<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1999
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number: 333-78957
----------------
TVN ENTERTAINMENT CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 95-4138203
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
2901 West Alameda Avenue, Seventh Floor
Burbank, California 91505
(Address of principal executive offices, including zip code)
(818) 526-5000
(Registrant's telephone number, including area code)
----------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 [_] NO [X]
There were 152,517 shares of the Company's Common Stock, par value $.001,
outstanding on December 31, 1999.
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TVN ENTERTAINMENT CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
------- --------------------- --------
<C> <S> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1999 and
March 31, 1999........................................... 3
Consolidated Statements of Operations for the Three and
Nine Months Ended December 31, 1999 and 1998............. 4
Consolidated Statements of Cash Flows for the Nine Months
Ended December 31, 1999 and 1998......................... 5
Notes to Consolidated Financial Statements................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk..................................................... 34
<CAPTION>
PART II. OTHER INFORMATION
-------- -----------------
<C> <S> <C>
Item 6. Exhibits and Reports on Form 8-K.......................... 34
Signatures.......................................................... 35
</TABLE>
2
<PAGE>
TVN ENTERTAINMENT CORPORATION
Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
December 31, March 31,
1999 1999
------------ ---------
(Unaudited) (Audited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................. $ 37,172 $ 84,343
Restricted short-term investments..................... 22,194 25,909
Trade and other accounts receivable, less allowance
for doubtful accounts of $292 and $427 at December
31, 1999 and March 31, 1999, respectively............ 7,309 5,615
Inventory............................................. 1,589 807
Prepaid expenses and other current assets............. 2,677 656
-------- --------
Total current assets................................ 70,941 117,330
Restricted cash....................................... 2,000 1,903
Restricted investments................................ 22,314 39,309
Property and equipment, net........................... 93,239 84,997
Intangible assets, net................................ 15,881 4,585
Other assets, net..................................... 7,037 6,601
-------- --------
Total assets........................................ $211,412 $254,725
======== ========
Liabilities, Redeemable Convertible Preferred Stock and
Stockholders' Deficit
Current liabilities:
Accounts payable...................................... $ 8,962 $ 4,496
Accrued liabilities................................... 11,228 9,445
License fees payable.................................. 9,953 8,321
Deferred revenue and advances......................... 1,479 1,140
Accrued interest...................................... 11,773 7,284
Current portion of capitalized leases................. 10,401 7,444
Current portion of notes payable...................... 6,703 8,228
-------- --------
Total current liabilities........................... 60,499 46,358
Accrued interest...................................... 405 --
Capitalized leases.................................... 91,776 88,259
Notes payable......................................... 18,636 7,439
Senior notes due 2008................................. 156,064 186,798
-------- --------
Total liabilities................................... 327,380 328,854
Commitments and contingencies
Series B redeemable convertible preferred stock;
Liquidation value: $54,414............................ 53,345 53,047
Stockholders' deficit:
Series A convertible preferred stock; liquidation value:
$18,750................................................ 8 8
Common stock.......................................... -- --
Additional paid-in-capital............................ 23,169 22,747
Accumulated deficit................................... (192,490) (149,931)
-------- --------
Total stockholders' deficit......................... (169,313) (127,176)
-------- --------
Total liabilities and stockholders' deficit......... $211,412 $254,725
======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
TVN ENTERTAINMENT CORPORATION
Consolidated Statements of Operations
(In thousands except per share data)
(Unaudited)
<TABLE>
<CAPTION>
The three months The nine months
ended December ended December
31, 31,
------------------ ------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue............................... $ 18,923 $ 11,244 $ 53,133 $ 25,362
Operating expenses:
Cost of revenue (exclusive of
depreciation shown separately
below)............................. 16,571 8,968 46,704 20,882
Selling............................. 3,834 3,311 12,175 9,251
General and administrative.......... 5,402 2,125 15,383 5,833
Depreciation and amortization....... 3,664 3,057 10,486 9,127
Amortization of intangible assets... 1,054 -- 2,287 --
-------- -------- -------- --------
Total operating expenses.............. 30,525 17,461 87,035 45,093
-------- -------- -------- --------
Loss from operations.................. (11,602) (6,217) (33,902) (19,731)
Interest expense...................... 10,541 10,958 32,673 23,459
Interest income....................... (1,132) (2,318) (4,615) (4,116)
Other (income) and expense............ 433 -- 571 (33)
-------- -------- -------- --------
Loss before extraordinary gain........ (21,444) (14,857) (62,531) (39,041)
Extraordinary gain.................... 19,972 -- 19,972 1,113
-------- -------- -------- --------
Net loss.............................. $ (1,472) $(14,857) $(42,559) $(37,928)
Accretion of Series B redeemable
convertible preferred stock.......... (100) (99) (298) (296)
-------- -------- -------- --------
Net loss applicable to common
stockholders......................... $ (1,572) $(14,956) $(42,857) $(38,224)
======== ======== ======== ========
Basic and diluted net loss per share
applicable to common stockholders:
Net loss applicable to common
stockholders before extraordinary
gain................................. $(141.26) $ (98.07) $(411.95) $(257.92)
Extraordinary gain.................... 130.95 -- 130.95 7.30
-------- -------- -------- --------
Net loss applicable to common
stockholders......................... $ (10.31) $ (98.07) $(281.00) $(250.62)
======== ======== ======== ========
Weighted average common shares........ 152,517 152,517 152,517 152,517
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
TVN ENTERTAINMENT CORPORATION
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
The nine months ended
December 31,
----------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss.............................................. $ (42,559) $ (37,928)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization....................... 10,486 9,127
Amortization of intangible assets................... 2,287 --
Provision for doubtful accounts..................... 181 224
Accretion of discount on senior notes............... 1,243 589
Amortization of debt issuance costs................. 540 275
Other non-cash charges.............................. 463 --
Debt forgiveness.................................... -- (1,113)
Gain on senior note redemption...................... (19,972)
Changes in assets and liabilities, net of
acquisition:
Restricted cash and investments................... (97) (61)
Accounts receivable............................... (701) (3,047)
Inventory......................................... (784) (44)
Prepaid expenses and other current assets......... (132) 239
Other assets...................................... (1,463) 46
Accounts payable.................................. 4,074 49
Accrued liabilities............................... 1,132 2,476
License fees payable.............................. 1,632 1,247
Deferred revenue and advances..................... 130 250
Accrued interest.................................. 4,894 10,306
---------- ----------
Net cash used for operating activities................ (38,646) (17,365)
Cash flows from investing activities:
Purchases of property and equipment................. (3,956) (1,694)
Disposals of property and equipment................. 322 --
Purchases of restricted investments................. -- (76,745)
Proceeds from maturities of restricted investments.. 11,764 (1,709)
Proceeds from redemption of restricted investments.. 8,945 --
Acquisition of NMN, net of cash acquired............ (165) --
Acquisition of GRTV Network, net of cash acquired... (216) --
Equity investments.................................. (1,627) --
---------- ----------
Net cash provided by (used for) investing activities.. 15,067 (80,148)
Cash flows from financing activities:
Issuance of stock................................... -- 38
Repurchase of senior notes and warrants............. (11,763) --
Repayments of capitalized leases.................... (5,676) (4,054)
Repayments of notes payable......................... (6,153) (16,365)
Net proceeds from issuance of senior notes............ -- 193,400
---------- ----------
Net cash provided by (used for) financing activities.. (23,592) 173,019
---------- ----------
Net increase (decrease) in cash and cash equivalents.. (47,171) 75,506
Cash and cash equivalents at the beginning of period.. 84,343 16,798
---------- ----------
Cash and cash equivalents at the end of period........ $ 37,172 $ 92,304
========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
TVN ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The financial statements are unaudited, other than the balance sheet at
March 31, 1999, and reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management, necessary for
a fair presentation of the Company's financial condition, operating results
and cash flows for the interim periods.
Certain items shown in the prior financial statements have been
reclassified to conform with the presentation of the current period.
These financial statements should be read in conjunction with the Company's
audited financial statements for the year ended March 31, 1999 and the notes
thereto.
2. Commitments and Contingencies
Commitments
On May 28, 1999, the Company entered into an agreement with Four Media
Company ("4MC") to purchase certain uplink, downlink, programming origination
and other services to be rendered to the Company by 4MC and for 4MC to finance
the acquisition of equipment and software to be used by 4MC to provide such
services, commencing on the execution date of the agreement and continuing
through November 30, 2004. The Company has the right to renew the agreement
for two additional two-year terms. Commencing on approximately November 1,
1999, the Company has agreed to pay 4MC $479,200 per month as consideration
for such services during the term of the agreement. The Company also entered
into an agreement with 4MC to sublease an additional 14,883 square feet of
office space in the building where the Company has its principal offices,
commencing April 1, 1999 and expiring on March 31, 2005. The minimum
commitment over the term of the sublease totals approximately $3.1 million.
In July 1999, the Company entered into a media access, consulting and
services agreement to purchase $15 million of such services to be rendered by
Guthy-Renker Corporation ("GRC") over a five year period and paid for by the
Company to GRC in equal monthly installments of $250,000. Such services
include (i) the right to broadcast infomercial programming provided by GRC on
a priority basis, (ii) consulting services regarding product selection,
infomercial production, worldwide operations, merchandising procurement and
order fulfillment, (iii) access to GRC's library of infomercials and (iv) the
availability of products distributed by or through GRC, for distribution by
the Company's home shopping network.
In September 1999, in connection with the resignation of an executive of
the Company, the Company paid the executive approximately $700,000 in
satisfaction of the executive's salary, bonus and severance benefits arising
under the executive's employment agreement. In addition, the Company paid the
executive approximately $1.9 million in connection with the cancellation of
options to purchase 599,775 shares of the Company's common stock previously
issued to the executive, as well as the termination of the executive's Put
Right.
The Company's minimum commitments and contingencies under employment
agreements entered into after March 31, 1999 aggregated approximately
$3,011,000 and $848,000, respectively, primarily as a result of our
acquisitions. These agreements are expiring at various times between 2001 and
2003.
6
<PAGE>
TVN ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Contingencies
The Company was a development stage enterprise from its incorporation in
1987 until March 5, 1991. On March 6, 1991, the Company entered into a limited
partnership, TVN Entertainment L.P. (the "Partnership"), comprised of itself
as a limited partner and two general partners. The Partnership was an
operating entity and was accounted for on the equity basis during the period
from March 6, 1991, to May 15, 1992.
On May 15, 1992, the Company acquired the general partners' interests in
the Partnership, which was dissolved pursuant to a partnership dissolution
agreement which provided that the Company receive all partnership assets and
assume certain liabilities as of the dissolution date for an effective
purchase price of $1. These liabilities included notes payable to the former
general partners and certain Company shareholders totaling $16,502,539 and
$1,080,000, respectively.
Interest accrues on these obligations at prime plus 1% and totaled
$11,401,256 and $866,351, respectively, at December 31, 1999. These loans and
related accrued interest (collectively the "Contingent Debt") will be paid on
a pari-passu basis out of "available cash flow", as defined in the Restated
Limited Partnership Agreement dated March 7, 1991. The dissolution agreement
provides that the Company will not make any distributions or pay any dividends
in respect of its capital stock or other equity interests prior to the payment
in full of its obligations to TVN's former general partners and will not
subordinate these obligations to other debt.
Because payment of these obligations is dependent upon "available cash
flow", this debt represents contingent consideration related to the
acquisition of net assets. The Company has had continuing negative operating
cash flows so payment of these obligations does not appear to be probable at
this time. Accordingly, these obligations have not been recorded as a
liability in accordance with Accounting Principles Board Opinion No. 16,
"Business Combinations," because the outcome of the contingency is not
determinable beyond a reasonable doubt. The company will record these
liabilities when the contingency is resolved.
On December 13, 1999, the Company was served with a lawsuit filed in
California state court by TV/COM International, Inc., a company with which we
entered into memoranda of understanding (MOU) concerning (i) it obtaining a
Digicipher II encryption technology license from General Instrument and (ii)
its obligation to utilize such license for the manufacture of Digicipher II
encryption compatible television set-top cable boxes for us, once TV/COM
demonstrated its ability to do so in quantity and to our specifications. The
lawsuit alleges breach of contract, fraud and negligent misrepresentation
along with several related causes of action and asks the court to award
specific damages of $25,050,000 as well as other unspecified damages and
costs. We have also scheduled meetings with TV/COM in an attempt to negotiate
a settlement of the lawsuit. We believe that the claims in the lawsuit are not
meritorious and we have retained counsel to provide a vigorous defense.
In addition, the Company has been party to other legal and administrative
proceedings related to claims arising from its operations in the normal course
of business. On the advice of counsel, the Company believes it has adequate
legal defenses and believes that the ultimate outcome of these actions will
not have a material adverse effect on the Company's consolidated financial
position, results of operations or cash flows.
3. Acquisitions
On January 18, 1999, the Company acquired certain assets of PSN, a 24-hour
home shopping video network, for aggregate consideration of $500,000 in cash,
the forgiveness of $948,000 in trade accounts receivable and the assumption of
$3.4 million in net liabilities. The acquisition has been accounted for as a
purchase. The excess of purchase consideration over net tangible assets
acquired of approximately $4.8 million has been allocated to goodwill which is
being amortized on a straight-line basis over 5 years.
7
<PAGE>
TVN ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
On June 30, 1999, the Company acquired 60% of the fully diluted equity of
New Media Network, Inc. ("NMN"), a start-up company that is developing and
plans to deploy a system utilizing state-of-the-art digital downloading
technology to deliver and sell entertainment products such as music, movies
and games via the Internet and at retail locations. The aggregate
consideration included a cash commitment totaling $2 million, a commitment to
render $4 million of Company services to NMN over a three-year period and an
obligation to purchase a portion of the outstanding stock of NMN for $2.68
million subject to certain conditions. The Company accounted for the
acquisition as a purchase. The excess of purchase consideration over net
tangible assets acquired of approximately $3.3 million has been allocated to
acquired technology and amortized over a period of three years.
In July 1999, the Company acquired from Guthy-Renker Corporation ("GRC")
substantially all of the assets of Guthy-Renker Television Network, Inc.
("GRTV"), a media buying business and a wholly owned subsidiary of GRC, for
consideration consisting of: (i) $302,000 in cash; (ii) $4 million payable in
cash per the terms of a promissory note, payable at 6% interest in two equal
annual installments commencing one year from the closing date; (iii) $9
million payable in cash or TVN stock per the terms of the promissory note,
payable at 9% interest on the earlier to occur of the fifth anniversary of the
closing date or the consummation of an initial public offering by the Company;
and (iv) a warrant to purchase 200,000 shares of the Company's stock.. The
acquisition was accounted for as a purchase.
The excess of purchase consideration after adjustments to the discount rate
on the notes; over net tangible assets acquired of approximately $10.2 million
has been allocated to goodwill and amortized over a period of five years.
The following summarized unaudited pro forma financial information assumes
the NMN and GRTV acquisition occurred at the beginning of each period and that
the PSN acquisition occurred on April 1, 1998.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ------------------
Dec 31, Dec 31, Dec 31, Dec 31,
1999 1998 1999 1998
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Revenue........................... $ 18,923 $ 19,362 $ 59,443 $ 50,929
Net Loss applicable to common
stockholders..................... (1,908) (18,347) (44,081) (46,301)
Basic and diluted net loss
applicable to Common
stockholders..................... $ (12.51) $ (120.30) $(289.02) $(303.58)
Weighted average shares........... 152,517 152,517 152,517 152,517
</TABLE>
4. Senior Note due 2008
In October 1999, the Company repurchased $33,850,000 of its 14% Senior
Notes due 2008 and 33,850 warrants to purchase 10.777 shares of the Company's
common stock for aggregate consideration of approximately $12.8 million in
cash. The repurchase resulted in the release of approximately $8.9 million of
restricted investments that were held in custody to fund the next four
scheduled interest payments on the repurchased notes. The repurchase also
resulted in an extraordinary gain of approximately $20 million.
5. Operating Segments
The Company's operating segments are strategic operating units that are
managed separately due to their different products and/or services. The
digital cable operating segment markets and sells the Company's DCTV service,
a turnkey digital delivery system with programming content, including 32
channels of pay-per-view movies and events, and support services which enables
cable operators to expand their existing channel capacity,
8
<PAGE>
TVN ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
and PPV Feeds service, a pay-per-view programming service without support
services. The home satellite dish operating segment markets and sells the
Company's home satellite dish service, an analog pay-per-view delivery system
transmitted directly to C-Band home satellite dish consumers. The satellite
transmission operating segment markets and sells transponder capacity and
uplinking services to the Company's other operating segments and to third
parties. The home shopping services operating segment broadcasts the Panda
Shopping Network, a live on-air home televised shopping channel which markets
and sells merchandise such as jewelry, watches and precious metal
collectibles. The music marketing services operating segment is a start-up
company, New Media Network, Inc., that markets and sells entertainment
products such as music, movies and games via the internet and at retail
locations. The media time sales operating segment, GRTV Network, Inc., sells
media time on its 24-hour broadcast network.
The Company's measure of profit or loss for its operating segments reviewed
by the chief operating decision maker and executive management is operating
loss, excluding depreciation and amortization (and also excludes interest and
other income and expense). Revenue and operating losses for the Company's
operating segments are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
-------------------- ------------------
Dec 31, Dec 31, Dec 31, Dec 31,
1999 1998 1999 1998
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Revenue:
Digital cable services........... $ 3,554 $ 4,325 $ 12,061 $ 6,429
Home satellite dish services..... 3,640 4,148 11,644 11,971
Satellite transmission services.. 5,402 6,659 15,096 18,734
Home shopping services........... 4,046 -- 13,803 --
Music marketing services......... 14 -- 230 --
Media time sales................. 6,724 -- 12,751 --
Intersegment eliminations........ (4,457) (3,888) (12,452) (11,772)
--------- -------- -------- --------
Total revenue................. $ 18,923 $ 11,244 $ 53,133 $ 25,362
========= ======== ======== ========
<CAPTION>
Three Months Ended Nine Months Ended
-------------------- ------------------
Dec 31, Dec 31, Dec 31, Dec 31,
1999 1998 1999 1998
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Operating profit/(loss):
Digital cable services........... $ (5,245) $ (5,859) $(17,403) $(17,425)
Home satellite dish service...... (2,914) (3,511) (9,599) (10,551)
Satellite transmission services.. 4,987 6,210 13,653 17,374
Home shopping services........... (2,694) -- (5,622) --
Music marketing services......... (1,204) -- (1,919) --
Media time sales................. 186 -- (239) --
--------- -------- -------- --------
Operating loss excluding
depreciation and amortization... (6,884) (3,160) (21,129) (10,603)
Depreciation and amortization.... 4,718 3,057 12,773 9,127
--------- -------- -------- --------
Operating loss................ $ (11,602) $ (6,217) $(33,903) $(19,731)
========= ======== ======== ========
</TABLE>
As of December 31, 1999, one customer accounted for 18% of accounts
receivable. For the three and nine months ended December 31, 1999, one
customer accounted for 19% and 17% of total revenues, respectively.
9
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TVN ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
6. Earnings Per Share
The following table sets forth the computation of basic and diluted net loss
per share applicable to common stockholders for the three and nine months ended
December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ------------------
Dec 31, Dec 31, Dec 31, Dec 31,
1999 1998 1999 1998
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Numerator:
Net loss......................... $ (1,472) $ (14,857) $(42,559) $(37,928)
Accretion of redeemable Series B
preferred stock................. (100) (99) (298) (296)
-------- --------- -------- --------
Net loss applicable to common
stockholders.................... $ (1,572) $ (14,956) $(42,857) $(38,224)
======== ========= ======== ========
Denominator:
Weighted average shares.......... 152,517 152,517 152,517 152,517
======== ========= ======== ========
Basic and diluted net loss
applicable to Common
stockholders..................... $ (10.31) $ (98.07) $(281.00) $(250.62)
======== ========= ======== ========
</TABLE>
7. Income Taxes
As a result of net losses for the three and nine months ended December 31,
1999 and 1998, and the Company's inability to recognize a benefit for its
deferred income tax assets, the Company did not record a provision for income
taxes as of December 31, 1999 and 1998.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to the other information in this report, certain statements in
the following Management's Discussion and Analysis of Financial Condition and
Results of Operation (MD&A) are forward looking statements. When used in this
report, the word "expects," "anticipates," "estimates," and similar
expressions are intended to identify forward looking statements. Such
statements are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. Such risks and
uncertainties are set forth below under "Factors Affecting Future Operating
Results." The following discussion should be read in conjunction with the
Consolidated Financial Statements and notes thereto included elsewhere in this
report.
Overview
Our company provides a wide variety of new television programming and
services that we deliver in digital format to cable operators for their
subscribers using existing cable infrastructure. Our TVN Digital Cable
Television service enables cable operators to substantially enhance the
variety and quality of programming choices through a more efficient use of
their cable transmission capacity by utilizing recent industry technology that
compresses eight or more digital channels onto one analog channel. We believe
our TVN Digital Cable Television service is attractive particularly to smaller
and medium size cable systems, including smaller systems owned by large cable
operators, which may lack the scale, funding, technical or administrative
resources to economically implement a full offering of digital programming on
their own. For larger cable systems that do not require all of the features of
our TVN Digital Cable Television service, we can deliver our digital satellite
feeds of pay-per-view movies and events, known as our Pay-Per-View Feeds
Service, which includes our Marquee Mix service, a three channel service that
cable operators receive in digital format and convert to analog format at
their facilities for subsequent delivery to their subscribers. We launched our
digital cable programming and services business in late 1997.
Our efforts have historically focused on providing national satellite pay-
per-view and related services to large satellite dish owners. A substantial
majority of our revenues to date have been generated by pay-per-view fees paid
by our C-band subscribers. During the fiscal year ended March 31, 1999, over
260,000 C-band large satellite dish customers purchased pay-per-view
programming from us using their home telephone or remote control. During 1997,
General Instrument announced the introduction of its "4DTV" technology and
receivers that enable large satellite dish owners to receive both digital and
analog signals. Although we expected a significant portion of our large
satellite dish subscribers to use our digital services through new digital
4DTV receivers, the deployment of these receivers has been slower than
projected by General Instrument. General Instrument now plans to sell a lower
cost version of its 4DTV receiver, which it expects to be more popular with
large satellite dish owners.
In January 1999, we acquired substantially all of the assets of Panda
Shopping Network, a live televised home shopping network. Upon closing, we
placed those assets into TVN Shopping, Inc., our wholly owned subsidiary. The
Panda Shopping Network currently sells new and vintage watches, new and estate
jewelry, gemstones and precious metal coins. We purchase unused broadcast time
known as "remnant time" from local and national broadcasters, cable networks
and cable operators to distribute the Panda Shopping Network service.
In June 1999, we acquired 60% of the fully diluted equity of New Media
Network, Inc., a start-up company that is developing and plans to deploy a
system utilizing state-of-the-art digital downloading technology to deliver
and sell entertainment products such as music, movies and games via the
Internet and at retail locations.
In July 1999, we acquired substantially all of the assets of the Guthy-
Renker Television Network, Inc., a media buying business. Upon closing, we
placed those assets into GRTV Network, Inc., our wholly owned subsidiary. The
GRTV Network purchases primarily remnant time from cable operators and
packages that time for resale to infomercial programmers and other users of
broadcast media time. The infomercial programming is either broadcast via our
satellite transponders or sent to cable operators via videotape for insertion
into their video transmission.
11
<PAGE>
Our business plan contemplates that a substantial portion of future
revenues will be generated by our digital cable programming and services
business which includes our TVN Digital Cable Television service and our
Pay-Per-View Feeds Service. Our digital cable programming and services were
launched in late 1997 and have generated only modest revenues to date. We
believe that our future ability to service our indebtedness and to achieve
profitability is dependent upon our success in generating substantial revenues
from our digital cable programming and services and home shopping services. We
expect to continue experiencing negative operating margins and EBITDA while
our TVN Digital Cable Television service, Pay-Per-View Feeds service and home
shopping service are being marketed to cable systems and their subscribers. We
expect to realize improved operating margins and EBITDA only as:
. the number of cable systems offering our TVN Digital Cable Television
service and the number of cable systems offering Pay-Per-View Feeds
Service increases so as to increase the numbers of homes with access to
our digital programming and services;
. the number of subscribers to TVN Digital Cable Television service
increases;
. recurring purchases of our pay-per-view movies and events increase; and
. revenues are generated from our home shopping and electronic commerce
products and services.
The continued roll out of our digital cable programming and services
requires significant operating expenditures, in particular selling expenses, a
large portion of which will be expended before any revenue is generated. We
have experienced negative operating cash flows and significant losses as we
have marketed our digital cable television services and home shopping service.
These losses will likely continue until we can establish a customer base of
cable operators and their subscribers that will generate revenue sufficient to
cover our costs.
Revenue
Revenues from our digital cable programming and services are directly
related to the number of subscribers in cable systems offering either our TVN
Digital Cable Television service or our Pay-Per-View Feeds Service. Revenues
are expected to be derived primarily from monthly fees per subscriber, from
the sale of pay-per-view programming to TVN Digital Cable Television
subscribers, and purchases by subscribers in cable systems offering our Pay-
Per-View Feeds Service. Revenues from our digital cable programming and
services totaled approximately $39,000 and $10.9 million for the years ended
March 31, 1998 and 1999, respectively, and $12.1 million for the nine months
ended December 31, 1999.
TVN Digital Cable Television subscriber revenue consists of a monthly fee
charged per digital subscriber to the cable operator. A portion of this fee
may be rebated to the cable operator based on achieving certain subscriber
penetration rates or if the cable system operator agrees to carry a greater
number of channels of our pay-per-view offerings. Pay-per-view revenues are
derived from programming orders by TVN Digital Cable Television subscribers.
We remit a percentage of the pay-per-view revenue to the cable operator and
the content provider. Pay-per-view orders are generally paid for by credit
card with revenue recognized once the programming is viewed.
Revenue from the Pay-Per-View Feeds Service is based on a percentage of the
cable operators' gross revenue generated by the purchase of our pay-per-view
movies and events by their subscribers. Cable operators provide us with
monthly reports detailing pay-per-view purchases by their subscribers for the
prior month and remit our share of the revenue with such report.
We expect to realize revenue from both our TVN Digital Cable Television
service and our Pay-Per-View Feeds Service pursuant to long-term agreements
with cable operators. We recognize revenues under our cable operator
agreements only when our TVN Digital Cable Television service or Pay-Per-View
Feeds Service is successfully integrated and operating and customer billing
commences. Accordingly, the recognition of revenues will lag the announcement
of a new cable operator agreement by at least the time necessary to install
the service,
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generally 90 days, and to achieve a meaningful number of subscribers and/or
number of pay-per-view purchases. Revenues are expected to increase as our
current and future cable operator customers successfully deploy our TVN
Digital Cable Television service and our Pay-Per-View Feeds Service and
achieve higher subscriber penetration rates.
Revenue from our home satellite dish service are derived from pay-per-view
programming orders by large home satellite dish owners who subscribe to our
service. Revenue is recognized once the programming is viewed.
Satellite Transmission service revenue is generated upon the sale of
satellite transmitter capacity to our internal business units and to third
party programmers. Satellite Transmission revenue is recognized as the
services are rendered and intercompany sales are eliminated upon
consolidation.
Home Shopping service revenue is generated through merchandise sales to
television viewers and is related to the number of subscribers in cable
systems and viewers in television broadcast areas who receive our home
shopping service. Consumers generally pay for merchandise orders by credit
card with revenue recognized upon shipment of the goods.
Media Time sales are generated by sales of media time to infomercial
programmers, and are related to the number of cable subscribers that can
potentially view our customers' programming. Programmers pay either a fixed
rate in advance or a percentage of the sales generated by their programming,
with revenue recognized as the programming is aired.
Operating expenses
Operating expenses consist of Cost of Revenue, Selling, General and
Administrative, Depreciation and Amortization, and Amortization of Intangible
Assets expenses. Historically, a large portion of our expenses have been
generated by the large satellite dish business, but have also included
substantial operating expenses, lease payments and capital investments to
develop our digital cable programming and services business, which was
launched in the third quarter of fiscal 1998.
Cost of revenue. Cost of revenue for our TVN Digital Cable Television
service and Pay-Per-View Feeds Service primarily consists of program license
fees, payments to cable operators, satellite transmission and playback service
fees, per-subscriber authorization fees for cable television set-top cable box
authorization control, communications charges related to orders for pay-per-
view movies and events , and salaries and related expenses of engineering and
field operations personnel. License fees for pay-per-view programming are
payable to content providers under the terms of our license agreements and
generally vary between 30% and 55% of revenue depending on the type of
content. Payments to cable operators represent the percentage of pay-per-view
revenue shared with operators who have entered into TVN Digital Cable
Television service agreements and vary by individual agreement. Satellite
transmission services are purchased from an outside vendor pursuant to an
agreement that provides for a flat monthly fee. With respect to television
set-top cable box authorization to enable the box to receive a pay-per-view
movie or event, a fee to maintain access control per television set-top cable
box is payable to the licensor of the operative software pursuant to its
license agreement with us. Cost of revenue related to our digital cable
programming and services totaled approximately $2.9 million and $13.1 million
for the years ended March 31, 1998 and 1999 respectively, and $18.2 million
for the nine months ended December 31, 1999. The majority of cost of revenue
for our TVN Digital Cable Television service and Pay-Per-View Feeds Service
will vary directly with revenues:
. as subscriber pay-per-view buy rates increase causing us to incur
program license fees and access control charges related to orders for
pay-per-view movies and events;
. as we are required to hire additional engineering and field operations
personnel in connection with the growth of our digital cable programming
and services business; and
. according to the mix of services provided and their respective costs.
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<PAGE>
Cost of revenue for the home satellite dish service consists primarily of
program license fees, uplink service fees and playback service fees.
Cost of revenue for the satellite transmission service consist primarily of
uplink and playback service fees, as the cost for the satellite transmitters
has been capitalized pursuant to capitalized leases.
Cost of revenue for the home shopping service consists primarily of the
cost of goods sold, fulfillment, and airtime purchased from cable operators,
cable networks and broadcast networks. Costs of goods sold are approximately
60% of the retail price charged. Fulfillment costs include packaging and
shipping costs, while the cost of airtime varies by hour. The majority of cost
of revenue for the home shopping service will vary directly with revenue:
. as we increase airtime purchases to achieve greater distribution;
. as more consumers purchase our products; and
. according to the mix of product and airtime and their respective costs.
Cost of revenue for media time sales primarily consists of the cost of
airtime purchased from cable operators. The cost of airtime varies by hour and
generally varies directly with revenue.
Selling. Selling expenses for TVN Digital Cable Television service and Pay-
Per-View Feeds Service consist of customer acquisition costs, billing
expenses, customer service expenses, and salaries and related expenses of our
marketing personnel. Customer acquisition costs include expenses associated
with our marketing campaign to cable systems, and co-op advertising and
marketing efforts with affiliated cable systems. These expenses are required
to acquire new customers and related revenues but are discretionary and may be
increased or decreased by management in accordance with the anticipated growth
in new business and revenue. We expect to incur significant customer
acquisition costs as we market our TVN Digital Cable Television service and
Pay-Per-View Feeds service.
Implementing our TVN Digital Cable Television service requires cable
operators to acquire digital equipment for their facilities and digital
television set-top boxes for their subscribers. The new digital receiving
equipment required at an operator's facility to receive TVN Digital Cable
Television costs the operator approximately $50,000. For systems serving in
excess of 5,000 subscribers, we generally agree to make monthly financing
payments to the operator which approximate the operator's monthly financing
payments on 80% of the digital equipment cost for so long as the affiliation
agreement remains in effect.
Billing expenses consist of subscriber maintenance fees and remittance
processing fees, which vary directly with revenue. Customer service expenses
consist of payroll for call center representatives and telephone charges for
customer calls. To the extent that our subscriber base increases or decreases,
the required costs to support such subscribers would change correspondingly.
We expect to continue to incur significant customer service expenses to
support our current and future subscribers.
Selling expenses for our home satellite dish service consist of advertising
expenses, billing expenses, customer service expenses, and salaries and
related expenses of our marketing personnel.
Selling expenses for our home shopping service consist of customer service
expenses and remittance processing costs which generally vary directly with
revenue.
We incur minimal selling expenses to generate satellite transmission
service revenue and media time sales.
General and administrative. General and administrative expenses consist of
executive and administrative staff compensation, office expenses and
professional fees. General and administrative expenses cover a broad range of
the costs of our operations including corporate functions such as
administration, finance, legal, human resources and facilities.
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<PAGE>
Depreciation and amortization. Depreciation and amortization expenses
consist of depreciation on our capitalized programming transmitter leases and
depreciation on equipment necessary for our digital services and are fixed
with respect to revenue. Generally, depreciation is calculated using the
straight-line method over the useful lives of the associated assets, which
range from 5 to 10 years.
Amortization of intangible assets. Amortization of intangible assets
includes the amortization of technology and goodwill acquired through our
acquisitions.
Interest income and expense. Interest income will continue to be earned by
investing the proceeds from the issuance of equity and debt securities until
such proceeds are needed to fund our operating expenditures, particularly such
expenses incurred in connection with the continued roll out of our digital
cable programming and services business. Interest income is expected to be
highly variable over time. Interest expense will consist primarily of interest
accruing under the notes, capitalized leases and other outstanding
indebtedness.
Income taxes and net operating loss carryforwards
As a result of projected operating losses and the potential inability to
recognize a benefit for deferred income tax assets, we do not foresee
recording a provision for income tax expense in the near term.
As of March 31, 1999, we had federal and state net operating loss
carryforwards of approximately $141 million and $57 million, respectively,
which expire at various times in varying amounts beginning in the years 2004
and 2000, respectively. However, due to the provisions of Section 382, Section
1502 and certain other provisions of the Internal Revenue Code of 1986, as
amended, the utilization of a portion of the net operating loss carryforwards
may be limited. In addition, we are also subject to certain state income tax
provisions which may also limit the utilization of net operating loss
carryforwards for state income tax purposes.
Section 382 of the Code provides annual restrictions on the use of net
operating loss carryforwards, as well as other tax attributes, following
significant changes in ownership of a corporation's stock, as defined in the
Code. Investors are cautioned that future events beyond our control could
reduce or eliminate our ability to utilize the tax benefits of our net
operating loss carryforwards. Future ownership changes under Section 382 could
further restrict the use of the net operating loss carryforwards. In addition,
the Section 382 limitation could reduce available net operating loss
carryforwards to zero if we fail to satisfy the continuity of business
enterprise requirement for the two-year period following an ownership change.
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<PAGE>
Results of Operations
The table below sets forth for the periods indicated certain data regarding
expenses expressed as a percentage of total revenues:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- -------------------
1999 1998 1999 1998
---------- --------- -------- --------
<S> <C> <C> <C> <C>
Revenue...................... 100.0% 100.0% 100.0% 100.0%
Operating expenses...........
Cost of revenue............. 87.6 79.8 87.9 82.3
Selling..................... 20.3 29.5 22.9 36.5
General and administrative.. 28.5 18.9 29.0 23.0
Depreciation and
amortization............... 19.4 27.2 19.7 36.0
Amortization of intangible
assets..................... 5.6 -- 4.3 --
---------- -------- -------- --------
Total operating expenses..... 161.4 155.4 163.9 177.8
---------- -------- -------- --------
Loss from operations......... (61.4) (55.4) (63.8) (77.8)
---------- -------- -------- --------
Interest expense............. 55.7 97.5 61.5 92.5
Interest income.............. (6.0) (20.6) (8.7) (16.2)
Other (income) and expense... 3.9 -- 1.7 (0.1)
---------- -------- -------- --------
Loss before extraordinary
gain and non-controlling
interest in subsidiary..... (114.9) (132.1) (118.3) (153.9)
Extraordinary gain........... 105.5 -- (37.6) 4.4
---------- -------- -------- --------
Net loss..................... (9.4%) (132.1%) (80.7%) (149.5%)
========== ======== ======== ========
</TABLE>
Three Months Ended December 31, 1999 Compared with Three Months Ended
December 31, 1998
Revenue. Total revenue increased $7.7 million, or 68.3%, to $18.9 million
in the three months ended December 31,1999 from $11.2 million in the three
months ended December 31, 1998. Revenue generated by our Digital Cable
Television service decreased approximately $771,000 or 17.8% to $3.6 million
in the three months ended December 31, 1999 from $4.3 million in the three
months ended December 31, 1998. The decrease is primarily attributable to a
$1.4 million decrease in Marquee Mix revenue offset by slight increases in
programming generated by our turnkey business. Revenue generated by our home
satellite dish service decreased approximately $509,000, or 12.3% to $3.6
million in the three months ended December 31, 1999 from $4.1 million in the
three months ended December 31,1998. The decrease is primarily attributable to
a decline in the number of active subscribers for the quarter ended December
31, 1999 as compared to the quarter ended December 31, 1998. Satellite
transmission service revenue decreased $1.3 million, or 18.9%, to $5.4 million
in the three months ended December 31, 1999 from $6.7 million in the three
months ended December 31, 1998. The decrease is primarily attributable to
revenue generated by the sales of transponder time to the Panda Shopping
Network and the GRTV Network in 1998 that were not replaced by sales of
transponder time to other third parties upon acquiring these entities in 1999.
These decreases were offset by approximately $4.0 million in home shopping
revenues generated by TVN Shopping and $6.7 million in media time sales
generated by the GRTV Network. We had not commenced operation of these
entities as of December 31, 1998.
Operating Expenses
Cost of Revenue. Cost of revenue increased $7.6 million or 84.8%, to $16.6
million in the three months ended December 31, 1999 from $9.0 million in the
three months ended December 31, 1998 and, as a percentage of revenue,
increased to 87.6% in the three months ended December 31, 1999 from 79.8% in
the three months ended December 31, 1998. Approximately $9.5 million of the
increase is attributable to costs incurred by TVN
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<PAGE>
Shopping and the GRTV Network. The increase as a percentage of revenue is
primarily attributable to the distribution of lower margin products and
services by TVN Shopping and the GRTV Network, as compared to the programming
services provided by Digital Cable Television service and our home satellite
dish service. We had not acquired our interests in these entities as of
December 31, 1998.
Selling. Selling expenses increased $523,000, or 15.8%, to $3.8 million in
the three months ended December 31, 1999 from $3.3 million in the three months
ended December 31 1998 and, as a percentage of revenue, decreased to 20.3% in
the three months ended December 31, 1999 from 29.5% in the three months ended
December 31, 1998. Approximately $1.3 million of the increase is attributable
to selling expenses incurred by TVN Shopping and the GRTV Network. We had not
commenced operation of these entities as of December 31, 1998. This increase
is offset by a decrease of approximately $799,000 in selling expenses incurred
by the Digital Cable Television and home satellite dish businesses due to one-
time cost savings for advertising agency, web site maintenance and call center
costs in the three months ended December 31, 1999. The decrease as a
percentage of revenue is primarily attributable to the $10.7 million in
revenue generated by TVN Shopping and the GRTV Network, as selling expenses
for these business units was approximately 12% of revenue as compared to 50%
and 20% of revenue for our Digital Cable Television service and home satellite
dish service, respectively.
General and Administrative. General and administrative expenses increased
$3.3 million, or 154.2%, to $5.4 million in the three months ended December
31, 1999 from $2.1 million in the three months ended December 31, 1998 and, as
a percentage of revenue, increased to 28.5% in the three months ended December
31, 1999 from 18.9% in the three months ended December 31, 1998. This increase
is attributable to general and administrative expenses incurred by TVN
Shopping, GRTV Network and New Media Network, all three of which had not been
acquired as of December 31, 1998.
Depreciation and Amortization. Depreciation and amortization increased
$607,000, or 19.9%, to $3.7 million in the three months ended December 31,
1999 from $3.1 million in the three months ended December 31, 1998 and, as a
percentage of revenue, decreased to 19.4% in the three months ended December
31, 1999 from 27.2% in the three months ended December 31, 1998. The decrease
as a percentage of revenue is due to the increase in revenue in the three
months ended December 31, 1999 as compared to the three months ended December
31, 1998 as depreciation is a fixed expense. The dollar increase is
attributable to amortization and depreciation recorded on assets acquired
since December 31, 1998, including the assets of TVN Shopping, GRTV Network
and New Media Network.
Amortization of intangible assets. Amortization of intangible assets
totaled $1.1 million in the three months ended December 31, 1999 as compared
to zero in the three months ended December 31, 1998 and, as a percentage of
revenue, increased to 5.6% in the three months ended December 31, 1999. The
increase is attributable to the amortization of acquired technology and
goodwill generated upon the acquisition of our interests in the Panda Shopping
Network, the Guthy-Renker Television Network and New Media Network.
Interest Expense/Interest Income. Interest expense decreased $417,000, or
3.8%, to $10.5 million in the three months ended December 31, 1999 from $11.0
million in the three months ended December 31, 1998. The decrease is primarily
due to the repurchase of approximately $33.9 million of our 14% Senior Notes
due 2008 in October 1999.
Extraordinary gain. During the three months ended December 31, 1999, we
realized an extraordinary gain of $20.0 million upon the repurchase of
approximately $33.9 million of our 14% Senior Notes due 2008. No extraordinary
items were recognized in the three months ended December 31, 1998.
Provision for Income Taxes. As a result of net losses and the Company's
inability to recognize a benefit for its deferred income tax assets, the
Company did not record a provision for income taxes in the three months ended
December 31, 1999 or the three months ended December 31, 1998.
17
<PAGE>
Nine Months Ended December 31, 1999 Compared with Nine Months Ended December
31, 1998
Revenue. Total revenue increased $27.8 million, or 109.5%, to $53.1 million
in the nine months ended December 31, 1999 from $25.4 million in the nine
months ended December 31, 1998. Revenue generated by our Digital Cable
Television service increased approximately $5.6 million or 87.6% to $12.1
million in the nine months ended December 31, 1999 from $6.4 million in the
nine months ended December 31, 1998. This increase is primarily attributable
to the fact that revenue was generated for the Marquee Mix service for only
six of the nine months ended December 31, 1998. Home satellite services
revenue decreased $328,000 or 2.7% to $11.6 million in the nine months ended
December 31, 1999 from $12.0 million in the nine months ended December 31,
1998. This decrease is primarily attributable to a $2.0 million decrease in
pay-per-view movie revenue, due primarily to a decline in the average number
of active home satellite dish subscribers per month during the nine months
ended December 31, 1999 as compared to the nine months ended December 31,
1998. This decrease was offset by a $1.9 million increase in special event
revenue generated by the introduction of professional wrestling as a franchise
in 1999. Satellite transmission service revenue decreased $3.6 million, or
19.4%, to $15.1 million in the nine months ended December 31, 1999 from $18.7
million in the nine months ended December 31, 1998. The decrease is primarily
attributable to revenue generated by the sales of transponder time to the
Panda Shopping Network and the Guthy-Renker Television Network in 1998 that
were not replaced by sales of transponder time to other third parties upon
acquiring our interests in these entities in 1999. These decreases were offset
by approximately $13.8 million in home shopping revenues generated by TVN
Shopping and $12.8 million in media time sales generated by the GRTV Network.
We had not commenced operation of these entities as of December 31, 1998.
Operating Expenses
Cost of Revenue. Cost of revenue increased $25.8 million, or 123.7%, to
$46.7 million in the nine months ended December 31, 1999 from $20.9 million in
the nine months ended December 31, 1998 and, as a percentage of revenue,
increased to 87.9% in the nine months ended December 31, 1999 from 82.3% in
the nine months ended December 31, 1998. Approximately $23.6 million of the
increase is attributable to costs incurred by TVN Shopping and the GRTV
Network. The increase as a percentage of revenue is primarily attributable to
the distribution of lower margin products and services by TVN Shopping and the
GRTV Network, as compared to the programming services provided by Digital
Cable Television service and our home satellite dish service. We had not
acquired our interests in these entities as of December 31, 1998.
Selling. Selling expenses increased $2.9 million, or 31.6%, to $12.2
million in the nine months ended December 31, 1999 from $9.3 million in the
nine months ended December 31, 1998 and, as a percentage of revenue, decreased
to 22.9% in the nine months ended December 31, 1999 from 36.5% in the nine
months ended December 31, 1998. Approximately all of the increase is
attributable to selling expenses incurred by TVN Shopping and the GRTV
Network. We had not acquired TVN Shopping and the GRTV Network as of December
31, 1998. The decrease as a percentage of revenue is primarily due to $26.8
million in revenue generated by TVN Shopping and the GRTV Network as selling
expenses for these business units was approximately 11% of revenue as compared
to 49% and 29% of revenue for our Digital Cable Television service and home
satellite dish service, respectively.
General and Administrative. General and administrative expenses increased
$9.6 million, or 163.7%, to $15.4 million in the nine months ended December
31, 1999 from $5.8 million in the nine months ended December 31, 1998 and, as
a percentage of revenue, increased to 29.0% in the nine months ended December
31, 1999 from 23.0% in the nine months ended December 31, 1998. The increase
as a percentage of revenue is primarily attributable to (i) approximately $2.1
million in general and administrative expenses incurred by New Media Network,
our start-up music retailing venture, which generated only $230,000 in revenue
during the nine months ended December 31, 1999, (ii) approximately $700,000 in
severance benefits paid to an executive upon his resignation and (iii)
approximately $458,000 in compensation expense recognized in connection with
the cancellation of the executive's options to purchase shares of the
Company's common stock and the cancellation of the executive's Put Right.
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<PAGE>
Depreciation and Amortization. Depreciation and amortization increased $1.4
million, or 14.9%, to $10.5 million in the nine months ended December 31, 1999
from $9.1 million in the nine months ended December 31, 1998 and, as a
percentage of revenue, decreased to 19.7% in the nine months ended December
31, 1999 from 36.0% in the nine months ended December 31, 1998. The decrease
as a percentage of revenue is due to an increase in revenue for the nine
months ended December 31, 1999 as depreciation is a fixed expense. The
increase is attributable to amortization and depreciation recorded on assets
acquired since December 31, 1998, including the assets of TVN Shopping, the
GRTV Network and New Media Network.
Amortization of intangible assets. Amortization of intangible assets
totaled $2.3 million in the nine months ended December 31, 1999 as compared to
zero in the nine months ended December 31, 1998 and, as a percentage of
revenue, increased to 4.3% in the nine months ended December 31, 1999. The
increase is attributable to the amortization of goodwill generated upon the
acquisition of our interests in the Panda Shopping Network, New Media Network
and the Guthy-Renker Television Network.
Interest Expense/Interest Income. Interest expense increased $9.2 million,
or 39.3%, to $32.7 million in the nine months ended December 31, 1999 from
$23.5 million in the nine months ended December 31, 1998. Nearly all of the
increase reflects interest expense recognized on the senior notes that we
issued on July 29,1998. Interest income increased $499,000, or 12.1%, to $4.6
million in the nine months ended December 31, 1999 from $4.1 million in the
nine months ended December 31, 1998. This increase reflects interest earned on
the invested proceeds of the senior notes.
Extraordinary gain. During the nine months ended December 31, 1999, we
realized an extraordinary gain of $20.0 million upon the repurchase of
approximately $33.9 million of our 14% Senior Notes due 2008. During the nine
months ended December 31, 1998, we realized an extraordinary gain upon the
early extinguishment of an $8.1 million note payable.
Provision for Income Taxes. As a result of net losses and the Company's
inability to recognize a benefit for its deferred income tax assets, the
Company did not record a provision for income taxes in the nine months ended
December 31, 1999 or the nine months ended December 31, 1998.
Liquidity and Capital Resources
The Company has been funded through a combination of equity, debt and lease
financing. As of December 31, 1999, the Company had current assets of $69.5
million, including $37.2 million of cash and cash equivalents and current
liabilities of $60.5 million, resulting in working capital of $9.0 million.
The Company invests excess funds in short-term, interest bearing investment
grade securities until such funds are needed to fund the capital expenditure
and operating needs of the Company's business.
Since inception, we have incurred operating losses and as of December 31,
1999, have a total deficit of $192.5 million. Our cash on hand and amounts
expected to be available through financing arrangements may not provide
sufficient funds necessary for us to expand our TVN Digital Cable Television
service, Pay-Per-View Feeds service and home shopping service as currently
planned and to fund our operating deficits beyond the next 6 months. There can
be no assurance, however, that we will not require additional capital sooner
than anticipated. We are making efforts to reduce expenses and may take steps
to raise additional capital in order to allow us to fund our operating
deficits for a longer period. We are unable, however, to predict the precise
amount of future capital that we will require and we cannot be certain that
additional financing will be available to us on acceptable terms or at all.
Cash Used For Operating Activities
The Company's operating activities used $38.7 million and $17.4 million in
the nine months ended December 31, 1999 and 1998, respectively. Cash used for
operations is primarily due to net losses of $42.6 million and $37.9 million
in the nine months ended December 31, 1999 and 1998, respectively, partially
19
<PAGE>
offset by non-cash expenses, such as depreciation and amortization,
amortization of intangible assets, gain on redemption of senior notes and
other changes in working capital items such as accounts receivable, accounts
payable and accrued interest. The Company expects to continue to generate
negative cash flows from operating activities as it continues to build a
distribution platform for its Digital Cable Television service and home
shopping service.
Cash Provided By and Used For Investing Activities
Cash provided by investing activities was $15.1 million in the nine months
ended December 31, 1999 and included approximately $11.8 million in proceeds
from the maturities of restricted investments that were purchased as security
for the senior notes and $8.9 million from the redemption of the restricted
investments. These proceeds were offset by $4.0 million used for capital
expenditures and $1.6 million used for equity investments. Cash provided by
investing activities in the nine months ended December 31, 1998 included
(i) approximately $76.7 million to purchase a portfolio of U.S. government
securities out of the net proceeds of the senior notes as security for the
notes, (ii) $1.7 million in proceeds from the investment of these securities
and (iii) $1.7 million in capital expenditures.
Cash Used For Financing Activities
Cash used for financing activities was $23.6 million in the nine months
ended December 31, 1999 and included $11.8 million used to repurchase $33.9
million in senior notes due 2008, $5.7 million in repayments of capitalized
leases and $6.2 million in repayments of notes payable. Cash provided by
financing activities in the nine months ended December 31, 1998 included
$193.4 million in net proceeds from the senior notes offset by $4.1 million in
repayments of capitalized leases and $16.4 million in repayments of notes
payable.
We have Contingent Notes Payable totaling approximately $29.8 million. The
Contingent Notes Payable do not have a defined maturity or repayment schedule.
These Contingent Notes Payable have not been recorded as a liability in
accordance with Accounting Principles Board Opinion No. 16, "Business
Combinations," because they represent contingent consideration related to the
acquisition of net assets and the outcome of the contingency is not
determinable beyond a reasonable doubt.
Recent accounting pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Software for Internal Use," which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. The adoption of SOP 98-1 during the first quarter
of fiscal 2000 did not have a material impact on our financial position,
results of operations or cash flows.
In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of
Start-Up Activities." SOP No. 98-5 requires that all start-up costs related to
new operations must be expensed as incurred. In addition, start-up costs that
were capitalized in the past must be written off when SOP No. 98-5 is adopted.
The adoption of SOP No. 98-5 during the first quarter of fiscal 2000 did not
have a material impact on our financial position, results of operations or
cash flows.
In June 1998, The Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities." The statement
requires the recognition of all derivatives as either assets or liabilities in
the balance sheet and the measurement of those instruments at fair value. The
accounting for changes in the fair value of a derivative depends on the
planned use of the derivative and the resulting designation. Because we do not
currently hold any derivative instruments or engage in hedging activities, the
impact of the adoption of SFAS No. 133 is not currently expected to have a
material impact on our business, results of operations or financial condition.
We will be required to implement SFAS No. 133 in the first quarter of
fiscal 2001.
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Factors Affecting Future Results
We have substantial existing debt and will incur substantial additional debt
which could adversely affect our financial health and prevent us from
fulfilling our obligations under the notes.
We have borrowed a significant amount of funds. As of December 31, 1999, we
had outstanding indebtedness of approximately $ 283.6 million and a
stockholders' deficit of approximately $192.5 million. We cannot be certain
that our operations will generate sufficient cash flows to pay our
obligations, including our obligations on the new notes. Earnings were
inadequate to cover fixed charges by the amount of $54.9 million for the year
ended March 31, 1999 and $42.6 million for the nine months ended December 31,
1999. The degree to which we have borrowed funds could have important
consequences to you. For example, it could:
. make it more difficult for us to satisfy our obligations to you with
respect to the notes and to satisfy our obligations under other
indebtedness;
. increase our vulnerability to general adverse economic and cable
industry conditions, including interest rate fluctuations;
. require us to dedicate a substantial portion of our cash flow from
operations to payments on our indebtedness, which will reduce our funds
available for working capital, capital expenditures, acquisitions of
additional systems and other general corporate requirements;
. limit our flexibility in planning for, or reacting to, changes in our
business and the cable industry generally;
. place us at a competitive disadvantage compared to our competitors that
have proportionately less debt;
. limit our ability to borrow additional funds, if we need them, due to
applicable financial and restrictive covenants in our indebtedness;
. increase our interest expenses above current levels due to increases in
interest rates, since much of our borrowings are and will continue to be
at variable rates of interest; and
. limit our ability to redeem our notes in the event of a change of
control.
We may also incur additional indebtedness to finance the continued
development, commercial deployment and expansion of our networks and for
funding operating losses or to take advantage of unanticipated opportunities.
We will require a significant amount of cash to service our indebtedness, and
our ability to generate cash depends on many factors beyond our control.
We expect that we will continue to generate substantial operating losses
and negative cash flow for at least the next several years. Our ability to
make scheduled payments on our debt, including the notes, will depend upon,
among other things:
. our ability to achieve significant and sustained growth in cash flow;
. the rate of and successful commercial deployment of our digital cable
programming and services;
. the market acceptance, subscriber demand, rate of utilization and
pricing for our digital cable programming and services;
. our future operating performance; and
. our ability to complete additional financings.
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Each of these factors is, to a large extent, subject to economic,
financial, competitive and other factors, many of which are beyond our
control. We cannot be certain that we will be successful in developing and
maintaining a level of cash flow from operations and financings sufficient to
permit us to pay the principal, premium, if any, and interest on our
indebtedness, including the notes. If we are unable to generate sufficient
cash flow from operations and financings to service our indebtedness,
including the notes, we may have to reduce or delay the deployment of our
digital cable programming and services or restructure or refinance our
indebtedness. We cannot be certain that any of these actions or any additional
debt or equity financings could be accomplished on satisfactory terms, if at
all, in light of our high leverage, or that they would yield sufficient
proceeds to service and repay our indebtedness, including the notes. Any
failure by us to satisfy our obligations with respect to the notes at maturity
or prior thereto would constitute a default under the indenture and could
cause a default under agreements governing our other indebtedness. In the
event of default, the holders of our indebtedness would have enforcement
rights, including the right to accelerate our debt and the right to commence
an involuntary bankruptcy proceeding against us. Accordingly, upon any
default, insolvency, bankruptcy or similar situation, we may have only limited
assets remaining after paying the prior claims of our secured creditors and
may be unable to repay the notes.
We anticipate that our existing capital and cash from operations may be
inadequate to satisfy our capital requirements beyond the next 6 months.
Our cash on hand and amounts expected to be available through vendor
financing arrangements may not provide sufficient funds necessary for us to
expand our TVN Digital Cable Television service and Pay-Per-View Feeds Service
as currently planned and to fund our operating deficits beyond the next 6
months. We have contingent notes payable totaling approximately $29.8 million
at December 31, 1999 that have no defined maturity and payment schedule.
Although the timing of the repayment of the contingent notes payable remains
uncertain and subject to events outside of our control, if we were to repay
the contingent notes payable in full, we believe that our existing working
capital following repayment would not be sufficient to fund our operations for
the next 6 months. We cannot be certain, however, that we will not require
additional capital sooner than currently anticipated. In addition, we are
unable to predict the precise amount of future capital that we will require
and whether additional financing will be available to us on acceptable terms
or at all. Our inability to obtain required financing could significantly
reduce the value of our business assets and impair our ability to continue the
normal operation of our business. Consequently, we could be required to
significantly reduce or suspend our operations, seek a merger partner, sell
the business, seek additional financing or sell additional securities on terms
that are highly dilutive to our stockholders.
We have incurred net losses in every fiscal year since inception. We may be
unable to become profitable, or to be so consistently.
We experienced net losses of $17.7 million, $29.9 million and $53.8 million
in fiscal 1997, fiscal 1998 and fiscal 1999, respectively, and a net loss of
$42.6 million for the nine months ended December 31, 1999. These net losses
are attributable to the significant costs incurred to develop and implement
our business plan and to develop, install and integrate our digital
programming and services. We expect that net losses will continue and increase
for the foreseeable future as we plan to continue to incur substantial sales
and marketing expenses to build our customer base of cable operators and
substantial capitalized lease payments for our satellite transponders. We have
not achieved profitability on a quarterly or annual basis, and we anticipate
that we will continue to incur net losses for at least the next several years.
We also expect to continue to incur significant product development and
administrative expenses. We cannot be certain that any of our business
strategies will be successful or that significant revenues or profitability
will ever be achieved or, if they are achieved, that they can be consistently
sustained or increased on a quarterly or annual basis in the future.
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The indenture governing our notes contains restrictions and limitations which
could significantly impact our ability to operate our business and repay our
notes.
The indenture governing our notes contains a number of significant
covenants that, among other things, restrict our ability and the ability of
our subsidiaries:
. to pay dividends or distributions to our shareholders;
. to dispose of assets or merge;
. to incur or guarantee additional indebtedness;
. to redeem or repurchase our equity or subordinated debt;
. our subsidiaries' ability to issue equity;
. to create liens;
. to enter into certain kinds of transactions; and
. to make certain investments or acquisitions, particularly with our
stockholders and affiliates.
The ability to comply with these provisions may be affected by events
beyond our control. The breach of any of these covenants will result in an
event of default under the indenture.
Because our historical financial information only partly reflects our digital
cable programming and services, it may be of limited use in predicting our
future financial results.
Our business plan will result in significant changes in our financial
performance. The historical financial information included herein for the
fiscal years ending 1995 to 1998 primarily reflects our large home satellite
dish business. The historical financial information for the fiscal year ended
1999 does not fully reflect the many significant changes in our financial
results that will occur as a result of the ongoing roll out of our digital
cable programming and services nor the changes that will occur in our funding
and operations in connection with the roll out. The continued roll out of our
digital cable programming and services requires significant operating
expenditures, particularly selling expenses, a large portion of which are
expended before any revenue is generated. We plan to significantly increase
our operating expenses to expand our sales and marketing operations, broaden
our cable support services, develop new distribution channels, fund greater
levels of research and development and establish additional strategic
alliances. We have experienced, and expect to continue experiencing, negative
cash flows and significant losses while we continue to market our digital
cable programming and services to establish a sufficient revenue generating
customer base of cable operators, their subscribers and other customers. We
cannot be certain that we will be able to successfully roll out our digital
cable programming and services or establish a sufficient customer base.
Our operations are influenced by many factors we cannot fully control. This
may cause our quarterly financial results to vary significantly in the future.
Factors which can cause our quarterly results to fluctuate include, but are
not limited to:
. changes in the growth rate of digital cable subscribers and their pay-
per-view buying patterns;
. cable operators' expenditures and other costs relating to the expansion
and penetration of their respective digital cable offerings;
. seasonal trends in home entertainment and home shopping;
. the mix of satellite delivered programming products and services sold
and the distribution channels for those products and services;
. with respect to our home shopping business, our ability to react quickly
to changing consumer trends and the popularity of some categories of
collectible items;
. general economic conditions; and
. specific economic conditions in the cable television and related
industries.
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Additionally, as a strategic response to a changing competitive
environment, we may elect from time to time to make pricing, service,
marketing or acquisition decisions that could reduce our revenues and our
quarterly financial results.
Moreover, because our expense levels in any given quarter are based, in
part, on management's expectations regarding future revenue, if revenue is
below expectations, the effect on our operating results may be magnified by
our inability to adjust spending in a timely manner to compensate for a
revenue shortfall. The extent to which expenses are not subsequently followed
by increased revenues would reduce our operating results and could seriously
impair our business. As a result of these and other factors, we believe that
period to period comparisons of our operating results may not be meaningful
and should not be relied upon as an indication of future performance. Due to
all of the foregoing factors, it is likely that in one or more future
quarters, our operating results may be below the expectations of analysts and
investors, which could cause the value of our notes to fall.
If we fail to achieve a significant customer base for our digital cable
programming and services, we may be unable to cover our costs.
The continued roll out of our digital cable programming and services
requires significant operating expenditures, in particular selling expenses, a
large portion of which will be expended before any revenue is generated. We
have experienced, and expect to continue experiencing, negative cash flows and
significant losses while we continue to market our digital cable television
programming and services and until we can establish a customer base of cable
operators and their subscribers that will generate revenue sufficient to cover
our costs. We cannot be certain that we will be able to successfully roll out
our digital cable programming and services or establish a sufficient customer
base, or that we will generate significant revenues from our home shopping or
electronic commerce products and services. If we fail to adequately address
any of these risks, it could harm our business, financial condition and
results of operations.
Our efforts have historically focused on providing national satellite pay-
per-view and related services to large home satellite dish owners. However,
beginning in late 1997, we have been devoting an increasing percentage of our
personnel and financial resources, and intend to devote substantially more
resources, to the continued development and integration of digital
programming, transactional services and delivery systems, home shopping, and
electronic commerce products and services. Our digital cable programming and
services were launched in late 1997 and have generated only modest revenues to
date. In fiscal 1999, 26.9% of total revenues were derived from our digital
cable programming and services. We believe that our future ability to service
our indebtedness and to achieve profitability is dependent upon our success in
generating substantial revenues from our digital cable programming and
services. We expect to continue experiencing negative operating margins and
EBITDA while our TVN Digital Cable Television and Pay-Per-View Feeds Service
are being marketed to cable systems and their subscribers. We expect to
realize improved operating margins and EBITDA only as:
. the number of cable systems offering TVN Digital Cable Television and
the number of cable systems offering Pay-Per-View Feeds Service
increases so as to increase the numbers of homes having access to our
digital programming and services;
. the number of subscribers to TVN Digital Cable Television increases;
. the buy rates of our pay-per-view movies and events increase; and
. revenues are generated from our home shopping and electronic commerce
products and services.
Because our TVN Digital Cable Television and Pay-Per-View Feeds Services must
succeed in markets new to us, we may encounter difficulties achieving the
level of revenue we have forecast.
These services will need to find acceptance not only in markets we
currently serve, but in new and newly evolving markets. We have expended and
will continue to expend substantial sums for our sales and marketing
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efforts to promote cable operator and subscriber awareness of our digital
cable programming and services. The digital cable television market is new and
rapidly evolving. Therefore, it is difficult to predict the rate at which this
market will grow, if at all. If the market fails to grow, or grows more slowly
than anticipated, our sales will be lower than expected and our operating
results will be harmed. Even if the market does grow, we cannot be certain
that our digital cable programming and services will realize market acceptance
or will meet the technical or other requirements of cable operators or their
subscribers. The failure of TVN Digital Cable Television or Pay-Per-View Feeds
Service to gain market acceptance would cause our sales to be lower than
expected and seriously harm our business prospects.
Our marketing efforts to date with regard to our digital programming and
services have involved identifying specific cable system market segments that
we believe will be the most receptive to our digital programming and services.
We cannot be certain that we have correctly identified our markets or that our
TVN Digital Cable Television or Pay-Per-View Feeds Services will adequately
address the needs of our markets. Broad commercialization of our digital cable
programming and services will require us to overcome significant market
development hurdles, many of which may not currently be foreseen.
Our success will depend in large part on our ability to sign long-term
agreements with cable operators to deploy TVN Digital Cable Television and
Pay-Per-View Feeds Service.
As of December 31, 1999, we have entered into agreements with only 84 cable
operators. Our ability to obtain additional long-term agreements will depend
upon, among other things, the successful commercial deployment of our TVN
Digital Cable Television and Pay-Per-View Feeds Service pursuant to our
initial agreements and our ability to demonstrate that our digital cable
programming and services are reliable and more attractive to cable operators
and their subscribers than alternative services. We cannot be certain that we
will be able to enter into definitive agreements with additional cable
operators or that the ongoing economic viability of TVN Digital Cable
Television or Pay-Per-View Feeds Service will be successfully demonstrated.
We do not set the prices charged by cable operators to their subscribers
for TVN Digital Cable Television or for pay-per-view movies and events. The
level at which prices are set may adversely affect the number of subscribers
and/or the rate at which subscribers purchase pay-per-view movies or events.
Therefore, we cannot be certain that we will be able to achieve projected
rates of return. The market for digital cable television programming and
services is new, and our digital cable service is only one possible means
available to cable operators for providing pay-per-view movies and events in
the home. Although we believe that our TVN Digital Cable Television offers a
comprehensive and economically viable digital cable solution, we cannot be
certain that we will be successful in obtaining a sufficient number of cable
operators who are willing:
. to be early adopters of new technology rather than waiting for
widespread industry implementation;
. to risk subscriber dissatisfaction if the removal of existing analog
channels is required to accommodate new digital channels that will only
be available to digital subscribers and not to the system's entire
subscriber base;
. to bear the costs of purchasing new digital television set-top cable
boxes and installing and supporting required receiving equipment at
their facilities; or
. to sign and remain party to long-term agreements with us for our digital
cable programming and services, including an arrangement to share
revenue from pay-per-view movie and event buys.
Our failure to enter into or to sustain additional long-term agreements
with cable operators and/or their lack of acceptance of digital cable
programming and services would harm our operating results and our ability to
achieve sufficient cash flow to service our indebtedness, including the notes.
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Selling and installing TVN Digital Cable Television requires lengthy sales and
implementation cycles, and delays could cause actual revenue and earnings to
be less than expected.
The decision by a cable operator to deploy TVN Digital Cable Television is
often viewed as an important and strategic decision that generally requires us
to engage in a lengthy sales cycle of typically between three and six months.
During this process, we provide a significant level of explanation to
prospective cable operators regarding the use and benefits of our digital
cable programming and services to cable operators and their respective
subscribers. Additionally, the sales cycle can be delayed by the size of the
transaction and prospective implementation costs including the purchasing,
installing and maintaining new digital television set-top cable boxes,
installing and supporting required digital equipment at the operators
facility, as well as the potential complexity of financing or other
arrangements. The cable operator's implementation of TVN Digital Cable
Television involves a significant commitment of resources over an extended
period of time which may lead prospective operators to defer indefinitely the
decision to implement TVN Digital Cable Television or to delay implementation
despite having agreed to do so. For these and other reasons, the sales and
customer implementation cycles are subject to significant delays over which we
have little or no control. Delay in the sale or implementation of even a
limited number of TVN Digital Cable Television installations would reduce our
operating results and could harm our business prospects.
Because we expect cable operator agreements to generate a significant portion
of our revenue, the loss or deferral of even a small number of agreements
could cause our operating results to vary significantly.
We expect that a significant portion of our future revenues will be
generated from long-term agreements with cable operators. A delay in
generating or recognizing revenue from a limited number of these agreements
could cause significant variations in our operating results and could result
in further operating losses. We recognize revenues under our cable operator
agreements only when our TVN Digital Cable Television or Pay-Per-View Feeds
Service is successfully integrated and operating and subscriber billing
commences. Accordingly, the recognition of revenues will lag the announcement
of a new cable operator agreement by at least the time necessary to install
the service and to achieve a meaningful number of subscribers and/or the rate
at which subscribers purchase pay-per-view movies or events. We expect that
the number and timing of cable operator agreements and the effect of
anticipated lagging revenues, all of which are difficult to forecast, may
cause significant fluctuations in our operating results, particularly on a
quarterly basis.
We operate in highly competitive markets and face intense competition from
existing and potential competitors, which could limit our ability to gain
market share.
Our competitors include a broad range of companies engaged in
communications and home entertainment, including small dish satellite services
and programming providers, wired and wireless cable operators, broadcast
television networks, home video companies featuring videocassette and digital
video disk technologies, as well as companies developing new in-home
entertainment technologies, such as the video-on-demand service being marketed
by DIVA Systems Corporation. We expect that competition will increase
substantially as a result of these and other new products and services, as
well as from industry consolidations and alliances. As a result, we may be
unable to achieve our sales and market share goals. In addition, we expect
that an increasingly competitive environment may result in price reductions
that could reduce profit margins and cause loss of market share. We cannot be
certain that we will be able to compete successfully with new or existing
competitors or that competitive pressures will not reduce our revenues and
operating results.
Because we are significantly smaller than most cable companies, we may lack
the financial and other resources to obtain sufficient market share.
We expect to encounter a number of challenges in competing with large cable
companies that generally have large installed subscriber bases and significant
investments in, and access to, competitive programming sources. In addition,
these large cable companies have the financial and technological resources to
create their own digital tier of services, including pay-per-view movies. We
also face the risk that the current trend of industry
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consolidation will continue with the result that smaller and medium size cable
operators that might otherwise become our customers will be acquired by such
large cable companies. Currently, the only other available alternative for
cable operators that wish to offer digital services similar to those provided
by small satellite dish is a satellite transmitted digital programming
delivery service commonly known as "HITS," a name derived from the acronym for
"Headend-In-The-Sky." Certain telephone companies have announced initiatives
and have made significant investments to become digital television providers.
We cannot be certain that we will be able to compete effectively against HITS,
telephone companies or other companies that provide digital cable television
programming and services. Moreover, we cannot be certain that large cable
companies developing their own digital tiers of programming will not offer
such services to our target markets.
Because small dish satellite companies are better positioned to introduce
digital television programming and services to viewers, we may emerge from
this industry phase of introducing digital television programming with only a
limited market share.
We compete with companies offering digital programming direct-to-the-home
via various small dish satellite systems. Increased competition by small dish
satellite companies could lower our profit margins and reduce our market
share. Small satellite dishes offer consumers the appeal of significantly
expanded channel capacity, features such as an interactive on-screen program
guide, digital pictures without the signal disruption often seen in analog
video, CD quality digital music channels and many channels of movies and
sports available on a pay-per-view basis. Several well capitalized small dish
satellite companies pose a substantial threat to cable operators. DirecTV,
owned by Hughes Electronics, was the first all-digital small dish satellite
service and as of November 1999 had in excess of 7.8 million subscribers to
its satellite small dish service according to its recent press release. Two
other satellite small dish services are currently in operation: EchoStar,
which markets its digital television service under the "Dish Network" brand
name, and USSB, whose small satellite dish programming service is owned by,
and operates in tandem with, DirecTV and offers premium subscription
programming such as multiple HBO and SHOWTIME channels. A medium sized
satellite dish service, PrimeStar, has also been acquired by DirecTV.
Currently, local programming is generally unavailable through small dish
satellite services; however, recently enacted legislation facilitates the
ability of small dish satellite companies to include local broadcasts in their
digital programming services. Given small dish satellite systems' ability to
market directly to viewers, these companies may be better positioned to
introduce new digital programming and services. Because they have large
subscriber bases, small dish satellite companies may also be able to devote
significantly greater resources to the development and marketing of new
competitive products and services.
Because the market for the sale of consumer products by electronic media is
intensely competitive, we may be unable to gain meaningful market share.
We compete with other televised shopping programs, Internet merchants and
catalog and other traditional retailers for the sale of consumer products.
Many of our competitors, both in television and Internet commerce, have
substantially greater financial, distribution and marketing resources than we
do. As a result, we may be unable to achieve or sustain sufficient market
share to sell our products profitably. The televised home shopping industry is
dominated by two established competitors, the Home Shopping Network and the
QVC Network. Both of these networks have substantially more viewers than we
do. We also compete with ValueVision, another broadly distributed television
commerce company. These and other competitors may enter into business
combinations, joint ventures and strategic alliances with each other, which
could further enhance their resources.
If our relationships with our programming providers falter, we may not be able
to obtain sufficient popular programming to offer to cable systems and their
subscribers, and our revenues would fall.
We depend on all the major and many independent movie studios to provide us
with hit movies that appeal to mass audiences. Our current pay-per-view movie
programming is obtained through on-going, unwritten arrangements that have no
specific renewal provisions. We have relationships with the Playboy
Entertainment Group, supplier of the Spice pay-per-view adult movie service
and the Playboy Channel that we distribute,
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ESPN, for our ESPN GamePlan college football subscription and pay-per-day-
programming packages, and Guthy-Renker, creator of direct response television
"infomercials" which sell various products direct to the viewer, including
self-improvement tapes and home exercise equipment. We cannot be certain that
any of our existing relationships will continue, that we would be able to
obtain or develop substitute programming or that such substitute programming
would be comparable in quality or profitability to our existing programming.
Because our ability to succeed in the digital cable television market will
depend on our ability to continue obtaining desirable programming and
successfully market it to cable operators and their subscribers, the
termination of any of our existing programming relationships could
significantly reduce our sales and operating results.
If we cannot deliver programming to our cable operator customers and their
subscribers within the time periods advertised, our revenue will fall and our
ability to offer our programming and services will be harmed.
Our failure to deliver programming within the time periods advertised,
whether or not within our control, could result in dissatisfied subscribers
and in lost orders for services which we could have otherwise sold.
Dissatisfied cable operators and subscribers may choose to no longer subscribe
to our digital cable programming and services, which could reduce our current
and future revenue. Although we maintain insurance against business
interruption, we cannot be certain that such insurance will be adequate to
protect us from significant loss in these circumstances, or that a major
catastrophe such as an earthquake or other natural disaster would not result
in a prolonged interruption of our business. In particular, our operations
center is located in the Los Angeles area, which has in the past and will in
the future experience significant, destructive seismic activity that could
damage or destroy the operations center. In addition, our ability to make
deliveries to subscribers within the time periods advertised depends on a
number of factors, some of which are outside of our control, including
equipment or software failure and our inability to provide programming to
cable subscribers due to service outages experienced by cable systems that
comprise our distribution network.
Our home shopping business may not grow if we are unable to increase our
television distribution.
If we fail to increase the television distribution of our shopping
programming, our revenue growth from this business will slow or decline.
Increasing the television distribution of our shopping programming requires
entering into new carriage agreements and acquiring additional television
media time. We cannot be certain that we will be successful in entering into
agreements or acquiring media time on terms acceptable to us. Additionally, we
cannot be certain that the funds required to enter into these agreements or to
acquire such media time will be available to us.
The loss of even a limited number of our satellite transmitters, and our
Galaxy IX satellite transmitters in particular, could prevent us from offering
our digital cable programming and services and harm our results of operations.
We transmit our programming content via 15 signal transmitters leased on
two PanAmSat satellites, Galaxy III and Galaxy IX, both of which have
desirable geostationary orbital positions with transmission coverage of the
continental United States. Our failure to maintain sufficient, well-located
satellite transmitter capacity would impair our ability to offer our digital
cable programming and services and would harm our results of operations. Our
satellite transmitter leases both expire in 2006, prior to the expiration of
each satellite's expected useful life. We cannot be certain that we will be
able to obtain replacement transmitter capacity on terms acceptable to us or
at all. If either satellite was destroyed or became inoperable prior to the
expiration of our lease, we would need to obtain replacement satellite
transmitter capacity. We cannot be certain that such replacement capacity will
be available when required or, if available, that it will be on terms
acceptable to us. The satellites now used by us are also subject to the risks
of all satellites, including damage or destruction by space debris, military
actions or acts of war, anti-satellite devices, electrostatic storms, solar
flares, loss of location or other extraterrestrial events. In addition,
satellite signal transmitters may malfunction or become
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inoperative in the ordinary course as a result of faulty operation or latent
faults in design or construction. If, for these or any other reason, we were
unable to transmit our programming on one or more of our satellite
transmitters, our revenues and operating results would fall and our business
could be seriously harmed.
Because we rely on PanAmSat satellites for transmission of all our
programming, we could lose substantial revenue if PanAmSat were unable to meet
our needs.
Our relationship with PanAmSat is important to our business. We could lose
substantial revenue if PanAmSat were unable for any reason to satisfy our
satellite transmission commitments, or if any of these transmissions failed to
satisfy our quality requirements. In the event that we were unable to continue
to use our PanAmSat satellite capacity or obtain comparable replacement
satellite capacity via PanAmSat, we would have to identify, qualify and
transition deliveries to an acceptable alternative satellite transmission
vendor. This identification, qualification and transition process could take
six months or longer, and we cannot be certain that an alternative satellite
transmission vendor would be available to us or be in a position to satisfy
our delivery requirements on a timely and cost effective basis.
We rely on General Instrument for technology and services essential to our
business, some of which are available only from General Instrument. We might
be unable to operate our business if General Instrument fails to meet our
expectations or if these technologies and services are no longer available to
us.
We are dependent on General Instrument, which recently agreed to be
acquired by Motorola, Inc., for services to turn on and off the showings of
our pay-per-view movies and events ordered by cable subscribers, and for the
continued development and standardization of equipment and the analog and
digital cable transmission technologies, known as DCII technology, that we
use. Our relationship with General Instrument includes not only the use of its
DCII technology and encoding equipment to digitally process our programming,
but also includes General Instrument's manufacture and supply of DCII cable
system equipment and television set-top cable boxes that are important to the
successful deployment of our TVN Digital Cable Television. We have no written
agreement with General Instrument for the provision of services to turn on and
off the showings of our pay-per-view movies and events, for which they are the
only provider. If we were unable to continue to receive these services from
General Instrument on acceptable terms, our only alternative would be to build
our own facility. We cannot be certain that building our own facility could be
completed in a timely manner or on a cost effective basis. If General
Instrument were unable for any reason to meet our TVN Digital Cable Television
deployment strategy, development schedule or delivery commitments with respect
to either cable system equipment or television set-top cable boxes, we would
be unable to meet our revenue goals and our operating results would be harmed.
If we are unable to continue to obtain and use the DCII technology, we would
have to identify, qualify and transition digital processing to an acceptable
alternative vendor. This identification, qualification and transition process
could take six months or longer, and we cannot be certain that an alternative
vendor would be available to us or be in a position to satisfy our delivery
requirements on a timely and cost effective basis.
We depend on technology and services provided by third parties. If we were
unable to access these technologies and services, our ability to operate our
business would be impaired and our results of operations would be harmed.
Our technical infrastructure features in-house production, storage and
digital processing, and other outsourced services supervised by TVN personnel.
Our revenue and our ability to offer our digital cable programming and
services would be harmed if our service providers were unable for any reason
to meet our editing and transmission schedule or delivery commitments or if
any uplink transmissions failed to satisfy our quality requirements. For
instance, our replay, editing and satellite transmission facilities were
custom built to our specifications and continue to be operated by Four Media
Company, a video editing and facilities service and management company, which
owns and operates those facilities for our use under renewable service
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agreements. Four Media Company recently agreed to be acquired by Liberty Media
Corp. If we are unable to continue relying on Four Media Company's operational
expertise and technology, we would have to identify, qualify and transition
such operations to an acceptable alternative vendor or perform such operations
ourselves. This identification, qualification and transition process could
take six months or longer, and we cannot be certain that we could perform
these services or that an alternative vendor would be available to us or be in
a position to satisfy our requirements on a timely and cost effective basis.
We depend on exclusivity arrangements with some of our vendors to provide
desirable merchandise for our shopping business, without which our gross
profit would decline.
Our gross profit margin in certain product categories of our home shopping
business is partially dependent upon maintaining exclusivity agreements with
our vendors for whom we are the only seller, or one of a limited number of
sellers, of particular products. Because we are positioned in the electronic
commerce market as a seller of certain unique products, including jewelry, new
and vintage watches and precious coins and collectibles, we depend upon a
limited number of suppliers for such products. This supply cannot be assured.
Many of our vendors have not entered into exclusivity agreements with us and
may not be willing to do so. Vendors who have entered into exclusivity
agreements with us may terminate such arrangements over time. Vendors with
whom we wish to establish exclusivity arrangements may instead enter into
exclusivity agreements with our competitors. The loss of one or more of our
exclusivity arrangements with product vendors could cause our gross profit to
decline.
Because we rely on third party vendors to provide us with transactional
services, the inability of these vendors to meet our requirements could
prevent us from providing our services cost effectively, or at all.
Our ability to collect our revenue and our results of operations would be
harmed if our third party vendors were unable for any reason to meet our
transactional service commitments, service management requirements or customer
service quality requirements to our cable operator customers. We contract with
CSG Systems, Inc. to provide customer billing and subscriber management
services. Certain customer response calls are outsourced to TicketMaster
Corporation, which maintains regional call centers with extensive switching
and live operator capabilities. These systems and resources are part of the
transactional services that we offer with our TVN Digital Cable Television. If
we are unable to continue using these systems and technological resources, we
would have to identify, qualify and transition such operations to an
acceptable alternative vendor or arrange for in-house operations. This
identification, qualification and transition process could take six months or
longer, and we cannot be certain that we could perform such functions or that
an alternative vendor would be available to us or be in a position to satisfy
our requirements on a timely and cost effective basis.
In addition, in our home shopping business we rely on the services of a
credit card processor, telephone service providers and shipping companies.
Should we lose or experience interruptions in the services of any of these
service providers, we may not be able to replace these providers and our
revenues and results of operations could suffer.
The market for electronic delivery of home television entertainment is
characterized by rapidly changing technology. As a result, our digital cable
services may become outdated.
Our future success and ability to remain competitive will depend in
significant part upon the technological quality of our products and processes
relative to those of our competitors, and our ability to both develop new and
enhanced products and services and to introduce products and services at
competitive prices in a timely and cost effective fashion. We cannot be
certain that our technological development will remain competitive.
We rely substantially on third party vendors for the continued development
of these technologies. We cannot be certain that our vendors will be able to
develop technologies in a manner that meets our needs and those of our
customers and subscribers. The failure to implement these technologies or to
obtain licenses on favorable economic terms from other vendors, individually
or in combination, could impair our prospects for future growth.
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We cannot be certain that we will be successful in identifying, developing,
contracting for the manufacture, and marketing of product enhancements or new
services or programming that are responsive to technological change, that we
will not experience difficulties that could delay or prevent the successful
development, introduction and marketing of these products or services or that
our new products and product enhancements will adequately meet the challenges
of emerging technologies, the requirements of the marketplace and achieve
market acceptance. Delays in commercial availability of new products and
services and enhancements to existing products and services may result in
customer dissatisfaction and delay or loss of revenue, and our operating
results could decline.
If our signals are pirated, we could lose substantial revenue.
While we use digital and analog encryption systems designed by General
Instrument to minimize the risk of signal piracy, we could lose substantial
revenue if signal piracy were to become widespread. The General Instrument
encryption system that we use is based on the use of cards inserted into the
television set-top cable box, which can be changed periodically to thwart
commercial piracy efforts. In addition, electronic countermeasures can be
transmitted over the cable system at any time in an effort to counter some
types of piracy. However, we cannot be certain that this encryption
technology, electronic countermeasures and other efforts designed to prevent
signal piracy will be effective. Moreover, we cannot be certain that future
technological developments will not render our anti-piracy features less
effective or completely useless. Any significant piracy of our programming
would substantially reduce our revenues and harm our results of operations.
We rely on a combination of trade secret, copyright and trademark laws,
confidentiality and nondisclosure agreements and other such arrangements to
protect our proprietary rights and confidential information. The loss of our
proprietary rights or confidential information would harm our competitiveness
and reduce the value of our business assets.
We consider our software, scheduling system, telephone ordering system,
trademarks, logos, copyrights, know-how, advertising, and promotion design and
artwork to be of substantial value and importance to our business. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or obtain and use information that we regard as proprietary. We cannot be
certain that the steps taken by us to protect our proprietary information will
prevent misappropriation of such information and such protection may not
preclude competitors from developing confusingly similar brand names or
promotional materials, technology, or developing products and services similar
to ours. In addition, the laws of some foreign countries do not protect our
proprietary rights to the same extent as do the laws of the United States.
While we believe that our proprietary software, trademarks, copyrights,
advertising and promotion design and artwork do not infringe upon the
proprietary rights of third parties, we cannot be certain that we will not
receive future communications from third parties asserting that our software,
systems, trademarks, copyrights, advertising and promotion design and artwork
infringe, or may infringe, on the proprietary rights of third parties. Any
such claims, with or without merit, could be time consuming, require us to
enter into royalty arrangements or result in costly litigation and diversion
of management personnel. We cannot be certain that any necessary licenses can
be obtained or that, if obtainable, can be obtained on terms acceptable to us.
Our failure or inability to develop non-infringing technology or license
necessary proprietary rights on a timely basis and in a cost-effective manner
would harm our business.
Rapid growth of our business could place a significant strain on our
managerial, operational and financial resources and on our internal systems
and controls.
We cannot be certain that we would have adequate resources to effectively
manage rapid growth of our business, and our inability to do so could increase
our costs and harm our business. Our financial and management controls,
reporting systems and procedures are constrained by limited resources.
Although some new controls, systems and procedures have been implemented, our
growth, if any, will depend on our ability to continue to implement and
improve operational, financial and management information and control systems
on a
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timely basis, together with maintaining effective cost controls. Further, we
will be required to manage multiple relationships with various customers and
other third parties. We cannot be certain that our systems, procedures or
controls will be adequate to support our operations or that our management
will be able to successfully offer our services and implement our business
plan.
If we fail to attract and retain qualified management, sales, operations,
marketing and technology personnel, our ability to meet our business goals
will be impaired and our financial condition and results of operations will
suffer.
In particular, our success depends on the continued contributions of Stuart
Z. Levin, our Chairman and Chief Executive Officer, and other senior level
sales, operations, marketing, technology, financial and legal officers. Our
business plan was developed in large part by these senior level officers and
requires skills and knowledge they possess in order to implement. In addition,
our products and technologies are complex and we are substantially dependent
upon the continued service of our existing engineering personnel. We intend to
hire a significant number of additional sales, support, marketing, operations
and research and development personnel in 2000 and beyond. Competition for
qualified personnel is intense, and we cannot be certain that we will be able
to attract, assimilate, train or retain additional highly qualified personnel
in the future. If we are unable to hire and retain such personnel,
particularly those in key positions, our business prospects may be harmed and
our results of operations may suffer.
A substantial portion of our revenues to date have been generated by pay-per-
view fees paid by subscribers of our satellite transmitted analog programming
for the large home satellite dish market. These revenues may not be
sustainable.
Revenues from our large home satellite dish business declined in fiscal
1996, in fiscal 1998, in fiscal 1999 and are expected to decline in fiscal
2000. The large home satellite dish market faces severe competition from
competing forms of content delivery, including digital content transmitted via
small satellite dishes, and has experienced no growth over the past four
years. As a result, we cannot be certain that we can continue to generate
sustained revenues from the large home satellite dish market.
We may be unable to successfully integrate any new companies, products or
technologies we acquire.
We have made and intend to continue to make investments in complementary
companies, products and/or technologies. If we fail to successfully integrate
these purchases with our existing operations, our ongoing business could be
disrupted, the attention of our management and other employees may be diverted
from other important projects, and our expenses may increase. Effective
January 1999, we acquired substantially all of the assets of the Panda
Shopping Channel. In June 1999, we acquired a majority interest in New Media
Network, a company involved in the digital delivery of music via the Internet
and retail locations. In July 1999, we acquired substantially all of the
assets of Guthy-Renker Television, which purchases media time from cable
operators and programmers, service providers and television broadcasters and
resells such time in packages to direct response infomercial and product sales
companies. Such acquisitions may result in difficulty integrating personnel
and operations. In addition, key personnel of the acquired businesses may
decide not to work for us. If we make other types of acquisitions, we could
have difficulty assimilating the acquired technology or products into our
operations.
Morgan Stanley Dean Witter has significant influence over us, and may have an
interest in pursuing actions adverse to the interests of the holders of the
notes.
Decisions concerning our operations or financial structure may present
conflicts of interest between the owners of capital stock and the holders of
the notes. For example, the holders of capital stock may have an interest in
pursuing acquisitions, divestitures, financings or other transactions that, in
their judgment, could enhance their equity investment, even though such
transactions might involve risks to the holders of the notes. Princes Gate
Investors II and its affiliates own 89.3% of our Series B Preferred Stock,
which ownership
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represents 54.8% of our outstanding voting capital stock on an as-converted
basis or 45.4% of the voting capital stock on an as-converted, diluted basis
including currently outstanding options and warrants exercisable for voting
capital stock. The general partner of Princes Gate Investors II and Morgan
Stanley are both wholly owned subsidiaries of Morgan Stanley Dean Witter, and
two of our directors are employees of Morgan Stanley. As a result of these
relationships, Princes Gate Investors II, Morgan Stanley Dean Witter and its
affiliates have, and will continue to have, significant influence over our
management policies and our corporate affairs.
Our certificate of incorporation requires us, upon demand, to redeem all of
the outstanding shares of our Series B Preferred Stock in August 2002. We may
be unable to satisfy this requirement, and our creditworthiness, business
condition and value of our equity could be harmed as a result.
Our certificate of incorporation requires us, upon demand, to redeem all of
the outstanding shares of our Series B Preferred Stock in August 2002, the
mandatory redemption date, for $54.4 million, unless such shares of Series B
Preferred Stock have previously been converted into our common stock at the
option of the holders thereof, or automatically converted upon our initial
public offering. Notwithstanding this requirement, the terms of the notes
significantly limit a redemption by us from available cash, but will permit us
to redeem the Series B Preferred Stock with the proceeds of an equity
financing. If we fail to redeem the Series B Preferred Stock, we would
continue to be in breach under our certificate of incorporation from the
redemption date until the date of a refinancing, if any. Although a breach of
this type has been excluded from the cross default provisions of the notes, it
may trigger default provisions in other financial instruments to which we may
then be a party. We cannot be certain that holders of Series B Preferred Stock
will not take legal action against us in an attempt to enforce their
redemption right, demand that we renegotiate the terms of the Series B
Preferred Stock or sell additional equity to finance the redemption. These
actions may harm our financial condition and have a dilutive effect on the
interests of our equity holders. A substantial majority of our Series B
Preferred Stock is held by Princes Gate Investors II.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Due to the nature and maturity of the Company's short-term investments the
Company does not believe such investments present significant market risk.
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the three-month period ended
December 31, 1999.
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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 on its behalf by the
undersigned, thereunto duly authorized.
TVN ENTERTAINMENT CORPORATION
<TABLE>
<S> <C>
Date: March 27, 2000 By: /s/ Stuart Z. Levin
----------------------------------------------
Stuart Z. Levin, Chairman of the Board of
Directors and Chief Executive Officer
(Principle Executive Officer)
Date: March 27, 2000 By: /s/ John McWilliams
----------------------------------------------
John McWilliams
Senior Vice President, Finance
(Principle Accounting Officer)
</TABLE>
35
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 37,172
<SECURITIES> 22,194
<RECEIVABLES> 7,601
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<INVENTORY> 1,589
<CURRENT-ASSETS> 70,941
<PP&E> 139,551
<DEPRECIATION> 47,898
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<BONDS> 283,985
53,345
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<COMMON> 0
<OTHER-SE> (169,321)
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<SALES> 53,133
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</TABLE>
