New Frontier Media, Inc., F4Q08 (Qtr End 4/30/08) Earnings Call Transcript

New Frontier Media, Inc. (NOOF)

F4Q08 Earnings Call

June 3, 2008, 11:00 am ET

Executives

Michael Weiner – Chief Executive Officer

Ken Boenish – President

Ira Bahr – Chief Operating Officer

Grant Williams – Chief Financial Officer

Analysts

Richard Ingrassia – Roth Capital Partners

Eric Wold – Merriman Curhan Ford & Co.

Presentation

Operator

Good morning, ladies and gentlemen. Thank you for standing by and welcome to the fourth quarter 2008 earnings release conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions).

This conference is being recorded today, June 3^rd, 2008.

I would now like to turn the conference over to Grant Williams, CFO. Please go ahead, Sir.

Grant Williams

Good morning and welcome to the New Frontier Media fiscal 2008 fourth quarter results conference call. With me 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.

For the call this morning Michael will begin with summary remarks on the fourth quarter results and discuss some key initiatives. After Michael’s comments I’ll spend some time discussing the fourth quarter financial results and other financial related information. We will then open up the conference call for questions.

A replay of this conference call will be available until June 10^th at 1-800-405-2236 using the pass code 11115064#. This call will be archived for 12 months on our website at noof.com under investor relations webcast 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 E-mail to [e-mail].

During this call we may make references to certain non-GAAP measures. This information, including 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 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 cautionary statements included in our press release and our most recent reports containing risk factors filed with the securities and exchange commission, including our most recently filed Form 10Q and Form 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

Thank you, Grant, and good morning, everyone. This morning we are reporting a solid fourth fiscal quarter with increased net income and EPS versus last year’s fourth quarter.

Excluding our discontinued C-band business, our core transactional TV segment was up both year-over-year and on a consecutive quarter basis. In some, New Frontier continues to execute well in an increasingly competitive market.

Over the past four months we have added some 12 million network households to our Penthouse TV-VOD distribution bringing the VOD footprint for this brand to over 23 million households. As we expected, much of this distribution has been incremental, meaning we are seeing added shell space as a direct result of the strength of the Penthouse brand. Incremental shell space means incremental revenue for New Frontier. During our coming fiscal year we expect to roll out the Penthouse TV-VOD product to an additional 7 million households.

Simultaneously, we have also launched our Penthouse high definition VOD product to a total of 17 million households. We believe this is the most extensive launch of any adult high definition VOD product to date. Over the next year we are expecting another 8 million homes to be added to this total.

We think it is possible that the high definition product, which is offered at the same price as standard definition, may have a materially positive effect on the overall health of the televised adult transactional segment which has been under pressure for roughly the past two years.

On the Pay-Per-View side we have successfully transitioned all carriage of the TEN brand to the Penthouse TV channel, which makes Penthouse TV available to more than 34 million homes. Further, we expect that by the end of this calendar year at least one major cable operator carrying this linear channel will launch a subscription service to Penthouse in which for one price viewers will get the Penthouse TV channel in addition to having unlimited access to 50 hours of Penthouse on-demand content. We are optimistic that this Penthouse subscription product, which creates an entirely new value proposition in our marketplace, will if properly promoted be an important component in increasing our value proposition on TV and assist us in fending off the threat of low-price and free content available through the Internet.

We’ve also made some good progress on the roll out of our products in international markets. Specifically, we have now concluded distribution deals with five MSOs in Canada, including the two largest cable operators, we’ve completed a deal with the largest land line phone company in Germany for their IPTV platform, and we are active in negotiations for distribution in the UK and France. Finally, within the next 60 days we expect launches from the top three cable TV operators in Mexico. Overall, we expect that international business may comprise up to 10% of overall transactional TV revenues for the next fiscal year.

In the United Kingdom we’ve begun deploying infrastructure for a direct to consumer set-top box test which will allow New Frontier to deliver its content directly to viewers’ television via IP. Through a well-timed and well-priced acquisition, the company now owns all intellectual property connected with an IP set-top box that is fully operational and has undergone extensive in-field functional testing.

We have chosen the UK because in that country there is currently no explicit adult content available on broadcast cable or satellite TV as these products are prohibited by statute from appearing on those platforms. This along with research we have evaluated suggests a strong market opportunity for our services. A service which will be marketed as Juice TV uses the Internet to deliver its content to televisions via proprietary set-top box. Juice TV will employ a vast library of content New Frontier already has under licence. Much of this material was licensed with the kind of application in mind, so our cost of content for this project is near zero.

Additionally, because Juice TV is an Internet product we have the ability to add a wide range of services beyond our core adult product. If successful, we expect over time to be able to deliver main stream entertainment, as well as other applications such as on-line gaming, which is widely accepted in that country. We expect to have initial market testing completed by the end of this calendar year.

We are optimistic that growth in our international business, as well as our set-top box initiative, will work to augment the somewhat slower growth rates we expect in our domestic markets.

Now turning to MOG. This business was slower in the fourth quarter than we expected and we experienced a year-over-year decline. Much of this decline is connected with weaker than expected sales of the company’s own content. One dynamic which is impacting this business is that some domestic pay-per-view distributors have been moving the location of the MOG content to a part of the program guide that is nearer to the more explicit content. Formerly, this content had been placed in the more mainstream part of the EPG, which gets a larger volume of traffic. As a result of these changes we believe that mainstream movie buyers are no longer exposed to these titles. However, we have been successful in capturing new VOD slots for the MOG content where we hope to see the results of those efforts over the coming year.

Our repped title business, like the entertainment, continues to grow in stature. We expect that incremental revenue and profits will soon follow. We’ve got a number of deals for the distribution of movies with well-known talent and pedigree production credentials, and we’ve also been able to attain domestic rights for some of these films which allow us to put the movies into our cable and DVS distribution channels.

It is important for shareholders to understand that with respect to this element of our business, that is the repped title business, we are not in the value chain as financiers or equity owners of the films we are involved in. Our role is to use our well-established international sales and marketing network to create broad and profitable returns for the owners of these films. Our revenue comes in the form of marketing fees and sales commissions. This creates predictable revenue streams with little or no risk capital.

In conclusion, our company continues to generate solid cash flows and I believe we have a real opportunity to create even greater value. We are optimistic about the prospects inherent in the growth initiatives that we’ve described in this call.

In addition, we do believe that our shares are currently undervalued by the market. Therefore, after having returned some $26 million to shareholders over the past 18 months our board of directors has elected to suspend the company’s quarterly dividends and simultaneously extend the company’s stock buy-back program for an additional two years. In our view, the application of funds to the repurchase of our shares will provide greater value to our shareholders than the continuation of the company’s dividend.

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

Grant Williams

Thank you, Michael. I’ll begin today’s financial review with a summary of the fourth quarter results and provide some information on the more significant changes in the year-over-year results. After that I’d like to spend some time discussing the in-depth results of each of our operating segments and items that might be less obvious from the earnings release. I’ll wrap up the financial review with a brief discussion of our liquidity position and conclude with some comments on directional expectations.

Our consolidated revenue was $12.6 million during the current quarter and declined from $14.2 million in the prior year quarter primarily due to the impact of our discontinuation of the C-band services and a decline in the film production segment’s own content revenue.

Cost of sales declined to $3.6 million from $4.4 million in the same prior quarter, and this decline also reflects the impact of discontinuing the C-band services as well as lower film amortization and transporting costs.

The consolidated gross margin for the company improved to 72% of revenue for the current quarter as compared to 69% in the prior year quarter.

Operating expenses declined during the fourth quarter to $6.1 million from $6.8 million in the prior year quarter, primarily from a decline in external legal costs and lower year-end bonus accruals.

The effective tax rate for the quarter was 37% as compared to 46% in the prior year quarter because the prior year tax provision included additional charges to adjust tax reserves. Our net income in the fourth quarter of fiscal year 2008 increased to $1.9 million or $0.08 per share as compared to $1.7 million or $0.07 per share in the same prior year quarter.

Now that we’ve provided some information on our consolidated results I’d like to provide some additional detail on the operating results of our segments.

Our transactional TV segment revenue declined as compared to the prior year quarter as a result of the previously mentioned discontinuation of the C-band service. However, we were happy to see that this segment’s core revenue has stabilized. When comparing the current quarter results to the prior sequential quarter ended December 31^st, 2007, the video-on-demand revenue has returned to a growth trend and increased approximately 20%. The growth was fuelled by a continuation of our improved performance on the country’s largest VOD platform.

Pay-per-view revenue was flat as compared to the prior sequential quarter ended December 31^st, 2007, and we have now lacked the impact of the renegotiation of our contract with the second largest EDS platform in the US.

The transactional TV segment cost of sales and operating expenses remain consistent with the prior sequential quarter and the segment profit improved to $6 million as compared to $5.1 million in the sequential quarter ended December 31^st, 2007.

As we’ve discussed on previous earnings calls, the film production segment historically has an unusually strong third fiscal quarter, so comparison of this segment’s current results for the quarter ended December 31^st, 2007, is not considered meaningful. When we compare this segment’s current quarter results with the prior year quarter ended March 31^st, 2007, revenue declined $1.4 million as compared to $2.5 million in the same prior year quarter. This decline was due to the execution and delivery of fewer home content deals during the current quarter and from a decline in revenue from the largest DVS provider in the US and a pay-per-view advocator. These declines were partially offset by an increase in video-on-demand.

Cost of sales for the segment also declined as a result of lower film amortization costs, which typically fluctuate consistent with the changes in the owned content revenue.

The film production segment operating expenses were in line with the prior year quarter and this segment had an operating loss in the current quarter at $0.3 million as compared to an operating income in the same prior year quarter of $0.3 million.

Moving to the direct consumer segment, which we formerly referred to as the Internet segment. Operating results were relatively flat as compared to the same prior year quarter. Revenue and cost of sales for this segment were also consistent as compared to the prior sequential quarter ended December 31^st, 2007, and operating expenses within this segment have increased as compared to the prior sequential quarter as a result of additional costs incurred in connection with the test IPTV business model that we are developing.

Our corporate administration costs declined to $2.5 million during the current quarter as compared to $2.9 million in the prior year quarter as a result of the previously mentioned decline in outside legal costs and year-end bonus accruals. Sequential results for the core admin operations were flat.

The company balance sheet on liquidity position continues to be solid. We generated $8.2 million of operating cash flows during fiscal year 2008. Included in these results were cash outflows associated with our production of a second 13-episode series within the film production segment and of significant producer advance for a high-quality repped movie.

Also, although we’ve collected a large portion of the outstanding customer receivables associated with the strong performance of the film production segment during the third quarter of fiscal 2008, approximately $1 million of these outstanding receivables were not collected until after the end of the fiscal year in April of 2008.

Our investing activities have generated $5.3 million of cash during fiscal year 2008. Approximately $8.4 million of cash was generated from net redemptions of investments during the year.

We used approximately $2.1 million for capital expenditures primarily related to purchases of equipment and approximately $0.4 million for intangible assets primarily related to the IPTV set-top box.

We have used $12.5 million of cash for financing activities during the year, including $9 million to pay quarterly dividends and $3.9 million to repurchase approximately 621,000 shares of our common stock at an average purchase price of approximately $6.24 per share.

At March 31^st, 2008, our cash to market securities balanced with $19.3 million.

Now that we’ve walked through the fourth quarter results I’d like to spend some time discussing areas of focus for fiscal year 2009 and how they are expected to impact our financial results.

Before I begin I would like to remind everyone that we do not give specific guidance forecast amounts in accordance with the corporate policy that was set by our board of directors. In the absence of this specific information we did want to provide some directional information and areas of focus for fiscal year 2009. Please keep in mind that many of the items that I’ll discuss are not expected to be immediately material to the company’s operating results but will be areas of focus as we move through the next several years of operations.

To begin with revenue, we expect to experience some growth in fiscal year 2009 in our core transactional TV segment from additional shelf space on domestic platforms related to our Penthouse TV brand content. We also expect to increase this segment’s revenue by expanding into international markets including South America, Europe, and Canada.

We will also work to improve revenue within our own production segment and will specifically focus on growing the main stream repped content revenue. We expect to expand those revenues by executing sale agency arrangements with high-quality film producers and by partnering with large distributors that can deliver our content to their existing DVD retail customers.

In addition, we will begin placing mainstream Hollywood movies on domestic VOD platforms.

The film production segment also continues to pursue opportunities to execute and produce a higher videos in fiscal year 2009, but we cannot predict if or when such a deal might be completed.

Within our direct consumer segment we expect to improve this segment’s revenues through the exploitation of our redesigned and updated consumer website. Additionally, the direct consumer segment will be testing an IPTV set-top box technology a year. We are optimistic that this test will be successful and will begin to contribute revenue during the latter half of fiscal year 2009.

Our cost of sales and operating expenses are expected to increase during fiscal year 2009 in connection with these growth initiatives. We will invest selectively in these initiatives, but additional investments by the company will be necessary to support our efforts to grow the business.

Also, we expect to incur additional capital expenditures in fiscal year 2009 to build out an infrastructure to support these growth initiatives. Although we will be investing prudently in opportunities to expand the business in 2009 we currently expect to generate positive cash flow from operations where we expect these cash flows will be lower than the fiscal year 2008 results. The impact of declining cash flows from operations will be a function of the pace at which we fund new growth initiatives in fiscal year 2009 and the timing of the future returns that we’ll see from those initiatives.

So to summarize the fiscal year 2009 outlook, the company will be focusing its efforts on growing the top line. This will result in additional upfront costs that will be necessary to drive the company in the high growth markets.

With that being said I’d now like to open up the call for questions.

Question-and-Answer Session

Operator

Thank you, Sir. We will now begin the question and answer session. (Operator Instructions). Our first question is from Rich Ingrassia with Roth Capital Partners. Please go ahead.

Richard Ingrassia – Roth Capital Partners

Thanks. Morning, everybody. Michael, I know you announced the extension of the time frame on the buy-back, but are you also extending the size of the buy-back using some of the cash earmarked last year for the dividend?

Michael Weiner

Yes. The original buy-back which was authorized was 2 million shares. We’ve bought back approximately 800,000 shares. We have about 1.2 million shares to buy under the existing plan. So if we want to extend, if we want to increase the plan I need to go back to the board. But right now we have 1.2 million on the existing plan, which has been extended.

Richard Ingrassia – Roth Capital Partners

Okay. And has the new series to HBO at Cinemax been delivered this quarter and what’s the timing this year, if you can share it, on the direct-to-video projects for Columbia?

Grant Williams

Rich, this is Grant. The second 13-series episode has not yet been delivered. We were wrapping up the production of that during the current quarter and we’re working to deliver that in one of the next two quarters. So I think that addresses this item. As far as I think your second question related to the producer-for-hire deals, I think we mentioned we haven’t currently executed a deal for fiscal year 2009 but we continue to pursue those opportunities as we move through the year.

Richard Ingrassia – Roth Capital Partners

Okay. Grant, can you share a capex number, a number for the increased capex for fiscal 2009?

Grant Williams

You know, unfortunately, Rich, we can’t give specific guidance around our forecast amounts, but to the extent that that number continues to increase it’s probably going to be good news for the company because it’s going to mean some of these growth initiatives have been successful for us.

Richard Ingrassia – Roth Capital Partners

Okay. While I’ve got you, Grant, can you say something about the sequential increases in accounts payable in the quarter?

Grant Williams

Yeah, that increase hasn’t related to any specific transaction or item. It’s just primarily related to the company paying its vendor slower as part of its efforts to manage its cash efficiently.

Richard Ingrassia – Roth Capital Partners

Okay. Last question I guess for Michael. Playboy is creating an ad supported on-line video network. What’s your assessment of that type of opportunity in general?

Ira Bahr

Hi. It’s Ira. I’ll take that call. We think that the Internet, particularly for adult oriented content, is becoming a more and more difficult place. You’re probably aware of all the sites that simply pervade us for free. I think probably you’re discussing an initiative, though I’m not familiar with it, in which the idea would be the content would be available for free and there’s an attempt to monetize that with advertising. The advertising market has been fine. Google’s been up and down, but for the most part people think that Internet advertising, whether it be pay-per-click or image oriented, is going to make some sense.

So I think that if you are able to build the traffic counts and get usage that is of demographics of interest to advertisers I think there could be some opportunity there. As it happens, we are exploring opportunities in which we are advertiser based for some of our content.

Richard Ingrassia – Roth Capital Partners

Okay.

Michael Weiner

Rich, this is Michael. Just to go back to the stock buy-back. As Grant pointed out, we bought back about 800,000 shares at an average of $6.24, so where the stock is right now we think it’s way under value. So I think (inaudible).

Richard Ingrassia – Roth Capital Partners

And the additional buy-back is going to ensue here immediately?

Michael Weiner

I don’t think I can answer that. At these stock prices I guess you can read between the lines.

Richard Ingrassia – Roth Capital Partners

Okay. Thanks.

Operator

Thank you. Our next question is from Eric Wold with Merriman Curhan Ford. Please go ahead.

Eric Wold – Merriman Curhan Ford & Co.

Thanks. Good morning. I just wanted to follow up on the buy-back dividend suspension question that Rich asked. In your comments, Michael, at the beginning you mentioned that the reason for the suspension of the dividend was because you think it’s a better opportunity to buy-back stock with that cash flow. In the press release it states that the reason suspended dividend was to take advantage of the new high-growth market opportunities that are coming at you. Which is the bigger driver of the suspended dividend, and if you start buying back stock now with that excess cash are you guys inclined to leverage up with debt to make these acquisition opportunities or the opportunities that come about, or would the buy-back using up the cash kind of hamper your efforts in that regard?

Grant Williams

This is Grant. I would say as far as your first question, it’s really a combination of those items. I think the company has seen an influx of opportunities, as we mentioned, with some of these growth item that we specifically mentioned that we’re working towards. Which are going to cause us to use some of our capital funds to push those forward? Then in addition to that we also in light of the fact that we think the stock is undervalued also extended that stock repurchase program. So we really are considering all of these factors as far as the ultimate decision regarding the discontinuation of the dividend payout.

Michael Weiner

I guess, Eric, if you’re asking if the stock buy-out is going to impact the other things that we do, the answer is no, and vice versa.

Eric Wold – Merriman Curhan Ford & Co.

And then following on that, Michael, what are your thoughts on leveraging up? Are you guys against taking on some debt to defer to the growth and, if so, what are your limitations? What are those where the leverage ratio is you think are the max that you’d want to go if you do lever up?

Michael Weiner

Well, we currently have a $7.5 million line and we’re working on increasing that. I don’t know what the debt markets are out there, but at these prices it certainly would be accretive if we were able to get the right transaction done on the debt side.

Eric Wold – Merriman Curhan Ford & Co.

Okay. And I know you guys can’t comment, but you gave some parts and it sounds like you’re expecting your revenue to grow, your cash flows to be lower in fiscal 2009 than in 2008. Would the spending or the increases spending you expect to fall in the first half of the year to kind of grow revenue in the back half of the year. Is it going to be enough to grow the bottom or (inaudible) likely to be weaker in 2009 than 2008.

Michael Weiner

Well, you know, Eric, unfortunately I can’t specifically speak to that. The best we can do is give this directional type of guidance associated with what we’re expecting to occur next year.

Eric Wold – Merriman Curhan Ford & Co.

Is it directionally down then or is it directionally up?

Michael Weiner

Well, we’re not going to give that information because it could be interpreted as guidance. We’re definitely going to be focusing on growing top line and in connection with that we’re going to incur additional costs. But we can’t give guidance and the thought process on giving some more directional information was really to try to provide investors with some information on the strategy of executive management going forward.

Eric Wold – Merriman Curhan Ford & Co.

I understand. Okay. Thank you, guys.

Operator

Thank you, Sir. (Operator Instructions).

Michael Weiner

Thank you, all. There are no more questions. We’ll look forward to the next conference call. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes the fourth quarter fiscal 2008 earnings release conference call. Thank you for your participation. You may now disconnect.

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