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| NOOF > SEC Filings for NOOF > Form 10-K on 12-Jun-2009 | All Recent SEC Filings |
12-Jun-2009
Annual Report
INTRODUCTION
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide the readers of our accompanying consolidated financial statements with a narrative discussion about our business. The MD&A is provided as a supplement to the consolidated financial statements and accompanying notes and should be read in conjunction with those financial statements and accompanying notes. Our MD&A is organized as follows:
º •
º Forward-Looking Statements. Cautionary information about
forward-looking statements and a description of certain risks and
uncertainties that could cause actual results to differ materially
from our historical results or our current expectations or
projections.
º •
º Executive Overview. General description of our business and operating
segments as well as trends, challenges and growth objectives.
º •
º Critical Accounting Policies and Estimates. Discussion of accounting
policies that require critical judgments and estimates.
º •
º Results of Operations. Analysis of our consolidated results of
operations for the three years presented in our financial statements
for each of our operating segments: Transactional TV, Film Production,
Direct-to-Consumer, and Corporate Administration.
º •
º Liquidity and Capital Resources. Analysis of cash flows, sources and
uses of cash, contractual obligations, and financial position.
FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K includes forward-looking statements. These are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from such statements. The words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "plan," "may," "should," "could," "will," "would," "will be," "will continue," "will likely result," "are optimistic that," and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to, our ability to:
1) retain our four major customers that accounted for approximately 65% of our
total revenue during the fiscal year ended March 31, 2009; 2) maintain the
license fee structures currently in place with our customers; 3) compete
effectively with our current competitors and potential future competitors that
distribute adult content to U.S. and international cable multiple system
operators ("MSOs") and direct broadcast satellite ("DBS") providers; 4) retain
our key executives; 5) produce film content that is well received by our Film
Production segment's customers; 6) attract market support for our stock;
7) comply with future regulatory developments; and 8) successfully compete
against other forms of adult and non-adult entertainment such as adult oriented
internet sites and adult oriented premium channel content. The foregoing list of
factors is not exhaustive. For a more complete list of factors that may cause
results to differ materially from projections, please refer to the Risk Factors
section of this Form 10-K.
EXECUTIVE OVERVIEW
Overview
We are a leader in transactional television and the distribution of independent general motion picture entertainment. Our key customers are large cable and satellite operators in the United States. Our products are sold to these operators who then distribute them to retail customers via pay-per-view ("PPV") and video-on-demand ("VOD") technology. We earn revenue through contractual percentage splits of the retail price. Our three principal businesses are reflected in the Transactional TV, Film Production and Direct-to-Consumer operating segments. Our most profitable business line has historically been the Transactional TV segment. The Film Production segment has also historically been a profitable business but during fiscal year 2009 has operated at a loss as a result of continued adverse changes in its business climate. Our Direct-to-Consumer segment operated at a loss in fiscal year 2009 as a result of costs we incurred to develop a test internet protocol television ("IPTV") business model. Based on lower than expected subscriber additions for the IPTV test business model during the second half of fiscal year 2009, we have restructured the operations of the Direct-to-Consumer segment through a planned, material reduction in the resources dedicated to test business models. Our Corporate Administration segment includes all costs associated with the operation of the public holding company, New Frontier Media, Inc., including costs such as legal and accounting expenses, human resources and training, insurance, registration and filing fees with NASDAQ, executive employee costs and the SEC, investor relations, and printing costs associated with our public filings and shareholder communications.
The business models of each of our segments are summarized below.
Transactional TV Segment
Our Transactional TV segment is focused on the distribution of its PPV and VOD service to MSOs and DBS providers. We earn a percentage of revenue, or "split", from our content for each
VOD, PPV or subscription that is purchased on our customers' platform. Revenue growth occurs as we launch our services to new cable MSOs or DBS providers, experience growth in the number of digital subscribers for systems where our services are currently distributed, when we launch additional services or replace our competitors' services on existing customer cable and DBS platforms, and when our proportional buy rates improve relative to our competitors. Alternatively, our revenue could decline if we experience lower buy rates, if the revenue splits we receive from our customers decline, if additional competitive channels are added to our customers' platforms or if our existing customers remove our services from their platform.
For most of its history, the Transactional TV segment has been focused on growing its distribution of digital TV to markets in the U.S. During fiscal year 2009, we began expanding our services into new markets in North America, Europe and Latin America. We believed that our business model, which has been proven in the U.S., would also be successful internationally. International expansion also provides us with an opportunity to leverage our existing content libraries and technology infrastructure. Thus far, we have had success in expanding our distribution to international markets. We plan to continue to expand our footprint to new international locations and customers, and gain additional market share and shelf space in international markets where we currently distribute content. The VOD infrastructure in many of these international markets is relatively undeveloped, and we expect that the development of that infrastructure will continue to offer opportunities to improve our international revenue. The revenue splits we receive internationally are typically higher than the splits we receive domestically because the international cable MSO and DBS industry has more market participants and is more fragmented which provides us better negotiating leverage. We have not historically operated internationally or transacted with international regulators, competitors or cultures and as a result, we may experience operating difficulties while gaining experience with our international growth initiatives.
Transactional TV segment revenue during the current fiscal year as compared to the prior fiscal year experienced the following trends:
º •
º Revenue from our VOD service has increased due to improved content
performance and from a related increase in the quantity of content
available on the largest MSO platform in the U.S and the other top ten
largest cable MSOs in the U.S. Our improved content performance is
primarily related to new content packages and recommended changes to
our customers' menu positioning. Revenue also improved from new
international VOD distribution. The increase in revenue was partially
offset by a decline in revenue from the second largest cable MSO in
the U.S. because the operator increased the retail price of content
early in fiscal year 2009 and since the economic downturn, we believe
consumers are less willing to pay the higher retail price. Although
our year-over-year VOD revenue has improved, we have experienced a
decline in buy rates during the second half of the fiscal year as
compared to the first half of the fiscal year which we believe is due
to a general reduction in consumer spending from the weakening
economic conditions. The weaker economic conditions could continue to
cause our VOD service revenue to remain depressed or cause VOD revenue
to decline further.
º •
º Revenue from our PPV services declined due to a reduction in revenue
from the second largest DBS provider in the U.S. believed to be
attributable to an increase in the number of competitors on the
platform and the impact of the recent economic downturn and related
reduction in consumer spending. Also contributing to the decline was
lower revenue from the other top ten largest cable MSOs in the U.S.
related to the economic downturn. The revenue decline was partially
offset by an increase in revenue related to the addition of a new
channel on the largest DBS platform in the U.S. The impact from the
economic downturn could continue to cause our PPV service revenue to
remain depressed or cause the PPV revenue to decline further.
º •
º C-Band and other revenue declined because we ceased offering C-Band
services after the service became unprofitable during the second half
of fiscal year 2008. The revenue reflected in this product line now
primarily reflects advertising revenue we receive for spots sold on
our PPV channels.
º •
º Although our Transactional TV segment revenue increased in fiscal year
2009 as compared to the prior fiscal year, revenue has trended lower
in the second half of fiscal year 2009 as compared to the first half
of fiscal year 2009. We believe this is a result of the increasingly
difficult economic conditions and related reduction in consumer
spending. If the difficult economic conditions persist or worsen, our
Transactional TV segment results could also be materially adversely
impacted.
Generally, we believe our business has been and we expect will continue to be impacted by the downturn in the economy. For our Transactional TV segment, we are reliant on discretionary consumer purchases of our content. When consumers spend less of their discretionary income on non-essential expenses such as our content, it adversely impacts our business. Additionally, the price point of our content is significantly higher than both mainstream content and adult content that is distributed through other less expensive and free media such as the internet. As a result, consumers that would otherwise purchase our content may opt to purchase less expensive mainstream content or obtain their adult entertainment through less expensive media such as the internet during an economic downturn. Although we believe that the deterioration in the economy has negatively impacted the Transactional TV segment's results, it is not possible for us to quantify or reasonably estimate the financial impact. We have remained focused on maintaining our competitive market position by offering a wide range of high-quality content that we believe is superior to other product offerings in the industry. We are currently in discussions with many of our largest customers to seek ways to encourage increased viewing of our content and to implement value-added offers in order for our content to be more competitive with alternative media.
When considering the future operating results of the Transactional TV segment, we believe the following challenges and risks could adversely impact the segment's future operating results:
º •
º increased pressure from customers to reduce the revenue splits we
receive or execute minimum guarantees or risk having those customers
remove one or more channels from their platform;
º •
º declines in new and existing customer buys of adult TV services due to
a migration to other lower cost adult services such as the internet;
º •
º adverse impacts to our business from a continued decline in
discretionary consumer spending as a result of less favorable economic
conditions;
º •
º increased VOD competition from established adult entertainment
companies or new entrants to the category because the barriers of
entry for this product line are low;
º •
º challenges associated with our continued expansion into international
markets and our inexperience with international customers, buy rates,
and consumer habits;
º •
º slowing growth of the overall adult entertainment category and limited
incremental distribution opportunities within the U.S.; and
º •
º continued product commoditization.
In addition to the above noted risks, our agreements typically allow our customers to make significant changes to our distribution (such as reduce the number of hours on the platform or remove one or more channels from the platform) and may be terminated on relatively short notice without penalty. For example, our agreement with DirecTV may be terminated upon 30 days notice to us. We are currently negotiating with DirecTV for a longer term agreement, but because revenue targets were
not achieved under the current agreement it is possible that they may seek to remove one or more of our channels from their platform going forward. If this occurs or if one or more of our cable MSO or DBS operators changes our distribution terms, terminates or does not renew our agreements, or does not renew the agreements on terms as favorable as those of our current agreements, our financial position and results of operations could be materially adversely affected.
All the above mentioned challenges and risks, and others that we may not have identified, could have a material adverse impact on our business. Nevertheless, we believe that we are well positioned to mitigate the impact of these risks and challenges. However, not all the risks and challenges can be managed by us because the ultimate outcome will be decided by other parties such as our customers.
During fiscal year 2010 and future periods, we believe that the Transactional TV segment will experience revenue growth if we can successfully manage and are not materially adversely impacted by the challenges and risks previously mentioned. We currently expect future growth in the segment to occur if we are successful with the following objectives:
º •
º continuing our international distribution expansion into new and
existing geographic locations;
º •
º increasing the proportional VOD hours we receive on existing customer
platforms;
º •
º replacing our competitors' PPV channels with our channels on both
existing and new customer platforms;
º •
º transitioning cable MSO and DBS providers to less edited content
standards;
º •
º improving the value proposition for customers such as including
limited term internet access to our content for each PPV or VOD
purchase;
º •
º improving the VOD user interfaces; and
º •
º increasing the advertising revenue we receive from our PPV channels.
Film Production Segment
The Film Production segment has historically derived the majority of its revenue from two principal businesses: (1) the production and distribution of original motion pictures such as erotic thrillers, horror movies, and erotic, event styled content ("owned content"); and (2) the licensing of third party films in international and domestic markets where we act as a sales agent for the product ("repped content"). This segment also periodically provides contract film production services to certain major Hollywood studios ("producer-for-hire" arrangements). The film markets have been significantly impacted by the economic downturn and as a result, the Film Production segment's customers have been reducing their content budgets. These changes significantly impacted the Film Production segment operating results during the third quarter of fiscal year 2009. As a result, we made material revisions to the segment's internal forecasts and engaged a third party valuation firm to assist us in performing a goodwill and intangible asset impairment analysis. Based on the analysis, we determined that the goodwill associated with the Film Production segment was impaired. We recorded a $10.0 million goodwill impairment charge for the quarter ended December 31, 2008 associated with this analysis. We believe that it is reasonably possible that this segment will continue to experience pressure from the current unfavorable economic conditions which could cause the operating results to remain depressed or decline.
We generate revenue by licensing our owned content for a one-time fee to premium TV services and through domestic and international distributors. Additionally, we leveraged our existing customer relationships with our Transactional TV segment customers and license the Film Production segment owned content to domestic and international cable MSO and DBS providers through revenue split arrangements that are structured in a similar manner to our Transactional TV segment agreements.
The revenue splits we receive from cable MSO and DBS providers for the Film Production segment content is higher than the revenue split we receive for our Transactional TV segment content primarily due to the more mainstream nature of the content. However, the retail price for our mainstream content is lower than our Transactional TV segment content, and our per-buy revenue is often the same as our Transactional TV segment.
We also generate repped revenue through sales agency arrangements whereby we earn a sales commission and market fees by selling mainstream titles on behalf of film producers. The Film Production segment has several well established relationships with certain independent mainstream filmmakers and licenses the rights to these filmmakers' movies through its Lightning Entertainment Group. Although the revenue is not yet meaningful to the Film Production segment, we have recently begun distribution of repped content titles to domestic retail DVD markets through a distribution partner. We have also recently identified another opportunity to leverage our existing Transactional TV segment customer relationships and have begun VOD distribution of the mainstream repped content through several domestic cable MSOs. We are optimistic that the mainstream repped content retail DVD and VOD distribution revenue could become more meaningful in fiscal year 2010.
Our Film Production segment also infrequently acts as a producer-for-hire for major Hollywood studios. Through these arrangements, we provide services and incur costs associated with the film production. Once the film has been delivered to the customer, we earn a fee for our services. Although we maintain no ownership rights for the produced content, we are responsible for the management and oversight of the production. Although we did not generate revenue in fiscal year 2009 from a producer-for-hire arrangement, we continue to pursue these opportunities and transactions and expect to generate revenue in fiscal year 2010 from such an arrangement.
Our Film Production segment results experienced some seasonality prior to fiscal year 2009 because the sales team attends a large proportion of film trade shows just prior to and during the third fiscal quarter. In the 2008 and 2007 fiscal years, we executed contracts that represented material revenue for the segment at those tradeshows. We were able to subsequently deliver the related content for those contracts in the third fiscal quarter and as a result, our Film Production segment experienced higher revenue in that quarter. During the current fiscal year ended March 31, 2009, the Film Production segment's third fiscal quarter revenue was significantly lower than the prior year third quarter results. We believe the reduction in revenue is primarily due to the deterioration in the film markets.
Film Production segment revenue during the current fiscal year as compared to the prior fiscal year experienced the following trends:
º •
º Owned content revenue declined we believe primarily due to unfavorable
economic conditions within the film markets. We believe the
unfavorable economic conditions caused current and potential customers
to reduce or eliminate acquisitions of our content in an effort to
reduce spending which resulted in the execution of fewer owned content
deals. We believe there is a reasonable possibility that the film
markets will continue to experience pressure from the unfavorable
economic conditions which could cause the Film Production segment's
revenue to remain depressed or decline.
º •
º Repped content revenue also declined we believe primarily due to the
above mentioned unfavorable economic conditions. In addition to the
negative impact the economic environment is having on revenue, we are
also finding it more difficult to identify repped content that is
higher quality and acceptable by our distributors because we believe
producers are having difficulty obtaining financing for their
productions due to contracted credit markets.
When considering the future operating results of the Film Production segment, we believe the following challenges and risks could adversely impact this segment's operating results:
º •
º continuation of the unfavorable economic conditions and related
reduction in our customers' acquisition budgets for our owned and
repped content;
º •
º the identification and execution of owned content deals with premium
movie channels could become less frequent;
º •
º adverse impacts to our business from a continued decline in
discretionary consumer spending as a result of less favorable economic
conditions;
º •
º declines in new and existing customer VOD buys of our erotic owned
content due to a migration to other lower cost adult services such as
the internet;
º •
º we are making larger producer advances and incurring more significant
costs for repped content films with larger production budgets and we
may be unable to recover these advances and costs through the future
sale of the films; and
º •
º increased competition to our owned content from more explicit adult
film offerings.
The impact of these challenges and risks, and others that we may not have identified, could have a material adverse impact on our business. Nevertheless, we believe that we are well positioned to mitigate the impact of these risks and challenges. However, not all the risks and challenges can be managed by us because the ultimate outcome will be decided by other parties such as our customers.
During fiscal year 2010 and in future periods, we will focus on improving the revenue we generate from this segment through the following strategic initiatives:
º •
º expanding the quantity of multi-series owned content deals with
premium movie channels;
º •
º continuing the development of unique, original programming franchises;
º •
º improving the buy rates of VOD owned content on cable MSO and DBS
platforms through the same methods utilized by our Transactional TV
segment;
º •
º increasing investments in higher quality titles that we represent
through Lightning Entertainment Group;
º •
º generating meaningful repped content revenue by distributing higher
quality titles through the DVD retail market; and
º •
º generating meaningful repped content revenue by distributing higher
quality titles through domestic cable MSOs.
Direct-to-Consumer Segment
Our Direct-to-Consumer segment generates revenue primarily by selling memberships to our consumer websites. During fiscal year 2009, we experienced a decline in the Direct-to-Consumer segment revenue which we believe is due to a decline in consumer spending as a result of the unfavorable economic conditions as well as the availability of free and low-cost internet content. We recently launched a new version of our primary consumer website during fiscal year 2009 and are optimistic that the new primary website will result in improved performance during fiscal year 2010.
The Direct-to-Consumer segment acquired certain intellectual property rights to an IPTV set-top box and other intangible assets in late fiscal year 2008 in an effort to expand the product lines that are delivered directly to consumers (rather than through an intermediary such as a cable or satellite operator). The intellectual property rights technology allows us to manufacture a device through which
consumers can obtain content directly through the internet and view the content
on television. Based primarily on (a) lower than expected subscriber additions
for the IPTV test business model during the second half of fiscal year 2009,
(b) the significant downturn in economic conditions and related reduction in
consumer spending during the second half of fiscal year 2009, and (c) slower
than expected development of new product lines, we have restructured the
operations of these new product lines to reduce future costs. Although we will
continue to operate the IPTV business model and other new Direct-to-Consumer
product lines, we intend to materially change the nature of those operations and
dedicate fewer resources towards marketing these products.
Corporate Administration Segment
The Corporate Administration segment reflects all costs associated with the operation of the public holding company, New Frontier Media, Inc., that are not directly allocable to the Transactional TV, Film Production, or Direct-to-Consumer operating segments. These costs include, but are not limited to, legal and accounting expenses, insurance, registration and filing fees with NASDAQ, executive employee costs, and the SEC, investor relations and printing costs associated with our public filings and shareholder communications. Our focus for this operating segment is balancing cost containment with the need for administrative support for the growth of the Company. We focus on reducing costs within this segment and expect to continue those efforts into fiscal year 2010.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The methods, estimates, and judgments that the Company uses in applying the accounting policies have a significant impact on the results that the Company reports in . . .
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