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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10 -Q
/X/ Quarterly report under Section 13 or 15(d) of the Securities and Exchange
Act of 1934.
For the quarterly period ended December 31, 2003
/ / Transition Report under Section 13 or 15(d) of the Exchange Act.
For the transition period from __________________ to __________________
000-23697
(Commission file number)
NEW FRONTIER MEDIA, INC.
(Exact name of small business issuer as specified in its charter)
Colorado 84-1084061
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)
7007 Winchester Circle, Suite 200, Boulder, Co 80301
(Address of principal executive offices)
(303) 444-0900
(Issuer's telephone number)
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes / / No /X/
As of January 31, 2004, 22,248,563 shares of Common Stock, par value $.0001,
were outstanding.
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FORM 10-Q
NEW FRONTIER MEDIA, INC.
Index
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
December 31, 2003 (Unaudited) and March 31, 2003.... 3
Condensed Consolidated Statements of Operations
(Unaudited) for the quarter and nine months ended
December 31, 2003 and 2002.......................... 5
Condensed Consolidated Statements of Cash Flows
(Unaudited) for the nine months ended December 31,
2003 and 2002....................................... 6
Notes to Consolidated Financial Statements
(Unaudited)......................................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 13
Item 3. Quantitative and Qualitative Disclosures about
Market Risk......................................... 21
Item 4. Controls and Procedures............................. 21
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................... 22
SIGNATURES.................................................. 23
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN 000S)
ASSETS
(UNAUDITED)
DECEMBER 31, MARCH 31,
2003 2003
------------ ---------
CURRENT ASSETS:
Cash and cash equivalents................................. $12,583 $ 4,264
Accounts receivable, net of allowance for doubtful
accounts of $90, respectively.......................... 7,013 5,680
Prepaid expenses.......................................... 456 610
Other..................................................... 769 452
------- -------
TOTAL CURRENT ASSETS................................. 20,821 11,006
------- -------
FURNITURE AND EQUIPMENT, net................................ 3,381 3,951
------- -------
OTHER ASSETS:
Prepaid distribution rights, net.......................... 12,067 11,520
Goodwill.................................................. 3,743 3,743
Other identifiable intangible assets, net................. 420 1,124
Deposits.................................................. 185 567
Other..................................................... 619 3,114
------- -------
TOTAL OTHER ASSETS................................... 17,034 20,068
------- -------
TOTAL ASSETS................................................ $41,236 $35,025
======= =======
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
3
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN 000S)
LIABILITIES AND SHAREHOLDERS' EQUITY
(UNAUDITED)
DECEMBER 31, MARCH 31,
2003 2003
------------ ---------
CURRENT LIABILITIES:
Accounts payable.......................................... $ 2,297 $ 2,606
Current portion of obligations under capital leases....... 486 996
Deferred revenue.......................................... 1,282 2,223
Accrued restructuring expense............................. 1,029 1,304
Current portion of notes payable.......................... 1,170 --
Accrued Compensation...................................... 1,098 478
Other accrued liabilities................................. 1,054 747
-------- --------
TOTAL CURRENT LIABILITIES............................ 8,416 8,354
-------- --------
LONG-TERM LIABILITIES:
Obligations under capital leases, net of current
portion................................................ 220 465
Notes payable, net of current portion..................... 360 --
Redeemable preferred stock................................ -- 3,750
-------- --------
TOTAL LONG-TERM LIABILITIES.......................... 580 4,215
-------- --------
TOTAL LIABILITIES................................. 8,996 12,569
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock, $.0001 par value, 50,000,000 shares
authorized, 21,408,777 and 21,322,816 respectively,
shares issued and outstanding.......................... 2 2
Preferred stock, $.10 par value, 5,000,000 shares
authorized:
Class A, no shares issued and outstanding.............. -- --
Class B, no shares issued and outstanding.............. -- --
Additional paid-in capital................................ 48,143 45,943
Accumulated deficit....................................... (15,905) (23,489)
-------- --------
TOTAL SHAREHOLDERS' EQUITY........................... 32,240 22,456
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 41,236 $ 35,025
======== ========
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
4
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN 000S)
(UNAUDITED) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- --------
SALES, net.................................... $10,779 $ 8,590 $31,778 $ 27,467
COST OF SALES................................. 4,220 4,413 12,407 14,141
------- ------- ------- --------
GROSS MARGIN.................................. 6,559 4,177 19,371 13,326
------- ------- ------- --------
OPERATING EXPENSES:
Sales and marketing......................... 944 1,449 3,480 4,760
General and administrative.................. 2,609 2,441 7,419 10,203
Restructuring expense....................... -- (256) 71 2,927
Impairment expense.......................... -- 805 -- 1,341
------- ------- ------- --------
TOTAL OPERATING EXPENSES............... 3,553 4,439 10,970 19,231
------- ------- ------- --------
OPERATING INCOME (LOSS)................ 3,006 (262) 8,401 (5,905)
------- ------- ------- --------
OTHER INCOME (EXPENSE):
Interest income............................. 11 13 31 52
Interest expense............................ (416) (433) (1,087) (1,371)
Other....................................... 129 -- 241 (118)
------- ------- ------- --------
TOTAL OTHER EXPENSE.................... (276) (420) (815) (1,437)
------- ------- ------- --------
NET INCOME (LOSS) BEFORE PROVISION FOR INCOME
TAXES....................................... 2,730 (682) 7,586 (7,342)
Provision for income taxes.................. -- (5,266) (2) (5,266)
------- ------- ------- --------
NET INCOME (LOSS)...................... $ 2,730 $(5,948) $ 7,584 $(12,608)
------- ------- ------- --------
Basic income (loss) per share................. $ .13 $ (.28) $ .38 $ (.59)
======= ======= ======= ========
Diluted income (loss) per share............... $ .12 $ (.28) $ .35 $ (.59)
======= ======= ======= ========
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
5
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN 000S)
(UNAUDITED)
NINE MONTHS ENDED
DECEMBER 31,
-------------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 7,584 $(12,608)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Warrants issued/amortized for services and financing.... 597 581
Amortization of deferred debt offering costs............ 173 268
Depreciation and amortization........................... 4,814 5,684
Asset impairment related to restructuring charge........ -- 2,554
Asset impairment........................................ -- 1,341
Other................................................... 39 --
Write-off of marketable securities available for sale... 90 118
Deferred income taxes................................... -- 5,251
(Increase) Decrease in operating assets
Accounts receivable................................ (1,333) (495)
Receivables and prepaid expenses................... 335 359
Prepaid distribution rights........................ (2,073) (3,293)
Other assets....................................... (247) 397
Increase (Decrease) in operating liabilities
Accounts payable................................... (90) 81
Deferred revenue, net.............................. (941) (222)
Reserve for chargebacks/credits.................... (64) (281)
Accrued restructuring cost......................... (274) (277)
Other accrued liabilities.......................... 1,047 194
-------- --------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES.................................. 9,657 (348)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and furniture..................... (751) (493)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES.............. (751) (493)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations................... (929) (1,314)
Repayment of related party notes receivable............. -- 4
Increase (decrease) in note payable..................... 400 (2,000)
Increase in debt offering costs......................... -- (225)
Proceeds from stock options and warrant exercises....... 4,812 245
Retirement of stock..................................... (1,500) --
Redemption of redeemable preferred stock................ (5,250) --
Issuance of redeemable preferred stock.................. 2,000 2,750
Decrease in other financing activities.................. (120) --
-------- --------
NET CASH USED IN FINANCING ACTIVITIES.............. (587) (540)
-------- --------
NET INCREASE (DECREASE) IN CASH............................. 8,319 (1,381)
CASH AND CASH EQUIVALENTS, beginning of period.............. 4,264 5,798
-------- --------
CASH AND CASH EQUIVALENTS, end of period.................... $ 12,583 $ 4,417
======== ========
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
6
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The accompanying financial statements have been prepared without audit pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles in the
United States of America have been condensed or omitted pursuant to such rules
and regulations. These statements include all adjustments considered necessary
for a fair presentation of financial position and results of operations. The
financial statements included herein should be read in conjunction with the
financial statements and notes thereto included in the latest annual report on
Form 10-K.
The results of operations for the nine-month period ended December 31, 2003 are
not necessarily indicative of the results to be expected for the full year.
BUSINESS
New Frontier Media, Inc. ("New Frontier Media"), is a publicly traded holding
company for its operating subsidiaries. Colorado Satellite Broadcasting, Inc.
("CSB"), d/b/a The Erotic Networks, ("TEN") is a leading provider of adult
programming to multi-channel television providers and low-powered direct-to-home
households. Through its networks Pleasure, TEN, TEN Clips, TEN Xtsy, TEN Blue,
TEN Blox and TEN Max, TEN is able to provide a variety of editing styles and
programming mixes that appeal to a broad range of adult consumers.
On October 27, 1999, New Frontier Media completed an acquisition of three
related Internet companies: Interactive Gallery, Inc. ("IGI"), Interactive
Telecom Network, Inc. ("ITN") and Card Transactions, Inc. ("CTI"). Under the
terms of the acquisition, which was accounted for as a pooling of interests, the
Company exchanged 6,000,000 shares of restricted common stock in exchange for
all of the outstanding common stock of IGI and ITN and 90% of CTI.
IGI is a leading aggregator and reseller of adult content via the Internet. IGI
aggregates adult-recorded video, live-feed video and still photography from
adult content studios and distributes it via its membership website,
www.ten.com. In addition, IGI resells its aggregated content to third-party web
masters. ITN and CTI have been inactive since March 31, 2002.
SIGNIFICANT ACCOUNTING POLICIES
PRINCIPALS OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of New
Frontier Media, Inc. and its majority owned subsidiaries (collectively
hereinafter referred to as New Frontier Media or the Company). All intercompany
accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Estimates have been made by management in several areas,
including, but not limited to, the realizability of accounts receivable, accrued
restructuring expenses, the valuation of chargebacks and reserves, the valuation
allowance associated with deferred income tax assets and the expected useful
life and valuation of our prepaid distribution rights. Management bases its
estimates and judgments on historical experience and on various other factors
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
could differ materially from these estimates.
7
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). This statement establishes standards for how an issuer classifies and
measures in its statement of financial position certain financial instruments
with characteristics of both liabilities and equity. In accordance with the
standard, financial instruments that embody obligations for the issuer are
required to be classified as liabilities. The Company adopted this pronouncement
on April 1, 2003. Upon adoption of SFAS No. 150 the Company reclassified its
Redeemable Preferred Stock as a liability.
STOCK BASED COMPENSATION
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," ("APB Opinion No. 25") and related interpretations
in accounting for its plans and complies with the disclosure provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Under APB Opinion No. 25, compensation expense
is measured as the excess, if any, of the fair value of the Company's common
stock at the date of the grant over the amount a grantee must pay to acquire the
stock. The Company's stock option plans enable the Company to grant options with
an exercise price not less than the fair value of the Company's common stock at
the date of the grant. Accordingly, no compensation expense has been recognized
in the accompanying consolidated statements of operations for its stock-based
compensation plans.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options vesting period. Adjustments are made
for options forfeited prior to vesting. The effect on compensation expense, net
income (loss), and net income (loss) per common share had compensation costs for
the Company's stock option plans been determined based on a fair value at the
date of grant consistent with the provisions of SFAS No. 123 for the quarters
and nine months ended December 31, 2003 and 2002 is as follows (in thousands,
except share data):
(UNAUDITED) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income (loss)
As reported................................ $ 2,730 $(5,948) $ 7,584 $(12,608)
Deduct:
Total stock-based employee compensation
expense determined under fair value based
method for awards granted, modified, or
settled, net of tax........................ (322) (234) (618) (703)
------- ------- ------- --------
Pro forma.................................. $ 2,408 $(6,182) $ 6,966 $(13,311)
======= ======= ======= ========
Basic income (loss) per common share
As reported................................ $ .13 $ (0.28) $ .38 $ (0.59)
Pro forma.................................. $ .12 $ (0.29) $ .35 $ (0.62)
Diluted income (loss) per common share
As reported................................ $ .12 $ (0.28) $ .35 $ (0.59)
Pro Forma.................................. $ .11 $ (0.29) $ .32 $ (0.62)
8
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- INCOME (LOSS) PER SHARE
The components of basic and diluted income (loss) per share are as follows (in
thousands):
(UNAUDITED) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income (loss)............................ $ 2,730 $(5,948) $ 7,584 $(12,608)
======= ======= ======= ========
Average outstanding shares of common stock... 20,603 21,323 19,998 21,302
Dilutive effect of Warrants/Employee Stock
Options.................................... 1,987 -- 1,708 --
------- ------- ------- --------
Common stock and common stock equivalents.... 22,590 21,323 21,706 21,302
======= ======= ======= ========
Basic income (loss) per share................ $ .13 $ (0.28) $ .38 $ (0.59)
======= ======= ======= ========
Diluted income (loss) per share.............. $ .12 $ (0.28) $ .35 $ (0.59)
======= ======= ======= ========
Options and warrants which were excluded from the calculation of diluted
earnings per share because the exercise prices of the options and warrants were
greater than the average market price of the common shares were approximately
485,750 and 632,750 for the quarter and nine months ended December 31, 2003,
respectively. Options and warrants which were excluded from the calculation of
diluted earnings per share because the Company reported a net loss were
approximately 7,356,000 for the quarter and nine months ended December 31, 2002.
Inclusion of these options and warrants would be antidilutive.
NOTE 3 -- SEGMENT INFORMATION
The Company has adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
establishes reporting and disclosure standards for an enterprise's operating
segments. Operating segments are defined as components of an enterprise for
which separate financial information is available and regularly reviewed by the
Company's senior management.
The Company has the following two reportable segments:
* Subscription/Pay-Per-View ("PPV") TV Group -- distributes branded adult
entertainment programming networks and Video-on-Demand ("VOD") services
through electronic distribution platforms including cable television, C-Band,
Direct Broadcast Satellite ("DBS"), and hotels
* Internet Group -- aggregates and resells adult content via the Internet. The
Internet Group sells content to monthly subscribers through its broadband
site, www.ten.com, partners with third-party gatekeepers for the distribution
of www.ten.com, and wholesales pre-packaged content to various webmasters. The
accounting policies of the reportable segments are the same as those described
in the summary of accounting policies. Segment profit (loss) is based on
income (loss) before minority interest and income taxes. The reportable
segments are distinct business units, separately managed with different
distribution channels.
9
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following tables represent financial information by reportable segment (in
thousands):
(UNAUDITED) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
NET SALES
Subscription/Pay-Per-View TV........ $10,025 $ 6,806 $29,186 $20,900
Internet Group...................... 754 1,784 2,592 6,567
------- ------- ------- -------
Total.......................... $10,779 $ 8,590 $31,778 $27,467
======= ======= ======= =======
SEGMENT PROFIT (LOSS)
Subscription/Pay-Per-View TV........ $ 4,299 $ 1,369 $11,951 $ 4,350
Internet Group...................... 71 (541) 102 (4,751)
Corporate Administration............ (1,640) (1,510) (4,467) (6,941)
------- ------- ------- -------
Total.......................... $ 2,730 $ (682) $ 7,586 $(7,342)
======= ======= ======= =======
INTEREST INCOME
Subscription/Pay-Per-View TV........ $ -- $ -- $ -- $ --
Internet Group...................... -- -- 3 1
Corporate Administration............ 11 13 28 51
------- ------- ------- -------
Total.......................... $ 11 $ 13 $ 31 $ 52
======= ======= ======= =======
INTEREST EXPENSE
Subscription/Pay-Per-View TV........ $ 22 $ 40 $ 85 $ 108
Internet Group...................... 16 129 170 247
Corporate Administration............ 378 264 832 1,016
------- ------- ------- -------
Total.......................... $ 416 $ 433 $ 1,087 $ 1,371
======= ======= ======= =======
DEPRECIATION AND AMORTIZATION
Subscription/Pay-Per-View TV........ $ 1,544 $ 1,485 $ 4,527 $ 4,276
Internet Group...................... 89 317 276 1,398
Corporate Administration............ 3 2 11 10
------- ------- ------- -------
Total.......................... $ 1,636 $ 1,804 $ 4,814 $ 5,684
======= ======= ======= =======
(UNAUDITED)
DECEMBER 31, MARCH 31,
2003 2003
------------ -----------
IDENTIFIABLE ASSETS
Subscription/Pay-Per-View TV.................. $32,437 $28,487
Internet Group................................ 3,305 4,067
Corporate Administration...................... 15,340 22,590
Eliminations.................................. (9,846) (20,119)
------- -------
Total.................................... $41,236 $35,025
======= =======
Expenses related to corporate administration include all costs associated with
the operation of the public holding company, New Frontier Media, Inc., that are
not directly allocable to the Subscription/ PPV TV and Internet operating
segments. These costs include, but are not limited to, legal and accounting
expenses, insurance, registration and filing fees with NASDAQ and the SEC,
investor relation costs, and printing costs associated with the Company's public
filings.
NOTE 4 -- MAJOR CUSTOMER
The Company's major customers (revenues in excess of 10% of total sales) are
EchoStar Communications Corporation ("EchoStar") and Time Warner Cable ("Time
Warner"). EchoStar and
10
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Time Warner are included in the Subscription/Pay-Per-View TV Segment. Revenue
from Echostar's DISH Network and Time Warner as a percentage of total revenue
for each of the quarters and nine months ended December 31, is as follows:
(UNAUDITED)
(UNAUDITED) NINE MONTHS
QUARTER ENDED ENDED
DECEMBER 31, DECEMBER 31,
----------------------- -----------------------
2003 2002 2003 2002
-------- -------- -------- --------
EchoStar................................ 34% 36% 34% 36%
Time Warner............................. 17% 8% 15% 7%
At December 31, 2003 and March 31, 2003, accounts receivable from EchoStar was
approximately $3,653,000 and $3,462,000, respectively. At December 31, 2003 and
March 31, 2003 accounts receivable from Time Warner was approximately $1,130,000
and $606,000, respectively.
The loss of its major customers could have a materially adverse effect on the
Company's business, operating results and/or financial condition.
NOTE 5 -- NOTES PAYABLE
During the quarter ended June 30, 2003, the Company entered into a secured loan
of $400,000 with an unrelated third party. The loan matures on May 29, 2004, and
bears interest at 7.5% per annum payable on a quarterly basis. The loan is
secured by 930,000 shares of the Company's common stock. The loan was amended to
delete a clause to convert the note into common stock at $0.65 per share on the
date of maturity. The Company may repay the note, in whole or part, at any time
without premium or penalty.
During the quarter ended December 31, 2003, the Company entered into a loan of
$500,000 with an unrelated third party. The loan matures in October 2004 and
bears interest at 5% per annum payable on a quarterly basis.
NOTE 6 -- REDEEMABLE PREFERRED STOCK
During the quarter ended June 30, 2003, the Company issued 2.5 million shares of
Class B Redeemable Preferred Stock ("Class B") at $0.81 per share. The proceeds
from this offering of $2,000,000 were used to redeem $1.0 million of the
Company's Class A Redeemable Preferred Stock and to fund the purchase and
subsequent retirement of 2,520,750 shares of New Frontier Media, Inc. common
stock as part of the Bonn settlement. During the quarter ended December 31,
2003, the Company redeemed all outstanding class B Redeemable Preferred Stock.
The Class B paid dividends at 10% per year payable on a quarterly basis.
NOTE 7 -- TAXES PAYABLE
No provision for taxes has been made as management believes they will be able to
offset net operating losses against any taxable income the Company may have for
the year ending March 31, 2004. At March 31, 2003, the Company had a net
operating loss carry forward of approximately $11,300,000, which will begin
expiring through 2023. During the last three years, issuances and redemptions of
stock and other equity instruments have effected ownership changes under
Internal Revenue Code Section 382. However, based on a study performed to
analyze ownership changes, management estimates that the amount of projected
taxable income will not exceed the estimated net operating losses available
under IRC 382.
NOTE 8 -- LITIGATION
During the fiscal quarter ended March 31, 2003, the Company settled its
litigation with Edward J. Bonn, a former director of the Company, and Jerry
Howard. In connection therewith, Mr. Bonn
11
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
returned 2.5 million shares of the Company's common stock and received $1.5
million, 150 internet domain names and warrants to purchase 350,000 shares at
$1.00 a share. The effect of this transaction was recorded during the quarter
ended June 30, 2003, and reduced equity by approximately $2,100,000.
On June 12, 2003, the Company settled its litigation with Pleasure Productions.
This litigation related to a complaint filed by the Company on August 3, 1999 in
District Court for the city and county of Denver (Colorado Satellite
Broadcasting, Inc. et al. vs. Pleasure Licensing LLC, et al., case no 99CV4652)
against Pleasure Licensing LLC and Pleasure Productions, Inc. (collectively,
"Pleasure"), alleging breach of contract, breach of express warranties, breach
of implied warranty of fitness for a particular purposes, and rescission,
seeking the return of 700,000 shares of New Frontier Media stock and warrants
for an additional 700,000 New Frontier Media shares which were issued to
Pleasure in connection with a motion picture licensing agreement. In the
settlement, the Company secured the exclusive broadcast rights to 2,000 titles
from Pleasure Productions catalog and up to 83 new releases. In addition,
Pleasure Productions agreed to the cancellation of 700,000 warrants issued to it
in 1999 to purchase New Frontier common stock at $1.12 a share. As a result of
the transaction, the Company reduced the carrying value of the underlying assets
and equity for an amount that approximates the value of the warrants.
NOTE 9 -- SUBSEQUENT EVENTS
In January 2004, the Board unanimously voted Michael Weiner to Chief Executive
Officer. Mr. Weiner had been appointed to the office of President of New
Frontier Media, Inc. on February 14, 2003, after the resignation of its former
CEO. Mr. Weiner previously held the title of Executive Vice President since the
Company's inception.
In January 2004, the Board unanimously voted to extend the employment contracts
of Michael Weiner, Chief Executive Officer and Ken Boenish, TEN President, for
one year, to March 31, 2006; and Karyn Miller, Chief Financial Officer, for two
years, to March 31, 2006. The annual compensation of each officer remains
unchanged.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-Q includes forward-looking statements. These
statements are subject to certain risks and uncertainties, including those
identified below, which could cause actual results to differ materially from
such statements. The words "believe", "expect", "anticipate", "optimistic",
"intend", "will", and similar expressions identify forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date on which they are made. The Company
undertakes no obligation to update or revise any forward-looking statements.
Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to: 1) our ability to
compete effectively with our primary Cable/ DBS competitor; 2) our ability to
retain our major customers which account for 34% and 15%, respectively, of our
total revenue; 3) our ability to compete effectively for quality content; 4) our
ability to successfully manage our credit card chargeback and credit percentages
in order to maintain our ability to accept credit cards as a form of payment for
our products and services; 5) our ability to compete effectively with new
competitors in the PPV or VOD space; and 6) our ability to retain our key
executives.The following table reflects the Company's results of operations for
the quarters and nine months ended December 31, 2003 and 2002.
RESULTS OF OPERATIONS
(IN MILLIONS) (IN MILLIONS)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- -------------------------
2003 2002 2003 2002
-------- -------- -------- --------
NET REVENUE
Subscription/Pay-Per-View TV
Cable/DBS/Hotel......................... $ 8.6 $ 5.0 $24.2 $15.3
C-Band.................................. 1.4 1.8 5.0 5.6
Internet Group
Net Membership.......................... 0.7 1.2 2.1 4.4
Sale of Content......................... 0.1 0.3 0.5 1.0
Sale of Traffic......................... 0.0 0.3 0.0 1.2
----- ----- ----- -----
TOTAL................................... $10.8 $ 8.6 $31.8 $27.5
===== ===== ===== =====
COST OF SALES
Subscription/Pay-Per-View TV................. $ 3.9 $ 3.6 $11.4 $10.5
Internet Group............................... 0.3 0.8 1.0 3.6
----- ----- ----- -----
TOTAL................................... $ 4.2 $ 4.4 $12.4 $14.1
===== ===== ===== =====
OPERATING INCOME (LOSS)
Subscription/Pay-Per-View TV................. $ 4.3 $ 1.4 $12.0 $ 4.4
Internet Group............................... 0.0 0.2 0.2 (0.2)
Restructuring Expense........................ 0.0 0.2 (0.1) (2.9)
Asset Impairment Expense..................... 0.0 (0.8) 0.0 (1.3)
Corporate Administration..................... (1.3) (1.3) (3.7) (5.9)
----- ----- ----- -----
TOTAL................................... $ 3.0 $(0.3) $ 8.4 $(5.9)
===== ===== ===== =====
EXECUTIVE SUMMARY
The Company continues to operate its business through two segments:
Subscription/PPV TV and Internet. The Company's core business is its
Subscription/PPV TV business, which is focused on the distribution of its eight
pay-per-view networks and its Video-on-Demand ("VOD") service to cable and
direct broadcast satellite ("DBS") providers. In addition, the Subscription/PPV
TV Group has had success in delivering its VOD service to hotel rooms through
its current distribution arrangement with On Command Corporation ("On Command").
The Subscription/PPV TV Group earns a percentage of revenue on each
pay-per-view, subscription, or VOD transaction for its services. Revenue growth
occurs as the Subscription/PPV TV Group launches its services to new cable or
DBS providers, experiences growth in subscribers of its currently distributed
services, launches additional services to
13
its existing cable/DBS partners, or experiences new and existing subscriber
growth for its VOD service.
VOD has become a significant contributor to the Company's revenue mix during the
current fiscal year as cable operators have upgraded their systems to deliver
content in this manner. The Subscription/PPV TV Group now delivers VOD content
to 8.9 million cable network households as compared to 4.9 million a year ago,
as well as to 900,000 hotel rooms through its distribution arrangement with On
Command. The Company expects growth in its home VOD revenue as cable operators
continue to upgrade their systems to allow for the delivery of VOD content. VOD
is delivered in a digital, cable environment. Currently, per the National Cable
and Telecommunications Association, there are 21.5 million digital cable
households in the U.S., of which, we estimate, 10.0 million are VOD enabled.
Growth in our VOD revenue generated through the hospitality industry will depend
upon an increase in business traveler occupancy rates, the addition of new hotel
rooms served by On Command, and our ability to launch our VOD content on the
platforms of other providers of in-room entertainment to the hospitality
industry.
In addition to the growth in VOD, the Company has experienced a growing
acceptance for its partially-edited services. The Subscription/PPV TV Group
launched two new partially-edited services in January 2003 to respond to this
change. Accordingly, we are seeing a shift in our distribution away from our
most-edited service -- Pleasure -- as more cable operators choose to launch our
partially-edited services -- TEN, Clips, Blue and Blox.
To date, the focus of the Subscription/PPV TV Group has been on the distribution
of its services to Cable, DBS and Hotel platforms in the U.S. market only.
The Internet segment continues to experience an erosion in its revenue as we
shift away from our consumer, dial-up website business and move towards forming
revenue sharing partnerships with third party gatekeepers such as cable
companies, hospitality providers like On Command, and portals for the
distribution of www.ten.com, whereby we can gain direct access to consumers in
search of high-quality adult entertainment. We have completed one such agreement
with On Command for the distribution of www.ten.com through their digitally
wired hotel rooms, and we expect to create additional revenue sharing
arrangements in the near-term with select cable operators. The success we
achieve with these cable operators will dictate the revenue potential for this
segment in the longer term and will serve as justification for larger MSO's to
adopt this business model.
SUBSCRIPTION/PAY-PER-VIEW (PPV) TV GROUP
The Subscription/PPV TV Group re-branded its networks under the TEN* name and
logo during the fourth quarter of the fiscal year ended March 31, 2003. Each
network (except Pleasure) has the TEN name associated with it. This change was
done in an effort to create brand recognition for the TEN name and associate
this name with the best adult programming available on Cable, DBS and Hotel
platforms. The networks are now named as follows: Pleasure, TEN, TEN*Clips
(formerly ETC), TEN*Xtsy (formerly Extasy), TEN*BluePlus (formerly True Blue),
TEN*Max (formerly X-Cubed and XClips), TEN*Blue (launched in January 2003), and
TEN*Blox (launched in January 2003). The Subscription/PPV TV Group's VOD service
is branded as TEN*On Demand.
14
The following table outlines the current distribution environment and network
households for each network:
ESTIMATED NETWORK HOUSEHOLDS
---------------------------------------
(IN THOUSANDS)
AS OF AS OF
DECEMBER 31, DECEMBER 31,
NETWORK DISTRIBUTION METHOD 2003 2002 % CHANGE
------- ------------------- ------------ ------------ ---------
Pleasure Cable/DBS 7,700 7,800 1%
TEN Cable/DBS 14,200 10,000 42%
TEN*Clips Cable/DBS 12,600 5,000 152%
Video-On-Demand Cable 8,900 4,900 82%
TEN*Blue Cable 2,000 N/A N/A
TEN*Blox Cable 2,300 N/A N/A
TEN*Xtsy C-band/Cable/DBS 9,400 8,700 8%(1)
TEN*Blue Plus C-band/Cable 500 660 (24%)(1)
TEN*Max C-band/Cable 500 660 (24%)(1)
------ ------
TOTAL NETWORK HOUSEHOLDS 58,100 37,720
====== ======
(1) % change gives effect to a 27% decline in the C-band market's total
addressable households. Total addressable C-Band households declined
from 590,000 as of December 31, 2002 to 428,000 as of December 31,
2003.
(2) The above table reflects network household distribution. A household
will be counted more than once if the home has access to more than one
of the Subscription/PPV TV Group's channels, since each network
represents an incremental revenue stream. The Subscription/ PPV TV
Group estimates its unique household distribution as 13.1 million cable
homes and 8.8 million DBS homes as of December 31, 2003.
NET REVENUE
Total net revenue for the Subscription/PPV TV Group was $10.0 million for the
quarter ended December 31, 2003 as compared to $6.8 million for the quarter
ended December 31, 2002, representing an increase of 47%. Of total net revenue,
C-Band net revenue was $1.4 million for the quarter ended December 31, 2003, as
compared to $1.8 million for the quarter ended December 31, 2002, representing a
decrease of 22%. Revenue from the Group's Cable/DBS/Hotel services was $8.6
million for the quarter ended December 31, 2003, as compared to $5.0 million for
the quarter ended December 31, 2002, representing an increase of 72%. Revenue
from the Group's Cable/DBS/Hotel services is responsible for 86% of the Group's
total net revenue as compared to 74% of the Group's total net revenue for the
quarter ended December 31, 2002.
Total net revenue for the Subscription/PPV TV Group was $29.2 million for the
nine months ended December 31, 2003, as compared to $20.9 million for the nine
months ended December 31, 2002, representing a 40% increase. Of total net
revenue, C-Band net revenue was $5.0 million for the nine months ended December
31, 2003, as compared to $5.6 million for the nine months ended December 31,
2002, representing a decrease of 11%. Revenue from the Group's Cable/DBS/Hotel
services was $24.2 million for the nine months ended December 31, 2003, as
compared to $15.3 million for the nine months ended December 31, 2002,
representing an increase of 58%. Revenue from the Group's Cable/ DBS/Hotel
services is responsible for 83% of the Group's total net revenue for the nine
months ended December 31, 2003, as compared to 73% of the Group's total net
revenue for the nine months ended December 31, 2002.
The quarterly and year-to-date increase in Cable/DBS/Hotel revenue is a result
of 1) the growth in the distribution of its Video-on-Demand ("VOD") service on
both cable and hotel platforms and 2) an increase in the distribution of the
Subscription/PPV TV Group's partially-edited services on cable platforms.
VOD revenue contributed to 72% and 85% of the increase in Cable/DBS/Hotel
revenue for the quarter and nine months ended December 31, 2003. The
Subscription/PPV TV Group currently provides its VOD service to 8.9 million VOD
enabled cable households, representing an 82% increase from the same period a
year ago, as well as to 900,000 hotel rooms in the U.S. through its distribution
agreement with On Command. Revenue from the Subscription/PPV TV Group's VOD
service
15
currently represents 37% and 36% of total Cable/DBS/Hotel revenue for the
quarter and nine months ended December 31, 2003, up from 9% and 7% for the
quarter and nine months ended December 31, 2002.
Growth in the distribution of this service has come as large multiple system
operators ("MSOs") like Time Warner Cable and Comcast Corporation have
aggressively upgraded their systems to serve the VOD market. Currently, the
Subscription/PPV TV Group is the sole provider of adult VOD content to these two
MSOs, which account for 6.4 million of the current 8.9 million VOD households.
Growth is expected to continue in this market as MSOs complete the necessary
upgrades to their digital plants in order to provide VOD service to their
customers. In addition, the Subscription/PPV TV Group expects MSOs to increase
the storage capacity of their VOD servers during the next twelve months, which
should allow for the amount of VOD programming currently provided by the Group
to be expanded beyond its current 60 hours.
As stated in the Company's Critical Accounting Policies on Revenue Recognition,
cable affiliates do not report actual monthly sales for each of their systems to
the Subscription/PPV TV Group until 45 - 60 days (and sometimes longer) after
each month end. This practice requires management to make monthly revenue
estimates based on the historical experience for each affiliated system.
Historically, any differences between the amounts estimated and the actual
amounts received have been immaterial due to the overall predictability of
pay-per-view revenues.
Since VOD is such a new service, the revenue expected from new VOD cable
affiliates can be more difficult to predict. The Subscription/PPV TV Group
believes it is conservative in estimating the impact of the rollout of VOD
households in individual quarters, and it continually adjusts estimates to
reflect actual revenue remitted.
As of December 31, 2003, the Subscription/PPV TV Group provided its pay-per-view
services to 48 million network households, up 55% from 31 million network
households a year ago. The Subscription/PPV TV Group has seen a growing
acceptance by its consumer base for its partially-edited services, which it
views as a positive development given the higher buy rates associated with such
programming. This growing acceptance prompted the Subscription/PPV TV Group to
launch two new partially-edited services in January 2003. These two new
services, TEN*Blue and TEN*Blox, plus the Group's legacy partially-edited
services, TEN and TEN*Clips, are now distributed to 31.1 million network
households, up from 15 million network households a year ago. Revenue from the
Subscription/PPV TV Group's partially-edited services, distributed on both Cable
and DBS platforms, increased 58% and 37% for the quarter and nine months ended
December 31, 2003 from the same periods a year ago.
The decrease in C-Band revenue for the quarter and nine months ended December
31, 2003 is due to the continued decline of the C-Band market as consumers
convert from C-Band "big dish" analog satellite systems to smaller, 18-inch
digital DBS satellite systems. The C-Band market has decreased 27% since
December 31, 2002, from 590,000 addressable subscribers to 428,000 addressable
subscribers as of December 31, 2003. The Subscription/PPV TV Group experienced a
decline in subscriptions to its three C-Band networks of 17% during this same
period. Although the C-Band market has continued to decline, the
Subscription/PPV TV Group's C-Band revenue has declined at a much slower rate
due to the fact that its only competitor on this platform went out of business
during the first quarter of the current fiscal year. Providing service to the
C-Band market continues to be profitable for the Subscription/PPV TV Group with
margins of approximately 42%. This market will continue to be monitored closely
and when margins erode to an unacceptable level, which the Subscription/PPV TV
Group anticipates will be within the next 12 - 15 months, its services will be
discontinued. The Subscription/PPV TV Group will be discontinuing one of its
C-Band services (TEN*BluePlus) during the fourth quarter of its fiscal year
ended March 31, 2004. The Group will continue to sell its two remaining C-Band
services for the same subscription price as it is currently selling three
services, so it does not anticipate any additional degradation in its revenue
because of this decision.
COST OF SALES
Cost of sales for the Subscription/PPV TV Group was $3.9 million, or 39% of
revenue for the quarter ended December 31, 2003, as compared to $3.6 million, or
53% of revenue, for the quarter ended December 31, 2002, representing an
increase of 8%. Cost of sales for the Subscription/PPV TV Group
16
was $11.4 million, or 39% of revenue for the nine months ended December 31,
2003, as compared to $10.5 million or 50% of revenue for the nine months ended
December 31, 2002, representing an increase of 9%.
Cost of sales consists of expenses associated with broadcast playout, satellite
uplinking, satellite transponder leases, programming acquisition costs, in-house
editing and programming costs, VOD transport costs, amortization of content
licenses, and the Subscription/PPV TV Group's in-house call center for its
C-Band business.
The increase in cost of sales for the quarter and nine months is due to: a) an
increase in transport costs related to the delivery of VOD content to cable
customers, b) the addition of an in-house editing and programming department
dedicated to the new partially-edited services and the VOD content provided to
On Command, and c) an increase in costs related to the hiring of additional
broadcast department personnel required to manage the delivery of the
Subscription/PPV TV Group's VOD product. The increase in these costs has been
partially offset by a 36% quarterly and 28% year-to-date decline in costs
associated with the Group's satellite transponder leases and a 25% decline in
call center costs for both the quarter and year-to-date.
OPERATING INCOME
Operating income for the Subscription/PPV TV Group was $4.3 million for the
quarter ended December 31, 2003, as compared to $1.4 million for the quarter
ended December 31, 2002, representing an increase of 207%. Operating income for
the Subscription/PPV TV Group for the nine months ended December 31, 2003 was
$12.0 million as compared to $4.4 million for the nine months ended December 31,
2002, representing an increase of 173%.
The increase in operating income for the quarter and nine months ended December
31, 2003 is related to an increase in gross margins while operating expenses
remained relatively flat. The Subscription/ PPV TV Group's gross margin
increased to 61% for the quarter ended December 31, 2003, from 47% for the
quarter a year ago. The Group's gross margin increased to 61% for the nine
months ended December 31, 2003, from 50% for the nine months ended December 31,
2002.
Operating expenses remained flat at $1.8 million for both quarters ended
December 31, 2003 and 2002, while operating expenses for the nine months ended
December 31, 2003 declined 3% to $5.8 million from $6.0 million a year ago.
Operating expenses as a percentage of revenue declined to 18% of revenue for the
quarter ended December 31, 2003 from 26% for the quarter a year ago. Operating
expenses as a percentage of revenue declined to 20% for the nine months ended
December 31, 2003 from 29% a year ago.
The Subscription/PPV TV Group discontinued the use of its barker channel during
the current fiscal year. This barker channel was used to market its C-Band
services. The decline in this marketing expense for the quarter and nine months
ended December 31, 2003 was offset by an increase in year-over-year commissions
paid to the sales team for the launching of the Group's services to new network
households and an increase in payroll costs due to the accrual of year-end
bonuses.
INTERNET GROUP
NET REVENUE
Total net revenue for the Internet Group was $0.8 million for the quarter ended
December 31, 2003, as compared to $1.8 million for the quarter ended December
31, 2002, representing a decrease of 56%. Total net revenue for the Internet
Group was $2.6 million for the nine months ended December 31, 2003, as compared
to $6.6 million for the nine months ended December 31, 2002, representing a
decrease of 61%. The Internet Group's revenue is comprised of membership revenue
from its consumer-based web sites, revenue from the sale of its content feeds,
and revenue from the sale of exit traffic.
Net membership revenue for the Internet Group was $0.7 million and $2.1 million
for the quarter and nine months ended December 31, 2003, as compared to $1.2
million and $4.4 million for the quarter and nine months ended December 31,
2002, representing a decrease of 42% and 52%, respectively. The Internet Group
has continued to see a decline in its net membership revenue from the prior
fiscal year due to the change made to its business model to no longer purchase
traffic from other
17
webmasters. The transfer of 150 domain names to Edward Bonn at March 31, 2003,
in settlement of the Company's lawsuit, has also adversely impacted the volume
of traffic to the Internet Group's websites. The Internet Group expects to see a
continued erosion of its recurring membership revenue since the current monthly
traffic to www.ten.com does not generate enough new monthly sign-ups to offset
the churn of its renewing membership base. However, it is important to note that
the Internet Group does not consider the monthly membership model to be the
focus of its future growth plans. Instead, the Internet Group's focus for growth
is on forming revenue sharing partnerships with third party gatekeepers such as
cable companies, hospitality providers like On Command Corporation, and portals
for the distribution of www.ten.com, whereby it can gain direct access to
consumers in search of high-quality adult entertainment.
Revenue from the Internet Group's sale of content was $0.1 million and $0.5
million for the quarter and nine months ended December 31, 2003, as compared to
$0.3 million and $1.0 million for the quarter and nine months ended December 31,
2002, representing a decrease of 67% and 50%, respectively. The decrease in
revenue from the sale of content for the quarter and nine months ended December
31, 2003 is due to a softening in the demand for content by third-party
webmasters. Webmasters are decreasing their reliance on outside sources for
content and demanding lower prices for content that they do purchase. The
continued reluctance on the part of webmasters to pay for high-quality adult
content makes this a difficult market segment in which to compete.
The Internet Group is no longer actively selling its exit traffic.
COST OF SALES
Cost of sales for the Internet Group was $0.3 million, or 38% of revenue for the
quarter ended December 31, 2003, as compared to $0.8 million, or 44% of revenue,
for the quarter ended December 31, 2002, representing a decrease of 63%. Cost of
sales for the Internet Group was $1.0 million or 38% of revenue for the nine
months ended December 31, 2003, as compared to $3.6 million, or 55% of revenue,
for the nine months ended December 31, 2002, representing a decrease of 72%.
Cost of sales consists of expenses associated with credit card fees, merchant
banking fees, bandwidth, membership acquisition costs (purchase of traffic), web
site content costs, and depreciation of assets.
Cost of sales has decreased for the quarter and nine months ended December 31,
2003 due to a decline in bandwidth costs, a decrease in variable costs related
to credit card processing, and a decrease in operating costs related to the
Internet Group's data center. The Internet Group relocated its data center
functions from Los Angeles to Boulder during the 2003 fiscal year (see
"Restructuring Expenses" below). This restructuring resulted in a 74% and 80%
decrease in depreciation, amortization, equipment lease and maintenance costs
for the quarter and nine months ended December 31, 2003, respectively, due to
the write-off of excess equipment and impaired assets.
OPERATING INCOME (LOSS)
Operating income for the Internet Group was $0 and $0.2 million for the quarter
and nine months ended December 31, 2003, respectively, as compared to operating
income of $0.2 million and an operating loss of $0.2 million for the quarter and
nine months ended December 31, 2002, respectively.
The decline in operating income for the quarter ended December 31, 2003 is
related to a 56% decline in revenue year-over-year for the quarter that was only
partially offset by declines in cost of sales and operating expenses. Gross
margins improved to 63% for the quarter ended December 31, 2003 from 56% for the
quarter a year ago. Quarterly operating expenses declined from $0.8 million, or
44% of revenue, to $0.5 million, or 63% of revenue, representing a decrease of
38%. This decline in operating expenses is related to a decrease in payroll,
benefits and other office expenses for all departments. The Internet Group
completed a final restructuring during the fourth quarter of its fiscal year
ended March 31, 2003, which resulted in a decrease in sales, marketing, data
center and web production personnel.
The increase in operating income for the nine months ended December 31, 2003 is
related to improved gross margins as a result of the data center restructuring
and to a decrease in operating expenses related to the restructuring completed
in the fourth quarter of the fiscal year ended March 31, 2003. The efficiencies
obtained through these restructurings more than offset the 61% decline in
revenue experienced during the nine months ended December 31, 2003. Gross margin
improved to 62% for the nine months ended December 31, 2003 as compared to 45%
for the nine months a year
18
ago. Operating expenses for the current nine-month period declined 56% from $3.2
million, or 48% of revenue, to $1.4 million, or 54% of revenue.
RESTRUCTURING EXPENSES
During the quarter ended June 30, 2002, the Company adopted a restructuring plan
with respect to the Internet Group's data center facility. The Company closed
the Internet Group's in-house data center in Sherman Oaks, California and moved
its servers, bandwidth and content delivery to the same location as the
Subscription/PPV TV Group's digital broadcast facility in Boulder, Colorado.
Total restructuring charges of $3.1 million related to this plan were recorded,
of which $28,000 related to the termination of 10 employees. Also included in
this charge was $0.4 million related to the data center space in Sherman Oaks
that the Company abandoned and $2.6 million of expenses related to the write-off
of excess equipment.
During the quarter ended September 30, 2002, the Internet Group increased the
amount of its restructuring expense accrued during the fourth quarter of the
prior fiscal year by $0.3 million due to an adjustment to the estimate used in
computing the expense related to its excess space. The change in the estimate
was related to an extension of the time necessary to sublet the space. Future
adjustments to this accrual may be required once a final settlement with respect
to the space is reached with the landlord. In addition, the restructuring
expense for this same period was decreased by $0.1 million and $0.3 million
during the quarters ended September 30 and December 31, 2002, respectively, for
a change in the amount estimated for certain payroll related expenses.
During the quarter ended September 30, 2003, the Internet Group incurred $0.1
million in additional restructuring costs related to equipment that had been
written off as part of the restructuring charges taken during fiscal years 2002
and 2003. These expenses were primarily related to lease buyouts and assumptions
of leased equipment that were written off in previous years.
ASSET IMPAIRMENT CHARGES
The Company recognized impairment losses on certain URLs of approximately
$535,000 and $805,000 for the quarters ended June 30 and December 31, 2002,
respectively, in connection with the Internet Division. Management identified
certain conditions including a declining gross margin due to the availability of
free adult content on the Internet and decreased traffic to the Company's URLs
as indicators of asset impairment. These conditions led to operating results and
forecasted future results that were substantially less than had been anticipated
at the time of the Company's acquisition of the Internet business. The Company
revised its projections and determined that the projected results would not
fully support the future amortization of the URLs associated with the Internet
business. In accordance with the Company's policy, management assessed the
recoverability of the URLs using a cash flow projection based on the remaining
amortization period of two to four years. Based on this projection, the
cumulative cash flow over the remaining amortization periods was insufficient to
fully recover the intangible asset balance, and the Company recorded an
impairment charge by writing down the URLs.
CORPORATE ADMINISTRATION
Expenses related to corporate administration include all costs associated with
the operation of the public holding company, New Frontier Media, Inc., that are
not directly allocable to the Subscription/ PPV TV and Internet operating
segments. These costs include, but are not limited to, legal and accounting
expenses, insurance, registration and filing fees with NASDAQ and the SEC,
investor relations costs, and printing costs associated with the Company's
public filings.
Corporate administration expenses were $1.3 million for both quarters ended
December 31, 2003 and 2002, respectively. Corporate administration expenses were
$3.7 million and $5.9 million for the nine months ended December 31, 2003 and
2002, respectively, representing a decrease of 37%.
Corporate administration expenses were flat year-over-year for the quarter due
primarily to an increase in accounting/auditing fees and payroll costs related
to the accrual of year-end bonuses, which were then offset by a 32% decrease in
legal expenses.
The decrease in corporate administration expenses for the nine months ended
December 31, 2003 is due primarily to an 82% decrease in legal fees. Legal fees
were higher during the prior fiscal year due
19
to the proxy fight and its associated litigation. Legal fees for the nine months
ended December 31, 2003 included a reimbursement of $166,000 as part of a
settlement reached during the first fiscal year quarter.
INCOME TAXES
At March 31, 2003, the Company had a net operating loss carry forward of
approximately $11.3 million, which will begin expiring through 2023. During the
last three years, issuances and redemptions of stock and other equity
instruments have effected ownership changes under Internal Revenue Code Section
382. However, based on a study performed analyzing these ownership changes, the
Company estimates that the amount of projected taxable income will not exceed
the estimated net operating losses available under IRC 382 for the current
fiscal year. The Company does expect that it will be a taxpayer in its fiscal
year ended March 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended December 31, 2003, cash provided by operating
activities was $9.7 million. Cash was provided by net income of $7.6 million
adjusted for depreciation and amortization of $4.8 million and other non-cash
items of $0.9 million. Accounts receivable increased by $1.3 million from March
31, 2003, as a result of an increase in revenue from the Subscription/PPV TV
Group. In addition, the Company's content licensing expenditures were $2.1
million for the nine months ended December 31, 2003.
Cash used in investing activities was $0.8 million for the nine months ended
December 31, 2003, compared to cash used in investing activities of $0.5 million
for the nine months ended December 31, 2002. Cash used in investing activities
for the nine months ended December 31, 2003 related to purchases of broadcast
equipment, including a new broadcast cluster to allow for increased redundancy,
encrypting equipment necessary for new cable launches, and upgrades to the
Company's digital broadcast facility. Cash used in investing activities for the
nine months ended December 31, 2002 was primarily related to the purchase of
software licenses, minor equipment upgrades to the Subscription/PPV TV Group's
digital broadcast facility and the purchase of encrypting equipment for new
cable launches.
Cash used in financing activities was $0.6 million for the nine months ended
December 31, 2003 as compared to cash used in financing activities of $0.5
million for the nine months ended December 31, 2002. Cash used in financing
activities for the nine months ended December 31, 2003 was related to $0.9
million paid on the Company's capital lease obligations, the redemption of $3.8
million of the Company's Class A Redeemable Preferred Stock, and the purchase
and subsequent retirement of 2.5 million shares of New Frontier Media, Inc.
stock acquired from Edward Bonn for $1.5 million as part of the settlement of
the Company's lawsuit with him. This use of cash was offset by the issuance of
2.5 million shares of Class B Redeemable Preferred Stock at $0.81 per share, of
which $1.5 million has been subsequently redeemed and $0.5 million of which was
converted to a note payable due in October 2004. This note payable accrues
interest, payable on a quarterly basis, at 5% per annum. In addition, cash used
in financing activities was offset by $4.8 million in proceeds from the exercise
of stock options and warrants and an increase in borrowings of $0.4 million.
Current debt outstanding is less than $1.0 million with an average interest rate
of 6%. Ongoing interest expense, including interest on capital lease
obligations, is expected to be approximately $55,000 per quarter.
Cash used in financing activities for the nine months ended December 31, 2002
was related to $1.3 million paid on the Company's capital lease obligations.
This use of cash was offset by the issuance of 1.4 million shares of Class A
Redeemable Preferred Stock at $2.00 per share. The proceeds from this offering
were used to repay $2.0 million of the Company's outstanding notes payable. An
additional $1.0 million in debt was converted to 0.5 million shares of Class A
Redeemable Preferred Stock during the nine months ended December 31, 2002.
The Company anticipates capital expenditures of approximately $0.8 million
during the fourth quarter of the current fiscal year as we complete the upgrades
to our digital broadcast facility in Boulder, CO. This upgrade will ensure that
the Company's technological infrastructure is positioned for future
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growth with proper HVAC, UPS and generator capabilities necessary to support our
current state-of-the-art facility. We expect to fund these capital expenditures
out of cash flows from operations.
It is important to note that the Company is not a taxpayer for its current
fiscal year ended March 31, 2004 due to the anticipated utilization of its net
operating losses from prior years. However, we do expect to fully utilizing our
available net operating loss during this current fiscal year. Consequently, the
Company anticipates paying federal income taxes during its fiscal year ended
March 31, 2005, which will require an additional use of cash that we expect to
fund out of cash flows from operations.
If we were to lose our major customers that account for 34% and 15%,
respectively, of our revenue, our ability to finance our future operating
requirements would be severely impaired.
We believe that our existing cash balances and cash generated from operations
will be sufficient to satisfy our operating requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk. The Company's exposure to market risk is principally confined to
cash in the bank, money market accounts, and notes payable, which have short
maturities and, therefore, minimal and immaterial market risk.
Interest Rate Sensitivity. As of December 31, 2003, the Company had cash in
checking and money market accounts. Because of the short maturities of these
instruments, a sudden change in market interest rates would not have a material
impact on the fair value of these assets. Furthermore, the Company's borrowings
are at fixed interest rates, limiting the Company's exposure to interest rate
risk.
Foreign Currency Exchange Risk. The Company does not have any foreign currency
exposure because it currently does not transact business in foreign currencies.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in its Securities and Exchange
("SEC") reports is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to the Company's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, as the
Company's are designed to do, and management necessarily was required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
As required by the SEC rules, we have evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures as of the end
of the period covered by this Quarterly Report. This evaluation was performed
under the supervision and with the participation of the Company's management,
including the Chief Executive Officer and Chief Financial Officer. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's controls and procedures were effective.
Subsequent to the date of this evaluation, there have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls, and no corrective actions taken with regard
to significant deficiencies or material weaknesses in such controls.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
10.1 Amendment to Employment Agreement between Michael Weiner and New Frontier
Media, Inc.
10.2 Amendment to Employment Agreement between Ken Boenish and Colorado
Satellite Broadcasting, Inc.
10.3 Amendment to Employment Agreement between Karyn Miller and New Frontier
Media, Inc.
31.01 Certification by Chief Executive Officer Michael Weiner pursuant to U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
31.02 Certification by CFO Karyn Miller pursuant to U.S.C. Section 1350, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.01 Certification by Chief Executive Officer Michael Weiner pursuant to U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.02 Certification by CFO Karyn Miller pursuant to U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
The Company filed a Form 8-K on December 10, 2003 to announce the adoption of a
10b5-1 Plan by each of its executive officers, Michael Weiner, Ken Boenish and
Karyn Miller.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed in its behalf by the
undersigned thereunto duly authorized.
NEW FRONTIER MEDIA, INC.
/s/ Karyn L. Miller
------------------------
Karyn L. Miller
Chief Financial Officer
(Principal Accounting Officer)
Dated: February 5, 2004
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