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GAIAM, INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this document. This section is designed to provide information that will assist in understanding our condensed consolidated financial statements, changes in certain items in those statements from period to period, the primary factors that caused those changes and how certain accounting principles, policies and estimates affect the condensed consolidated financial statements. Overview and Outlook We are a lifestyle media company providing a broad selection of information, media, products and services to customers who value personal development, wellness, ecological lifestyles, and responsible media. We offer our customers the ability to make purchasing decisions and find responsible content based on these values by providing quality offerings at a price comparable to mainstream alternatives. Our media brand is built around our ability to develop and offer media content, products, and lifestyle solutions to consumers in the lifestyles of health and sustainability, also referred to as "LOHAS," market. We market our media and products through a multi-channel approach including traditional media channels, direct to consumers via ecommerce, direct response marketing, subscriptions, digital streaming through Gaiam TV and catalogs, and through national retailers, digital partners and corporate accounts. Our content forms the basis of our proprietary offerings, which then drive demand for parallel product and service offerings. Our operations are vertically integrated from content creation, through product development and sourcing, to customer service and distribution. We market our products and services across two segments: business and direct to consumer. We distribute the majority of our products from our fulfillment center or drop-ship products directly to customers. We also utilize a third party replication and fulfillment center for media distribution in our business segment. Our business segment sells directly to retailers, with our products available in over 60,000 retail doors in the United States. At the end of the first quarter of 2012, our store within store presentations, which include custom fixtures that we design, were in over 14,900 locations worldwide, up from 14,600 at the end of 2011. In 2008, we launched a media category management role that is part of our long term strategy and a key step in securing shelf space for media. We have now expanded this strategy to approximately 7,000 doors, up from 6,300 at the end of 2011. Through its diverse media reach, the direct to consumer segment provides an opportunity to launch and support new media releases, a sounding board for new product testing, promotional opportunities, a growing subscription base, and customer feedback on us and the LOHAS industry's focus and future. During the first quarter of 2012, the improvement in our business segment was driven primarily by our media aggregator role with Target, which we expect to leverage and expand to other retailers and digital partners. This segment also benefited from two new branded product lines: Restore, our at-home rehabilitative and restorative accessories, and Gaiam Sol, our premium yoga line, both of which we launched during the fourth quarter of 2011. During 2012, this segment will also be offering through its retailer and digital partners several As Seen On TV fitness media and healthy living products, some of which will be featuring The Biggest Loser star, Jillian Michaels, as well as our other branded fitness media, such as The Firm Express. With our branded products and category management and media aggregator roles, we effectively control the yoga and fitness offerings at some of the largest retailers in the nation. In addition to our fitness accessory business, we also distribute entertainment media titles owned by third-party studios and ourselves. We provide full distribution services including marketing, logistics, and sales to physical and digital online retailers. With the acquisition of Vivendi Entertainment in March 2012, Gaiam's entertainment media business has grown to become the the third largest non-theatrical content distributor in the United States with rights to over 8,000 titles. By combining the distribution operations of both companies, we expect to realize operational and financial synergies, including reduced replication, fulfillment, post-production and digital distribution costs. Overall, we believe the financial benefits of this acquisition strengthen our position as a leading branded lifestyle media company with extensive retailer, direct to consumer, and online sales channels. During the following months, our entertainment business will be focused on finalizing the integration of Vivendi and delivering growth through addition of new distribution and licensing contracts as well as expansion of sales to digital video providers. In our direct to consumer segment, during the first quarter of 2012, we debuted through our direct response television business Jillian Michael's Body Revolution media and accessories weight loss product, the sales of which thus far have been very strong. Later in 2012, this business is expected to launch a next generation healthy cooker and new skin care and fitness products. Also during 2012, we plan to continue our repositioning of our ecommerce and catalog product offerings towards more apparel and fitness. We are also continuing to develop our digital platform, Gaiam TV.com, which will allow us to further leverage our existing subscriber base and catalog and Internet consumer relationships to grow our digital sales through the delivery of primarily exclusive media content. 12 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth certain financial data as a percentage of revenues for the three months ended March 31st as indicated: Pro Forma 2012(a) 2011(b) 2011(c) Net revenue 100.0 % 100.0 % 100.0 % Cost of goods sold 42.7 % 44.3 % 52.8 % Gross profit 57.3 % 55.7 % 47.2 % Expenses: Selling and operating 51.1 % 53.8 % 44.5 % Corporate, general and administration 5.4 % 6.3 % 5.5 % Acquisition-related costs 3.5 % - % - % Total expenses 60.0 % 60.1 % 50.0 % Loss from operations -2.7 % -4.4 % -2.8 % Interest and other income 0.1 % 0.1 % 0.1 % Loss from equity method investment -1.5 % 0.0 % - % Income tax benefit -1.3 % -1.6 % -1.0 % Net (income) loss attributable to noncontrolling interest 0.2 % -0.1 % -0.1 % Net loss attributable to Gaiam, Inc. -2.6 % -2.8 % -1.8 % (a) With Real Goods Solar deconsolidated and accounted for as an equity method investment. (b) As if Real Goods Solar was deconsolidated effective January 1, 2011 and accounted for as an equity method investment. (c) With Real Goods Solar as a consolidated subsidiary. Supplemental Pro Forma Financial Information The following supplemental pro forma information is presented for informational purposes only, as an aid to understanding our historical financial results as if our deconsolidation of Real Goods Solar had occurred on January 1, 2011. This pro forma should not be considered a substitute for the actual historical financial information prepared in accordance with generally accepted accounting principles ("GAAP"), as presented in our filings on Forms 10-Q and 10-K. The unaudited pro forma consolidated financial information disclosed below is for illustrative purposes only and is not necessarily indicative of results of operations that would have been achieved had the pro forma events taken place on the date indicated, or our future consolidated results of operations. On December 31, 2011, we converted our Real Goods Solar Class B common shares, which had ten votes per share, to Real Goods Solar Class A common shares, which have one vote per share. As a result of this conversion, our voting ownership decreased to approximately 37.5% and, thus, we no longer had financial control of Real Goods Solar, but retained significant financial influence. Accordingly, we deconsolidated Real Goods Solar and reported it as an equity investment on our consolidated balance sheet at December 31, 2011. The unaudited pro forma condensed consolidated statement of operations for the three months ended March 31, 2011 presents our condensed consolidated results of operations giving pro forma effect to the deconsolidation of Real Goods Solar as if it had occurred on January 1, 2011. These pro forma financial statements should be read in connection with our historical unaudited condensed consolidated financial statements for the three months ended March 31, 2012 and 2011, which are included herein. We have made pro forma adjustments based on currently available information, estimates and assumptions that we believe are reasonable in order to reflect, on a pro forma basis, the impact of this deconsolidation on our historical financial information. 13 -------------------------------------------------------------------------------- Table of Contents The following are our unaudited statements of operations for the three months ended March 31st: Pro Forma (in thousands, except per share data) 2012 2011 Net revenue $ 47,333 $ 37,387 Cost of goods sold 20,227 16,556 Gross profit 27,106 20,831 Expenses: Selling and operating 24,161 20,111 Corporate, general and administration 2,573 2,341 Acquisition-related costs 1,667 - Total expenses 28,401 22,452 Loss from operations (1,295 ) (1,621 ) Interest and other income 56 44 Loss from equity method investment (696 ) (14 ) Loss before income taxes and noncontrolling interest (1,935 ) (1,591 ) Income tax benefit (637 ) (599 ) Net loss (1,298 ) (992 ) Net (income) loss attributable to noncontrolling interest 79 (42 ) Net loss attributable to Gaiam, Inc. $ (1,219 ) $ (1,034 ) Net loss per share attributable to Gaiam, Inc. common shareholders: Basic $ (0.05 ) $ (0.04 ) Diluted $ (0.05 ) $ (0.04 ) Weighted average shares outstanding: Basic 22,698 23,301 Diluted 22,698 23,301 Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011 Net revenue. Net revenue decreased $7.5 million, or 13.6%, to $47.3 million during the first quarter of 2012 from $54.8 million during the first quarter of 2011. Excluding our formerly consolidated subsidiary, Real Goods Solar, which was deconsolidated on December 31, 2011(refer to the Supplemental Pro Forma Financial Information above), net revenue increased $9.9 million, or 26.6%, during the first quarter of 2012 as compared to the first quarter of 2011. Net revenue in our business segment increased $6.3 million, or 32.6%, to $25.8 million during the first quarter of 2012 from $19.5 million during the first quarter of 2011, due to our media aggregator role for Target that commenced during the fourth quarter of 2011, as well as to improvements in stock levels and sales performance at our top three retailer customers. Net revenue in our direct to consumer segment increased $3.6 million, or 20.1%, to $21.5 million during the first quarter of 2012 from $17.9 million during the first quarter of 2011, primarily attributable to increased sales in our direct response marketing business due to our repositioning of that business in 2011. Cost of goods sold. Cost of goods sold decreased $8.7 million, or 30.1%, to $20.2 million during the first quarter of 2012 from $29.0 million during the first quarter of 2011. Excluding Real Goods Solar, cost of goods sold increased $3.7 million, or 22.2%, during the first quarter of 2012 as compared to the first quarter of 2011 and, as a percentage of net revenue, decreased to 42.7% during the first quarter of 2012 from 44.3% during the first quarter of 2011. Cost of goods sold in our business segment increased $3.4 million, or 32.9%, to $13.5 million during the first quarter of 2012 from $10.2 million during the first quarter of 2011 and, as a percentage of net revenue, increased slightly to 52.4% during the first quarter of 2012 from 52.3% during the first quarter of 2011, primarily due to a shift in product sales mix. Cost of goods sold in our direct to consumer segment increased $0.3 million, or 5.0%, to $6.7 million during the first quarter of 2012 from $6.4 million during the first quarter of 2011 and, as a percentage of net revenue, decreased to 31.1% during the first quarter of 2012 from 35.6% during the first quarter of 2011, primarily reflecting the significant increase of sales in our direct response marketing business. 14 -------------------------------------------------------------------------------- Table of Contents Selling and operating expenses. Selling and operating expenses decreased $0.2 million, or 0.9%, to $24.2 million during the first quarter of 2012 from $24.4 million during the first quarter of 2011. Excluding Real Goods Solar, selling and operating expenses increased $4.1 million, or 20.1%, during the first quarter of 2012 as compared to the first quarter of 2011 and, as a percentage of net revenue, decreased to 51.1% during the first quarter of 2012 from 53.8% during the first quarter of 2011, primarily due to increased television advertising costs related to the sales growth in our direct response marketing business. Corporate, general and administration expenses. Corporate, general and administration expenses decreased $0.5 million, or 15.1%, to $2.6 million during the first quarter of 2012 from $3.0 million during the first quarter of 2011. Excluding Real Goods Solar, corporate, general and administration expenses increased $0.2 million, or 9.9%, during the first quarter of 2012 as compared to the first quarter of 2011 and, as a percentage of net revenue, decreased to 5.4% during the first quarter of 2012 from 6.2% during the first quarter of 2011, primarily as a result of the incremental cost of stock option modifications. Acquisition-related costs. Acquisition-related costs were $1.7 million during the first quarter of 2012 and were the result of our acquisition of Vivendi Entertainment. Loss from equity method investment. Loss from equity method investment was $0.7 million during the first quarter of 2012 and represents our portion of Real Goods Solar's net loss for the quarter. Income tax benefit. Income tax benefit during the first quarter of 2012 was primarily increased due to the reducing of a deferred tax liability related to the carrying value of our equity method investment in Real Goods Solar. Net loss attributable to Gaiam, Inc. As a result of the above factors, net loss attributable to Gaiam, Inc. was $1.2 million during the first quarter of 2012 compared to $1.0 million during the first quarter of 2011. Net loss per share attributable to Gaiam, Inc. common shareholders was $0.05 per share during the first quarter of 2012 compared to $0.04 per share during the first quarter of 2011. Excluding our acquisition-related costs and loss from equity method investment, our net income for the first quarter of 2012 would have been $0.6 million or $0.03 per share. Refer to the Non-GAAP Financial Measures table below. Non-GAAP Financial Measures We have utilized the non-GAAP information set forth below as an additional device to aid in understanding and analyzing of our financial results for the quarter ended March 31, 2012. We believe that these non-GAAP measures will allow for a better evaluation of the operating performance of our business and facilitate meaningful comparison of the results in the current period to those in prior periods and future periods. Reference to these non-GAAP measures should not be considered a substitute for results that are presented in a manner consistent with GAAP. A reconciliation of GAAP net loss to the non-GAAP net income is set forth below (unaudited, in millions): For the Quarter Ended March 31, 2012 Net loss attributable to Gaiam, Inc. $ (1.2 ) Exclusion of acquisition-related costs (net of taxes of $0.6 million) (a) 1.1 Exclusion of loss from equity method investment 0.7 Non-GAAP net income attributable to Gaiam, Inc. $ 0.6 15 -------------------------------------------------------------------------------- Table of Contents A reconciliation of GAAP net loss per share to the non-GAAP net income per share is set forth below (unaudited): For the Quarter Ended March 31, 2012Net loss per share attributable to Gaiam, Inc. common shareholders-diluted $ (0.05 ) Exclusion of acquisition-related costs per share (net of taxes of $0.6 million) (a) 0.05 Exclusion of loss from equity method investment per share 0.03 Non-GAAP net income per share attributable to Gaiam, Inc. common shareholders-diluted $ 0.03 Weighted average shares used in net income per share calculations-diluted 22,698,000 (a) Income taxes were computed at an effective tax rate of approximately 35.5%. Seasonality Our sales are affected by seasonal influences. On an aggregate basis, we generate our strongest revenues and net income in the fourth quarter due to increased holiday spending and retailer fitness purchases. Liquidity and Capital Resources Our capital needs arise from working capital required to fund operations, capital expenditures related to acquisition and development of media content, development of our ecommerce and digital platforms and new products, acquisitions of new businesses, replacements, expansions and improvements to our infrastructure, and future growth. These capital requirements depend on numerous factors, including the rate of market acceptance of our product offerings, our ability to expand our customer base, the cost of ongoing upgrades to our product offerings, the level of expenditures for sales and marketing, the level of investment in distribution systems and facilities and other factors. The timing and amount of these capital requirements are variable and we cannot accurately predict them. Additionally, we will continue to pursue opportunities to expand our media libraries, evaluate possible investments in businesses, products and technologies, and increase our sales and marketing programs and brand promotions as needed. We have a revolving line of credit agreement with a financial institution with a current expiration date of November 16, 2012. The credit agreement permits borrowings up to the lesser of $15 million or our borrowing base which is calculated based upon the collateral value of our accounts receivable, inventory, and certain property and equipment. Borrowings under this agreement bear interest at the prime rate, provided, however, that at no time will the rate be less than 4.25% per annum. Borrowings are secured by a pledge of certain of our assets, and the agreement contains various financial covenants, including covenants requiring compliance with certain financial ratios. At March 31, 2012, we had $14.0 million of outstanding borrowings under this agreement and another $0.5 million was reserved for outstanding letters of credit. We believe we are in compliance with all of the financial covenants under this credit agreement. We are currently in negotiations for a line of credit with a larger borrowing capacity to replace our existing line of credit. The new line of credit is expected to be in place no later than June 30, 2012. Cash Flows The following table summarizes our primary sources (uses) of cash during the periods presented: Three Months Ended March 31, (in thousands) 2012 2011 Net cash provided by (used in): Operating activities $ (746 ) $ 3,243 Investing activities (14,008 ) (994 ) Financing activities 14,000 39 Effects of exchange rates on cash 39 24 Net change in cash $ (715 ) $ 2,312 16 -------------------------------------------------------------------------------- Table of Contents Operating activities. Our operating activities used net cash of $0.7 million and provided net cash of $3.2 million during the first quarters of 2012 and 2011, respectively. Our net cash used in operating activities during the first quarter of 2012 was primarily attributable to decreased accounts payable and participations payable of $3.7 million and $2.1 million, respectively, increased inventory of $2.2 million, our net loss of $1.3 million and increased receivable from equity method investee of $0.9 million, partially offset by decreased accounts receivable of $7.2 million and noncash adjustments to our net loss of $2.2 million. Our net cash provided by operating activities during the first quarter of 2011 was primarily attributable to decreased accounts receivable, inventory and income taxes receivable of $18.1 million and noncash adjustments to our net loss of $0.9 million, partially offset by decreased accounts payable, participations payable, and accrued liabilities of $10.7 million, $1.9 million, and $1.0 million, respectively, increased advances of $0.9 million and deferred advertising costs of $0.5 million, and a net loss of $0.9 million. The reduction in accounts payable reflects payments for inventory purchases of holiday and fitness season shipments. Investing activities. Our investing activities used net cash of $14.0 million and $1.0 million during the first quarters of 2012 and 2011, respectively. The net cash used in investing activities during the first quarter of 2012 was used primarily for the $13.4 million cash portion of the purchase price used to acquire Vivendi Entertainment, and to acquire property and equipment to maintain normal operations for $0.5 million and media content for $0.1 million. The net cash used in investing activities during the first quarter of 2011 was used primarily to acquire property and equipment to maintain normal operations for $0.6 million and media content for $0.4 million. Financing activities. Our financing activities provided net cash of $14.0 million and $39 thousand during the first quarters of 2012 and 2012, respectively. The net cash provided by financing activities during the first quarter of 2012 was from borrowings on a line of credit for $14.0 million, the funds from which were used to acquire Vivendi Entertainment and pay for acquisition-related costs. The net cash provided by financing activities during the first quarter of 2011 was as a result of stock option exercise issuances and related tax benefits. On January 11, 2012, we renewed a shelf registration statement on Form S-3 with the Securities and Exchange Commission for the unissued portion of the 5,000,000 shares of our Class A common stock that we originally registered on November 8, 2007. During the quarter ended March 31, 2012, no shares were issued under this shelf registration. We believe our available cash, anticipated borrowing capabilities, cash expected to be generated from operations, and cash generated by the sale of our stock should be sufficient to fund our operations on both a short-term and long-term basis. However, our projected cash needs may change as a result of acquisitions, product development, unforeseen operational difficulties or other factors. In the normal course of our business, we investigate, evaluate and discuss acquisition, joint venture, minority investment, strategic relationship and other business combination opportunities in the LOHAS market. For any future investment, acquisition or joint venture opportunities, we may consider using then-available liquidity, issuing equity securities or incurring additional indebtedness. Contractual Obligations We have commitments pursuant to lease agreements, but have no outstanding commitments pursuant to purchase obligations. The following table shows our commitments to make future payments under operating leases: (in thousands) Total < 1 year 1-3 years 3-5 years > 5 years Operating lease obligations $ 4,442 $ 1,815 $ 2,520 $ 107 $ - Risk Factors We wish to caution you that there are risks and uncertainties that could cause our actual results to be materially different from those indicated by forward looking statements that we make from time to time in filings with the Securities and Exchange Commission, news releases, reports, proxy statements, registration statements and other written communications as well as oral forward looking statements made from time to time by our representatives. These risks and uncertainties include those risks listed in our Annual Report on Form 10-K for the year ended December 31, 2011. Historical results are not necessarily an indication of the future results. Except for the historical information contained herein, the matters discussed in this analysis are forward-looking statements that involve risk and uncertainties, including, but not limited to, general economic and business conditions, competition, pricing, brand reputation, consumer trends, and other factors which are often beyond our control. We do not undertake any obligation to update forward-looking statements except as required by law. 17 -------------------------------------------------------------------------------- Table of Contents |