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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10 -Q
/X/ Quarterly report under section 13 or 15(d) of the Securities and Exchange
Act of 1934.
For the quarterly period ended December 31, 2001
/ / Transition Report under Section 13 or 15(d) of the Exchange Act.
For the transition period from __________________ to __________________
000-23697
(Commission file number)
NEW FRONTIER MEDIA, INC.
(Exact name of small business issuer as specified in its charter)
Colorado 84-1084061
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)
7007 Winchester Circle, Suite 200, Boulder, Co 80301
(Address of principal executive offices)
(303) 444-0900
(Issuer's telephone number)
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes /X/ No / /
As of February 11, 2002, 21,246,913 shares of Common Stock, par value $.0001,
were outstanding.
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<Page>
FORM 10-Q
NEW FRONTIER MEDIA, INC.
Index
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2001
(Unaudited) and March 31, 2001..................... 3-4
Consolidated Statements of Operations (Unaudited)
for the quarter and nine months ended December 31,
2001 and 2000...................................... 5
Consolidated Statements of Comprehensive Income
(Unaudited) for the quarter and nine months ended
December 31, 2001 and 2000......................... 6
Consolidated Statements of Cash Flows (Unaudited)
for the nine months ended December 31, 2001 and
2000............................................... 7
Notes to Consolidated Financial Statements
(Unaudited)........................................ 8-13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 13-23
Item 3. Quantitative and Qualitative Disclosures about
Market Risk......................................... 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................... 23
Item 6. Exhibits and Reports on Form 8-K.................... 23
SIGNATURES.................................................. 24
2
<Page>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN 000S)
ASSETS
<Table>
<Caption>
(UNAUDITED)
DECEMBER 31, MARCH 31,
2001 2001
------------ ---------
CURRENT ASSETS:
Cash and cash equivalents, including restricted cash of
$500,000 and $324,016, respectively.................... $ 7,491 $ 8,667
Accounts receivable, net of allowance for doubtful
accounts of $406,690 and $363,000, respectively........ 4,558 5,747
Prepaid distribution rights............................... 2,686 2,292
Prepaid expenses.......................................... 892 2,118
Deferred tax asset........................................ 3,124 3,412
Due from related party.................................... 104 64
Other..................................................... 564 399
------- -------
TOTAL CURRENT ASSETS................................. 19,419 22,699
------- -------
FURNITURE AND EQUIPMENT, at cost............................ 23,665 19,230
Less: accumulated depreciation and amortization........... (10,814) (7,082)
------- -------
NET FURNITURE AND EQUIPMENT.......................... 12,851 12,148
------- -------
OTHER ASSETS:
Prepaid distribution rights............................... 8,060 6,876
Excess cost over fair value of net assets acquired, less
accumulated amortization of $2,458,566 and $1,981,499,
respectively........................................... 3,902 4,379
Deferred tax asset........................................ 1,953 1,953
Marketable securities -- available for sale............... 14 25
Other..................................................... 4,949 4,526
------- -------
TOTAL OTHER ASSETS................................... 18,878 17,759
------- -------
TOTAL ASSETS................................................ $51,148 $52,606
======= =======
</Table>
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
3
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN 000S)
LIABILITIES AND STOCKHOLDERS' EQUITY
<Table>
<Caption>
(UNAUDITED)
DECEMBER 31, MARCH 31,
2001 2001
------------ ---------
CURRENT LIABILITIES:
Accounts payable.......................................... $ 2,176 $ 1,632
Current portion of obligations under capital leases....... 1,708 1,459
Deferred revenue.......................................... 3,092 3,860
Reserve for chargebacks/credits........................... 387 443
Litigation reserve........................................ -- 2,500
Current portion of notes payable.......................... 3,000 --
Other accrued liabilities................................. 3,251 2,981
-------- --------
TOTAL CURRENT LIABILITIES............................ 13,614 12,875
-------- --------
LONG-TERM LIABILITIES:
Obligations under capital leases, net of current
portion................................................ 1,409 1,035
Note payable, net of current portion...................... 1,000 6,000
Other..................................................... -- 41
-------- --------
TOTAL LONG-TERM LIABILITIES.......................... 2,409 7,076
-------- --------
TOTAL LIABILITIES................................. 16,023 19,951
-------- --------
SHAREHOLDERS' EQUITY
Common stock, $.0001 par value, 50,000,000 shares
authorized, 21,176,549 and 20,938,420, respectively,
shares issued and outstanding.......................... 2 2
Preferred stock, $.10 par value, 5,000,000 shares
authorized:
Class A, no shares issued and outstanding.............. -- --
Class B, no shares issued and outstanding.............. -- --
Additional paid-in capital................................ 44,636 43,929
Minority interest in subsidiary........................... (171) (171)
Other comprehensive loss.................................. (104) (93)
Accumulated deficit....................................... (9,238) (11,012)
-------- --------
TOTAL SHAREHOLDERS' EQUITY........................... 35,125 32,655
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 51,148 $ 52,606
======== ========
</Table>
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
4
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN 000S)
<Table>
<Caption>
(UNAUDITED) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
SALES, net......................................... $12,400 $15,214 $41,221 $42,757
COST OF SALES...................................... 6,104 7,341 20,124 21,653
------- ------- ------- -------
GROSS MARGIN....................................... 6,296 7,873 21,097 21,104
------- ------- ------- -------
OPERATING EXPENSES:
Sales and marketing.............................. 1,793 2,096 6,231 5,700
General and administrative....................... 3,858 4,897 12,160 13,755
Goodwill amortization............................ 159 159 477 477
------- ------- ------- -------
TOTAL OPERATING EXPENSES.................... 5,810 7,152 18,868 19,932
------- ------- ------- -------
OPERATING INCOME............................ 486 721 2,229 1,172
------- ------- ------- -------
OTHER INCOME (EXPENSE):
Interest income.................................. 40 31 165 142
Interest expense................................. (439) (167) (1,451) (706)
Loss on write-off of stock....................... -- -- -- (508)
Litigation reserve............................... 1,680 -- 1,680 (10,000)
Other............................................ 341 -- 341 --
------- ------- ------- -------
TOTAL OTHER INCOME (EXPENSE)................ 1,622 (136) 735 (11,072)
------- ------- ------- -------
INCOME (LOSS) BEFORE MINORITY INTEREST AND INCOME
TAXES............................................ 2,108 585 2,964 (9,900)
------- ------- ------- -------
Minority interest in loss of subsidiary.......... -- 15 -- 112
------- ------- ------- -------
NET INCOME (LOSS) BEFORE (PROVISION)
BENEFIT FOR INCOME TAXES......................... $ 2,108 $ 600 $ 2,964 $(9,788)
(Provision) benefit for income taxes............. (845) 396 (1,190) 7,636
------- ------- ------- -------
NET INCOME (LOSS)........................... 1,263 $ 996 1,774 $(2,152)
======= ======= ======= =======
Basic/Diluted Earnings (Loss) per share............ $ .06 $ .05 $ .08 $ (.10)
======= ======= ======= =======
</Table>
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
5
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
IN (000'S)
<Table>
<Caption>
(UNAUDITED) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------- -----------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net income (loss).......................... $ 1,263 $ 996 $ 1,774 $(2,152)
Other comprehensive income (loss)
Unrealized loss on available-for-sale
marketable securities, net............ (24) (93) (11) (93)
------- ------- ------- -------
Total comprehensive income (loss)..... $ 1,239 $ 903 $ 1,763 $(2,245)
======= ======= ======= =======
</Table>
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
6
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN 000S)
<Table>
<Caption>
(UNAUDITED)
NINE MONTHS ENDED
DECEMBER 31,
-------------------------
2001 2000
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $ 1,774 $(2,152)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Conversion of interest to common stock................. 251 187
Accretion of interest.................................. -- 69
Stock/warrants issued for services and legal
settlement............................................ 373 177
Deferred Debt offering costs........................... 426 21
Depreciation and amortization.......................... 6,478 4,555
(Decrease) Increase in legal reserve................... (2,500) 10,000
Write-off of marketable securities available for
sale.................................................. -- 508
Minority interest in loss of subsidiary................ -- (112)
(Increase) Decrease in operating assets
Accounts receivable............................. 1,189 (2,016)
Deferred tax asset.............................. 288 (7,678)
Receivables and prepaid expenses................ 1,538 (247)
Prepaid distribution rights..................... (3,767) (3,409)
Other assets.................................... (609) (246)
Increase (Decrease) operating liabilities
Accounts payable................................ 544 784
Deferred revenue, net........................... (767) 55
Reserve for chargebacks/credits................. (56) 25
Other accrued liabilities....................... 231 195
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES.... 5,393 716
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and furniture.................... (2,571) (3,594)
Purchase of subscriber base............................ (500) --
------- -------
NET CASH USED IN INVESTING ACTIVITIES............. (3,071) (3,594)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations.................. (1,602) (919)
Payment of related party notes payable................. (40) (962)
Increase (Decrease) in note payable.................... (2,000) 5,000
Issuance of common stock............................... 144 1,617
Payment on distribution payable........................ (500)
Increase in debt offering costs........................ -- 152
------- -------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES...................................... (3,498) 4,388
------- -------
NET (DECREASE) INCREASE IN CASH............................. (1,176) 1,510
CASH AND CASH EQUIVALENTS, beginning of period.............. 8,667 7,329
------- -------
CASH AND CASH EQUIVALENTS, end of period.................... 7,491 8,839
======= =======
</Table>
The accompanying notes are an integral part of the unaudited consolidated
financial statements.
7
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The accompanying consolidated financial statements include the accounts of New
Frontier Media, Inc. ("the Company" or "New Frontier Media") and its wholly
owned subsidiaries Colorado Satellite Broadcasting, Inc. d/b/a The Erotic
Networks ("CSB" or "TEN") and Interactive Gallery, Inc. ("IGI").
BUSINESS
New Frontier Media is a publicly traded holding company for its operating
subsidiaries.
TEN is a leading provider of adult programming to multi-channel television
providers and low powered direct-to-home C-Band households. Through its six
networks, Pleasure, TeN, ETC, Extasy, True Blue and X-Cubed, TEN is able to
provide a variety of editing styles and programming mixes that appeal to a broad
range of adult customers.
IGI is a leading aggregator and reseller of adult content via the Internet. IGI
aggregates adult-recorded video, live-feed video and still photography from
adult content studios and distributes it via its membership websites and
Pay-Per-View feeds. In addition, IGI resells its aggregated content to
third-party web masters and resells its Internet traffic that does not convert
into memberships.
BASIS OF PRESENTATION
The financial information included in these financial statements is unaudited
but, in the opinion of management, reflects all normal recurring adjustments
necessary for a fair presentation of the results for the interim periods. The
interim results of operations and cash flows are not necessarily indicative of
those results and cash flows for the entire year. These financial statements
should be read in conjunction with the financial statements and notes to the
financial statements contained in the Annual Report on Form 10-K for the fiscal
year ended March 31, 2001 (the "2001 Form 10-K") of New Frontier Media and its
subsidiaries. Certain amounts reported for prior periods have been reclassified
to conform to the current year's presentation.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, "Business Combinations." This statement requires the use of the purchase
method of accounting for all business combinations initiated after June 30,
2001, establishes specific criteria for the recognition of intangible assets
separately from goodwill, and requires unallocated negative goodwill to be
written off immediately as an extraordinary gain. SFAS No. 141 is effective for
the Company's financial statements for the year ending March 31, 2002.
In July 2001, the FASB also issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement primarily addresses the accounting for goodwill and
intangible assets subsequent to their acquisition. SFAS No. 142 requires that
goodwill and indefinite lived intangible assets no longer be amortized, that
goodwill be tested for impairment at least annually at the reporting unit level,
that intangible assets deemed to have an indefinite life be tested for
impairment at least annually, and that the amortization period of intangible
assets with finite lives no longer be limited to forty years. SFAS No. 142 is
effective for the Company's financial statements for the year ending March 31,
2003.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal 2003. For 2002, the
amortization of goodwill and intangible assets is expected to be approximately
$636,000, or $.03 per share. The Company is evaluating the
8
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
impact that application of the nonamortization provisions of the Statements will
have on the Company's financial statements. The Company will perform the first
of the required impairment tests of goodwill and indefinite-lived intangible
assets as of April 1, 2002 and has not yet determined what the effect of these
tests will be on the financial statements of the Company.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement is not applicable to the Company.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement addresses significant issues
relating to the implementation of SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and
establishes a single accounting model, based on the framework established in
SFAS No. 121, for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired. SFAS No. 144 is effective for the
Company's financial statements for the year ending March 31, 2003. The Company
has not yet determined what the effect of these tests will be on the financial
statements of the Company.
NOTE 2 -- EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted earnings per share is computed on
the basis of the weighted average number of common shares outstanding plus the
effect of outstanding warrants and stock options using the "treasury stock"
method.
The components of basic and diluted earnings per share are as follows:
EARNINGS (LOSS) PER SHARE
(IN 000S)
<Table>
<Caption>
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net income (loss) available for common
shareholders....................................... 1,263 996 1,774 (2,152)
======= ======= ======= =======
Average outstanding shares of common stock........... 21,151 20,864 21,099 21,004
Dilutive effect of:
Warrants/Employee Stock Options...................... 1,017 1,151 1,136 --
------- ------- ------- -------
Common stock and common stock equivalents............ 22,168 22,015 22,235 21,004
======= ======= ======= =======
Earnings (loss) per share:
Basic/Diluted........................................ $ .06 $ .05 $ .08 $ (.10)
</Table>
Common stock equivalents are not included in the loss per share calculation
since their effect would be anti-dilutive.
NOTE 3 -- SHAREHOLDERS' EQUITY
During the quarter and nine months, respectively, the Company issued 33,611 and
114,711 shares of common stock upon the exercise of compensatory warrants and
options.
During the quarter and nine months, respectively, the Company issued 12,058 and
38,081 shares of common stock in lieu of interest.
During the quarter and nine months, respectively, the Company repurchased 1,400
and 8,800 shares of common stock. The Company retired these shares.
9
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the nine months, the Company issued 94,137 shares of common stock for the
purchase of a subscriber base.
NOTE 4 -- STOCK OPTIONS AND WARRANTS
As of December 31, 2001, the Company had granted 2,624,500 Options from the 2000
Millenium Stock Option Plan, 1,607,950 Options from the 1999 Incentive Stock
Option Plan and 843,000 Options from the 1998 Stock Option Plan.
The Company grants warrants to consultants for services provided allowing them
to purchase common stock of New Frontier Media. During the quarter ended
December 31, 2001, no warrants were issued. During the nine months ended
December 31, 2001, 105,000 warrants were issued.
NOTE 5 -- SEGMENT INFORMATION
For internal reporting purposes, management segregates the Company into three
divisions: 1) Subscription/Pay-Per View TV, 2) Internet Group and 3) Corporate
Administration.
The following tables represent unaudited financial information by reportable
segment (in thousands):
<Table>
<Caption>
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- ----------------------
2001 2000 2001 2000
------------ -------- -------- --------
NET REVENUE
Subscription/Pay-Per-View TV.............. 7,309 6,210 21,876 17,565
Internet Group............................ 5,070 8,973 19,262 25,098
Corporate Administration.................. 21 31 83 94
------- -------- ------- --------
Total................................ 12,400 15,214 41,221 42,757
======= ======== ======= ========
INCOME (LOSS) BEFORE MINORITY INTEREST AND
INCOME TAXES
Subscription/Pay-Per-View TV.............. 1,419 (39) 4,443 973
Internet Group............................ 160 876 2,006 2,890
Corporate Administration.................. 529 (252) (3,485) (13,763)
------- -------- ------- --------
Total................................ 2,108 585 2,964 (9,900)
======= ======== ======= ========
INTEREST INCOME
Subscription/Pay-Per-View TV.............. -- 6 2 14
Internet Group............................ 2 8 4 23
Corporate Administration.................. 38 17 159 105
------- -------- ------- --------
Total................................ 40 31 165 142
======= ======== ======= ========
INTEREST EXPENSE
Subscription/Pay-Per-View TV.............. 36 33 140 97
Internet Group............................ 101 83 315 242
Corporate Administration.................. 302 51 996 367
------- -------- ------- --------
Total................................ 439 167 1,451 706
======= ======== ======= ========
DEPRECIATION AND AMORTIZATION
Subscription/Pay-Per-View TV.............. 1,336 993 3,799 2,858
Internet Group............................ 921 617 2,680 1,628
Corporate Administration.................. 6 4 14 6
------- -------- ------- --------
Total................................ 2,263 1,614 6,493 4,492
======= ======== ======= ========
</Table>
10
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
(UNAUDITED) (AUDITED)
DECEMBER 31, MARCH 31,
2001 2001
------------ ---------
IDENTIFIABLE ASSETS
Subscription/Pay-Per-View TV.............. $26,536 $ 25,268
Internet Group............................ 14,465 18,248
Corporate Administration.................. 30,142 35,610
Eliminations.............................. (19,995) (26,520)
------- --------
Total................................ $51,148 $ 52,606
======= ========
</Table>
NOTE 6 -- MAJOR CUSTOMER
The Company's revenue from a major customer (revenues in excess of 10% of total
sales) is from a leading provider of direct broadcast satellite services. The
revenue from such customer as a percentage of total revenues for the quarters
ended December 31 are as follows:
<Table>
<Caption>
2001 2000
-------- --------
Customer A............................................ 27% 17%
</Table>
At December 31, 2001 and March 31, 2001, accounts receivable from Customer A is
$2,378,000 and $2,888,000, respectively. There were no other customers with
receivable balances in excess of 10% of consolidated accounts receivable.
Customer A is included in the Subscription/Pay-Per-View TV Segment.
The loss of its significant customer could have a materially adverse effect on
the Company's business, operating results or financial condition. To limit the
Company's credit risk, management performs ongoing credit evaluations of its
customers and maintains allowances for potentially uncollectable accounts.
NOTE 7 -- LITIGATION
The Company was a defendant in a lawsuit filed on January 25, 1999 in which J.P.
Lipson sought to enforce an alleged agreement with the Company. On September 1,
2000, a jury entered a verdict awarding to the plaintiff $10 million in
liquidated damages and, in the alternative, $1 million in actual damages and $1
million in punitive damages. The Company established a $10 million reserve on
its books during the quarter ended September 30, 2000 as a result of the jury
verdict.
Subsequent to September 30, 2000, the Boulder District Court entered an order
granting the Company's motion to reduce the actual damages against the Company
from $10 million to $1 million, thereby reducing Mr. Lipson's total award,
exclusive of interest, to $2.5 million. The Company thereafter reduced the $10
million reserve on its books to $2.5 million.
On December 26, 2001, the Company announced that it had settled the Lipson
lawsuit in its entirety for a lump sum payment of $820,000 made to his
attorneys. The Company reversed the remaining $1.7 million in legal reserve
during the quarter ended December 31, 2001.
In February 1999, the Company issued 700,000 shares of its common stock to
Pleasure Licensing LLC and Pleasure Productions, Inc. (collectively "Pleasure")
at $2.12 per share for consideration in obtaining a license agreement for the
rights to distribute approximately 4,000 adult motion pictures. In addition, the
Company issued a five year common stock purchase warrant valued at $1.00 per
share to purchase 700,000 shares of the Company's common stock at an exercise
price of $1.12 per share.
On August 3, 1999, the Company filed a lawsuit against Pleasure alleging breach
of contract, breach of express warranties, breach of implied warranty of fitness
for a particular purpose, and rescission, seeking the return of 700,000 shares
of New Frontier Media stock and warrants. Pleasure removed the
11
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
District Court action to Federal District Court in Colorado and filed
counterclaims related to the Company's refusal to permit Pleasure to trade the
securities issued to Pleasure. Pleasure's counterclaims allege breach of
contract, copyright and trademark infringement, and fraud.
The Company contends that Pleasure, among other things, breached its license
agreement with the Company by failing to deliver to the Company approximately
4,000 broadcast-quality pictures, as required by the agreement, and by failing
to deliver to the Company three "new releases" a month. The Company intends to
pursue vigorously its claims against Pleasure and to defend the counterclaims
asserted against it.
At December 31, 2001, the carrying value of the Pleasure licenses' was
approximately $1.7 million and has been recorded in Other Assets--Other.
Although a loss on these licenses is possible, no provision for such losses has
been recorded in the accompanying financial statements due to the uncertainty of
the outcome of the litigation proceedings.
NOTE 8 -- NOTES PAYABLE
Notes payables consisted of the following:
<Table>
<Caption>
(UNAUDITED) (AUDITED)
DECEMBER 31, MARCH 31,
2001 2001
------------ ----------
Unsecured note payable bearing interest at 15% per annum.
The principal is payable in cash on January 16, 2003.
Interest is payable at the option of the Holder in cash
or stock on a quarterly basis, in arrears, commencing
May 1, 2001............................................ $ 250,000 $ 250,000
Unsecured note payable bearing interest at 15% per annum.
The principal is payable in cash on January 30, 2003.
Interest is payable at the option of the Holder in cash
or stock on a quarterly basis, in arrears, commencing
May 1, 2001............................................ 250,000 250,000
Unsecured note payable bearing interest at 15% per annum.
The principal is payable in cash on February 2, 2003.
Interest is payable at the option of the Holder in cash
or stock on a quarterly basis, in arrears, commencing
May 1, 2001............................................ 500,000 500,000
Unsecured note payable bearing interest at 12% per annum.
The principal is payable in cash on or before December
17, 2002. Interest will be paid on the outstanding
principal amount on a monthly basis on or before the
fifth day of each month................................ $3,000,000 $5,000,000
---------- ----------
4,000,000 6,000,000
---------- ----------
Less current portion...................................... 3,000,000 --
---------- ----------
LONG-TERM PORTION................................. $1,000,000 $6,000,000
========== ==========
</Table>
NOTE 9 -- OTHER INCOME
The Company recognized $0.3 million in deferred revenue during the quarter ended
December 31, 2001, in connection with Metro Global Media, Inc. ("Metro")
releasing the Company from its obligations to perform services under a contract
signed in July 1999 for which the Company was given 250,000 shares of Metro
stock. At the time the contract was signed, the Company recognized deferred
revenue in the amount of $0.6 million, the fair market value of the Metro stock
on that date. Since that time, the Company has amortized this deferred revenue
over 60 months for services it was
12
<Page>
NEW FRONTIER MEDIA, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
providing to Metro. The Company has ceased providing these services to Metro and
Metro released the Company from its obligation of providing any future services
during this current quarter. Accordingly, the remaining deferred revenue has now
been recognized and is included in Other Income.
NOTE 10 -- SUBSEQUENT EVENTS
The Internet Group is undergoing a restructuring of its operations subsequent to
December 31, 2001. This restructuring includes the elimination and/or
consolidation of job functions to the Company's Boulder, Colorado location and
the planned sublease of its eighth floor facility in Sherman Oaks, California.
The Internet Group expects that all consolidation activities will be finalized
by the end of the first quarter of its fiscal year ending March 31, 2003.
In January 2002, the Company has approved the granting of 230,000 stock options
from the 2001 Incentive Stock Plan.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-Q includes forward-looking statements. These
statements 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", "expect", "anticipate", "optimistic",
"intend", "will", 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 update or revise any forward-looking statements.
Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to: 1) our ability to
successfully manage our credit card chargeback and credit percentage in order to
maintain our ability to accept credit cards as a form of payment for our
products and services; 2) our ability to compete effectively with our primary
Cable/ DSB competitor; 3) our ability to compete effectively with our Internet
competitors; 4) our ability to attract traffic and increase the conversion and
retention rates of our web sites; 5) our ability to retain our key executives;
and 6) our ability to retain our major customer which accounts for 27% of our
total revenue.
The following table reflects the Company's results of operations for the quarter
and nine months ended December 31, 2001 and 2000.
13
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RESULTS OF OPERATIONS
<Table>
<Caption>
(IN MILLIONS) (IN MILLIONS)
QUARTER ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------- -------------------------
2001 2000 2001 2000
-------- -------- -------- --------
NET REVENUE
Subscription/Pay-Per-View TV
Cable/DBS.............................. 5.0 3.7 14.7 10.0
C-Band................................. 2.3 2.5 7.2 7.6
Internet Group
Net Membership......................... 3.2 5.0 12.7 14.5
Sale of Content........................ 0.4 1.0 1.5 3.0
Sale of Traffic........................ 1.4 2.8 4.7 6.9
Other.................................. 0.1 0.2 0.4 0.7
----- ----- ----- -----
TOTAL.................................. 12.4 15.2 41.2 42.7
===== ===== ===== =====
COST OF SALES
Subscription/Pay-Per-View TV................ 3.5 2.9 10.0 8.5
Internet Group.............................. 2.6 4.4 10.1 13.1
----- ----- ----- -----
TOTAL.................................. 6.1 7.3 20.1 21.6
===== ===== ===== =====
OPERATING INCOME (LOSS)
Subscription/Pay-Per-View TV................ 1.4 0.7 4.6 1.8
Internet Group.............................. 0.3 1.2 2.3 3.6
Corporate Administration.................... (1.2) (1.2) (4.7) (4.2)
----- ----- ----- -----
TOTAL.................................. 0.5 0.7 2.2 1.2
===== ===== ===== =====
</Table>
NET REVENUE
Net revenue for the Company was $12.4 million for the quarter ended December 31,
2001, as compared to $15.2 million for the quarter ended December 31, 2000,
representing a decrease of 18%. Net revenue for the Company was $41.2 million
for the nine months ended December 31, 2001, as compared to $42.7 million for
the nine months ended December 31, 2000, representing a decrease of 4%.
The decrease in net revenue for the quarter is due to a 43% decrease in net
revenue generated by the Internet Group that was offset by an 18% increase in
net revenue generated by the Subscription/PPV TV Group. Net revenue for the
Subscription/PPV TV Group increased to $7.3 million for the quarter ended
December 31, 2001, from $6.2 million as of the quarter ended December 31, 2000.
Net revenue for the Internet Group declined from $9.0 million as of the quarter
ended December 31, 2000 to $5.1 million for the quarter ended December 31, 2001.
The decrease in net revenue for the nine months ended December 31, 2001 is due
to a 24% increase in net revenue generated by the Subscription/PPV TV Group that
was offset by a 23% decrease in net revenue generated by the Internet Group. Net
revenue for the Subscription/PPV TV Group increased to $21.9 million for the
nine months ended December 31, 2001 from $17.6 million for the nine months ended
December 31, 2000. Net revenue for the Internet Group declined from $25.1
million as of the nine months ended December 31, 2000 to $19.3 million as of the
nine months ended December 31, 2001.
OPERATING INCOME
Operating income for the Company decreased to $0.5 million for the quarter ended
December 31, 2001, from $0.7 million for the quarter ended December 31, 2000,
representing a 29% decrease. Operating income for the Company increased to $2.2
million for the nine months ended December 31, 2001, from $1.2 million for the
nine months ended December 31, 2000, representing a 83% increase.
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The decrease in operating income for the quarter ended December 31, 2001 is due
to a decrease in operating income generated by the Internet Group. The Internet
Group's operating income declined from $1.2 million for the quarter ended
December 31, 2000, to $0.3 million for the quarter ended December 31, 2001,
representing a 75% decrease. This decline was offset by an increase in operating
income by the Subscription/PPV TV Group. Operating income generated by the
Subscription/PPV TV Group was $1.4 million for the quarter ended December 31,
2001, as compared to $0.7 million for the quarter ended December 31, 2000,
representing a 100% increase.
The increase in operating income for the nine months ended December 31, 2001,
was due to an increase in operating income generated by the Subscription/PPV TV
Group. Operating income for the Subscription/PPV TV Group was $4.6 million for
the nine months ended December 31, 2001, as compared to $1.8 million for the
nine months ended December 31, 2000, representing a 156% increase. This increase
was offset by a decrease in operating income for the Internet Group. Operating
income for the Internet Group declined from $3.6 million as of the nine months
ended December 31, 2000, to $2.3 million as of the nine months ended December
31, 2001, representing a 36% decrease.
SUBSCRIPTION/PAY-PER-VIEW (PPV) TV GROUP
The following table outlines the current distribution environment and
addressable households for each network:
<Table>
<Caption>
ESTIMATED ADDRESSABLE HOUSEHOLDS
---------------------------------------
(IN THOUSANDS)
AS OF AS OF
DECEMBER 31, DECEMBER 31,
NETWORK DISTRIBUTION METHOD 2001 2000 % CHANGE
------- ------------------- ------------ ------------ ---------
Pleasure Cable/DBS 17,800 14,200 25%
TeN Cable/DBS 8,000 5,600 43%
ETC Cable/DBS 3,500 2,300 52%
Extasy C-band/Cable/DBS 7,600 3,800 100%(1)
True Blue C-band 840 1,700 -51%(1)
X-Cubed (2) C-band 840 1,200 -30%(1)
TOTAL ADDRESSABLE SUBSCRIBERS 38,580 28,800
</Table>
(1) % change gives effect to a 30% decline in the C-band market addressable
households. Total addressable C-Band households declined from 1.2 million as
of December 31, 2000 to 840,000 as of December 31, 2001.
(2) This network was formerly known as GonzoX. The network was renamed X-Cubed
in May 2001.
NET REVENUE
Total net revenue for the Subscription/PPV TV Group was $7.3 million for the
quarter ended December 31, 2001, representing an 18% increase from $6.2 million
for the quarter ended December 31, 2000. Of total net revenue, C-Band net
revenue was $2.3 million for the quarter ended December 31, 2001, as compared to
$2.5 million for the quarter ended December 31, 2000, representing a decrease of
8%. Revenue from the Group's Cable/DBS services for the quarter ended December
31, 2001, was $5.0 million as compared to $3.7 million for the quarter ended
December 31, 2000, an increase of 35%. Revenue from the Group's Cable/DBS
services is responsible for approximately 68% of the Group's total net revenue
for the quarter ended December 31, 2001, as compared to 60% for the quarter
ended December 31, 2000.
Total net revenue for the Subscription/PPV TV Group was $21.9 million for the
nine months ended December 31, 2001, representing a 24% increase from $17.6
million for the nine months ended December 31, 2000. Of total net revenue,
C-Band net revenue was $7.2 million for the nine months ended December 31, 2001,
as compared to $7.6 million for the nine months ended December 31, 2000,
representing a decrease of 5%. Revenue from the Group's Cable/DBS services for
the nine months ended December 31, 2001, was $14.7 million as compared to $10.0
million for the nine months ended
15
<Page>
December 31, 2000, an increase of 47%. Revenue from the Group's Cable/ DBS
services is responsible for approximately 67% of the Group's total net revenue
for the nine months ended December 31, 2001, as compared to 57% for the nine
months ended December 31, 2000.
The decrease in C-Band revenue for both the quarter and nine months ended
December 31, 2001 is due to the declining C-Band market as consumers continue to
convert C-Band "big dish" analog satellite systems to smaller, 18-inch digital
DBS satellite systems. The C-Band market has decreased 30% since December 31,
2000, from 1.2 million addressable subscribers to 840,000 addressable
subscribers as of December 31, 2001.
The Subscription/PPV TV Group acquired the C-Band subscriber base of Emerald
Media, Inc. ("EMI") in April 2001 for a total of $750,000 in stock and cash. EMI
was formerly the Group's largest competitor in the adult C-Band market,
operating two competing networks, which were discontinued after this
acquisition. The effect of this acquisition has been to support the Group's
C-Band revenue stream in a quickly eroding market place. Although the C-Band
market continues to decline, the number of subscribers to the Subscription/PPV
TV Group's networks remains relatively stable quarter to quarter as does its
average revenue earned per sale.
The increase in the Subscription/PPV TV Group's Cable/DBS revenue for the
quarter and nine months ended December 31, 2001 is a result of the following
factors as discussed further below: 1) the launch of Erotic Television Clips
("ETC"); 2) the increase in Extasy's addressable subscriber base; and 3) an
increase in Pleasure's addressable subscriber base.
The Subscription/PPV TV Group launched ETC in July 2000. As of December 31,
2001, ETC was available to 3.5 million Cable and DBS addressable subscribers,
representing an increase of 52% from 2.3 million addressable subscribers as of
December 31, 2000. Revenue from ETC has grown 168% and 429% for the quarter and
nine months ended December 31, 2001, respectively, when compared to the same
periods a year ago.
As of December 31, 2001, Extasy was available to 6.8 million Cable/DBS
addressable subscribers up from 2.6 million addressable subscribers as of
December 31, 2000, an increase of 162%. In August 2001, EchoStar Communication
Corporation's DISH network ("DISH") moved Extasy from its satellite at 110
degrees, where it has resided since its launch on DISH, to its satellite at 119
degrees. DISH's satellite at 119 degrees is viewed by nearly double the number
of addressable subscribers than its satellite at 110 degrees.
Pleasure is available to 17.8 million addressable subscribers as of December 31,
2001, representing an increase of 25% from 14.2 million subscribers as of
December 31, 2000. The increase in addressable subscribers is a result of the
addition of new affiliates and on-line growth of existing affiliates. The
Subscription/PPV TV Group has signed corporate carriage agreements with AOL Time
Warner, Inc. ("Time Warner") and Comcast Corporation ("Comcast") for the
distribution of Pleasure on all of their digital systems. In addition, many
analog systems of these multiple system operators ("MSO's") have chosen to carry
Pleasure. Time Warner replaced Playboy TV with Pleasure on its largest analog
system in New York City's borough of Manhattan in September 2001.
As of the period ended December 31, 2001, Pleasure is distributed on nearly all
of the digital systems for Time Warner and 100% of the digital cable systems for
Comcast and Cable One.
During the quarter ended September 30, 2001, DISH terminated the distribution of
Pleasure on its platform. The Subscription/PPV TV Group has not experienced a
material change in its total net revenue due to this disaffiliation.
The Group was notified by Hughes Electronic Corporation's DirecTV ("DirecTV")
that it will be terminating the six-hour feed of the Group's Pleasure network as
of January 31, 2002. The Subscription/PPV TV Group does not anticipate any
material change in its total net revenue as a result of this disaffiliation.
During the quarter ended December 31, 2001, the Subscription/PPV TV Group began
distribution of its Pleasure, TeN and ETC networks on several new Charter
Communication, Inc. digital systems.
16
<Page>
COST OF SALES
Cost of sales for the Subscription/PPV TV Group was $3.5 million, or 48% of
revenue, for the quarter ended December 31, 2001, as compared to $2.9 million,
or 47% of revenue, for the quarter ended December 31, 2000, an increase of 21%.
Cost of sales for the Subscription/PPV TV Group was $10.0 million or 46% of
revenue, for the nine months ended December 31, 2001, as compared to $8.5
million, or 48% of revenue, as of the nine months ended December 31, 2000, an
increase of 18%.
Cost of sales consists of expenses associated with broadcast playout, satellite
uplinking, satellite transponder leases, programming acquisition costs,
amortization of content licenses, TeN.com internet costs, and call center
operations.
The increase in cost of sales is due to the following: a) an increase in
programming acquisition costs for screening, quality control and editing of the
Group's content as it has expanded the number of movies offered on each of its
networks; b) an increase in amortization expense related to the purchase of
additional content as the Group has expanded the number of movies airing on its
networks each month; and c) an increase in costs associated with the operation
of the Subscription/PPV TV Group's digital broadcast center as the Group has
added additional functionalities.
The Subscription/PPV TV Group is currently renegotiating its satellite
transponder lease contract effective January 1, 2002. This negotiation is
expected to result in a 20% decline in cost for this expense.
As part of the renegotiation of its transponder leases, the Subscription/PPV TV
Group will be creating a digital tier for its Pleasure, TeN, and ETC networks on
Loral Space & Communications' ("Loral") satellite known as T-7. This digital
tier will take the place of the edgeband technology that the Group is currently
using. Edgeband technology permits multiple services to be carried over an
existing satellite transponder by adding a multiplex of MPEG-2 compressed
programs at the band edge of the transponder. This change to a digital tier
makes the distribution of the Group's services more bandwidth efficient for its
cable affiliates.
OPERATING INCOME
Operating income for the Subscription/PPV TV Group for the quarter ended
December 31, 2001 was $1.4 million as compared to operating income of $0.7
million for the quarter ended December 31, 2000, an increase of 100%. Operating
income for the Subscription/PPV TV Group for the nine months ended December 31,
2001 was $4.6 million as compared to operating income of $1.8 million for the
nine months ended December 31, 2000, an increase of 156%.
The increase in operating income for the quarter and nine months ended December
31, 2001, as compared to the quarter and nine months ended December 31, 2000, is
due to an 18% and 24% increase in revenue for the quarter and nine months ended
December 31, 2001, respectively. Additionally, the Subscription/PPV TV Group's
gross margin percentage increased from 52% as of the nine months ended December
31, 2000, to 54% as of the nine months ended December 31, 2001.
Operating expenses as a percentage of revenue were 33% for the quarter and nine
months ended December 31, 2001, as compared to 42% and 41% for the quarter and
nine months ended December 31, 2000, respectively. The decrease in operating
expenses as a percentage of revenue is a result of the Subscription/PPV TV
Group's operating expenses such as advertising, payroll, trade show expenses,
and consulting remaining fairly flat as revenue increased. Operating expenses
declined from $2.6 million as of the quarter ended December 31, 2000, to $2.4
million for the quarter ended December 31, 2001, representing a decrease of 8%.
Operating expenses increased 1% from $7.2 million as of the nine months ended
December 31, 2000, to $7.3 million for the nine months ended December 31, 2001.
17
<Page>
INTERNET GROUP
NET REVENUE
Total net revenue for the Internet Group was $5.1 million for the quarter ended
December 31, 2001, as compared to $9.0 million for the quarter ended December
31, 2000, which represents a decrease of 43%. Total net revenue for the Internet
Group was $19.3 million for the nine months ended December 31, 2001, as compared
to $25.1 million for nine months ended December 31, 2000, which represents a
decrease of 23%. The Internet Group's revenue is comprised of membership revenue
from its consumer-based web sites, revenue from the sale of its content feeds,
revenue from the sale of exit traffic, and revenue from its Internet Service
Provider ("ISP") services.
Net membership revenue for the Internet Group was $3.2 million for the quarter
ended December 31, 2001 as compared to net membership revenue of $5.0 million
for the quarter ended December 31, 2000, which represents a decrease of 36%. Net
membership revenue for the Internet Group was $12.7 million for the nine months
ended December 31, 2001, as compared to $14.5 million for the nine months ended
December 31, 2000, which represents a decrease of 12%. The Internet Group's
chargebacks and credits were $0.3 million, or 9% of gross membership revenue for
the quarter ended December 31, 2001, as compared to $0.7 million, or 12% of
gross membership revenue for the quarter ended December 31, 2000. The Internet
Group's chargebacks and credits were $1.6 million, or 11% of gross membership
revenue for the nine months ended December 31, 2001, as compared to $2.0
million, or 12% of gross membership revenue for the nine months ended December
31, 2000. The Internet Group has continued to manage its credit card revenue
closely in order to ensure that it is meeting the necessary chargeback
parameters required by the major credit card companies.
The Internet Group has seen a decline in its membership revenue as a result of a
decrease in traffic to its sites. This decrease in traffic to the Internet
Group's sites during the quarter and nine months ended December 31, 2001 is
primarily due to changes made to the Internet Group's webmaster payout model.
The Internet Group changed its payout model during fiscal 2002 to compensate a
webmaster for traffic directed to the Internet Group's websites only upon the
conversion of a referral into a paying monthly member. This change resulted in a
74% and 46% decline in webmaster payouts for the quarter and nine months ended
December 31, 2001, while net membership revenue declined only 36% and 12% for
the quarter and nine months ended December 31, 2001. Membership revenue and
traffic has also decreased because of the proliferation of free adult material
available on the Internet.
Revenue from the Internet Group's sale of content was $0.4 million for the
quarter ended December 31, 2001, as compared to $1.0 million for the quarter
ended December 31, 2000, representing a decrease of 60%. Revenue from the
Internet Group's sale of content was $1.5 million for the nine months ended
December 31, 2001, as compared to $3.0 million for the nine months ended
December 31, 2000, which represents a decrease of 50%. This decrease in revenue
from the sale of content is due to a softening in the demand for content by
third-party webmasters.
Revenue is earned from traffic sales by forwarding exit traffic and traffic from
selected vanity domains to affiliate webmaster marketing programs. Revenue from
the sale of traffic was $1.4 million for the quarter ended December 31, 2001, as
compared to $2.8 million for the quarter ended December 31, 2000, which
represents a decrease of 50%. Revenue from the sale of traffic was $4.7 million
for the nine months ended December 31, 2001, as compared to $6.9 million for the
nine months ended December 31, 2000, which represents a decrease of 32%. The
Internet Group's revenue from sale of traffic has decreased for the quarter and
nine months ended December 31, 2001 because of a decline in overall traffic
purchased by the Internet Group under its new webmaster payout model. The
decline in traffic to the Internet Group's web sites results in less traffic
available to sell.
The Internet Group's other revenue was earned from the sale of services such as
co-location and bandwidth management ("ISP" services) to non-affiliated
companies. The Group's other revenue was $0.1 million for the quarter ended
December 31, 2001, as compared to $0.2 million for the quarter ended December
31, 2000, representing a decrease of 50%. The Internet Group's other revenue was
$0.4 million for the nine months ended December 31, 2001, as compared to $0.7
million for the nine months ended December 31, 2000, representing a decrease of
43%. This decrease in other revenue for
18
<Page>
the quarter and nine months ended December 31, 2001 was due to the Group's major
non-affiliated customer changing service providers.
COST OF SALES
Cost of sales for the Internet Group was $2.6 million for the quarter ended
December 31, 2001, as compared to $4.4 million for the quarter ended December
31, 2000, representing a decrease of 41%. Cost of sales for the Internet Group
was $10.1 million for the nine months ended December 31, 2001, as compared to
$13.1 million for the nine months ended December 31, 2000, which represents a
decrease of 23%. Cost of sales consists of expenses associated with credit card
fees, merchant banking fees, bandwidth, membership acquisition costs (purchase
of traffic), web site content costs, and depreciation of assets. Cost of sales
was 51% and 52% of total net revenue for the quarter and nine months ended
December 31, 2001, respectively, as compared to 49% and 52% of net revenue for
the quarter and nine months ended December 31, 2000, respectively.
More than 70% of the traffic to the Internet Group's web sites is acquired
through affiliate programs that it markets to webmasters. These programs
compensate webmasters for traffic referrals to the Internet Group's web sites. A
webmaster will be paid a fee of $25 - $45 per referral that results in a monthly
membership to one of the Internet Group's web sites. Any traffic referred that
does not result in a membership to the Internet Group's web sites will be sold
by the Internet Group to other webmasters via affiliate programs to which it
belongs, resulting in revenue from traffic sales.
The Internet Group's traffic acquisition costs were $0.7 million, or 14% of net
revenue, as of the quarter ended December 31, 2001, as compared to $2.7 million,
or 30% of net revenue, for the quarter ended December 31, 2000, representing a
decrease of 74%. The Internet Group's traffic acquisition costs were $3.9
million, or 20% of net revenue, for the nine months ended December 31, 2001, as
compared to $7.1 million, or 28% of net revenue, for the nine months ended
December 31, 2000, which represents a decrease of 45%. This decrease is due to
the implementation of new traffic acquisition programs that focused on
decreasing customer acquisition costs. The Internet Group is focusing its
efforts on further refining its customer acquisition programs in order to
balance these costs with the revenue generated. The Group expects to see
incremental increases in its customer acquisition costs in future periods in
order to generate additional traffic to its sites.
Merchant banking fees, including fees for credits and chargebacks, were 9% of
gross membership revenue for both quarters ended December 31, 2001 and 2000.
Merchant banking fees, including fees for credits and chargebacks increased from
9% of gross membership revenue as of the nine months ended December 31, 2000 to
10% as of the nine months ended December 31, 2001. The Internet Group was
successful in its attempt to reverse the Visa fine assessed during the quarter
ended September 30, 2001, and this is reflected in the current quarter's
results.
Operational expenses, which include depreciation and amortization of Internet
equipment, were 20% and 9% of net revenue for the quarters ended December 31,
2001 and December 31, 2000, respectively. Operational expenses, which include
depreciation and amortization of Internet equipment, were 15% and 8% of net
revenue for the nine months ended December 31, 2001 and December 30, 2000,
respectively. This increase in operational expenses is primarily related to
operating lease, maintenance and depreciation expenses incurred in the build out
of the Internet Group's ISP facility which was completed this quarter.
OPERATING INCOME
Operating income for the Internet Group was $0.3 million for the quarter ended
December 31, 2001 as compared to $1.2 million for the quarter ended December 31,
2000, representing a decrease of 75%. Operating income for the Internet Group
was $2.3 million for the nine months ended December 31, 2001 as compared to $3.6
million for the nine months ended December 31, 2000, which represents a decrease
of 36%.
19
<Page>
Operating expenses were 43% and 36% of net revenue for the quarter and nine
months ended December 31, 2001, respectively, as compared to 38% and 33% of net
revenue for the quarter and nine months ended December 31, 2000, respectively.
Total operating expenses decreased 35% and 19% from the quarter and nine months
ended December 31, 2000.
The decrease in operating expenses for the quarter and nine months is a result
of the establishment of a reserve for bad debts during the quarter ended
December 31, 2000, in the amount of $0.8 million and a decrease in legal, trade
show, advertising and consulting expenses.
The Internet Group is currently undergoing a restructuring of its operations.
This restructuring includes the elimination and/or consolidation of job
functions to the Company's Boulder, Colorado location and the planned sublease
of its eighth floor facility in Sherman Oaks, California. The Internet Group
expects that all consolidation activities will be finalized by the end of the
first quarter of its fiscal year ending March 31, 2003.
CORPORATE ADMINISTRATION
The Corporate Administration segment includes all costs associated with the
operation of the public holding company, New Frontier Media, Inc. These costs
include, but are not limited to, legal and accounting expenses, insurance,
registration and filing fees with NASDAQ and the SEC, investor relations costs,
and printing costs associated with the Company's public filings.
The operating loss for this segment was $1.2 million for both the quarters ended
December 31, 2001 and 2000. The operating loss for this segment increased from a
loss of $4.2 million as of the nine months ended December 31, 2000 to a loss of
$4.7 million as of the nine months ended December 31, 2001, an increase of 12%.
The increase in the operating loss for this segment for the nine months ended
December 31, 2001, is due to an increase in consulting expenses related to the
hiring of an investment advisory firm, an increase in travel expenses related to
more frequent travel to the Internet Group location in Los Angeles, and an
increase in the Company's insurance premiums. These increases were offset by a
32% decrease in legal costs during the same period.
OTHER INCOME (EXPENSE)
Other income (expense) increased from expense of $0.1 million and $11.1 million
for the quarter and nine months ended December 31, 2000, respectively, to income
of $1.6 million and $0.7 million for the quarter and nine months ended December
31, 2001, respectively. The nine months ended December 31, 2000, includes two
nonrecurring items: 1) a $10 million reserve for the jury verdict issued in the
J.P. Lipson lawsuit ("Lipson lawsuit"), and 2) a $507,500 loss for the write
down of Metro Global Media, Inc. ("Metro") stock.
The quarter and nine months ended December 31, 2001, include two nonrecurring
items: 1) the reversal of $1.7 million of the Company's legal reserve subsequent
to the settlement of the Lipson lawsuit and 2) $0.3 million in revenue related
to the release of the Company's service obligations to Metro.
The Company was a defendant in a lawsuit filed on January 25, 1999 in which J.P.
Lipson sought to enforce an alleged agreement with the Company. On September 1,
2000, a jury entered a verdict awarding to the plaintiff $10 million in
liquidated damages and, in the alternative, $1 million in actual damages and $1
million in punitive damages. The Company established a $10 million reserve on
its books during the quarter ended September 30, 2000 as a result of the jury
verdict.
Subsequent to September 30, 2000, the Boulder District Court entered an order
granting the Company's motion to reduce the actual damages against the Company
from $10 million to $1 million, thereby reducing Mr. Lipson's total award,
exclusive of interest, to $2.5 million. The Company thereafter reduced the $10
million reserve on its books to $2.5 million.
20
<Page>
On December 26, 2001, the Company announced that it had settled the Lipson
lawsuit in its entirety for a lump sum payment of $820,000 made to his
attorneys. At that time, the Company reversed the remaining $1.7 million in
legal reserve.
In July 1999, the Company entered into an agreement with Metro in which it
received 250,000 shares of Metro common stock. The market value of this stock on
the date of the transaction was $2.47 per share. Subsequent to this agreement
the stock was delisted from the NASDAQ, is now thinly traded on the
over-the-counter market, and its value as of September 30, 2000 had declined to
$0.47 per share. Due to the permanent impairment in the value of this stock, the
Company wrote the stock down to $117,500 on its books during the quarter ended
September 30, 2000, and took a write off of $507,500.
The Company recognized $0.3 million in revenue during the quarter ended December
31, 2001, in connection with Metro releasing the Company from its obligations to
perform services under a contract signed in July 1999 for which the Company was
given 250,000 shares of Metro stock. At the time the contract was signed, the
Company recognized deferred revenue in the amount of $0.6 million, the fair
market value of the Metro stock on that date. Since that time, the Company has
amortized this deferred revenue over 60 months for services it was providing to
Metro. The Company has ceased providing these services to Metro and Metro
released the Company from its obligation of providing any future services during
this current quarter. Accordingly, the remaining deferred revenue has now been
recognized.
The Company's interest expense has increased from $0.1 million and $0.7 million
for the quarter and nine months ended December 31, 2000, respectively, to $0.4
million and $1.5 million for the quarter and nine months ended December 31,
2001, respectively. This increase is due to the additional $4.0 million in debt
outstanding as of December 31, 2001.
DEFERRED TAX ASSET
SFAS 109, "Accounting for Income Taxes" requires, among other things, the
separate recognition, measured at currently enacted tax rates, of deferred tax
assets and deferred tax liabilities for the tax effect of temporary differences
between the financial reporting and tax reporting bases of assets and
liabilities, and net operating loss and tax credit carryforwards for tax
purposes. A valuation allowance must be established for deferred tax assets if
it is "more likely than not" that all or a portion will not be realized.
As of September 30, 2000, the Company estimated that it had $7.6 million in net
operating loss carryfowards which expire from 2012 through 2021. Based on the
recent history of operating profits and the expected profitability of the
Company in future periods, the Company concluded at that time that it was "more
likely than not" that the full benefit of its deferred tax assets would be
realized in future years. Accordingly, a valuation allowance was not required
for the $8.5 million in deferred tax assets.
The Company expects to realize its deferred tax assets through the generation of
future taxable income. The amount of future income required based on currently
enacted tax rates applied to the deferred tax asset amount as of September 30,
2000, is approximately $21 million. Due to the fact that the Company had
recorded several quarters of operating profitability the Company concluded
during the quarter ended September 30, 2000 that a valuation allowance was not
necessary for its net deferred tax assets.
CRITICAL ACCOUNTING POLICIES
Accounting policies that management believes are most critical to the Company's
financial condition and operating results pertain to the valuation of prepaid
distribution rights, revenue recognition and stock based compensation. In
deriving accounting estimates management considered available information and
exercised reasonable judgment. However, actual results could differ from these
estimates.
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LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended December 31, 2001, cash provided by operating
activities of $5.4 million was primarily associated with net income of $1.8
million, depreciation and amortization expense of $6.5 million, a decrease in
other receivables and prepaid assets of $1.5 million, and a decrease in accounts
receivable of $1.2 million. This cash provided by operations was offset by a
$3.8 million increase in distribution rights related to the Company's licensing
of content and a $2.5 million decrease in the Company's legal reserve related to
the Lipson lawsuit (see Part II, Item I. Legal Proceedings).
For the nine months ended December 31, 2000, cash provided by operating
activities of $0.7 million was primarily associated with a $10.0 million
increase in the Company's reserve related to the Lipson lawsuit, depreciation
and amortization of $4.6 million, $0.5 million for the write down of the
Company's investment in Metro, and a $0.8 million increase in accounts payable.
The cash provided by operations was offset by a net loss of $2.1 million, an
increase in the Company's deferred tax asset of $7.7 million, an increase in
accounts receivable of $2.0 million primarily related to receivables from the
Subscription/PPV TV Group's DBS providers and receivables related to the
Internet Group's sale of traffic and content, and a $3.4 million increase in the
Subscription/PPV TV Group's prepaid distribution rights for its content
licensing.
Cash used in investing activities was $3.0 million for the nine months ended
December 31, 2001. This use of cash was primarily related to $0.5 million paid
for the acquisition of the subscriber base of Emerald Media, Inc. by the
Subscription/PPV TV Group and $2.1 million related to the build out of space for
the Internet Group, the ISP facility and the Boulder, Colorado headquarters.
Cash used in investing activities for the nine months ended December, 2000 was
$3.6 million and was primarily associated with the purchase of domain names for
the Internet Group in the amount of $1.6 million and equipment for the broadcast
and Internet service provider facilities.
Cash used in financing activities was $3.5 million for the nine months ended
December 31, 2001, compared to cash provided by financing activities of $4.4
million for the nine months ended December 31, 2000. Cash used in financing
activities for the nine months ended December 31, 2001 was related to the
repayment of $2.0 million in principal on the Company's notes payable and $1.6
million in payments made on the Company's capital leases. Cash provided by
financing activities of $4.4 million for the nine months ended December 31,
2000, was attributable to the contribution of $1.3 million by the senior
management group as part of the agreement reached with NASDAQ to maintain the
Company's listing and an increase of $5.0 million in notes payable. This cash
provided by financing activities was offset by $0.5 million distributed to the
previous shareholders of the Internet Group, $0.9 million paid on capital lease
obligations, and $1.0 million paid to related parties.
The Company currently has $4.0 million in notes payable outstanding. The notes
bear interest at 12 - 15% per annum and the principal is due in 2002 and 2003.
The Company expects to pay the interest due in common stock where possible and
out of cash flow from operations in all other instances. In addition, the
Company expects to pay the principal due in 2002 and 2003 out of cash flows from
operations or through a refinancing of the notes at the time of maturity.
The Company is seeking to raise up to $10 million of senior debt during its
current fiscal year in order to fund expansion and consolidation opportunities.
There can be no assurances provided that the Company will be successful in its
ability to complete this financing.
The Company believes that its existing cash balances and cash generated from
operations will be sufficient to satisfy its operating requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk. The Company's exposure to market risk is principally confined to
cash in the bank, money market accounts, and notes payable, which have short
maturities and, therefore, minimal and immaterial market risk.
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Interest Rate Sensitivity. As of December 31, 2001, the Company had cash in
checking and money market accounts. Because of the short maturities of these
instruments, a sudden change in market interest rates would not have a material
impact on the fair value of these assets.
Foreign Currency Exchange Risk. The Company does not have any foreign currency
exposure because it currently does not transact business in foreign currencies.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and two of its officers were defendants in a lawsuit filed on
January 25, 1999 by J.P. Lipson in the District Court in Boulder, Colorado (Case
No. 99CV30). On December 26, 2001, the Company announced that it had settled the
Lipson lawsuit in its entirety for a lump sum payment of $820,000 made to his
attorneys. On January 25, 2002, the District Court issued an order dismissing
Lipson's lawsuit with prejudice and vacating the judgment previously entered in
the case.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
10.1 Revised Employment Agreement between Interactive Telecom Network, Inc.
and Jerry Howard
b) Reports on Form 8-K
On November 29, 2001, the Company filed a Form 8-K to announce its change in
accountants from Singer, Lewak, Greenbaum & Goldstein LLP to Grant Thornton LLP.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed in its behalf by the
undersigned thereunto duly authorized.
NEW FRONTIER MEDIA, INC.
/s/ Karyn L. Miller
--------------------------------------
Karyn L. Miller
Chief Financial Officer
(Principal Accounting Officer)
Dated: February 11, 2002.
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