Gaia, Inc Q2 FY2020 Earnings Call

Good afternoon, everyone, and thank you for joining today's conference call to review Gaia Inc.'s financial results for the second quarter that ended on June 30, 2020. We have with us Gaia's CEO, Jirka Rysavy, and CFO, Paul Tarell. Before we begin, I would like to read the safe harbor language. The following is the safe harbor statement under the Private Securities Litigation Reform Act of 1995. Today's discussion includes forward-looking statements that involve various assumptions, risks, and uncertainties. These factors include, but are not limited to, general business conditions, past losses, competition, shifting consumer preferences, subscriber costs and retention rates, acquisitions, and other risks and uncertainties that we detail occasionally in our filings with the Securities and Exchange Commission, including our reports on the Form 10-K and Form 10-Q. Gaia does not have an obligation to publicly update or revise any forward-looking statements. Now, I will turn the call over to Gaia's CEO, Jirka Rysavy.

Thank you, Kathy, and good afternoon, everyone. So our revenue for second quarter increased 23% to $16.2 million. We ended the quarter with 663,000 members, which is 59,000 above the first quarter. Our gross margin increased to 87.1% from 86.4% in the year-ago quarter. We also achieved a 39% improvement in our gross profit per employee to $436,000 from $314,000 a year ago. During the quarter, we generated a gain, not only the $1.9 million positive adjusted EBITDA, an improvement of $3.5 million, but also $1.9 million in cash flow from operations, which was a $4.4 million improvement. Cash use in the quarter was $1.6 million, which was an operational improvement of $6.9 million. And we ended the quarter with $8.5 million in cash. We did achieve positive earnings for the month of June, which is months earlier than planned, and we fully expect to reach our key milestone of positive earnings and free cash flow in July, as planned and communicated 18 months ago. With that, I will get Paul to talk to you more about the quarter results.

Revenues in the second quarter increased 23% to $16.2 million compared to the year-ago quarter. Gross profit in the second quarter increased 24% to $14.1 million from $11.4 million in the year-ago quarter, with an improvement in gross margins to 87.1% compared to 86.4% in the year-ago quarter and also up from 86.9% in the first quarter of 2020. We ended the quarter with 663,400 members and we have continued to see increased interest in our unique and exclusive content library, which is evidenced by our Alexa global site rankings improving 37% from 8,375 in April of 2020 to 5,317 in July of 2020. Selling and operating expenses, excluding marketing and member acquisition costs in the second quarter, were $6 million or 37% of revenues, which is down from $6.7 million or 51% of revenues in the year-ago quarter. Our focus on continued operating efficiency and expense rationalization over the last 18 months has been successful. Corporate and G&A expenses in the second quarter were $1.8 million or 12% of revenues, which includes a nonrecurring noncash charge of $715,000 related to the earn-out consideration we issued in June of 2020 tied to the success of the acquisition we completed in June of 2019. The acquired company maintained profitability since the acquisition, while exceeding the upper end of their member growth target. We have been very pleased with the integration of the acquired content library and member base into Gaia. The seller has also elected to convert $1.8 million in convertible notes that were due in January 2021 into Gaia shares in June of 2020. Total member acquisition costs were $8.4 million or 52% of revenues, down from 57% of revenues in the year-ago quarter and in line with the 52% we spent in Q1 of 2020. We have continued to focus on increasing the volume of members we are adding via organic and nonpaid sources while also driving efficiency on our paid media channels. As a result, we were able to improve our average CPA for the quarter to $55, down from $68 in the first quarter and $77 in the year-ago quarter. The annual planned take rate for new members has been maintained in the 28% to 30% range, which has allowed us to recover almost 70% of our customer acquisition spend for each monthly cohort immediately upon their conversion to becoming paying members. Excluding the noncash charge previously mentioned, total operating expenses were $15.6 million or 96.4% of revenues, down from 119% of revenues in the year-ago quarter. We have continued our trend of positive adjusted EBITDA margins and cash flows from operations for the third consecutive quarter with significant improvements on both measures from the year-ago quarter. We also kept our cash utilization for the quarter in line with the first quarter at $1.6 million, representing significant improvement from the year-ago quarter where we consumed $8.9 million, excluding the incremental borrowings from refinancing our building last year. This brings total cash used in the past nine months down to $3.2 million from $17.4 million in the same period a year ago. With our current revenue levels and disciplined spend management, we have crossed the threshold for sustainable, internally funded growth. The transition to positive earnings in June, a month ahead of plan, and we are free cash flow positive in July as planned. We expect to be able to add 30,000 members in the third quarter while maintaining positive earnings and free cash flows. With that, I would like to open the call up for questions.

We will take our first question from Eric Wold with B. Riley.

I have a couple of questions. First, Paul, I would like to follow up on your previous comment about expecting to add 30,000 new subscribers in the third quarter while maintaining positive cash flow. As you approach that threshold, do you anticipate it being sustainable? How do you plan to manage marketing spending going forward? What is the overall goal? Is it to grow as much as possible while keeping breakeven to slightly positive free cash flow, or is there a specific growth rate you are aiming for? Additionally, how do you plan to use any savings beyond that?

Yes. I'd say in the near term, and the reason we only provided one-quarter of visibility is it's a very dynamic situation as COVID and the related states are responding in different ways. So the plan is to really drive revenue growth at the 25% level while maintaining the positive earnings and free cash flows in Q3. And then obviously, wherever we end the quarter sets the new threshold for the next quarter. So that's the goal, though. It's to try and drive revenues 25% while maintaining profitability on the two measures that we talked about and then really being adaptive from there as the market continues to evolve.

Okay. Any noticeable change in the dynamics of the subscribers you saw coming in during the COVID pandemic and the initial state of it? I know you mentioned that the annual subscribers are kind of coming in at that 28% to 30% range. But any metrics you're seeing in terms of that may have this group be different in terms of maybe consumption, sustainability versus who may have been in the base part of that?

Yes. I think first and foremost, we've seen improvements across the board, not just with new members, but with existing members because they've had time to be able to dig into the library. And so we're seeing positive trends in terms of content consumption in multiple groups, which tends to lead to improved retention over time. As we look at the gross cohorts that came through starting in the second half of March, we've been paying very close attention to see how they're behaving as they continue to mature. And to be honest, we haven't seen really any degradation in terms of initial engagement during that 7-day trial period, and we've seen our trial conversion rates maintain over the period. So we'll see how the summer plays out. But we haven't seen really any degradation in terms of the quality of customer, even with the volume that we've been driving.

Yes. We have a bit more focus. I think Paul mentioned not only the new additions but also the existing members of our series. I believe our content, produced over the last two years, definitely drives engagement, and the original series is a significant contributor. Furthermore, our original content accounts for about 80% of the VOD.

Okay. And then final question for me. Now that the contracts were renewed during the quarter with the two third-party distributors that were outstanding, has the higher monthly subscription price garnered an effect with all new subscribers, all subscribers, both those in the third parties as well as your own? If that is the case, would the higher price go into effect?

So first of all, we don't control the pricing that our partners charge to their customers. We don't really have visibility into that. We only see what they pay us. And so we've started to be paid at the higher rates for all of them, but we don't have visibility into what they're charging their customers and what their plans around grandfathering or not grandfathering are. But we do know that the new price for our largest online partner has gone to match our current monthly pricing.

We see that people are subscribing through Comcast, but we are unsure if this is a widespread change or limited to certain regions, which is what Paul was referring to. Generally, we know that they are all paying us high rates, but we don't have complete visibility on their pricing strategies. The cable subscribers might not reflect the same changes due to customer variations, so we cannot draw any definitive conclusions.

And then also one more quick one in there. I know it's a small number, but just kind of looking at the mid-June announcement you had. We expect to end the quarter around 655,000 and ended up 663,400. Any reason to that? Was that more subscribers coming in that month than you expected? Was it a lower churn rate than you expected? Anything that drove that specifically, something we should expect going forward?

Yes. So it was definitely the lower loss than we expected, particularly going into the renewal period for a lot of the acquired FMTV subscribers on annual plans in June. The second piece was that we just continued to see improvements in our cost to bring people in for trial and maintaining that conversion on them. So we expected that to start to pull back as things started opening up and the summer started getting into full swing in the U.S. But really, we were able to see pretty meaningful CPA efficiency through all of June, which we hadn't banked on.

Our next question comes from Darren Aftahi with ROTH Capital.

So can I follow-up on some of the questions that were asked? So I'm just kind of curious, dive a little bit deeper into the linearity of subs. Like when you did kind of a pre-announcement in early June, what is then kind of the cadence post that, how linear were the adds in the quarter and any kind of insight into trends in July? And then Paul, I think you've said, CPAs were pretty steady throughout the quarter. Just any kind of color you can give on trends into July? And how competitive kind of a market for the audience are going after has kind of changed from, say, April to late July?

Yes. So I'll refer back to what we talked about in late April when we originally talked about the growth that we were seeing in March and April. We spent pretty aggressively in April. So it was obviously heavily skewed to the number of subs that we added in April to allow us to get to the number that we provided on the April 27 call and then obviously, what we put out there on June 5. But what we saw was that even with the summer coming on and the economy opening back up, we were able to see cost per thousand, or CPM, on our paid media continue to maintain. So our dollars were able to go farther than we expected. But on the other side of that, I mentioned that Alexa site ranking. That helps pretty significantly with our paid search and other nonpaid channels into the second half of June. So we got a decent lift from that going into the second half of June that allowed us to get slightly ahead of where we expected to be. And I will say that all of those things have been continuing into July to date from a CPM and a CPA trend perspective.

Great. Following up on the profitability question, given that you mentioned being profitable a month earlier and generating free cash flow moving forward, should we consider this third quarter as the bottom point for your cash balance? Also, as we aim for a 25% growth in revenue, how aggressive will you be in reinvesting profits? I appreciate that you are making positive changes, but how do you plan to balance growth with demonstrating operating efficiency?

Yes. So I think to address the cash question first. The intent is to have this be the low point in terms of cash, as we've said going forward. But again, there's a lot of uncertainty as it relates to what the future looks like from an economy perspective. So I don't think anyone in our position would be prudent in saying that they have a crystal ball to say what it's going to look like. But our plans and where the business is at today allows us to operate as this being the low point of the cash. And it's really being funded with that 30% of annual take and being able to get 70% of our cash back immediately. That creates a pretty consistent source of funds for us to be able to keep growing. And then it's really just about moderating the amount that we're willing to invest in marketing initiatives in any period because that ultimately hits the expense side of the P&L. And so based on the trends that we're seeing today, we're pretty confident with our 25% growth target, and we'll see how that goes. Going into the second part of Q4 is really when we're going to start going on the annual renewals for our big push that started in October of 2019. So that's a little bit of an area that we're paying attention to because we're going to have a much higher volume of annual people renewing once we get over that. So early indications don't show any potential increase in drop-off from those groups, but it will be something that we're paying attention to in Q4 as it relates to the cash balance.

We began this journey 18 months ago, and throughout this period, we have mostly stayed on track, with some quarters slightly ahead or behind expectations. The boost from second-quarter COVID subscribers has provided some additional support, but we believe we would have reached profitability in June regardless. Our plan is to remain committed to our strategy and maintain our current positive trend, irrespective of the economic situation. We aim to keep moving forward with what has been effective for us.

And last one for me. I know in the past, you've invested a lot in the translation engine. I'm just curious kind of on a run rate over the last 6 months, how much of your mix has come from international? And then are you going to get more aggressive in terms of investing in international, marketing in international? Is it going to be kind of status quo as you kind of go through the rest of the year?

Yes. So I think we talk about international in two components. One is non-English and then the other is U.S.-speaking, non-U.S. countries. We've seen a pretty healthy amount of growth, obviously, with the acquisition we did last June in Australia and New Zealand, where their member bases were at, but also in terms of the English-speaking European countries. But one of the things that we've done is we've actually made a pretty decent investment in our Spanish language programming. One of our shows, Initiation, which is an original program, we also did a Spanish version of it, and that's been driving a decent amount of growth in our Spanish-speaking audience without us really focusing on our paid media activities there. So now that we've crossed the threshold and we can start to look at where is the next marginal dollar going to go to drive growth, we're evaluating what our non-English plans are for 2021 and what we want to allocate to that from a growth perspective. So I'd say, stay tuned. But organically, with the content, we're seeing increased demand and awareness of Gaia in Spanish-speaking countries. And we think we've figured out a playbook there, and we're going to then look at German and see what we can do there because that's a language that we already support and already have subscribers.

To provide some clarity, three years ago, our international presence was around 29% to 30%. Currently, nearly all our third-party efforts are focused in the U.S. If we consider that 30%, it would translate to approximately 37% today. We estimate that we've added about 20% to our mix. As Paul mentioned, this segment will continue to grow. However, at this moment, we have significant opportunities in the U.S., so we're allowing it to develop organically and gradually without any aggressive initiatives.

Next question, from Mark Argento with Lake Street Capital Markets.

Just a couple of quick ones. Content. Obviously, we think you guys are doing a nice job managing your content expense. Maybe talk a little bit about when you anticipate maybe being able to start firing up or doing some more live content or augmenting the catalog? And then also, I'm thinking about additional channels. One time, you were looking at adding additional pillars of channels to the platform. Any thoughts on kind of the next leg of maybe subscriber growth coming from either some acquisition or organic channel development?

So there are several questions there. So the content, as I said, we kind of focus on our series more. Also, we're going to be focusing on the content when we didn't have international rights. So that's kind of hopefully finishing over next year. So we have the international rights to virtually all of our content or at least the plan. We're spending pretty even pace. We don't really slow down. We have a little bit on the beginning of the second quarter, but it just lasted about a month. So we got to actually film a little more in the case. Their traveling gets shut down or something, so we have some buffer. But generally, on average, we want to keep it kind of firm to stay where it is.

The live event.

The live events are still largely restricted due to local laws preventing gatherings of any size. As a result, we haven't held any live content since we began this period. We will continue to monitor the situation and have plans in place, but we need to see how things develop. At this point, we are not planning any events for this month.

I will say on the live access premium level subscription, even if we don't have events, we are still seeing organic interest coming in every day taking that $299 annual plan to get access to that content. So once we can get the events going again, we have a slate of really high-end presenters that are ready to come in. So it's just deferred, I would think at this point. But with the growth in our direct subscription business and the organic growth in that live access premium, we're on trend for where we expect it to be from a revenue perspective, even with having events.

Any additional channels or thoughts on expanding the platform or exploring further potential M&A to enhance the portfolio?

We don't want to make any changes right now because things are going well. We are considering adding more series to some of the newer channels, like Alternative Healing. We will see a boost from the acquisition of FMTV, which we planned for when we launched that channel. However, we would like to wait until at least the end of the year before considering another addition. Currently, all the overall metrics are moving in a positive direction, especially with the increased attention mentioned by Paul. Therefore, we plan to continue our current strategy through the end of the year.

We'll take our next question from Peter Rabover with Artko Capital. Healing. Obviously, we will benefit from the acquisition of FMTV, which was planned when we launched that channel. However, we would like to wait until at least the end of the year before considering another acquisition. Currently, the overall numbers are trending positively, especially with increased attention, so we plan to continue our current strategy through the end of the year.

Congratulations on reaching your milestone. You announced a significant strategic shift about 18 months ago and successfully met your goal, despite some fluctuations in quarterly results. The overall trend remains positive. Now that we are at this point, which may feel a bit anticlimactic, what are your next major milestones or goals? I’m hesitant to ask for specific numbers, but I’m sure the market is curious about your direction.

I think we would have, for right now, we're going to kind of see by end of the year how the market is going because it is uncertainly going back and forth between can we film, can people travel. So we don't want to really put really big things out there. For us, it's really kind of continue, honestly, our desire is to continue with positive earnings and free cash flow and keep growing the 25% and see how this year goes. I wouldn't, with all these economy jitters going on, to go and say something beyond that because I don't think it will be prudent in this kind of market.

But I will say the reason it feels a little bit anticlimactic is because our approach has been slow and steady improvement on all of the things that we pay attention to. And I think that will be our philosophy going forward. We obviously aren't comfortable providing any forward-looking guidance at this point. But that's the methodology and mindset that has really been ingrained in our employee base over the last 18 months, and we plan on continuing that going forward.

Okay, that's great. I wanted to ask a question that others have also raised. How do you view your cash situation? Excluding the uncertainties of this year or the next six months, considering that you will be positive in free cash flow, what is your approach to capital allocation at the board level? I will leave it at that.

At this point, as Paul mentioned, we are aiming for positive cash flow and we shouldn't fall significantly below our previous levels. Our plan is to start building cash, and the first use of that cash would likely be to address the mortgage on our headquarters.

Okay. And then I guess, maybe a final bigger question. But what's your view, I guess, in the video streaming service industry in general and where do you think Gaia sits into it? Does it make sense for it to be a stand-alone channel or be part of a bigger media group, or maybe you guys become a bigger media group? Your thoughts on the industry would be great.

We don't really want to speculate on this one. There's no time to even comment on it.

At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Rysavy for closing remarks.

Well, thank you everyone for joining, and we look forward to speaking with you when we report our third quarter, which will be in November 9, and we expect for the first time, obviously, to be with positive earnings and free cash flow, so hopefully. Talk to you then. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.