New Frontier Media F2Q07 (Qtr End 9/30/06) Earnings Call Transcript

| About: New Frontier (NOOF)
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New Frontier Media, Inc. (NASDAQ:NOOF)

F2Q07 Earnings Call

November 07, 2006 11:00 am ET

Executives

Karyn Miller - Principal Accounting Officer, Treasurer and Chief Financial Officer

Michael Weiner - Chairman of the Board and Chief Executive Officer

Ken Boenish - President

Analysts

Richard Ingrassia - Roth Capital Partners

Eric Wold - Merriman Curhan Ford

Jason Williams - Botti Brown Asset Management

Stuart Quan - Zander

Operator

Good morning, ladies and gentlemen, and welcome to New Frontier Media's Second Quarter Fiscal 2007 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. [Operator Instructions]. As a reminder, this call is being recorded today, Tuesday, November 7th 2006.

I would now like to turn the conference over to your host, Ms. Karyn Miller, Chief Financial Officer of New Frontier Media. Please go ahead, madam.

Karyn Miller

Thank you. Good morning and welcome to the New Frontier Media fiscal 2007 second 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.

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 November 14th, at 800-405-2236, using the pass-code 11074975. 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 questions via email to "hpatton@noof.com."

During this call, we may make references to non-GAAP measures. This information, including a reconciliation to the related GAAP measures, 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 conference 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, its financing plans, and the outcome of any contingencies are forward-looking statements.

In addition, forward-looking statements may be 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 Exchange Commission, including the Company's Form 10-K, in the "Risk Factors" section, and Form 10-Q.

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

Michael Weiner

Thank you, Karyn, and good morning everyone. This morning, we are reporting another solid quarter in which our core business showed impressive results.

The most important news over the last three months was the completion of our contract with EchoStar. For most of the past year, these ongoing negotiations have been an overhang on the Company, a concern to investors, and a time-consuming project for management.

The closure of this issue, with continuing carriage of all three of our networks on this platform, is good news for New Frontier. The negotiations concluded very much where we had expected them to and are consistent with our full-year revenue and EPS guidance.

In September, we announced the most significant content deal in our history, when we completed an exclusive agreement with Digital Playground. Digital Playground, a company that has never done a broadcast deal, is a perfect fit for New Frontier.

Its movies feature some of the most beautiful and exciting women in the world in a style very consistent with our networks. This content will hit our air in January, supported by significant on-network promotions.

Also this quarter, we facilitated an important development in the integration of our MRG unit with Colorado Satellite Broadcasting unit. Specifically, we have successfully sold in a portfolio of MRG content to the largest cable MSO in the country. As of last week, this content is now online, in distribution, and earning revenues for the Company.

We anticipate that this content will be carried business operators serving the majority of VOD households in the United States. We have not yet included the revenue stream in our guidance, as it is a completely new product line for the Company, and we'd like to see some initial buy rate data prior to creating a forecast.

Our management team has leveraged their excellent relationships with cable executives to facilitate the speedy rollout, and I am very pleased that the Company has achieved these synergies within six months of having consummated the MRG transaction.

Playboy's recent network shakeup is also good news for the Company, as it hastened operator rollout of our own networks. We believe the Company may gain as many as 5 million new linear households on the platform operated by the country's largest MSO over the next six months.

Finally, in the second quarter, we executed on our stock buyback program with a successful market purchase of 250,000 shares. And now, Karyn will take you through the quarter. And then we'll be happy to take your questions.

Karyn Miller

Thank you, Michael.

Starting with an overview of the Company. On a consolidated basis, net revenue for the Company was $16.2 million for the current year quarter compared to $11.3 million for the quarter a year ago, representing an increase of 43%.

Gross margin percentage for the Company was 68% for both the current year and prior year quarters. And operating expenses were 33% of revenue for the quarter ended September 30th 2006 as compared to 34% for the quarter a year ago.

The Company reported net income of $3.7 million, or $0.15 per fully diluted share, as compared to net income of $2.6 million, or $0.11 per fully diluted share, for the second quarter last year.

The Company reported EBITDA for the second quarter of the current year of $6.1 million as compared to $4.2 million for the quarter a year ago, representing an increase of 45%. A reconciliation of EBITDA to our GAAP numbers is included in our press release on our website.

The Company has approximately $31.9 million in cash and marketable securities on its balance sheet as of the end of our second quarter. The Company also has approximately 23.6 million shares outstanding as of today. And as Michael mentioned, we did begin to execute on our stock buyback during the current quarter, buying back 250,000 shares at an average share price of $8.64 a share.

Moving on to look at the Pay Television results. Quarterly revenue for the Pay TV group increased to $12.2 million for the quarter ending September 30th 2006 from $10.7 million for the quarter a year ago, representing a 14% increase.

Our Pay TV revenue is comprised of both revenue from sales to our C-Band customers and revenue from our core business of distributing our pay-per-view networks and VOD offerings via our relationships with our cable DBS and hotel partners.

The group's quarterly C-Band revenue decreased 29%, to $0.5 million for the current year quarter from $0.7 million for the second 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 100,000 total active units.

The group's cable and DBS pay-per-view revenue increased 25%, to $7.5 million for the current year quarter from $6 million for the quarter a year ago. This increase is primarily the result of the launch of two of our services on the largest DBS platform in the US, which occurred in April of this year.

The Pay TV group's VOD revenue increased 5% to $4.2 million in the second quarter of the current fiscal year from $4 million for the quarter a year ago. Currently we provide VOD content to over $23 million VOD-enabled cable customers and 800,000 hotel rooms in the US.

Our VOD revenue increased due to launching our content on new cable systems and the transitions certain MSOs were making and changing the editing standard of the VOD content to partially edited.

In addition, we experienced an increase in VOD revenue as we were able to successfully regain some of our market share since the initial launch of our largest competitor on one of our major customer's VOD platform which occurred over a year ago.

Cost of sales for the Pay TV group decreased 15% to $2.8 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, a decrease in cable transponder costs due to the negotiation of a reduced rate, and a decrease in depreciation and operating lease costs.

Quarterly operating income for the Pay TV group increased 34% to $7.5 million for the current year quarter from $5.6 million a year ago. Operating expenses increased slightly to $1.9 million for the current year quarter from $1.8 million for the quarter a year ago. This increase was a result of expensing our stock options, as required under FAS 123(NYSE:R), and an increase in promotional costs.

Now, moving on to the Internet group. The Internet group's revenue was flat at $0.6 million for both quarters ending September 30, 2006 and 2005. Cost of sales increased to $0.3 million from $0.2 million a year ago, and operating income is breakeven for the current year quarter, compared to $0.1 million for the year ago quarter. Increase in cost of sales was related to additional content costs incurred in providing our content to wireless platforms.

Now, moving on to our Film Production group. The Film Production group's revenue is comprised of two segments: our repped title revenue and our owned title revenue. Revenue earned from our repped title 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 60 mainstream titles that we represent through our Mainline Releasing and Lightening Entertainment labels. Revenue from our owned titles is earned as we license our own erotic film library on either a flat fee or revenue share basis.

The Film Production group earned $0.3 million in repped title revenue and $3 million in owned title revenue during the current year quarter. Our quarterly owned title revenue is impacted by the delivery of the remaining four episode of a 13-episode series to one of that group's major customers, the delivery of 10 titles to three of the group's major customers, and the distribution of several new events to cable and DBS platforms.

Cost of sales for the Film Production group was $2.1 million for the current year quarter. Cost of sales relates primarily to owned titles and consists of film amortization costs, as well as delivery and distribution costs.

Film amortization represents approximately 88% of our total cost of sales. As we continue to amortize the content that we purchased as part of the acquisition, as well as released newly produced titles, we expect our profit margins in this business to increase.

Operating expenses for the film production group are $1.1 million, and this group has operating income of $0.1 million for the second quarter. Operating expenses include amortization of identifiable and tangibles resulting from the acquisition, as well as the accrualty earnout related to the acquisition, and other payroll benefit and tradeshow-related costs.

Looking at the business from a cash flow perspective, that business, on an adjusted EBITDA, as we computed in our press release, the Film Production group's contribution to that was $2.7 million for the six months ended September 30, 2006.

Looking at our corporate overhead -- excuse me -- corporate administration operating expenses increased 24% to $2.1 million for the current year quarter from $1.7 million for the quarter a year ago.

This increase is related to stock option expense from the adoption of FAS 123(R), and increase in costs related to the addition of a marketing and corporate strategy department, which was added in January of this year, and an increase in insurance costs for DNO and key man life insurance.

And now, I would like to open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions].

Our first question is from Richard Ingrassia with Roth Capital Partners. Please go ahead.

Richard Ingrassia - Roth Capital Partners

Thanks. Good morning everybody.

Karyn Miller

Hi, Richard.

Richard Ingrassia - Roth Capital Partners

I have three questions, if that's okay. It looks like your marketing expenses might have been flat to lower sequentially, and there was a time when you thought you might need to ramp the spend there due to competition. We all know Playboy is reeling here, but there are still a number of smaller players looking to compete. Should we still expect a higher spend over the long-term, apart from the Digital Playground promotions here in the near-term?

Ken Boenish

Rich, this is Ken. Yes, we are going to be ramping up some of our marketing efforts on supporting both of our pay-per-view services and our VOD services. So as we've attained critical mass in terms of distribution, we're really competing on these platforms based on the performance of our individual services and our VOD content. And we feel that it's very, very important to reinforce the benefits of the consumer experience as it relates to our product. And we are going to be rolling out some marketing campaigns in the future.

Richard Ingrassia - Roth Capital Partners

Okay. Thanks, Ken. And on MRG, in June the operating margin spiked, and then September obvious depressed here, and it's explained well in the PR, but I would expect this business to run normalized at something north of 40% operating margin. Is that still in the right ballpark for the second half of the fiscal year, or do you expect the amortization to still weigh on it?

Karyn Miller

I think the amortization will weigh on the margins for the rest of this fiscal year. But obviously, we are starting to release some content that MRG was in the process of developing and has developed since we've acquired them. So again, I think the profit margins will start to grow probably more likely into next year as we start to monetize that new content.

Richard Ingrassia - Roth Capital Partners

Okay. Is my expectation too high there, though, for the long-term, that 40 to 45%, or would you not want to say?

Operator

Sir, I'm going to take you out of queue, because you're giving some feedback into the call.

[Operator Instructions].

Thank you. Please go ahead, madam.

Karyn Miller

Rich, are you still there? Well, Rich, I'll answer your question. I think though is that that margin is probably pretty good. But again, it's more of a long-term margin. I don't think it's something we'll see during this fiscal year.

Operator

Thank you. [Operator Instructions].

Our next question is from Eric Wold with Merriman Curhan Ford. Please go ahead, sir.

Eric Wold - Merriman Curhan Ford

Hey. Good morning, guys. Was there anything specific in the sequential drop of VOD revenues from Q1 to Q2 or is that just kind of seasonality?

Karyn Miller

The drop is actually related to the fact that Adelphia's systems were distributed to Time Warner and Comcast during this period of time. And we had a different split with those MSOs than we had with Adelphia.

Eric Wold - Merriman Curhan Ford

Okay. Then to the Q2 level is kind of the -- with the new -- what's in there for the entire quarter, so that's kind of the run rate?

Karyn Miller

It was there for most of the quarter.

Eric Wold - Merriman Curhan Ford

Okay. Do you have a sense of what we should look for content acquisition expenses or costs for this year, then any swag of how that may change next year?

Karyn Miller

We -- our content costs -- we expect our total -- well, I guess, there's two pieces of it, Eric. The content acquisition piece of it -- I think, we're estimating about a total of $4.3 million for the current year in total. Obviously, we spent tentatively on that in this particular quarter with the acquisition of the Digital Playground library. The content creation costs that we said with MRG, we're expecting to be no more than $3 million for this current fiscal year.

Eric Wold - Merriman Curhan Ford

Okay. So the 4.3 for this year, assuming no, you know, large acquisitions like Digital Playground next year -- is that likely to come down or is that a good run rate?

Michael Weiner

Michael. I think we can -- we don't believe it's going to be any higher. And the Digital Playground, you know, was a fairly expensive deal, although it was within our budget. So there is a chance that it will come down.

Eric Wold - Merriman Curhan Ford

Okay. And then, lastly, you know, not necessarily looking for anything specifically, but kind of going back to what you said in the press release from a few weeks ago. Any initial success or initial thoughts on convincing some of these networks to add more of your content and move more towards you, away from what Playboy is trying to do with their brands?

Ken Boenish

This is Ken. Yes. I think we mentioned -- or actually Michael mentioned that in his remarks. We are benefiting quite a bit from the shakeup over at Playboy, and they are dropping quite a few of the Spice-branded networks across-the-board. We've got quite a few operators that are accelerating their plans to add one or more of our services to their pay-per-view lineup.

Eric Wold - Merriman Curhan Ford

What's the earliest that we might see that benefit flow through?

Ken Boenish

I think you'll probably start to see some of that benefit, you know, next quarter. We've got launches happening right now.

Eric Wold - Merriman Curhan Ford

Okay. Perfect. Thanks, guys.

Operator

Thank you. Our next question is with Jason Williams with Botti Brown. Please go ahead.

Jason Williams - Botti Brown Asset Management

Yes. Thanks. I just had a quick question. Can you give what cash flow from operations was in the quarter as well as CapEx?

Karyn Miller

Yeah. The cash flow from the operations for the six months on the cash flow was about $10.8 million. And we've spent a little less than $600,000 on CapEx for the six months.

Jason Williams - Botti Brown Asset Management

Great. Thank you.

Operator

Thank you. Our next question is a follow-up question with Eric Wold. Please go ahead.

Eric Wold - Merriman Curhan Ford

That was quick. I just wanted to get a sense on what the large chunks -- just remind us, the large chunk of amortization that's flowing through MRG, when does that, for the most part, you know, if there is kind of a big step down, what quarter do we see that happen, should you lead to those charges?

Karyn Miller

Yes. Again, I don't think we'll see it this fiscal year, Eric. And it's going to depend on how we monetize that content and what period of time we monetize it over. As far as the content that we acquired, I guess I think as we start to introduce additional events and movies that MRG has had in the pipeline since we acquired them and continues to have in the pipeline that you'll see those margins, again the profit margin, increase. But I can't give you an exact deadline.

Eric Wold - Merriman Curhan Ford

Okay. But it was something kind of maybe mid-next fiscal year would be reasonable to think of that kind of coming down a little bit?

Karyn Miller

Yes. I mean, as an estimate, yes, but don't hold me to it.

Eric Wold - Merriman Curhan Ford

No, I won't. Okay. Prefect. Thanks, Karen.

Operator

Thank you. Our next question is with Stuart Quan with Zander. Please go ahead.

Stuart Quan - Zander

Hi. Good morning, guys. Can you clarify for MRG what is in the current guidance and what's not included?

Karyn Miller

I'm sorry -- for MRG?

Stuart Quan - Zander

Yes.

Karyn Miller

You know, we're not going to give that, Stuart. That kind of level of -- you're talking about as far as the new business that we have. I'm sorry.

Stuart Quan - Zander

Yes. I thought Michael had mentioned earlier in the call that some of the MRG new business was not included. So I just wanted to clarify what…

Karyn Miller

None of the new business that we have sold-in is contemplated in the guidance for this fiscal year.

Stuart Quan - Zander

Okay. So the only thing that's included is you took base business MRG as you acquired it.

Karyn Miller

Exactly.

Ken Boenish

Right, their historical business. MRG had not been in the business of package and selling their content to cable operators for delivery on VOD platforms. Since we do have excellent relationships with cable operators in that area and a lot of experience on VOD platforms, that's one of the first things that we saw that we could execute on to bring additional value to that acquisition. And so we've begun doing that, and we're experiencing quite a bit of success.

The content is just getting launched, and we've got no historical information regarding how this content is going to perform on VOD, although we do have fairly high hopes for the content. And we're confident that it will sell well and contribute to revenue. It's hard for us to estimate at this point what that revenue might be, again, because we've got no historical experience with the content. So we thought it might be better for us to wait and see what the initial buy rates look like, and then begin to do some projections from there.

Stuart Quan - Zander

Okay. And then in terms -- you mentioned earlier about increased marketing expense?

Ken Boenish

Yes, it's been our plan, and we've talked about it quite often that we are going to begin to market our pay-per-view services and our VOD content more heavily. We hired a very experienced marketing executive to come work at the company, Ira Bahr, who's got experience from his days at big advertising firms, such as BVDO. He's got experience in the multi-channel space, and Ira was -- yes, in fact, one of the gentlemen that helped start Sirius radio.

I think he was the number two executive at Sirius. And Ira's bringing his expertise to the company and helping us position our pay-per-view services and our VOD content competitively in the market to solicit customers to buy our services more often and come back to our services if, indeed, they enjoyed their experience.

Stuart Quan - Zander

And where is that going to show up to the potential customer? Is it just with…

Ken Boenish

That will show up in a number of places. It will show up in terms of cross-channel promotion, in-market promotion, on-air promotion with our channels. We're doing some interesting things in terms of creating movie previews for the first time for our content that we'll delivering to cable and satellite customers and movie trailers that will be attached to our VOD assets.

And so we've got a fairly broad-based approach. We're not buying billboards, and we're not buying ads in magazines, just most of our marketing efforts will be geared towards multi-channel customers on multi-channel platforms.

Stuart Quan - Zander

Okay. Great. Thank you.

Operator

Thank you. At this time, there are no further audio questions. Management, if there are any concluding remarks, please go ahead.

Michael Weiner

Okay. Thank you all for being on the call. We look forward to our next conference call. Thanks a lot.

Operator

Thank you. Ladies and gentlemen, this concludes the New Frontier Media second quarter fiscal 2007 earnings release. Once again, we wish to thank you for your participation. Have a great day.

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