge includes a non-cash, tax-deductible impairment charge related to companies-acquired media libraries, website development costs, and related assets. This charge accelerates about $5.5 million of tax receivable, which brings our overall deferred tax benefit line in our current assets to over $12 million. We expect to receive that in early 2009.

While we cannot control the economy as we move into holiday season, we are focusing on many manageable aspects of the business, such as key strategies, products and growth initiatives, which we expect to strengthen our core business and enable us to expand our market share and our position.

We continue to evaluate opportunities which the current environment can yield for our Company, with a good balance sheet and debt-free and with good cash flow. Right now we still see a good opportunity to drive additional shelf space at our retailers and further distance ourself from our competitors.

We have consistently delivered strong sell-through and our retailers are quite receptive to giving us more space. So we intend to pursue this plan. Also benefiting from our strong cash position during the last few days, we won a large price concession on products cost, which will benefit us during the first Q of 2009.

We continue to negotiate with our retail partners to expand our category management. And we plan to increase our control of shelf space at retailers by expanding our store-in-store presentation. It's obviously our main focus.

We ended the third quarter with over 73 retail doors, which is up from 71,000 last quarter and remain on track to be at 75,000 doors by the end of January, as we said in the last call. We ended the quarter with over 9,000 store within a store locations, up from 6,500 at the end of the same period of last year, and 7,500 by the end of what we reported in the last quarter. This is obviously a huge increase from [9,000] and we believe that we have more to go, and we will focus on this strategy because it will be very, very valuable in the future.

We also are accelerating transformation of our direct business from transactional selling to relationship model and through our communities and clubs. As of September 30, we grew our membership to 235,000, and which contributed approximately $25 million in revenue on an annual basis. We believe that the retail will grow to 300,000 members by January; obviously, the main push will be during the holiday.

Our cash position remains strong with over $50 million in cash in end of the quarter plus additional $12 million on our returning tax benefit line. We still have no debt and have untapped [$15 million] line of credit. We show this cash position, no debt and current ratio at 5.4. We definitely differently have the ability to weather the prolonged downturn in the economy and still accelerate implementation of our strategic plan.

And because of the initiatives, what we did this year, especially our aggressive market share approach during the second half of the year, we believe that even without any improvement in overall economy, that the year 2009 is going to our best year ever. And that both in the revenue and EPS lines.

So that combined with our current stock price, which is close to our net tangible value, between $6 and $7, is our strong cash position at $42 million value and our publicly traded sole subsidiary should provide significant upside to our equity evaluation with very good downside protection.

Now I will turn it over to Vilia, who will give you some more detail on the numbers and then to Lynn for a business overview. So Vilia, go ahead.

Thank you, Jirka. In the third quarter 2008, we achieved revenue of $60.3 million, down 14.3% from $70.3 million in the third quarter of 2007, as we faced overall challenging macroeconomic conditions in the US. International revenue declined as we shifted to an international licensing model in the first quarter this year. Also impacting our comps are the early holiday orders we received in the third quarter of 2007.

For the third quarter 2008, revenue from our Solar segment doubled from $4.3 million to $9.5 million, reflecting acquisitions of California-based solar companies since the third quarter of 2007. For more information concerning results of Real Goods Solar, a separate earnings call will be held tomorrow, Friday, November 7 at 9:30 a.m. Mountain Standard Time.

Revenue generated by our Direct to Consumer segment decreased 4.8% to $34.2 million from $36 million in the third quarter of 2007, in part to our decision to reduce catalog circulation and direct response marketing as well as the overall economic environment.

Revenue from our Business segment decreased to $16.5 million during the third quarter of 2008 from $30.1 million in the comparable period last year. The revenue decrease includes $12.8 million lower international product sales, which includes the shift to licensing arrangements and the disposition of our UK operations, and approximately $6 million to $8 million of early holiday orders received in the third quarter last year. Excluding these items, our Business segment revenue grew by approximately $3 million.

Our gross margin was 56.1% of revenue for the third quarter of 2008 compared to 65.6% of revenue in the third quarter of 2007, reflecting the shift in our sales mix to lower margin solar business and our aggressive approach to retail positioning. In addition, foreign currency fluctuations and raw material costs resulted in an increase in product costs and certain core items. To help mitigate these cost increases, we renegotiated certain manufacturing arrangements and transitions from overseas manufacturing to new, lower-cost, but still high-quality vendors.

As a result of these initiatives, we expect to return to our mid-'60s margins for the Business segment in first quarter 2009 as we place orders for new inventory. The strength of our balance sheet affords us this opportunity at a time when other companies are passing cost increases on to both retail partners and the end consumer. As Lynn will discuss later, this was a key part of our strategy to continue to grow market share and build brand loyalty with our customers.

Our selling and operating expenses decreased to 11.9% to $34 million from $38.6 million in the same period last year, reflecting cost control initiatives we implemented to help mitigate the effect of lower revenues. These initiatives include reducing catalog circulation, payroll and incentive reductions, and integrating recent business acquisitions.

Our corporate, general, and administration expenses improved to $3.1 million from $3.3 million in the same quarter last year. Depreciation and amortization for the quarter was $2.1 million.

As Jirka mentioned, we recorded in other expense, a charge of $13.9 million, consisting of impairments of our media library, tangible assets primarily related to website development, certain deferred advertising costs and related assets, as well as severance costs. Impairments to our media library were primarily for titles acquired through historical acquisitions.

Our interest income for the third quarter 2008 decreased to approximately $300,000 from $1 million in the same period last year, reflecting both lower interest rates and lower cash investments. During the year, we used cash to fund operations, repurchase our shares, acquire businesses, and invest in infrastructure.

Our capital expenditures of $3.5 million in the quarter include investments in our infrastructure of $2.3 million and video production costs of $1.2 million. Our day sales outstanding improved to 40 days this quarter from 43 days last quarter. Approximately 75% of our receivables in the Trade division are comprised of our top 10 customers who are household names like Target, Wal-Mart, Dick's, Amazon and Best Buy.

For the quarter, we recorded a loss per share of $0.06, excluding other expenses of $0.36 per share. For the third quarter of 2007, we reported earnings of $0.12 per share. For the nine months, our revenue increased 0.8% to $182.7 million from $181.1 million during the same nine-month period last year. Our net loss for the current nine-month period was $5.3 million or $0.22 per share, from net income of $4.3 million or $0.17 per share for the first nine months of 2007.

Our balance sheet remains strong at the end of the third quarter with cash at $50.3 million, no debt, and $15 million of availability on our revolving credit facility.

Since the first quarter of 2008, we repurchased 1.3 million shares of our Class A common stock for a total expenditure of $19 million, and spent approximately $17.7 million for our new corporate building and building improvements, including a solar PV system. At the same time, average short-term interest rates have declined to 2.65% as of September 30, 2008 from 5.24% at September 30, 2007. We had 24 million shares outstanding common stock as of September 30, 2008.

We remain optimistic about our long-term opportunities. By diversifying and expanding our market share through new product offerings, distribution channels, and our online communities, we are positioning ourselves for continued growth when the economic climate improves.

Now I'll turn the call over to Lynn to provide more detail on how we are positioning ourselves for long-term growth.

Thanks, Vilia. In the midst of the current economic challenges which are beyond our control, we spent much of the third quarter focused on our key strategies, products, and growth initiatives, which will strengthen our core business, enable us to expand our market share, and position us for long-term growth.

Recent industry drops in same-store sales in the retail sector have begun to affect the Business to Business segment, as our customers have heightened their focus on inventory levels, taking a conservative approach to holiday buying, and increase their focus on vendor chargebacks. The Direct to Consumer business also experienced modest declines, due to lower overall consumer confidence and buying trends, as well as the weather-related impacts of Hurricane Ike in mid-September during the drop of our first holiday catalog.

As we move into the holiday selling season, we remain focused on the core strategies that we control and that will support the long-term growth and health of our business. These strategies include -- enhancing our current distribution through the implementation of our store within store concept; expanding our category management program for media; increasing the number of our retail doors; diversifying our portfolio of brands; and expanding our reach to new demographics through the development of key strategic partnerships; continuing to encourage our direct catalog customers to utilize our e-commerce site to drive optimization and retention; and transforming our direct business from a transactional model to a relationship model through our communities and clubs.

I'd now like to elaborate on some of our key initiatives and accomplishments by business unit.

Comp sales on our domestic Business to Business segment were down 8%, compared to the third quarter last year, reflecting the early holiday orders received last year at the end of third quarter. Looking forward, we expect the Business to Business segment to improve in Q4, as retailers are shifting some holiday orders from third to fourth quarter as a part of their conservative approach to this year's holiday season.

This holiday season, we have also additional offerings that will drive new business, including Biggest Loser branded accessories; a new line of Gaiam eco water bottles; Gaiam new item corrugates; and three new holiday family feature films, which are expected to create excitement at retail.

International revenues contributed over $13 million in Q3 '07, as our distributors took inventory for fourth quarter as compared with approximately $1 million in Q3 '08. With our change to licensing, there were minimal revenues in international this year, as our partners moved through inventory purchased in '07 and early '08. This impact should dissipate by the end of first quarter 2009.

With a 46% market share in fitness media, up from 44% announced in Q2, our position in the market relative to other fitness media players is more than twice that of our nearest competitor. We believe there is an opportunity for continued growth here, as our category management and store within store initiatives expand.

The category management initiative remains a key strategy for us in enhancing our share of the market and counteracting the effects of the weak economic environment. After successfully implementing this strategy in the third quarter with Target, we are in the planning stages with several other key accounts in the sporting goods channel to implement this strategy in Q4 and early 2009. We are on track to have implemented this strategy in over 2,500 doors by the end of the year.

We continue to expand our retail distribution, and ended the third quarter with placement in over 73,000 doors, compared to 70,000 in Q3 '07 and 71,000 announced in Q2 '08. Our store within store growth continues to anchor our distribution with over 9,000 doors of store within store presentation as of September 30, 2008. That's up from 6,500 in Q3 '07 and 7,500 in Q2 '08. We remain on track to achieve 10,000 store within store doors by the end of the year.

Expansion of the store within store concept requires some initial setup costs at retail, which may temporarily affect margins. However, this is an essential part of our long-term retail strategy and a key step in securing additional shelf space during the market downturn.

As a part of our aggressive retail approach, we continue to absorb all cost increases from our manufacturers due to currency fluctuations and increased costs of raw material and freight. We feel it's important that we maintain our retail price points and contract our margin short-term, in order to build our long-term, branded presence at retail.

With the current uptick of the dollar, the decline in oil prices, and our strong negotiations based on our cash position, we expect to return to our mid-'60s margin in the Business to Business segment and first quarter 2009, as we place orders for new inventory.

Following a successful roll-out of our first online store within store concept at Amazon.com, we are targeting several other venues for similar concepts in the coming months. We have received commitments from several other key retailers to implement online store within store concepts early in 2009.

We believe this is a critical strategy for Gaiam, as more and more consumers are preferring to shop online. Cost to implement full online store within store presentations, including compilation of digital video clips and interviews, has been expensed over the past few quarters.

Last quarter, I mentioned our agreement to license the Biggest Loser for branded kids in the fourth quarter. This initiative was met with great enthusiasm by our retail partners and is an example of several other similar licensing arrangements we expect to announce later in this quarter. Through carefully selected partners, we believe that Gaiam can leverage its infrastructure and expertise to expand the reach of our distribution beyond the core demographic historically targeted by Gaiam products.

In summary, while the retail industry continues to be challenged during these difficult economic times, our sell-through remains strong, as shown by our over 30% increase in sell-through at Target year-over-year, where we manage 12 feet of shelf space.

For the solid balance sheet and strong overall financial position, we are well-positioned to secure additional shelf space through category management, store within store growth, and strategic licensing opportunities. We believe that our decision not to raise prices in spite of increased costs in order to expand our market share, along with our aggressive pursuit of store within store expansion, as strategic licensing opportunities may contract our margin in the short-term, but will give us a long-term competitive advantage in the years ahead.

Sales from our Direct to Consumer business, which includes results from direct-mail, Internet sales, community subscriptions, and our direct response campaigns, decreased 4.8%, reflecting planned reductions in catalog prospecting, shipment interruptions associated with Hurricane Ike, and overall slower consumer spending in the quarter.

We're committed to a strategy of increasing long-term margins by continuing to develop a relationship-based business model and reducing our dependence on direct-mail catalogs and costly prospecting. As I mentioned last quarter, we've received catalog circulation to prospects by over 2 million catalogs for the holiday season in response to the increased cost for freight, postage, and paper. This shift in strategy will continue to negatively impact revenues in the fourth quarter, but is one of several key steps in achieving profitability in the direct business.

During the third quarter, we increased our efforts in community, including launching Illumination University, an online educational campus providing transformational learning at home. The university is an integral part of our strategy to develop a robust offering of information and services to our community subscribers. Our investment in the community contributed a negative impact of $0.05 a share in the quarter.

The Direct Response division declined in revenue quarter-over-quarter, reflecting our decision to reduce media spending. Our decision to curtail media spending in the third quarter was based on a 12% increase in media air time costs as a percentage of revenue, partly attributable to air time supply shortages resulting from election campaign advertisement.

While directly impacting revenue for the quarter, we feel this decision was necessary to reduce the negative impact of increased costs on operating income. We continue to assess the return on investment based on market pricing of air times, and will resume higher media spending once the price of air time returns to typical levels.

In summary, we believe we are well-positioned to continue our strong brand momentum and leadership in the LOHAS industry. We believe we have built a solid financial foundation, which will allow us to capitalize on our strength in retail distribution to gain placement and market share, creating a distinct competitive advantage for the Company.

We are conscious of the macroeconomic environment and are reducing our marketing efforts in catalog and DRTV to minimize expenses in these areas, and putting our efforts into online customer acquisition, community, and our retail initiative. We also completed a cost reduction plan during the third quarter, which should begin to yield cost savings in Q4.

Through continued focus on maintaining a strong financial position, and implementing strategies designed to diversify our business, and capitalize on our market leadership position, we believe we can mitigate any severe effects of an economic downturn. We are committed to expanding our high quality, socially responsible content and brands, and we continue to review and revise strategy across all of our business units to better position Gaiam for future growth. Regardless of the economic conditions, we expect 2009 to be our best year ever in both revenue and EPS.

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

(Operator Instructions). Mark Argento, Craig-Hallum Capital.

A quick question on the write-off. Can you just kind of walk through with a little more specificity what it is you're writing off? And do you anticipate that this is all -- but now I know you took some in Q2 -- why don't we start there?

Okay. So if you compare to Q2, we took -- most of it is media library which we acquired; does not mean the things where we capitalized as we produced. We wrote off what we acquired during parts of acquisitions and we call them the library, which we discussed several times. And most of it comes from our acquisition of Good Times. And pretty much all deals recalled media library.

And so we basically accelerated the depreciation. All these things we'd be writing off amortizes typically between seven and 15 years. We're just basically doing it up front. So we accelerated tax receipts.

Other things this will do -- it will lower the spread between EBITDA and EPS, which several times during the year, we heard from different investors that we were cheap on EBITDA but not on EPS. So this will kind of lower that spread.

There is some write-off of goodwill intangibles and we also took -- this quarter, we did a reduction in force and we took a severance charge on that line. And we also took some capitalized production, some from acquisitions, some things from the projects [that we do].

All right. So --

The total for both quarters together is about $38 million.

Are there any production costs that you have written off from current Gaiam production or is it -- it's all acquired catalog?

It's all acquired -- no current developments was written off. We did write-off something what we did years ago, which we have, but it's very little what we have left on some old titles. But those are -- well, [you're] nothing over the last few years what we -- did we develop here written off.

And Lynn, could you touch on what you're seeing from the retailers in October? Clearly, things haven't gotten better; they've got incrementally worse. Overall trends in terms of buying patterns -- are people ordering later? Should we expect to see a shift from Q3 to Q4 like you hinted at?

Certainly we did see a shift this year on the buying patterns changing from Q3 to Q4. I think part of that is a later Thanksgiving that we're having this year. And part of that is just everyone being cautious.

We are still seeing, though, that our retailers are anxious to try some new things. So we've gotten good indication on things like our Biggest Loser kits, where people want something new to spark up their assortments, and on our Gaiam new item corrugates. So we've gotten good response on both of those.

And obviously, by the increase in our store within store numbers, we're finding that people are anxious to have someone kind of category-manage for them in the categories that we're in. We're seeing increase in store within store in the grocery area with -- like a Safeway and a Hannaford; with our firm brand in a place like Longs Drugs. We just recently got a test for store within store at GNC. So a lot of people trying new things and loving the store within store concept, but just being very cautious on their inventory levels.

And most of the 2,500 incremental store in a stores, were they coming from grocery in particular, like a Safeways and drugstores? Is that where you're seeing most of the growth?

A lot of the growth is coming from that, yes. And where we're going in rack -- our racking abilities are also really growing at store within store concept for us. It makes it very easy for the retailers to get into this space and to partner with the category leader to do that.

It was obviously a good decision to kind of go aggressively at that time. Obviously, in August, we didn't know that it was going to get this bad. When I said, it's going to get worse before it gets better, I expected it would get worse but obviously it well exceeded my expectations.

But it is helping a lot in retailers because obviously, in this environment, us going there aggressively, we get much more traction than we ever expected. And one of our competitors in this environment really have a hard time and some of them might even belly up or just go sideways. There's obviously really cheap acquisition opportunities right now.

And so while this is obviously bad what is happening, it will definitely make us when this is through, much stronger, better player in the market. Because when everybody is retreating, we striking ahead, then what Lynn mentioned a 30% sales through increase at Target is definitely helping our overall positioning. And so we plan to continue on that trend. And we definitely have the means of [volunteer] to keep continuing doing it. And I think as we turn, go through in the first quarter even if the economy stays the same, we still going to have a very good year.

Could you walk me through just a little bit in terms of understanding the dynamic in the gross margin line? You had indicated that you expect the gross margins would return back to the mid-'60s. How much of a store in a store and you guys providing some comp dollars and mark down dollars -- is that the biggest thing that is impacting margins right now? Or is it actually fixtures or --? If you could just walk me through that dynamic a little bit.

Well, really there's three things in the Business to Business side affecting the margin. One is the cost increases that we absorb. As you know, with the dollar fluctuation earlier in the year, which was when we had to place our holiday orders, the dollar and the oil prices were certainly working against us. And we absorbed all that. We made the decision not to pass any of those costs on to our consumer. So that's affecting the gross margin right now.

As I stated in the prepared remarks, we've gone back with the change of the uptick of the dollar and the change in the oil prices and renegotiated everything. Now, once we get through the inventory that we own from previous quarters, then beginning and at least by first quarter '09, we expect that to come back and to go back to the margins that we had before.

Then we're affected of course by vendor chargebacks, mark-downs associated with store within store and fixturing. So, all three of those.

And as we go forward, as we kind of -- we said we will help retailers with any costs when they sometimes might encounter, but the mid-'60s margin is pretty much what we historically have, ex-solar. So that's where we expect to be back in the base.

And then understand a little bit more about just the overall trend -- I mean, are the media products selling better? What are you seeing in terms of mix that retailers are taking or that could have potential this holiday season?

Well, a couple of things. First of all, where we've gone into category management and we control like we are -- like the set-up in Target with the four feet of media space -- that's working really well for us. It creates a home for the consumer that they can come back to if they want to expand their practice. So that's worked very well.

Other things -- whenever we've brought out new items and we have a lot of new item corrugates going out for the holiday season, that's received really positive impact from the retailers. And then things like anything eco still has a lot of play in the marketplace, so things like our eco water bottles have been very well received.

And then finally, what we think is a huge opportunity for us is to go beyond what's been our core demographic in the past, which the Gaiam demographic and licensing some brands where we can apply our expertise and our infrastructure to, such as the Biggest Loser, which appeals to a different core demographic. And you will see over the next -- well, at least by the end of the quarter, we'll have several other of those kinds of arrangements to announce that allow us to go after a different demographic, an additional space within the retail environment.

Great. That's helpful. Thank you.

(Operator Instructions). We have no other questions at this time.

So we'd like to thank everybody for participating. And hopefully, you will be with us next quarter. Thank you.

Thank you for participating in today's conference call. You may disconnect at this time.