New Frontier Media Q1 2007 Earnings Conference Call Transcript (NOOF)

New Frontier Media, Inc., (NOOF)
Q1 2007 Earnings Conference Call
August 8, 2006 11:00 am ET

Executives

Karyn Miller - Chief Financial Officer
Michael Weiner - Chief Executive Officer
Ken Boenish - President

Analysts

Richard Ingrassia - Roth Capital Partners
James Clement - Sidoti and Company
Eric Wold - Merriman Curhan Ford
Mike Kelman - Susquehanna Financial Group
Jack Ripstein - Potrero Capital
Jason Williams - Botti Brown Asset Management

Presentation

Operator

Good morning, ladies and gentlemen and welcome to the New Frontier Media’s first quarter fiscal 2007 earnings release conference call. (Operator Instructions) I would now like to turn the conference over to your host, Ms. Karyn Miller, Chief Financial Officer. Please go ahead, ma’am.

Karyn Miller

Thank you, and good morning. Welcome to the New Frontier Media fiscal 2007 first quarter results conference call. This is Karyn Miller, New Frontier Media's Chief Financial Officer. With me today is Michael Weiner, Chief Executive Officer of New Frontier Media; and Ken Boenish, President of New Frontier Media. Also, on the call is our SEC Counsel, Hank Gracin with the law firm of Lehman & Eilen.

During this call, Michael will give an overview of the Company's strategic position, and then I will review New Frontier Media's results of operations for the quarter. After our commentary we will open up the conference call for questions.

A replay of this conference call will be available until August 15th, at 800-405-2236 using the passcode 110 67 152. This call will be archived for 12 months on our website at www.noof.com under Investor Relations Webcasts & Events. This call is also being webcast.

During the question-and-answer segment, those of you listening via the Internet will be asked to will be able to ask questions. Please submit your question via e-mail to [e-mail].

During this call, we may make references to non-GAAP measures. This information, including a reconciliation to the related GAAP measure, is available in today's earnings release. A copy of our earnings press release is available at our website at www.noof.com under Investor Relations, News Releases. All information discussed during the conference call is as of today and the Company assumes no obligation to update information discussed during this call.

During this conference call, management may make forward-looking statements and intends for these statements to be covered by the Safe Harbor provisions for forward-looking statements. All statements regarding the Company's expected financial position and operating results, its business strategy, financing plans and the outcome of any contingencies are forward-looking statements.

In addition, forward-looking statements maybe identified by the use of words such as believes, expects, intends, seeks, estimates and anticipates or variations of such words. 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.

For more information about these risks and uncertainties, please refer to the Company's press release and its filings with the Securities and the Exchange Commission including the Company's Form 10-K and 10-Q in the Risk Factors section.

Now, I would like to turn the call over to Michael Weiner.

Michael Weiner

Thank you, Karyn and good morning, everyone. We are this morning reporting a 48% increase in year-over-year revenue. In addition, we are also reporting substantial gains in free cash flow as well as in earnings. The Company’s performance in this quarter is mainly attributable to increased distribution of our pay-per-view services. As you know, our launch of TEN and TEN Clips on DirecTV in April added some 30 million network households to our distribution base. Consistent with the fundamental underpinning of our business model, this addition distribution did not create any material associated costs. I am pleased both with the way our DirecTV launch was managed and with the initial performance results we have seen, which are consistent with our internal expectations.

As they do on most platforms, our pay-per-view networks are leading the category in terms of monthly buys and revenue generated. We believe this is because we pay more careful attention both to the nature of the market and to the manner in which we address it than do our competitors.

We are proud to announce this week that we have concluded a major agreement with Ninn Works, one of the most highly acclaimed adult movie studios in the business. Led by Michael Ninn, this studio produces some of the most arresting and distinctive erotic features ever made.

The fact is that the general adult film business is filled with look-alike content and look-alike talent. The industry’s assembly line of well-endowed blondes leads to a mind-numbing procession of porn queens distinguished only by the alliteration of their names.

Over time, the real innovation in this business will come from the writers, directors and musicians who combine cutting-edge techniques with highly erotic story lines and innovative casting.

New Frontier has known from the start that the adult broadcast market is not perfectly synchronized with the retail DVD market. For example, proven retail performers from well-branded studios, which are featured on our competitors’ services consistently under-perform our more selective, hand-picked content. Our services perform best because we have the best handle on what works in the medium.

This quarter, our advantage was seen not only in pay-per-view, but in VOD where we have been fine-tuning our product, increasing distribution and recovering market share lost when a large competitor launched a big platform in the year-ago period. We have steadily been improving our VOD product by reacting to market research, indicating the strength of our trademark. The Erotic Networks.

Just this month, our key entry point on the largest VOD platform in the country has undergone a brand change from ‘TEN’ to The Erotic Networks. This mark, which denotes quality, variety and competitive distinctiveness allows us to deploy a wide range of content, of building to a wide range of individual tastes.

Our integration of MRG is of to a strong start. The Company has an excellent first quarter and we’ve gotten more visibility into the nature of the enterprise. Further, we’ve begun to exploit new distribution opportunities for the MRG content. Both of these factors are contributors to our improved overall guidance for the fiscal year.

The Company filed a Form 8-K this morning providing additional information regarding the resignation of Dr. Skender Fani from the Board of Directors at New Frontier. As many of you know, Dr. Fani lives in Vienna and over the last nine months has found it difficult to attend Board meetings in person. Subsequent to his former resignation letter, Dr. Fani sent an e-mail indicating that he disagreed with the other six Board members regarding fiscal 2007 compensation for New Frontier’s President and its Chief Financial Officer. We wish Dr. Fani well, and are presently engaged in developing our requirements for recruiting a new board member.

In closing, our Company is performing solidly, even in the face of ever-increasing competition. We believe we are both more strategic and more nimble than our competition, and we believe our results this quarter prove it. Now Karyn will take you through the numbers in more detail.

Karyn Miller

Thank you, Michael. Starting with an overview of the Company, net revenue for the Company for the first quarter $16.3 million compared to $11 million for the quarter a year ago, representing an increase of 48%. Gross margin percentage for the Company was 67% for the current year quarter, compared to 68% for the quarter a year ago. Operating expenses were 34% of revenue for the quarter ended June 30, 2006 as compared to 35% for the quarter a year ago.

The Company reported net income of $3.5 million or $0.15 per fully diluted share, as compared to net income of $2.5 million or $0.11 per fully diluted share for the first quarter of last year. The Company reported EBITDA for the first quarter of the current year of $5.9 million. This compared to $4 million for the quarter a year ago, representing a 48% increase. The reconciliation of EBITDA to our GAAP numbers is included in our press release on our website.

The Company has approximately $27.3 million in cash and marketable securities on its balance sheet as of the end of our first quarter and the Company has approximately 23.8 million shares outstanding as of today.

Looking at just our Pay Television group and its results for the quarter. Quarterly revenue for the Pay TV group increased to $12.6 million for the quarter ended June 30th 2006 from $10.4 million for the quarter a year ago, representing a 21% increase. As you know, our Pay TV revenues comprise of both revenue from sales to our C-Band customers and revenue from our core business of distributing our pay-per-view network and VOD offering via our relationship with our cable, DVS and hotel partners.

The group’s quarterly C-Band revenue decreased 38% to $0.5 million for the current year quarter from $0.8 million for the first quarter a year ago. As always, we continue to monitor the margins of this business and work to find ways to decrease our costs as our revenue erodes. The C-Band market now has less than 108,000 total active units.

The group’s Cable and DVS pay-per-view revenue increased 23% to $7.5 million for the current year quarter from $6.1 million for the quarter a year ago. This increase is primarily the result of the launch of two of our services on the DirecTV platform which occurred in April.

The Pay TV group’s VOD revenue increased 31% to $4.6 million in the first quarter of the current fiscal year from $3.5 million for the quarter a year ago. Currently, we provide VOD content to over 22 million VOD-enabled customers; up from 19 million a year ago; and 800,000 hotel rooms in the US. Our VOD revenue increased due to increases in revenue from Comcast as they launched our content on new systems, and transitioned the editing standards of their VOD content to be more explicit.

In addition, we experienced an increase in VOD revenue from Time Warner as we are able to successfully regain some of our market share since the initial launch of our largest competitor on this platform over a year ago.

Cost of sales for the Pay TV group decreased 12% to $2.9 million for the current year quarter, from $3.3 million for the quarter a year ago. The quarterly year-over-year decrease in cost of sales is primarily related to a decrease in our C-Band call center costs, a decrease in VOD transport fees and a decrease in depreciation and operating lease costs.

Quarterly operating income for the Pay TV group increased 54% to $7.4 million for the current year quarter from $4.8 million a year ago. The Group’s quarterly EBITDA increased 46% to $7.6 million for the current year quarter from $5.2 million for the quarter a year ago.

Operating expenses for the Pay TV group were flat at $2.3 million for both quarters ended June 30 2006 and 2005 respectively.

Moving now to the Internet group, the Internet group’s revenue declined 14% to $0.6 million from $0.7 million for the quarter a year ago. Cost of sales were flat at $0.3 million for both quarters. Operating expenses increased 33% to $0.4 million from $0.3 million for the quarter a year ago. The Internet group generated an operating loss of $0.1 million for the current year quarter, compared to operating income of $0.1 million for the quarter year ago.

Moving on to our new segment, the Film Production group, just as a reminder, the Film Production’s group’s revenue is comprised of two segments. We have our rep-titled revenue and our owned-titled revenue.

Revenue earned from our rep-titled business is a result of licensing film titles which we represent but do not own under international sales agency agreements with various independent film producers. We have a portfolio of approximately 80 mainstream titles that we represent through our mainline releasing Enlightening Entertainment labels. Revenue from our owned titles is earned as we license our own erotic film library, either on a flat fee or rev share basis to customers such as Cinemax, Showtime, DirecTV, In Demand and DISH.

The Film Production group earned $0.4 million in rep-titled revenue and $2.7 million in owned-title revenue during the current year quarter. Over half of our rep-titled revenue is generated by the licensing of five major titles. Our quarterly owned-titled revenue was impacted by the delivery of nine episodes of a 13-episode series to one of our major customers this quarter.

Cost of sales for the Film Production group was $2.1 million for the current year quarter. Cost of sales relates entirely to owned titles and consists primarily of film amortization costs as well as delivery and distribution costs. Film amortization represents approximately 89% of our total cost of sales, and resulted in margins of 27% of our owned content. As we continue to amortize the content that we’ve purchased as part of the acquisition, as well as release newly produced titles, we expect this margin to increase.

Operating expenses were $1.1 million and the Film Production group has an operating loss of $0.1 million for the first quarter. Operating expenses include amortization related to the identifiable intangibles purchased as a result of the acquisition, as well as the accrual of the earn out related to the acquisition.

Looking at our corporate overhead, corporate administration operating expenses increased 31% to $1.7 million for the current year quarter, from $1.3 million for the quarter a year ago. This increase is related to stock option expenses from the adoption of FAS 123 R this quarter, an increase in outside accounting fees and an increase in costs related to the addition of a marketing and corporate strategy department, which was added in January of this year.

In our press release, we also updated our guidance which I will go over real briefly. We increased our revenue guidance from $56.5 million to $58.5 million to the revised guidance of revenue of $60 million to $62 million. Our net income guidance previously was $7.7 million to $8.9 million. We have updated this to be $10 million to $11.4 million.

Our previous EPS guidance was $0.32 to $0.37 a share. We have updated this to be $0.42 to $0.47 a share, and our pre-tax free cash flow was previously $18 million to $20 million; we have updated this to be $22 million to $24 million.

Now, we would like to open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Richard Ingrassia - Roth Capital Partners.

Richard Ingrassia - Roth Capital Partners

Thanks, good morning everybody.

Michael Weiner

Hi Rich.

Karyn Miller

Good morning.

Richard Ingrassia - Roth Capital Partners

Given the upward revision in guidance, can we assume that the uncertainty you had last quarter regarding the Dish contract has been mostly resolved? Or is there any other detail you can provide on the negotiations there?

Ken Boenish

What I can tell you is that we continue to be engaged with DISH Network and we continue to operate on a month-to-month agreement that we’ve had for the past three years plus. Whether that arrangement will change today, tomorrow, next year, we really don’t have any visibility into that, but we will keep investors apprised of any material development on this front.

Richard Ingrassia - Roth Capital Partners

Can you share concentration in the quarter from DISH and DirecTV?

Karyn Miller

Dish Network, I think was 25% of our revenue, it has obviously declined a bit as total percentage of our revenue because we have MRG in there as well. Dish was 26% of our revenue, DirecTV was 13% of our revenue. Also remember that we get revenue from DirecTV from both our Pay Television and our Film Production groups.

Richard Ingrassia - Roth Capital Partners

Finally, now that Comcast has stepped up to XXX on VOD, would you say that the long awaited transition there at cable is underway?

Michael Weiner

Well, just to be clear, I don’t believe Comcast has embraced the XXX standard. They are airing on VOD what we call our partially edited content for XX. The majority of the cable television industry has already embraced this edit standard. Comcast is probably the last major operator to make that transition.

We have heard some rumors that some of the operators are looking at our least edited standard, but nobody has really made a firm commitment to that.

Richard Ingrassia - Roth Capital Partners

Thank you.

Operator

Our next question is with James Clement - Sidoti and Company.

James Clement - Sidoti and Company

Good morning Michael, Ken and Karyn. How are you?

Michael Weiner

Great, thanks.

James Clement - Sidoti and Company

Karyn, a quick question on the purchased intangibles. I think last quarter, they were at $4.7 million MRG, I think in this press release you are $3.4 million. Is the difference there all what's amortized, or was there a little bit of a revaluation there?

Karyn Miller

Actually, when we had filed our 10-K, we had noted that the valuation was preliminary. We have finalized that valuation. It resulted in a slight change in some of the values of the intangibles. The rest of that difference went back into goodwill.

James Clement - Sidoti and Company

Regarding your guidance for the year, I think you said on the last call that there was something baked in accounting for the potential result of the Dish renegotiation. How should we think about what's changed and how you guys are viewing your business today versus two months ago? Is a good portion of the increase in guidance simply that more months have gone by and there has been no resolution to that?

Ken Boenish

We can't say that. It’s a little bit of everything. We have not come to a resolution with our Dish agreement. We continue to work with them on a number of fronts that would create a scenario that’s both good for them and good for our Company.

The rest of our business segments are actually doing quite well, and some better than expected. So, everything added together really gave us confidence in the uptick in the guidance.

James Clement - Sidoti and Company

Final question and then I will get back into queue. Can you provide a little more color on the deal with Ninn Works, is there an upfront that you guys have to pay? What is the nature of the financial arrangement with them?

Michael Weiner

We really can't give you the specifics, but we licensed 87 of their movies that have never been shown on cable and we have an output deal for them to produce two movies a month for us, which we will license.

James Clement - Sidoti and Company

Thank you very much.

Operator

Our next question is with Eric Wold - Merriman Curhan Ford.

Eric Wold - Merriman Curhan Ford

Good morning. A couple of follow-up questions on the previous callers, one on Dish negotiations. The Q1 results including the rev split under the old model or the old contracts, if we look going forward, I am assuming your guidance for Q2 through Q4 includes what you think is going to be renegotiated towards. How much of that difference is in Q1? How much would that boost help Q1, because that wasn’t negotiated during the quarter?

Karyn Miller

Eric, I am not quite certain what you are asking, but I mean obviously we are under our historical rates in Q1 and for the rest of the year we made some assumptions which we've continued to feel are fairly conservative. I think as we move through the year and get more visibility on what's happening, we will be able to continue to update that.

Eric Wold - Merriman Curhan Ford

What I was asking was if since Q1 was under historical rates and you are making an assumption for what Q2 to Q4 will be under your assumption for what it is going to re-negotiated to, if we look at that difference from the historical rates to what you are assuming Q2 and beyond, can we put a dollar amount on that, revenues, to see what the difference is between Q1 and guidance?

Karyn Miller

No, we are not going to give that kind of detail.

Eric Wold - Merriman Curhan Ford

On the editing standards changing, any sense on what kind of increase in buy rates you saw when the editing standards was switched and then what is the change in price points from the old editing standards to the new one?

Ken Boenish

Well, on the Comcast platform, there is a lot of things going on at once there. As they move to a more explicit edit standards, they are also adding in more competitive providers on the platform; so that's slightly offsetting the uptick we would normally see from the transition from X to XX content.

But we are still seeing some of the benefits of that flow through to the Company, so even though there is competition on the platform, it's still a very good thing for our VOD revenue for that to happen. What was your second part of your question?

Eric Wold - Merriman Curhan Ford

What was the average change in the price point when you switched the editing standards?

Ken Boenish

Typically when we switch edit standards, we see about $1 increase across the board in retail pricing. But again, within cable television, local operators do have the ability to adjust their price locally. So we do see some systems that will go up a couple of bucks based on the transition.

Eric Wold - Merriman Curhan Ford

Okay, perfect. Thanks guys, I appreciate it.

Operator

Our next question is with Mike Kelman - Susquehanna Financial Group.

Mike Kelman - Susquehanna Financial Group

Can you talk about the potential impact from the Adelphia Systems being acquired by Time Warner Cable and Comcast? Specifically when you would likely start to see some TEN Branded pay-per-view channels being carried by those systems?

Also to that effect, can you update us on the continued rollout of pay-per-view channels in the legacy AT&T Systems now under the Comcast umbrella, and whether or not you are now fully rolled out in all those systems?

Michael Weiner

Sure. We expect the changes within the former Adelphia Systems to happen over the next six to eight months. Some of the system operators are telling us that they are going to be executing on that fairly quickly, so we may see some of that transition even in the next quarter, but we really can’t be assured of that until it does happen.

As far as Comcast launching TEN services in their legacy systems, we have seeing quite a few markets launch already. I believe we picked up Chicago, Detroit, St. Paul, Minnesota and we've got quite a few more systems that are positioning themselves to launch our pay-per-view services in the coming quarter. So, we will enjoy growth in our pay-per-view services throughout this fiscal year.

Mike Kelman - Susquehanna Financial Group

Great thanks. And one other quick question. I know Playboy’s strategy seems to be focused on rolling out a subscription VOD offering of their Playboy channel. I think they already have agreements with Comcast and Time Warner Cable. Do you see this is viable platform for the adult entertainment content? Do you think that’s going to have any impact on the buy rates of your channels?

Michael Weiner

We really don’t see that as having much impact on the buy rate of our channels. People that typically subscribe to Playboy services are not necessarily the same customers that buy our movies. Historically, Playboy as a subscription service has been a very, very poor performer. I think that’s why we see most cable operators over the past 10 years have not put any marketing effort into that service as a subscription.

When it comes to movie services like ours, we find that if operators were to sell us on a subscription basis, they most likely would be leaving a lot of money on the table. If you think about it, a household might just buy one movie a week at $10 a movie. That’s $40 a month in pay-per-view or VOD revenue versus the Playboy service sells for $19 a month on a subscription basis. So, we really don’t see that as a real competitive threat to us.

Mike Kelman - Susquehanna Financial Group

That’s great. Thanks guys.

Operator

Thank you. Our next question is from Jack Ripstein - Potrero Capital.

Jack Ripstein - Potrero Capital

Hi, I have four questions. I might have misheard you, but it sounds like there is a loss of $1 million in the Internet. Are there any plans to ramp that back up or scale it down?

Any progress on cell phone, iPods, any commentary there?

Third, I think VOD was light quarter-on-quarter. Was there seasonality or anything in there?

Then in terms of the payback just for yourself and for Karyn, just what the deltas are there, if you could put it in some perspective that would be really helpful.

Karyn Miller

I will take the first couple. Actually, the Internet group loss $0.1 million, so $100,000 not $1 million. I will let Ken talk about what we have for plans with that and obviously, the wireless is part of our Internet division and we haven’t recognized any material revenue with respect wireless right now, but we have incurred some costs getting that ramped up.

Ken Boenish

I will speak to wireless just a bit. We are focusing on wireless distribution, this year we’ve enjoyed some initial distribution outside the US. We’ve recently completed two wireless deals for providers within the US. These are smaller companies that are known as MVNOs and we are rolling out our content on one of those providers right now. The other one will roll out in the coming month. Like I’ve said in previous calls, wireless for us right now is still a great opportunity for the Company. We look at it as an investment in where our Company will be in the months and years down the road. We look forward to good things from that division.

Karyn Miller

On the VOD revenue, you may or you may not recall, but when we talked at fourth quarter I had actually pointed out to everybody that the fourth quarter was heavy with respect to some adjustments that we made. Obviously, we have to estimate our revenue for VOD, for the Pay Television business and then once we get the actual numbers in, we adjust the accruals up or down depending on which way the accrual was.

Fourth quarter, we are starting to see VOD revenue trend up as a lot of our accruals were in the up direction, made our fourth quarter VOD revenue a little heavier than we knew would be the continuing trend. That’s why you are seeing a successive quarter decline.

Jack Ripstein - Potrero Capital

So should that smooth out then by the end of the year?

Karyn Miller

Yes, I would expect so.

Jack Ripstein - Potrero Capital

Okay.

Michael Weiner

Regarding the question about the contracts. Just to give you a little background, you may or may not know that the contracts for Ken, Karyn and myself, as a matter of fact, expire on March 31 2007. What we did, the Board of Directors reviewed several different firms and the competition committee retained Mercer Consulting to doing an analysis and advise on executive salary ranges. The contracts that were proposed are within the ranges described in the Mercer Report and six out of the seven Board members agreed to the recommended terms.

Further, these contracts are not materially different in any respect versus the existing contracts.

Jack Ripstein - Potrero Capital

Thank you.

Operator

Our next question is with Jason Williams - Botti Brown Asset Management.

Jason Williams - Botti Brown Asset Management

What was cash flow from operations in the quarter?

Karyn Miller

Cash flow from operations is on our cash flow statement, about $3.9 million.

Jason Williams - Botti Brown Asset Management

$3.9 million, great. The only other question is how about CapEx in the quarter?

Karyn Miller

CapEx is about 300,000.

Jason Williams - Botti Brown Asset Management

Great. Thank you.

Operator

Thank you. At this time, I will turn the conference back over to management.

Michael Weiner

Thank you all. If there are no more questions, we look forward to getting together on the next conference call. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the New Frontier Media first quarter fiscal 2007 earnings release conference call. Once again, we would like to thank you for your participation, you may now disconnect.

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