New Frontier Media F3Q08 (Qtr End 12/31/07) Earnings Call Transcript

New Frontier Media (NOOF)

F3Q08 Earnings Call

February 5, 2008 11:00 am ET

Executives

Grant Williams - Corporate Controller

Michael Weiner - Chief Executive Officer, Secretary and Chairman

Ken Boenish - President of New Frontier Media

Analysts

Paul Thomas – Roth Capital

Aram Fuchs - Fertilemind Capital

Eric Wold - Merriman Curhan

David Vorr - Montgomery Street Research

Presentation

Operator

Welcome to the third quarter fiscal 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Grant Williams. Please go ahead, sir.

Grant Williams

Good morning, everyone and welcome to the New Frontier Media fiscal 2008 third quarter results conference call. With me on the call this morning is 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.

During the 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 February 12 at 1-800-405-2236 using the pass code 11108180. This call will be archived for 12 months on our website at 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 able to ask questions. Please submit your question via e-mail to [e-mail].

During this call, we may make references to certain non-GAAP measures. This information, including a reconciliation to the most directly comparable GAAP financial measure, is available in today’s earnings release. A copy of our earnings press release is available at our website at 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 conference call. During this conference call, management may make forward-looking statements, 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 at the Securities and Exchange Commission, including our most recently filed Form 10-K and our Form 10-Q which we expect to file later this week.

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

Michael Weiner

Thank you, Grant and good morning, everyone. This morning we are reporting a solid fiscal quarter for New Frontier Media. Our revenue of $17.9 million is the highest quarterly revenue achieved in the company’s history. Our results were driven by strong seasonal performance from our film production unit MRG, which in this quarter delivered a mainstream motion picture to a major Hollywood studio. MRG also delivered a 13-part series to a premium cable channel and additionally saw strong fourth calendar quarter sales of both its owned and rep product in overseas markets. We are pleased with MRG’s performance. We continue to make cash investments in that business.

MRG’s Lightning Entertainment unit now represents a wide range of high quality, mainstream motion pictures and is making itself an important force in international distribution. More and more frequently producers of content featuring well-known and well-established stars are seeking out Lightning to represent its movies internationally. If you have not done so already, I would encourage you to visit Lightning-Ent.com to get a more tangible sense of that business unit.

MRG recently added to its already impressive distribution network with the addition of a new business unit which will produce, acquire and distribute motion pictures both internationally and within the United States. The new unit’s business will pivot around a key customer which will distribute motion pictures within the U.S. Using this relationship, Lightning will target the market of films which are put into a limited theatrical release in order to drive revenue in the larger DVD marketplace.

The U.S. market for sales and rentals of DVD is estimated at over $24 billion and to this point has been largely untapped by New Frontier. We are optimistic that starting late in our next fiscal year Lightning could begin to contribute meaningful revenue to our film production unit, perhaps rising to a run rate of $4 million or more annually over the next 36 months.

Our Transactional TV unit has continued to produce meaningful margins and profit while we have assimilated the significant [DBS re-rate] we experienced in last year’s third fiscal quarter. We believe that this quarter’s year-over-year decline in pay-per-view revenue will be the last one connected with that re-rate, and that starting next quarter we should again resume a year-over-year growth trend in that business.

That trend will be assisted by a number of factors. Key among these is the launch of a third channel on the nation’s largest DBS platform. This launch has materially improved our revenue performance on this platform. We expect these results to improve further over the coming months as we optimize our line-up on this platform with even stronger performing services.

On VOD, New Frontier continues to be the performance leader. On the systems we are able to track via third party research, our services outperform our nearest competition by at least 25% on a revenue per server hour basis. New Frontier products make more money for our partners and over time we have found that this superior performance is making us a partner of choice for additional server hours, new product launches and new strategic initiatives. While we expect stabilization and modest growth in pay-per-view services, we believe there is material growth to be had in VOD, and we believe our company is well-positioned to capitalize on it.

A key piece of the overall growth strategy in domestic transactional TV is our deal with Penthouse. As we announced in September, our deal with PMGI makes New Frontier the exclusive distributor of that brand in adult pay-per-view and VOD in the United States. As we indicated in our last call, New Frontier has conducted substantial primary research on the Penthouse trademark and we believe that it is by far the most powerful mark in our category. It connotes all the attributes transactional TV buyers want and is differentiated versus other competitive products.

The company has been executing exceptionally well on the Penthouse transaction and has seen strong results. In December, we announced that we have launched Penthouse VOD product to nearly 11 million households. This launch included the first-ever high-definition adult VOD offering in the United States. By this summer, we expect to have launched Penthouse VOD to another 15 million U.S. homes, giving the brand virtually full distribution on American digital cable.

Further, leveraging on the strength of Penthouse we are also experimenting with a subscription video-on-demand service. This service would offer a large menu of Penthouse VOD products, all for one recurring monthly price. If successful, we expect the launch of this service by summer 2008.

Finally, to buttress our position in pay-per-view, we are going to replace the linear service branded at Ten with a Penthouse linear channel. By this summer, we expect the Penthouse TV linear channel to be available to some 30 million cable homes as well as some 30 million DBS homes. We believe that the launch of this branded offering will work to secure a longer-term carriage for New Frontier products.

As our core businesses show good growth, New Frontier is simultaneously working with customers and strategic partners to create new products which leverage IP connectivity to the television. At this year’s Consumer Electronics Show in Las Vegas, one of our partners featured a new satellite and IP set-top box which facilitates IP movie downloading. New Frontier was prominently featured as the exclusive library content provider for this product. We are also excited with the progress we have made with the technology and content in the Internet unit and expect to speak more about these prospects later in 2008.

Today I am as confident as ever in the prospects of our company. While it’s true that we continue to face pressure from new competition both on and off platform, our execution and innovation will be the engines of our growth in the years to come. New Frontier has increasingly become an excellent choice for global content partners and for a range of high-tech and entrepreneurial employees who are attracted to our vision of what our company can do over the coming years.

We are excited to explore, cultivate, and develop some of the opportunities to leverage our expertise and leadership in this market, and convert those opportunities to financial results for our shareholders.

Now Grant will walk us through New Frontier’s third quarter operating results.

Grant Williams

Thank you, Michael. I would like to begin our discussion of the company’s financial operations by sharing some information on our overall consolidated results for the quarter. Earlier this morning, we reported net income of $3.1 million or $0.13 per share as compared to net income of $3.4 million or $0.14 per share during the same quarter in the prior year.

We generated $3.7 million of cash flow from operations during the current quarter and adjusted EBITDA was $5.6 million for the current quarter as compared to $6.5 million during the same quarter in the prior year. A reconciliation of adjusted EBITDA to our GAAP results is included in our press release on our website.

We are pleased to report that the company’s consolidated net revenue increased 8% during the current quarter to $17.9 million as compared to $16.6 million a year ago. The increase in revenue was primarily driven by the results of our film production segment. This segment delivered a 13-episode series to a premium TV service provider and completed a produce-for-hire arrangement with a major Hollywood studio during the current quarter.

These improvements in revenue were partially offset by lower transactional TV segment revenue, which we have historically referred to as our Pay TV segment and specifically the decline was due to lower pay-per-view revenue from the renegotiation of our contract for the second-largest direct broadcast satellite provider during the third quarter of fiscal 2007. This new contract revised the revenue split we receive downwards so that we now receive a smaller percentage of the overall revenue this customer generates from our content.

Our consolidated cost of sales for the current quarter was higher as compared to the prior year quarter, primarily as a result of additional costs associated with the completion of the produce-for-hire arrangement. Sales and marketing expenses were basically flat at $1.7 million during the current quarter compared to $1.8 million during the same prior year quarter.

General and administrative costs during the current quarter declined to $3.8 million as compared to $4.5 million in the prior-year quarter. This decline was primarily the result of a $0.5 million reversal of an earnout accrual that was recorded during the nine months ended September 30, 2007. The company had previously estimated that it would be required to pay the former shareholders of MRG an earnout payment in accordance with the MRG purchase agreement. However, the actual performance at MRG during the 12-month period ended December 31, 2007 was not sufficient to meet the earnout performance target so the accrual was reversed in the current quarter.

Our results this quarter also included an impairment charge of $0.8 million, primarily associated with the estimated performance of two movie events in the film production segment. We will discuss this charge in more detail in a few moments during our discussion of the film production segment results.

Now that we’ve laid out the company’s consolidated results, let’s discuss each of our operating segment’s performance for the quarter in more detail. The revenue from our transactional TV segment declined during the current quarter to $9.9 million as compared to $11.2 million during the prior year quarter. Pay-per-view revenue was $5.4 million compared to $6.9 million in the prior year quarter and was lower as a result of the renegotiation of our contract with the second-largest direct broadcast satellite provider in the U.S. The pay-per-view revenue results this quarter include a partial benefit from adding a new channel to the platform of the largest DBS provider.

VOD revenue for this segment increased to $4.4 million as compared to $3.8 million in the same prior year quarter, due to continued improvement in our performance on the largest and second-largest cable operator platforms in U.S. Our C-Band service contributed just over $100,000 of revenue to the segment’s quarterly results because we terminated the service in November. As we previously disclosed, the company made a strategic decision to discontinue the C-Band service as a result of the continued decline in C-Band subscribers.

Moving on to the transactional TV segment expenses, cost of sales during the current quarter was $2.8 million, which is consistent with the $2.7 million of costs incurred in the same prior year quarter. Operating expenses for the segment declined slightly to $2 million during the quarter as compared to $2.2 million in the prior year quarter, primarily from a reduction in certain advertising expenses. Income from operations for the segment was $5.1 million as compared to $6.3 million in the prior year quarter.

For our film production segment, we reported strong revenue for the current quarter of $7.6 million as compared to $4.8 million for the same prior year quarter. Owned product revenue for the quarter was $4.3 million as compared to $3.7 million in the prior year quarter and this increase is primarily due to the delivery of a 13-episode series during the current quarter. We also delivered a 13-episode series in the prior fiscal year, but that delivery occurred during the first half of fiscal 2007.

Rep product revenue for the current quarter was down slightly at $0.7 million as compared to $0.9 million in the prior year quarter and other revenue for this segment increased substantially to $2.6 million as compared to $0.2 million in the prior year quarter. This increase is due to the completion of a produce-for-hire arrangement during the quarter.

Cost of sales for the film production segment was $4 million for the current quarter as compared to $1.8 million in the prior year quarter. The increase in these costs is due to the expenses we’ve realized in connection with the completion of the produce-for-hire arrangement.

Operating expenses for the current quarter were $1.4 million as compared to $1.2 million in the prior-year quarter. As previously mentioned, these costs include an impairment charge of $0.8 million primarily related to two film events. These two events were originally valued based on the estimated future benefit we expected to receive from the titles when we purchased MRG Entertainment in February of 2006.

During the current quarter, we received certain data indicating that the benefit from the events will be less than originally estimated. As a result, we recorded an impairment charge equal to the difference in unamortized film costs and the estimated fair value of the events. Partially offsetting this impairment charge was a decrease in expenses associated with a previously discussed reversal and earnout accrual of $0.5 million. For the current quarter, the film production segment generated operating income of $2.2 million reflecting a 22% increase as compared to the $1.8 million earned in the same prior year quarter.

Internet segment revenue during the current quarter was $0.4 million as compared to $0.6 million in the prior year quarter. We continue to dedicate our resources in this segment to the redesigning of our consumer websites and we plan to launch an enhanced version of the Ten.com website in fiscal year 2009. We believe this should improve the performance of the segment.

The Internet segment’s cost of sales during the third quarter of fiscal 2008 were $0.1 million as compared to $0.2 million in the prior year quarter and operating expenses were $0.2 million as compared to $0.8 million during the same quarter in the prior fiscal year. The decline in operating expenses was due to a reduction in our employee costs associated with the segment’s wireless activities and additionally the prior year results include a $0.4 million impairment charge for the write-off of certain licensed content.

Corporate and administration costs during the current quarter of $2.6 million were consistent with the prior-year quarter.

We generated $4.6 million of operating cash flows during the nine months ended December 31, 2007 and we expect to continue to produce strong operating cash flows through the remainder of the fiscal year 2008.

During the first half of the current fiscal year, we had a cash outlay of $2.1 million for a produce-for-hire arrangement that was delivered in December of 2007. This was a profitable deal for us and we expect that our film production segment will receive payment for this arrangement in the fourth fiscal quarter. We also expect that the film production segment will receive payments in the fourth fiscal quarter for many of the films it delivered during the current quarter, which will provide the company with an improvement in operating cash flows.

Operating cash flows are also expected to be positively impacted from additional VOD revenue related to our recent launches of Penthouse and Penthouse HD content, as well as other new niche programming packages that received incremental distribution space on our customers’ platforms.

Cash flows from investing have generated $4 million of cash during the first nine months of fiscal 2008. We received cash of approximately $6.1 million associated with our net redemptions of investments during the period which was partially offset by capital expenditures of $1.5 million, primarily related to purchases of equipment. We have used approximately $9.5 million of our cash during the nine months ended December 31, 2007 for financing activities. Approximately $6 million of this cash was used to pay quarterly dividends, and we used $3.8 million to repurchase approximately 614,000 shares of our common stock at an average purchase price of $6.26 per share.

Our cash and marketable securities balance at quarter end was $19.6 million.

Before we move onto the Q&A portion of the call, I would like to give some information on our sequential quarter results. Revenue increased to $17.9 million during the current quarter as compared to $12.4 million in the prior sequential quarter ended September 30, 2007. This improvement was due to an increase in our film production segment revenue of $5.6 million. Revenue from the transactional TV segment of $9.9 million was flat as compared to the $10 million in revenue for the prior sequential quarter. Although the transactional TV segment experienced an increase in revenue from an additional channel on the largest DBS platform in the U.S., this increase was offset by a slight decline in revenue from the largest MSO in the U.S. due to seasonality.

Cost of sales during the third quarter of fiscal 2008 increased to $6.9 million as compared to $3.5 million during the prior sequential quarter ended September 30, 2007. This increase is primarily from additional expenses for the produce-for-hire arrangement the film production segment completed during the current quarter. Cost of sales were also higher due to additional film production costs, which increased in a manner consistent with the increase in the film production segment’s owned product revenue.

Sales and marketing costs of $1.7 million were relatively flat as compared to the prior sequential quarter and consolidated, general and administrative expenses declined to $3.8 million as compared to $4 million in the second fiscal quarter of 2008, primarily from our reversal of the Film Production segment earnout accrual. This decline was partially offset by higher audit fees associated with the timing of those services.

As previously discussed, the current quarter included an impairment charge of $0.8 million for two film production segments and there was not a similar charge incurred in the prior sequential quarter.

Our net income increased to $3.1 million for the current quarter as compared to $2.1 million earned during the prior sequential quarter ended September 30, 2007 and earnings per share also improved to $0.13 per share during the current quarter from $0.09 per share in the second fiscal quarter.

With that, I would now like to open the call up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Paul Thomas - Roth Capital.

Paul Thomas – Roth Capital

You gave us some color on Penthouse and how that’s going right now. Any update on private?

Ken Boenish

As far as our private distribution goes, earlier in the fiscal year we created a brand new VOD product called Foreign Erotique, and we’ve to-date gained quite a bit of incremental distribution as a result of launching that product. I think we’re up over 8 million new VOD households taking that new product.

Paul Thomas – Roth Capital

Any update on the dividend policy at this point for next year?

Michael Weiner

What I can tell you is that our board of directors’ policy has been to pay a dividend on a quarterly basis. This remains the policy of the board. The board, of course, does have the right to modify that policy if, for example, financial conditions change or the board determines that alternative uses of the company’s capital would provide greater shareholder value.

Operator

Your next question comes from Aram Fuchs - Fertilemind Capital.

Aram Fuchs - Fertilemind Capital

I was wondering if you can talk about if you are searching for a CFO?

Michael Weiner

We continue to search, but have not yet made any decisions. In the meantime, we have a topnotch controller and we continue to work with Matt Pullam who was our original hire, on a consulting basis for oversight of our financials. Matt remains our Chief Accounting and Financial Officer and signs off on all our filings.

Aram Fuchs - Fertilemind Capital

To give a little context, I’m trying to figure out if your value-add to the MSOs and DBS players is changing. It seems for quite some time you were a nice alternative to Playboy, but now with their channel capacity and bandwidth expanding there can be other players. Do you agree with that assessment? If you do, how do you react in such an environment?

Ken Boenish

I’ll take that question. It’s true that we have seen a capacity increase, especially on the VOD side of the business. But I think it’s important to note the performance track record of our company in both the VOD and the pay-per-view space. From a performance perspective, to give you an example, we occupy just 29% of the total server hours on the largest VOD platform in the U.S. while our product produces more than 40% of all the buy transactions. So we think there is really no clear indicator of our success, of our marketing monitoring, our research and our fast cycle programming change systems we put into place over the past two years.

Our value add today is really the performance of our product. Nobody on the video-on-demand platform today even comes close to the performance of the product that we place on these platforms.

Aram Fuchs - Fertilemind Capital

In the last six months, several sites on the web are emulating what YouTube has done with standard content in the adult world. Are they impacting you at all? What’s your strategy to either benefit or limit there?

Ken Boenish

We have seen a lot more free content being offered on the Internet. We believe that our value proposition is and continues to be the high quality video that’s available to a large screen, in the home, in the room of the subscribers choosing. Going forward, we intend on bringing not only our television content to consumers’ households, but also our Internet content right to the television as well.

Operator

Our next question comes from Eric Wold - Merriman Curhan.

Eric Wold - Merriman Curhan

Can you talk about over the next few years as you are becoming much more of a rounded media company as opposed to one focused exclusively on adult content, even though adult content would still be a big part of your company , what could New Frontier Media look like in the next three years in terms of the mix between adult and non-adult either via launches internally, acquisitions or something of that nature?

Michael Weiner

First, we do expect to resume a growth trend in our core transactional business. We’re adding channels, improving our performance on existing channels, and improving our brand portfolio all at the same time.

Second, we are investing more resources into our MRG unit. MRG has shown the ability, as far as we’re concerned, to exploit a profitable mid-market niche of the mainstream film business and we’re investing in that growth.

Third, we’ve been working to reverse the trend in IP, which has been sloping down for several years and we’re cautiously optimistic that we have accomplished this. Further, we’re developing newer IP concepts which we hope to tell you more about in the coming months.

Finally, a strong balance sheet puts us in an excellent position to exploit acquisitions on an opportunistic basis and we continue to keep our eye open for opportunities where we can leverage our existing infrastructure and strong industry relationships.

So I’d say core business, MRG, new IP concepts, and opportunistic acquisitions. I think bottom line, people know that we know how to execute and we’ve proven it for years and we’re expecting a lot out of this company in the next fiscal year.

Eric Wold - Merriman Curhan

Just one follow-up on the expansion into the infrastructure in more different areas. If you were to go into non-adult areas, is that something you think you could do internally or would that pretty much have to be done through acquisitions?

Michael Weiner

Well, a lot of it can be done through both, but a lot of it is going to be done through MRG.

Operator

Our next question comes from David Vorr - Montgomery Street Research.

David Vorr - Montgomery Street Research

Could you maybe compare and contrast perhaps adult theme growth rates versus more traditional non-adult growth rates looking forward for the next year or two?

Ken Boenish

As Michael said, we really expect to resume our growth rate on the core content side of the business which is the adult entertainment side of the business. We expect to see that through the addition of new pay-per-view channels and new VOD products, primarily led by the Penthouse brand which we expect very big things out of.

Now, I think on the non-adult side of the business from a growth rate perspective, chances are that might become a little bit more substantial because we’re starting from probably a lower starting point. I think the point is that the business is really hitting on all cylinders. We’ve got great resources in terms of the executive experience, the management that we’ve got in place and certainly the infrastructure that we’ve got in place to deliver content to platforms in the U.S., outside of the U.S., television platforms, online platforms, and we intend on fully using the infrastructure that we’ve built.

Operator

Mr. Williams, there are no further questions at this time.

Grant Williams

Thank you everybody for joining the call.

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