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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 September 30, 2004
/ / Transition Report under Section 13 or 15(d) of the Exchange Act.
For the transition period from ______________ to ______________
0-23697
(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 November 9, 2004, 22,250,530 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 September
30, 2004 (Unaudited) and March 31, 2004............. 3-4
Condensed Consolidated Statements of Operations
(Unaudited) for the quarter and six months ended
September 30, 2004 and 2003......................... 5
Condensed Consolidated Statements of Cash Flows
(Unaudited) for the six months ended September 30,
2004 and 2003....................................... 6
Condensed Consolidated Statements of Comprehensive
Income (Unaudited) for the quarter and six months
ended September 30, 2004 and 2003................... 7
Condensed Consolidated Statements of Changes in
Shareholders' Equity (Unaudited) for the six months
ended September 30, 2004 and 2003................... 8
Notes to Consolidated Financial Statements
(Unaudited)......................................... 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 16
Item 3. Quantitative and Qualitative Disclosures about
Market Risk......................................... 24
Item 4. Controls and Procedures............................. 24
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security
Holders............................................. 26
Item 6. Exhibits............................................ 26
SIGNATURES.................................................. 27
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN 000S)
ASSETS
(UNAUDITED)
SEPTEMBER 30, MARCH 31,
2004 2004
------------- ---------
CURRENT ASSETS:
Cash and cash equivalents................................. $16,515 $15,352
Investments............................................... 7,736 1,478
Accounts receivable, net of allowance for doubtful
accounts of $68 and $68, respectively................... 7,854 6,872
Prepaid expenses.......................................... 422 497
Other..................................................... 538 236
------- -------
TOTAL CURRENT ASSETS.................................. 33,065 24,435
------- -------
FURNITURE AND EQUIPMENT, net................................ 3,527 3,727
------- -------
OTHER ASSETS:
Prepaid distribution rights, net.......................... 10,311 11,627
Goodwill.................................................. 3,743 3,743
Investments............................................... 2,127 --
Other identifiable intangible assets, net................. 229 356
Deposits.................................................. 43 156
Other..................................................... 618 718
------- -------
TOTAL OTHER ASSETS.................................... 17,071 16,600
------- -------
TOTAL ASSETS................................................ $53,663 $44,762
======= =======
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
3
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN 000S)
LIABILITIES AND SHAREHOLDERS' EQUITY
(UNAUDITED)
SEPTEMBER 30, MARCH 31,
2004 2004
------------- ---------
CURRENT LIABILITIES:
Accounts payable.......................................... $ 1,392 $ 1,767
Current portion of obligations under capital leases....... 248 356
Deferred revenue.......................................... 912 1,304
Current portion of notes payable.......................... 279 653
Taxes payable............................................. 356 --
Accrued restructuring expenses............................ 1,018 1,026
Accrued compensation...................................... 1,054 952
Accrued liabilities....................................... 1,595 1,259
-------- --------
TOTAL CURRENT LIABILITIES............................. 6,854 7,317
-------- --------
LONG-TERM LIABILITIES:
Obligations under capital leases, net of current
portion................................................. 60 154
Notes payable, net of current portion..................... 133 275
Deferred tax liability.................................... 42 --
-------- --------
TOTAL LONG-TERM LIABILITIES........................... 235 429
-------- --------
TOTAL LIABILITIES................................... 7,089 7,746
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock, $.0001 par value, 50,000,000 shares
authorized, 22,116,506 and 22,386,008 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................................ 53,361 49,590
Accumulated deficit....................................... (6,786) (12,576)
Accumulated other comprehensive loss...................... (3) --
-------- --------
TOTAL SHAREHOLDERS' EQUITY............................ 46,574 37,016
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 53,663 $ 44,762
======== ========
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
4
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN 000S)
(UNAUDITED) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
NET SALES..................................... $12,026 $10,919 $23,502 $20,999
COST OF SALES................................. 4,133 4,295 8,078 8,187
------- ------- ------- -------
GROSS MARGIN.................................. 7,893 6,624 15,424 12,812
------- ------- ------- -------
OPERATING EXPENSES:
Sales and marketing......................... 1,248 1,030 2,326 2,536
General and administrative.................. 2,331 2,457 4,884 4,881
------- ------- ------- -------
TOTAL OPERATING EXPENSES................ 3,579 3,487 7,210 7,417
------- ------- ------- -------
OPERATING INCOME.............................. 4,314 3,137 8,214 5,395
------- ------- ------- -------
OTHER INCOME (EXPENSE):
Interest income............................. 81 8 114 20
Interest expense............................ (28) (361) (62) (671)
Other income................................ 25 49 25 112
------- ------- ------- -------
TOTAL OTHER INCOME (EXPENSE)............ 78 (304) 77 (539)
------- ------- ------- -------
NET INCOME BEFORE PROVISION FOR INCOME
TAXES....................................... 4,392 2,833 8,291 4,856
------- ------- ------- -------
Provision for income taxes.................. (1,330) (1) (2,501) (2)
------- ------- ------- -------
NET INCOME.................................... $ 3,062 $ 2,832 $ 5,790 $ 4,854
------- ------- ------- -------
Basic income per share........................ $ 0.14 $ 0.15 $ 0.26 $ 0.25
======= ======= ======= =======
Diluted income per share...................... $ 0.13 $ 0.14 $ 0.25 $ 0.23
======= ======= ======= =======
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
5
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN 000S)
(UNAUDITED)
SIX MONTHS ENDED
SEPTEMBER 30,
-------------------------
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 5,790 $ 4,854
Adjustments to reconcile net income to net cash provided
by operating activities:
Warrants issued/amortized for services and financing.... -- 292
Amortization of deferred debt offering costs............ -- 116
Tax Provision for capital transaction................... (657) --
Depreciation and amortization........................... 2,963 3,178
Other................................................... -- 38
Tax benefit from option/warrant exercise................ 2,863 --
(Increase) Decrease in operating assets
Accounts receivable................................. (981) (1,087)
Prepaid expenses and other current assets........... (122) 198
Prepaid distribution rights......................... (813) (1,069)
Deferred tax asset.................................. (108) --
Other assets........................................ 114 335
Increase (Decrease) in operating liabilities
Accounts payable.................................... (306) (668)
Deferred revenue, net............................... (392) (502)
Taxes payable....................................... 356 --
Deferred tax liability.............................. 42 --
Accrued restructuring cost.......................... (7) (295)
Accrued liabilities and other current liabilities... 437 868
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES....... 9,179 6,258
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments................................. (10,185) --
Purchase of equipment and furniture..................... (574) (313)
Sale/Redemption of investments.......................... 1,897 --
-------- --------
NET CASH USED IN INVESTING ACTIVITIES............... (8,862) (313)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations................... (202) (731)
Increase (decrease) in note payable..................... (400) 400
Issuance of common stock................................ 1,565 1,294
Retirement of common stock.............................. -- (1,500)
Redemption of redeemable preferred stock................ -- (1,750)
Decrease in other financing activities.................. (117) (60)
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES........................................ 846 (2,347)
-------- --------
NET INCREASE IN CASH........................................ 1,163 3,598
CASH AND CASH EQUIVALENTS, beginning of period.............. 15,352 4,264
-------- --------
CASH AND CASH EQUIVALENTS, end of period.................... $ 16,515 $ 7,862
======== ========
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
6
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN 000S)
(UNAUDITED) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income........................................ $3,062 $2,832 $5,790 $4,854
Other comprehensive loss
Unrealized loss on available-for-sale marketable
securities, net of tax.......................... (3) -- (3) --
------ ------ ------ ------
Total comprehensive income.................... $3,059 $3,832 $5,787 $4,854
====== ====== ====== ======
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
7
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN 000S)
(UNAUDITED)
SIX MONTHS ENDED
SEPTEMBER 30,
----------------------
2004 2003
-------- --------
NEW FRONTIER MEDIA, INC. COMMON STOCK
Balance at beginning of year............................ $ 2 $ 2
------- --------
Balance at end of period................................ 2 2
------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period.......................... 49,590 45,943
Exercise of stock options/warrants...................... 1,565 1,294
Tax provision for capital transaction................... (657) --
Tax benefit for stock option/warrant exercise........... 2,863 --
Retirement of stock..................................... -- (1,500)
Legal settlement........................................ -- 45
Cancellation of warrants associated with license
agreement............................................. -- (1,152)
Stock issued in connection with financing............... -- 410
Elimination of inter-company investment................. -- (558)
Other................................................... -- 144
------- --------
Balance at end of period................................ 53,361 44,626
------- --------
ACCUMULATED DEFICIT
Balance at beginning of year............................ (12,576) (23,489)
Net income.............................................. 5,790 4,854
------- --------
Balance at end of period................................ (6,786) (18,635)
------- --------
ACCUMULATED COMPREHENSIVE LOSS
Balance at beginning of year............................ -- --
Unrealized losses on available-for-sale securities...... (3) --
------- --------
Balance at end of period................................ (3) --
------- --------
TOTAL SHAREHOLDERS' EQUITY.................................. $46,574 $ 25,993
======= ========
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
8
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 United States 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. Management believes 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 six-month period ended September 30, 2004 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 VOD service and 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. Ten Sales, Inc., formed in April
2003, is responsible for selling TEN's services.
Interactive Gallery, Inc. (IGI) aggregates and resells adult content over the
Internet. IGI sells content to monthly subscribers through its broadband site,
www.TEN.com, partners with third-party gate-keepers for the distribution of
www.TEN.com and wholesales pre-packaged content to various webmasters.
SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES 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.
9
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the current
period presentation.
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.
Pro forma information regarding net income and income per share is required by
SFAS 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS No. 123. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average for the
quarter and six months ended September 30, 2004: risk free interest rate of
3.47% and 3.73%, respectively; dividend yield of 0%; expected lives of 3 years
and 1 year, respectively; and expected volatility of 68% and 78%, respectively;
for the quarter and six months ended September 30, 2003; risk free interest rate
of 2.96%; dividend yield of 0%; expected lives of 5 years; and expected
volatility of 95%.
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, and net income per common share had compensation costs for the Company's
stock option plans been determined based on fair value at the date of grant
consistent with the provisions of SFAS No. 123 for the quarters ended June 30,
2004 and 2003 are as follows (in thousands, except share data):
(UNAUDITED) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income
As reported................................. $ 3,062 $ 2,832 $ 5,790 $ 4,854
------- ------- ------- -------
Deduct:
Total stock-based employee compensation
expense determined under fair value based
method for awards granted, modified, or
settled, net of tax......................... (129) (225) (199) (296)
------- ------- ------- -------
Pro forma................................... $ 2,933 $ 2,607 $ 5,591 $ 4,558
======= ======= ======= =======
Basic income per common share
As reported................................. $ 0.14 $ 0.15 $ 0.26 $ 0.25
Pro forma................................... $ 0.13 $ 0.13 $ 0.25 $ 0.23
Diluted income per common share
As reported................................. $ 0.13 $ 0.14 $ 0.25 $ 0.23
Pro forma................................... $ 0.13 $ 0.13 $ 0.24 $ 0.22
10
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- INCOME PER SHARE
The components of basic and diluted income per share are as follows (in
thousands):
(UNAUDITED) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income.................................... $ 3,062 $ 2,832 $ 5,790 $ 4,854
======= ======= ======= =======
Average outstanding shares of common stock.... 22,002 19,436 22,174 19,584
Dilutive effect of Warrants/Employee Stock
Options..................................... 807 1,312 831 1,183
------- ------- ------- -------
Common stock and common stock equivalents..... 22,809 20,748 23,005 20,767
======= ======= ======= =======
Basic income per share........................ $ 0.14 $ 0.15 $ 0.26 $ 0.25
======= ======= ======= =======
Diluted income per share...................... $ 0.13 $ 0.14 $ 0.25 $ 0.23
======= ======= ======= =======
Options and warrants which were excluded from the calculation of diluted
earnings per share because the exercise price of the options and warrants was
greater than the average market price of the common shares were approximately
371,000 and 3,396,000 for the quarter ended September 30, 2004 and 2003,
respectively; and 371,000 and 3,525,000 for the six months ended September 30,
2004 and 2003, respectively. 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:
* Pay TV Group -- distributes branded adult entertainment programming
networks and Video-On-Demand (VOD) content through electronic distribution
platforms including cable television, C-Band, and Direct Broadcast
Satellite (DBS)
* 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 is based on
income before income taxes. The reportable segments are distinct business units,
separately managed with different distribution channels.
11
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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
NET SALES
Pay TV........................................ $11,349 $10,079 $22,138 $19,161
Internet Group................................ 677 840 1,364 1,838
------- ------- ------- -------
Total..................................... $12,026 $10,919 $23,502 $20,999
------- ------- ------- -------
SEGMENT PROFIT
Pay TV........................................ $ 5,505 $ 4,244 $10,784 $ 7,652
Internet Group................................ 38 (101) (26) 31
Corporate Administration...................... (1,151) (1,310) (2,467) (2,827)
------- ------- ------- -------
Total..................................... $ 4,392 $ 2,833 $ 8,291 $ 4,856
======= ======= ======= =======
INTEREST INCOME
Internet Group................................ $ -- $ -- $ -- $ 3
Corporate Administration...................... 81 8 114 17
------- ------- ------- -------
Total..................................... $ 81 $ 8 $ 114 $ 20
======= ======= ======= =======
INTEREST EXPENSE
Pay TV........................................ $ 21 $ 29 $ 46 $ 63
Internet Group................................ 2 108 9 154
Corporate Administration...................... 5 224 7 454
------- ------- ------- -------
Total..................................... $ 28 $ 361 $ 62 $ 671
======= ======= ======= =======
DEPRECIATION AND AMORTIZATION
Pay TV........................................ $ 1,399 $ 1,498 $ 2,795 $ 2,978
Internet Group................................ 81 91 164 192
Corporate Administration...................... 2 5 4 8
------- ------- ------- -------
Total..................................... $ 1,482 $ 1,594 $ 2,963 $ 3,178
======= ======= ======= =======
(UNAUDITED)
SEPTEMBER 30, MARCH 31,
2004 2004
------------- ------------
IDENTIFIABLE ASSETS
Pay TV......................................... $ 46,476 $ 36,232
Internet Group................................. 3,428 2,790
Corporate Administration....................... 29,429 20,008
Eliminations................................... (25,670) (14,268)
-------- --------
Total...................................... $ 53,663 $ 44,762
======== ========
During the quarter ended June 30, 2004, the Company moved certain prepaid
distribution rights, totaling $1 million, from the Pay TV Group to the Internet
Group. The Company determined that these certain prepaid distribution rights
will be used exclusively by the Internet Group and have, therefore, reclassified
them accordingly. As of the quarter and six months ended September 30, 2003,
included in the Pay TV segment, is amortization related to these certain prepaid
distribution rights of approximately $52,000.
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 Pay TV and Internet operating segments. These
costs include, but are not limited to, legal and accounting
12
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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), Time Warner, Inc. (Time Warner)
and Comcast Corporation (Comcast). EchoStar, Time Warner and Comcast are
included in the Pay TV Group. Revenue from Echostar's DISH Network, Time Warner
and Comcast as a percentage of total revenue for each of the quarters and six
months ended September 30 are as follows:
(UNAUDITED)
(UNAUDITED) SIX MONTHS
QUARTER ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2003 2004 2003
-------- -------- -------- --------
EchoStar...................... 35% 34% 34% 35%
Time Warner................... 20% 15% 20% 14%
Comcast....................... 11% 3% 10% 4%
At September 30, 2004 and March 31, 2004, accounts receivable from EchoStar was
approximately $3,425,000 and $3,333,000, respectively. At September 30, 2004 and
March 31, 2004, accounts receivable from Time Warner was approximately
$1,223,000 and $880,000, respectively. At September 30, 2004 and March 31, 2004,
accounts receivable from Comcast was approximately $1,144,000 and $799,000,
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 -- STOCK OPTIONS
During the quarter ended June 30, 2004, the Company granted 330,000 options to
certain employees from the 1999 Incentive Stock Option Plan.
During the quarter ended September 30, 2004, the Company granted 155,000 options
to certain employees and members of the Board of Directors from the 1999
incentive stock option plan.
NOTE 6 -- STOCK RETIREMENT
During the quarter ended June 30, 2004, the Company cancelled 929,250 shares of
common stock. The Company acquired these shares in exchange for certain domain
names as part of a legal settlement with a former officer in April 2003.
Subsequent to this, these shares were encumbered as security for a note payable.
This note was repaid during the quarter ended June 30, 2004, and the company
cancelled the shares.
NOTE 7 -- FINANCIAL ARRANGEMENTS
During the quarter ended June 30, 2004, the company obtained a $3 million line
of credit from an outside financial institution. The line of credit expires in
June of 2005 and is secured by the Pay TV Group's trade accounts receivable. The
interest rate applied on the line of credit is variable based on the current
prime rate. The line of credit requires that the Company maintain certain
restrictive financial covenants and ratios. The Company did not draw down on the
line of credit during the six months ended September 30, 2004.
13
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- INCOME TAXES
The Company's effective tax rate of 30% reflects the use of net operating losses
(NOLs) in the current year as well as establishing deferred tax assets for all
temporary differences other than net operating losses which may expire due to
the statutory limitations. Because the Company anticipates generating taxable
income that exceeds available NOLs, the Company expects to pay federal income
taxes for the current year. The Company also anticipates paying certain State
Income taxes in jurisdictions for which there are not enough NOLs to offset the
Company's taxable income. During the quarter ended September 30, 2004, the
Company recorded a tax benefit of $1.6 million related to the tax deductions in
connection with stock option exercises as a component of Additional Paid-In
Capital.
NOTE 9 -- COMMITMENTS
SERVICE CONTRACT
During the quarter ended September 30, 2004, the Company entered into a service
contract with an unrelated party for uplinking services. The service contract
expires in May 2007.
Future minimum payments under this contract as of September 30, 2004 are as
follows (in thousands):
YEAR ENDED SERVICE
MARCH 31, CONTRACT
---------- --------
2005................................................... $ 424
2006................................................... 849
2007................................................... 849
2008................................................... 141
------
Total minimum payments................................. $2,263
======
EMPLOYMENT CONTRACTS
During the quarter ended September 30, 2004, the Company entered into
non-cancelable employment contracts with certain key employees. The employment
contracts expire in August 2006.
Future minimum payments under these contracts as of September 30, 2004 are as
follows (in thousands):
YEAR ENDED EMPLOYMENT
MARCH 31, CONTRACT
---------- ----------
2005................................................... $ 268
2006................................................... 537
2007................................................... 224
------
Total minimum obligation under employment contracts.... $1,029
======
14
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- INVESTMENTS
Investments in debt securities are required to be categorized as either trading,
available-for-sale or held-to-maturity. On September 30, 2004, the Company had
no trading or held-to-maturity securities. Debt securities categorized as
available-for-sale are reported at fair value as follows:
GROSS GROSS UNREALIZED
AMORTIZED ----------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
Available-for-sale securities..............
Bank Debt.............................. $ 2,951 $ -- $ -- $2,951
Mortgage-backed securities............. 2,077 1 -- 2,078
Corporate debt securities.............. 2,245 -- (3) 2,242
Debt securities issued by the US
Treasury............................. 2,592 -- -- 2,592
--------- -------- -------- ------
Total Available-for-sale
Securities......................... $ 9,865 $ 1 $ (3) $9,863
========= ======== ======== ======
The contractual maturities of these investments as of September 30, 2004, were
as follows (in thousands):
AVAILABLE-FOR-SALE
SECURITIES
---------------------------
YEAR ENDED GROSS
MARCH 31, AMORTIZED COST FAIR VALUE
---------- -------------- ----------
2005...................................................... $6,176 $6,177
2006...................................................... 3,062 3,061
2007...................................................... 627 625
------ ------
Total Available-for-Sale Securities....................... $9,865 $9,863
====== ======
15
PART I. FINANCIAL INFORMATION
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
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 publicly update or revise any forward-looking statements, whether as a result
of new information, future events, or otherwise.
Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to: 1) our ability to
retain our three major customers that account for approximately 34%, 20% and 10%
of our total revenue, respectively; 2) our ability to compete effectively for
quality content with our Pay TV Group's primary competitor who has significantly
greater resources than us; 3) our ability to compete effectively with our Pay TV
Group's major competitor or any other competitors that may distribute adult
content to Cable MSOs, DBS providers, or to the Hotel industry; 4) our ability
to retain our key executives; 5) 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; and 6)
our ability to attract market support for our stock. The foregoing list of
important factors is not exclusive.
EXECUTIVE SUMMARY
Our goal is to be the leading provider in the electronic distribution of
high-quality adult entertainment via Cable, Satellite and Broadband platforms.
We operate our Company in two different segments -- Pay TV and Internet. Our
core business resides within the Pay TV segment and this is where the majority
of our financial and human resources are concentrated.
PAY TV SEGMENT
Our Pay TV segment is focused on the distribution of its seven pay-per-view
(PPV) networks and its Video-on-Demand (VOD) service to cable multiple system
operators (MSOs) and direct broadcast satellite (DBS) providers. In addition,
the Pay 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 Pay TV Group earns a percentage of revenue on each PPV,
subscription, or VOD transaction related to its services. Revenue growth is
expected to occur as the Pay TV Group launches its services to new cable MSOs or
DBS providers, experiences growth in the number of digital subscribers for
systems where its services are currently distributed (on-line growth), and
launches additional services with its existing cable/DBS partners. Revenue
growth is also expected to occur as the Pay TV Group experiences new and on-line
growth for its VOD service, is able to effect increases in the retail price of
its products, and is able to increase the buy rates for its products. The Pay TV
Group seeks to achieve distribution for at least four of its services on every
digital platform in the U.S. Based on the current market of 22.4 million DBS
households and 22.9 million digital cable households, the Pay TV Group currently
has 40% of its defined market share.
Revenue growth for the Pay TV Group for the quarter ended September 30, 2004 was
driven primarily by:
* Growth in revenue from its VOD service provided to the Cable and Hotel
industries, and
* Growth in its PPV revenue primarily attributable to its most recent
agreement with Time Warner, Inc.
16
Revenue from the Pay TV Group's VOD service became a significant part of its
overall revenue mix during the fiscal year ended March 31, 2004, as cable
operators upgraded their systems to deliver content in this manner. The Pay TV
Group currently delivers its VOD content to 14.2 million cable network
households as compared to 8.0 million a year ago, as well as to 840,000 hotel
rooms through its distribution arrangement with On Command.
The Company expects cable operators to continue to upgrade their digital cable
systems to allow for the delivery of VOD content to the home. According to the
National Cable and Television Association (NCTA), as of March 31, 2004 there
were 22.9 million digital cable households in the U.S. We estimate that 17.3
million digital cable households are VOD enabled and, of this amount, 15.2
million provide adult content to their VOD customers. Kagan Research, LLC
(Kagan) estimates that there will be 19.8 million and 23.9 million VOD enabled
households by the end of calendar years 2004 and 2005, respectively. We expect
that our VOD cable revenue will increase as MSOs continue the deployment of this
technology to their digital cable subscribers and as they increase the amount of
space allocated on their VOD servers to the adult category (currently we provide
75 hours of programming each month). Today, we are the sole provider of adult
VOD content to the largest U.S. cable MSO. However, we can give no assurances
that we will continue to remain the exclusive provider of adult VOD content to
this cable MSO.
The Pay TV Group also provides its two least-edited services to the C-Band
market on a direct-to-the-consumer basis. C-Band customers contact the Pay TV
Group's in-house call center directly to purchase the networks on a one-month,
three-month or six-month subscription basis or PPV basis. The Pay TV Group
retains 100% of the revenue from these customers and over 95% of the sales are
made via credit cards. This market has been declining for several years as these
consumers convert from C-Band big dish analog satellite systems to smaller,
18-inch digital DBS satellite systems. The Pay TV Group has been able to
decrease its transponder, uplinking and call center costs related to this
business over the years in order to maintain its margins. However, based on the
rate of revenue decline and the expected erosion of its C-Band margins, the Pay
TV Group expects that it will no longer be operating this business after the
first quarter of its 2006 fiscal year. The Pay TV Group expects continued
declines in revenue from this segment of its business during its 2005 fiscal
year.
INTERNET SEGMENT
The Internet Group generates revenue by selling monthly memberships to its
website, TEN.com, by earning a percentage of revenue from third-party
gatekeepers for the distribution of TEN.com, and by selling pre-packaged video
and photo content to webmasters for a monthly fee.
During the 2002 and 2003 fiscal years, we significantly restructured our
Internet business. The decision to restructure our Internet business was based
on a number of factors including: the large number of adult websites competing
for web surfers, the lack of barriers to entry into the adult web business, the
increased regulation from VISA and MasterCard, and the amount of free adult
content available on the Internet.
Once the restructuring was completed, we shifted our focus to forming long-term
revenue sharing partnerships with third-party gatekeepers such as cable
companies, hospitality providers and portals for the distribution of TEN.com,
whereby we could gain direct access to consumers in search of adult
entertainment and leverage the gatekeepers' billing platform. We completed one
such agreement with On Command for the distribution of 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. Currently, we do not generate material revenue from
these third-party arrangements (less than 5% of our total Internet revenue).
Over 80% of our revenue from the Internet Group continues to be generated from
monthly memberships to TEN.com. However, we have seen this revenue erode over
the past several years since the traffic volume to TEN.com did not generate
enough new monthly sign-ups to offset the
17
cancellations in our membership base. The decline in membership revenue has
slowed over the past several quarters as new marketing efforts have increased
traffic to TEN.com, generating monthly sign-ups that are close to or slightly
exceeding our monthly cancellation rate. We will continue to focus on ways to
generate profitable traffic during the 2005 fiscal year in order to reverse the
decline in membership revenue from TEN.com.
We have also seen a decrease in revenue generated from selling pre-packaged
content to webmasters. This decrease in revenue from the sale of pre-packaged
content is due to a softening in demand for content by third-party webmasters.
Webmasters are decreasing their reliance on outside sources for content and
demanding lower prices for the content that they do purchase. In addition, in
the past, we have not allocated any significant resources towards a sales effort
for these content products. However, we contracted with a third-party marketing
company at the end of this current quarter to sell our products on our behalf to
the webmaster community in an attempt to gain more exposure in the marketplace
and increase the revenue from this business.
We view our Internet Group as an investment in the future, and we do not
anticipate any significant revenue growth from this segment during the 2005
fiscal year. As technology advances, we expect to leverage our existing Internet
infrastructure to take advantage of new distribution opportunities such as
interactive TV applications, wireless distribution, and digital subscriber line
(DSL) delivery to the set-top box. Until then, the Internet Group will focus its
efforts on deriving monthly subscription revenue from traffic directed to
TEN.com through advertising on the Pay TV Group's networks and affiliate
webmaster programs, as well as to completing new revenue sharing partnerships
through which we can gain access to captive adult consumers of the Cable MSOs.
PAY TV GROUP
The following table outlines the current distribution environment and network
households for each network:
ESTIMATED NETWORK HOUSEHOLDS(2)
-----------------------------------------
(IN THOUSANDS)
AS OF AS OF
SEPTEMBER 30, SEPTEMBER 30,
NETWORK DISTRIBUTION METHOD 2004 2003 % CHANGE
------- ------------------- ------------- ------------- ---------
Pleasure Cable/DBS 8,600 8,100 6%
TEN Cable/DBS 16,100 13,500 19%
TEN*Clips Cable/DBS 15,900 11,900 34%
Video-On-Demand Cable 14,200 8,000 78%
TEN*Blue Cable 2,700 1,600 69%
TEN*Blox Cable 4,200 1,700 147%
TEN*Xtsy C-band/Cable/DBS 10,600 9,400 13%(1)
TEN*Blue Plus(3) C-band/Cable 0 500 N/A
TEN*Max C-band/Cable 380 500 (24%)(1)
TOTAL NETWORK HOUSEHOLDS 72,680 55,200
(1) % change gives effect to a 32% decline in the C-band market's total
addressable households. Total addressable C-Band households declined
from 466,000 as of September 30, 2003 to 316,000 as of September 30,
2004.
(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 Pay TV Group's channels, since each network represents an
incremental revenue stream. The Pay TV Group estimates its unique
household distribution as 19.7 million and 12.8 million digital cable
homes as of September 30, 2004 and 2003, respectively, and 10 million
and 8.8 million DBS homes as of September 30, 2004 and 2003,
respectively.
(3) The Pay TV Group discontinued providing its TEN*BluePlus network in
February 2004.
18
The following table sets forth certain financial information for the Pay TV
Group for the quarter and six months ended September 30, 2004 and 2003:
YEAR-TO-
(IN MILLIONS) QUARTERLY (IN MILLIONS) DATE
QUARTER ENDED PERCENT YEAR-TO-DATE PERCENT
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
----------------------- ------------ ----------------------- ------------
2004 2003 '04 VS '03 2004 2003 '04 VS '03
-------- -------- ------------ -------- -------- ------------
NET REVENUE
Cable/DBS/Hotel........... $10.3 $ 8.4 23% $20.0 $15.6 28%
C-Band.................... 1.0 1.7 (41%) 2.1 3.6 (42%)
----- ----- ----- -----
TOTAL....................... $11.3 $10.1 12% $22.1 $19.2 15%
----- ----- ----- -----
COST OF SALES................. $ 3.8 $ 4.0 (5%) $ 7.4 $ 7.5 (1%)
----- ----- ----- -----
GROSS PROFIT.................. $ 7.5 $ 6.1 23% $14.7 $11.7 26%
===== ===== ===== =====
GROSS MARGIN.................. 66% 60% 67% 61%
----- ----- ----- -----
OPERATING EXPENSES............ 2.0 1.8 11% 3.9 4.0 (3%)
----- ----- ----- -----
OPERATING INCOME.............. $ 5.5 $ 4.3 28% $10.8 $ 7.7 40%
===== ===== ===== =====
NET REVENUE
CABLE/DBS/HOTEL REVENUE
The 23% and 28% increase in our cable/DBS/hotel revenue for the quarter and six
months ended September 30, 2004 was attributable to the following items:
* A 32% and 51% increase in VOD revenue for the quarter and six month period,
respectively
* A 36% and 35% increase in our cable PPV revenue for the quarter and six
month period, respectively
* A 13% and 11% increase in revenues generated by our three services on the
DISH platform for the quarter and six month period, respectively
Revenue from our VOD service continues to be a significant contributor to our
revenue growth year-over-year for the quarter and six month period. Revenue from
our cable and hotel VOD service was 38% and 37% of our total Pay TV revenue for
the quarter and six months ended September 30, 2004, as compared to 32% and 28%
of total Pay TV revenue for the quarter and six months ended September 30, 2003.
Our VOD content is available through our distribution arrangements with cable
MSOs to 14.2 million cable network households as of September 30, 2004, as
compared to 8.0 million for the quarter a year ago, as well as to 840,000 hotel
rooms through our distribution arrangement with On Command.
We are currently the sole provider of VOD content to the largest cable MSO in
the U.S. Prior to the current quarter, we were also the sole provider of adult
VOD content to the second largest cable MSO in the U.S. However, we will begin
to share this platform with our largest competitor in future quarters. At this
time, we cannot determine what the effect of additional competition on this
MSO's platform will be. However, we do not anticipate any significant changes in
our VOD revenue from this MSO because we have always operated in a competitive
environment on cable/DBS platforms.
The 36% and 35% increase in our cable PPV revenue for the quarter and six months
ended September 30, 2004 is primarily related to our new distribution deal with
Time Warner, Inc. that provides for the distribution of up to five of our
networks on their affiliated systems. Through this deal we have added 3.8
million new network households for our TEN, TEN*Clips, TEN*Blue and TEN*Blox
services since September 2003.
The 13% and 11% increase in revenues from our three services on the DISH
platform for the quarter and six months ended September 30, 2004 is attributable
to the increase in the number of subscribers
19
to the DISH platform and to certain changes that DISH has made to the way it
prices and packages its adult programming networks.
C-BAND REVENUE
The 41% and 42% decline in C-Band revenue for the quarter and six months ended
September 30, 2004 is a result of 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 32% since
September 30, 2003, from 466,000 addressable subscribers to 316,000 addressable
subscribers as of September 30, 2004.
During the quarter ended March 31, 2004, we discontinued selling TEN*BluePlus on
the C-Band platform. Providing our other two networks to the C-Band market
continues to be profitable for us, generating operating margins of 52% and 49%
for the quarter and six months ended September 30, 2004, respectively, as
compared to 52% for the quarter and six months ended September 30, 2003. We will
continue to closely monitor this business, and we will discontinue providing our
content on this platform when margins erode to an unacceptable level.
COST OF SALES
Our cost of sales consists of expenses associated with our digital broadcast
facility, satellite uplinking, satellite transponder leases, programming
acquisition and conforming costs, VOD transport costs, amortization of content
licenses, and our in-house call center operations related to our C-Band
business.
The 5% and 1% decline in our cost of sales year-over-year for the quarter and
six months is primarily related to a decline in call center and programming
acquisition and conforming costs. Call center costs have decreased due to staff
layoffs necessitated by declining call volume as the C-Band market continues to
erode. Programming acquisition and conforming costs have decreased because we no
longer outsource these services to a third-party. We have developed in-house
programming and conforming departments that perform these same services at a
much lower cost for us.
We also experienced a decrease in our transponder lease and uplinking costs for
the quarter and six months ended September 30, 2004. Our satellite transponder
lease costs declined year-over-year because we terminated the delivery of our
TEN*BluePlus network in February 2004, resulting in the cancellation of the
transponder lease for this network. Our uplinking costs declined for this same
period due to the renegotiation of our uplink service contract with our current
provider. The decline in these costs was offset by an increase in transport
costs for the quarter and six-months ended September 30, 2004, related to the
delivery of our VOD content to cable MSOs.
OPERATING INCOME
Operating income increased 28% and 40% for the quarter and six months ended
September 30, 2004, primarily as a result of a 12% and 15% increase in revenue
for the same periods, respectively. Gross margins increased to 66% for the
quarter ended September 30, 2004, from 60% for the quarter a year ago, and to
67% for the six months ended September 30, 2004, from 61% for the six month
period a year ago.
Operating expenses increased 11% for the quarter ended September 30, 2004 as a
result of an increase in marketing costs incurred in connection with a consumer
outreach event to promote the TEN* brand and services. We expect to continue to
incur similar costs for promotional events in future quarters in an effort to
increase recognition for the TEN* brand within our consumer base.
The 3% decline in operating expense for the six months ended September 30, 2004
was related to a decrease in C-Band marketing costs, as we are no longer
utilizing a barker channel to promote these services, and a decrease in trade
show expenses year-over-year for the six month period. The decline in these
expenses was offset by an increase in brand promotion expenses incurred during
the current year quarter as discussed above.
20
INTERNET GROUP
The following table sets forth certain financial information for the Internet
Group for the quarter and six months ended September 30, 2004 and 2003:
YEAR-TO-
(IN MILLIONS) QUARTERLY (IN MILLIONS) DATE
QUARTER ENDED PERCENT YEAR-TO-DATE PERCENT
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
----------------------- ------------ ----------------------- ------------
2004 2003 '04 VS '03 2004 2003 '04 VS '03
-------- -------- ------------ -------- -------- ------------
NET REVENUE
Net Membership............ $ 0.6 $ 0.6 0% $ 1.2 $ 1.4 (14%)
Sale of Content........... 0.1 0.2 (50%) 0.2 0.4 (50%)
----- ----- ----- -----
TOTAL....................... $ 0.7 $ 0.8 (13%) $ 1.4 $ 1.8 (22%)
----- ----- ----- -----
COST OF SALES................. $ 0.3 $ 0.3 0% $ 0.6 $ 0.7 (14%)
----- ----- ----- -----
GROSS PROFIT.................. $ 0.4 $ 0.5 (20%) $ 0.8 $ 1.1 (27%)
===== ===== ===== =====
GROSS MARGIN.................. 57% 63% 57% 61%
----- ----- ----- -----
OPERATING EXPENSES............ $ 0.3 $ 0.6 (50%) $ 0.8 $ 1.1 (27%)
----- ----- ----- -----
OPERATING INCOME (LOSS)....... $ 0.1 $(0.1) (200%) $ -- $ -- 0%
===== ===== ===== =====
NET REVENUE
The 13% decline in total net revenue for the quarter and 22% decline in net
revenue for the six months are related to the following:
* Net membership revenue being flat to slightly down for the quarter and six
months ended September 30, 2004, and
* A 50% decline in revenue from the wholesale of content products created by
the Internet Group
Net membership revenue was flat to slightly down for the quarter and six months
ended September 30, 2004 as we continue to experience the erosion of the sale of
monthly memberships to our website, www.ten.com. We are implementing new pricing
and marketing strategies in an effort to slow the decline in our membership
revenue. During the current quarter we increased the price of a monthly
membership to $29.95 from $19.95. In addition, we are now offering a three-month
membership for $74.95. This price increase applies only to new members joining
our site. This price increase will, therefore, have only a minimal effect on our
revenue as old members are billed at the rate in effect at the time they joined
the site.
We continue to market www.ten.com on the Pay TV Group's networks. Additionally,
we have implemented new affiliate marketing programs for webmasters sending
traffic to our site. These webmasters are paid a fee for any traffic sent to our
website that converts into a paying member. The amount paid to the webmaster is
a one-time fee of 40%- 67% of the first month's membership revenue. The effect
of these new affiliate marketing programs has been to attract additional traffic
to our site, resulting in a reduction in our churn rate. At the same time, we
are experiencing an increase in the number of chargebacks and credits, which is
to be expected as we grow our gross revenue. Chargebacks and credits have
increased from 0% to 5% of our gross membership revenue for both the quarter and
six months ended September 30, 2004.
The 50% decline in revenue from the sale of content products is due to a
continued softening in demand for content by third-party webmasters. Webmasters
continue to decrease their reliance on outside sources for content and are
demanding lower prices for the content that they do purchase. In addition, we
have not allocated any significant resources towards a sales effort for our
content products. However, during the current quarter, we contracted with a
third-party marketing company to sell our content products on our behalf. We
expect that this company will be successful in increasing the revenue from the
sale of these products.
21
COST OF SALES
Cost of sales consists of fixed and variable expenses associated with the
processing of credit cards, bandwidth, traffic acquisition costs, content costs
and depreciation of assets related to our Internet infrastructure.
Cost of sales was flat year-to-year for the quarter. We did experience an
increase in our content costs and traffic acquisition costs during this period.
Traffic acquisition costs increased from 0% to 11% of net membership revenue for
the current year quarter. The increase in these costs was fully offset by a 61%
decrease in depreciation expense and a 35% decrease in bandwidth costs due to
the renegotiation of these contracts during the year.
The 14% decrease in cost of sales for the six months ended September 30, 2004
was related to a 62% decline in depreciation expense and a 29% decrease in
bandwidth costs. The decline in these costs was partially offset by an increase
in content and traffic acquisition costs. Traffic acquisition costs for the six
month period increased from 0% to 8% of net membership revenue.
OPERATING INCOME (LOSS)
The 200% increase in operating income year-over-year for the quarter is related
to a 50% decrease in operating expenses which offset the 20% decline in gross
profit during the current year quarter. The 50% decrease in operating expenses
for the quarter was primarily related to a 63% decrease in legal expenses. Legal
expenses declined due to the settlement of a lawsuit during the first quarter of
the current fiscal year.
Operating income was $0 for the six months ended September 30, 2004 and 2003.
Operating expenses declined 27% year-over-year for the six-month period, which
offset the 27% decline in gross profit for the same period. The decline in
operating expenses for the current six-month period was related to a decrease in
legal expenses. However, legal expenses for the six months ended September 30,
2004 included a non-recurring $0.2 million charge for the settlement of a
lawsuit during the first quarter of the current fiscal year.
CORPORATE ADMINISTRATION
The following table sets forth certain financial information for our Corporate
Administration expenses for the quarter and six months ended September 30, 2004
and 2003:
YEAR-TO-
(IN MILLIONS) QUARTERLY (IN MILLIONS) DATE
QUARTER ENDED PERCENT YEAR-TO-DATE PERCENT
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
----------------------- ------------ ----------------------- ------------
2004 2003 '04 VS '03 2004 2003 '04 VS '03
-------- -------- ------------ -------- -------- ------------
Operating Expenses... $(1.2) $(1.1) 9% $(2.5) $(2.4) 4%
===== ===== ===== =====
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 Pay 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.
The $0.1 million increase in our Corporate Administration fees for the quarter
and six months ended September 30, 2004 is related to an increase in our
accounting and professional fees for the implementation of Section 404 of the
Sarbanes-Oxley Act with respect to our internal controls over our financial
reporting. We have hired an outside consulting firm to assist us with this
project, and we expect to continue to incur additional fees for this during the
next six months.
22
Additionally, consulting fees for the six months ended September 30, 2004
declined $0.2 million. This decline in consulting fees, which was related to
fees paid to our former Chief Executive Officer and a non-cash expense related
to the extension of his options during the quarter ended June 30, 2003, was
offset by an increase in listing fees paid in connection with the acceptance of
our phase-up application to the NASDAQ National Market during the quarter ended
June 30, 2004, and an increase in payroll costs for that same quarter.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS FROM OPERATING ACTIVITIES AND INVESTING ACTIVITIES:
Our statements of cash flows are summarized as follows (in millions):
SIX MONTHS ENDED
SEPTEMBER 30,
-----------------------
2004 2003
-------- --------
Net cash provided by operating activities................. $ 9.2 $ 6.3
======== ========
Cash flows used in investing activities:
Purchases of equipment and furniture.................. (0.6) (0.3)
Purchase of investments............................... (10.2) 0.0
Sale/Redemption of investments........................ 1.9 0.0
-------- --------
Net cash used in investing activities..................... $ (8.9) $ (0.3)
======== ========
The increase in cash provided by operating activities year-over-year for the
six-month period is primarily related to increased profits for the period as
well as to a $2.9 million tax benefit from the exercise of options and warrants.
Accounts receivable increased $0.9 million from March 31, 2004 and our content
licensing costs were $0.8 million for the six months ended September 30, 2004.
The increase in cash used in investing activities year-over-year for the
six-month period is related to the purchase of investments in the amount of
$10.2 million. These investments relate to certificates of deposits and fixed
income debt instruments with average maturities of less than eight months. In
addition, we purchased $0.6 million in equipment for the six months ended
September 30, 2004. These purchases relate to the final improvements made to our
broadcast facility in the amount of $0.2 million and the purchase of servers,
computers, conforming and broadcast equipment in the amount of $0.4 million.
Cash used in investing activities for the six months ended September 30, 2003
related to the purchase of broadcast equipment, encrypting equipment for new
cable launches, storage capacity and upgrades to our broadcast facility.
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Our cash flows provided by (used in) financing activities are as follows (in
millions):
SIX MONTHS ENDED
SEPTEMBER 30,
-----------------------
2004 2003
-------- --------
Cash flows provided by (used in) financing activities:
Payments on capital lease obligations................. $ (0.2) $ (0.7)
Increase (Decrease) notes payable..................... (0.4) 0.4
Issuance of Common Stock.............................. 1.6 1.3
Retirement of stock................................... 0.0 (1.5)
Net redemption of redeemable preferred stock.......... 0.0 (1.8)
Decrease in other financing obligations............... (0.1) 0.0
-------- --------
Net cash provided by (used in) financing activities:...... $ 0.9 $ (2.3)
======== ========
During the six months ended September 30, 2004 we repaid our $0.4 million
secured note payable that was due to an unrelated third party. Our remaining
debt is primarily related to capital lease
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obligations and other financing obligations. Interest expense is expected to be
immaterial during the current fiscal year.
Cash used in financing activities for the six months ended September 30, 2003
related to payments on capital lease obligations, the repayment of $3.8 million
of our Class A Redeemable Preferred Stock, and the purchase and subsequent
retirement of 2.5 million shares of our stock acquired from a former officer of
the Company as part of a legal settlement. The use of this cash was offset by
the issuance of 2.5 million shares of Class B Redeemable Preferred Stock, the
receipt of $1.3 million in proceeds from the exercise of stock options and
warrants, and an increase in net borrowings of $0.4 million.
We currently have a $3 million line of credit available with a bank that expires
in June 2005. The interest rate applied to the line of credit is variable based
on the current prime rate. The balance on the line of credit is $0. The line of
credit is secured by the Pay TV Group's trade account receivables and requires
that we comply with certain financial covenants and ratios.
If we were to lose our three major customers that account for 34%, 20%, and 10%
of our revenue, respectively, our ability to fund our operating requirements
would be severely impaired.
We do not expect to pay any federal income taxes until later in the fiscal year,
as we expect to utilize our net operating loss carryovers for tax purposes. We
anticipate requiring cash of less than $0.5 million to satisfy our tax
obligations for the current fiscal year.
Our Pay TV Group executed a new agreement with our uplink service provider
during the quarter ended September 30, 2004. This contract commits us to $2.5
million over 36 months for these services.
We believe that our current cash balances and cash generated from operations
will be sufficient to satisfy our operating requirements, and we believe that
any capital expenditures that may be incurred can be financed through our cash
flows from operations. We anticipate total capital expenditures for the current
fiscal year to be less than $1.3 million.
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 September 30, 2004, the Company had cash in
checking and money market accounts, certificates of deposits, and fixed income
debt instruments. 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.
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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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held an annual meeting of its shareholders on August 24, 2004
(the Annual Meeting).
(b) The Annual Meeting involved the election of directors. The directors elected
at the meeting were Michael Weiner, Alan L. Isaacman, Hiram J. Woo, David
Nicholas, Melissa Hubbard and Dr. Skender Fani.
(c) Two matters were voted on at the Annual Meeting, as follows:
(i) The election of six directors to the Board of Directors for the
following year and until their successors are elected.
The votes were cast for this matter as follows:
BROKER
FOR AGAINST ABSTAIN WITHHELD NON-VOTE
----------- ----------- ----------- ----------- -----------
Michael Weiner 18,298,258 0 2,691,420 0
Alan L. Isaacman 18,298,258 0 2,691,420 0 0
Hiram J. Woo 18,298,258 0 2,691,420 0 0
David Nicholas 18,298,258 0 2,691,420 0 0
Melissa Hubbard 18,298,258 0 2,691,420 0 0
Dr. Skender Fani 18,298,258 0 2,691,420 0 0
(ii) The ratification of the appointment of Grant Thornton LLP as the
Company's independent auditors for the fiscal year ending March 31,
2005.
The votes were cast for this matter as follows:
BROKER
FOR AGAINST ABSTAIN WITHHELD NON-VOTE
----------- ----------- ----------- ----------- -----------
20,915,486 69,500 4,692 0 0
ITEM 6. EXHIBITS
a) Exhibits
31.01 Certification by CEO 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 CEO 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
10.01 Telecommunications Services Agreement between WilTel Communications,
LLC and Colorado Satellite Broadcasting, Inc.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
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: November 10, 2004
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