New Frontier Media, Inc. F2Q09 (Qtr End 9/30/08) Earnings Call Transcript

New Frontier Media, Inc. (NOOF)

F2Q09 Earnings Call

November 5, 2008 11:00 am ET

Executives

Grant H. Williams – Chief Financial Officer

Michael Weiner – Chairman of the Board, Chief Executive Officer & Secretary

Ken Boenish – President

Ira H. Bahr – Chief Operating Officer

Analysts

Richard Ingrassia – Roth Capital Partners, LLC.

Jamie Clement – Sidoti & Company

Eric Wold – Merriman Curhan Ford & Co.

[John Roff – Argon Capital]

[Barry Forcluse – Stark]

Dan Mendoza – Agincourt Capital

Presentation

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the New Frontier Media’s second quarter fiscal 2009 earnings release conference call. At this time, all participants lines have been placed in a listen only mode. Following today’s presentation, you will be given instructions for the question and answer session. As a reminder, today’s conference is being recorded today, November 5, 2008.

At this time I’d like to turn the presentation over to your host Chief Financial Officer Grant Williams.

Grant H. Williams

Welcome to the New Frontier Media fiscal 2009 second quarter results conference call. With me this morning are Michael Weiner, Chief Executive Officer of New Frontier Media, Ken Boenish, President of New Frontier Media and Ira Bahr, Chief Operating Officer of New Frontier Media. For the call this morning Michael will begin with some highlights from the quarter as well as comments on our strategic direction. Then, I’ll run through our financial results and provide some forward-looking information before we open up the call for questions.

A replay of this conference call will be available for seven days at 1-800-405-2236 using the passcode 11121990#. This call will be archived for 12 months on our website at www.NOOF.com under investor relations webcasts and events. This call is also being webcast. During the question and answer segment those of you listening via the Internet will be able to ask questions. Please submit your question via email to [[e-mail]].

During this conference we may make reference to certain non-GAAP financial measures. This information including a reconciliation to the most directly comparable GAAP financial measures is available in today’s earnings release. A copy of our earnings release is available at our website at www.NOOF.com under investor relations news releases.

All information discussed during the conference call is current only as of today or as of the date of the applicable financial results and the company assumes no obligation to update information discussed during this conference call. During this conference call management may make forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 including statements regarding the company’s expected financial position and operating results, its business strategy, its financing plans and the outcome of contingencies.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those set forth or implied by any forward-looking statements and should be considered in conjunction with the cautionary statements included in our press release and our most recent reports containing risk factors filed with the Securities & Exchange Commission including our most recently filed Forms 10Q and 10K.

With that being said I’d now like to turn the call over to New Frontier Media’s Chief Executive Officer Michael Weiner.

Michael Weiner

During a very difficult time in our economy, New Frontier continues to demonstrate the strength of our businesses. For the second quarter of the fiscal 2009, overall we grew revenue 8% over the same quarter last year. We maintained strength in our balance sheet with cash and investments of $15 million, no debt and access to a $9 million line of credit.

Most importantly, the company is driving continued profitability led by our core transactional TV business which delivered solid growth this quarter. One, within the domestic operations of the transactional TV segment we added 1.3 million video on demand homes this quarter bringing the total to 34 million. Secondly, we added almost 2 million pay-per-view homes bringing the pay-per-view total to 144 million network homes.

Thirdly, we have also begun providing high definition video on demand content to domestic MSOs and this service now reaches 21 million US homes. Fourth, in addition to adding new network homes, we are also gaining incremental shelf space on our existing VOD customer platforms. Lastly, our VOD hours on the nation’s largest MSO platform increased 25% as compared to the prior year quarter and we have tripled the number of hours we provide on the largest IPTV platform in the country growing from 30 to 90 hours of video on demand content.

Looking ahead, we expect to continue to drive domestic transactional TV growth via category growth, improvements in our share of self space and by improving our content performance. We are also seeing promising growth for our transactional TV segment in markets outside of the US where we are building our presence in regions such as Canada, Latin America and Europe.

Especially in Canada we’ve begun supplying additional 2 million homes with video on demand content. In Latin America we are delivering pay-per-view channels to approximately half a million network homes and VOD services to approximately 100,000 homes. In Europe, we have signed agreements to launch content on IPTV and IPPC platforms in Germany and have also executed an agreement with the UK’s largest MSO to deliver content to 2.3 VOD subscribers in that country. In France, we have a deal with the largest IPTV platform which serves over $1.5 VOD homes.

International markets continue to be a strong opportunity for us. In Europe operators are just beginning to roll out VOD content. Less than 30% of the multichannel market has VOD capability. Over the next few years we expect to see material growth in the number of VOD enabled homes. Our sales team this year led by Ken Boenish I think has done a phenomenal job in the growth opportunities that we are now being presented with.

Moving on with the film production segment; we continue to have success with our 13 episode series and have now begun production on the third installment of that series. We are also moving towards a new producer for hire arrangement and assuming our negotiations conclude successfully, we do expect to execute the deal and begin shooting in Q4 and to deliver revenue in fiscal year 2010.

Our plans to distribute the film production segment’s mainstream content in retail DVD markets is moving forward and in September our first titles were placed in major domestic DVD retail markets. We also continue to leverage customer relations in our transactional TV segments to facilitate the distribution of the film production segments main stream content on cable platforms and on satellite platforms.

We expect to see the first deployment of this content in our fiscal fourth quarter. So, overall the film production segment continues to have promising long term growth potential. Within our direct-to-consumer segment we are focusing on the set-top box initiative and expect several key marketing events to occur in the second half of fiscal 2009. As we have previously mentioned, we should have a better idea of the success of the test initiatives by the end of the fiscal year.

Looking ahead, we believe we have the resources in place to continue to be a leader in providing branded content to cable and satellite platforms and to expand our region to promising new markets. I’ll now have Grant walk you through the financial results of the company.

Grant H. Williams

I’ll begin the financial discussion this morning by providing some additional details on the individual results of our operating segments and then briefly discuss our liquidity position and some forward-looking information. For the transactional TV segment, revenue grew to $10.8 million as compared to $10 million in the same prior year quarter due to an increase in domestic VOD revenue and from new content package offerings and improved menu positioning.

Cost of sales for the segment increased to $2.9 million as compared to $2.7 million in the same prior year quarter due primarily to additional costs for certain transponder, transport and uplink costs to support our growth in domestic operations. Gross margins in this business have remained steady at 73% of net sales. Operating expenses increased to $2.4 million from $2.1 million in the same prior year quarter due to additional domestic advertising and promotion costs.

For the current quarter, the transactional TV segment reported $5.5 million of operating income which is an 8% improvement from the same quarter of last year. Moving to the film production segment, revenue increased to $2.2 million from $2 million in the same prior year quarter from growth in owned content revenue related to the delivery of seven titles from a 13 episode series. Cost of sales for the film production segment increased to $1 million for the current quarter as compared to approximately $500,000 in the same quarter last year.

In the prior year quarter this segment generated revenue on several older titles who’s film costs were fully amortized resulting in an unusually low film production cost in that prior year quarter. Film production operating expenses were $1.1 million as compared to $1 million of expenses incurred in the same prior year quarter and for the quarter ended September 30, 2008 the film production operating income was breakeven as compared to operating income of $400,000 in the same quarter of last year.

For the direct-to-consumer segment revenue was $400,000 for both the second fiscal quarter of 2009 and the same quarter last year. For the current quarter, this segment had an operating loss of approximately $700,000 as compared to operating income of $100,000 in the same quarter last year. The direct-to-consumer segment results include approximately $700,000 in incremental costs associated with the company’s set-top box initiative.

Corporate administration cost during the quarter were $2.7 million as compared to $2.4 million in the same prior year quarter primarily reflecting higher consulting advisor fees. For the six months ended September 30, 2008 net sales grew to $26.4 million from $25.4 million in the same period last year. Net income was $2.5 million or $0.11 per diluted share compared to $3.6 million or $0.15 per diluted share.

Our liquidity position continues to be strong. Cash flow from operations was $1.5 million for the current quarter as compared to cash used in operations of $0.2 million in the same prior year quarter. As a reminder, the prior year quarter cash flows included $2.1 million of cash disbursements related to a produce for hire arrangement. For the first half of fiscal 2009, the company has generated $6 million of cash flows from operations as compared to approximately $888,000 in the same period of last year.

During the quarter we also repurchased almost 750,000 shares of our common stock at an average purchase price of $3.77 per share and have now materially completed our stock repurchase program. The 2 million total shares of common stock repurchased during the past several years represents roughly 8% of the company’s outstanding common stock. As of September 30, 2008 we had cash and investments of $15 million and $9 million available through our line of credit.

Before we open up to questions I’d like to mention a few forward-looking items to consider for the remainder of fiscal 2009 and beyond. For the transactional TV segments international initiatives, while we have executed every new business agreement we have planned for this year, the fiscal roll out to retail by our partners has been slower than expected.

We now expect the full year fiscal 2009 revenue contribution for non-US TV to be between $1 million and $1.5 million and we anticipate it to be an annualized run rate of approximately $3 million by the end of the fiscal year. This estimate could vary due to a variety of factors including the timing of our customer’s launch of our content and the buy rates for the customers in these new international markets.

For the film production segment we continue to be optimistic about the long term prospects of this segment. As Michael mentioned, we’ve begun production on the third installment of the 13 episode series and expect to recognize revenue for this during the fourth fiscal quarter of 2009 or early fiscal 2010. We are also in negotiations for a new producer for hire project. If we are able to conclude negotiations as anticipated we expect to begin production on the producer for hire project during the second half of fiscal 2009 which will result in cash outflows and lower cash flows from operations.

Revenue for the producer for hire deal is not expected until fiscal 2010. For the film production segment results net quarter we expect the Q3 of fiscal 2009 will be a strong quarter consistent with historical results of the segment because our sales teams will be attending several significant trade shows during the quarter. However, keep in mind that the prior year Q3 results included approximately $3.6 million of revenue related to a producer for hire deal and our first installment of the 13 episode series that will not recur this year.

So, we do not expect that fiscal 2009 Q3 revenue to be at the same level as the prior year quarter results. Now, let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Richard Ingrassia – Roth Capital Partners, LLC.

Richard Ingrassia – Roth Capital Partners, LLC.

I’m not sure who wants to take this question, but I think there’s a bit of a disconnect between the increased network penetration, your increased content of files, etc. and the per household TV revenue figures especially since normally we’d expect your business to be somewhat immune from consumer spending pressures. Is that not the case anymore?

Or are the results suggesting that overall demand in the segment is weaker, that your placement maybe on some cable tiers has suffered, splits are lower? There must be some explanation for the lower year-over-year per household figures. Can you fill us in a little bit?

Ken Boenish

In terms of per household figures, as we gain incremental distribution on existing platforms we don’t always see a one-for-one return in terms of revenue in line with what initial distribution looks like. Further, I would say that there is a lot of competition out there. I don’t think that we’re necessarily being direct affected by consumer spending habits however, we have competition both inside the existing adult category, we’ve got competition from premium program providers line Cinemax and Showtime that do show adult themed content and we have off platform competition from online companies.

So, I think all of that does have a slight impact on the business but, I think the good news is that we’re continuing to gain distribution, our content is performing very well, we’re gaining incremental shelf space with existing customers and we’re beginning to grow our business outside the US. If you look at the revenue we’re definitely performing well. You’re just not domestically see the same sort of revenue ramp in line with incremental distribution as you did with the very first distribution that we got seven years ago.

Richard Ingrassia – Roth Capital Partners, LLC.

I guess the prevailing wisdom is that on the last time we saw a downturn that was consumer driven there were fewer options for, I wouldn’t call it quality content but let’s just say alternative content available online at no charge. Is that a fair characterization of the environment we’re in now or not?

Ken Boenish

Well, like I said there is a lot of competition out there right now. Internet delivered content is certainly a better experience than it was even three years ago so there is low price content available online, there’s free content available online. Some of it is a decent consumer experience, a lot of it isn’t but, those things do have an impact on the business.

Richard Ingrassia – Roth Capital Partners, LLC.

Just the last one, I know it’s still early but can you share maybe some more specific metrics on the set-top platform in the UK? Maybe some sense for what criteria you have for go, no go decision on a full scale roll out there?

Ira H. Bahr

The answer is if we can produce ROI on the first tranche of set-top boxes that we’re marketing, obviously that would be enough information we need to invest further in the project. But, the microscopic way to look at this is that for a relatively small investment we’ve got a shot at what could potentially be a very, very large market. There are 24 million broadband households in the UK. If we were to attract a number like less than one half of 1% of those, say 100,000 that’s $36 million in revenue to the company. We think the upside absolutely justifies the investment we’re making in it and we’re still on our time line, we expect to have initial results on this test by the end of this fiscal year.

Richard Ingrassia – Roth Capital Partners, LLC.

Ira, is it any ROI or is there a specific hurdle that you’re looking for?

Ira H. Bahr

There are a number of metrics that we have internally that we’re going to evaluate but if the thing is making money for us, that’s obviously going to be an important one.

Operator

Our next question comes from Jamie Clement – Sidoti & Company.

Jamie Clement – Sidoti & Company

Michael, let me just ask you a question, I know you bought back a fair number of shares during the quarter, it seemed that Grant alluded to some cash needs over the next couple of quarters but it didn’t seem like it was that tremendous and certainly you all have a very strong balance sheet and access to more capital if you need it. I mean, with the stock where it is would the board consider another repurchase there?

Michael Weiner

Jamie, we as you know we just finished the buyback, we just about completed the 2 million share buyback that we had originally instituted. We bought back about 8% of the company’s outstanding shares. We evaluate the use of our cash every quarter and right now we are evaluating the opportunities in the industry, the opportunities to bring value to our shareholders for long term success but certainly a share buyback we know is accretive and that’s always on top of the list when looking at other alternatives.

Jamie Clement – Sidoti & Company

Typically in your third quarter there is some industry shows on the MRG side and usually you tend to report sequentially higher sales figures in MRG in your December quarter and you alluded to that in your prepared remarks. Can you just give a little refresher on that?

Michael Weiner

There are a number of trade shows towards the last half of the year, one of them is [NYMCOM] in France, the other one is the American Film Market which is actually happening right now and those shows typically produce a good amount of new revenue for the MRG subsidiary. I think the thing that Grant alluded to in his remarks is that last year in the third quarter we also had a producer for hire deal that happened which is not recurring this year so although we do expect stronger sales from the trade shows, you’re not going to see quite as big of a quarter due to that producer for hire deal that’s not happening.

Operator

Our next question comes from Eric Wold – Merriman Curhan Ford & Co.

Eric Wold – Merriman Curhan Ford & Co.

A couple of questions, one just to follow up on what you just said Ken about the producer for hire that was in the fiscal ’08 number, Q3 ’08 will not be this year, if that does go through for next year could it be comparable size to what you got in fiscal ’08 appearing in next year’s numbers?

Grant H. Williams

You’re referring to fiscal year 2010 being comparable to fiscal year 2008 from a revenue standpoint?

Eric Wold – Merriman Curhan Ford & Co.

No, just the one producer for hire segment that you commented you’re working on?

Grant H. Williams

Yes, we’re expecting that deal to be comparable to the deal we did back in Q3 ’08.

Eric Wold – Merriman Curhan Ford & Co.

Then switching gears a little bit to the transactional TV side and kind of going back to the first question following on that, is anything that you’re seeing by region, I know it’s tough to look at these things on a minute basis, but anything by region be it buy rates that are shifting or kind of trends that you’re seeing or anything that you’re doing to stabilize or improve buy rates in the markets and the [inaudible] that you’re already on in this environment?

Michael Weiner

Well, as I said the buys continue to be strong. As we add in incremental VOD hours and we go to our third and fourth pay-per-view service on cable platforms we see a marginal uptick in revenue but it’s not quite as impactful as when we launch our content for the first time. I think the thing that’s happening now to our benefit is that a lot of operators that typically had refused to market our content in the past are beginning to be much more aggressive about marketing the adult category as a whole where they hadn’t before.

So, I think that bodes well for us going forward. We haven’t seen any noticeable shift in buys on a regional basis or on a market basis due to economic pressures.

Eric Wold – Merriman Curhan Ford & Co.

Then last question, if you think about the infrastructure you’ve got in place and I know in the past you’ve talked about getting in to some additional non-adult revenue using what you’re doing now, how important could that be over the coming years? How much could non-adult represent of your revenues in the next two to three to four years? And, is there any kind of margin difference between what you get now as an adult and what you could see with non-adult?

Michael Weiner

I think that we’ve demonstrated over the past 10 years that we’ve been in this business our expertise in transactional television and I think our distribution partners recognize that and we are moving forward with rolling out some non-adult VOD movies with some of our cable partners. We think those launches will begin to happen sometime after the first of the year.

The revenue share on that content is quite a bit better than what we receive on our adult content but the retail is quite a bit lower so I think on a per buy basis we end up kind of in the same neighborhood.

Eric Wold – Merriman Curhan Ford & Co.

You said starting the first of the year, starting on the first of the calendar year or fiscal year?

Michael Weiner

It would be after the first of the calendar year.

Eric Wold – Merriman Curhan Ford & Co.

Over the next couple of years could it be significantly important?

Michael Weiner

I think it could be very material to the company depending on our initial success with the product. I think that the extent that we can demonstrate an ability to create new revenue for our distribution partners that they will allow us more and more shelf space and in that way I think we could build that up to be a very material piece of our business.

Operator

Our next question comes from the line of [John Roff – Argon Capital].

[John Roff – Argon Capital]

A couple of quick question for you, first could you just remind me the produce for hire arrangement from last year’s third fiscal quarter, how much did that contribute in revenue in that quarter?

Grant H. Williams

Unfortunately John, under the terms of that agreement I can’t give you the specific amount, we’re not in a position to do that we’re restricted under the contract. But, my suggestion would be if you look back to our Q3 fiscal ’08 results and the MRG entertainment segment you should get a good idea of what the impact from that was.

[John Roff – Argon Capital]

Secondly, can you give me a sense for what the costs associated with the UK set-top box initiative were in the quarter and where they would have appeared in the income statement?

Grant H. Williams

Sure, the total cost for the set-top box initiative in the quarter were approximately $700,000 and they were reported within the direct-to-consumer segment and they were split pretty evenly between the cost of sales line item and the operating expenses line item.

[John Roff – Argon Capital]

The last of all, could you just give me some updates in terms of what you’re expectations are for the year for D&A? Then secondarily, what your expectations are on the cap ex side?

Grant H. Williams

We don’t usually get in to that much detail on the D&A side. From a cap ex standpoint based on where we are in the year and obviously depending on some of the timings of the purchases we think cap ex would come in between $3.5 million and $4.5 million.

Operator

Our next question comes from [Barry Forcluse – Stark].

[Barry Forcluse – Stark]

I noticed that your cost of sales has increased 19% and your G&A has increased 19%, your sales are only up 7.5%. Do you want to comment on why the cost of sales jumped so dramatically and whether or not the operating expenses are under control to have jumped almost double the percentage increase from your sales increase?

Grant H. Williams

I’ll go ahead and take that, first let me mention that within our core business, the transactional TV business, our gross margin percentage came in at 73% which is consistent with where we were at the same time last year. From a cost of sales standpoint the two things primarily driving that are one, the additional costs we just mentioned associated with the set-top box initiative and the second item is primarily related to higher film cost amortization within the film production segment.

In our prior year quarter we had delivered several titles that were older whose film costs had been fully amortized so in that prior quarter cost of sales within that segment was unusually low. What you’re seeing there is a more normalized cost of sales for that segment which is reflected in an increase. So, that was primarily the drivers within the cost of sales line item.

But then the operating expenses line item again, we had the additional costs for the set-top box initiative and we had some additional advertising and promotion costs associated with driving additional domestic transactional TV revenue. That’s how we would characterize the increases in those items.

[Barry Forcluse – Stark]

Is that coming from market competition or product mix analysis or strategy or why? Are you going to be mixing more of the low cost films in to your programs going forward or are we going to see more high cost films?

Grant H. Williams

I think to the extent that we’re able to generate revenue on the older titles that have fully amortized film costs we try to build that in to the revenue stream as best we can. But, the older the title is the quality might not be up to the quality of the newer films so it begins to get a little more tricky as far as being able to sell that older content but obviously we try to utilize all the movies within our libraries within that segment.

Operator

Our next question comes from Dan Mendoza – Agincourt Capital.

Dan Mendoza – Agincourt Capital

I have a handful of questions, did you guys have a full quarter’s benefit of the increase of VOD shelf space at the MSO and satellite player or did that kind of get layered in during the quarter?

Michael Weiner

That was layered in during the quarter.

Dan Mendoza – Agincourt Capital

So in each case when did those kind of come on board fully?

Michael Weiner

The increases happened at various points. I mean a few of them happened in the beginning of the quarter. I think most of it was mid quarter towards the end of the quarter.

Dan Mendoza – Agincourt Capital

So we should see a sequential uptick then from those two just based on the increase shelf space?

Michael Weiner

Going forward we expect to see the full benefit of those increases yes.

Dan Mendoza – Agincourt Capital

Then you mentioned you guys had some consulting fees in the quarter, can you talk a little bit about the nature of the project and how many people you had in and if they’re still there?

Grant H. Williams

I don’t want to get in to too much of a level of granularity on that Dan but basically there’s some consulting fees associated with the company’s investigation of strategic alternatives and opportunities generally and so as Michael mentioned we’re always investigating all strategic potentials out there and those consulting fees are associated with some assistance to the company in analyzing those options.

Dan Mendoza – Agincourt Capital

Is that ongoing or is that completed?

Grant H. Williams

We expect that to have been completed this quarter.

Dan Mendoza – Agincourt Capital

Then I guess the follow up to that is, is consulting a euphemism for investment banker or sort of industry consultant?

Grant H. Williams

It’s a variety of consulting items, communication, strategic considerations, etc. So again, I wouldn’t characterize it specifically as one or the other.

Dan Mendoza – Agincourt Capital

Last question is just on the producer for hire what sort of cash outflows kind of come in front of the revenue?

Grant H. Williams

Again, under the contract Dan I’m not really in a position to give specifics. My suggestion is take a hard look at the company’s cash flows during the second quarter of fiscal 2008, those initial cash outflow are considered deferred costs initially and so there’s a specific line item in the statement of cash flows that sort of picks up the majority of those cash outflows. And, as we mentioned, we expect the economic structure of that deal that’s coming during the second half of fiscal 2009 to be similar as to what we experienced during the third quarter of fiscal 2008.

Operator

Management at this time we have no additional questions. I’ll turn the conference to you for any closing remarks.

Michael Weiner

Thank you all. Just finally I’d like to say in this tough economic environment we delivered a strong quarter and we’re continuing to execute on our strategies. We are expanding agreements with existing customers and adding new customers to gain an even more dominate position in the US and growing our presence internationally.

We believe we have a clear vision for our expansion. Our growth initiatives are focused on evaluating and testing new technology that leverages our current business assets and we’re on track for continuing capitalizing on this strategy. We look forward to talking to you soon. Thank you.

Operator

Ladies and gentlemen at this time we will conclude today’s teleconference presentation. We do thank you for your participation on the conference call. At this point you may now disconnect. Please have a pleasant afternoon and morning.