-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LcqP+EZ7GR3RNzcgebPGy/v/rsU5CtIY/Ih+AoCF0G1iCvZokmQmkXewiYZCNpOi T1cm+COvDyVTFmRjsKzuLQ== 0000890163-04-000290.txt : 20040614 0000890163-04-000290.hdr.sgml : 20040611 20040614074813 ACCESSION NUMBER: 0000890163-04-000290 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040614 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEW FRONTIER MEDIA INC CENTRAL INDEX KEY: 0000847383 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MOTION PICTURE & VIDEO TAPE DISTRIBUTION [7822] IRS NUMBER: 841084061 STATE OF INCORPORATION: CO FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-23697 FILM NUMBER: 04859592 BUSINESS ADDRESS: STREET 1: 5435 AIRPORT BLVD STREET 2: SUITE 100 CITY: BOULDER STATE: CO ZIP: 80301 BUSINESS PHONE: 3034440632 FORMER COMPANY: FORMER CONFORMED NAME: NEW FRONTIER MEDIA INC /CO/ DATE OF NAME CHANGE: 19970627 FORMER COMPANY: FORMER CONFORMED NAME: NATIONAL SECURITIES HOLDING CORPORATION DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: STRATEGIC ACQUISITIONS INC DATE OF NAME CHANGE: 19600201 10-K 1 s11-4473_10k.txt FORM 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10 -K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Year Ended March 31, 2004 Commission File Number: 0-23697 NEW FRONTIER MEDIA, INC. (Exact name of registrant as specified in its charter) Colorado 84-1084061 (State or Incorporation) (I.R.S. Employer I.D. Number) 7007 Winchester Circle, Suite 200, Boulder, CO 80301 (Address of principal executive offices and Zip Code) (303) 444-0632 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Exchange Act: None. Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock. 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: /X/ YES / / NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: /X/ Aggregate market value of voting stock held by non-affiliates: $181,007,918 based on 21,729,642 shares at June 9, 2004 held by non-affiliates and the closing price on the NASDAQ National Market on that date which was $8.33. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). / / YES /X/ NO State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter. $74,127,664 Indicate the number of shares outstanding of each of the registrant's classes of common stock: 21,954,458 common shares were outstanding as of June 9, 2004 DOCUMENTS INCORPORATED BY REFERENCE The information required in response to Part III of Form 10-K is hereby incorporated by reference from the Registrant's Definitive Proxy Statement to be filed with the Securities and Exchange Commission with respect to the Registrant's Annual Meeting of Stockholders to be held in August 2004. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FORM 10-K FORM 10-K FOR THE FISCAL YEAR ENDED MARCH 31, 2004 TABLE OF CONTENTS
PAGE ----- PART I. Item 1. Business.................................................................... 3 Item 2. Properties.................................................................. 21 Item 3. Legal Proceedings........................................................... 22 Item 4. Submission of Matters to a Vote of Security Holders......................... 22 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters....... 22 Item 6. Selected Financial Data..................................................... 23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................. 23 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.................. 39 Item 8. Financial Statements and Supplementary Data................................. 39 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.................................................................. 39 Item 9a. Controls and Procedures..................................................... 39 PART III. Item 10. Directors and Executive Officers of the Registrant.......................... 40 Item 11. Executive Compensation...................................................... 40 Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 40 Item 13. Certain relationships and Related Transactions.............................. 40 Item 14. Principal Accountant Fees and Services...................................... 41 PART IV. Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 41 SIGNATURES............................................................................ 43 Table of Contents to Financial Statements............................................. F-1
2 PART I. ITEM 1. BUSINESS CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 THIS ANNUAL REPORT ON FORM 10-K AND THE INFORMATION INCORPORATED BY REFERENCE INCLUDES "FORWARD-LOOKING STATEMENTS". THE COMPANY INTENDS FOR THE FORWARD-LOOKING STATEMENTS TO BE COVERED BY THE SAFE HARBOR PROVISIONS FOR FORWARD-LOOKING STATEMENTS. ALL STATEMENTS REGARDING THE COMPANY'S EXPECTED FINANCIAL POSITION AND OPERATING RESULTS, ITS BUSINESS STRATEGY, ITS FINANCING PLANS AND THE OUTCOME OF ANY CONTINGENCIES ARE FORWARD-LOOKING STATEMENTS. THE WORDS "BELIEVE", "EXPECT", "ANTICIPATE", "OPTIMISTIC", "INTEND", "WILL", AND SIMILAR EXPRESSIONS ALSO IDENTIFY FORWARD-LOOKING STATEMENTS. THE FORWARD- LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE SET FORTH OR IMPLIED BY ANY FORWARD LOOKING STATEMENTS. SOME OF THESE RISKS ARE DETAILED IN PART I, ITEM 1 "RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-K. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE ON WHICH THEY ARE MADE. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS, OR OTHERWISE. GENERAL On February 18, 1998, New Frontier Media, Inc. and its subsidiaries ("New Frontier Media" or "the Company") acquired the adult satellite television assets of Fifth Dimension Communications (Barbados), Inc. and its related entities ("Fifth Dimension"). As a result of the Fifth Dimension acquisition, New Frontier Media, through its wholly owned subsidiary Colorado Satellite Broadcasting, Inc., d/b/a The Erotic Networks, ("TEN") became a leading provider of adult programming to low-powered ("C-Band") direct-to-home ("DTH") households through its networks TEN*Xtsy ("Xtsy") and TEN*Max ("Max"). Subsequent to this purchase, the Company launched five networks targeted specifically to cable television system operators and high-powered DTH satellite service providers (Direct Broadcast Satellite or "DBS"): TEN, Pleasure, TEN*Clips ("Clips"), TEN*Blue ("Blue"), and TEN*Blox ("Blox"). On October 27, 1999, New Frontier Media completed an acquisition of three related Internet companies: Interactive Gallery, Inc. ("IGallery"), Interactive Telecom Network, Inc. ("ITN") and Card Transactions, Inc. ("CTI"). ITN and CTI are currently inactive subsidiaries. New Frontier Media is organized into two reportable segments: O Pay TV Group (formerly called Subscription/Pay-Per-View TV Group) -- distributes branded adult entertainment programming via Pay-Per-View ("PPV") networks and Video-on-Demand ("VOD") content through electronic distribution platforms including cable television, DBS, hotels and C-Band O Internet Group -- aggregates and resells adult content via the Internet. The Internet Group sells content to monthly subscribers through its broadband web site, www.TEN.com, partners with third-party gatekeepers for the distribution of www.TEN.com, and wholesales pre-packaged content to various web masters. Information concerning revenue and profit attributable to each of the Company's business segments is found in Part II, Item 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," and in Part IV, Item 15 of 3 "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS," of this Form 10-K, which information is incorporated by reference into this Part I, Item 1. PAY TV GROUP INDUSTRY OVERVIEW New Frontier Media, through its wholly owned subsidiary TEN (also referred to as "Pay TV Group"), is focused on the distribution of adult entertainment programming through electronic distribution platforms including cable television, DBS, hotels and C-band. Adult entertainment content distribution has evolved over the past twenty-five years from home video platforms (video cassette) to cable television systems and DBS providers, and most recently to the Internet. Cable television operators began offering subscription and PPV adult programming from network providers such as Playboy Enterprises, Inc. ("Playboy") in the early 1980's. PPV technology enables cable television operators or satellite providers to sell a block of programming, an individual movie, or an event for a set fee. PPV technology also permits cable television operators or satellite providers to sell the Pay TV Group's programming on a monthly, quarterly, semiannual and annual basis. PPV and VOD programming competes well with other forms of entertainment because of its relatively low price point. Kagan World Media ("Kagan") estimates that adult PPV and VOD revenue generated by cable systems and DBS providers in 2003 was $530 million, representing an increase of 14% from revenues of $465 million generated by the category in 2002. Kagan projects revenues from the adult category to grow to $950 million by the year 2008. PPV programming is delivered through any number of delivery methods, including: (a) cable television; (b) DTH to households with large satellite dishes receiving a low-power analog or digital signal (C-Band) or DBS services (such as those currently offered by EchoStar Communications Corporation and DIRECTV Group, Inc.); (c) wireless cable systems; and (d) low speed (dial-up) or broadband Internet connections (i.e., streaming video). The Pay TV Group provides programming on both a PPV and subscription basis to home satellite dish viewers through large backyard satellite dishes receiving a low-power analog or digital signal (C-Band). According to General Instrument Corporation's ("GI") Access Control Center reports, the U.S. C-Band market has declined 29% year-to-year, from 534,058 households as of April 2003 to 375,683 as of April 2004. The Pay TV Group provides PPV and subscription programming to small dish viewers receiving a high-power digital signal (via DBS providers such as EchoStar Communications Corporation's DISH Network) as well. As of December 31, 2003, EchoStar Communications Corporation ("DISH") and DIRECTV Group, Inc. ("DIRECTV") had 9.425 million and 12.21 million subscribers, respectively, according to public filings made by each company. Kagan estimates that the number of DBS subscribers will grow to 28 million by the year 2008. The Pay TV Group also provides its programming on a PPV, subscription and VOD basis through large multiple system operators ("MSOs") and their affiliated cable systems, as well as independent, privately-held cable systems. As of May 2004, the Pay TV Group maintained distribution arrangements with nine of the ten largest domestic cable MSOs which control access to 56.1 million, or 69%, of the total basic cable household market. According to the National Cable and Telecommunications Association ("NCTA"), Cable MSOs delivered service to 73.7 million basic households in the United States as of April 2004. In addition, Kagan indicates that total analog and digital addressable cable service (i.e., basic cable households that have the capability of receiving PPV or subscription services) was provided to 36.0 million households. Growth in the PPV market is expected to result in part from cable system upgrades utilizing fiber-optic, digital compression technologies or other bandwidth expansion methods that provide cable operators additional channel capacity. Cable operators have shifted from analog to digital technology in order to upgrade their cable systems and to respond to competition from DBS providers who offer programming in a 100% digital environment. When implemented, digital compression technology increases channel capacity, improves audio and video quality, provides fully secure scrambled signals, 4 allows for advanced set-top boxes for increased interactivity, and provides for integrated electronic programming guides ("EPG"). The Pay TV Group expects that most of its future cable launches will be on a digital platform. According to the NCTA, as of December 2003 more than 30% of U.S. Cable customers, or approximately 22.2 million households, received digital cable service. This represents an increase of 16% over the number of digital subscribers receiving service at the end of 2002 (19.2 million). Kagan estimates that the number of digital cable subscribers will grow to 40.9 million by the year 2008, which will represent a 60% penetration rate. Cable operators are also using their upgraded plants to provide their digital customers with VOD services (due to technology constraints, DBS providers are not able to provide VOD service to their customers). VOD is a more advanced form of pay-per-view service which provides a digital video subscriber with the ability to watch movies, TV shows, infomercials, and other content on demand with full VCR functionality, in contrast to watching programs at preset times. The Pay TV Group currently provides programming to over 10.5 million VOD enabled households. Kagan estimates that there were 16.5 million VOD enabled households at the end of 2003 compared to only 7.4 million VOD enabled households at the end of 2002. Kagan projects that there will be 23.3 million VOD enabled households by the end of 2004 and 38.2 million VOD enabled households by the end of 2008. DESCRIPTION OF NETWORKS The Pay TV Group provides seven, 24-hour per day adult programming networks: Pleasure, TEN, TEN*Clips, TEN*Blue, TEN*Blox, TEN*Xtsy, and TEN*Max. The following table outlines the current distribution environment for each service: TABLE 1 SUMMARY OF NETWORKS
ESTIMATED NETWORK HOUSEHOLDS(3) ------------------------------------- (IN THOUSANDS) AS OF AS OF AS OF MARCH 31, MARCH 31, MARCH 31, NETWORK DISTRIBUTION METHOD 2004 2003 2002 - ---------------------- ----------------------- --------- --------- --------- Pleasure Cable 7,800 8,000 7,500 TEN Cable/DBS 15,200 11,100 8,100 TEN*Clips Cable/DBS 13,700 5,800 3,600 Video-on-Demand Cable 10,500 5,300 1,100 TEN*Xtsy(1) C-band/Cable/DBS 10,000 9,000 7,800 TEN*BluePlus(1)(2) C-band/Cable N/A 570 800 TEN*Max(1) C-band/Cable 470 570 800 TEN*Blue Cable 2,500 300 N/A TEN*Blox Cable 2,800 300 N/A TOTAL NETWORK HOUSEHOLDS 62,970 40,940 29,700
Note: "N/A" indicates that network was not launched at that time (1) TEN*Xtsy, TEN*BluePlus and TEN*Max addressable household numbers include 0.8 million, 0.5 million, and 0.4 million C-Band addressable households for the years ended March 31, 2002, 2003, and 2004 respectively. (2) The Pay TV Group discontinued providing its TEN*BluePlus network in February 2004. (3) The above table reflects network household distribution. A household will be counted more than once if the home has access to more than one of the Pay TV Group's services, since each service represents an incremental revenue stream. The Pay TV Group estimates its unique household distribution as of March 31, 2004 to be 14.3 million cable homes and 9.4 million DBS homes. 5 TEN* FAMILY OF NETWORKS -- PROGRAMMING STRATEGY The TEN* family of networks is designed to be offered together as one cohesive programming package. The counter-programming strategy employed between each of the seven PPV networks and VOD service provides the widest variety of content to the consumer while at the same time supporting an efficient use of TEN's vast content library. Premiere titles are programmed on VOD first and then flow through to the PPV networks. Because TEN does not duplicate titles across its PPV channels or between PPV and VOD in a single month, TEN is able to give consumers access to more unique titles, a wider variety of talent, and a greater variety of studio representation than its competitors. TEN focuses on prime time viewing blocks and programs specific types of content in those blocks to create an appointment-viewing calendar. All networks are counter-programmed to one another creating an even greater level of variety for the consumer with multiple channels. Ultimately, this strategy is responsible for the fact that TEN has 2.65 networks per unique addressable home. Following are individual descriptions of each network. PLEASURE On June 1, 1999, the Pay TV Group launched Pleasure, a 24-hour per day adult network that incorporates the most edited standard available in the category. Pleasure is distributed via cable television operators. Pleasure's programming consists of adult feature-length film and video productions and is programmed to deliver subscription and PPV households up to 21 monthly premiere adult movies with a total of up to 110 adult movies per month. Pleasure was specifically designed to provide adult content programming to operators that have not yet embraced a less inhibited adult programming philosophy and for those operators that wish to use the service to "upsell" subscription or PPV households to a less edited network such as TEN or TEN*Clips. Pleasure is distributed via Cable system operators on either a pay-per-view or pay-per-block basis at prices ranging from $5.95 to $11.95. TEN On August 15, 1998, the Pay TV Group launched TEN, a 24-hour per day adult network that incorporates a partial editing standard targeted to cable television system operators and DBS providers. The Pay TV Group has programmed TEN with feature-length film and video productions that incorporate less editing than traditional cable adult premium networks. TEN is distributed via Cable system operators and DBS providers on either a pay-per-view or pay-per-block basis at retail prices ranging from $7.95 to $11.95 and on a monthly subscription basis for $24.95. TEN offers a diverse programming mix with movies and specials that appeal to a wide variety of tastes and interests. TEN offers subscription and PPV households up to 21 monthly premiere adult movies and up to 110 total adult movies per month. TEN was developed to capitalize on the number of cable operators/DBS providers now willing to carry partially edited adult network services and the momentum toward broader market acceptance of partially edited adult programming by their subscribers. New Frontier Media believes the growing market acceptance of partially edited programming is due, in large part, to the higher buy rates (the theoretical percentage of network households ordering one PPV movie, program or event in a month) achieved for cable system operators/DBS providers as compared to network programming that incorporates the most edited adult programming. TEN*CLIPS The Pay TV Group launched TEN*Clips on May 17, 2000. The unique formatting of this network provides for thematically organized clips that are compiled into 90-minute blocks of programming in order to provide more variety in a single viewing block and encourage appointment viewing by the PPV adult consumer. Through the Pay TV Group's proprietary database technology, approximately eight scenes are organized thematically and programmed into one 90-minute block. TEN*Clips delivers 240 unique thematic blocks with over 500 different adult film scenes during a typical month. This "clips" format is the most differentiated service in the adult category and consistently generates 6 higher buy rates than feature-driven adult services. TEN*Clips is distributed via Cable system operators and DBS providers on a pay-per-view and pay-per-block basis at retail prices ranging from $7.95 to $11.95 and on a monthly subscription basis for $24.95. TEN*BLUE TEN*Blue was launched on January 1, 2003 as the Pay TV Group's newest, partially edited network. This network is programmed to deliver up to 110 movies each month. TEN*Blue offers adult consumers feature-length amateur, ethnic, and urban content. TEN*Blue was developed to capitalize on the number of cable operators/DBS providers now willing to carry partially edited adult network services and the momentum toward broader market acceptance of partially edited adult programming by their subscribers. Additionally, TEN*Blue was designed specifically to achieve broader market acceptance by appealing to people with different ethnic backgrounds and interests. TEN*Blue is distributed via Cable system operators on a PPV or pay-per-block basis at retail prices ranging from $7.95 to $11.95. TEN*BLOX TEN*Blox was launched on January 1, 2003 as the Pay TV Group's newest, partially edited "clips" network (similar in formatting to TEN*Clips). This network is programmed to compliment TEN*Blue by utilizing thematically organized clips from the network's amateur, ethnic, and urban feature-length programs. TEN*Blox was developed to capitalize on the number of cable operators/ DBS providers now willing to carry partially edited adult network services and the momentum toward broader market acceptance of partially edited adult programming by their subscribers. Additionally, TEN*Blox was designed specifically to achieve broader market acceptance by appealing to people with different ethnic backgrounds and interests. TEN*Blox is distributed via Cable system operators on a pay-per-view or pay-per-block basis at retail prices ranging from $7.95 to $11.95. TEN*ON DEMAND (VIDEO-ON-DEMAND) TEN*On Demand is the brand under which the Pay TV Group delivers its VOD service. This service is available to Cable operators in each of the Pay TV Group's three editing standards. TEN*On Demand is provided to Cable operators as a "kit" of adult content with 5 - 40 titles in each kit. Content is refreshed on a monthly basis and provides for a 30-day early release window to the PPV services. Accordingly, there is no duplication of content between the PPV networks and the VOD content in any one month. TEN*On Demand is distributed via Cable operators on a per-movie basis at retail prices ranging from $5.95 to $11.95. In addition, the Pay TV Group provides its TEN*On Demand service to On Command Corporation ("On Command"), the leading provider of in-room interactive entertainment for the hotel industry and its guests. The Pay TV Group provides up to 14 titles a month to On Command's 895,000 VOD enabled hotel rooms in four different editing formats. TEN*XTSY TEN*Xtsy's programming consists of feature-length adult film and video productions and is programmed with up to 21 monthly premieres and 130 adult movies per month. TEN*Xtsy's programming is "least edited", which is similar to the editing standard employed in the home video market. The network offers a diverse programming mix with movies and specials that appeal to a wide variety of tastes and interests. TEN*Xtsy is distributed via C-band DTH, Cable system operators and DBS providers. Cable operators and DBS providers distribute TEN*Xtsy on a pay-per-view or pay-per block basis at retail prices ranging from $8.95 to $11.95 and on a monthly subscription basis for $27.99. TEN*Xtsy had 43,360, 34,618 and 23,580 active C-Band subscriptions as of March 31, 2002, 2003 and 2004, respectively. C-Band retail prices range from $24.99 to $81.99 for monthly, quarterly, and semi-annual subscriptions. 7 TEN*BLUEPLUS TEN*BluePlus was primarily provided to the C-Band DTH market. Given the continued decline in the number of addressable households in the C-Band market and the continued decline in the Pay TV Group's revenue from this market, the Pay TV Group made the decision to discontinue this service in February 2004. TEN*MAX TEN*Max incorporates the same editing standard as TEN*Xtsy and is programmed to compliment this network by utilizing thematically organized clips (similar to the TEN*Clips format) from TEN*Xtsy's premieres, network specials and compilations. TEN*Max is distributed via C-band DTH and Cable operators. C-band retail prices range from $24.99 to $81.99 for monthly, quarterly, and semiannual subscriptions. TEN*Max had 40,210, 33,606, and 22,923 active C-Band subscriptions as of March 31, 2002, 2003, and 2004, respectively. SATELLITE TRANSMISSION The Pay TV Group delivers its video programming via satellite transmission. Satellite delivery of video programming is accomplished as follows: Video programming is played directly from the Pay TV Group's Boulder, Colorado digital broadcast center. The program signal is then scrambled (encrypted) so that the signal is unintelligible unless it is passed through the proper preauthorized decoding devices. The signal is transmitted (uplinked) by an earth station to a designated transponder on a communications satellite. The transponder receives the program signal uplinked by the earth station, amplifies the program signal and broadcasts (downlinks) it to satellite dishes located within the satellite's area of signal coverage. The signal coverage of the domestic satellite used by New Frontier Media is the continental United States, Hawaii, Alaska, and portions of the Caribbean, Mexico, and Canada. The Pay TV Group's programming is received by C-Band subscribers, Cable system operators and DBS providers. This programming is received in the form of a scrambled signal. In order for subscribers to receive the programming the signal must be unscrambled. C-Band subscribers purchase programming directly from the Pay TV Group. The satellite receivers of C-Band subscribers contain unscrambling equipment that may be authorized to decode the Pay TV Group's satellite services. Each set top box or satellite receiver has a unique electronic "address". This "address" is activated for the requisite services purchased. Cable system operators and DBS providers receive their programming in the same manner as a C-Band subscriber. These multi-channel distributors in turn, provide the received programming to their captive subscriber audience. The equipment utilized by Cable system operators and DBS providers is similar to that utilized by C-Band subscribers but manufactured to an industrial grade specification. The Cable system operators and DBS providers are able to remotely control each subscriber's set-top box or satellite receiver on their network, and cause it to unscramble the television signal for a specified period of time after the subscriber has made a purchase of a premium service or PPV movie or event. TRANSPONDER AGREEMENTS New Frontier Media maintains satellite transponder lease agreements for two full-time analog transponders with Intelsat USA Sales Corporation ("Intelsat") on its Intelsat Americas 6 satellite and 20.5 MHz of total bandwidth allocation on a digital transponder on its Intelsat Americas 7 satellite. These transponders provide the satellite transmission necessary to broadcast each of the Pay TV Group's seven adult networks. In April 2000, the Pay TV Group signed a multi-year agreement with iN DEMAND L.L.C. ("iN DEMAND") for carriage of its Pleasure network. As a result of the contract, Pleasure is available to cable operators representing approximately 7.4 million digital households across the country. iN DEMAND carries Pleasure on Intelsat Americas 7, transponder 4. iN DEMAND is the 8 world's largest provider of VOD and PPV programming, offering titles from all of the major Hollywood and independent studios, plus pay-per-view boxing, soccer and concerts, and professional sports packages from the NBA, NHL, MLB and NASCAR. iN DEMAND serves over 1,400 affiliated systems. iN DEMAND's three shareholders include Time Warner Entertainment - Advance/Newhouse Partnership, Comcast iN DEMAND Holdings, Inc., and Cox Communications, Inc. In June 2002, the Pay TV Group began offering its VOD service to cable MSOs via its transport agreement with TVN Entertainment ("TVN"). TVN is one of the largest privately held digital content aggregation, management, distribution, and service companies in the country. TVN offers the only single-source management and distribution solution for VOD and PPV, including content aggregation, packaging, encoding, asset management and transport via satellite to all video service providers. TVN has been chosen as a VOD solution for many Cable MSOs, including Charter, Comcast, Insight and Mediacom. As of March 31, 2004, the Pay TV Group reached approximately 6.3 million VOD households through its distribution agreement with TVN. DIGITAL BROADCAST CENTER The Pay TV Group internally encodes, originates, distributes and manages its own networks. The Company has differentiated itself by developing broadcast and broadband distribution capabilities to fully control and exploit its large content library across various platforms. The Pay TV Group acquired the necessary broadcast technologies and support services from third party providers, and internally developed its own media asset management systems, for the distribution of video-based content to Cable and DBS providers. The Pay TV Group, through its Boulder, Colorado based Digital Broadcast Center, currently broadcasts 7 channels, with capacity to add 11 additional channels, to Cable/DBS systems and direct-to-home C-band subscribers. Broadcast of all media to air is accomplished using state-of-the-art digital technology solutions, which includes playlist automation for all channels; SeaChange MPEG 2 encoding and playout to air and MPEG 1 encoding for internet and broadband use; archiving capability on DLT data cartridges pushing and pulling the data through a StorageTek jukebox; and complete integration of the media asset management database to create automated playlists. The Pay TV Group has worked with its uplinking vendor, WilTel Communications, LLC ("WilTel") to secure a license to allow an 18Ghz microwave transmission in order to provide a fully redundant path from the broadcast center to its uplink facility. The Pay TV Group also runs a fiber transmission path directly to its largest customer's facility to ensure redundancy of its services in case of an outage with its primary uplinking vendor, WilTel. The technology team that manages the broadcast center also oversees the Pay TV Group's media asset management needs. Using its own core proprietary asset management systems, supplemented with other third party software programs, the Digital Broadcast Center catalogs, monitors, and distributes the Group's licensed content across multiple technology platforms. NETWORK PROGRAMMING The Pay TV Group had contracted with an outside third party in California to screen, license, edit, and program content for most of its services. At the same time, the Pay TV Group edited and programmed content in-house for TEN*Blue, TEN*Blox, TEN*Clips, TEN*Max and the On Command VOD content. In May 2004, the Pay TV Group discontinued its relationship with the outside third party in California and brought all screening, licensing, editing and programming functions in-house. The Pay TV Group now has its own office in California. This office ensures that all legal documentation is obtained for each title licensed (i.e., cast lists, talent releases and two photo identifications for each cast member), screens the content to ensure the commercial and broadcast viability of the title, and once the title is deemed acceptable, ships the title, related documentation and promotional content to Boulder. The Pay TV Group's in-house programming department in Boulder, Colorado conducts preliminary screening of potentially licensable content, licenses acceptable content, 9 conforms content into appropriate editing standards (i.e., partially edited, least edited and most edited) and programs the monthly schedules for all networks and services. The Pay TV Group acquires 100% of its feature-length broadcast programming for each network by licensing the exclusive and non-exclusive rights from various third party studios and independent producers within the industry for generally a five-year term. The Group does not produce any of its own adult-feature content for its networks. The Pay TV Group licenses its content on both an exclusive and non-exclusive basis from as many as fifty-four independent companies. The Pay TV Group acquires approximately 15 new titles per month. Once the Pay TV Group licenses a title, it will undergo several rigorous quality control processes prior to playing to air to ensure compliance with the strict broadcasting standards the Pay TV Group uses for its adult content. The Pay TV Group obtains age verification documentation for each title it licenses, including two forms of photo identification for each cast member in the film. This documentation is maintained on site for the duration of the license term. In July 1999, the Company licensed the rights for seven years to Metro Global Media, Inc.'s ("Metro") 3,000 title adult film and video library and multi-million still image archive in exchange for 500,000 shares of its common stock at $7.875 per share and 100,000 warrants to purchase its common stock at an exercise price equal to the market value of the stock on the date the warrants were issued. In June 2003, New Frontier Media reached an agreement to license all of the broadcast and electronic distribution rights to approximately 2,000 adult films under a Content License Agreement with Pleasure Productions, Inc. As a result of the licensing of these libraries, the Company believes that it is one of the largest aggregators of adult video content in the world. CALL CENTER SERVICE The Pay TV Group's in-house call center receives incoming calls from customers wishing to order C-Band network programming, or having questions about their C-Band service or billing. The call center is accessible from anywhere in the U.S. via toll-free numbers. Its workstations are equipped with a networked computer, Company-owned proprietary order processing software, and telephone equipment. These components are tied into a computer telephony integrated switch which routes incoming calls and enables orders to be processed and subscriber information to be updated "on-line." The Pay TV Group's call center is operational 19-hours per day, seven days a week, and is staffed according to call traffic patterns, which take into account time of day, day of the week, seasonal variances, holidays, and special promotions. Customers pay for their order with credit cards and electronic checks, which are authorized and charged before the order is sent electronically to GI's Access Control Center in San Diego, California for processing. GI receives the subscriber order and the subscriber's identification information, and sends a signal to the appropriate satellite, which "unlocks" the service ordered for the applicable period of time. MARKETING The Pay TV Group's marketing department has developed numerous programs and promotions to support its pay-per-view and VOD services. These include the development of detailed monthly program guides, promotional pieces, direct mail campaigns, and cross channel interstitial programming for use on a Cable or DBS systems' channel that allows for local insertion. The Pay TV Group also maintains a sales force of four full-time employees to promote and sell carriage of its programming on cable television, DBS and alternative platforms. The sales force consists of cable television industry veterans that each has more than ten years of experience in the cable television business in both operations and programming. The Pay TV Group's sales team attends at least four major industry trade shows per year, including the National Cable Television Association (NCTA) show, the Cable Television Advertising and Marketing (CTAM) Summit, PPV and Digital Television Summit, and DBS Summit. The Pay TV Group's promotions department creates interstitial programming for use on its networks between each movie to promote and market additional movies premiering in the current 10 month, movies premiering in the following month, behind-the-scenes segments of its movies, and star and director profiles. This interstitial programming encourages appointment viewing of the Pay TV Group's networks by Cable/DBS consumers. The Pay TV Group brands its services to the consumer under the TEN* name and logo. The Pay TV Group seeks out low cost, high impact ways to reach its consumer audience and build brand recognition. The Pay TV Group participated in the Sturgis Motorcycle Rally, sponsored a band's summer tour, and participated in a Super Bowl promotion during the year ended March 31, 2004 in order to gain further recognition for its brand. These types of branding promotions will continue during the fiscal year ended March 31, 2005. COMPETITION The Pay TV Group principally competes with Playboy Enterprises, Inc. ("Playboy") in the subscription, PPV and VOD markets. Playboy has a longer operating history and broader name recognition than the Pay TV Group. Playboy's size and market position makes it a more formidable competitor than if it did not have the resources and name recognition that it has. The Pay TV Group competes directly with Playboy with respect to the editing standards of its programming, network performance in terms of subscriber buy rates, and the license fees that the Pay TV Group offers to Cable and DBS providers. However, the Pay TV Group cannot and does not compete with Playboy in the amount of money spent on promoting its products. While there can be no assurance that the Pay TV Group will be able to maintain its current distribution and fee structures in the face of competition from Playboy or any other content provider, the Pay TV Group believes that the quality and variety of its programming, as well as the attractive revenue splits and its ability to generate higher buy rates for its programming, are the critical factors which have influenced Cable operators and DBS providers to choose the Pay TV Group's programming over its competition. The Pay TV Group also faces general competition from other forms of non-adult entertainment, including sporting and cultural events, other television networks, feature films, and other programming. In addition, the Pay TV Group faces competition in the adult entertainment arena from other providers of adult programming including producers of adult content, adult video rentals and sales, books and magazines aimed at adult consumers, telephone adult chat lines, and adult-oriented Internet services. SEASONALITY The Pay TV Group's business is generally not seasonal in nature. CUSTOMER CONCENTRATION New Frontier Media derived 34% and 16% of its total revenue for the year ended March 31, 2004 from DISH and Time Warner Cable, respectively, through its Pay TV Group. The loss of these major customers could have a material adverse effect on the Pay TV segment and upon the Company as a whole. INTERNET GROUP INDUSTRY OVERVIEW According to Pew Internet & American Life ("Pew"), a non-profit entity whose initiative is the timely information on the Internet's growth and societal impact, adoption of high-speed Internet connections in the home grew strongly in the United States in the first several months of 2004, with home broadband penetration standing at 39% among American Internet users by the end of February 2004. This is up from 31% in the Pew's November 2003 study. Overall, Pew states that 48 million American adults had high-speed connections in the home in February 2004. Of these high-speed connections, Pew's survey shows that 54% of home broadband users connected with cable modems, 42% used digital subscriber lines ("DSL"), and 3% used wireless or fixed-satellite technology. According to NCTA, the cable industry served approximately 15 million high-speed Internet 11 customers as of September 2003, up from 10.3 million in September 2002, an increase of 46% year-over-year. In anticipation of the continued increase in broadband users, during the fiscal year ended March 31, 2004 the Internet Group shifted its focus from the dial-up web surfer to creating an award-winning website targeted specifically to the broadband consumer. This site, TEN.com, features over 1,100 hours of video content, over 16,000 photos, live chat, and voyeur cams. TEN.com is offered to consumers on a monthly subscription basis for $19.95. Traffic to TEN.com is derived primarily from advertising on the Pay TV Group's networks. In addition, a targeted network of affiliated adult webmasters directs traffic to TEN.com and is compensated only if the traffic converts into a paying member to TEN.com. Monthly subscription revenue declined during the fiscal year ended March 31, 2004, as the Internet Group was not attracting enough new traffic to TEN.com to offset the churn of its recurring membership base. The Internet Group plans to focus its efforts on attracting a higher volume of traffic to TEN.com during the upcoming year, as it believes that it can attract profitable traffic to offset its subscriber churn. The Internet Group also sells TEN.com through revenue sharing partnerships with third-party gatekeepers. The Internet Group believes that creating these third party relationships will be the manner in which it will ultimately sustain and grow the revenue for this segment. The Internet Group executed its first such revenue sharing agreement with On Command during the fiscal year ended March 31, 2003. Under the terms of the agreement, the Internet Group is the exclusive provider of adult content for On Command's TV Internet Service. The Internet Group is providing a customized version of its TEN.com broadband product for delivery through On Command's TV Internet Service in its hotel rooms nationwide. The Internet Group continues to work on completing additional revenue sharing partnerships with Cable MSOs such as Wide Open West and RCN Corporation for the distribution of TEN.com. New Frontier Media views its Internet Group as an investment in the future. As broadband distribution grows, and as technology improves the delivery of content through wireless applications such as cell phones and Personal Digital Assistants ("PDAs"), the Internet Group will be the segment through which New Frontier Media will capitalize on these potential revenue-generating opportunities. Until then, the Internet Group will focus its efforts on deriving revenue from traffic directed to TEN.com through advertising on the Pay TV Group's networks and affiliate webmaster programs, as well as to completing new revenue sharing partnerships through which it can gain access to captive adult consumers of the Cable MSOs. DESCRIPTION OF INTERNET REVENUE STREAMS BUSINESS TO CONSUMER: TEN.COM Prior to March 31, 2003, the Internet Group owned and operated more than 10 consumer web sites in addition to owning over 1,300 vanity adult domains. These web sites were developed to convert dial-up web surfers into subscribers through various subscription models. Recurring monthly subscription rates ranged from $14.74 to $29.95. The Internet Group used to offer consumers the ability to view its web sites on a trial basis, generally three days, for a special rate of $2.97. The Internet Group discontinued offering free trials to its web sites in December 2001 and discontinued offering paid trials to its web sites during the quarter ended March 31, 2003. In connection with a legal settlement, the Internet Group transferred approximately 150 of its primary domain names to a third party as of March 31, 2003. At the same time, the Internet Group merged all of its dial-up web sites (and corresponding members) into its premiere broadband site, www.TEN.com. The Internet Group offers TEN.com to consumers on a recurring monthly subscription basis for $19.95. The site is targeted to adult broadband consumers and provides access to over 1,100 hours of video content. The Internet Group generates traffic to its web sites through three primary sources. The first, "type-in" traffic, is generated when a consumer types the name of one of the Internet Group's web sites or one of its domain names into their browser address bar. There is no cost to the Internet 12 Group when traffic comes to its web sites in this manner other than the initial cost to acquire the domain name. However, type-in traffic has declined over the past few years as portals such as Microsoft Corporation's MSN no longer default words typed into a browser dialogue box to the "dot-com" web site associated with such word. Currently, the Internet Group actively markets its TEN.com web site on the Pay TV Group's networks in order to drive type-in traffic to its site. Over 70% of the Internet Group's traffic is currently generated from advertising on the Pay TV Group's networks or through type-in traffic. The second way in which the Internet Group generates traffic is through its affiliate marketing programs utilizing banner ads, hypertext, or graphic links. The marketing programs compensate an affiliated webmaster for a referred visitor if the visitor becomes a member to TEN.com. The affiliated webmaster programs currently pay out an amount equal to the first month's membership revenue for a new member ($19.95). The Internet Group then keeps 100% of the revenue from each recurring monthly membership and any associated revenue from other products sold within the site. During the past few years, the Internet Group has decreased its reliance on affiliated webmaster programs as a way to generate traffic to its sites. However, the Internet Group does expect to create new affiliated webmaster programs during its fiscal year ended March 31, 2005 in order to generate more traffic to TEN.com. These programs will only compensate a webmaster for traffic that converts into a paying member. The third way in which traffic is generated to TEN.com is through search engines. Search engine traffic is generated from listings of the Internet Group's web sites in search engines and directories. The Internet Group uses discreet and proprietary technology to position (optimize) its web site within a search engine's results page so that visitors using the search engine to look for certain types of content have a higher chance of finding what they want. BUSINESS TO BUSINESS: CONTENT, TRAFFIC SALES AND PAY-PER-CLICK Content Sales: The Internet Group is one of the leading licensors of adult content on the Internet. The Internet and Pay TV Groups have licensed thousands of hours of adult video content and over 500,000 still images from various adult studios, all of which have been organized thematically and, if necessary, digitized for Internet distribution. The Internet Group, in addition to using this content within its own web site, sublicenses this content to webmasters through its business-to-business programs on a flat-rate monthly basis. During the upcoming fiscal year, the Internet Group intends to outsource the sales effort for its content products in an effort to gain more visibility and generate more revenue from these products. Traffic Sales: The Internet Group had developed a significant source of revenue by selling traffic from its own web site to other adult web sites. Since every visitor to the Internet Group's web site does not necessarily purchase a membership, the Internet Group maximized its return on traffic by "pushing" these exiting non-member visitors to other adult web sites. In doing so, it was able to generate revenue from affiliate webmaster programs on a pay-per-member basis. While the revenue from the sale of traffic did not have the potential to generate long-term recurring revenue like the Internet Group's membership revenue, it also did not have the credit and working capital issues associated with membership revenue. Because the Internet Group has seen a significant decline in traffic to its site, it also has seen a corresponding decrease in the amount of traffic available to resell. The Internet Group does not expect any significant revenue from Traffic Sales in the future. Pay-Per-Click: During the fiscal year ended March 31, 2003, the Internet Group developed its own pay-per-click ("PPC") search engine whereby advertisers registered keywords or keyword combinations, along with a title and description. Placement in the search results was purchased by the advertiser rather than determined by a complex formula relating to relevance or popularity. This resulted in a pure market model for the advertiser. The more they bid for a keyword, the higher their site was shown in the list of search results returned to the consumer on that keyword search. The result for the advertiser was qualified traffic that was more likely to convert into a paying member of its site, while the consumer received immediate access to relevant results. 13 The success of the PPC search engine was based primarily on how much traffic was pushed through it. Because the Internet Group experienced a significant decline in its traffic, the PPC search engine was abandoned as of March 31, 2003. MARKETING The Internet Group currently generates 70% of its traffic to TEN.com from advertising its site on the Pay TV Group's networks and through type-in traffic. Prior to the fiscal year ended March 31, 2003, the Internet Group actively marketed its websites through affiliate webmaster programs which were incentive-based traffic generation programs that compensated affiliated webmasters for traffic referrals. A webmaster was compensated when a referred visitor became a member to one of the Internet Group's web sites, at an average payout of $30 - $45 per active member. During the fiscal year ended March 31, 2003, the Internet Group ceased actively marketing its traffic acquisition programs. Currently, the Internet Group has a small group of affiliated webmasters that send traffic to TEN.com and are compensated if the traffic converts into a paying member. The affiliate webmaster programs currently pay out an amount equal to the first month's membership revenue for a new member ($19.95). The Internet Group then keeps 100% of the revenue from each recurring monthly membership and any associated revenue from other products sold within the site. DATA CENTER The Internet Group had its own data center in Sherman Oaks, California that provided for all of its web farm, hosting and co-location needs. The data center occupied approximately 4,400 square feet. The Internet Group moved its data center to Boulder, Colorado in January 2003 where it currently resides within the Pay TV Group's digital broadcast facility. This move allowed the Internet Group to significantly reduce its data center costs. Integrating the data center with the broadcast facility enables the Company to more efficiently leverage its content across multiple platforms. The data center uses leading networking hardware, high-end web and database servers, and computer software to effectively address the Internet Group's diverse systems and network integration needs. E-COMMERCE BILLING Historically, credit card purchases, primarily through VISA and MasterCard, have been face-to-face paper transactions. This has evolved into face-to-face swipe transactions with the advent of point-of-sale terminals and a magnetic stripe on the back of the card storing the cardholder's information. The credit card system, however, was never designed for non face-to-face transactions such as those that occur on the Internet. Because the credit card system was not designed for non face-to-face transactions, it is understandable that most fraud originates in this area. The credit card networks were not engineered to verify a valid card in a "card not present" environment such as the Internet. The card associations, instead of investing in modifications of its legacy networks necessary to operate in this changing environment, have combated fraud in "card not present" environments by charging high chargeback fees and penalties to merchants and banks. In the past few years the number of banking relationships available for merchant banking has dropped, the cost of chargebacks has increased, and the acceptable level allowed for chargeback rates has also been dramatically reduced. Prior to 2002, the Internet Group maintained its own in-house billing personnel and processed its own credit cards for its membership sites. In order to maintain its in-house credit card processing function the Internet Group would have had to invest a large amount of capital to upgrade its facilities and technology to become compliant with VISA's rules and regulations. Rather than make this investment and detract from its core competency of aggregating and marketing adult content, the Internet Group determined that it was best to outsource its credit card processing and customer 14 service functions to third party processors. The Internet Group completed the outsourcing of its credit card processing functions in the third quarter of fiscal 2002. To date, the Internet Group utilizes one credit card company to process its membership revenue from TEN.com and maintains chargeback and credit ratios that are well below the 1% requirement. COMPETITION The adult Internet industry is highly competitive and highly fragmented given the relatively low barriers to entry. The leading adult Internet companies are constantly vying for more members while also seeking to hold down member acquisition costs paid to webmasters. Increased tightening of chargebacks by credit card companies has reduced membership sales and further intensified this already competitive environment. The Internet Group believes that the primary competitive factors in the adult Internet industry include the quality of content, technology, pricing, and sales and marketing efforts. Although the Internet Group no longer actively competes for traffic with its primary Internet competitors, the Group believes that it has a distinct competitive advantage in forming third-party gatekeeper arrangements for the distribution of TEN.com since it already has many of the same relationships through the Pay TV Group's contracts. EMPLOYEES As of the date of this report, New Frontier Media and its subsidiaries had 119 employees. New Frontier Media employees are not members of a union, and New Frontier Media has never suffered a work stoppage. The Company believes that it maintains a good relationship with its employees. GEOGRAPHIC AREAS Revenue for the Company is primarily derived from within the United States. Additional information required by this item is incorporated herein by reference to Note 1 "Organization and Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements that appears in Item 8 of this Form 10-K. AVAILABLE INFORMATION The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). You may read and copy any document the Company files at the SEC's public reference room at Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains a web site (www.sec.gov) that contains annual, quarterly and current reports, proxy statements and other information that issuers (including the Company) file electronically with the SEC. The Company makes available, free of charge through its web site (www.noof.com), its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Forms 3, 4 and 5 filed on behalf of directors and executive officers, and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. The information on the Company's web site is not incorporated by reference into this report. 15 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of New Frontier Media are as follows:
NAME AGE POSITION - ------------------------------ ------ ----------------------------------------------------- Michael Weiner........... 61 Chairman of the Board, Chief Executive Officer, Secretary, and Director, New Frontier Media, Inc. Karyn L. Miller.......... 38 Chief Financial Officer and Treasurer, New Frontier Media, Inc. Ken Boenish.............. 37 President, The Erotic Networks, Inc. Bill Mossa............... 41 Vice President of Affiliate Sales and Marketing, The Erotic Networks, Inc. George Sawicki........... 44 Vice President, Legal Affairs and Assistant Secretary, New Frontier Media, Inc.
MICHAEL WEINER. Mr. Weiner was appointed President of New Frontier Media, Inc. in February 2003 and was then appointed to the position of Chief Executive Officer in January 2004. Prior to being appointed President, he held the title of Executive Vice President and co-founded the Company in 1995. As Executive Vice President, Mr. Weiner oversaw content acquisitions, network programming, and all contract negotiations related to the business affairs of the Company. In addition, he was instrumental in securing over $20 million to finance the infrastructure build-out and key library acquisitions necessary to launch the Company's seven television networks. Mr. Weiner's experience in entertainment and educational software began with the formation of Inroads Interactive, Inc. in May 1995. Inroads Interactive, based in Boulder, Colorado, was a reference software publishing company dedicated to aggregating still picture, video, and text to create interactive, educational-based software. Among Inroad Interactive's award winning releases were titles such as Multimedia Dogs, Multimedia Photography, and Exotic Pets. These titles sold over 1 million copies throughout the world through its affiliate label status with Broderbund Software and have been translated into ten different languages. Mr. Weiner was instrumental in negotiating the sale of Inroads Interactive to Quarto Holdings PLC, a UK-based book publishing concern. Prior to this, Mr. Weiner was in the real estate business for 20 years, specializing in shopping center development and redevelopment in the Southeast and Northwest United States. He was involved as an owner, developer, manager, and syndicator of real estate in excess of $250 million. KARYN L. MILLER. Ms. Miller joined New Frontier Media in February 1999 as Chief Financial Officer. She began her career at Ernst & Young in Atlanta, Georgia and brings fifteen years of accounting and finance experience to the Company. Prior to joining the Company, Ms. Miller was the Corporate Controller for Airbase Services, Inc. a leading aircraft repair and maintenance company. Previous to that she was the Finance Director for Community Medical Services Organization and Controller for Summit Medical Group, P.L.L.C. Before joining Summit Medical Group, P.L.L.C., Ms. Miller was a Treasury Analyst at Clayton Homes, Inc., a former $1 billion NYSE company which was recently purchased by Warren Buffet. Ms. Miller graduated with Honors with both a Bachelors of Science degree and a Masters in Accounting from the University of Florida and is a licensed CPA in the state of Colorado. KEN BOENISH. Mr. Boenish is a 15-year veteran of the cable television industry. In October 2000, he was named President of The Erotic Networks, a subsidiary of New Frontier Media, and in April 2002 he began managing the day-to-day operations of the Internet Group under The Erotic Networks' umbrella. Mr. Boenish joined The Erotic Networks as the Senior Vice President of Affiliate Sales in February 1999. Prior to joining the Company, Mr. Boenish, was employed by Jones Intercable ("Jones") from 1994 - 1999. While at Jones he held the positions of National Sales Manager for Superaudio, a cable radio service serving more than 9 million cable customers. He was promoted to 16 Director of Sales for Great American Country a new country music video service in 1997. While at Great American Country Mr. Boenish was responsible for adding more than 5 million new customers to the service while competing directly with Country Music Television, a CBS cable network. From 1988 - 1994 he sold cable television advertising on systems owned by Time Warner, TCI, COX, Jones, Comcast and other cable systems. Mr. Boenish holds a B.S. degree in Marketing from St. Cloud State University. BILL MOSSA. Mr. Mossa joined The Erotic Networks as Vice President of Affiliate Sales and Marketing in 1998 and has been instrumental in growing the Company's network distribution from zero to over 60 million addressable subscribers. Prior to joining The Erotic Networks, Mr. Mossa was the Regional Director of Affiliate Sales and Marketing for Spice Entertainment, directing all affiliate sales and marketing efforts for its northeast region. Mr. Mossa has also held positions as Affiliate Marketing Manager of the SportsChannel NY, Regional Pay-Per-View Director for Century Communications, Corporate Pay-Per-View Manager for TKR Cable, and Marketing Manager for TKR Cable. Mr. Mossa holds a Bachelors Degree in Business Administration from Northeastern University in Boston, Massachusetts. GEORGE SAWICKI. Mr. Sawicki joined New Frontier Media in September 2003 as Vice President of Legal Affairs. He began his legal career in December 1995 with Norris, McLaughlin & Marcus, the largest law firm in Somerset County, New Jersey, and brings over twenty years of combined technology and legal experience to the Company. Prior to joining the Company, and beginning in September 2001, Mr. Sawicki was Senior Corporate Counsel for Storage Technology Corporation ("StorageTek"), a leading information storage and lifecycle management company. Previous to that, and beginning in November 2000, he was the Director of Legal for a global supply chain event management software company headquartered in Atlanta, Georgia and, beginning in October 1996, was Corporate Counsel for Oracle Corporation in its Atlanta Global Business Office. Before beginning his legal career, Mr. Sawicki was a Senior Chemist and Information Systems Analyst with Texaco, Inc, in Houston, Texas. Mr. Sawicki holds an A.B. degree in Chemistry from Vassar College, a Masters degree in Management Information Systems from Houston Baptist University and a J.D. from the University of Houston Law Center. He is a member of the Texas, New Jersey and Georgia bar associations and is licensed to practice before the United States Patent and Trademark Office. No executive officer of the Company is related to any other director or executive officer. None of the Company's executive officers hold any directorships in any other public company. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Pursuant to Section 16 of the Exchange Act, the Company's directors and executive officers and beneficial owners of more than 10% of the Company's Common Stock are required to file certain reports, within specified time periods, indicating their holdings of and transactions in the Common Stock and derivative securities of the Company. Based solely on a review of such reports provided to the Company and written representations from such persons regarding the necessity to file such reports, the Company is not aware of any failures to file reports or report transactions in a timely manner during the Company's fiscal year ended March 31, 2004. RISK FACTORS THIS REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS. YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY THEIR USE OF THE FORWARD-LOOKING WORDS "ANTICIPATE," "ESTIMATE," "PROJECT," "LIKELY," "BELIEVE," "INTEND," "EXPECT," OR SIMILAR WORDS. THESE STATEMENTS DISCUSS FUTURE EXPECTATIONS, CONTAIN PROJECTIONS REGARDING FUTURE DEVELOPMENTS, OPERATIONS, OR FINANCIAL CONDITIONS, OR STATE OTHER FORWARD-LOOKING INFORMATION. WHEN CONSIDERING THE FORWARD-LOOKING STATEMENTS MADE IN THIS REPORT, YOU SHOULD CONSIDER THE RISKS SET FORTH BELOW AND OTHER CAUTIONARY STATEMENTS THROUGHOUT THIS REPORT. YOU SHOULD 17 ALSO KEEP IN MIND THAT ALL FORWARD-LOOKING STATEMENTS ARE BASED ON MANAGEMENT'S EXISTING BELIEFS ABOUT PRESENT AND FUTURE EVENTS OUTSIDE OF MANAGEMENT'S CONTROL AND ON ASSUMPTIONS THAT MAY PROVE TO BE INCORRECT. IF ONE OR MORE RISKS IDENTIFIED IN THIS REPORT OR OTHER FILING MATERIALIZES, OR ANY OTHER UNDERLYING ASSUMPTIONS PROVE INCORRECT, OUR ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE ANTICIPATED, ESTIMATED, PROJECTED, OR INTENDED. THE LOSS OF OUR MAJOR CUSTOMERS, DISH NETWORK AND TIME WARNER CABLE, WOULD HAVE A MATERIAL ADVERSE AFFECT ON OUR OPERATING PERFORMANCE AND FINANCIAL CONDITION. DISH Network, one of the leading providers of direct broadcast satellite services in the United States, and Time Warner Cable, are major customers of our Pay TV Group. The loss of DISH Network and Time Warner Cable as customers would have a material adverse effect on our business operations and financial condition. For our fiscal year ended March 31, 2004, our revenues from DISH Network and Time Warner Cable equaled approximately 34% and 16%, respectively, of our total Company-wide revenues. DISH Network is not contractually required to carry our programming and can cancel its broadcast of our programming at any time. Management considers its long-standing personal contacts with its counterparts at DISH Network to be critically important to maintaining DISH Network as a major customer, especially given the nature of our content and the importance of DISH Network's reliance on our judgment and ability in assuring that all of its programming has been pre-screened and appropriately edited in accordance with established guidelines. LIMITS TO OUR ACCESS TO DISTRIBUTION CHANNELS COULD CAUSE US TO LOSE SUBSCRIBER REVENUES AND ADVERSELY AFFECT OUR OPERATING PERFORMANCE. Our satellite uplink provider's services are critical to us. If our satellite uplink provider fails to provide the contracted uplinking services, our satellite programming operations would in all likelihood be suspended, resulting in a loss of substantial revenue to the Company. If our satellite uplink provider improperly manages its uplink facilities, we could experience signal disruptions and other quality problems that, if not immediately addressed, could cause us to lose subscribers and subscriber revenues. Our continued access to satellite transponders is critical to us. Our satellite programming operations require continued access to satellite transponders to transmit programming to our subscribers. We also use satellite transponders to transmit programming to cable operators and DBS providers. Material limitations to satellite transponder capacity could materially adversely affect our operating performance. Access to transponders may be restricted or denied if: O we or the satellite owner is indicted or otherwise charged as a defendant in a criminal proceeding; O the FCC issues an order initiating a proceeding to revoke the satellite owner's authorization to operate the satellite; O the satellite owner is ordered by a court or governmental authority to deny us access to the transponder; O we are deemed by a governmental authority to have violated any obscenity law; or O our satellite transponder provider determines that the content of our programming is harmful to its name or business. In addition to the above, the access of our networks to transponders may be restricted or denied if a governmental authority commences an investigation concerning the content of the transmissions. Our ability to convince Cable operators and DBS providers to carry our programming is critical to us. The primary way for us to expand our Cable subscriber base is to convince additional Cable 18 operators and DBS providers to carry our programming. We can give no assurance, however, that our efforts to increase our base of subscribers will be successful. IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH OUR PRIMARY CABLE/DBS COMPETITOR, WHO HAS SIGNIFICANTLY GREATER RESOURCES THAN US, WE WILL NOT BE ABLE TO INCREASE SUBSCRIBER REVENUES. Our ability to increase subscriber revenues and operate profitably is directly related to our ability to compete effectively with Playboy, our principal competitor. Playboy has significantly greater financial, sales, marketing and other resources to devote to the development, promotion and sale of its cable programming products, as well as a longer operating history and broader name recognition, than we do. We compete with Playboy as to the editing standards of its programming, network performance in terms of subscriber buy rates and the license fees that we offer to Cable operators and DBS providers. IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH OTHER FORMS OF ADULT AND NON-ADULT ENTERTAINMENT, WE WILL ALSO NOT BE ABLE TO INCREASE SUBSCRIBER REVENUE. Our ability to increase revenue is also related to our ability to compete effectively with other forms of adult and non-adult entertainment. We face competition in the adult entertainment industry from other providers of adult programming, adult video rentals and sales, books and magazines aimed at adult consumers, adult oriented telephone chat lines, and adult oriented Internet services. To a lesser extent, we also face general competition from other forms of non-adult entertainment, including sporting and cultural events, other television networks, feature films and other programming. Our ability to compete depends on many factors, some of which are outside of our control. These factors include the quality and appeal of our competitors' content, the technology utilized by our competitors, the effectiveness of their sales and marketing efforts and the attractiveness of their product offerings. Our existing competitors, as well as potential new competitors, may have significantly greater financial, technical and marketing resources than we do. This may allow them to devote greater resources than we can to the development and promotion of their product offerings. These competitors may also engage in more extensive technology research and development and adopt more aggressive pricing policies for their content. Additionally, increased competition could result in price reductions, lower margins and negatively impact our financial results. THE ADDITION OF NEW COMPETITORS ON THE VIDEO-ON-DEMAND DISTRIBUTION PLATFORM WOULD LIKELY HAVE A MATERIAL ADVERSE AFFECT ON OUR OPERATING PERFORMANCE. Revenue from our Pay TV Group's Video-on-Demand ("VOD") service became a significant part of our overall revenue mix during our fiscal year ended March 31, 2004. We believe that we currently are the exclusive provider of adult VOD content to the two largest cable MSOs in the U.S. The addition of new competitors to the VOD platform, either on platforms where we enjoy exclusivity or where we currently share the platform, would likely have a material adverse affect on our operating performance. We face competition on the VOD platform from established adult video producers with post-production capabilities, as well as independent companies that distribute adult entertainment. These competitors include producers such as Video Company of America, Hustler, Vivid Video, Wicked Pictures, and Metro Global Media Inc. In the event that cable companies seek to purchase adult video content for their VOD service directly from adult video producers or other independent distributors of such content, including Playgirl, our VOD business is likely to suffer. For the fiscal year ended March 31, 2004, revenue from our VOD service was 32% of our total Pay TV revenue. 19 WE MAY BE LIABLE FOR THE CONTENT WE MAKE AVAILABLE ON THE INTERNET. Because of the adult-oriented content of our web site, we may be subject to obscenity or other legal claims by third parties. We may also be subject to claims based upon the content that is available on our web site through links to other sites. Our business, financial condition and operating results could be harmed if we were found liable for this content. Implementing measures to reduce our exposure to this liability may require us to take steps that would substantially limit the attractiveness of our web site and/or its availability in various geographic areas, which would negatively impact our ability to generate revenue. Furthermore, our insurance may not adequately protect us against all of these types of claims. INCREASED GOVERNMENT REGULATION IN THE UNITED STATES AND ABROAD COULD IMPEDE OUR ABILITY TO DELIVER OUR CONTENT AND EXPAND OUR BUSINESS. New laws or regulations, or the new application of existing laws could prevent us from making our content available in various jurisdictions or otherwise have a material adverse effect on our business, financial condition and operating results. These new laws or regulations may relate to liability for information retrieved from or transmitted over the Internet, taxation, user privacy and other matters relating to our products and services. Moreover, the application to the Internet of existing laws governing issues such as intellectual property ownership and infringement, pornography, obscenity, libel, employment and personal privacy is uncertain and developing. Cable system and DBS operators could become subject to new governmental regulations that could further restrict their ability to broadcast our programming. If new regulations make it more difficult for Cable and DBS operators to broadcast our programming, our operating performance would be adversely affected. The current Republican administration in Washington D.C. could result in increased government regulation of our business. It is not possible for us to predict what new governmental regulations we may be subject to in the future. CONTINUED IMPOSITION OF TIGHTER PROCESSING RESTRICTIONS BY THE VARIOUS CREDIT CARD ASSOCIATIONS AND ACQUIRING BANKS WOULD MAKE IT MORE DIFFICULT TO GENERATE REVENUES FROM OUR WEBSITE. Our ability to accept credit cards as a form of payment for our products and services is critical to us. Unlike a merchant handling a sales transaction in a card present environment, the e-commerce merchant is 100% responsible for all fraud perpetrated against them. Our ability to accept credit cards as a form of payment for our products and services has been or could further be restricted or denied for a number of reasons, including but not limited to: O Visa Tier 1 capital ratio requirements for financial institutions have significantly restricted the level of adult-related Internet activity a particular bank may be allowed to process in any given month; O MasterCard changing its chargeback ratio policies to include credits and fining merchants whose chargeback and credit ratios together exceed 1%; O if we experience excessive chargebacks and/or credits; O if we experience excessive fraud ratios; O there is a change in policy of the acquiring banks and/or card associations with respect to the processing of credit card charges for adult-related content; O continued tightening of credit card association chargeback regulations in international areas of commerce; O association requirements for new technologies that consumers are less likely to use; O an increasing number of European and U.S. banks will not take accounts with adult-related content 20 In this regard we note that American Express has a policy of not processing credit card charges for online adult-related content. To the extent other credit card processing companies were to implement a similar policy it could have a material adverse effect on our business operations and financial condition. IF WE ARE NOT ABLE TO RETAIN OUR KEY EXECUTIVES IT WILL BE MORE DIFFICULT FOR US TO MANAGE OUR OPERATIONS AND OUR OPERATING PERFORMANCE COULD BE ADVERSELY AFFECTED. As a small company with approximately 119 employees, our success depends upon the contributions of our executive officers and our other key personnel. The loss of the services of any of our executive officers or other key personnel could have a significant adverse effect on our business and operating results. We cannot assure that New Frontier Media will be successful in attracting and retaining these personnel. It may also be more difficult for us to attract and recruit new personnel due to the nature of our business. OUR INABILITY TO IDENTIFY, FUND THE INVESTMENT IN, AND COMMERCIALLY EXPLOIT NEW TECHNOLOGY COULD HAVE AN ADVERSE IMPACT ON OUR FINANCIAL CONDITION. We are engaged in a business that has experienced tremendous technological change over the past several years. As a result, we face all the risks inherent in businesses that are subject to rapid technological advancement, such as the possibility that a technology that we have invested in may become obsolete. In that event, we may be required to invest in new technology. Our inability to identify, fund the investment in, and commercially exploit such new technology could have an adverse impact on our financial condition. Our ability to implement our business plan and to achieve the results projected by management will be dependent upon management's ability to predict technological advances and implement strategies to take advantage of such changes. NEGATIVE PUBLICITY, LAWSUITS OR BOYCOTTS BY OPPONENTS OF ADULT CONTENT COULD ADVERSELY AFFECT OUR OPERATING PERFORMANCE AND DISCOURAGE INVESTORS FROM INVESTING IN OUR PUBLICLY TRADED SECURITIES. We could become a target of negative publicity, lawsuits or boycotts by one or more advocacy groups who oppose the distribution of "adult entertainment." These groups have mounted negative publicity campaigns, filed lawsuits and encouraged boycotts against companies whose businesses involve adult entertainment. The costs of defending against any such negative publicity, lawsuits or boycotts could be significant, could hurt our finances and could discourage investors from investing in our publicly traded securities. To date, we have not been a target of any of these advocacy groups. As a leading provider of adult entertainment, we cannot assure you that we may not become a target in the future. BECAUSE WE ARE INVOLVED IN THE ADULT PROGRAMMING BUSINESS, IT MAY BE MORE DIFFICULT FOR US TO RAISE MONEY OR ATTRACT MARKET SUPPORT FOR OUR STOCK. Some investors, investment banking entities, market makers, lenders and others in the investment community may decide not to provide financing to us, or to participate in our public market or other activities due to the nature of our business, which, in turn, may hurt the value of our stock, and our ability to attract market support. ITEM 2. PROPERTIES. The Company uses the following principal facilities in its operations: COLORADO: New Frontier Media occupies two buildings in Boulder, Colorado. The Airport Boulevard facility is 11,744 leased square feet and houses the Pay TV Group's digital broadcast facility, technical operations group, content conforming and quality control functions, as well as the Internet Group's data center. This facility is 80% utilized. The Winchester Circle facility is 18,000 leased square feet and is used by New Frontier Media as its corporate headquarters, as well as by the Internet Group's web production, sales and marketing departments, and by the Pay TV Group's marketing, sales, call center, promotions, and programming departments. This facility is 80% utilized. 21 CALIFORNIA: As of May 1, 2004, New Frontier Media leased 1,200 square feet in Woodland Hills, California. The facility houses three employees of the Pay TV Group's content acquisitions department. This facility is 100% utilized. The Company believes that its facilities are adequate to maintain its existing business activities. ITEM 3. LEGAL PROCEEDINGS. The Company is involved in a number of pending or threatened legal proceedings in the ordinary course of business. In the opinion of management, there are no legal proceedings that will have a material adverse effect on the Company's results of operations or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted for a vote of the shareholders during the fourth quarter of the fiscal year covered by this Report. PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Beginning on April 27, 2004, the Company's Common Stock has been quoted on the NASDAQ National Market under the symbol "NOOF". Prior to April 27, 2004, the Company's common stock was quoted on the NASDAQ SmallCap Market. The following table sets forth the range of high and low closing prices for the Company's Common Stock for each quarterly period indicated, as reported by brokers and dealers making a market in the capital stock. Such quotations reflect inter-dealer prices without retail markup, markdown or commission, and may not necessarily represent actual transactions:
QUARTER ENDED HIGH LOW QUARTER ENDED HIGH LOW - ---------------------------------------------- ---------------------------------------------- June 30, 2002........... 2.30 1.87 June 30, 2003........... 1.85 0.75 September 30, 2002...... 2.11 1.11 September 30, 2003...... 4.90 1.65 December 31, 2002....... 1.14 0.65 December 31, 2003....... 9.30 3.73 March 31, 2003.......... 0.94 0.70 March 31, 2004.......... 11.38 6.61
As of June 1, 2004, there were approximately 2,600 beneficial owners of New Frontier Media's Common Stock. New Frontier Media has not paid any cash or other dividends on its Common Stock since its inception and does not anticipate paying any such dividends in the foreseeable future. New Frontier Media intends to retain any earnings for use in New Frontier Media operations and to finance the expansion of its business. 22 ITEM 6. SELECTED FINANCIAL DATA FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA(1) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FISCAL YEAR ENDED MARCH 31, -------------------------------------------------------- 2004 2003 2002 2001 2000 ------- -------- ------- ------- ------- Net Sales............................... $42,878 $ 36,747 $52,435 $58,638 $45,351 Net income (loss)....................... $10,913 $(11,895) $ (582) $ 3,324 $ 1,082 Net income (loss) per basic common share................................. $ 0.53 $ (0.56) $ (0.03) $ 0.16 $ 0.06 Total assets............................ $44,762 $ 35,025 $48,132 $52,606 $36,288 Long term obligations................... $ 429 $ 465 $ 1,013 $ 7,076 $ 2,003 Redeemable preferred stock.............. $ 0 $ 3,750 $ 0 $ 0 $ 4,073 Cash dividends.......................... $ 0 $ 0 $ 0 $ 0 $ 0
(1) The selected consolidated financial data for 2000 includes the effect of the acquisition of IGallery, ITN, and 90% of CTI on October 27, 1999, which was accounted for as a pooling-of-interests. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand New Frontier Media, Inc. MD&A is provided as a supplement to -- and should be read in conjunction with -- our financial statements and the accompanying notes. This overview provides our perspective on the individual sections of MD&A. Our MD&A includes the following sections: O Forward-Looking Statements -- cautionary information about forward-looking statements and a description of certain risks and uncertainties that could cause actual results to differ materially from the Company's historical results or our current expectations or projections. O Our Business -- a general description of our business, our strategy for each business segment, and goals of our business. O Application of Critical Accounting Policies -- a discussion of accounting policies that require critical judgments and estimates. O Results of Operations -- an analysis of our Company's consolidated results of operations for the three years presented in our financial statements. Our Company operates in two segments -- Pay TV and Internet. We present the discussion in this MD&A on a segment basis and, additionally, we discuss our corporate overhead expenses. O Liquidity, Capital Resources and Financial Position -- an analysis of cash flows, sources and uses of cash, contractual obligations, and financial position. FORWARD-LOOKING STATEMENTS This annual report on Form 10-K includes forward-looking statements. These are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from such statements. The words "believe", "expect", "anticipate", "optimistic", "intend", "will", and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to: 1) our ability to retain our major customers that account for 34% and 16% of our total revenue; 2) our ability to compete effectively for quality content with our Pay TV 23 Group's primary competitor who has significantly greater resources than us; 3) our ability to compete effectively with our Pay TV Group's major competitor or any other competitors that may distribute adult content to Cable MSOs, DBS providers, or to the Hotel industry; 4) our ability to retain our key executives; 5) our ability to successfully manage our credit card chargeback and credit percentages in order to maintain our ability to accept credit cards as a form of payment for our products and services; and 6) our ability to attract market support for our stock. The foregoing list of important factors is not exclusive. OUR BUSINESS Our goal is to be the leading provider in the electronic distribution of high-quality adult entertainment via Cable, Satellite and Broadband platforms. As part of our overall strategy to compete in each relevant market segment, we use the following core competencies: O Leveraging our technical infrastructure: We own and operate a broadcast origination facility where our licensed content is a) ingested at one central point and converted into multiple digital formats that allow for broadcast, VOD and Internet delivery, b) tagged with meta-data that allows for efficient cataloging of the elements included in the movie, c) edited into the proper formats required by our customers (i.e., most-edited, partially-edited, and least-edited), and d) subjected to several rigorous quality control reviews prior to airing on our PPV or VOD services or the Internet. By owning and operating our own technical infrastructure, including our proprietary media asset management software tool, we are able to quickly respond to new revenue opportunities with zero to very little capital outlay. For example: Over the years, we have worked closely with many cable MSOs in understanding and perfecting the delivery of VOD content, allowing us to become the leader in the delivery of VOD content in the adult category. We have been able to easily capitalize on new opportunities for delivering our content to the hotel industry due to our technical infrastructure. We responded to the demand for new partially edited PPV services by launching two new networks in only 90 days at very little additional cost. We believe that our technical infrastructure will allow us to respond quickly and effectively to new opportunities in the Cable, Satellite, and Broadband areas as well as any new platforms that may be discovered. O Content library: We license content from a network of over 54 different adult studios, allowing us access to a wider variety of directors, actors and actresses, and content niches than our primary competitor. We are committed to providing our consumers with variety, breadth and depth of content in order to appeal to the widest audience base possible. We understand that our content is purchased in an impulse environment and in order to capture those purchases we must provide a large amount of content to the consumer. Therefore, we have licensed what we believe to be the largest digital library of adult content in the world that we use to program our PPV networks, VOD service and Internet website. Content is used continuously through the life of the license term and will be repurposed in many ways, including using "clips" of the content and creating compilations or blocks of programming from several movies. We spend approximately $2.4 million annually licensing content for our PPV networks, VOD service and Internet website. The amount spent annually on licensing content has been the same for three years. O Expertise in aggregation of adult content: We consider ourselves to be experts in the aggregation of high-quality adult content. We ensure that we have all proper documentation required to verify that the cast members of the movies that we license are eighteen years or older. We monitor the trends in the video sales and rental market to understand what content niches are popular and program our networks to correspond to these trends. We monitor the trends of the VOD buys of our own content to understand what type of content is selling the best and adjust our programming models for these trends. We strive to provide the best performing PPV networks and VOD service to the Cable/DBS/Hotel markets. We program seven PPV networks in order to accommodate different editing standards and different programming niches to best 24 serve our customers' needs. We also ensure that the interstitial programming that we create is entertaining, edgy, and appeals to our consumer audience. We operate our Company in two different segments -- Pay TV and Internet. Our core business resides within the Pay TV segment and this is where the majority of our financial and human resources are concentrated. PAY TV SEGMENT Our Pay TV segment is focused on the distribution of its seven PPV networks and its Video-on-Demand ("VOD") service to cable MSOs and DBS providers. In addition, the Pay TV Group has had success in delivering its VOD service to hotel rooms through its current distribution arrangement with On Command. The Pay TV Group earns a percentage of revenue on each pay-per-view, subscription, or VOD transaction related to its services. Revenue growth occurs as the Pay TV Group launches its services to new cable MSOs or DBS providers, experiences growth in the number of digital subscribers for systems where its services are currently distributed ("on-line growth"), launches additional services to its existing cable/DBS partners, experiences new and on-line growth for its VOD service, is able to effect increases in the retail price of its products, and is able to increase the buy rates for its products. The Pay TV Group seeks to achieve distribution for at least four of its services on every digital platform in the U.S. Based on the current market of 21.6 million DBS households and 22.2 million digital cable households, the Pay TV Group currently has 36% of its defined market share. Revenue growth for the Pay TV Group for the year ended March 31, 2004 was driven primarily by: O Growth in revenue from its VOD service provided to the Cable and Hotel industries O Growing acceptance for its partially-edited services Revenue from the Pay TV Group's VOD service became a significant part of its overall revenue mix (representing 32% of total Pay TV revenue) during the fiscal year ended March 31, 2004, as cable operators upgraded their systems to deliver content in this manner. The Pay TV Group currently delivers its VOD content to 10.5 million cable network households as compared to 5.3 million a year ago, as well as to 900,000 hotel rooms through its distribution arrangement with On Command. The Company expects cable operators will continue to upgrade their systems to allow for the delivery of VOD content to the home. VOD can only be delivered in a digital, cable environment. Currently, per the NCTA, there are 22.2 million digital cable households in the U.S. We estimate that 12.5 million digital cable households are VOD enabled and, of this amount, 11.5 million provide adult content to their VOD customers. We anticipate that by the end of calendar year 2004 over 85% of digital cable households will be VOD enabled. We expect that our VOD cable revenue will increase as MSOs continue the deployment of this technology to their digital cable subscribers and as they increase the amount of space allocated on their VOD servers to the adult category (currently we provide 75 hours of programming each month). Today, we are the sole provider of adult VOD content to the two largest U.S. cable MSOs. However, we can give no assurances that we will continue to remain the exclusive provider of adult VOD content to these two cable MSOs. The Pay TV Group's relationship with On Command generated incremental VOD revenue for the year ended March 31, 2004. However, we do not expect significant revenue growth in fiscal year 2005 from the hospitality industry. Future revenue growth from VOD revenue generated through the hospitality industry is dependent upon the addition of new hotel properties by On Command, an increase in business traveler occupancy rates, and our ability to distribute our VOD content through other providers of in-room entertainment to the hospitality industry. In addition to the growth in VOD, the Pay TV Group experienced a growing acceptance for its partially edited services during the 2004 fiscal year. The Pay TV Group launched two new partially edited services in January 2003 to respond to this change. Accordingly, we are seeing a shift in our distribution away from our most-edited service - Pleasure - as more cable operators choose to launch our partially edited services - TEN, TEN*Clips, TEN*Blue and TEN*Blox. 25 To date, the focus of the Pay TV Group has been on the distribution of its PPV and VOD services to Cable, DBS and Hotel platforms in the U.S. market only. The Pay TV Group also provides its two least-edited services to the C-Band market on a direct-to-the-consumer basis. C-Band customers contact the Pay TV Group's in-house call center directly to purchase the networks on a one-month, three-month or six-month subscription basis or PPV basis. The Pay TV Group retains 100% of the revenue from these customers and over 95% of the sales are made via credit cards. This market has been declining for several years as these consumers convert from C-Band "big dish" analog satellite systems to smaller, 18-inch digital DBS satellite systems. The Pay TV Group has been able to decrease its transponder, uplinking and call center costs related to this business over the years in order to maintain its margins. However, based on the rate of revenue decline and the expected erosion of its C-Band margins, the Pay TV Group expects that it will no longer be operating this business by the end of its 2005 fiscal year. The Pay TV Group expects continued declines in revenue from this segment of its business during 2005. Looking forward, management has identified certain challenges and risks that could impact the Pay TV Group's future financial results including the following: O Increased competition from other adult companies attempting to provide VOD content and PPV services to Cable providers or DBS platforms O Increased regulation of the adult industry O Loss of exclusivity on the VOD platform of certain cable operators We believe that many opportunities accompany these challenges and risks. Among these opportunities, we believe the following exist for the Pay TV Group: O Upcoming PPV and VOD launches with our newest Cable affiliates O Obtaining distribution for our PPV services with DIRECTV O Continued growth in the VOD segment from further deployment of this technology by the largest Cable operator in the U.S. O Implementation of technologies that will allow for distribution of our content on new platforms O Future international distribution opportunities INTERNET SEGMENT The Internet Group generates revenue by selling monthly memberships to its website, TEN.com, by earning a percentage of revenue from third-party gatekeepers like On Command for the distribution of TEN.com to their customer base, and by selling pre-packaged video and photo content to webmasters for a monthly fee. In fiscal years 2002 and 2003, the Internet Group also generated revenue by selling traffic from its sites that did not convert into a member to other webmasters. Due to the decline in the volume of traffic to TEN.com, we no longer generate revenue from selling non-converting traffic to other webmasters. During the 2002 and 2003 fiscal years, we significantly restructured our Internet business. The decision to restructure our Internet business was based on a number of factors including: the large number of adult websites competing for web surfers, the lack of barriers to entry into the adult Internet business, the increased regulation from VISA and MasterCard, and the amount of free adult content available on the Internet. Through this restructuring we moved the Internet Group from Los Angeles, California to Boulder, Colorado, decreased staffing levels from approximately 80 employees to seven, decreased the number of websites we were creating and managing from thirty to one, discontinued the practice of purchasing large amounts of traffic, and focused the business on creating a premiere broadband website branded as TEN.com. In addition, in connection with a legal settlement, the Internet Group transferred approximately 150 of its primary domain names to a third party as of April 1, 2003. The 26 transfer of these domain names resulted in a significant, although expected, decline in traffic volume to TEN.com. Once the restructuring was completed, we shifted our focus to forming long-term revenue sharing partnerships with third-party gatekeepers, such as cable companies, hospitality providers and portals for the distribution of TEN.com, whereby we could gain direct access to consumers in search of adult entertainment. We completed one such agreement with On Command for the distribution of TEN.com through their digitally wired hotel rooms, and we expect to create additional revenue sharing arrangements in the near-term with select cable operators. The success we achieve with these cable operators will dictate the revenue potential for this segment in the longer term and will serve as justification for larger MSO's to adopt this business model. Currently we do not generate any meaningful revenue from these third-party arrangements (less than 4% of total Internet revenue). Over 75% of revenue from the Internet Group continues to be generated from monthly memberships to TEN.com. However, we have seen this revenue erode over the past several years since the current traffic volume to TEN.com does not generate enough new monthly sign-ups to offset the churn of our renewing membership base. The decline in membership revenue has slowed over the past several quarters as new marketing efforts have increased traffic to TEN.com, generating monthly sign-ups that are close to or slightly exceeding our monthly cancellation rate. We will be focusing on other ways to generate profitable traffic during the 2005 fiscal year in order to reverse the decline in membership revenue from TEN.com. We have also seen a decrease in revenue generated from selling pre-packaged content to webmasters. This decrease in revenue from the sale of content is due to a softening in demand for content by third-party webmasters. Webmasters are decreasing their reliance on outside sources for content and demanding lower prices for the content that they do purchase. In addition, we have not allocated any significant resources towards a sales effort for these content products during the 2004 fiscal year. We expect to contract with a third-party during the 2005 fiscal year to sell our products to the webmaster community. We view our Internet Group as an investment in the future, and we do not anticipate any significant revenue growth from this segment during the 2005 fiscal year. As broadband distribution grows, and as technology improves the delivery of content through wireless applications such as cell phones and Personal Digital Assistants ("PDAs"), the Internet Group will be the segment through which we will capitalize on these potential revenue-generating opportunities. Until then, the Internet Group will focus its efforts on deriving monthly subscription revenue from traffic directed to TEN.com through advertising on the Pay TV Group's networks and affiliate webmaster programs, as well as to completing new revenue sharing partnerships through which we can gain access to captive adult consumers of the Cable MSOs. CRITICAL ACCOUNTING POLICIES Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, valuation allowances, goodwill impairment, and prepaid distribution rights (content licensing). We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We have discussed with our Audit Committee the development, selection, and disclosure of our critical accounting policies and estimates and the application of these policies and estimates. 27 REVENUE RECOGNITION Our revenues for the Pay TV Group are primarily related to the sale of our PPV and VOD services to Cable/DBS and Hotel affiliates. The Cable affiliates do not report actual monthly PPV or VOD sales for each of their systems to the Pay TV Group until 60-90 days after the month of service ends. This practice requires management to make monthly revenue estimates based on the Pay TV Group's historical experience for each affiliated system. The Pay TV Group subsequently adjusts its revenue to reflect the actual amount earned upon receipt of the cash. Historically, any differences between the amounts estimated and the actual amounts received have been immaterial due to the overall predictability of pay-per-view revenues. Since VOD is such a new service, the revenue expected from new VOD cable affiliates can be more difficult to predict. The Pay TV Group believes that it is conservative in estimating the impact of the rollout of VOD households, and it continually adjusts estimates to reflect actual revenue remitted. The recognition of revenues for both the Pay TV and Internet Groups is partly based on our assessment of the probability of collection of the resulting accounts receivable balance. As a result, the timing or amount of revenue recognition may have been different if different assessments of the probability of collection of accounts receivable had been made at the time the transactions were recorded in revenue. VALUATION ALLOWANCES We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Judgments regarding realization of deferred tax assets and the ultimate outcome of tax-related contingencies represent key items involved in the determination of tax expense and related balance sheet accounts. We have currently recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Should we determine that a reduction in the valuation allowance is appropriate, an adjustment to our deferred tax assets would increase income in the period such determination was made. We maintain a reserve for chargebacks and credits for estimated refunds related to customers whose transactions were processed via credit cards for both the Pay TV and Internet Groups. Should our actual chargebacks and credits be higher than estimated we would have an additional expense for the period in which this was experienced. GOODWILL IMPAIRMENT Goodwill represents the excess of cost over the fair value of the net identifiable assets acquired in a business combination accounted for under the purchase method. Through the end of fiscal year 2002, the Company amortized its goodwill over 10 years using the straight-line method. As a result of the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangibles" ("FAS 142"), that was effective for the Company as of the beginning of fiscal year 2003, goodwill and intangible assets with an indefinite useful life are no longer amortized, but are tested for impairment at least annually. The Company completed the initial impairment test during the first quarter of fiscal year 2003 and concluded that the fair value of the Company's reporting unit (the Pay TV Group) exceeded its respective carrying value as of June 30, 2002 and, therefore, no impairment existed at that date. In addition to the initial impairment test completed during the first quarter of fiscal year 2003, we perform an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill is impaired. Our impairment process compares the fair value of the Pay TV Group to its carrying value, including the goodwill related to the Pay TV Group. We concluded for the 2003 and 2004 fiscal years that the fair value of the Company's reporting unit exceeded its carrying value and no impairment charge was required. If actual operating results or cash flows are different than our estimates and assumptions, we could be required to record impairment charges in future periods. 28 PREPAID DISTRIBUTION RIGHTS (CONTENT LICENSING) Our Pay TV Group's film and content library consists of newly produced and historical film licensing agreements. We account for the licenses in accordance with FAS 63 Financial Accounting by Broadcasters. Accordingly, we capitalize the costs associated with the licenses and certain editing costs and amortize the costs on a straight-line basis over the life of the licensing agreement (usually 3 to 5 years). Pursuant to FAS 63 the costs associated with the license agreements should be amortized based on the relative revenues earned for each usage of the film. We have determined that it is appropriate to amortize these costs on a straight-line basis under the assertion that each usage of the film is expected to generate similar revenues. We regularly review and evaluate the appropriateness of amortizing film costs on a straight-line basis and assess if an accelerated method would more appropriately reflect the revenue generation of the content. Through our analysis, we have concluded that the current policy of recognizing the costs incurred to license the film library on a straight-line basis most accurately reflects the revenue generated by each showing of the film. We periodically review our film library and assess if the unamortized cost approximates the fair market value of the films. In the event that the unamortized costs exceed the fair market value of the film library, we will expense the excess of the unamortized costs to reduce the carrying value of the film library to the fair market value. RESULTS OF OPERATIONS PAY TV GROUP (FORMERLY, CALLED SUBSCRIPTION/PAY-PER-VIEW TV GROUP) The following table outlines the current distribution environment and networks households for each network and our VOD service:
ESTIMATED NETWORK HOUSEHOLDS(3) ------------------------------------- (IN THOUSANDS) AS OF AS OF AS OF MARCH 31, MARCH 31, MARCH 31, NETWORK DISTRIBUTION METHOD 2004 2003 2002 - --------------------- ----------------------- --------- --------- --------- Pleasure Cable 7,800 8,000 7,500 TEN Cable/DBS 15,200 11,100 8,100 TEN*Clips Cable/DBS 13,700 5,800 3,600 Video-on-Demand Cable 10,500 5,300 1,100 TEN*Xtsy(1) C-band/Cable/DBS 10,000 9,000 7,800 TEN*BluePlus(1)(2) C-band/Cable N/A 570 800 TEN*Max(1) C-band/Cable 470 570 800 TEN*Blue Cable 2,500 300 N/A TEN*Blox Cable 2,800 300 N/A TOTAL NETWORK HOUSEHOLDS 62,970 40,940 29,700
Note: "N/A" indicates that network was not launched at that time (1) TEN*Xtsy, TEN*BluePlus and TEN*Max addressable household numbers include 0.8 million, 0.5 million, and 0.4 million C-Band addressable households for the years ended March 31, 2002, 2003, and 2004 respectively. (2) The Pay TV Group discontinued providing its TEN*BluePlus network in February 2004. (3) The above table reflects network household distribution. A household will be counted more than once if the home has access to more than one of the Pay TV Group's services, since each service represents an incremental revenue stream. The Pay TV Group estimates its unique household distribution as of March 31, 2004 to be 14.3 million cable homes and 9.4 million DBS homes. 29 The following table sets forth certain financial information for the Pay TV Group for the three years ended March 31:
(IN MILLIONS) TWELVE MONTHS ENDED MARCH 31 PERCENT CHANGE ------------------------- ------------------------ 2004 2003 2002 '04 VS '03 '03 VS '02 ----- ----- ----- ---------- ---------- NET REVENUE Cable/DBS/Hotel....................... $33.9 $21.4 $19.7 58% 9% C-Band................................ 5.7 7.5 9.4 (24%) (20%) ----- ----- ----- TOTAL.................................... $39.6 $28.9 $29.1 37% (1%) ----- ----- ----- COST OF SALES.............................. $15.4 $14.0 $13.4 10% 4% ----- ----- ----- GROSS PROFIT............................... $24.2 $14.9 $15.7 62% (5%) ===== ===== ===== GROSS MARGIN............................... 61% 52% 54% ----- ----- ----- OPERATING EXPENSES......................... 7.7 7.8 9.4 (1%) (17%) ----- ----- ----- OPERATING INCOME........................... $16.5 $ 7.1 $ 6.3 132% 13% ===== ===== =====
NET REVENUE CABLE/DBS/HOTEL REVENUE 2003 TO 2004 The increase in the Pay TV Group's Cable/DBS/Hotel revenues from 2003 to 2004 was attributable to the following items: O A 399% increase in VOD revenue O The addition of VOD revenue from the hospitality industry O A 10% increase in revenues generated by our three services on the DISH platform O An 86% increase in Cable revenue from our partially edited services The above items are described in more detail below. Revenue from our VOD service became a significant contributor to the Pay TV Group's revenue mix during the 2004 fiscal year as cable operators have aggressively upgraded their plants to deliver content in this manner to their customers. Our VOD content is available through our distribution arrangements with cable MSOs to 10.5 million cable network households, up from 5.3 million households a year ago, representing an increase of 98%. Additionally, we are currently the sole provider of adult VOD content to the two largest cable MSOs in the U.S. During the 2004 fiscal year, we also began delivering our VOD content to 900,000 hotel rooms through our distribution arrangement with On Command. Through this agreement we deliver up to fourteen titles on a monthly basis to On Command for use on their in-room entertainment platform which they provide to the hospitality industry. Our VOD revenue from both Cable households and the hospitality industry via our arrangement with On Command accounted for 37% and 10% of total Cable/DBS/Hotel revenue for the fiscal years ended March 31, 2004 and 2003, respectively. Revenue from our TEN, TEN*Clips and TEN*Xtsy networks on the DISH platform increased 10% year-over-year. This increase was due to an overall increase in PPV buys for each service while the number of monthly subscribers to each service increased 3%. We believe that these increases in buys and subscribers can be attributed to the increase in overall subscribers to the DISH platform. As discussed above, the Pay TV Group has seen a growing acceptance by its consumer base for its partially edited services, TEN, TEN*Blue, TEN*Blox, and TEN*Clips. We view this as a positive development given the higher buy rates and higher retail rates associated with this editing standard. In anticipation of the increased acceptance for partially edited programming, we launched two new 30 networks in January 2003. These two new services, TEN*Blue and TEN*Blox, plus our legacy partially edited services, TEN and TEN*Clips, are now distributed to 34.2 million network households as compared to 17.5 million network households a year ago, representing a 95% increase. Revenue from these four networks increased 86% from 2003 to 2004. CABLE/DBS/HOTEL REVENUE 2002 TO 2003 The increase in the Pay TV Group's Cable/DBS/Hotel revenues from 2002 to 2003 was attributable to the following items: O An increase in revenue generated by TEN*Xtsy on the DISH platform O An increase in revenue generated by TEN*Clips as a result of an increase in distribution for this network from 2002 to 2003 O An increase in our VOD revenue from 2002 to 2003 The following items offset the increase in revenue from the above items: O A decrease in revenue from our Pleasure network due to disaffiliations by DIRECTV and DISH O A decrease in TEN revenue generated on the DISH platform The above items are described in more detail below. In January 2000, DISH launched TEN*Xtsy on its satellite at 110 degrees. In August 2001, DISH moved TEN*Xtsy to its satellite at 119 degrees. Significantly more addressable subscribers view DISH's satellite at 119 degrees than its satellite at 110 degrees. In addition to the satellite change, in September 2001 DISH increased its retail price for TEN*Xtsy to $10.99 for a PPV purchase and $27.99 for a monthly subscription from $9.99 and $24.99, respectively. Together, these changes resulted in an 11% increase in revenue generated by the TEN*Xtsy network on the DISH platform from 2002 to 2003. TEN*Clips was available to 3.6 million and 5.8 million network households as of March 31, 2002 and 2003, respectively, representing a 61% increase in distribution year-over-year. DISH also increased its retail prices for TEN*Clips in September 2001 to $9.99 for a PPV purchase and $22.99 for a monthly subscription from $8.99 and $19.99, respectively. Revenue from TEN*Clips increased 29% from 2002 to 2003 as a result of an increase in distribution and the increase in retail prices on the DISH platform. We experienced significant growth in revenue from our VOD service, TEN*On Demand, between 2002 and 2003 as this technology was rolled out for the first time by several cable MSOs. Revenue from our VOD service accounted for 10% of total Cable/DBS/Hotel revenue for the year ended March 31, 2003, as compared to 1% for the year ended March 31, 2002. During the 2002 fiscal year, both DISH and DIRECTV terminated distribution of our Pleasure network. Both DBS providers terminated distribution of Pleasure to create available bandwidth for the addition of partially edited services to their platforms. The loss of this distribution resulted in a 40% decrease in revenue from the Pleasure network from 2002 to 2003. However, this decrease was offset by an increase in revenue from new launches and online growth for our Pleasure network with several cable MSOs. Revenue from our TEN network declined from 2002 to 2003 because of a decrease in the number of monthly DISH subscribers. This decline in the number of monthly subscribers has been ongoing since DISH converted TEN to a PPV service in 1999. In addition, PPV buys from TEN on the DISH platform declined from 2002 to 2003 due to the addition of a competing network of the same editing standard to the DISH platform in September 2001. C-BAND REVENUE The year-over-year decreases in C-Band revenue are due to the continued decline of the C-Band market as consumers convert C-Band "big dish" analog satellite systems to smaller, 18-inch digital 31 DBS satellite systems. The total C-Band market declined 29% from 2003 to 2004 and 38% from 2002 to 2003. Although the C-Band market has continued to decline, our C-Band revenue declined at a slower rate due to the fact that our only competitor on this platform went out of business during the 2004 fiscal year. Providing service to the C-Band market continues to be profitable for us, generating operating margins of approximately 37% during the 2004 fiscal year. We will continue to closely monitor this business and when margins erode to an unacceptable level we will discontinue providing our content on this platform. We anticipate that we will no longer be providing our networks on the C-Band platform by the end of the 2005 fiscal year. In an effort to minimize costs associated with this revenue stream, we discontinued selling TEN*BluePlus on the C-Band platform during the fourth quarter of our 2004 fiscal year. COST OF SALES Cost of sales consists of expenses associated with our digital broadcast facility, satellite uplinking, satellite transponder leases, programming acquisition and conforming costs, VOD transport costs, amortization of content licenses, and C-Band call center costs. The 10% increase in cost of sales from fiscal year 2003 to 2004 is due to a) a 20% increase in costs associated with our digital broadcast center and b) the addition of VOD transport costs during the 2004 fiscal year. The increase in costs related to our digital broadcast facility is due to the hiring of additional personnel to manage our growing VOD business. We began paying transport costs to TVN for the services they provide in delivering our VOD content to cable MSOs during the 2004 fiscal year. These fees are expected to increase during the 2005 fiscal year as our VOD business continues to grow. The increase in our cost of sales from 2003 to 2004 was offset by a 22% decrease in C-Band call center costs and a 24% decrease in transponder costs for this same period. The Pay TV Group successfully renegotiated its lease costs for its analog transponders during the fourth quarter of its 2003 fiscal year. In addition, during the fourth quarter of our 2004 fiscal year we discontinued one of our C-Band services allowing us to terminate the lease for one of our analog transponders. The 4% increase in cost of sales from fiscal year 2002 to 2003 is due to: a) a 27% increase in the amortization of the Pay TV Group's content licenses and b) a 16% increase in costs associated with the digital broadcast center related to new functionalities and redundancies added during the fiscal year. These increases were offset by a 12% decrease in transponder lease costs and a 12% decrease in C-Band call center costs. The Pay TV Group successfully renegotiated its lease cost for its four analog transponders at the end of its 2002 fiscal year. OPERATING INCOME Operating income increased 132% from 2003 to 2004 largely as a result of a 37% increase in revenue year-over-year. Gross margins increased from 52% to 61% year-over-year and operating expenses declined 1% during the same period. Operating expenses as a percentage of revenue decreased to 19% for the 2004 fiscal year from 27% for the 2003 fiscal year. The 1% decrease in operating expenses from 2003 to 2004 is primarily related to a decrease in C-Band marketing costs during the 2004 fiscal year. At the end of the first quarter of its 2004 fiscal year, the Pay TV Group discontinued using its barker channel to market its C-Band services. The decrease in operating costs associated with the barker channel was offset by an increase in sales commissions and costs associated with the Pay TV Group's in-house promotions department. Sales commissions increased during the 2004 fiscal year due to an increase in distribution for our PPV and VOD services. Costs associated with operating our in-house promotions department increased 17% during the 2004 fiscal year as we hired more personnel to produce and edit the promotional and branding elements of our PPV and VOD programming. The 13% increase in operating income from 2002 to 2003 is primarily related to a 17% decrease in operating expenses during this period. Operating expenses as a percentage of revenue declined from 32% to 27% during this same period. The decline in operating expenses from 2002 to 2003 was related to a decline in: a) the costs associated with the Group's C-Band barker channel, b) advertising 32 costs, c) payroll costs associated with the elimination of two senior manager positions, and d) commissions paid to the Group's sales force as a result of a change in the commission plan and a decline in the number of people being commissioned. In addition, due to an accounting pronouncement change, goodwill and intangible assets with indefinite lives are no longer required to be amortized and are, instead, tested for impairment on an annual basis using the guidance for measuring impairment as set forth in SFAS 142, "Goodwill and Other Intangible Assets". Goodwill amortization was $0, $0 and $636,000 for the fiscal years ended March 31, 2004, 2003, and 2002, respectively. INTERNET GROUP The following table sets forth certain financial information for the Internet Group for the three years ended March 31:
(IN MILLIONS) TWELVE MONTHS ENDED MARCH 31 PERCENT CHANGE -------------------------- ------------------------ 2004 2003 2002 '04 VS '03 '03 VS '02 ----- ------ ----- ---------- ---------- NET REVENUE Net Membership..................... $ 2.7 $ 5.3 $15.3 (49%) (65%) Sale of Content.................... 0.6 1.2 1.9 (50%) (37%) Sale of Traffic.................... -- 1.3 5.6 * (77%) Other.............................. -- -- 0.4 * * ----- ------ ----- TOTAL................................. $ 3.3 $ 7.8 $23.2 (58%) (66%) ----- ------ ----- COST OF SALES........................... $ 1.3 $ 4.2 $12.2 (69%) (66%) ----- ------ ----- GROSS PROFIT............................ $ 2.0 $ 3.6 $11.0 (44%) (67%) ===== ====== ===== GROSS MARGIN............................ 61% 46% 47% ----- ------ ----- OPERATING EXPENSES...................... $ 1.8 $ 3.9 $ 8.9 (54%) (56%) ----- ------ ----- OPERATING INCOME (LOSS)................. $ 0.2 $(0.3) $ 2.1 167% (114%) ===== ====== ===== * Calculation is not meaningful
NET REVENUE The 49% decline in net membership revenue from 2003 to 2004 and the 65% decline in net membership revenue from 2002 to 2003 was a result of a significant decline in traffic to our web sites as we eliminated most of our traffic generating programs during the 2003 and 2004 fiscal years. We ceased actively purchasing traffic for our web sites during the fiscal year ended March 31, 2003. Instead, we depended upon our adult domain names and the advertising of TEN.com on the Pay TV Group's networks to generate type-in traffic for TEN.com. In addition, we transferred 150 domain names to a third-party in settlement of a lawsuit at the end of the 2003 fiscal year. The loss of these URLs resulted in an expected decline in the volume of traffic to TEN.com during the 2004 fiscal year such that the number of new monthly sign-ups was not enough to offset the monthly cancellation rate. The decrease in revenue from the sale of content during the past three fiscal years is a result of a softening in demand for content by third-party webmasters. Webmasters are decreasing their reliance on outside sources for content and demanding lower prices for the content that they do purchase. In addition, we did not allocate any significant resources towards a sales effort for our content products during the 2004 fiscal year. Revenue from the sale of traffic was earned by forwarding exit traffic and traffic from selected vanity domains to affiliated webmaster marketing programs domestically, monetizing foreign traffic via international dialer companies, marketing affiliated webmaster sites through our double opt-in email list, and by directing traffic to our pay-per-click ("PPC") search engine, www.sexfiles.com. Due to the 33 decline in traffic volume to TEN.com during the 2003 and 2004 fiscal years, our sale of traffic revenue decreased 77% from 2002 to 2003 and was completely eliminated during the 2004 fiscal year. In addition, we ceased the use of our opt-in email list and PPC search engines at the end of the 2003 fiscal year as a means to generate revenue from the sale of traffic. Our other revenue was earned from the sale of services such as hosting, co-location and bandwidth management ("ISP services") to non-affiliated companies. During the fiscal year ended March 31, 2003, we ceased selling our ISP services to outside customers and focused our data center operations solely on our internal needs. COST OF SALES Cost of sales consists of variable expenses associated with credit card fees, bandwidth costs, traffic acquisition costs (purchase of traffic), web site content costs and depreciation of assets. Cost of sales, as a percentage of revenue, was 39%, 54%, and 53% for the years ended March 31, 2004, 2003, and 2002, respectively. The 69% decrease in cost of sales from 2003 to 2004 is related to a 67% decline in depreciation expense and bandwidth costs. These costs declined due to the data center restructuring completed during the 2003 fiscal year (See "Data Center Restructuring 2003" below) through which we wrote-off excess equipment, moved the data center to Boulder, Colorado, and negotiated more favorable bandwidth rates. In addition, we eliminated the costs associated with our PPC search engine and email program at the end of 2003 fiscal year. Variable costs related to the processing of credit cards for membership revenue also declined from 2003 to 2004 in tandem with the decrease in this revenue stream. The 66% decrease in costs of sales from 2002 to 2003 is related to a 95% decline in traffic acquisition costs. Traffic acquisition costs declined from 2002 to 2003 because we ceased actively purchasing traffic for our sites during the 2003 fiscal year. In addition, depreciation expense declined 47% due to the restructuring completed during the 2003 fiscal year through which we wrote off excess equipment. Variable costs related to the processing of credit cards for membership revenue also declined from 2002 to 2003 as this revenue stream declined year-over-year. OPERATING INCOME (LOSS) Operating income increased from 2003 to 2004 primarily due to the fact that cost of sales and operating expenses declined by $5.0 million year-over-year while revenue for the same period declined by only $4.5 million. The 54% decline in operating expenses from 2003 to 2004 is related to decreases in payroll, benefits and other office expenses for all of our departments as a result of the final restructuring completed during the fourth quarter of the 2003 fiscal year (see "Internet Restructuring 2003" below). This restructuring resulted in a decrease in sales, marketing, data center, and web development personnel. Operating income decreased 114% from 2002 to 2003 primarily due to the fact that the 66% decrease in revenue year-over-year was only partially offset by a 62% decrease in cost of sales and operating expenses for the same period. The 56% decrease in operating expenses from 2002 to 2003 was related to a) the elimination of our in-house customer service and credit card processing functions; b) a decrease in payroll, benefits, and facility costs related to the restructuring and relocation of the sales, marketing, engineering and web development departments to Boulder, Colorado; c) a decrease in trade show related costs; and d) a decrease in travel related costs. 34 RESTRUCTURING EXPENSES
(IN MILLIONS) TWELVE MONTHS ENDED MARCH 31 ---------------------------- 2004 2003 2002 ------ ------ ------ Asset impairment expense........................................ $ 0.0 $(1.4) $ 0.0 Restructuring expense........................................... $ 0.0 $(3.2) $(3.2) ------ ------ ------ Total Impairment and Restructuring......................... $ 0.0 $(4.6) $(3.2) ====== ====== ======
INTERNET RESTRUCTURING 2002 During the fiscal year ended March 31, 2002, we adopted a restructuring plan with respect to our Internet Group's operations. The plan provided for the consolidation of the Internet Group's engineering, web production, sales and marketing departments to our Boulder, Colorado location and the elimination of the Internet Group's customer service department due to the outsourcing of its credit card processing functions. In addition, the Internet Group vacated its office facilities in Sherman Oaks, California that were being utilized by these functions. Total restructuring charges of $3.2 million related to this plan were recorded during the 2002 fiscal year, of which $0.8 million related to the termination of 31 employees. In addition, 10 other positions were eliminated through attrition. Also included in the restructuring charge was $1.2 million of expenses related to the excess office space in Sherman Oaks, California and $1.0 million related to the write off of excess furniture and equipment. DATA CENTER RESTRUCTURING 2003 During the fiscal year ended March 31, 2003, we adopted a restructuring plan to close the Internet Group's in-house data center in Sherman Oaks, California and move its servers, bandwidth and content delivery functions to the same location as the Pay TV Group's digital broadcast facility in Boulder, Colorado. Total restructuring charges of $3.1 million related to this plan were recorded during the year, of which $28,000 related to the termination of 10 employees. Also included in this charge was $0.4 million of rent expense related to the data center space in Sherman Oaks and $2.6 million related to the write off of excess equipment. INTERNET RESTRUCTURING 2003 During the fiscal year ended March 31, 2003, we adopted a final restructuring plan to eliminate 13 positions within our Internet Group. Total restructuring charges of $0.3 million were recorded, of which $10,000 related to the termination of thirteen positions and $0.2 million related to the write off of excess equipment and operating leases. ASSET IMPAIRMENT We recognized impairment losses on certain domain names owned by our Internet Group of $1.4 million during the fiscal year ended March 31, 2003. Management identified certain conditions, including a declining gross margin due to the availability of free adult content on the Internet and decreased traffic to the Internet Group's domain names, as indicators of asset impairment. These conditions led to operating results and forecasted future results that were substantially less than had been anticipated at the time of our acquisition of the Internet Group. We revised our projections and determined that the projected results would not fully support the future amortization of the domain names associated with the Internet Group. In accordance with the Company's policy, management assessed the recoverability of the domain names using a cash flow projection based on the remaining amortization period of two to four years. Based on this projection, the cumulative cash flow over the remaining amortization periods was insufficient to fully recover the intangible asset balance. 35 CORPORATE ADMINISTRATION The following table sets forth certain financial information for Corporate Administration expenses for the three years ended March 31:
(IN MILLIONS) TWELVE MONTHS ENDED MARCH 31 PERCENT CHANGE ---------------------------- ------------------------ 2004 2003 2002 '04 VS '03 '03 VS '02 ------ ------ ------ ---------- ---------- Operating Expenses.................... $(5.0) $(7.2) $(5.9) (31%) 22% ====== ====== ======
Expenses related to corporate administration include all costs associated with the operation of the public holding company, New Frontier Media, Inc., that are not directly allocable to the Pay TV and Internet operating segments. These costs include, but are not limited to, legal and accounting expenses, insurance, registration and filing fees with NASDAQ and the SEC, investor relation cost, and printing costs associated with the Company's public filings. The 31% decrease in corporate administration expenses from 2003 to 2004 is primarily due to an 81% decrease in legal fees. Legal fees decreased from 2003 due to the settlement of a lawsuit with three former officers of our Company during the last quarter of our 2003 fiscal year. In addition, we also saw a decrease in our postage, printing and public relation expenses. These expenses were 62% higher in the 2003 fiscal year due to the proxy fight that the Company was involved in that year. Consulting costs also declined from 2003, as we were no longer using an outside corporate advisory firm. The decline in these costs was offset by an increase in our accounting and auditing costs and an increase in fees paid to our outside Board members for the 2004 fiscal year. The 22% increase in corporate administration expenses from 2002 to 2003 is primarily due to 1) an 82% increase in legal fees related to a lawsuit that we filed against three former officers of our Company (these lawsuits were settled by the end of the 2003 fiscal year and no additional costs were incurred going forward), 2) a 59% increase in general insurance and directors and officers insurance premiums, 3) the addition of fees paid to our outside Board members, and 4) a 99% increase in expenses related to the proxy fight that the Company defended itself against (public relations, printing and postage costs). The increase in these expenses was offset by a 27% decrease in payroll and benefit costs due to the elimination of several senior management positions and a 29% decrease in travel costs. We estimate that approximately $1.9 million of our 2003 corporate administration expenses related to the proxy fight and our lawsuit with our former officers. DEFERRED TAXES SFAS 109, "Accounting for Income Taxes" requires, among other things, the separate recognition, measured at currently enacted tax rates, of deferred tax assets and deferred tax liabilities for the tax effect of temporary differences between the financial reporting and tax reporting bases of assets and liabilities, and net operating loss and tax credit carryforwards for tax purposes. A valuation allowance must be established for deferred tax assets if it is "more likely than not" that all or a portion will not be realized. The Company routinely evaluates its recorded deferred tax assets to determine whether it is still more likely than not that such deferred tax assets will be realized. During the years ended March 31, 2004 and 2003, we determined that it is more likely than not that our deferred tax assets will not be realized and we, accordingly, recorded a valuation allowance against the net deferred tax assets of $6.7 million and $7.2 million, respectively. If we generate future taxable income against which these attributes may be applied, some portion of the valuation allowance would be reversed and a corresponding increase in net income would be reported in future periods. However, during the 2004 fiscal year, options and warrants were exercised and certain disqualified dispositions occurred resulting in deductions for tax purposes of approximately $10.5 million. As the $3.9 million valuation allowance for these tax assets is reversed it will be credited to Additional Paid-in-Capital instead of net income. 36 LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS FROM OPERATING ACTIVITIES AND INVESTING ACTIVITIES: Our statements of cash flows are summarized as follows (in millions):
YEAR ENDED MARCH 31, ------------------------- 2004 2003 2002 ----- ----- ----- Net cash provided by operating activities.......... $13.9 $ 0 $ 5.8 ===== ===== ===== Cash flows used in investing activities: Purchases of equipment and furniture.......... (1.4) (0.7) (2.8) Purchase of investments....................... (1.6) 0.0 0.0 Purchase of subscriber base................... 0.0 0.0 (0.5) ----- ----- ----- Net cash used in investing activities.............. $(3.0) $(0.7) $(3.3) ===== ===== =====
The increase in cash provided by operating activities from 2003 to 2004 was primarily related to increased profits in 2004 versus 2003. The following items also significantly impacted cash flows from operations for 2004 versus 2003: O Depreciation and amortization charges decreased to $6.0 million for the 2004 fiscal year from $7.5 million for the 2003 fiscal year O Prepaid distribution rights related to the licensing of content declined to $2.9 million in 2004 from $4.2 million in 2003 O Other accrued liabilities increased by $1.1 million from 2003 to 2004 O Accounts receivable increased from $5.7 million in 2003 to $6.9 million in 2004 The decrease in cash provided by operating activities from 2002 to 2003 was primarily related to an increase in our net loss from $0.6 million in 2002 to $11.9 million in 2003. The following items also significantly impacted cash flows from operations for 2003 versus 2002: O Accounts receivable increased from $4.3 million in 2002 to $5.7 million in 2003 O Prepaid distribution rights related to the licensing of content was $4.2 million in 2003 compared to $4.8 million in 2002 O We established a valuation allowance for our deferred tax assets in the amount of $5.3 million during our 2003 fiscal year O We had $4.0 million in non-cash charges related to our Internet restructurings and the impairment of certain domain names during the 2003 fiscal year Purchases of equipment and furniture accounted for the most significant cash outlays for investing activities in each of the three years ended March 31, 2004, 2003 and 2002. Purchases of equipment and furniture during the 2004 fiscal year related primarily to purchases of broadcast equipment, including a new broadcast cluster to allow for increased redundancy of our digital broadcast center, purchases of encrypting equipment necessary for new cable launches, and leasehold improvements necessary to upgrade our digital broadcast facility. Purchases of equipment and furniture for the 2003 fiscal year related primarily to purchases of software licenses, minor equipment upgrades to the Pay TV Group's digital broadcast facility and the purchase of encrypting equipment for new cable launches, while the purchases completed during the 2002 fiscal year were primarily related to the Internet Group's data center facility in Los Angeles. We currently estimate that purchases of equipment and furniture during the 2005 fiscal year will be less than $1.5 million, which will include approximately $0.3 million to complete the improvements we are making to our digital broadcast facility. Purchases of investments represented the next most significant investing activity during the 2004 fiscal year. These purchases related to certificates of deposits in which we invested during the year. 37 FINANCING ACTIVITIES: Our cash flows provided by (used in) financing activities are as follows (in millions):
YEAR ENDED MARCH 31, ------------------------- 2004 2003 2002 ----- ----- ----- Cash flows provided by (used in) financing activities: Payments on capital lease obligations......... $(1.1) $(1.7) $(2.1) Decrease notes payable........................ (0.1) (2.0) (3.0) Stock options/warrants exercised.............. 6.3 0.2 0.2 Retirement of stock........................... (1.5) 0.0 0.0 Issuance of redeemable preferred stock........ 2.0 2.8 0.0 Redemption of redeemable preferred stock...... (5.3) 0.0 0.0 Other......................................... (0.2) (0.2) 0.0 ----- ----- ----- Net cash provided by (used in) financing activities:...................................... $ 0.1 $(0.9) $(4.9) ===== ===== =====
During the 2003 fiscal year we issued 1.4 million shares of Class A Redeemable Preferred Stock at $2.00 per share. The proceeds from this offering were used to repay $2.0 million of the Company's notes payable. An additional $1.0 million in debt was converted to 0.5 million shares of Class A Redeemable Preferred Stock. During the 2004 fiscal year, we issued 2.5 million shares of Class B Redeemable Preferred Stock at $0.81 per share. The proceeds from this offering were used to redeem $1.0 million of the Company's Class A Redeemable Preferred Stock and to fund the purchase and subsequent retirement of 2,520,750 shares of New Frontier Media, Inc. common stock from Edward Bonn, a former officer of the Company. During the 2004 fiscal year, we redeemed $5.3 million of the Class A and Class B Redeemable Preferred Stock. In addition, during the 2004 fiscal year $0.5 million of the Class B Redeemable Preferred Stock was converted into a note payable which was then subsequently repaid. Much of our cash used in financing activities during the 2004 fiscal year was offset by the exercise of stock options and warrants which generated cash from financing activities of $6.3 million. In May 2004, we repaid our secured note payable in the amount of $0.4 million. Ongoing interest expense for our remaining capital lease obligations and debt is anticipated to be immaterial. If we were to lose our major customers that account for 34% and 16% of our revenue, our ability to finance our future operating requirements would be severely impaired. The Company did not incur any Federal income taxes for the year ended March 31, 2004, due to certain prior year restructuring charges and impairments being deductible in the current year, deductions resulting from the exercise of warrants and options, and the availability of prior year net operating loss carryforwards. Certain state taxes were unable to be offset by these deductions. We expect that we will be able to utilize our net operating loss carryovers from this and prior years to offset most of our taxable income for the 2005 fiscal year. However, we do expect to pay some federal and state taxes during the 2005 fiscal year. We currently estimate the cash required for these taxes to be less than $1.0 million. We believe that existing cash and cash generated from operations will be sufficient to satisfy our operating requirements, and we believe that any capital expenditures that may be incurred can be financed through our cash flows from operations. 38 The following is a summary of the Company's contractual obligations for the periods indicated that existed as of March 31, 2004, and is based on information appearing in the Notes to the Consolidated Statements:
PAYMENTS DUE BY PERIOD (IN 000'S) ----------------------------------------------------- LESS THAN 1-3 3-5 MORE THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS - -------------------------------------------- ------- ------- ------ ------ --- Capital Lease Obligations................... $ 570 $ 408 $ 162 $ -- -- Operating Lease Obligations................. 9,017 3,640 2,457 2,920 -- Long-term notes payable..................... 275 0 275 -- -- TOTAL....................................... $ 9,862 $ 4,048 $2,894 $2,920 0
The Company is currently renegotiating its broadcast uplinking contract with a third party provider. The current contract expires May 31, 2004. The new contract is expected to be for a three-year term with an annual cost of $900,000 per year. NEW ACCOUNTING PRONOUNCEMENTS In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS No. 150"). This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. The Company adopted this pronouncement on April 1, 2003. Upon adoption of SFAS No. 150 the Company reclassified its Redeemable Preferred Stock as a liability. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK. The Company's exposure to market risk is principally confined to cash in the bank, money market accounts, and notes payable, which have short maturities and, therefore, minimal and immaterial market risk. INTEREST RATE RISK. As of June 1, 2004, the Company had cash in checking and money market accounts and certificates of deposit. Because of the short maturities of these instruments, a sudden change in market interest rates would not have a material impact on the fair value of these assets. Furthermore, the Company's borrowings are at fixed interest rates, limiting the Company's exposure to interest rate risk. FOREIGN CURRENCY EXCHANGE RISK. The Company does not have any foreign currency exposure because it currently does not transact business in foreign currencies. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of New Frontier Media, Inc. and its subsidiaries, including the notes thereto and the report of independent accountants therein, commence at page F-2 of this Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Securities and Exchange ("SEC") reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and 39 procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as the Company's are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In connection with its audit of the Company's consolidated financial statements for the year ended March 31, 2004, Grant Thornton, LLP ("Grant Thornton") the Company's independent registered accountants, advised the Audit Committee and management of an internal control matter with respect to deferred revenue that they considered to be a reportable condition as that term is defined under standards established by the American Institute of Certified Public Accountants. The Company considered these matters in connection with the year end closing process and the preparation of the March 31, 2004 consolidated financial statements included in this Form 10-K and also determined that no prior period financial statements were materially affected by such matters. In response to the observations made by Grant Thornton, in fiscal 2005 the Company will (i) expand the scope of the review of the deferred revenue calculation on a monthly and quarterly basis, and (ii) will implement certain enhancements to its internal controls and procedures, which it believes will address the matter raised by Grant Thornton. As required by the SEC rules, we have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this Annual Report. This evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's controls and procedures were effective, except as noted above. Subsequent to the date of this evaluation, there have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls, and no corrective actions taken with regard to significant deficiencies or material weaknesses in such controls. PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 will be included in our proxy statement to be filed relating to the annual meeting of stockholders to be held in August 2004, which will be filed within 120 days after the close of our fiscal year ended March 31, 2004, and is incorporated herein by reference, pursuant to General Instruction G(3). Please see "Executive Officers of the Registrant" in Part I of this form. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 will be included in our proxy statement to be filed relating to the annual meeting of stockholders to be held in August 2004, which will be filed within 120 days after the close of our fiscal year ended March 31, 2004, and is incorporated herein by reference, pursuant to General Instruction G(3). ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 will be included in our proxy statement to be filed relating to the annual meeting of stockholders to be held in August 2004, which will be filed within 120 days after the close of our fiscal year ended March 31, 2004, and is incorporated herein by reference, pursuant to General Instruction G(3). ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 will be included in our proxy statement to be filed relating to the annual meeting of stockholders to be held in August 2004, which will be filed within 120 days 40 after the close of our fiscal year ended March 31, 2004, and is incorporated herein by reference, pursuant to General Instruction G(3). ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by Item 14 will be included in our proxy statement to be filed relating to the annual meeting of stockholders to be held in August 2004, which will be filed within 120 days after the close of our fiscal year ended March 31, 2004, and is incorporated herein by reference, pursuant to General Instruction G(3). PART IV. ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K. The following documents are filed as part of this report: 1) FINANCIAL STATEMENTS The financial statements listed in the Table of Contents to Consolidated Financial Statements are filed as part of this report. 2) FINANCIAL STATEMENT SCHEDULES -- All schedules have been included in the Consolidated Financial Statements or Notes thereto. 3) EXHIBITS
EXHIBITS NUMBER DESCRIPTION ------ --------------------------------------------------------------------------------- 3.01 --Articles of Incorporation of Company, with Amendment(1) 3.02 --First Amended ByLaws of Company(1) 4.01 --Form of Common Stock Certificate(1) 10.01 --Office Lease Agreement, dated August 12, 1998, for premises at 5435 Airport Boulevard, Boulder CO.(2) 10.02 --Agreement between Colorado Satellite Broadcasting, Inc. and Loral Skynet Concerning Skynet Transponder Service(4) 10.03 --Agreement between Colorado Satellite Broadcasting, Inc. and Loral Skynet Concerning Skynet Space Segment Service(4) 10.04 --Amendment No. 1 to Agreement between Colorado Satellite Broadcasting, Inc. and Loral Skynet Concerning Skynet Space Segment Service(4) 10.05 --Teleport Services Agreement Between Colorado Satellite Broadcasting, Inc. and Williams Vyvx Services(4) 10.06 --Amendment No. 1 to Teleport Services Agreement Between Colorado Satellite Broadcasting, Inc. and Williams Vyvx Services(4) 10.07 --Amendment No. 2 to Teleport Services Agreement Between Colorado Satellite Broadcasting, Inc. and Williams Vyvx Services(4) 10.08 --Amendment No. 3 to Teleport Services Agreement Between Colorado Satellite Broadcasting, Inc. and Williams Vyvx Services(4) 10.09 --Employment Agreement between New Frontier Media, Inc. and Karyn L. Miller(4) 10.10 --License Agreement between Colorado Satellite Broadcasting, Inc. and Metro Global Media, Inc.(4) 10.11 --Employment Agreement between Ken Boenish and Colorado Satellite Broadcasting, Inc.(5) 10.12 --Amendment IV to Teleport Services Agreement Between Colorado Satellite Broadcasting, Inc. and Williams Vyvx Services(5) 10.13 --Amendment Number Two to the Agreement between Colorado Satellite Broadcasting, Inc. and Loral Skynet Concerning Skynet Space Segment Service(5)
41
EXHIBITS NUMBER DESCRIPTION ------ --------------------------------------------------------------------------------- 10.14 --Amendment Number 1 between Colorado Satellite Broadcasting, Inc. and Loral Skynet Concerning Skynet Transponder Service(6) 10.15 --Amendment Number 4 between Colorado Satellite Broadcasting, Inc. and Loral Skynet Concerning Skynet Space Segment Service(9) 10.16 --Employment Agreement between Michael Weiner and New Frontier Media, Inc.(7) 10.17 --Separation and Consulting Agreement between Mark Kreloff and New Frontier Media, Inc.(7) 10.18 --Amendment to Employment Agreement between Michael Weiner and New Frontier Media, Inc.(8) 10.19 --Amendment to Employment Agreement between Ken Boenish and Colorado Satellite Broadcasting, Inc.(8) 10.20 --Amendment to Employment Agreement between Karyn Miller and New Frontier Media, Inc.(8) 10.21 --Office Lease Agreement dated April 11, 2001 between New Frontier Media, Inc. and Northview Properties, LLC(9) 10.22 --Lease Modification Agreement between New Frontier Media, Inc. and LakeCentre Plaza Limited, LLP dated July 2003(9) 10.23 --Catalog License Agreement between Pleasure Productions, Inc. and Colorado Satellite Broadcasting, Inc.(9) 14.00 --Code of Ethics for New Frontier Media, Inc.'s Financial Management(7) 21.01 --Subsidiaries of the Company(3) 23.01 --Consent of Grant Thornton LLP(9) 31.01 --Certification by President Michael Weiner pursuant to U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(9) 31.02 --Certification by CFO Karyn Miller pursuant to U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(9) 32.03 --Certification by President Michael Weiner pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(9) 32.04 --Certification by CFO Karyn Miller pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(9)
1 Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 333-35337). 2 Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended March 31, 1999. 3 Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended March 31, 2000. 4 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002. 5 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002. 6 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2002. 7 Incorporated by reference to the Company's Annual Report filed on Form 10-K for the year ended March 31, 2003. 8 Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2003. 9 Filed herewith. REPORTS ON FORM 8-K The Company did not file any Form 8-Ks during the quarter ended March 31, 2004. 42 SIGNATURES In accordance with the requirements of Section 13 or 15(d) of the Exchange Act, New Frontier Media has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NEW FRONTIER MEDIA, INC. /s/ Michael Weiner Michael Weiner Chief Executive Officer
NAME AND CAPACITY DATE - ----------------------------------------------- -------------------------------------------- /s/ MICHAEL WEINER June 14, 2004 .............................................. Name: Michael Weiner Title: Chief Executive Officer (Principal Executive Officer) /s/ KARYN MILLER June 14, 2004 .............................................. Name: Karyn Miller Title: Chief Financial Officer (Principal Financial and Accounting Officer) /s/ MATT ARMSTRONG June 14, 2004 .............................................. Name: Matt Armstrong Title: Director /s/ MELISSA HUBBARD June 14, 2004 .............................................. Name: Melissa Hubbard Title: Director /s/ ALAN ISAACMAN June 14, 2004 .............................................. Name: Alan Isaacman Title: Director /s/ HIRAM WOO June 14, 2004 .............................................. Name: Hiram Woo Title: Director /s/ DAVID NICHOLAS June 14, 2004 .............................................. Name: David Nicholas Title: Director /s/ SKENDER FANI June 14, 2004 .............................................. Name: Skender Fani Title: Director
43 [This page intentionally left blank] NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES TABLE OF CONTENTS
PAGE ----- Report of Registered Public Accounting Firm........................ F-2 Consolidated Balance Sheets........................................ F-3 Consolidated Statements of Operations.............................. F-5 Consolidated Statements of Comprehensive Income (Loss)............. F-6 Consolidated Statements of Changes in Shareholders' Equity......... F-7 Consolidated Statements of Cash Flows.............................. F-8 Notes to Consolidated Financial Statements......................... F-10 SUPPLEMENTAL INFORMATION Valuation and Qualifying Accounts -- Schedule II................... F-32
F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To The Board of Directors of NEW FRONTIER MEDIA INC. AND SUBSIDIARIES We have audited the accompanying consolidated balance sheets of New Frontier Media, Inc. and Subsidiaries as of March 31, 2004 and March 31, 2003, and the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the New Frontier Media Inc. and Subsidiaries as of March 31, 2004 and March 31, 2003, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, New Frontier Media, Inc. and Subsidiaries adopted Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets," on January 1, 2002. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule included in the accompanying supplementary information section is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. For the years ended March 31, 2004 and 2003, this schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. GRANT THORNTON LLP New York, New York May 20, 2004 F-2 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN 000S) ASSETS
MARCH 31, -------------------- 2004 2003 ------- ------- CURRENT ASSETS: Cash and cash equivalents........................................... $15,352 $ 4,264 Accounts receivable, net of allowance for doubtful accounts of $68 and $90, respectively............................ 6,872 5,680 Investments......................................................... 1,478 -- Prepaid expenses.................................................... 497 610 Other............................................................... 236 452 ------- ------- TOTAL CURRENT ASSETS........................................ 24,435 11,006 ------- ------- EQUIPMENT AND FURNITURE, net.......................................... 3,727 3,951 ------- ------- OTHER ASSETS: Prepaid distribution rights, net.................................... 11,627 11,520 Goodwill............................................................ 3,743 3,743 Other identifiable intangible assets, net........................... 356 1,124 Deposits............................................................ 156 567 Investments......................................................... 100 -- Other............................................................... 618 3,114 ------- ------- TOTAL OTHER ASSETS.......................................... 16,600 20,068 ------- ------- TOTAL ASSETS................................................ $44,762 $35,025 ======= =======
The accompanying notes are an integral part of the audited consolidated financial statements. F-3 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) (IN 000S EXCEPT PER SHARE DATA) LIABILITIES AND SHAREHOLDERS' EQUITY
MARCH 31, -------------------- 2004 2003 ------- ------- CURRENT LIABILITIES: Accounts payable.................................................... $ 1,767 $ 2,606 Current portion of obligations under capital lease.................. 356 996 Deferred revenue.................................................... 1,304 2,223 Current portion of notes payable.................................... 653 -- Accrued restructuring expense....................................... 1,026 1,304 Accrued compensation................................................ 952 478 Accrued liabilities................................................. 1,259 747 ------- ------- TOTAL CURRENT LIABILITIES................................... 7,317 8,354 ------- ------- LONG-TERM LIABILITIES: Obligations under capital leases, net of current portion............ 154 465 Notes payable, net of current portion............................... 275 -- Redeemable preferred stock.......................................... -- 3,750 ------- ------- TOTAL LONG-TERM LIABILITIES................................. 429 4,215 ------- ------- TOTAL LIABILITIES........................................... 7,746 12,569 ------- ------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Common stock, $.0001 par value, 50,000,000 shares authorized, 22,386,008 and 21,322,816 shares issued and outstanding, respectively..................................................... 2 2 Preferred stock, $.10 par value, 5,000,000 shares authorized: Class A, no shares issued and outstanding........................ -- -- Class B, no shares issued and outstanding........................ -- -- Additional paid-in capital.......................................... 49,590 45,943 Accumulated deficit................................................. (12,576) (23,489) ------- ------- TOTAL SHAREHOLDERS' EQUITY.................................. 37,016 22,456 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................ $44,762 $35,025 ======= =======
The accompanying notes are an integral part of the audited consolidated financial statements. F-4 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN 000S EXCEPT PER SHARE DATA)
YEAR ENDED MARCH 31, ------------------------------------ 2004 2003 2002 -------- -------- -------- NET SALES................................................ $ 42,878 $ 36,747 $ 52,435 COST OF SALES............................................ 16,696 18,197 25,634 -------- -------- -------- GROSS MARGIN............................................. 26,182 18,550 26,801 -------- -------- -------- OPERATING EXPENSES: Sales and marketing.................................... 4,653 6,135 7,906 General and administrative............................. 9,813 12,837 15,729 Impairment expense..................................... -- 1,341 -- Goodwill amortization.................................. -- -- 636 Restructuring expense.................................. -- 3,230 3,158 -------- -------- -------- TOTAL OPERATING EXPENSES....................... 14,466 23,543 27,429 -------- -------- -------- OPERATING INCOME (LOSS)........................ 11,716 (4,993) (628) -------- -------- -------- OTHER INCOME (EXPENSE): Interest income........................................ 50 62 193 Interest expense....................................... (1,157) (1,633) (1,842) Litigation reserve..................................... -- -- 1,680 Other.................................................. 311 (60) 341 -------- -------- -------- TOTAL OTHER INCOME (EXPENSE)................... (796) (1,631) 372 -------- -------- -------- INCOME (LOSS) BEFORE MINORITY INTEREST AND INCOME TAXES.................................................. 10,920 (6,624) (256) -------- -------- -------- Minority interest in loss of subsidiary................ -- -- (171) -------- -------- -------- INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES........................................... 10,920 (6,624) (427) Provision for income taxes............................. (7) (5,271) (155) -------- -------- -------- NET INCOME (LOSS)........................................ $ 10,913 $(11,895) $ (582) ======== ======== ======== Basic income (loss) per share............................ $ 0.53 $ (0.56) $ (0.03) ======== ======== ======== Diluted income (loss) per share.......................... $ 0.50 $ (0.56) $ (0.03) ======== ======== ========
The accompanying notes are an integral part of the audited consolidated financial statements. F-5 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (IN 000'S)
YEAR ENDED MARCH 31, ------------------------------------ 2004 2003 2002 -------- -------- -------- Net income (loss)...................................... $ 10,913 $(11,895) $ (582) Other comprehensive loss Unrealized loss on available-for-sale marketable securities, net of tax............................ -- -- (13) -------- -------- -------- Total comprehensive income (loss).............. $ 10,913 $(11,895) $ (595) ======== ======== ========
The accompanying notes are an integral part of the audited consolidated financial statements. F-6 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN 000S EXCEPT SHARE DATA)
COMMON STOCK ACCUMULATED $.0001 PAR VALUE ADDITIONAL OTHER ---------------------- PAID-IN COMPREHENSIVE ACCUMULATED SHARES AMOUNTS CAPITAL LOSS DEFICIT TOTAL ---------- ------- ---------- ------------- ----------- ---------- BALANCES, March 31, 2001................... 20,938,420 $ 2 $ 43,929 $ (93) $ (11,012) $ 32,826 Exercise of stock options/warrants........ 168,693 -- 306 306 Issuance of warrants for consulting....... -- -- 145 145 Issuance of stock for other............... 54,466 -- 151 151 Issuance of stock for purchase of subscriber base......................... 94,137 -- 250 250 Issuance of warrants for license agreement............................... -- -- 861 861 Retirement of stock....................... (8,800) -- (16) (16) Unrealized losses on available-for-sale securities.............................. (13) (13) Net loss.................................. (582) (582) ---------- ----- -------- ----- --------- -------- BALANCES, March 31, 2002................... 21,246,916 2 45,626 (106) (11,594) 33,928 Exercise of stock options/warrants........ 75,900 -- 111 111 Permanent impairment to investment........ 106 106 Issuance of warrants for consulting....... -- 72 72 Legal settlement.......................... -- 134 134 Net loss.................................. (11,895) (11,895) ---------- ----- -------- ----- --------- -------- BALANCES, March 31, 2003................... 21,322,816 2 45,943 -- (23,489) 22,456 Exercise of stock options/warrants........ 2,391,414 6,239 6,239 Cashless exercise of warrants............. 675,347 -- -- Legal settlement.......................... 60,000 45 45 Retirement of stock....................... (2,520,750) (1,500) (1,500) Cancellation of warrants associated with license agreement....................... (1,152) (1,152) Elimination of inter-company investment... (558) (558) Stock issued in connection with financing............................... 500,000 410 410 Other..................................... (42,819) 163 163 Net income................................ 10,913 10,913 ---------- ----- -------- ----- --------- -------- BALANCES, March 31, 2004................... 22,386,008 $ 2 $ 49,590 $ -- $ (12,576) $ 37,016 ========== ===== ======== ===== ========= ========
The accompanying notes are an integral part of the audited consolidated financial statements. F-7 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN 000S)
YEAR ENDED MARCH 31, ------------------------------- 2004 2003 2002 -------- -------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)............................................. $ 10,913 $(11,895) $ (582) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Conversion of interest to common stock................... -- 115 336 Stock/warrants issued for services, interest and legal settlement............................................. 597 490 410 Amortization of deferred debt offering costs............. 173 305 555 Depreciation and amortization............................ 5,976 7,479 8,867 Asset impairment related to restructuring charge......... -- 2,676 1,087 Asset impairment......................................... -- 1,341 -- Deferred income taxes.................................... -- 5,251 114 Decrease in legal reserve................................ -- -- (2,500) Minority interest in subsidiary.......................... -- -- 171 Other.................................................... 129 10 -- Write-off of marketable securities -- available for sale................................................... -- 118 -- (Increase) Decrease in operating assets Accounts receivable............................... (1,192) (1,427) 1,494 Receivables and prepaid expenses.................. 158 252 1,441 Prepaid distribution rights....................... (2,945) (4,177) (4,841) Other assets...................................... 455 689 (369) Increase (Decrease) in operating liabilities Accounts payable.................................. (213) 436 538 Deferred revenue, net............................. (919) (696) (940) Reserve for chargebacks/credits................... (61) (265) (104) Accrued restructuring cost........................ (279) (438) 1,851 Other accrued liabilities......................... 1,103 (211) (1,718) -------- -------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES.............................. 13,895 53 5,810 -------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of equipment and furniture...................... (1,367) (667) (2,772) Purchase of domain names................................. -- -- (33) Purchase of subscriber base.............................. -- -- (500) Purchase of investments.................................. (1,578) -- -- -------- -------- ------- NET CASH USED IN INVESTING ACTIVITIES............... (2,945) (667) (3,305) -------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments on capital lease obligations.................... (1,125) (1,696) (2,099) Repayment (issuance) of related party notes receivable... -- 6 (10) Decrease in notes payable................................ (100) (2,000) (3,000) Proceeds from stock options and warrant exercises........ 6,258 245 235 Retirement of stock...................................... (1,500) -- -- Redemption of redeemable preferred stock................. (5,250) -- -- Issuance of redeemable preferred stock................... 2,000 2,750 -- Increase in debt offering cost........................... -- (225) -- Decrease in other financing obligations.................. (145) -- -- -------- -------- ------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES........................................ 138 (920) (4,874) -------- -------- -------
The accompanying notes are an integral part of the audited consolidated financial statements. F-8 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (IN 000S)
YEAR ENDED MARCH 31, ----------------------------- 2004 2003 2002 ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ $11,088 $(1,534) $(2,369) CASH AND CASH EQUIVALENTS, beginning of year.................... 4,264 5,798 8,167 ------- ------- ------- CASH AND CASH EQUIVALENTS, end of year.......................... $15,352 $ 4,264 $ 5,798 ======= ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid.............................................. $ 1,280 $ 949 $ 948 ======= ======= ======= Income taxes paid.......................................... $ 7 $ 20 $ 52 ======= ======= ======= SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Purchase of equipment via capital lease obligation......... $ 135 $ 537 $ 2,225 ======= ======= ======= Warrants issued for equity raising......................... $ -- $ (196) $ -- ======= ======= ======= Warrants issued for debt raising........................... $ -- $ (187) $ -- ======= ======= ======= Common stock issued for subscriber base.................... $ -- $ -- $ 250 ======= ======= ======= Conversion of notes payable to Class A Redeemable Preferred Stock.................................................... $ -- $ 1,000 $ -- ======= ======= ======= Conversion of Class B Redeemable Preferred Stock to notes payable.................................................. $ 500 $ -- $ -- ======= ======= =======
The accompanying notes are an integral part of the audited consolidated financial statements. F-9 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION New Frontier Media, Inc. ("New Frontier Media"), is a publicly traded holding company for its operating subsidiaries. Colorado Satellite Broadcasting, Inc. ("CSB"), d/b/a The Erotic Networks, ("TEN") is a leading provider of adult programming to multi-channel television providers and low-powered direct-to-home households. Through its VOD service and its networks--Pleasure, TEN, TEN*Clips, TEN*Xtsy, TEN*Blue, TEN*Blox, and TEN*Max--TEN is able to provide a variety of editing styles and programming mixes that appeal to a broad range of adult consumers. Ten Sales, Inc. formed in April 2003, is responsible for marketing the products for TEN. On October 27, 1999, New Frontier Media completed an acquisition of three related Internet companies: Interactive Gallery, Inc. ("IGI"), Interactive Telecom Network, Inc. ("ITN") and Card Transactions, Inc. ("CTI"). Under the terms of the acquisition, which was accounted for as a pooling of interests, the Company exchanged 6,000,000 shares of restricted common stock in exchange for all of the outstanding common stock of IGI and ITN and 90% of CTI. IGI aggregates and resells adult content via the Internet. IGI sells content to monthly subscribers through its broadband site, www.TEN.com, partners with third-party gate-keepers for the distribution of www.TEN.com and wholesales pre-packaged content to various web masters. ITN and CTI have been inactive since March 31, 2002. The majority of the Company's sales are derived from the United States. International sales were approximately $524,000, $1,022,000 and $3,101,000 for the years ended March 31, 2004, 2003 and 2002, respectively. SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of New Frontier Media, Inc. and its majority owned subsidiaries (collectively hereinafter referred to as New Frontier Media or the Company). All intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates have been made by management in several areas, including, but not limited to, the realizability of accounts receivable, accrued restructuring expenses, the valuation of chargebacks and reserves, the valuation allowance associated with deferred income tax assets and the expected useful life and valuation of our prepaid distribution rights. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from these estimates. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. F-10 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, cash in banks and cash equivalents, which are highly liquid instruments with original maturities of less than 90 days. The Company maintains cash deposits with major banks which exceed federally insured limits. At March 31, 2004, the Company exceeded the federally insured limits by approximately $15,252,000. The Company periodically assesses the financial condition of the institutions and believes that the risk of any loss is minimal. INVESTMENTS Short and long-term investments are classified as `held to maturity' securities and are stated at cost. Investments consist of certificates of deposits with varying maturity lengths and approximates fair market value. These are recorded at fair value on the Consolidated Balance Sheet. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of cash and cash equivalents, accounts receivable, investments, accounts payable, accrued expenses and other liabilities approximate their carrying value due to their short maturities. The fair value of obligations under capital leases and preferred stock approximate the carrying value and is estimated based on the current interest rates offered to the Company for debt of similar maturity. ACCOUNTS RECEIVABLE The majority of the Company's accounts receivable are due from customers in the cable and satellite industries. Credit is extended based on evaluation of a customer's financial condition and collateral is not required. Accounts receivable are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the cable and satellite industries as a whole. PREPAID DISTRIBUTION RIGHTS The Company's Pay TV Group's film and content library consists of newly produced and historical film licensing agreements. The Company accounts for the licenses in accordance with FAS 63 Financial Accounting by Broadcasters. Accordingly, the Company capitalizes the costs associated with the licenses and certain editing costs and amortizes these costs on a straight-line basis over the life of the licensing agreement (generally 5 years). Pursuant to FAS 63 the costs associated with the license agreements should be amortized based on the relative revenues earned for each usage of the film. Management has determined that it is appropriate to amortize these costs on a straight-line basis under the assertion that each usage of the film is expected to generate similar revenues. The Company regularly reviews and evaluates the appropriateness of amortizing film costs on a straight-line basis and assesses if an accelerated method would more appropriately reflect the revenue generation of the content. Through its analysis, management has concluded that the current policy of recognizing the costs incurred to license the film library on a straight-line basis most accurately reflects the revenue generated by each usage of the film. Management periodically reviews the film library and assesses if the unamortized cost approximates the fair market value of the films. In the event that the unamortized costs exceed the F-11 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) fair market value of the film library, the Company will expense the excess of the unamortized costs to reduce the carrying value of the film library to the fair market value. EQUIPMENT AND FURNITURE Equipment and furniture are stated at cost less accumulated depreciation. The cost of maintenance and repairs is charged to operations as incurred; significant additions and betterments are capitalized. Depreciation is computed using the straight-line method over the estimated useful life of the assets. The estimated useful lives of the assets are as follows: Furniture and fixtures................................ 3 to 5 years Computers, equipment and servers...................... 2 to 5 years
Leasehold improvements are amortized over the lives of the respective leases or the service lives of the improvements, whichever is shorter. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill represents the excess of cost over the fair market value of net assets acquired. Goodwill recorded in connection with an acquisition had been amortized using the straight-line method over the estimated useful life of 10 years through March 31, 2002. The Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," at the beginning of 2002. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives not be amortized but instead be tested for impairment annually. Other identifiable intangible assets primarily include amounts paid to acquire domain names, trademarks and customer lists. These costs are capitalized and amortized on a straight-line basis over their estimated useful lives that range from 3 to 15 years. LONG-LIVED ASSETS The Company continually reviews long-lived assets and certain identifiable intangibles held and used for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating the fair value and future benefits of such assets, the Company performs an analysis of the anticipated undiscounted future net cash flows of the individual assets over the remaining amortization period and recognizes an impairment loss if the carrying value exceeds the expected future cash flows. The impairment loss is measured based upon the difference between the fair value of the asset and its recorded carrying value. DEBT ISSUE COSTS Fees and warrants issued in connection with the issuance of notes payable and preferred stock were capitalized and are being amortized using the straight-line method over the term of the notes. As of March 31, 2004 and 2003, the Company capitalized debt issue costs of approximately $0 and $101,000 net of accumulated amortization of approximately $0 and $482,000, respectively. These amounts are included in other assets on the balance sheet. INCOME (LOSS) PER COMMON SHARE Basic income (loss) per share is computed on the basis of the weighted average number of common shares outstanding. Diluted income (loss) per share is computed on the basis of the weighted F-12 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) average number of common shares outstanding plus the potential dilutive effect of outstanding warrants and stock options using the "treasury stock" method. REVENUE RECOGNITION The Pay TV Group's Cable/DBS revenues are recognized based on pay-per-view buys and monthly subscriber counts reported each month by its cable and DBS affiliates. The cable/DBS affiliates do not report actual monthly sales for each of their systems to the Pay TV Group until approximately 60 - 90 days after the month of service ends. This practice requires management to make monthly revenue estimates based on the Pay TV Group's historical experience for each affiliated system. Revenue is subsequently adjusted to reflect the actual amount earned upon receipt by the Pay TV Group. Adjustments made to adjust revenue from estimated to actual have historically been immaterial. Revenue from sales of C-Band network subscriptions, ranging from one to twelve months, is recognized monthly on a straight line basis over the term of the subscription. Revenue from hotel VOD is recognized on a monthly basis based on buy counts reported each month by a third party provider. The third party provider does not report actual monthly sales for its hotels until approximately 30 days after the month of service. This practice requires management to make monthly revenue estimates based on the third party provider's historical experience. Revenue is subsequently adjusted to reflect the actual amount earned upon receipt. Adjustments made to adjust revenue from estimated to actual have historically been immaterial. Revenue from internet membership fees is recognized over the life of the membership, which is typically one month. The Company provides an allowance for refunds based on expected membership cancellations, credits and chargebacks. Revenue from processing fees is recorded in the period services are rendered. Revenue from advertising of products on the Company's PPV networks is recognized in the month the product is sold as reported by the Company's third party partners. Revenue from spot advertising is recognized in the month the spot is run on the Pay TV Group's networks. ADVERTISING COSTS The Company expenses advertising costs as incurred. Advertising costs for the years ended March 31, 2004, 2003 and 2002 were approximately $875,000, $1,573,000, and $2,529,000, respectively. INSURANCE PROGRAMS In general, the Company is fully insured for costs of casualty claims and medical claims. INCOME TAXES The Company utilizes SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities. F-13 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) STOCK-BASED COMPENSATION The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB Opinion No. 25") and related interpretations in accounting for its plans and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). Under APB Opinion No. 25, compensation expense is measured as the excess, if any, of the fair value of the Company's common stock at the date of the grant over the amount a grantee must pay to acquire the stock. The Company's stock option plans enable the Company to grant options with an exercise price not less than the fair value of the Company's common stock at the date of the grant. Accordingly, no compensation expense has been recognized in the accompanying consolidated statements of operations for its stock-based compensation plans. Pro forma information regarding net income (loss) and income (loss) per share is required by SFAS No. 123, "Accounting for Stock-Based Compensation" and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for the years ended March 31, 2004, 2003 and 2002, respectively: risk free interest rates of 2.78% - 4.62%, 4.62% - 5.93% and 4.75% - 5.25%, respectively; dividend yields of 0%; expected lives of 2 to 5 years, 10 years and 3 years, respectively; and expected volatility of 95%, 95% and 105%, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting period. Adjustments are made for options forfeited prior to vesting. The effect on compensation expense, net income (loss), and net income (loss) per common share had compensation costs for the Company's stock option plans been determined based on a fair value at the date of grant consistent with the provisions of SFAS No. 123 for the years ended March 31, 2004, 2003 and 2002 is as follows (in thousands, except share data): F-14 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED MARCH 31, ------------------------------------- 2004 2003 2002 --------- --------- ------- Net income (loss) As reported........................... $ 10,913 $ (11,895) $ (582) Deduct: Total stock-based employee compensation expense determined under fair value based method for awards granted, modified, or settled, net of tax................................... (877) (937) (1,698) --------- --------- ------- Pro forma............................. $ 10,036 $ (12,832) $(2,280) ========= ========= ======= Basic earnings (loss) per common share As reported........................... $ 0.53 $ (0.56) $ (0.03) Pro forma............................. $ 0.49 $ (0.60) $ (0.11) Diluted earnings (loss) per common share As reported........................... $ 0.50 $ (0.56) $ (0.03) Pro Forma............................. $ 0.46 $ (0.60) $ (0.11)
COMPREHENSIVE INCOME The Company utilizes SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting comprehensive income and its components in the financial statements. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS No. 150"). This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. The Company adopted this pronouncement on April 1, 2003. Upon adoption of SFAS No. 150 the Company reclassified its Redeemable Preferred Stock as a liability. F-15 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 -- INCOME (LOSS) PER SHARE The components of basic and diluted income (loss) per share are as follows (in thousands):
YEAR ENDED MARCH 31, --------------------------------- 2004 2003 2002 -------- -------- ------- Net income (loss).............................. $ 10,913 $(11,895) $ (582) ======== ======== ======= Average outstanding shares of common stock..... 20,522 21,319 21,128 Dilutive effect of Warrants/Employee Stock Options...................................... 1,370 -- -- -------- -------- ------- Common stock and common stock equivalents...... 21,892 21,319 21,128 ======== ======== ======= Basic income (loss) per share.................. $ 0.53 $ (0.56) $ (0.03) ======== ======== ======= Diluted income (loss) per share................ $ 0.50 $ (0.56) $ (0.03) ======== ======== =======
Options and warrants which were excluded from the calculation of diluted earnings per share because the exercise prices of the options and warrants were greater than the average market price of the common shares and/or because the Company reported a net loss during the period were approximately 485,750, 7,054,000 and 7,489,000 for the years ended March 31, 2004, 2003 and 2002, respectively. Inclusion of these options and warrants would be antidilutive. NOTE 3 -- EQUIPMENT AND FURNITURE Equipment and furniture at March 31, consisted of the following (in thousands):
2004 2003 -------- -------- Furniture and fixtures......................................... $ 964 $ 978 Computers, equipment and servers............................... 7,922 7,295 Leasehold improvements......................................... 1,467 967 -------- -------- Equipment and furniture, at cost............................... 10,353 9,240 Less accumulated depreciation.................................. (6,626) (5,289) -------- -------- EQUIPMENT AND FURNITURE, NET................................... 3,727 $ 3,951 ======== ========
Depreciation expense was approximately $1,731,000, $2,706,000 and $3,997,000 for the years ended March 31, 2004, 2003 and 2002, respectively. NOTE 4 -- SEGMENT INFORMATION The Company has adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes reporting and disclosure standards for an enterprise's operating segments. Operating segments are defined as components of an enterprise for which separate financial information is available and regularly reviewed by the Company's senior management. The Company has the following two reportable segments: O Pay TV Group -- distributes branded adult entertainment programming networks and VOD content through electronic distribution platforms including cable television, C-Band, and Direct Broadcast Satellite ("DBS") F-16 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) O Internet Group -- aggregates and resells adult content via the Internet. The Internet Group sells content to monthly subscribers through its broadband site, www.TEN.com, partners with third-party gatekeepers for the distribution of www.TEN.com and wholesales pre-packaged content to various web masters. The accounting policies of the reportable segments are the same as those described in the summary of accounting policies. Segment profit (loss) is based on income (loss) before minority interest and income taxes. The reportable segments are distinct business units, separately managed with different distribution channels. The following tables represent financial information by reportable segment (in thousands):
YEAR ENDED MARCH 31, --------------------------------- 2004 2003 2002 ------- ------- ------- NET SALES Pay TV.............................................. $39,594 $28,870 $29,118 Internet Group...................................... 3,284 7,877 23,234 Corporate Administration............................ -- -- 83 ------- ------- ------- Total.......................................... $42,878 $36,747 $52,435 ======= ======= ======= SEGMENT PROFIT (LOSS) Pay TV.............................................. $16,417 $ 6,951 $ 6,132 Internet Group...................................... 204 (5,082) (1,432) Corporate Administration............................ (5,701) (8,493) (4,956) ------- ------- ------- Total.......................................... $10,920 $(6,624) $ (256) ======= ======= ======= INTEREST INCOME Pay TV.............................................. $ -- $ -- $ 7 Internet Group...................................... 3 1 5 Corporate Administration............................ 47 61 181 ------- ------- ------- Total.......................................... $ 50 $ 62 $ 193 ======= ======= ======= INTEREST EXPENSE Pay TV.............................................. $ 138 $ 140 $ 176 Internet Group...................................... 183 296 391 Corporate Administration............................ 836 1,197 1,275 ------- ------- ------- Total.......................................... $ 1,157 $ 1,633 $ 1,842 ======= ======= ======= DEPRECIATION AND AMORTIZATION Pay TV.............................................. $ 5,610 $ 5,853 $ 5,302 Internet Group...................................... 351 1,613 3,545 Corporate Administration............................ 15 13 20 ------- ------- ------- Total.......................................... $ 5,976 $ 7,479 $ 8,867 ======= ======= =======
F-17 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED MARCH 31, -------------------- 2004 2003 ------- ------- IDENTIFIABLE ASSETS Pay TV.............................................. $36,232 $28,487 Internet Group...................................... 2,790 4,067 Corporate Administration............................ 20,008 22,590 Eliminations........................................ (14,268) (20,119) ------- ------- Total.......................................... $44,762 $35,025 ======= =======
Expenses related to corporate administration include all costs associated with the operation of the public holding company, New Frontier Media, Inc., that are not directly allocable to the Pay TV and Internet operating segments. These costs include, but are not limited to, legal and accounting expenses, insurance, registration and filing fees with NASDAQ and the SEC, investor relation costs, and printing costs associated with the Company's public filings. NOTE 5 -- INCOME TAXES The components of the income tax provision (benefit) for the years ended March 31 were as follows:
(IN 000S) (IN 000S) (IN 000S) 2004 2003 2002 --------- --------- --------- Current Federal.................................................... $ -- $ -- $ -- State...................................................... 7 20 41 ------- ------- ------- Total Current........................................... 7 20 41 ------- ------- ------- Deferred Federal.................................................... -- 5,251 (131) State...................................................... -- -- 245 ------- ------- ------- Total Deferred.......................................... -- 5,251 114 ------- ------- ------- TOTAL.............................................. $ 7 $ 5,271 $ 155 ======= ======= =======
A reconciliation of the expected income tax (benefit) computed using the federal statutory income tax rate to the Company's effective income tax rate is as follows for the years ended March 31:
2004 2003 2002 ------- ------- ------- Income tax computed at federal statutory tax rate............. 34% (34.0)% (34.0)% State taxes, net of federal benefit........................... .06 .1 42.67 Change in valuation allowance................................. (36.87) 108.86 -- Non-deductible items.......................................... 2.87 4.1 30.59 Other......................................................... -- .51 (2.97) ------- ------- ------- TOTAL............................................... .06% 79.57% 36.29% ======= ======= =======
F-18 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Significant components of the Company's deferred tax liabilities and assets as of March 31 are as follows:
(IN 000S) (IN 000S) (IN 000S) 2004 2003 2002 --------- --------- --------- Deferred tax liabilities: Depreciation............................................... $(1,102) $ (938) $ (964) Change in accounting method................................ -- (32) (26) ------- ------- ------- Total deferred tax liabilities (1,102) (970) (990) ------- ------- ------- Deferred tax assets: Net operating loss carryforward............................ 6,334 4,591 2,534 Deferred revenue........................................... 483 823 1,168 Accrued restructuring reserve.............................. 380 483 683 Impairment of long lived assets............................ -- 1,002 288 Loss on write-off of stock................................. -- 232 203 Allowance for doubtful accounts and reserve for sales returns................................................. 25 61 279 Goodwill................................................... 113 371 377 Capital loss carryforward.................................. 221 157 170 Other...................................................... 199 461 539 ------- ------- ------- Total deferred tax assets 7,755 8,181 6,241 ------- ------- ------- Total deferred tax assets and liabilities.................... 6,653 7,211 5,251 Valuation allowance for deferred tax assets and liabilities................................................ (6,653) (7,211) -- ------- ------- ------- NET DEFERRED TAX ASSET..................................... $ -- $ -- $ 5,251 ======= ======= =======
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. The Company has deferred tax assets that have arisen primarily as a result of operating losses incurred and other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," requires the establishment of a valuation allowance when, based on an evaluation of objective evidence, there is a likelihood that some portion or all of the deferred tax assets will not be realized. The Company continually reviews the adequacy of the valuation allowance for deferred tax assets. During the years ended March 31, 2004 and 2003, the Company determined that it is more likely than not that its deferred tax assets will not be realized and accordingly has recorded a valuation allowance against the net deferred tax assets of $6.7 million and $7.2 million, respectively. If the Company generates future taxable income against which these tax attributes may be applied, some portion or all of the valuation allowance would be reversed and a corresponding increase in net income would be reported in future periods except as explained below. The Company has net operating loss carryforwards of approximately $17,200,000 for Federal Income Tax purposes, which expire through 2024. For tax purposes there is an annual limitation of approximately $208,000 for the remaining 15 years on $4,600,000 of the Company's net operating losses generated prior to the year ended March 31, 1999 under Internal Revenue Code Section 382. The remaining net operating loss carryforwards are not currently limited under IRC 382. F-19 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Internal Revenue Code Section 382 places a limitation on the utilization of net operating losses carryforwards when an ownership change, as defined in the tax law, occurs. Generally, an ownership change occurs when there is a greater than 50 percent change in ownership. When a change occurs the actual utilization of net operating loss carryforwards, for tax purposes, is limited annually to a percentage of the fair market value of the Company at the time of such change. During the year ended March 31, 2004, options and warrants were exercised and certain disqualified dispositions occurred resulting in deductions for tax purposes of approximately $10,500,000. The net operating losses reflected in the table above include a benefit of $3,900,000 that will be credited to Additional Paid in capital as the valuation allowance is reversed. NOTE 6 -- STOCK OPTIONS AND WARRANTS STOCK OPTION PLANS The Company has adopted four stock option plans: the 1998 Incentive Stock Option Plan, the 1999 Incentive Stock Option Plan, the Millennium Incentive Stock Option Plan and the 2001 Incentive Stock Option Plan (collectively referred to as the "ISO Plans"). Under the ISO Plans options may be granted by the Compensation Committee to officers, employees, and directors. Options granted under the ISO Plans may either be incentive stock options or non-qualified stock options. The maximum number of shares of common stock subject to options of any combination that may be granted during any 12-consecutive-month period to any one individual is limited to 250,000 shares. Incentive stock options may only be issued to employees of the Company or subsidiaries of the Company. The exercise price of the options is determined by the Compensation Committee, but in the case of incentive stock options, the exercise price may not be less than 100% of the fair market value on the date of grant. No incentive stock option may be granted to any person who owns more than 10% ("10% Shareholders") of the total combined voting power of all classes of the Company's stock unless the exercise price is at least equal to 110% of the fair market value on the date of grant. No incentive stock options may be granted to an optionee if the aggregate fair market value of the stock with respect to which incentive stock options are exercisable by the optionee in any calendar year under all such plans of the Company and its affiliates exceeds $100,000. Options may be granted under each ISO Plan for terms of up to 10 years, except for incentive stock options granted to 10% Shareholders, which are limited to five-year terms. The aggregate number of shares that may be issued under each plan is as follows: 1998 Incentive Stock Plan............................. 750,000 1999 Incentive Stock Plan............................. 1,500,000 Millennium Incentive Stock Plan....................... 2,500,000 2001 Incentive Stock Plan............................. 500,000
The ISO Plans were adopted to provide the Company with a means to promote the long-term growth and profitability of the Company by: i) Providing key people with incentives to improve stockholder value and to contribute to the growth and financial success of the Company. ii) Enabling the Company to attract, retain, and reward the best available people for positions of substantial responsibility. F-20 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) CONSULTANT STOCK PLANS The Company adopted two Consultant Stock Plans: the 1999 Consultant Stock Plan and the Millennium Consultant Stock Plan (the "Consultant Stock Plans"). Under the Consultant Stock Plans awards may be granted by the Board of Directors, who have sole discretion. The maximum number of shares of common stock to which awards may be granted under each of the Consultant Stock Plans is 500,000 shares. The Consultant Plans are for a term of up to 10 years and the Board of Directors may suspend or terminate it at any time or from time to time. However, no such action shall adversely affect the rights of a person awarded a grant under the Consultant Stock Plans prior to that date. The Consultant Stock Plans were adopted to further the growth of the Company and its subsidiaries by allowing the Company to compensate consultants and certain other people providing bona fide services to the Company. SUMMARY INFORMATION The following table describes certain information related to the Company's compensatory stock option and warrant activity for the years ending March 31, 2004, 2003, and 2002:
APPROXIMATE WEIGHTED- WEIGHTED- AVERAGE AVERAGE STOCK EXERCISE EXERCISE FAIR VALUE OF OPTIONS WARRANTS TOTAL PRICE RANGE PRICE OPTIONS GRANTED ---------- ---------- ---------- ----------- --------- --------------- Balances at March 31, 2001............... 4,336,883 5,316,448 9,653,331 $1.00-10.25 $3.32 Granted......... 841,000 105,000 946,000 $2.00- 4.61 $3.06 $ 1.38 Exercised....... (46,361) (114,332) (160,693) $1.00- 2.00 $1.53 Expired/Forfeited.. (962,551) (341,666) (1,304,217) $1.00- 7.31 $2.95 ---------- ---------- ---------- Balance at March 31, 2002............... 4,168,971 4,965,450 9,134,421 $1.00-10.25 $3.15 Granted......... 540,000 50,000 590,000 $2.00- 3.00 $2.20 $ 1.05 Exercised....... (75,900) -- (75,900) $1.00- 2.00 $1.46 Expired/Forfeited.. (1,072,115) (1,033,142) (2,105,257) $1.00-10.00 $3.77 ---------- ---------- ---------- Balance at March 31, 2003............... 3,560,956 3,982,308 7,543,264 $1.00-10.25 $3.20 Granted......... 250,000 350,000 600,000 $1.00- 4.67 $2.43 $ 2.10 Exercised....... (968,606) (2,098,155) (3,066,761) $1.00- 6.90 $2.75 Expired/Forfeited.. (446,800) (1,316,153) (1,762,953) $1.00- 7.13 $2.73 ---------- ---------- ---------- Balance at March 31, 2004............... 2,395,550 918,000 3,313,550 $1.00-10.25 $3.64 ========== ========== ========== Number of options and warrants exercisable at March 31, 2003..... 2,746,766 2,333,141 5,079,907 $1.00-10.25 $2.78 ========== ========== ========== Number of options and warrants exercisable at March 31, 2004..... 1,884,550 918,000 2,802,550 $1.00-10.25 $3.68 ========== ========== ==========
F-21 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes additional information regarding all stock options and warrants outstanding.
OPTIONS AND WARRANTS OUTSTANDING OPTIONS AND WARRANTS ------------------------------------------------------ EXERCISABLE WEIGHTED- ---------------------------------- NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED- RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE EXERCISE PRICES MARCH 31, 2004 CONTRACTUAL LIFE EXERCISE PRICE MARCH 31, 2004 EXERCISE PRICE - --------------- -------------- ----------------- -------------- --------------- -------------- $1.00- $2.00 1,248,000 6.77 $ 1.77 1,248,000 $ 1.77 $2.01- $3.00 417,700 6.73 $ 2.20 204,300 $ 2.17 $3.01- $5.00 966,850 6.71 $ 4.08 669,250 $ 3.99 $5.01- $7.00 195,250 3.04 $ 6.03 195,250 $ 6.03 $7.01-$10.25 485,750 0.74 $ 7.87 485,750 $ 7.87 ---------- --------- 3,313,550 2,802,550 ========== =========
NOTE 7 -- MAJOR CUSTOMER The Company's major customers (revenues in excess of 10% of total sales) are EchoStar Communications Corporation ("EchoStar") and Time Warner Cable ("Time Warner"). EchoStar and Time Warner are included in the Pay TV Segment. Revenue from EchoStar's DISH Network and Time Warner as a percentage of total revenue for each of the three years ended March 31 are as follows:
2004 2003 2002 ---- ---- ---- EchoStar................................... 34% 36% 27% Time Warner................................ 16% 8% 3%
At March 31, 2004 and 2003, accounts receivable from EchoStar was approximately $3,333,000 and $3,462,000, respectively. At March 31, 2004 and 2003, accounts receivable from Time Warner was approximately $880,000 and $606,000, respectively. The loss of its major customers could have a materially adverse effect on the Company's business, operating results or financial condition. NOTE 8 -- DEFERRED REVENUE The Company recognizes deferred revenue from the Pay TV and Internet Group. Revenue can be deferred up to six and twelve months for the years ended March 31, 2004 and 2003, respectively.
BALANCE, BALANCE, BEGINNING REVENUE REVENUE END OF OF THE YEAR RECOGNIZED DEFERRED YEAR ------------------ ------------- ------------- ------------- March 31, 2004........... $2,223 $ (1,518) $ 599 $ 1,304 March 31, 2003........... $2,920 $ (987) $ 290 $ 2,223
NOTE 9 -- COMMITMENTS & CONTINGENCIES LEASES The Company maintains non-cancelable leases for office space and equipment under various operating and capital leases. Included in property and equipment at March 31, 2004 and 2003 is approximately $1,567,000 and $2,077,000, respectively, of equipment under capital leases. Accumulated depreciation relating to these leases under property and equipment was approximately $534,000 and $790,000, respectively. Included in restructuring expenses at March 31, 2004 and 2003 is approximately $0 and $2,485,000, respectively, of equipment under capital leases. Accumulated depreciation related F-22 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) to equipment under capital leases in restructuring expenses at March 31, 2004 and 2003 was approximately $0 and $1,516,000, respectively. In addition, TEN has entered into direct lease agreements with an unrelated party for the use of transponders to broadcast TEN's channels on satellites. The leases expire through December 2005. TEN, as lessee of transponders under the transponder agreements, is subject to arbitrary refusal of service by the service provider if that service provider determines that the content being transmitted by the Company is harmful to the service provider's name or business. Any such service disruption would substantially and adversely affect the financial condition of the Company. In addition, the Company bears the risk that the access of their networks to transponders may be restricted or denied if a governmental authority commences an investigation concerning the content of the transmissions. Also, certain cable operators may be reluctant to carry less edited or partially edited adult programming on their systems. This could adversely affect the Company's business if either of the above occurs. Rent expense for the years ended March 31, 2004, 2003 and 2002 was approximately $3,427,000, $6,232,000, and $6,597,000 respectively, which includes transponder payments. The Company is currently renegotiating its uplinking contract, which expires in May 2004, with a third party provider. The contract is expected to have a yearly cost of approximately $900,000 and a term of three years. Future minimum lease payments under these leases as of March 31, 2004 were as follows (in thousands):
YEAR ENDED OPERATING CAPITAL MARCH 31, LEASES LEASES --------- ------- 2005.................................................... $ 3,640 $ 408 2006.................................................... 1,352 162 2007.................................................... 545 -- 2008.................................................... 560 -- 2009.................................................... 581 -- Thereafter.............................................. 2,339 -- ------- ------- Total minimum lease payments.................. $ 9,017 $ 570 ======= Less amount representing interest....................... (60) ------- Present value of minimum lease payments................. 510 Less current portion of obligations under capital leases.................................................. (356) ------- Long-term portion of obligations under capital leases........................................ $ 154 =======
EMPLOYMENT CONTRACTS The Company employs certain key executives under non-cancelable employment contracts in Colorado. These employment contracts expire through March 31, 2006. Commitments under these obligations at March 31, 2004 were as follows (in thousands):
YEAR ENDED MARCH 31, 2005........................................................ $ 810 2006........................................................ $ 809 ------ TOTAL OBLIGATION UNDER EMPLOYMENT CONTRACTS....... $1,619 ======
F-23 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10 -- NOTES PAYABLE Notes payable at March 31 consisted of the following (in thousands):
2004 2003 ------ ------ Secured note payable bearing interest at 7.5% per annum. The principal is payable in cash on May 29, 2004. This note is secured by 930,000 shares of the company's common stock. Interest is payable in cash on a quarterly basis, in arrears, commencing July 10, 2003.......................................................... $ 400 $ -- Unsecured note payable bearing interest at an imputed rate of 7.5% per annum. The principal is payable in cash. The final monthly installment is payable in December 2005........................... 528 -- ------ ------ Total notes payable.................................................. 928 -- Less portion of notes payable due within one year.................... (653) -- ------ ------ LONG-TERM NOTES PAYABLE...................................... $ 275 $ -- ====== ======
During the quarter ended December 31, 2003, the Company converted $500,000 of its Class B Redeemable Preferred Stock into a note payable with an unrelated third party. The loan matures in October 2004 and bears interest at 5% per annum payable on a quarterly basis. This loan was paid in full during the quarter ended March 31, 2004. NOTE 11 -- LICENSE AGREEMENTS In July 1999 New Frontier Media executed a definitive license agreement to acquire exclusive rights to Metro Global Media, Inc's ("Metro") 3,000 title adult film and video library and multi-million still image archive for a period of seven years with renewal provisions. In addition, the Company entered into a multi-year production agreement with Metro which calls for the delivery of at least three new adult feature titles per month over the next five years. In June 2003, the Company entered into a licensing agreement with Pleasure Productions. Pursuant to the agreement, the Company secured the exclusive broadcast rights for 5.5 years to 2,000 titles from the Pleasure Productions' catalog and up to 83 new titles. See the Litigation Note for further discussion. NOTE 12 -- DEFERRED COMPENSATION PLAN The Company sponsors a 401(k) retirement plan. The plan covers substantially all eligible employees of the Company. Employee contributions to the plan are elective, and the Company has discretion to match employee contributions. All contributions by the Company are vested over a three-year period. Contributions by the Company for the years ended March 31, 2004, 2003, and 2002 were approximately $138,000, $101,000 and $208,000, respectively. NOTE 13 -- RESTRUCTURING EXPENSES INTERNET RESTRUCTURING 2002 During the fiscal year ended March 31, 2002, the Company implemented a restructuring plan with respect to its Internet Group's operations. The plan included a consolidation of the Internet Group's engineering, web production, sales and marketing departments to the Company's Boulder, Colorado location and the elimination of its customer service department due to the outsourcing of its credit card processing functions. In addition, the Internet Group vacated its office facilities in Sherman Oaks, California that were being utilized by these functions. F-24 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Total restructuring charges of $3.2 million related to this plan were recorded in 2002, of which $0.8 million related to the termination of 31 employees. In addition, 10 other positions were eliminated through attrition. Also included in the restructuring charge were $1.2 million of expenses related to the excess office space in Sherman Oaks, California and $1.0 million of expenses related to excess furniture and equipment. During the year ended March 31, 2003 the Company lowered the accrued restructuring charges related to this restructuring approximately $256,000 due to a change in estimate with respect to several employment contracts. SELECTED INTERNET RESTRUCTURING 2002 DATA: (In 000s)
SEVERANCE AND ASSET EXCESS TERMINATION WIND IMPAIRMENT OFFICE SPACE BENEFITS DOWN TOTAL ---------- ------------- ----------- ---- ------- Fiscal Year 2002 Provision.............. $ 1,087 $ 1,235 $ 822 $14 $ 3,158 Fiscal Year 2002 Activity............... (1,087) -- (207) (13) (1,307) -------- ------- ----- ---- ------- Balance at March 31, 2002............... -- 1,235 615 1 1,851 Fiscal Year 2003 Adjustment............. -- 286 (397) -- (111) Fiscal Year 2003 Activity............... -- (592) (218) (1) (811) -------- ------- ----- ---- ------- Balance at March 31, 2003............... -- 929 -- -- 929 Fiscal Year 2004 Adjustment............. -- -- -- -- -- Fiscal Year 2004 Activity............... -- (167) -- -- (167) -------- ------- ----- ---- ------- Balance at March 31, 2004............... $ -- $ 762 $ -- $-- $ 762 ======== ======= ===== ==== =======
DATA CENTER RESTRUCTURING 2003 During the fiscal year ended March 31, 2003 the Company adopted a restructuring plan to close the Internet Group's in-house data center in Sherman Oaks, California and move its servers, bandwidth and content delivery functions to the same location as the Pay TV Group's digital broadcast facility in Boulder, Colorado. Total restructuring charges of $3.1 million related to this plan were recorded during the year, of which $28,000 related to the termination of 10 employees. Also included in this charge was $0.4 million of rent expense related to the data center space in Sherman Oaks and $2.6 million for excess equipment written off as a result of this restructuring. INTERNET RESTRUCTURING 2003 During the fourth quarter of the fiscal year ended March 31, 2003, the Internet Group adopted a final restructuring plan to eliminate 13 positions. Total restructuring charges of $0.3 million were recorded, of which $10,000 related to the termination of the thirteen positions and $0.2 million related to the write off of excess equipment and operating leases. F-25 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) SELECTED DATA CENTER RESTRUCTURING 2003 AND INTERNET RESTRUCTURING 2003 DATA: (In 000s)
SEVERANCE AND ASSET EXCESS TERMINATION OPERATING WIND IMPAIRMENT OFFICE SPACE BENEFITS LEASES DOWN TOTALS ---------- ------------- ----------- --------- ---- ------- Fiscal Year 2003 Provision..... $ 2,662 $ 331 $ 28 $ 81 $20 $ 3,122 Fiscal Year 2003 Provision Adjustment................... -- 108 (11) 122 -- 219 Fiscal Year 2003 Activity...... (2,662) (137) (17) (130) (20) (2,966) -------- ------- ----- ----- ---- ------- Balance at March 31, 2003...... -- 302 -- 73 -- 375 Fiscal Year 2004 Provision Adjustment................... -- $ -- -- -- -- -- Fiscal Year 2004 Activity...... -- (67) -- (44) -- (111) -------- ------- ----- ----- ---- ------- Balance at March 31, 2004...... $ -- $ 235 $ -- $ 29 $-- $ 264 ======== ======= ===== ===== ==== =======
NOTE 14 -- REDEEMABLE PREFERRED STOCK During the year ending March 31, 2003, the Company authorized a series of shares of 2 million Class A Redeemable Preferred Stock, par value $2 per share, of which 1.875 million shares were issued. The Company recorded the Class A Redeemable Preferred Stock at its redemption value of $3.75 million. The proceeds of the Class A Redeemable Preferred Stock were used to satisfy outstanding notes payable of approximately $3,000,000 and for working capital purposes. Holders of the Class A Redeemable Preferred Stock were entitled to receive cumulative cash dividends at a rate of 15.5% per annum per share payable in quarterly or monthly installments. Such dividends had preference over all other dividends of stock issued by the Company. The dividends were reported as interest expense. Shares were subject to mandatory redemption on or before January 2, 2004 at a redemption price of face value plus accrued dividends. During the quarter ended June 30, 2003, the Company issued 2.5 million shares of Class B Redeemable Preferred Stock ("Class B") at $0.81 per share. The proceeds from this offering of $2,000,000 were used to redeem $1.0 million of the Company's Class A Redeemable Preferred Stock and to fund the purchase and subsequent retirement of 2,520,750 shares of New Frontier Media, Inc. common stock as part of a legal settlement (see Note 18). The Class B paid dividends at 10% per year on a quarterly basis. As of March 31, 2004, all Class A Redeemable Preferred Stock and all Class B Redeemable Preferred Stock were fully redeemed. NOTE 15 -- GOODWILL AND INTANGIBLE ASSETS On April 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Under the new rules, goodwill and intangible assets with indefinite lives are no longer being amortized, but are tested for impairment using the guidance for measuring impairment set forth in this statement. Through the end of fiscal year 2002, the Company amortized its goodwill over 10 years using the straight-line method. As a result of the adoption of SFAS No. 142, that was effective for the Company as of the beginning of fiscal year 2003, goodwill and intangible assets with an indefinite useful life are no longer amortized, but are tested for impairment at least annually. The Company completed the initial impairment test during the first quarter of fiscal year 2003 and concluded that the fair value of F-26 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) the Company's reporting unit (Pay TV Group) exceeded its respective carrying value as of June 30, 2002 and, therefore, no impairment existed at that date. In addition to the initial impairment test completed during the first quarter of fiscal year 2003, the Company performed annual impairment tests during the fourth quarter of fiscal year 2004 and 2003, and concluded for both fiscal years that the fair value of the Company's reporting unit exceeded its carrying value and no impairment charge was required. The following presents a comparison of net (loss) income and (loss) income per share for the year ended March 31, 2004 to the respective adjusted amounts for the years ended March 31, 2003 and 2002, respectively, that would have been reported had SFAS No. 142 been in effect during the prior years (in 000s).
YEAR ENDED MARCH 31, ---------------------------------- 2004 2003 2002 -------- -------- ------ Reported net income (loss)............................... $ 10,913 $(11,895) $ (582) Goodwill amortization.................................... -- -- 636 -------- -------- ------ Adjusted net income (loss)............................... $ 10,913 $(11,895) $ 54 ======== ======== ====== Net income (loss) per share--basic Reported net income (loss)............................... $ 0.53 $ (0.56) $(0.03) Goodwill amortization.................................... 0.00 0.00 0.03 -------- -------- ------ Adjusted net income (loss) per share--basic.............. $ 0.53 $ (0.56) $ 0.00 ======== ======== ====== Net income (loss) per share--diluted Reported net income (loss)............................... $ 0.50 $ (0.56) $(0.03) Goodwill amortization.................................... 0.00 0.00 0.03 -------- -------- ------ Adjusted net income (loss) per share--diluted............ $ 0.50 $ (0.56) 0.00 ======== ======== ======
OTHER INTANGIBLE ASSETS The components of prepaid distribution rights are as follows (in 000s):
MARCH 31, -------------------- 2004 2003 ------- ------- Prepaid Distribution Rights Gross Carrying Amount.................................... $24,597 $21,352 Accumulated Amortization................................. (12,970) (9,832) ------- ------- Net Carrying Amount.................................... $11,627 $11,520 ======= =======
Amortization expense for prepaid distribution rights in each of the next five years is estimated to be approximately $3,679,000, $2,942,000, $1,867,000, $1,014,000 and $419,000, based on balances as of March 31, 2004. F-27 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The components of other identifiable intangible assets are as follows (in 000s):
OTHER INTANGIBLE DOMAIN NAMES ASSETS MARCH 31, MARCH 31, ---------------- ---------------- 2004 2003 2004 2003 ------ ------ ------ ------ Amortized Intangible Assets Gross Carrying Amount............................. $ 52 $2,688 $ 775 $ 775 Accumulated Amortization.......................... (49) (2,121) (422) (218) ------ ------ ------ ------ Net Carrying Amount............................. $ 3 $ 567 $ 353 $ 557 ====== ====== ====== ======
Amortization expense for intangible assets subject to amortization in each of the next five fiscal years is estimated to be approximately $255,000, $85,000, $2,000, $2,000 and $2,000, respectively. The average weighted life of domain names and other intangible assets is approximately 4 years at inception. See Note 18 for explanation regarding decline of carrying amount of Domain Names. ASSET IMPAIRMENT CHARGES During the year ended March 31, 2003, the Company recognized impairment losses on certain domain names of approximately $1,341,000 in connection with the Internet Group. Management identified certain conditions including a declining gross margin due to the availability of free adult content on the Internet and decreased traffic to certain of the Company's domain names as indicators of asset impairment. These conditions led to operating results and forecasted future results that were substantially less than had been anticipated at the time of the Company's acquisition of IGI, ITN, and CTI. The Company revised its projections and determined that the projected results would not fully support the future amortization of the domain names associated with IGI, ITN, and CTI. In accordance with the Company's policy, management assessed the recoverability of the domain names using a cash flow projection based on the remaining amortization period of two to four years. Based on this projection, the undiscounted sum of the estimated cash flow over the remaining amortization periods was insufficient to fully recover the intangible asset balance. NOTE 16 -- STOCKHOLDER RIGHTS PLAN On December 4, 2001, the Company's Board of Directors adopted a Stockholder Rights Plan in which Rights will be distributed at the rate of one Right for each share of the Company's common stock held by stockholders of record as of the close of business on December 21, 2001. The Rights generally will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's outstanding common stock after November 29, 2001, or commences a tender offer upon consummation of which the person or group would beneficially own 15% or more of the Company's outstanding common stock. Each Right will initially be exercisable at $10.00 and will expire on December 21, 2011. F-28 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 17 -- QUARTERLY INFORMATION (UNAUDITED) The consolidated results of operations on a quarterly basis were as follows (in thousands of dollars, except per share amounts).
EARNINGS (LOSS) PER COMMON SHARE NET INCOME ------------------- REVENUE GROSS MARGIN (LOSS) BASIC DILUTED ------- ------------ ---------- ------ ------- 2004 First quarter................. $10,081 $ 6,188 $ 2,022 $ 0.10 $ 0.10 Second quarter................ 10,919 6,624 2,832 0.15 0.14 Third quarter................. 10,779 6,559 2,730 0.13 0.12 Fourth quarter................ 11,099 6,811 3,329 0.15 0.14 ------- -------- -------- ------ ------- Total......................... $42,878 $ 26,182 $ 10,913 $ 0.53 $ 0.50 ======= ======== ======== ====== ======= 2003 First quarter................. $9,597 $ 4,356 $ (5,640) $ (.27) $ (.27) Second quarter................ 9,280 4,793 (1,019) (.05) (.05) Third quarter................. 8,590 4,177 (5,948) (.28) (.28) Fourth quarter................ 9,280 5,224 712 .04 .04 ------- -------- -------- ------ ------- Total......................... $36,747 $ 18,550 $(11,895) $ (.56) $ (.56) ======= ======== ======== ====== ======= 2002 First quarter................. $14,974 $ 7,694 $ 241 $ 0.01 $ 0.01 Second quarter................ 13,847 7,107 270 0.01 0.01 Third quarter................. 12,400 6,296 1,263 0.06 0.06 Fourth quarter................ 11,214 5,704 (2,356) (0.11) (0.11) ------- -------- -------- ------ ------- Total......................... $52,435 $ 26,801 $ (582) $(0.03) $ (0.03) ======= ======== ======== ====== =======
NOTE 18 -- LITIGATION In the normal course of business, the Company is subject to various other lawsuits and claims. Management of the Company believes that the final outcome of these matters, either individually or in the aggregate, will not have a material effect on its financial statements. During the fiscal quarter ended March 31, 2003, the Company settled its litigation with Edward J. Bonn, a former director of the Company, and Jerry Howard. In connection therewith, Mr. Bonn returned 2.5 million shares of the Company's common stock and received $1.5 million, 150 internet domain names and warrants to purchase 350,000 shares at $1.00 a share. The effect of this transaction was recorded during the quarter ended June 30, 2003, and reduced equity by approximately $2,100,000. On June 12, 2003, the Company settled its litigation with Pleasure Productions. This litigation related to a complaint filed by the Company on August 3, 1999 in District Court for the city and county of Denver (Colorado Satellite Broadcasting, Inc. et al. vs. Pleasure Licensing LLC, et al., case no 99CV4652) against Pleasure Licensing LLC and Pleasure Productions, Inc. (collectively, "Pleasure"), alleging breach of contract, breach of express warranties, breach of implied warranty of fitness for a particular purposes, and rescission, seeking the return of 700,000 shares of New Frontier Media stock and warrants for an additional 700,000 New Frontier Media shares which were issued to Pleasure in connection with a motion picture licensing agreement. In the settlement, the Company secured the exclusive broadcast rights to 2,000 titles from Pleasure Productions' catalog and up to 83 new releases. In addition, Pleasure Productions agreed to the cancellation of 700,000 warrants issued F-29 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) to it in 1999 to purchase New Frontier common stock at $1.12 a share. As a result of the transaction, the Company reduced the carrying value of the underlying assets and equity for an amount that approximates the value of the warrants. NOTE 19 -- SUBSEQUENT EVENTS In June 2004, the Company secured a $3 million Line of Credit with a bank. In June 2004, the company paid in full the $400,000 note payable. In connection with this transaction, the Company received the return of the collateral of 929,250 shares of New Frontier Media stock. The Company has retired these shares. F-30 SUPPLEMENTAL INFORMATION F-31 NEW FRONTIER MEDIA, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS -- SCHEDULE II (in 000s)
ADDITIONS ADDITIONS BALANCE, (DEDUCTIONS) (DEDUCTIONS) BALANCE, BEGINNING CHARGED TO FROM END OF YEAR OPERATIONS RESERVE OF YEAR --------- ------------ ------------ -------- Allowance for doubtful accounts March 31, 2004............................. $ 90 $ (10) $ (12) $ 68 ======= ======== ======== ======== March 31, 2003............................. $ 369 $ 170 $ (449) $ 90 ======= ======== ======== ======== March 31, 2002............................. $ 363 $ 120 $ (114) $ 369 ======= ======== ======== ======== ADDITIONS ADDITIONS BALANCE, (DEDUCTIONS) (DEDUCTIONS) BALANCE, BEGINNING CHARGED TO FROM END OF YEAR OPERATIONS RESERVE OF YEAR ------- -------- -------- -------- Valuation allowance for deferred tax asset March 31, 2004............................. $ 7,211 $ (4,492) $ 3,934 $ 6,653 ======= ======== ======== ======== March 31, 2003............................. $ 0 $ 5,271 $ 1,940 $ 7,211 ======= ======== ======== ======== March 31, 2002............................. $ -- $ -- $ -- $ -- ======= ======== ======== ======== ADDITIONS ADDITIONS BALANCE, (DEDUCTIONS) (DEDUCTIONS) BALANCE, BEGINNING CHARGED TO FROM END OF YEAR OPERATIONS RESERVE OF YEAR ------- -------- -------- -------- Reserve for chargebacks/credits March 31, 2004............................. $ 74 $ 1 $ (62) $ 13 ======= ======== ======== ======== March 31, 2003............................. $ 339 $ 154 $ (419) $ 74 ======= ======== ======== ======== March 31, 2002............................. $ 443 $ 2,004 $ (2,108) $ 339 ======= ======== ======== ========
ADDITIONS ADDITIONS BALANCE, (DEDUCTIONS) (DEDUCTIONS) BALANCE, BEGINNING CHARGED TO FROM END OF YEAR OPERATIONS RESERVE OF YEAR --------- ------------ ------------ -------- Accrued restructuring expense March 31, 2004............................. $ 1,304 $ 0 $ (278) $ 1,026 ======= ======== ======== ======== March 31, 2003............................. $ 1,851 $ 3,230 $ (3,777) $ 1,304 ======= ======== ======== ======== March 31, 2002............................. $ -- $ 3,158 $ (1,307) $ 1,851 ======= ======== ======== ========
F-32
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AND LORAL SKYNET(R)1 CONCERNING SKYNET SPACE SEGMENT SERVICE On this 27th day of January, 2004, this amendment number four ("Amendment Number Four") is made to the Agreement between Colorado Satellite Broadcasting Inc., a corporation organized and existing under the laws of the State of Colorado and having its primary place of business at 7007 Winchester Circle, Suite 200, Boulder, CO 80301 (hereinafter referred to as "CUSTOMER", which expression shall include its successors and permitted assigns) and Loral Skynet, a Division of Loral SpaceCom Corporation, a corporation organized and existing under the laws of the State of Delaware and having a place of business at 500 Hills Drive, Bedminster, New Jersey 07921 (hereinafter referred to as "SKYNET", which expression shall include its successors and permitted assigns). WITNESSETH: WHEREAS, on January 24, 2002, CUSTOMER and SKYNET entered into an Agreement whereby SKYNET is providing C-Band Service on the Telstar 4 satellite; and WHEREAS, on November 26, 2002, May 15, 2003, and October 20, 2003 CUSTOMER and SKYNET amended the above-referenced Agreement; and WHEREAS, CUSTOMER and SKYNET now wish to further amend the Agreement; and NOW, THEREFORE, CUSTOMER and SKYNET, in consideration of the mutual covenants expressed herein, agree as follows: 1. SECTION 1.1 OF THE AGREEMENT IS DELETED IN ITS ENTIRETY AND IS REPLACED WITH THE FOLLOWING: 1.1 (a) SKYNET offers and CUSTOMER hereby orders satellite space segment services as indicated in Section 2 below. Such services are provided on the Telstar 6 satellite on a full-time basis, along with Telemetry, Tracking and Control ("TT&C"), and maintenance of the satellite used to provide the space segment capacity (collectively, the "Service" or "Services"). 2. SECTION 2 OF THE AGREEMENT IS DELETED IN ITS ENTIRETY AND IS REPLACED WITH THE FOLLOWING: - ------------------------------------------------------------------------------ 1 SKYNET and its logo are registered trademarks of Loral SpaceCom Corporation 2. RATES AND TERMS OF SERVICE CUSTOMER shall pay a monthly rate for the Service in accordance with Paragraph 2 of the General Terms and Conditions and the following table:
--------------- --------------------------- -------------- --------------------------- ------------------------------ QUANTITY SERVICE TYPE SATELLITE START AND END DATE MONTHLY RATE PER TRANSPONDER --------------- --------------------------- -------------- --------------------------- ------------------------------ 1 (C1) 36 MHz, C-Band Telstar 6 1-1-04 - 12-31-04 $ Business Preemptible --------------- --------------------------- -------------- --------------------------- ------------------------------ 1 (C7) 36 MHz, C-Band Telstar 6 1-1-04 - 12-31-04 $ Business Preemptible --------------- --------------------------- -------------- --------------------------- ------------------------------ 1 (C14) 36 MHz, C-Band Telstar 6 9-19-03 - 1-31-04 $ Business Preemptible --------------- --------------------------- -------------- --------------------------- ------------------------------
3. SECTION 4.2 OF THE AGREEMENT IS DELETED IN ITS ENTIRETY AND IS REPLACED WITH THE FOLLOWING: 4.2 EARLY TERMINATION OPTION At any time after November 30, 2004 CUSTOMER may terminate one (1) 36 MHz, C-Band transponder upon not less than thirty (30) days prior written notice. Upon the effective date of such a termination, CUSTOMER shall have no further payment obligation for the terminated transponder other than for outstanding charges for the terminated transponder provided up until the date of termination, and for any indemnification obligations of CUSTOMER. Except as specifically amended in this Amendment Number Four, the Agreement shall remain in full force and effect in accordance with its terms. IN WITNESS WHEREOF, the parties have entered into this Amendment Number Four to the Agreement on the day and year first above written. COLORADO SATELLITE LORAL SKYNET, A DIVISION OF BROADCASTING INC. LORAL SPACECOM CORPORATION By: /s/ Larry Harmon By: /s/Sandra James --------------------------------- ----------------------------------- Print: Larry Harmon Print: Sandra James ----------------------------- ------------------------------- Title: VP of Broadcast Operations Title: Director, Contract Management ----------------------------- ------------------------------- Date: 1/29/04 Date: 1/29/04 ------------------------------- -------------------------------
EX-10 4 s11-4473_ex1021.txt EXHIBIT 10.21 *execution version* LEASE{PRIVATE] 1. PARTIES. This Lease ("Lease"), dated, for reference purposes only, April 11, 2001, is made by and between New Frontier Media, Inc., a Colorado corporation (herein called "Tenant") and Northview Properties, LLC, a Colorado limited liability company (herein called "Landlord"). 2. PREMISES. Landlord does hereby lease to Tenant and Tenant hereby leases from Landlord that certain office space (herein called "Premises") indicated on Exhibit A attached hereto and by reference thereto made a part hereof, said Premises being agreed, for the purposes of this Lease, to have an area of approximately 18,305 square feet (including a pro rata share of the common areas in the Building) and being situated on the SECOND (2nd) FLOOR of that certain building known as the NORTHVIEW BUILDING ("Building"), 7007 Winchester Circle, Boulder, Colorado 80301. The land on which is the Building is located is legally described as Lot 2, Gunbarrel Technical Center, Replat, County of Boulder, State of Colorado. The Building, certain Common Facilities and the land on which the Building is located are depicted on the site plan which is attached to this Lease as Exhibit A-1 ("Site Plan"). Said Lease is subject to the terms, covenants and conditions herein set forth and the parties covenant as a material part of the consideration for this Lease to keep and perform each and all of said terms, covenants and conditions by it to be kept and performed and that this Lease is made upon the condition of said performance. 3. TERM. The term of this Lease shall be for ten (10) years, four (4) months. This Lease shall commence on the earlier of the following dates ("Commencement Date"): (i) the date the Tenant opens a substantial portion of the Premises for the operation of the Tenant's business; or (ii) Ninetieth (90th) day following Tenant's receipt of a building permit allowing it to begin the Tenant Improvements, and shall end on the One hundred twenty fourth (124th ) month anniversary of the Commencement Date (i.e. ten years and four months after the Commencement Date), unless sooner terminated in accordance with the provisions of this Lease; provided, however, that if the Commencement Date is not the first day of a calendar month, then the Lease term shall be increased by the number of days between the Commencement Date and the first day of the first complete calendar month in the Lease term. After the Commencement Date, at the request of either party, the parties shall promptly execute and deliver a letter agreement setting forth the Commencement Date and the date the Lease term will expire. If Tenant has not received its building permit allowing it to begin the Tenant Improvements on or before the date that is Ninety (90) days following the date of execution of this Lease, then at any time thereafter but prior to issuance of such building permit, Landlord shall have the right to, upon written notice to Tenant, terminate this Lease. 4. POSSESSION. Landlord shall deliver possession of the Premises to Tenant, in order to commence with preparations for completion of the Tenant Improvements, within ten (10) days of execution of this Lease, with such possession being subject to the terms of this Lease. Subject to the agreement of Landlord and Tenant on the final Plans as set forth in Section 32(b) hereof, Tenant agrees to submit a complete application for a building permit to the appropriate authorities within thirty (30) days of execution of this Lease, and agrees that Tenant's obligation to pay rent shall commence upon the date the Lease term commences. 5. RENT. a. Tenant agrees to pay to Landlord as basic rental, without prior notice or demand, the sum of twenty-two thousand four hundred ninety nine AND 90/100 Dollars ($22,499.90), on or before the first day of the first full calendar month of the term hereof and a like sum on or before the first day of each and every successive calendar month thereafter during the term hereof, except that the one month's rent shall be paid upon the execution hereof. Rent for any period during the term hereof which is for less than one (1) month shall be a per diem prorated portion of the monthly installment herein, based upon the actual number of days in the month. Said rental shall be paid to Landlord, without deduction or offset (except as otherwise authorized in this Lease) in lawful money of the United States of America, which shall be legal tender at the time of payment at 3434 47th Street #220, Boulder, Colorado 80301, or to such other person or at such other place as Landlord may from time to time designate in writing. However, basic rental excluding amortized tenant finish for months one (1), two (2), three (3), and thirteen (13) shall be abated during the primary term of the Lease. 1 b. On not less than 15 days prior notice, effective as of the first day of the month following the end of a Lease year Landlord may increase the basic rental payable for the subsequent twelve (12) month period. The increase shall be a fixed four percent (4.0%) escalation per annum. c. Notwithstanding any provision contained herein, the basic monthly rental due under the terms hereof shall at no time be less than twenty-two thousand four hundred ninety nine AND 90/100 Dollars ($22,499.90). 6. SECURITY DEPOSIT. Tenant has deposited with Landlord, upon the execution of this Lease, the sum of twenty-eight thousand three-hundred two AND 08/100 Dollars ($28,302.08) by check payable to the direct order of the Landlord. Subject to the terms contained in this Section 6, Landlord also requires a letter of credit in the amount of seventy-five thousand And 00/100 Dollars ($75,000.00) ("Letter of Credit"). Said sum shall be held by Landlord as security for the faithful performance by Tenant of all the terms, covenants, and conditions of this Lease to be kept and performed by Tenant during the term hereof. If Tenant defaults with respect to any provision of this Lease, including, but not limited to the provisions relating to the payment of Rent, Landlord may (but shall not be required to) use, apply or retain all or any part of this security deposit for the payment of any Rent or any other sum in default, or for the payment of any amount which Landlord may spend or become obligated to spend by reason of Tenant's default, or to compensate Landlord for any other loss or damage which Landlord may suffer by reason of Tenant's default. If any portion of said deposit is so used or applied, Tenant shall within five (5) days after written demand therefor, deposit cash with Landlord in an amount sufficient to restore the security deposit to its original amount and Tenant's failure to do so shall be a material breach of this Lease. Landlord shall not be required to keep this security deposit separate from its general funds, and Tenant shall not be entitled to interest on such deposit. If Tenant shall fully and faithfully perform every provision of this Lease to be performed by it, the security deposit or any balance thereof shall be returned to Tenant (or at Landlord's option, to the last assignee of Tenant's interest hereunder) at the expiration or earlier termination of the Lease term. In the event of termination of Landlord's interest in this Lease, Landlord shall transfer said deposit to Landlord's successor in interest. The Letter of Credit shall be reduced by one-half (or replaced by a Letter of Credit in the amount of $37,500.00) at the end of the 24th month of the primary lease term and eliminated entirely at the end of the 48th month of the primary lease term. Despite the foregoing, if the money judgment entered against the Tenant in the case filed in Boulder District Court, by J.P. Lipson (Case No. 99CV30), is vacated by the trial court or on appeal, or on remand, the amount of the money judgment is reduced to $2,500,000.00 or less by the trial court, or the judgment is satisfied; then the Letter of Credit shall immediately be eliminated entirely, provided, however, that if said judgement is subsequently reinstated or increased to $2,500,000.00 or more for any reason whatsoever, then Tenant's obligation to provide said Letter of Credit shall be automatically reinstated and such Letter of Credit shall be delivered to Landlord within fifteen (15) days of such reinstatement or increase. So long as Tenant is required to maintain the Letter of Credit, the Letter of Credit shall be replaced at least 30 days prior to the expiration of the then current Letter of Credit. 7. OPERATING EXPENSES. For the purposes of this Section, operating expenses means all reasonable and necessary costs and expenses , paid or incurred by Landlord in operating, managing, repairing, maintaining and administering the building in a cost-effective manner, and on competitive terms including, without limitation or duplication: a. The cost of all insurance required to be kept by Landlord pursuant to this Lease and any other insurance reasonably customarily procured for other commercial buildings in the same geographical area as the Building and which Landlord may reasonably elect to obtain with respect to the operation or ownership of the Property and the part of any claim required to be paid under the reasonable deductible portion of any insurance policies carried by Landlord in connection with the Property (which deductible shall not exceed $20,000.00). 2 b. The cost of reasonable and necessary general repairs, maintenance and replacements, excluding capital expenditures, made from time to time by Landlord to the Property, including costs under mechanical or other maintenance contracts and repairs and replacements of equipment used solely in connection with the Building and associated with such maintenance and repair work. c. The cost of pest control, security, cleaning and snow and ice removal services. d. The cost of maintaining, repairing, redecorating, renovating, replacement of floor coverings of the Building's common areas, and landscaping the Common Facilities, excluding capital expenditures, and of maintaining and operating any fire detection, fire prevention, lighting and communications systems, provided, however, that the cost of any such redecorating and/or renovating shall not exceed one hundred twenty percent (120%) of the cost of the initial decorating or improvement of the portion of the common area(s) being redecorated or renovated, as the case may be. Redecorating, renovating and replacement of floor coverings of common areas shall be charged to operating expenses as provided in Subsection i. of this Section. "Common Facilities" shall mean the areas of the Building and the lot or other parcel on which the Building is located which are built for the common use of the Building's occupants and are available for the common use of the Building's occupants, including by way of example only: Building lobby, elevators, common hallways, walkways and parking areas. e. The cost of all utilities (including, without limitation, water, sewer, gas and electricity) used or consumed in the common areas or supplied to all tenants. f. The cost of providing heating, ventilating and cooling to the interior portions of the Building. g. Remuneration (including wages; fringe benefits;, costs to Landlord of workmen's compensation and disability insurance and payroll taxes) and fees of persons and companies to the extent directly engaged in operating, repairing, maintaining, or administering the Property. To the extent that any individual does not work full-time at the Building, Landlord shall maintain complete and accurate timesheets for each person and each company for whom remuneration is to be paid pursuant to this Section. h. The cost of professional property management fees, not to exceed 6% of all of the basic rents paid by all of the tenants in the Building, and costs incurred by Landlord or its agents in engaging accountants or other consultants to assist in making the computations required hereunder. i. The cost of capital improvements and structural repairs and replacements made in, on or to the Property that are [i] made in order to conform to changes subsequent to the Commencement Date in any applicable laws, ordinances, rules, regulations or orders of any governmental or quasi-governmental authority having jurisdiction over the Property, or [ii] designed primarily to reduce Operating Expenses or the rate of increase in Operating Expense, and such expenses shall be included only to the extent of the savings realized, or [iii] redecoration, renovating and replacement of floor coverings (so long as Landlord is in compliance with the requirements of Subsection (d), above). To the extent that this Subsection (i) authorizes Landlord to include capital expenditures in Operating Expenses, such costs shall be charged by Landlord to Operating Expense in equal annual installments over the useful life of such capital improvement or structural repair or replacement as determined by generally accepted accounting principles consistently applied together with interest on the balance of the unreimbursed cost at 2% above the Prime Rate charged by Bank One, Colorado, N.A. in Boulder on the date the cost was incurred by Landlord. j. Real property taxes and assessments (collectively "Real Estate Taxes"), gross receipts, taxes (whether assessed against the Landlord or assessed against the Tenant and collected by the Landlord, or both). Tenant shall not be responsible to pay any fines, late charges or penalties assessed against Landlord as a result of Landlord's failure to timely pay such taxes and assessments. Assessments which may be paid in installments shall be paid over the maximum period of time permitted by law and only those installments which are payable for the Lease term shall be included in Operating Expenses. Assessments levied in connection with any governmental approvals of the Building, the lot or subdivision in which the Building is situated, or with the consent of the Landlord, or at the behest of the Landlord, shall not be included within Operating Expenses. 3 k. Other costs and expenses, including supplies, not otherwise expressly excluded hereunder attributable to the operation, repair and maintenance of the Property. l. A reserve for replacement of heating, ventilating and air-conditioning equipment, replacement of the roof, and parking lot at a rate of fifty cents ($.50) per net rentable square foot per annum. Operating Expenses shall not, however, include the following: m. Any charge for depreciation of the Building or equipment and any principal, interest or other finance charge, or any rent or lease payments except any for any equipment temporarily required during any emergency or breakdown. n. The cost of any work, including painting, decorating and work in the nature of tenant finish, which Landlord performs in any Rentable Premises other than work which Landlord performs whenever required. o. The cost of repairs, replacements or other work occasioned by (i) casualty or (ii) defects in construction or equipment. p. Expenditures required to be capitalized for federal income tax purposes (except as provided in Section 7, Subsections d. and i.). q. Leasing commissions, advertising expenses, attorneys' fees, tenant improvement allowances and other costs incurred in leasing space in the Building except as otherwise expressly provided in this Lease. r. The cost of repairing or rebuilding necessitated by condemnation. s. The cost of any damage to the Property or any settlement, payment or judgment incurred by Landlord, resulting from Landlord's tortious act, neglect or breach of this Lease that is not covered by insurance proceeds. t. Costs (including, without limitation, attorneys fees) incurred by Landlord in attempting to collect rent or evict tenants (other than Tenant) from the Building. u. Costs, including, without limitation, any penalties, fines and legal expenses incurred by Landlord or any other tenant in the Building as a result of a violation of any federal, state or local law, code or regulation. v. Costs of land acquisition; expenses incurred on behalf of any individual tenant; costs resulting from the act, neglect, fault or omission of Landlord, legal, auditing, accounting or consulting fees except to the extent related to the operation, maintenance, repair and replacement of the Building; administrative fees except for the management fee specifically authorized above; repairs or replacements covered or required to be covered by the insurance Landlord is required to maintain or which Landlord does maintain; registration fees, travel fees and other expenses incurred by Landlord's employees and agents not directly related to the operation, maintenance, repair and replacement of the Building; costs and expenses related to any art or other aesthetic amenity hereafter acquired which exceed ten cents ($0.10) per square foot per year (provided that with respect to costs and expenses which are included as an Operating Expense for Tenant, the Tenant's responsibility for payment of such costs and expenses shall be contingent upon Tenant's approval of such art or aesthetic amenity which approval shall not be unreasonably withheld, delayed or conditioned); advertising, promotional, or membership costs, fees or dues; costs and expenses related to hazardous materials, hazardous substances or contamination (provided, however, that up to ten cents ($0.10) per square foot per year for hazardous materials monitoring expenses shall be included as Operating Expenses); costs and expenses incurred in connection with the initial construction or design of the Building, any expansion of the Building, or the construction of additional buildings, structures or improvements on any part of the land on which the Building is located or any adjacent land; any amounts paid to persons or entities related to Landlord or any of its principals or affiliates in excess of the fair market value of services or materials provided in exchange therefore; costs and expenses incurred in advertising or promoting the Building or any other property for any purpose, including (without limitation) sale of the Building, or incurred with respect to tenants; rental or other expenses incurred in leasing air conditioning systems, elevators or other items typically purchased and affixed to the Building in connection with the ownership and management of a commercial office building, except for temporary equipment during emergencies or breakdowns; costs and expenses incurred with respect to any real estate other than the Building and Common Facilities; 4 During the Term of this lease (and any renewal term hereunder) during which the Building is less than 100% leased, then Tenant shall pay 53.3347% of Operating Expenses paid or incurred by the Landlord for the operation or maintenance of the Building of which the Premises are a part, except for the cost of utilities for the Building (referred to herein as "Utilities Costs"). This percentage is calculated as Tenant's pro-rata share of such Operating Expenses based upon the assumption of a 95% occupancy rate and a total net rentable area of 36,127 square feet. During any period of time in which the Building is less than 100% leased, then Tenant shall, in addition to paying the percentage of Operating Expenses for the Building set forth above, pay its pro rata share (which shall be calculated by dividing the number of square feet leased by Tenant pursuant to this Lease by the total number of leased square feet leased by all tenants in the Building at such time) of Utilities Costs, provided, however, that during any such time, Landlord agrees to pay its proportionate share of costs associated with utility usage in: (i) unleased office space in the Building which are not attributable to Tenant or another tenant in physical occupancy in the Building, e.g. utilities costs associated with construction activities in an unleased portion of the Building or (ii) construction activities in any portion of the Building leased but which has not been physically occupied by the tenant under the applicable lease. Notwithstanding the foregoing, during any time that the Building is 100% leased, then the Tenant's pro rata share shall be 50.6885% of all Operating Expenses paid or incurred by the Landlord for the operation and maintenance of the Building of which the Premises are a part. If the Building or the total net rentable area is changed, Tenant's pro rata share of the Operating Expenses shall be adjusted proportionately. Upon commencement of this Lease, Landlord shall give Tenant a statement of the amount of Operating Expenses payable by Tenant with each payment of rent, which shall be based upon a best estimate of such expenses if no record of actual expenses for the prior year are available. Landlord shall give to Tenant on or before the first day of March of each year thereafter an itemized statement of the prior year's Operating Expenses payable by Tenant hereunder and advise Tenant of any increase in Operating Expenses, but failure by Landlord to give such statement by said date shall not constitute a waiver by Landlord of its right to require an increase in Operating Expenses. The total amount of actual Operating Expenses for the prior year shall be used as an estimate for current year and this amount shall be divided into twelve (12) equal monthly installments, and Tenant shall pay to Landlord, concurrently with the regular monthly rent payment next due following 20 days after the Tenant's receipt of such statement, an amount equal to one (1) monthly installment multiplied by the number of months from January in the calendar year in which said statement is submitted to the month of such payment, less the aggregate amount of all installments previously paid by Tenant with respect to Operating Expenses for such calendar year and any overpayment made by Tenant with respect to the previous calendar year. Subsequent installments shall be payable concurrently with the regular monthly rent payments for the balance of that calendar year and shall continue until the next year's statement is rendered. If actual Operating Expenses are more or less than estimated, then not less than 20 days after receipt of a statement from Landlord, Tenant shall pay a lump sum equal to such total increase with the next regular monthly rent payment or receive a credit against said rent payment. Tenant or its representative shall have the right to inspect, copy and audit Landlord's books and records relating to the Operating Expenses during normal business hours. If any inspection or audit discloses that Tenant has overpaid its pro rata share of Operating Expenses for any calendar year, Landlord shall refund the overpayment within 20 days after Landlord has been given notice of the overpayment and a copy of the inspection or audit report. If the Landlord requested that Tenant pay more than 105.00% of the Tenant's actual pro rata share of Operating Expenses for any calendar year, Landlord shall reimburse the Tenant for all reasonable costs and expenses incurred in connection with the inspection or audit of Landlord's books and records. Landlord shall maintain accurate and complete books and records of all Operating Expenses, in accordance with generally accepted accounting principles consistently applied. 5 Even though the term has expired and Tenant has vacated the Premises, when the final determination is made of Tenant's share of Operating Expenses for the year in which this Lease terminates, Tenant shall immediately pay any increase due over the estimated expenses paid and, conversely, any overpayment made in the event said expenses decrease shall be immediately rebated by Landlord to Tenant. 8. USE. Tenant shall use the Premises for administrative offices, and related storage and shall not use or permit the Premises to be used for any other purpose without the prior written consent of Landlord, which shall not be unreasonably withheld, delayed or conditioned. Tenant shall not do or permit anything to be done in or about the Premises nor bring or keep anything therein which will in any way increase the existing rate or affect any fire or other insurance upon the Building or any of its contents, or cause cancellation of any insurance policy covering said Building or any part thereof or any of its contents. Landlord represents and warrants that the Tenant's use of the Premises in accordance with this Lease shall not result in any breach of Tenant's obligations under the preceding sentence. Tenant shall not do or permit anything to be done in or about the Premises which will, in any material way, obstruct or interfere with the rights of other tenants or occupants of the Building or injure or unreasonably annoy them or use or allow the Premises to be used for any improper or unlawful purpose, nor shall Tenant cause, maintain or permit any nuisance in, on or about the Premises. Landlord acknowledges that Tenant, its subsidiaries and affiliates are engaged in the promotion, offering, distribution and sale of adult entertainment and goods, which some reasonable people might find objectionable or morally reprehensible, and so long as Tenant's business is conducted and maintained within the confines of the Premises, this Lease authorizes the use of the Premises for such purposes, provided, however, that Tenant agrees to use its diligent efforts to prevent any adult entertainment items or materials which may tend to offend or annoy reasonable persons from being readliy visible to persons passing outside of the Premises (i.e. through a window or open door). Tenant shall not commit or suffer to be committed any waste in or upon the Premises. 9. COMPLIANCE WITH LAW. Tenant shall not use the Premises or permit anything to be done in or about the Premises which will violate any applicable law, statute, ordinance or governmental rule or regulation now in force or which may hereafter be enacted or promulgated. Tenant shall, at its sole cost and expense, promptly comply with all laws, statutes, ordinances and governmental rules, regulations or requirements now in force or which may hereafter be in force, and with the requirements of any board of fire insurance underwriters or other similar bodies now or hereafter constituted, relating to, or affecting the condition, use or occupancy of the Premises, excluding the structural or system (eg. sprinkler, fire alarm) changes: (i) not required as a result of any Tenant's improvements or Tenant's specific use or method of operation and/or (ii) which would be required of an office in the Building generally. A judgment against Tenant, whether the Landlord be a party thereto or not, that Tenant has violated any law, statute, ordinance or governmental rule, regulation or requirement, shall be conclusive of that fact as between the Landlord and Tenant. 10. ALTERATIONS AND ADDITIONS. During any 180 day period during the Term of this Lease, Tenant may make up to Five thousand dollars ($5,000) in non-structural alterations, additions or improvements to the Premises without Landlord's consent. Except as specifically permitted in the preceding sentence, Tenant shall not make or suffer to be made any alterations, additions or improvements to or of the Premises or any part thereof without the written consent of Landlord first had and obtained, which will not be unreasonably withheld, conditioned or delayed. Any alterations, additions or improvements to or of said Premises, including, but not limited to, wall covering, paneling and built-in cabinet work, but excepting movable furniture and trade fixtures, shall, on the expiration of the term, become a part of the realty and belong to the Landlord and shall be surrendered with the Premises. In the event Landlord consents to the making of any alterations, additions or improvements to the Premises by Tenant, the same shall be made by Tenant at Tenant's sole cost and expense, and any contractor or person selected by Tenant to make the same, must first be approved of in writing by the Landlord, which will not be unreasonably withheld, conditioned or delayed. Upon the expiration or earlier termination of the term hereof, Tenant shall, upon the written demand by the Landlord, at Tenant's sole cost and expense, forthwith and with all due diligence, remove any alterations, additions, or improvements which have been made by the Tenant and which are designated by the Landlord to be removed, and repair any damage to the Premises caused by such removal. Additionally, Landlord may elect to have Tenant remove such alterations, additions and improvements as may be required to restore Tenant's Premises to a condition suitable for multi-tenant occupancy (referred to herein as "Common Core Restoration"). If Landlord, in its discretion, elects to complete such Common Core Restoration, then Tenant shall be responsible for the cost of the Common Core Restoration up to $17,500.00. In other words, Tenant shall be responsible for the cost of removal and repair related to any alterations, additions, or improvements which have been made by Tenant and which are designated by Landlord to be removed , except that Tenant's responsibility for payment of costs related to the Common Core Restoration shall be limited to the lesser of (a) the cost of the Common Core Restoration; or (b) $17,500.00. Landlord shall give Tenant notice on or before the expiration or termination of this Lease of its decision to complete the Common Core Restoration. Tenant shall also be responsible for the removal of any telecommunications and data cabling as requested by Landlord. Landlord and Tenant agree to perform a walk-through of the Premises not less than thirty (30) days prior to the expiration of the term hereof (or within a reasonable time prior to Tenant's vacancy of the Premises if this Lease is otherwise terminated prior to the expiration of the term) for the purpose of determining what alterations, additions and improvements (and telecommunications and data cabling) which have been made or installed by The Tenant shall be removed upon expiration or early termination of the term of this Lease. 6 11. REPAIRS. a. By taking possession of the Premises, Tenant shall be deemed to have accepted the Premises as being in good, sanitary order, condition and repair (subject to Tenant's rights set forth in Section 32(d)). Tenant shall, at Tenant's sole cost and expense, keep the interior of Premises and every part thereof in good condition and repair, except for: (i) any structural maintenance, repair or replacement; (ii) any portion of any system (eg. HVAC) serving any premises in addition to or other than the Premises; (iii) any portion of any system located within exterior walls or slabs (except to the extent that such systems were installed by Tenant); (iv) damage thereto from causes beyond the reasonable control of Tenant; (v) damages from any casualty which Landlord is required to insure against or which Landlord does insure against; (vi) ordinary wear and tear; and (vii) any janitorial or pest control services which Landlord is obligated to provide. Tenant shall, upon the expiration or sooner termination of this Lease hereof, surrender the Premises which Tenant is obligated to maintain and repair, to the Landlord in good condition, except for: (i) any janitorial or pest control services which Landlord is obligated to provide; (ii) ordinary wear and tear; (iii) damage from causes beyond the reasonable control of Tenant; and (iv) damages from any casualty which Landlord is required to insure against or which Landlord does insure against excepted. Except as specifically provided in an addendum, if any, to this Lease, Landlord shall have no obligation whatsoever to alter, remodel, improve, decorate or paint the Premises or any part thereof, and the parties hereto affirm that Landlord has made no representations to Tenant respecting the condition of the Premises or the Building except as specifically herein set forth. b. Landlord shall cause the Building and the Common Facilities to be operated, maintained, repaired and replaced in first class condition. Landlord shall repair, replace and maintain the structural portions of the Building, including the roof, plumbing, air conditioning, heating, and electrical and sprinkler systems installed or furnished by Landlord, and all portion of the Building and the Premises which Tenant is not obligated to maintain and repair, except to the extent that such maintenance and repairs are: (i) caused by the breach of the Tenant's obligations under this Lease or the act, neglect, fault or omission of any duty by the Tenant, its agents, servants, employees or invitees; and (ii) are not covered by any insurance which Landlord is required to maintain or by any insurance which Landlord does maintain, in which case Tenant shall pay to Landlord the reasonable cost of such maintenance and repairs. The cost of all such repairs borne by the Landlord shall be included in Operating Expenses to the extent provided in Section 7 hereof. Landlord shall not be liable for any failure to make any such repairs or to perform any maintenance unless such failure shall persist for an unreasonable period of time (Landlord must complete such maintenance or repairs prior to the expiration of the applicable grace period. If, for any reason, Landlord is unable to complete such maintenance or repairs within the applicable grace period, then Landlord shall notify Tenant in writing of such situation prior to the expiration of the applicable grace period) after the date Landlord has been given notice of the need for such repairs or maintenance. Except as specifically authorized by this Lease,, there shall be no abatement of Rent and no liability of Landlord by reason of any injury to or interference with Tenant's business arising from the making of any repairs, alterations or improvements in or to any portion of the Building or the Premises or in or to fixtures, appurtenances and equipment therein. In the event of an actual or apparent emergency, or Landlord's breach of any of Landlord's maintenance, repair or replacement obligations which is not cured within any applicable grace period, Tenant shall have the right but not the obligation to make any repairs or replacements and perform any maintenance at Landlord's expense and present an invoice for the actual cost of such repairs or replacements to Landlord, which sum shall be remitted within twenty (20) days of receipt of such invoice. Subject to Landlord's right to contest said invoice in good faith, if Tenant is not paid in full within 20 days after Landlord is invoiced, then the Tenant shall have the right to offset the amount invoiced against the rent and any other charges payable under this Lease (collectively "Rent") until Tenant is reimbursed in full. For the purposes of this Lease an actual or apparent emergency means circumstances in which or in which it appears that unless immediate action is taken, there will be significant damage to property or significant interference with the Tenant's authorized use of the Premises, Building or Common Facilities, or any risk of injury to person. 7 12. LIENS. Tenant shall keep the Premises and the property in which the Premises are situated free from any liens arising out of any work performed, materials furnished or obligations incurred by Tenant. In the event that Tenant elects to complete improvements, additions or alterations to the Premises, the estimated cost of which exceeds Fifty Thousand Dollars ($50,000), then Landlord may require, at Landlord's sole option, that Tenant shall provide to Landlord, at Tenant's sole cost and expense, a lien and completion bond or other security reasonably acceptable to Landlord in an amount equal to one and one-half (1-1/2) times any and all estimated cost of improvements, additions, or alterations to be made by the Tenant in the Premises, to insure Landlord against any liability for mechanics' and materialmen's liens and to insure completion of the work. 13. ASSIGNMENT AND SUBLETTING. Except as expressly provided below, Tenant shall not either voluntarily or by operation of law, assign, transfer, mortgage, pledge, hypothecate or encumber this Lease or any interest therein, and shall not sublet the said Premises or any part thereof, or any right or privilege appurtenant thereto, or suffer any other person (the employees, agents, servants and invitees of Tenant excepted) to occupy or use the said Premises, or any portion thereof, without the written consent of Landlord first had and obtained, which consent shall not be unreasonably withheld, conditioned or delayed, and a consent to one assignment, subletting, occupation or use by any other person shall not be deemed to be a consent to any subsequent assignment, subletting, occupation or use by another person. Any such assignment or subletting without such consent shall be void, and shall, at the option of the Landlord, constitute a default under this Lease. Tenant may, upon written notice to Landlord, but without the consent of Landlord, (i) transfer (by assignment or sublease, in whole or in part) this Lease to any parent or affiliate of Tenant or to a wholly owned subsidiary of Tenant, or (ii) transfer (by assignment or sublease, in whole or in part) this Lease to any person or entity acquiring, by asset or stock purchase, merger, consolidation, reorganization or liquidation, all or substantially all of Tenant's assets or voting stock, provided that such person or entity assumes in writing the obligations of Tenant under this Lease. 50.00 percent (50.00%) of any rent or other consideration realized by Tenant under any such assignment, subletting or occupancy in excess of the Basic Rental and other sums payable hereunder, after amortization of the reasonable costs incurred by Tenant for leasing commissions, leasehold improvements and other expenses in connection with such assignment, subletting or occupancy, at the time incurred over the term of such assignment, subletting or occupancy, shall be paid to Landlord by Tenant when collected by Tenant. Any consideration paid in connection with any sale or other transfer of Tenant's business or assets shall not be shared with Landlord. Landlord may charge a reasonable fee not to exceed $1,000 as part of its consent to any assignment, sublease, or encumbrance. 14. HOLD HARMLESS. 14.01 Tenant shall indemnify and hold harmless Landlord against and from any and all claims arising from Tenant's use of the Premises for the conduct of its business or from any activity, work, or other thing done, permitted or suffered by the Tenant in or about the Building, and shall further indemnify and hold harmless Landlord against and from any and all claims arising from any breach or default in the performance of any obligation on Tenant's part to be performed under the terms of this Lease, or arising from any act or negligence of the Tenant, or any officer, agent, employee, guest, or invitee of Tenant, and from all and against all costs, 8 reasonable attorneys' fees, expenses and liabilities incurred in or about any such claim or any action or proceeding brought thereon, and, in any case, action or proceeding be brought against Landlord by reason of any such claim, Tenant, upon notice from Landlord shall defend the same at Tenant's expense. Landlord shall immediately give Tenant notice of such claim, and shall cooperate with the Tenant in all reasonable respects. Tenant, as a material part of the consideration to Landlord, hereby assumes all risk of damage to property or injury to persons in, upon or about the Premises, from any cause other than Landlord's negligence or willful acts. Landlord or its agents shall not be liable for any damage to property entrusted to employees of the Building, nor for loss or damage to any property by theft or otherwise, nor for any injury to or damage to property resulting from fire, explosion, falling plaster, steam, gas, electricity, water or rain which may leak from any part of the Building or from the pipes, appliances or plumbing works therein or from the roof, street or subsurface or from any other place resulting from dampness or any other cause whatsoever, unless caused by or due to the negligence of Landlord, its agents, servants or employees, or any default in the fulfillment of the Landlord's obligations under this Lease. Landlord or its agents shall not be liable for interference with the light or other incorporeal hereditament, loss of business by Tenant, nor shall Landlord be liable for any latent defects in the Premises or in the Building (subject to Tenant's rights as set forth in Section 32(d) of this Lease). Tenant shall give prompt notice to Landlord in case of fire or accidents in the Premises or in the Building or of defects therein or in the fixtures or equipment which Tenant has actual knowledge of. 14.02 Subject to the waiver of subrogation contained in Section 15, to the extent Tenant is not covered by Landlord's and Tenant's insurance, Landlord shall, and hereby agrees to, indemnify and hold Tenant harmless from any damages, costs and expenses (including reasonable attorneys' fees) in connection with loss of life, bodily or personal injury or property damage arising from any occurrence in the Common Areas of the Building or the land on which the Building is located, except to the extent of the acts or omissions of Tenant. 15. SUBROGATION. Landlord and Tenant hereby mutually waive their respective rights of recovery against each other for any loss which would be covered by "special form" casualty insurance policies, regardless of whether the parties obtain such coverage. Each party shall obtain any special endorsements, if required by their insurer to evidence compliance with the aforementioned waiver. 16. LIABILITY INSURANCE. 16.1 Tenant shall, at Tenant's expense, obtain and keep in force during the term of this Lease a policy of comprehensive public liability insurance or commercial general liability insurance with limits not less than $2,000,000, combined single limit, insuring Landlord and Tenant against any liability arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto, as their interests may appear. Said insurance policy shall contain an deductible portion not to exceed Five Thousand and no/100ths Dollars ($5,000). The limit of said insurance shall not, however, limit the liability of the Tenant hereunder. Tenant may carry said insurance under a blanket policy, providing, however, said insurance by Tenant shall have a Landlord's protective liability endorsement attached thereto. Tenant may provide any portion of such coverage under an "excess liability" or "umbrella policy." If Tenant shall fail to procure and maintain said insurance, Landlord may, but shall not be required to, procure and maintain same, but at the expense of Tenant after notifying Tenant and allowing ten (10) business days. Tenant shall deliver to Landlord prior to occupancy of the Premises certificates evidencing the existence and amounts of such insurance with named insured as their interests may appear. No policy shall be cancelable or subject to reduction of coverage except after thirty (30) days' prior written notice to Landlord. 16.2 Landlord shall, at Landlord's expense, obtain and keep in force during the term of this Lease a policy of comprehensive public liability insurance or commercial general liability insurance with limits not less than $2,000,000, combined single limit, insuring Landlord and Tenant against any liability arising out of the ownership, use, occupancy or maintenance of the Building and all areas appurtenant thereto, as their interests may appear. The limit of said insurance shall not, however, limit the liability of the Landlord hereunder. Landlord may carry said insurance under a blanket policy, providing, however, said insurance by Landlord shall have a Tenant's protective liability endorsement attached thereto. Landlord may provide any portion of such coverage under an "excess liability" or "umbrella policy." If Landlord shall fail to procure and maintain said insurance, Tenant may, but shall not be required to, procure and maintain same, but at the expense of Landlord after notifying Landlord and allowing ten (10) business days. Landlord shall deliver to Tenant prior to occupancy of the Premises certificates evidencing the existence and amounts of such insurance with named insured as their interests may appear. No policy shall be cancelable or subject to reduction of coverage except after thirty (30) days' prior written notice to Tenant. 9 16.3. In addition, if either party fails to obtain liability insurance policies on an "occurrence basis" such party shall obtain extension policies commonly referred to as "tail" policies at least thirty (30) days prior to the expiration of any policy which will not be renewed. All extension policies (x) shall include coverage for all claims made after the date, of the policy not renewed, regardless of the date such claims are made; and (y) shall have limits equal to or greater than the policies which are not being renewed. All liability policies shall specifically: (i) insure performance of the agreement of the party procuring the policy, to indemnify as, set forth in Section 14 of this Lease, as it relates to liability for injury to or death of persons and damage to property; and (ii) provide that although the other party is named as an insured, it shall nevertheless be entitled to recover under the policy for any loss suffered as a result of the acts or omissions of the party procuring the insurance policy. 16.4. All insurance which parties are obligated to maintain under any provision of this Lease, shall be issued by insurance companies authorized to do business in the jurisdiction in which the Premises is located, which have a "Best's Letter Rating" of not less than "A" ("Excellent"), with no adverse "Rating Modifier," and a "Financial Size Category" of not less than "Class VIII" (or their then current equivalents) in the most current "Best's Key Rating Guide" or the equivalent in a substitute or successor publication selected by Landlord. All insurance policies shall be written as primary policy coverage, not contributing with, or in excess of any coverage carried by the other party or another. 17. SERVICES AND UTILITIES. Landlord agrees to furnish to the Premises during all hours and on all days, electricity for normal lighting and fractional horsepower office machines, heat and air conditioning, water and sanitary sewer service required for the comfortable use and occupation of the Premises. Landlord shall also maintain and keep lighted the common stairs, common entries and toilet rooms in the Building of which the Premises are a part. Landlord shall not be liable for, and Tenant shall not be entitled to any reduction of rental by reason of Landlord's failure to furnish any of the foregoing when such failure is caused by accident, breakage, repairs, strikes, lockouts or other labor disturbances or labor disputes of any character, or by any other cause, similar or dissimilar, beyond the reasonable control of Landlord. Landlord shall not be liable under any circumstances for a loss or injury to property, however occurring, through or in connection with or incidental to failure to furnish any of the foregoing, except as to Landlord's negligence or tortious acts; provided, however, that if the Tenant cannot reasonably use the Premises for the operation of Tenant's authorized business all Rent shall abate until the Premises is reasonably suitable for the operation of Tenant's authorized business. Wherever heat generating machines or equipment are used in the Premises which extraordinarily affect the temperature otherwise maintained by the air conditioning system, Landlord reserves the right to install supplementary air conditioning units in the Premises and the reasonable cost thereof, including the cost of installation, and the cost of operation and maintenance thereof shall be paid by Tenant to Landlord upon demand by Landlord. Tenant will not, without written consent of Landlord, use any apparatus or device in the Premises, including, but without limitation thereto, electronic data processing machines, punch card machines, and machines using in excess of 220 volts, which will in any extraordinary way increase the amount of electricity usually furnished or supplied for the use of the Premises as general office space; nor connect with electric current except through electrical outlets in the Premises, any apparatus or device, for the purpose of using electric current. If Tenant shall require water or electric current extraordinarily in excess of that usually furnished or supplied for the use of the Premises as general office space, Tenant shall first procure the written consent of Landlord, which Landlord shall not unreasonably refuse, to the use thereof and Landlord may cause a water meter or electrical current meter to be installed in the Premises, so as to measure the amount of water and electric current consumed for any such use. The reasonable cost of any such meters and of installation, maintenance and repair thereof shall be paid for by the Tenant and Tenant agrees to pay to Landlord promptly within 20 days after demand therefor by Landlord for the extraordinary portion of all such water and electric current consumed as shown by said meters at the rates charged for such services by the local public utility furnishing the same, plus any additional expense incurred in keeping account of the water and electric current so consumed. If a separate meter is not installed, such excess cost for such water and electric current will be established by an estimate made by a utility company or electrical engineer and it is agreed that the cost of hiring such person and obtaining such estimate shall be shared equally by Landlord and Tenant. 10 18. PROPERTY TAXES. Tenant shall pay, or cause to be paid, before delinquency, any and all taxes levied or assessed and which become payable during the term hereof upon all Tenant's leasehold improvements, equipment, furniture, fixtures and personal property located in the Premises; except that which has been paid for by Landlord, and is the standard of the Building. In the event any or all of Tenant's leasehold improvements, equipment, furniture, fixtures and personal property shall be assessed and taxed with the Building, Tenant shall pay to Landlord its share of such taxes within thirty (30) days after receipt by Tenant from Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant's property which statement shall include a copy of the tax bill. 19. RULES AND REGULATIONS. Tenant shall faithfully observe and comply with the non-discriminatory and even-handedly enforced rules and regulations that Landlord shall, from time to time, promulgate for the use of the Premises and the Common Facilities which are not contrary to any provision of this Lease and do collectively not impose any significant limitation on the Tenant's use of the Premises and the Common Facilities as set forth in this Lease and the rules and regulations which are attached to this Lease as Exhibit B and do not collectively impose any obligation on the part of Tenant to incur material out of pocket expense not imposed by this Lease and the rules and regulations attached to this Lease as Exhibit B. Landlord reserves the right, from time to time, to make all reasonable modifications to said rules. The additions and modifications to those rules shall be binding upon Tenant 20 days after delivery of a copy of them to Tenant. Landlord shall not be responsible to Tenant for the nonperformance of any said rules by any other tenants or occupants. A copy of the current rules and regulations are attached hereto as Exhibit B. 20. HOLDING OVER. If Tenant remains in possession of the Premises or any part after the expiration of the term hereof, without the express written consent of Landlord, such occupancy shall be a tenancy from month-to-month at a rental in the amount of one and one-half times the last monthly rental, plus all other charges payable hereunder, and upon all the terms hereof applicable to a month-to-month tenancy. 21. ENTRY BY LANDLORD. Landlord reserves, and shall during normal business hours upon reasonable written notice to Tenant and subject to Tenant's security requirements, as herein defined, the right to enter the Premises, inspect the same, supply janitorial service and any other service to be provided by Landlord to Tenant hereunder, to submit said Premises to prospective purchasers or during the last six months of the term to prospective tenants, to post notices of non-responsibility, and to alter, improve or repair the Premises and any portion of the Building of which the Premises are a part that Landlord may reasonably deem necessary or desirable; provided, however, that: (i) to the extent any entry upon the Premises materially interferes with the conduct of Tenant's business and Tenant's use of the Premises for the purposes authorized by this Lease, the Rent shall be equitably abated, and (ii) Landlord shall take all steps reasonably required to minimize interference with Tenant's use of the Premises, including without limitation intended, and by way of example only, whenever feasible, by performing work outside of normal business hours. In connection with any work to be performed by Landlord under this Lease, Landlord may erect scaffolding and other necessary structures where reasonably required by the character of the work to be performed, always providing that the entrance to the Premises shall not be blocked thereby. Except for such abatement of Rent, Tenant hereby waives any claim for damages or for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises, and any other loss occasioned thereby unless caused by negligence or tortious acts of Landlord or Landlord's breach of its obligations under this Section. For each of the aforesaid purposes, Landlord shall, at all times, have and retain a key with which to unlock all of the doors in, upon and about the Premises, excluding Tenant's vaults, safes and files and locked interior rooms, and Landlord shall have the right to use any and all means which Landlord may deem proper to open said doors in an emergency, in order to obtain entry to the Premises without liability to Tenant except for the damage resulting from the entry and any failure to exercise due care for Tenant's property. Any such entry to the Premises obtained by Landlord by any of said means, or otherwise shall not, under any circumstances, be construed or deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or an eviction of Tenant from the Premises or any portion thereof. 11 22. RECONSTRUCTION. In the event the Premises, or the Building of which the Premises are a part, are damaged by fire or other perils covered by "special form" casualty insurance, Landlord agrees to forthwith repair the same to substantially the same condition as existed immediately prior to such damage; and this Lease shall remain in full force and effect, except that the Tenant shall be entitled to an equitable reduction of the Rent while such repairs are being made. Such proportionate reduction to be based upon the extent to which the damage and the making of such repairs shall materially interfere with the business carried on by the Tenant in the Premises. If the damage is due to the fault or neglect of Tenant or its employees, there shall be no abatement of rent unless the damage is covered by "special form" casualty insurance. If the restoration of the Premises or the Building is not likely to be completed, or is not completed, within 180 days after the date of the casualty, the Tenant shall have the right to terminate this Lease without liability. Landlord shall give Tenant at least 30 days prior notice of the date when the Premises would be restored and delivered to Tenant. During any period of rent abatement or reduction as described in this Section 22, it is agreed and understood that such rent abatement or reduction shall commence on the date which the Premises or portion thereof are subjected to such damage or casualty and continue until the later of (a) the date that is thirty (30) days after the date that Landlord provides notice to Tenant of the repair and restoration of the Premises or (b) the date on which the Premises are restored and possession of such is delivered to Tenant. In the event the Premises or the Building of which the Premises are a part are damaged as a result of any cause other than the perils covered by fire and extended coverage insurance, then Landlord shall forthwith repair the same within one hundred and fifty (150) days of casualty, provided the extent of the destruction be less than ten percent (10%) of the then full replacement cost of the Premises or the Building of which the Premises are a part. In the event the destruction of the Premises or the Building is to an extent greater than ten percent (10%) of the full replacement cost, then Landlord shall have the option: (1) to repair or restore such damage, this Lease continuing in full force and effect, but the rent to be proportionately reduced as hereinabove in this Section provided; or (2) give notice to Tenant at any time within thirty (30) days after such damage terminating this Lease as of the date specified in such notice, which date shall be no less than thirty (30) and no more than sixty (60) days after the giving of such notice. In the event of giving such notice, this Lease shall expire and all interest of the Tenant in the Premises shall terminate on the date so specified in such notice and the Rent, reduced by a proportionate amount, based upon the extent, if any, to which such damage materially interfered with the business carried on by the Tenant in the Premises, shall be paid up to date of said such termination. Notwithstanding anything to the contrary contained in this Section, Landlord shall not have any obligation whatsoever to repair, reconstruct or restore the Premises when the damage resulting from any casualty covered under this Section occurs during the last twelve (12) months of the term of this Lease or any extension thereof and in the event of such casualty during the last twelve (12) months of the term of this Lease either Landlord or Tenant shall have the right to terminate this Lease by giving written notice to the other party within thirty (30) days of such casualty; provided, however, that if there is an unexercised renewal term of the Lease remaining, Tenant shall have the right to exercise such term by giving Landlord notice thereof within 30 days after the date Landlord gives Tenant notice of termination, in which event Landlord's notice of termination shall be a nullity Landlord shall not be required to repair any injury or damage by fire or other casualty, or to make any repairs or replacements of any panels, decoration, office fixtures, railings, floor coverings, partitions, or any other property installed in the Premises by Tenant unless covered by Landlord's insurance as part of the Building. Except for the abatements of Rent provided for in this Lease, The Tenant shall not be entitled to any compensation or damages from Landlord for loss of the use of the whole or any part of the Premises, or Tenant's personal property, unless caused by Landlord, or, subject to Section 21, any compensation or damages for inconvenience or annoyance occasioned by such damage, repair, reconstruction or restoration. Landlord shall throughout the Lease term maintain "special form" casualty insurance coverage for the Building and all related insurable improvements, for their full replacement cost, with an agreed value endorsement. 12 The term "special form" insurance coverage as used in this Lease may exclude the perils of "flood," "earthquake," and "law and ordinance" for the Building and all related insurable improvements, for their full replacement cost, with an agreed value endorsement. 23. DEFAULT. The occurrence of any one or more of the following events shall constitute a default and breach of this Lease: a. The vacating or abandonment of the Premises by Tenant, without payment of Rent, where such failure shall continue for a period of ten (10) days after written notice thereof by Landlord to Tenant. b. The failure by Tenant to make any payment of rent or any other payment required to be made by Tenant hereunder, as and when due, where such failure shall continue for a period of ten (10) days after written notice thereof by Landlord to Tenant. c. The failure by Tenant to observe or perform any of the covenants, conditions or provisions of this Lease to be observed or performed by the Tenant, other than described in Section 23.b above, where such failure shall continue for a period of thirty (30) days after written notice thereof by Landlord to Tenant; provided, however, that if the nature of Tenant's default is such that more than thirty (30) days are reasonably required for its cure, then Tenant shall not be deemed to be in default if Tenant takes steps to commence such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. d. The making by Tenant of any general assignment or general arrangement for the benefit of creditors; or the filing by or against Tenant of a petition to have Tenant adjudged a bankrupt, or a petition of reorganization or arrangement under any law relating to bankruptcy (unless, in the case of a petition filed against Tenant, the same is dismissed within 90 days); or the appointment of a trustee or a receiver to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where possession is not restored to Tenant within 90 days; or the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where such seizure is not discharged in 90 days. e. If Landlord is in default in the performance of any obligation under this Lease on the part of Landlord to be performed and such default continues for a period of thirty (30) days after Tenant's written notice to Landlord specifying the nature of the default then Tenant may exercise any right or remedy it may possess at law or equity, which is not otherwise waived in this Lease. If the default set forth in Tenant's notice cannot reasonably be cured within thirty (30) days, then Landlord shall not be deemed to be in default if (i) Landlord notifies Tenant in writing that it will cure the default, (ii) commences to cure the default within such thirty (30)-day period, and (iii) proceeds diligently and in good faith thereafter to cure such default and does cure such default within a reasonable time. 24. REMEDIES IN DEFAULT. In the event of any such default or breach by Tenant which continues uncured after the expiration of any applicable grace period, Landlord may at any time thereafter, with notice or demand (which notice requirement may be satisfied by the provision of notice of default from Landlord to Tenant as set forth in Section 23, above, but only if such notice includes a statement notifying Tenant that failure to cure such default within the applicable grace period will result the exercise of one of Landlord's remedies in default as set forth below), and without limiting Landlord in the exercise of a right or remedy which Landlord may have by reason of such default or breach: a. Terminate Tenant's right to possession of the Premises by any lawful and peaceful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Premises to Landlord. In such event Landlord shall be entitled to recover from Tenant all damages incurred by Landlord by reason of Tenant's default including, but not limited to, the cost of recovering possession of the Premises; expenses of reletting, including necessary and reasonable expenses incurred in connection with renovation and alteration of the Premises, reasonable attorneys' fees, any real estate commission actually paid (which shall be limited to (a) the real estate commission due under the remaining term of the Lease and (b) real estate commission due in connection with reletting the Premises, provided, however, that Tenant shall only be responsible for item (a) until such time as the Premises are re-let and thereafter shall be responsible for item (b) for the time which would have encompassed the remaining term of this Lease, if it had remained in effect); the worth at the time of award by the court having jurisdiction thereof of the amount by which the unpaid Rent for the balance of the term after the time of such award exceeds the amount of such rental loss for the same period that Tenant proves could be reasonably avoided, with the resulting figure discounted to present value using the Discount Rate provided in the following sentence (and defined therein). For any sums discounted to present value pursuant to the preceding sentence, it is agreed that the discount rate used shall be the average of three (3) rates of interest given on high-balance savings accounts, as the same existed on the date of award by the court, which rates shall be determined by Landlord selecting three (3) national or regional banks operating within Boulder County and taking the average of those three (3) rates. The resultant rate shall be known as the Discount Rate for purposes of this Lease. Unpaid installments of rent or other sums shall bear interest from the date due at the rate of twenty percent (20%) per annum. In the event Tenant shall have abandoned the Premises without payment of rent, Landlord shall have the option of (a) taking possession of the Premises and recovering from Tenant the amount specified in this Section, or (b) proceeding under the provisions of the following Section 24.b. 13 b. Maintain Tenant's right to possession, in which case this Lease shall continue in effect whether or not Tenant shall have abandoned the Premises. In such event, Landlord shall be entitled to enforce all of Landlord's rights and remedies under this Lease, including the right to recover the rent as it becomes due hereunder. c. Pursue any other remedy now or hereafter available to Landlord under the laws or judicial decision of the State in which the Premises are located. Despite any other provision of this Lease to the contrary, Landlord shall have an obligation to mitigate Landlord's damages. 25. EMINENT DOMAIN. If any portion of the Premises shall be taken or appropriated by any public or quasi-public authority under the power of eminent domain, or more than 15.00 percent of the Tenant's parking spaces or any portion of the Building or Common Facilities reasonably required for the Tenant's authorized use of the Premises, either party shall have the right, at its option, to terminate this Lease by giving written notice to the other party, and Landlord shall be entitled to any and all income, rent, award, or any interest therein whatsoever which may be paid or made in connection with such public or quasi-public use or purpose, and Tenant shall have no claim against Landlord for the value of any unexpired term of this Lease. If any portion of the Premises or any portion of the Building or Common Facilities reasonably required for the Tenant's authorized use of the Premises is taken and neither party elects to terminate as herein provided, the Rent thereafter to be paid shall be equitably reduced. If more than ten percent (10%) of the Building other than the Premises may be so taken or appropriated, Landlord shall have the right at its option to terminate this Lease by giving thirty (30) days written notice to Tenant and shall be entitled to the entire award as above provided. Tenant shall, however, have the right to pursue a separate claim for any other damage suffered as a result of such taking. If Landlord does not terminate this Lease in accordance with this Section, Landlord shall forwith restore the Premises, Building and Common Facilities affected by the taking to the fullest extent possible. 26. ESTOPPEL STATEMENT. Landlord and Tenant shall at any time and from time to time upon not less than ten (10) business days' prior written notice from the other party execute, acknowledge, and deliver to the other party a statement in writing, (a) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease as so modified, is in full force and effect), and the date to which the rental and other charges are paid in advance, if any, and (b) acknowledging that there are not, to Tenant's or Landlord's knowledge, as appropriate, any uncured defaults or breaches on the part of the other party hereunder, or specifying such breaches or defaults if any are claimed. Any such statement may be relied upon by any prospective purchaser or encumbrance of all or any portion of the real property of which the Premises are a part. 14 27. PARKING. Tenant shall have the right to use in common with other tenants or occupants of the Building the parking facilities of the Building, subject to the non-discriminatory, even-handedly enforced rules and regulations which may be established or altered by Landlord at any time or from time to time during the term hereof. Tenant shall have the exclusive right to the use of fifty-three (53) parking spaces, may, subject to Landlord's consent, sign the exclusive spaces accordingly, and to the extent permitted by applicable law, may sticker any vehicles parked in derogation of the rights conferred by this Section. There shall be no additional rent or other charge imposed for the use of such spaces. If any occupant of the Building does not require its pro rata share of parking spaces, Landlord shall make reasonable efforts to assist Tenant in Tenant's efforts to procure the use of the spaces not required by the other occupant(s). 28. AUTHORITY OF PARTIES. a. Corporate Authority. If Tenant is a corporation, each individual executing this Lease on behalf of said corporation represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the corporation, in accordance with a duly adopted resolution of the board of directors of said corporation or in accordance with the bylaws of said corporation, and that this Lease is binding upon said corporation in accordance with its terms. b. Limited Partnerships. If the Landlord herein is a limited partnership, it is understood and agreed that any claims by Tenant on Landlord shall be limited to the assets of the limited partnership, and furthermore, Tenant expressly waives any and all rights to proceed against the individual partners or the officers, directors or shareholders of any corporate partner, except to the extent of their interest in said limited partnership. c. Limited Liability Company. If the Landlord herein is a limited liability company, it is understood and agreed that any claims by Tenant on Landlord shall be limited to the assets of the limited liability company, and furthermore, Tenant expressly waives any and all rights to proceed against individual members or managing members, except to the extent of their interest in said limited liability company. Each individual executing this Lease on behalf of said limited liability company represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the company, in accordance with a duly adopted resolution of the managers or all of the members of the company, whichever has the authority to do so, and that this Lease is binding upon said company in accordance with its terms, and that Landlord is not required to obtain any consents or approvals of any third parties with respect to this Lease. d. Use of Premises. Landlord, after appropriate inquiry, represents to the Tenant that the Building and the land on which the Building is located, may lawfully be used for administrative offices, provided, however, that despite the foregoing, it is mutually agreed and acknowledged that Tenant is solely responsible for conducting its own due diligence and making its own conclusions regarding all matters relating to zoning and use. Landlord represents and warrants that, during the Term of this Lease, it will not commence any action to change the current zoning of the Building or land on which the Building is located which would negatively impact Tenant. 29. GENERAL PROVISIONS. a. Plats and Riders. Clauses, plats, exhibits and riders, if any, signed by the Landlord and the Tenant and endorsed on or affixed to this Lease are hereby incorporated by reference as a part hereof as if set forth at length in this Lease. b. Waiver. The waiver by either party of any term, covenant, or condition herein contained shall not be deemed to be a waiver of such term, covenant or condition or any subsequent breach of the same or any other term, covenant or condition herein contained. The subsequent acceptance of Rent hereunder by Landlord or payment of Rent by Tenant, shall not be deemed to be a waiver of any preceding breach by Tenant or Landlord respectively, of any term, covenant or condition of this Lease, other than the failure of the Tenant to pay the particular rental so accepted, regardless of knowledge of such preceding breach at the time of the acceptance or payment of such rent. 15 c. Notices. All notices, demands, approvals, consents and other communications (collectively "Notices") which may or are to be required or permitted to be given by either party to the other hereunder shall be in writing. All Notices by the Landlord to the Tenant shall be sent by a) United States Mail, certified mail, return receipt requested, postage prepaid, or b) nationally recognized overnight bonded courier, addressed to the Tenant at 5435 Airport Blvd. Suite 100, Boulder, Colorado 80301, or to such other place(s) as Tenant may, from time to time, designate in a notice to the Landlord. For the period beginning on the date Tenant takes possession of the Premises, unless Tenant otherwise gives Landlord notice specifying another address for Notices, all Notices to Tenant shall be addressed to the Tenant at the Premises All notices and demands by the Tenant to the Landlord shall be sent by a) United States Mail, postage prepaid, certified mail, return receipt requested, postage prepaid, or b) nationally recognized overnight bonded courier, addressed to the Landlord at the Office of the Building, or to such other person or place as the Landlord may, from time to time, designate in a notice to the Tenant. d. Joint Obligation. If there were more than one Tenant the obligations hereunder imposed upon Tenants shall be joint and several. e. Marginal Headings. The marginal headings and Section titles to the Sections of this Lease are not a part of this Lease and shall have no effect upon the construction or interpretation of any part hereof. f. Time. Time is of the essence of this Lease and each and all of its provisions in which performance is a factor. g. Successors and Assigns. The covenants and conditions herein contained, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators and assigns of the parties hereto. h. Recordation. Neither the Landlord nor Tenant shall record this Lease. At the request of either party, the other party shall execute and deliver a short form memorandum hereof in substantially the form attached to Lease as Exhibit C, which may be recorded. i. Quiet Possession. So long as Tenant is not in default under this Lease after the expiration of any applicable grace period, Tenant shall have quiet possession of the Premises for the entire term hereof, subject to all the provisions of this Lease. j. Late Charges. Tenant hereby acknowledges that late payment by Tenant to Landlord of rent or other sums due hereunder will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Landlord by terms of any mortgage or trust deed covering the Premises. Accordingly, if any installment of rent or of a sum due and payable from Tenant shall not be received by Landlord or Landlord's designee on or before the date payment is due, and remains unpaid seven (7) days after the date Landlord gives Tenant notice specifying the payment and amount past due, then Tenant shall pay to Landlord a late charge equal to four percent (4%) of such overdue amount. The parties hereby agree that such late charges represent a fair and reasonable estimate of the cost that Landlord will incur by reason of the late payment by Tenant. Acceptance of such late charges by the Landlord shall in no event constitute a waiver of Tenant's default with respect to such overdue amount, nor prevent Landlord from exercising any of the other rights and remedies granted hereunder. k. Prior Agreements. This Lease contains all of the agreements of the parties hereto with respect to any matter covered or mentioned in this Lease, and no prior agreements or understanding pertaining to any such matters shall be effective for any purpose. No provision of this Lease may be amended or added to except by an agreement in writing signed by the parties hereto or their respective successors in interest. This Lease shall not be effective or binding on any party until fully executed by both parties hereto. l. Attorneys' Fees. In the event of any action or proceeding brought by either party against the other under this Lease, the prevailing party shall be entitled to recover all costs and expenses, including the fees of its attorneys in such action or proceeding in such amount as the court may adjudge reasonable as attorneys' fees. 16 m. Sale of Premises by Landlord. In the event of any bona fide sale of the Building, and assignment and transfer of Tenant's Security Deposit to Purchaser, Landlord shall be and is hereby entirely freed and relieved of all liability under any and all of its covenants and obligations contained in or derived from this Lease arising out of any act, occurrence or omission occurring after the consummation of such sale; provided the purchaser, at such sale expressly agrees to assume and carry out any and all of the covenants and obligations of the Landlord under this Lease, and Tenant has been given notice of the sale, together with the name, address and telephone number of the purchaser. n. Subordination, Non-Disturbance and Attornment. Upon request of the Landlord, Tenant will, in writing, subordinate its rights hereunder to the lien of any first mortgage or first deed of trust to any bank, insurance company or other lending institution, now or hereafter in force against the land and Building of which the Premises are a part, and upon any buildings hereafter placed upon the land of which the Premises are a part, and to all advances made or hereafter to be made upon the security thereof. Tenant and Landlord's construction lender, First National Bank of Colorado ("Construction Lender") shall, within thirty days of the date of this Lease, agree upon the form and content of a subordination, non-disturbance and attornment agreement ("SNDA") and take all steps necessary to execute the same. If Tenant and Construction Lender fail to agree upon and execute such SNDA within thirty (30) days of the date of this Lease, then Tenant shall thereafter, but prior to the execution of such SNDA, have the right to terminate this Lease without liability by giving notice of termination to Landlord. In the event any proceedings are brought for foreclosure, or in the event of the exercise of the power of sale under any mortgage or deed of trust made by the Landlord covering the Premises, the Tenant shall attorn to the purchaser upon any such foreclosure or sale and recognize such purchaser as the Landlord under this Lease; provided the purchaser recognizes this Lease and all of the Tenant's rights under this Lease.. Notwithstanding anything to the contrary contained herein, Tenant shall only be obligated under this Section 29(n) if such bank, insurance company or other lending institution or purchaser upon any such foreclosure or sale (a) recognizes Tenant's interest under this Lease, (b) agrees that, so long as Tenant is not in default under this Lease beyond any applicable cure periods, to recognize all of the Tenant's rights under this Lease, not disturb Tenant's possession of the Premises, nor to interfere with Tenant's use of the Building and Common Facilities, nor join Tenant in any foreclosure or other enforcement proceeding, (c) further agrees that despite any subordination of this Lease, the proceeds of insurance and condemnation shall be applied to pay the costs of restoration of the Building and Common Facilities in accordance with this Lease; (d) executes and delivers a subordination, non-disturbance and attornment agreement in a form reasonably acceptable to Tenant and such lending institution or purchaser. o. Name. Tenant shall not use the name of the Building or of the development in which the Building is situated for any purpose other than as an address of the business to be conducted by the Tenant in the Premises. Landlord shall not use Tenant's name for any purpose except to identify the Tenant. p. Separability. Any provision of this Lease which shall prove to be invalid, void or illegal shall in no way affect, impair or invalidate any other provision hereof and such other provisions shall remain in full force and effect. q. Cumulative Remedies. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. r. Choice of Law. This Lease shall be governed by the law of the State of Colorado 17 s. Signs and Auctions. Tenant shall not place any sign upon the exterior of the Premises or Building or conduct any auction thereon without Landlord's prior written consent which shall not be unreasonably withheld, conditioned or delayed. Tenant shall, subject to the prior consent of the Landlord which consent shall not be unreasonably withheld, delayed or conditioned, have the right to: (i) place Tenant's name and suite number in the Building's directory, (ii) place Tenant's name and logo on a sign in the elevator lobby on the 2nd floor, (iii) place Tenant's name and logo (and those of any other authorized occupants) on a sign adjacent to the entrance to the Premises, (iv) place Tenant's name, office hours, telephone numbers and like information on the door to the Premises, and (v) on the exterior monument sign, have Landlord provide Tenant its pro rata share (based on amount of square feet occupied in the Building) of space on all sign fascia and have Landlord provide Tenant with the uppermost space on the area of said sign facia reserved for tenant signage. All of the above signage shall be subject to any approvals required by law, the parties' approval of the content and appearance (which shall not be unreasonably withheld, delayed or conditioned), and with respect to the directory specified in (i), above and the monument sign fascia specified in (v) above, Landlord shall complete the same at Tenant's reasonable expense. Landlord and Tenant agree to work together promptly and in good faith to determine the design, content, and placement of such signage. t. Landlord's Liability. The liabilities of the partners or members of the Landlord pursuant to this Lease shall be limited to the assets of the partnership or limited liability company and the proceeds thereof, and Tenant, its successors and assigns hereby waive all other right to proceed against any of the partners, members, or the officers, shareholders, or directors of any corporate partner of Landlord. The term "Landlord," as used in this Section, shall mean only the owner or owners at the time in question of the fee title or an interest in a ground lease of the building. Notwithstanding anything to the contrary contained herein, the extent of the Landlord's liability under this Lease shall be limited to the property of which the Premises herein are a part, and Tenant shall not seek any personal liability against Landlord or any of Landlord's partners or members except to the extent of the assets of the Landlord and the proceeds thereof. u. Waiver of Jury Trial. Landlord and Tenant waive trial by jury in any action, proceeding or counterclaim brought by either of the parties to this Lease against the other on any matters whatsoever arising out of or in any way connected with this Lease, the relationship of Landlord and Tenant, Tenant's use of occupancy of the Premises, or any other claims (except claims for personal injury or property damage), and any emergency statutory or any other statutory remedy. v. Arbitration. Except for an action to gain possession of the Premises and except as provided below, any and all disputes arising under or related to this Agreement which are not resolved through negotiations between the parties shall be submitted to binding arbitration. If the parties fail to reach a settlement of their dispute within fifteen (15) days after the earliest date upon which one of the parties notified the other(s) of its desire to attempt to resolve the dispute, then the dispute shall promptly be submitted to arbitration by a single arbiter through the Judicial Arbiter Group, any successor of the Judicial Arbiter Group, or any similar arbitration provider (collectively "JAG") provided, however, that the arbitrator provided must be either: (i)a former judge or (ii) an attorney with not less than 15 years of extensive commercial real estate experience. The arbiter shall be selected by JAG or the court on the basis, if possible, of his or her expertise in the subject matter(s) of the dispute. The decision of the arbiter shall be final, nonappealable and binding upon the parties, and it may be entered in any court of competent jurisdiction. The arbitration shall take place in Boulder, Colorado. The arbitrator shall be bound by the law of the State of Colorado applicable to the issues involved in the arbitration and all Colorado rules relating to the admissibility of evidence, including, without limitation, all relevant privileges and the attorney work product doctrine. Discovery shall be limited to document production and four depositions by each party. All such discovery shall be completed within 90 days after the date the arbiter is appointed, and otherwise all such discovery shall be completed in accordance with the time limitations prescribed in the Colorado Rules of Civil Procedure, unless otherwise agreed by the parties or ordered by the arbitrator on the basis of strict necessity adequately demonstrated by the party requesting an extension or reduction of time. The arbitrator shall have the power to grant equitable relief where applicable under Colorado law. The arbitrator shall issue a written opinion setting forth her or his decision and the reasons therefor within thirty (30) days after the arbitration proceeding is concluded. The obligation of the parties to submit any dispute arising under or related to this Agreement to arbitration as provided in this Section shall survive the expiration or earlier termination of this Agreement. Notwithstanding the foregoing, either party may seek and obtain an injunction or other appropriate relief from a court to preserve or protect the status quo with respect to any matter pending conclusion of the arbitration proceeding, but no such application to a court shall in any way be permitted to stay or otherwise impede the progress of the arbitration proceeding. 18 w. Financial Statements. Tenant shall provide their most recent annual report, including statements of income and expense and statements of net worth ("financial statements") within 15 business days following the written request of Landlord. Landlord may request said annual report once during any twelve (12) month period. Said annual report shall be verified as being true and correct and Landlord agrees to keep said annual report confidential, but may use the annual report for purposes of obtaining financing upon the property. At the time Landlord requests annual financial statements from Tenant for financing purposes, Landlord shall advise Tenant to whom the annual report will be submitted and Landlord shall, if requested to do so by Tenant, obtain from such individual or entity a written agreement which shall provide that said annual report will be and shall remain confidential. Within fifteen (15) days after the execution of this Lease, Tenant shall submit to Landlord its most recent financial statements. x. Interest on Past Due Payments. Except as otherwise provided in any section of this Lease, if either party fails to pay any money due and payable to the other party within ten days after the date the party entitled to payment gives notice that the payment is past due; then the amount past due shall earn interest at the rate of two percent (2%) over the prime rate as published by Bank One, Colorado, N.A. or its successor on the date the party entitled to payment gives notice that the payment is past due (the "Prime Rate") per year until paid. 30. BROKERS. Each party severally warrants to the other that it has had no dealings with any real estate brokers or agents in connection with the negotiation of this Lease excepting only The Colorado Group, Inc., Gibbons-White, Incorporated and Staubach Company and it knows of no other real estate broker or agent who is entitled to a commission in connection with this Lease. Landlord shall pay all commissions and other compensation payable to such brokers in accordance with the separate written agreement(s) between Landlord and such brokers. 31. HAZARDOUS MATERIALS AND ENVIRONMENTAL CONSIDERATIONS 31.1 a. Tenant covenants and agrees that Tenant and its agents, employees, contractors, invitees and suppliers shall comply with all Hazardous Materials Laws (as hereinafter defined). Without limiting the foregoing, Tenant covenants and agrees that it will not use, generate, store or dispose of, nor permit the use, generation, storage or disposal of Hazardous Materials (as hereinafter defined) on, under or about the Leased Premises, nor will it transport or permit the transportation of Hazardous Materials to or from the Leased Premises, except in full compliance with any applicable Hazardous Materials Laws. Any Hazardous Materials located on the Leased Premises by or at the request of Tenant shall be handled appropriately, which shall include the use of such equipment (at Tenant's expense) as is necessary to meet any standards imposed by any Hazardous Materials Laws and in such a way as not to interfere with any other tenant's use of its premises. Upon breach of any covenant contained herein, Tenant shall, at Tenant's sole expense, cure such breach by taking all action prescribed by any applicable Hazardous Materials Laws or by any governmental authority with jurisdiction over such matters. b. Tenant shall inform Landlord at any time of (i) any Hazardous Materials it intends to use, generate, handle, store or dispose of, on or about or transport from, the Leased Premises which is not commonly employed in the operation of commercial offices (such commonly employed Hazardous Materials include by way of example only, cleaning fluids, correction fluids, and batteries employed in computers and other office equipment), and (ii) of Tenant's discovery of any event or condition which constitutes a violation of any applicable Hazardous Materials Laws. Tenant shall provide to Landlord copies of all communications to or from any governmental authority or any other party relating to Hazardous Materials affecting the Leased Premises, except any which are subject to any attorney-client or attorney work product privilege. c. Tenant shall indemnify and hold Landlord harmless from any and all claims, judgments, damages, penalties, fines, reasonable costs, liabilities, reasonable expenses or losses (including without limitation, diminution on value of the Premises, damages for loss or restriction on use of all or part of the Premises, sums paid in settlement of claims provided Tenant has approved the settlement which approval shall not be unreasonably withheld, delayed or conditioned, necessary investigation of site conditions created by Tenant, or any cleanup, removal or restoration work required by any federal, state or local governmental agency, attorney's fees, consultant fees and expert fees) which arise as a result of or in connection with any breach of the foregoing covenants or any other violation contained in this Section. The indemnity in this subsection shall also accrue to the benefit of the employees, members, agents, officers, directors and/or partners of Landlord. 19 d. Upon termination of the Lease and/or vacation of the Leased Premises, Tenant shall properly remove all Hazardous Materials placed in the Premises by the Tenant. e. "Hazardous Materials" shall mean (a) any chemical, material, substance or pollutant which poses a hazard to the Premises or to persons on or about the Premises or would cause a violation of or is regulated by any Hazardous Materials Laws, and (b) any chemical, material or substance defined as or included in the definitions of "hazardous substances", "hazardous wastes", "hazardous materials", "extremely hazardous waste", "restricted hazardous waste", "toxic substances", "regulated substances", or words of similar import under any applicable federal, state or local law or under the regulations adopted or publications promulgated pursuant thereto, including, but not limited to, the Comprehensive Environmental Response. Compensation and Liability Act of 1980, as amended, 42 U.S.C. Sec. 9601, et seq.; the Hazardous Materials Transportation Act, as amended, 49 U.S.C. Sec. 1801, et seq.; the Resource Conservation and Recover Act, as amended, 42 U.S.C. Sec. 6901, et seq.; the Solid Waste Disposal Act, 42 U.S.C. Sec. 6991 et seq.; the Federal Water Pollution Control Act, as amended, 33 U.S.C. Sec. 1251, et seq., of the Colorado Revised Statutes. "Hazardous Materials Laws" shall mean any federal, state or local laws, ordinances, rules or regulations (including, but not limited to, those laws specified above) relating to the environment, health and safety or the use, handling, transportation, production, disposal, discharge or storage of Hazardous Materials, or to industrial hygiene or the environmental conditions on, under or about the Premises, the Building or the land on which the Building is located. Said term shall be deemed to include all such laws as are now in effect or as hereafter amended and all other such laws as may hereafter be enacted or adopted during the term of this Lease. f. All obligations of Tenant hereunder shall survive and continue after the expiration of this Lease or its earlier termination for any reason. g. Tenant further covenants and agrees that it shall not install any storage tank (whether above or below the ground) on the Leased Premises without obtaining the prior written consent of the Landlord, which consent may be conditioned upon further requirements imposed by Landlord with respect to, among other things, compliance by Tenant with any applicable laws, rules, regulations or ordinances and safety measures or financial responsibility requirements. 31.2 a. Landlord covenants and agrees that Landlord and its agents, employees, contractors and suppliers shall comply with all Hazardous Materials Laws (as hereinafter defined). Without limiting the foregoing, Landlord covenants and agrees that it will not use, generate, store or dispose of, nor permit the use, generation, storage or disposal of Hazardous Materials (as hereinafter defined) on, under or about the Building, nor will it transport or permit the transportation of Hazardous Materials to or from the Building and land on which the Building is located, except in full compliance with any applicable Hazardous Materials Laws. Any Hazardous Materials located on the Building or adjacent land by or at the request of Landlord shall be handled appropriately, which shall include the use of such equipment (at Landlord's expense) as is necessary to meet any standards imposed by any Hazardous Materials Laws and in such a way as not to interfere with any Tenant's use of the Premises. Upon breach of any covenant contained herein, Landlord shall, at Landlord's sole expense, cure such breach by taking all action prescribed by any applicable Hazardous Materials Laws or by any governmental authority with jurisdiction over such matters. b. Landlord represents and warrants that Landlord has no knowledge and Landlord has no notice of the presence or release of any Hazardous Materials not commonly found in commercial offices, nor of any violation or potential violation of Hazardous Materials Laws on or about the Building or adjacent land, except as disclosed in the Final Report dated October 9, 1998, Phase I Environmental Assessment, Lot 2, Gunbarrel Technical Center, Boulder CO, prepared by Enpro Consulting Group, prepared for Bank One of Boulder. 20 c. Landlord shall inform Tenant at any time of (i) any Hazardous Materials it intends to use, generate, handle, store or dispose of, on or about or transport from, the Building or adjacent land which is not commonly employed in the operation of commercial offices, and (ii) of Landlord's discovery of any event or condition which constitutes a violation of any applicable Hazardous Materials Laws. Landlord shall provide to Tenant copies of all communications to or from any governmental authority or any other person or entity relating to Hazardous Materials affecting the Building or adjacent land, except any which are subject to any attorney-client or attorney work product privilege. d. All obligations of Landlord hereunder shall survive and continue after the expiration of this Lease or its earlier termination for any reason. 32. MISCELLANEOUS a. At Tenant's option, Landlord shall provide janitorial services to the Premises at Tenant's cost on a month-to-month basis, and shall bill Tenant therefor monthly. b. Tenant shall, at Landlord's expense (but only to the extent of the tenant improvement allowance set forth in the following subsection (c)), construct certain build-out improvements to the Premises, including construction of suspended ceilings; exterior and partitioning walls; doors, installation of carpeting; carpet padding, painting; installation of fire sprinkling system; HVAC, and lighting systems; and other improvements as agreed upon in accordance with plans and specifications ("Plans") to be approved by Landlord and Tenant, and attached hereto as Exhibit D (hereinafter collectively referred to as the "Tenant Improvement"). Landlord and Tenant will use diligent efforts to prepare and approve construction drawings and specifications and approve them in writing within twenty-one (21) days after the date of this Lease. If there are no Plans within 45 days after the date of this Lease either party shall have the right to terminate this Lease without liability by giving notice of termination to the other party before there are Plans. Tenant Improvements shall be completed pursuant to the provisions of the Plans and the Work Letter attached hereto as Exhibit E. Landlord's construction of the Building of which the Premises are a part shall be in accordance with Landlord's "Preliminary Specifications for the Base Building", a copy of which is attached hereto as Exhibit F. 1. Upon (i) compliance with the requirements set forth Subsubsection (4 ) of this Subsection (b), and (ii) Landlord's approval of Tenant's selection of contractor, which approval (subject to the criteria set forth below) will not be unreasonably withheld, conditioned or delayed, Tenant shall be permitted by Landlord to contract directly with the contractor of its choice ("Contractor") for completion of the Tenant Improvements and that except for the obligation to remit payment for the cost of such improvements in accordance with the allowance set forth in Subsection (c), below, Landlord shall have no liability whatsoever to Tenant with respect to the completion of said Tenant Improvements. Tenant acknowledges that Landlord's approval of the Contractor to complete the Tenant Improvements shall be granted or withheld based on objective and subjective pertinent criteria, and shall include, among other things, Landlord's opinion regarding the quality of work and workmanship of such Contractor, specifically whether such quality of workmanship meets or exceeds that which is typically performed by Chrisman Construction, Inc. It is acknowledged that it is Landlord's preference that Tenant utilize Chrisman Construction, Inc. for completion of the Tenant Improvements, and Tenant agrees to use reasonable efforts to select Chrisman Construction, Inc. as its Contractor. 2. As of the date hereof, Tenant has identified the following four (4) contractors as candidates for completion of the Tenant Improvements: Chrisman Construction, Inc., Centerre Construction, Sand Construction and Jordy Carter Construction. Within ten (10) business days of execution of this Lease, Landlord shall provide written notice to Tenant of its acceptance or rejection of each of these candidates, which acceptance shall not be unreasonably withheld or conditioned, provided, however, that if, prior to said ten day period (and prior to Tenant's receipt of Landlord's approval or rejection of such four candidates), Tenant provides Landlord with written notice of its selection of one (1) of those contractors, then Landlord shall have three (3) business days thereafter to respond to Tenant with approval or rejection of said selection, which approval shall not be unreasonably withheld or conditioned. If Landlord thereafter rejects said selection, then Landlord shall provide Tenant written notice of its approval or rejection of the remaining three (3) candidates within the remaining portion of the ten (10) business day time period set forth above. If Landlord rejects any contractor, Landlord shall specify in its notice the reasons for such rejection. Landlord represents that as of the date of this Lease, Landlord is unaware of any reason to reject any of the contractors identified by Tenant above, but reserves the right to conduct further investigations regarding such contractors in accordance with the criteria and time frames set forth herein.. Following selection and approval of Tenant's contractor, Tenant shall provide written notice to Landlord confirming its selection. 21 3. If Tenant selects a Contractor which is not Chrisman Construction, Inc. then during the construction of the Tenant Improvements, Tenant agrees to take reasonable steps necessary to facilitate open communication between Landlord and Tenant's consultant Don Fitzmartin ("Consultant") with the intent of keeping Landlord informed as to the status of the Tenant Improvements and any problems encountered in connection therewith. Said open communication includes, but is not limited to: communication with Landlord regarding status of the Tenant Improvements and any problems encountered in connection therewith, availability to answer Landlord's questions regarding all matters related to the Tenant Improvements, and copying Landlord on all material communication between Tenant and Consultant which relates to the Tenant Improvements. 4. Tenant agrees to execute, in a form reasonably acceptable to Landlord's lender, an assignment of the construction contract between it and its Contractor, assigning Tenant's rights under said contract to lender upon the occurrence of any default by the Tenant under this Lease which continues after the applicable grace period expires. c. Landlord's allowance for Tenant Improvements is $539,997.50, and shall be paid directly to Tenant's Contractor in monthly installments within ten (10) days following receipt of (i) an invoice for work performed pursuant to the Plans and (ii) a lien waiver, executed by Contractor, acknowledging payment in full (subject to receipt of Landlord's portion of such sums, if necessary) for work performed pursuant to its contract with Tenant. To the extent that the cost of said improvements is less than or exceeds $539,997.50, basic monthly rental shall increase or decrease by amortizing the increase or decrease over ten (10) years four (4) months at the greater of (a) 10% per annum or (b) two percent (2%) over the interest rate secured by Landlord in financing such amounts, or Tenant has the option of paying up front any amount above and beyond the $539,997.50 allowance, or prepaying any unamortized balance at anytime without premium or penalty. By way of example only, if the cost of Tenant Improvements increase or decrease by $1,000.00, the basic monthly rent will increase or decrease by $13.22. The above amortization of Tenant Improvements by Landlord shall be capped at a total per-square-foot Tenant Improvement cost of thirty five dollars ($35.00), and all amounts spent on Tenant Improvements above that amount shall be paid directly by Tenant at the time such costs are incurred. In other words, Landlord will amortize up to an additional $100,677.50 in Tenant Improvements above the $539,997.50 described in this Subsection (c). If Landlord fails to make any payment to the Tenant's Contractor (towards the Tenant Improvement allowance) which is required by this Lease within ten days after the date Tenant gives Landlord notice specifying the payment past due, then Tenant shall have the right to make the payment which Landlord failed to make and to offset the payment made by the Tenant against the base rent and any other rent payable under this Lease until Tenant has been reimbursed in full for the payments made by the Tenant, together with interest at the rate payable under this Lease for past due payments owed by one party to the other under Section 29(x) above. d. Within one year of the date of completion of construction of the core and shell portions of the Building by Landlord, Tenant shall have the right to later demand and Landlord shall have the obligation to correct, any defects in workmanship or materials of said core and shell portions which could not reasonably be observed by a visual inspection of the exposed improvements at the time Tenant took possession. 22 e. Reasonable HVAC maintenance costs for the Premises shall be charged monthly by Landlord to Tenant as costs are incurred. f. Landlord shall provide an allowance of thirty thousand AND 00/100 ($30,000.00) for the burial of two (2) power poles and related lines located directly to the north of subject property. Tenant at tenant's sole expense shall pay for any cost beyond the allowance of $30,000.00. This payment shall be made within fifteen (15) days after written notice to Tenant after the burial is completed. Before commencing such work, and within 45 days after the date of this Lease, Landlord shall endeavor to provide Tenant with a firm good faith proposal for the work at a fixed or maximum cost. Tenant may reject the proposal by giving Landlord notice within ten days after Tenant receives the proposal, in which event Tenant shall have no right to require the burial. If Tenant elects to require the burial and the entire thirty thousand dollar allowance is not used, then any amounts remaining following such burial shall be allocated to Tenant for further tenant improvement work. If, however, Tenant elects to not bury the power poles described in this Subsection (f), then it is understood that Tenant shall instead receive an additional abatement of rent (in addition to that described in Section 5(a), above) in the amount of Twenty thousand and no/100ths Dollars ($20,000.00), which abatement shall be applied to Tenant's basic rental obligation in the fourteenth (14th) month of this Lease. g. Tenant shall have access to Premises 24 hours per day, seven days per week, 52 weeks per year. h. Tenant shall have the right during the Term hereof to install, operate, and maintain 3 Satellite Dishes on the roof of the Building not exceeding 18 inches in diameter, and one Satellite Dish not exceeding 8 feet in diameter on an agreed to portion of the land on which the Building is located. Tenant covenants that Satellite Dish installation, operation, and maintenance of any Satellite Dish shall be subject to the following: 1. All such installation, maintenance and operation shall be at Tenant's sole cost, expense, and risk. 2. The size, weight and configuration of such Satellite Dish shall be approved by Landlord in advance, such approval not to be unreasonably withheld, delayed or conditioned. 3. All plans and specifications for such installation shall be approved by Landlord in advance, such approval not to be unreasonably withheld, delayed or conditioned. 4. Any damage to the Building roof or any other portion of the Building resulting from the installation, maintenance and operation of any Satellite Dish, including without limitation water damage or damage to the roof membrane, shall be repaired promptly and at Tenant's sole expense. 5. Tenant shall carry additional insurance with respect to any Satellite Dish in reasonably adequate amounts and coverage. 6. Tenant shall maintain any Satellite Dish and all related facilities and equipment in good order and repair, at Tenant's sole expense. 23 7. Tenant shall maintain any Satellite Dish belonging to Tenant and upon the expiration of this Lease or any extension thereof, or in no event later than fifteen (15) days thereafter, the cost and expense of said removal, and any necessary repair of the roof or premises by reason of said Satellite Dish removal shall be borne by the Tenant. The installation, existence, maintenance and operation of any Satellite Dish shall be lawful under all applicable laws, ordinances, rules, orders, regulations, etc., of any federal, state, local or other authorities having jurisdiction, and Tenant, in advance and at its sole expense and in a timely manner, shall obtain all licenses and permits, perform all monitoring, make all reports, and take all other steps necessary to permit the lawful installation and continued lawful operation of the Satellite Dish. i. Tenant shall have the option to extend this Lease for two (2) additional successive terms of five (5) years each. In the event Tenant desires to exercise said option, Tenant shall give written notice of such fact to Landlord not less than two hundred seventy (270) days prior to the expiration of the then current term of this Lease. In the event of such exercise, this Lease Agreement shall be automatically extended for the additional term. Notwithstanding the foregoing, this option shall be void and of no force or effect if the Tenant is in default hereunder after the expiration of the applicable grace period, either as of the date of the Tenant's exercise of said option or as of the date of the commencement of the option or additional term. a. Rent. Tenant shall pay the Fair Market Rental Value of the Premises (as such term is defined below) as base rent during the first five year option period. Tenant shall pay the then-current Fair Market Rental Value of the Premises as base rent during the second five year option period. b. Calculation of Fair Market Rental Value. Landlord and Tenant will attempt to agree upon a Fair Market Rental Value of the Premises (expressed on a dollar per square foot per year basis) as determined by comparison to parcels of similar size located in property in or near the City of Boulder, Colorado, having comparable development, use and density capability, containing existing buildings of comparable quality and such other characteristics as may be deemed relevant by a subject appraiser whose selection is outlined herein (the "Fair Market Rental Value"). Landlord shall select an independent MAI real estate appraiser with at least ten (10) years' experience in appraising commercial real property in the City of Boulder, Colorado (a "Qualified Appraiser"). The Qualified Appraiser selected by the Landlord shall be referred to as the "Landlords Appraiser". Within thirty (30) days of being selected by the Landlord, the Landlord's appraiser shall determine the Fair Market Rental Value of the Premises in accordance with the appraisal standards set forth above and shall immediately give the Landlord and the Tenant written notification of his determination. If the Tenant agrees with the Landlord's Appraiser's determination of the Fair Market Rental Value, such Fair Market Rental Value shall be multiplied by 18,305, and the resultant amount shall be divided by twelve (12) to arrive at the new base monthly rental ("Base Monthly Rental"). The new Base Monthly Rental shall become effective beginning with the first month of the Option Term. If the Tenant does not agree with the Landlord's Appraiser's determination of Fair Market Rental Value, the Tenant shall have the right to select its own Qualified Appraiser to determine the Fair Market Rental Value. If the Tenant does elect to appoint a Qualified Appraiser, (the Tenant's Appraiser"), the Tenant shall select the Tenant's Appraiser within thirty (30) business days after receiving the Landlord's Appraiser's Determination of Fair Market Rental Value. The Tenant's Appraiser shall make his own determination of the Fair Market Rental Value in accordance with the provisions set forth above, within thirty (30) business days of being selected by the Tenant and shall immediately give the Landlord and the Tenant written notice of his determination. 24 If the Fair Market Rental Value as determined by the Landlord's Appraiser and the Tenant's Appraiser, respectively, differ by an amount which is equal to or less than five percent (5%) of the Fair Market Rental Value determined by the Landlord's Appraiser, then the arithmetic mean average of the two Fair Market Rental Values shall constitute the fair Market Rental Value used to calculate the new Base Monthly Rental which will be in effect for the Option Term. If the Fair Market Rental Value determined by the Landlord's Appraiser and the Tenant's Appraiser's determination of the Fair Market Rental Value differ by more than five percent (5%), the Landlord's Appraiser and the Tenant's Appraiser shall agree upon and select a third Qualified appraiser who shall be independent of and have no prior or existing affiliation or relationship with either the Landlord or the Tenant (the "Independent Appraiser"). If Landlord's Appraiser and Tenant's Appraiser fail to agree upon and select an Independent Appraiser within ten (10) days of the decision to seek an Independent Appraiser, then said Independent Appraiser shall be selected by the agreement of Landlord's legal counsel and Tenant's legal counsel. Within ten (10) business days of being appointed, the Independent Appraiser shall, after exercising his best professional judgement, choose either the Landlord's Appraiser's or the Tenant's Appraiser's determination of the Fair Market Rental Value whichever best represents the Fair Market Rental Value at that point in time. Upon making such a selection, the Independent Appraiser shall immediately give the Landlord and the Tenant written notice of this selection of the Fair Market Rental Value. The Fair Market Rental Value selected by the Independent Appraiser shall be used to calculate the new Base Monthly Rental which will be in effect during the Extension Option, and such selection by the Independent appraiser shall be binding and conclusive upon the Landlord and the Tenant. All Appraisal fees incurred hereunder shall be shared equally by the Landlord and Tenant. j. Tenant shall have the right to use its own Architect for the Plans and Tenant Improvements upon Landlord's approval of the architect which approval shall not be unreasonably withheld, delayed or conditioned. The Landlord hereby approves B2SJ. All architectural fees will be paid from the Tenant Improvement Allowance. Tenant's architect shall coordinate with Landlord's architect for review of documents and submittal of construction documents to the City of Boulder. Landlord's architect shall not incur expenses that will exceed $1,000 in coordinating with Tenant's architect for review of documents and submittal of construction documents to the City of Boulder. However, if Landlord's architect finds an error in Tenant's plans that shall result in additional work on behalf of Landlord's architect, then Tenant could incur incremental costs associated with rectifying such errors. k. Tenant shall be provided its pro rata share of the existing monument signage and Tenant's design shall be approved in writing by Landlord, which approval shall not be unreasonably withheld, delayed or conditioned. l. Whenever the consent or approval of either party is required under this Lease, such consent or approval shall be deemed given unless within 20 days after the consent or approval is requested, notice is given specifying reasonable reasons why consent or approval is denied; provided the text of this Section is included in the request for consent or approval. m. Landlord shall not alter, improve or add to the Building or the land on which the Building is located in any manner which will materially adversely affect the Tenant's authorized use of the Premises, access to or from the Premises, the Common Facilities existing as of the date of this Lease or the parking granted to the Tenant under this Lease. n. Landlord represents and warrants that on the date the Lease term commences the mechanical systems in the Building and Premises, including without limitation intended, HVAC, plumbing and electrical systems are in good working order, and the structure of the Building including the roof is in good condition and free from leaks. o. Landlord warrants and represents that so long as the amount of computer equipment, machinery and other related office equipment used in the Premises is not in excess of the amount of equipment utilized in a typical administrative office and, provided that adequate measures are taken by Tenant to address additional cooling needs that may be necessary for Tenant's computer equipment and server rooms within the Premises, the HVAC for the Building has and will have sufficient capacity to maintain 70 degrees Fahrenheit when the outside temperature is higher than 70 degrees Fahrenheit and will be able to maintain 72 degrees Fahrenheit when the outside temperature is less than 72 degrees Fahrenheit. 25 p. Landlord shall maintain in good condition and repair, the two venting systems currently in place under the Building, which were designed to remove or reduce any risk to occupants of the Building which could be caused if vapors were to migrate from the soil. The venting system located in the air space between the top of the plastic sheeting over the gravel and the first floor concrete is and shall remain in operation throughout the term of this Lease, except for any period of time that its operation is unwarranted in the opinion of a duly qualified expert. The second venting system beneath the plastic sheeting and gravel shall be connected to a vacuum blower and commence and remain in operation, during such period of time as its operation is warranted in the opinion of a duly qualified expert. Landlord shall, at such times as is warranted in the opinion of a duly qualified expert, engage a duly qualified expert to: (i) monitor the air beneath the first floor concrete; (ii) recommend any change in the operation of the venting systems or other action which is appropriate; and (iii) summarize in writing, his or her findings, conclusions and recommendations. Further, Landlord shall promptly take any action which the Landlord's duly qualified expert opines is warranted. 26 IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the date first written above. LANDLORD: TENANT: NORTHVIEW PROPERTIES, LLC NEW FRONTIER MEDIA, INC. 3434 47th Street #220 5435 Airport Blvd. Suite 100 Boulder, CO 80301 Boulder, CO 80301 Tax I.D. #84-1474385 By:/s/ Susan Chrisman By: /s/ Michael Weiner .............................. ........................ Susan J. Chrisman Its: Exec. VP. Manager ........................ By:/s/ Scott Reichenberg .............................. William Scott Reichenberg Manager 27 EXHIBIT A DIAGRAM OF THE PREMISES [ATTACHED] 28 EXHIBIT A-1 Site Plan [to be attached] 29 EXHIBIT B RULES AND REGULATIONS 1. Except within the Premises, or as authorized in the Lease, no sign, picture, name, notice or other object shall be displayed or affixed on any part of the Premises (including all common areas) which is visible from outside the Premises without the prior written consent of the Landlord, which consent shall not be unreasonably withheld, delayed or conditioned. If placed outside the Premises without authorization in the Lease or the consent of the Landlord, Landlord shall have the right to remove any such object without notice and at the expense of Tenant. 2. Landlord shall provide a pro rata share of parking spaces to Tenant. Tenant, its employees and invitees shall not use parking spaces in the Premises assigned to another tenant, if Tenant is given exclusive use of the number of spaces provided for in the Lease. 3. Sidewalks, corridors, lobbies and stairways in the Premises shall not be used for storage or be obstructed by bicycles or any other objects. Except for entry related to the improvements and equipment Tenant is authorized to install, maintain, repair or replace and only then upon prior oral or written notice to Landlord, Tenant shall not go upon the roof of the Premises or into any mechanical system. 4. Tenant shall not alter any lock nor install any new or additional locks on any door of the Premises without written consent of Landlord, which consent shall not be unreasonably withheld, delayed or conditioned. 5. Toilets, urinal and wash bowls shall not be used for any purpose other than that for which they were constructed and no foreign substance of any kind shall be thrown therein. 6. Tenant shall not overload the floor of the Premises. Except for work or alterations which Landlord consents to or which Tenant is authorized to make without consent pursuant to the Lease, Tenant shall not mark, glue, drive nails, screw, cut or drill into the partitions, woodwork, walls, ceilings, floors, or doors or in any way deface the Premises. 7. No furniture, freight or equipment of any kind shall be brought into the Premises without the consent of Landlord, which consent shall not be unreasonably withheld, delayed or conditioned, and all moving shall be done at such times and in such manner as Landlord may reasonably designate, so as not to interfere with other tenants. There shall not be used in any space, or in any public hall: any hand trucks except those equipped with rubber tires and side guards. Despite the foregoing, during all business hours, Tenant shall have the right to deliveries of furniture, freight, merchandise and equipment which during any two (2) hour period, do not consume more than two (2) elevator carloads. 8. Tenant shall not permit the Premises to be used in a manner offensive to Landlord or other occupants of the Premises by reason of unreasonable noise, odors or vibrations, or unreasonably interfere in any way with other tenants. Tenant shall not discard anything outside of its entrance door or in corridors, lobbies or other common areas unless safely stored in non-combustible containers. 9. Tenant shall not keep in the Premises any combustible fluid or material, except in customary small quantities as would typically be kept in connection with the conduct of an administrative office. 10. Landlord will direct electricians as to where and how telephone and electrical wires are to be introduced outside the Premises. No boring or cutting of wires will be allowed in the Premises without the consent of Landlord, which consent shall not be unreasonably withheld, conditioned or delayed. Any boring or cutting associated with such electrical or telephone work and conducted within the Premises which is not subject to Landlord's consent per the Lease shall be conducted at such times and in such a manner as to not interfere with any other tenant's ability to conduct its business. 30 11. Except as set forth above, no furniture or merchandise will be received in the Premises or carried up or down in the elevators except between such hours and in such elevators as shall be designated by Landlord which designation shall not be unreasonable. Despite the foregoing, during all business hours, Tenant shall have the right to deliveries made in the ordinary course of business, such as deliveries of merchandise in packages carried by United Parcel Service drivers or on their rubber wheeled hand trucks; provided, however, that Landlord may restrict deliveries which are not carried by an individual to a freight elevator (provided that a freight elevator is in operation in the Building). Tenant shall cause its movers to use only the loading facilities and elevator designated by Landlord. Tenant shall obtain Landlord's prior approval of moving time, which approval shall not be unreasonably withheld, conditioned or delayed. In the event Tenant's movers damage any part of the Premises, Tenant shall immediately pay to Landlord the amount required to repair damage. 12. Tenant shall see that the doors of the Premises are closed and locked before leaving the Premises and must observe strict care and caution that all water faucets or water apparatus (except water heaters) are entirely shut off. 13. Tenant shall not solicit any occupant of the Premises and shall cooperate to prevent same. 14. No window shades, blinds, screens or draperies will be attached or detached by Tenant without Landlord's prior consent, which consent shall not be unreasonably withheld, delayed or conditioned. Tenant agrees to abide by Landlord's reasonable rules with respect to maintaining uniform curtains, draperies and linings at all windows so that the Premises will present a uniform exterior appearance. The blinds shall be of a light color. 15. Tenant shall furnish chair pads under all chairs or stools in the carpeted areas of the Premises. 16. Landlord shall at all reasonable times on reasonable notice have the right to inspect the Premises. 31 EXHIBIT C Recording requested by and when recorded return to: Chrisman, Bynum & Johnson, P.C. attn: Gretchen Miller Busch, Esq. 1900 Fifteenth Street Boulder, CO 80302 _______________________________________________________________________________ MEMORANDUM OF LEASE THIS MEMORANDUM OF LEASE is made and entered into as of April 11, 2001 by and between NORTHVIEW PROPERTIES, LLC, a Colorado limited liability company ("Landlord") and NEW FRONTIER MEDIA, INC, a Colorado corporation ("Tenant"). Pursuant to the unrecorded Lease, dated April 11, 2001, between Landlord and Tenant (the "Lease"), Landlord has let and hereby leases to Tenant and Tenant has leased and hereby leases from Landlord upon all of the terms set forth in the Lease certain improved real property located in the County of Boulder, State of Colorado, described as follows: Certain office space containing approximately 18,305 square feet on the second floor of the building known as the Northview Building, 7007 Winchester Circle, Boulder, Colorado 80301, and having a legal description of: Lot 2, Gunbarrel Technical Center, Replat, County of Boulder, State of Colorado, together with all fixtures and other improvements now or hereafter located thereon and all appurtenances thereto. The term of the Lease agreement commenced on April 11, 2001 and continues for a period of one hundred and twenty four (124) months from that date, subject to certain adjustments as set forth in the Lease, and contains an option for Tenant to extend the Lease for two (2) additional successive terms of five (5) years each. This Memorandum is subject to the terms, provisions and conditions of the unrecorded Lease, as heretofore amended and as amended by any amendments made after this date. IN WITNESS WHEREOF, Landlord and Tenant have executed this Memorandum of Lease as of the date first written above. LANDLORD: NORTHVIEW PROPERTIES, LLC A Colorado limited liability company By: /s/ Scott Reichenberg .............................. Name: William Scott Reichenberg Its: Manager By: /s/ Susan Chrisman .............................. Name: Susan J. Chrisman Its: Manager 32 TENANT: NEW FRONTIER MEDIA, INC. A Colorado corporation By: /s/ Michael Weiner .......................... Name: Its: 33 EXHIBIT D PLANS [TO BE AGREED UPON FOLLOWING EXECUTION OF THE LEASE, INITIALED BY BOTH PARTIES, AND ATTACHED HERETO] 34 EXHIBIT E WORK LETTER Description of Landlord's Work for the NORTHVIEW Building lease by and between Northivew Properties, LLC ("Landlord") and New Frontier Media, Inc., a Corporation ("Tenant"): Landlord and Tenant agree as follows: 1. Defined Terms. The following defined terms shall have the meaning set forth below and, unless provided to the contrary herein, the remaining defined terms shall have the meaning set forth in the Lease: Landlord's Representative: Susan J. Chrisman or W. Scott Reichenberg Tenant's Representative: Don Fitzmartin Landlord's Contribution: The lesser of (a) $539,997.50 (i.e. approximately $29.50 for each rentable square foot of space in the Premises) or (b) the actual cost of Tenant Improvements, as defined below. Tenant's General Contractor: To be determined. 2. Tenant Improvements. The "Tenant Improvements" shall mean the drywall for exterior walls, window sills, interior walls, partitions, doors, door hardware, wall coverings, wall base, counters, lighting fixtures, electrical and telephone wiring, cabling for computers, metering and outlets, suspended ceilings, floor and window coverings, HVAC system, fire sprinklers system, other items of general applicability that Tenant desires to be installed in the interior of the Premises in accordance with plans and specifications approved by Landlord and Tenant. 3. Drawings. Tenant shall engage and Landlord shall pay for the services of a licensed architect and engineers to prepare a space layout, drawings and specifications for all Tenant Improvements (the "Architect"). Tenant shall devote such time in consultation with the Architect as shall be necessary to enable the Architect to develop complete and detailed architectural, mechanical and engineering drawings and specifications, as necessary, for the construction of Tenant Improvements, showing thereon all Tenant Improvements substantially in accordance with the space plan to be approved by the parties (the "Drawings" and also referred to in the Lease as the "Plans") which approval shall not be unreasonably withheld, conditioned or delayed. Landlord and Tenant hereby acknowledge and agree that it is Landlord's sole and exclusive responsibility to cause the Premises and the Drawings to comply with all applicable laws, including the Americans with Disabilities Act and other ordinances, orders, rules, regulations and requirements of all governmental authorities having jurisdiction thereof. All architectural and engineering fees shall be included as a Tenant Improvement cost. 4. Landlord's Approval. On or before the applicable Time Limit set forth below, Tenant shall submit to Landlord complete and final Drawings for Tenant Improvements in the form of two sets of Drawings. The Drawings shall be subject to the approval of Landlord, which approval shall not be unreasonably withheld or conditioned. If Landlord should disapprove such Drawings, Landlord shall specify to Tenant the reasons for its disapproval and Tenant shall cause the same to be revised to meet Landlord and Tenant's mutually reasonable satisfaction and shall resubmit the same to Landlord, as so revised, on or before the applicable Time Limit set forth below. 5. Landlord's Work. It is understood and agreed by the parties that, as hereinafter set forth, Tenant has elected to retain the General Contractor and arrange for the construction and installation of Tenant Improvements in a good and workmanlike manner. If the total costs exceed Landlord's Contribution ("Excess Costs"), Tenant must provide to Landlord, adequate assurance that Tenant has the financial resources to pay for such Excess Costs if Tenant has elected to pay for such costs in lieu of amortizing them over the term of the Lease, as set forth in Section 32(c). 35 6. Time Limits. The following maximum time limits and periods shall be allowed for the indicated matters:
- --------------------------------------------------- ------------------------------------------------ ACTION TIME LIMIT - --------------------------------------------------- ------------------------------------------------ Tenant submits Drawings, prepared by On or before twenty one (21) days after date Architect, to Landlord for review and of this Lease Approval - --------------------------------------------------- ------------------------------------------------ Landlord notifies Tenant of its approval On or before two (2) business of the Drawings with any required changes in after the date of Landlord's receipt of the detail Drawings - --------------------------------------------------- ------------------------------------------------ Tenant submits revised drawings to Landlord On or before five (5) business days after the for approval date of reciept of Landlord's required changes - --------------------------------------------------- ------------------------------------------------ If applicable, Landlord and Tenant mutually On or before two (2) business days after the approve the final revised Drawings date of Landlord's receipt of the final revised Drawings - --------------------------------------------------- ------------------------------------------------ Landlord submits Drawings for building permit As soon as reasonably possible after Landlord and Tenant mutually approve the final revised Drawings, but in no event later than thirty (30) days after execution of the Lease. - --------------------------------------------------- ------------------------------------------------
Except as may be otherwise specifically provided for herein, in all instances where either Tenant's or Landlord's approval is required, if no written notice of disapproval is given within the applicable Time Limit, at the end of such period the applicable party shall be deemed to have given its approval and the next succeeding time period shall commence. Any delay in any of the foregoing dates (including any "re-do," continuation or abatement of any item due to Tenant's or Landlord's disapproval thereof) shall automatically delay all subsequent deadlines by a like amount of time. 7. Landlord's Contribution. Landlord shall contribute to the costs and expenses of all costs for the planning and design of Tenant Improvements, including all permits, licenses and construction fees and constructing Tenant Improvements in an amount not to exceed Landlord's Contribution ($539,997.50, as set forth in Section 32(c) of the Lease) unless Tenant elects to have Landlord pay all Tenant Improvement Costs and amortize the amount in excess (up to the maximum amount set forth in Section 32(c) of the Lease) of Landlord's Contribution over the term of the Lease. If the final costs for Tenant Improvements exceed Landlord's Contribution and Tenant has not elected to amortize such costs, those Excess Costs shall be paid by Tenant and shall be paid to Landlord or Contractor promptly upon submission of a statement therefor by Landlord or Contractor. 8. Substantial Completion. Tenant Improvements shall be deemed "Substantially Complete" when all work called for by the Drawings has been finished and the Premises is ready to be used and occupied by Tenant, even though minor items may remain to be installed, finished or corrected. The date Tenant Improvements is substantially complete shall be deemed the "Substantial Completion Date" or the "Date of Substantial Completion." Tenant shall cause the Contractor to diligently complete any items of work not completed when the Premises are substantially complete. In the event of any dispute as to substantial completion of Tenant Improvements, the statement of the Architect, objectively and reasonably based, shall be conclusive. Substantial Completion shall have occurred notwithstanding punch list items. 36 9. Changes. Tenant may request reasonable changes in the Drawings; provided, however, that (a) no change shall be made to the Drawings without Landlord's Representative's prior written approval, which approval shall not be unreasonably withheld, conditioned or delayed; (b) no such request shall effect any structural change in the Building or otherwise render the Premises or Building in violation of applicable laws; (c) Tenant shall pay any additional costs required to implement such change, including, without limitation, loss of rents, architecture and other consultant fees, increases in construction costs and other charges payable caused to the extent total costs exceed Landlord's Contribution; and (d) such requests shall constitute an agreement by Tenant to any delay in completion caused by Landlord's reviewing, and processing such change. If Tenant requests or causes any change, addition or deletion to the Premises to be necessary after approval of the Drawings, a request for the change shall be submitted to Landlord's Representative, accompanied by revised plans prepared by the Architect, all at Tenant's sole expense. Tenant acknowledges that neither the Architect nor any contractor engaged by Tenant is Landlord's agent and neither entity has authority to enter into agreements on Landlord's behalf or otherwise bind Landlord. 10. Tenant's Representative. Tenant has designated Tenant's Representative as its sole representative with respect to the matters set forth in this Work Letter, who shall have full authority and responsibility to act on behalf of Tenant as required in this Work Letter. Tenant shall not change Tenant's Representative except upon prior written notice to Landlord. 11. Landlord's Representative. Landlord has designated Landlord's Representative as its sole representative with respect to the matters set forth in this Work Letter, who shall have full authority and responsibility to act on behalf of Landlord as required in this Work Letter. Landlord shall not change Landlord's Representative except upon notice to Tenant. 12. No Representations or Warranties. Notwithstanding anything to the contrary contained in the Lease or herein, Landlord's participation in the preparation of the Drawings, the cost estimates for Tenant Improvements and the construction of Tenant Improvements shall not constitute any representation or warranty, express or implied, that (i) the Drawings are in conformity with applicable governmental codes, regulations or rules or (ii) Tenant Improvements, if built in accordance with the Drawings, will be suitable for Tenant's intended purpose; provided, however, Landlord shall nonetheless have the obligation to fully comply with the provisions of Section 3 hereof. Tenant acknowledges and agrees that Tenant Improvements are intended for use by Tenant and the specification and design requirements for such improvements are not within the special knowledge or experience of Landlord. Landlord's obligations shall be to review the Drawings; and any additional cost or expense required for the modification thereof to more adequately meet Tenant's use, whether during or after construction thereof, shall be borne entirely by Tenant. 13. Incorporation. This Work Letter is incorporated in the Lease; and all of the terms and provisions of the Lease are incorporated herein by this reference. All capitalized terms used herein and not otherwise defined shall utilize the definitions set forth in the Lease. 37 EXHIBIT F PRELIMINARY SPECIFICATIONS FOR THE BASE BUILDING Scope of Work Definition Base Building vs. Tenant Improvement Work
- ---------------- ---------------------------------------- ------------------------------------------ ITEM BASE BUILDING TENANT IMPROVEMENTS - ---------------- ---------------------------------------- ------------------------------------------ - ---------------- ---------------------------------------- ------------------------------------------ Sitework a. Provide asphalt paving, sidewalks, a. No requirement. curb and gutters per development plan. - ---------------- ---------------------------------------- ------------------------------------------ The site will accommodate a parking ratio of 1 person/400 SF. - ---------------- ---------------------------------------- --------------------------------- b. Provide landscape material and b. No requirement. irrigation system per development plan. - ---------------- ---------------------------------------- --------------------------------- c. Furnish and install concrete pad c. No requirement. for trash dumpster. - ---------------- ---------------------------------------- --------------------------------- STRUCTURE a. Concrete floor over steel frame a. Misc. floor prep as required. finished per ACI spec and UBC code requirements. - ---------------- ---------------------------------------- --------------------------------- b. Supported floor live load capacity b. No requirement. of 125 pounds per square foot at firs floor and 100 pounds per square foot at second floor. - ---------------- ---------------------------------------- --------------------------------- c. Clear ceiling height for first floorof c. No requirement. 9'-8". Clear height to structure 13'-2". Clear ceiling height for second floor of 9'-0". Minimum clear height to structure is 10'-0". - ---------------- ---------------------------------------- --------------------------------- d. Building shell shall meet ADA code d. Norequirement. requirements. - ---------------- ---------------------------------------- --------------------------------- e. Leveling, patching and floating of e. No requirement. all floors within the Premises shall be reasonably acceptable (level to 1/4" within 10ft.). Variances which so not impair the tenant's ability to improve the Premises, install it's furnishings, fixtures or equipment, or use and enjoy the Premises shall be deemed acceptable. - ---------------- ---------------------------------------- --------------------------------- f. Fire proofing over frame per code f. No requirement. requirements. - ---------------- ---------------------------------------- --------------------------------- g. Not Used g. Not Used - ---------------- ---------------------------------------- --------------------------------- h. Provide return air plenums on all h. No requirement. floors complete with code required fireproofing. - ---------------- ---------------------------------------- --------------------------------- i. All pipe sleeves in beams or walls i. No requirement. shall be packed tight and fire proofed per code requirement. - ---------------- ---------------------------------------- --------------------------------- CORE SERVICE h. Janitor's closets complete. a. No requirement. AREAS - ---------------- ---------------------------------------- --------------------------------- b. Doors finished including doors for b. No requirement mechanical, electrical, telephone, and janitor's closet in addition to stairwells. - ---------------- ---------------------------------------- ---------------------------------
38
- --------------- ---------------------------------------- --------------------------------- c. Sound attenuation consistent a. No requirement. around core to provide a level of STC45 and other specified areas. - ---------------- ---------------------------------------- --------------------------------- d. Locking devices for all closets, d. No requirement. exits, stairwells, and electrical/telephone doors. - ---------------- ---------------------------------------- --------------------------------- e. One drinking fountain per floor e. No requirement. that meet ADA code. - ---------------- ---------------------------------------- --------------------------------- f. Floors finished with carpet, tile, f. Flooring at tenant space. granite or other approved materials. - ---------------- ---------------------------------------- --------------------------------- g. Exit signs at core and stairwells g. No requirement. including battery pack emergency lighting as required by code. - ---------------- ---------------------------------------- --------------------------------- h. Convenience outlets evenly h. No requirement. distributed throughout the core areas. - ---------------- ---------------------------------------- --------------------------------- BUILDING LOBBY a. Finished in accordance with a. No requirements. Building's plans and specifications complete with directory board - ---------------- ---------------------------------------- --------------------------------- TELEPHONE a. Furnish and install a Telephone a. No requirement. Company frame room in the first floor of the building in addition to phone closets on every floor. The main telephone service shall be stubbed to the telephone company frame room and3/4"x4'x8' plywood - ---------------- ---------------------------------------- -------------------------------- BASE BUILDING a. Furnish and install ceramic tile a. No requirement. REST ROOMS on floor and walls. - ---------------- ---------------------------------------- --------------------------------- b. Furnish plastic laminate vanity b. No requirement. with drop in porcelain lavatories with full width mirror. - ---------------- ---------------------------------------- --------------------------------- c. Furnish and install baked enamel, c. No requirement. floor-mounted toilet partitions. - ---------------- ---------------------------------------- --------------------------------- d. Furnish and install floor-mount d. No requirement. tank-type water closets and wall-hung urinals. - ---------------- ---------------------------------------- --------------------------------- e. Fully ADA compliant restrooms. e. No requirement. - ---------------- ---------------------------------------- --------------------------------- f. Accessories: Mirrors, soap f. No requirement. dispensers, grab bars, sanitary napkin vendor, and disposal, toilet tissue dispensers, towel dispenser and waste receptacle. - ---------------- --------------------------------------- --------------------------------- SHOWER a. Provide a minimum two (2) public a. No requirement. FACILITIES shower stalls with dressing areas divided equally between men and women, located near or adjacent to restrooms. - ---------------- --------------------------------------- ---------------------------------
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- ---------------- --------------------------------------- --------------------------------- Perimeter Walls a. Construct gypsum board walls a.Apply paint/wall covering andbase. below sills and at perimeter columns, taped and sanded smooth. (Work to be completed during Tenant build-out.) b. Insulation in roof and walls to meet local energy codes b. No requirement. c. Exterior windows shall be energy efficient tinted glazing. c. No requirement. - ---------------- --------------------------------------- --------------------------------- INTERIOR COLUMNS a. No requirement. a. Furnish and install gypsum board to columns. Tape and sand smooth. Apply paint/wall covering and base. - ---------------- --------------------------------------- --------------------------------- ELEVATORS a. Elevator cab shall have a minimum a. No requirement. 7'-9" interior clearance and carry a minimum 4,500 lb. Capacity. Elevators shall meet current building and ADA code requirements with wiring for an emergency telephone. - ---------------- --------------------------------------- --------------------------------- b. Elevator machine room shall have b. No requirement. an exhaust fan installed to dissipate excessive heat during elevator operation. - ---------------- --------------------------------------- --------------------------------- CEILINGS a. Furnish and install acoustical a. Provide ceiling system as required by ceiling grid throughout Core area. tenant space plan. - ---------------- --------------------------------------- --------------------------------- b. Not Used b. Not Used - ---------------- --------------------------------------- --------------------------------- FLOOR COVERING a. Provide concrete sub-floor. a. Furnish and install floor coverings for all areas except required common area corridors. - ---------------- --------------------------------------- ---------------------------------- DOORS, FRAMES & a. Furnish and install natural a. Furnish, install and finish doors, HARDWARE finished flush birch doors in frames and hardware as required by hollow metal frames at core tenant's space plan. building areas and exits. - ---------------- --------------------------------------- ---------------------------------- b. Not Used b. No Used - ---------------- --------------------------------------- ---------------------------------- c. Furnish brushed aluminum finish on c. No requirement. all base building exterior door hardware. - ---------------- --------------------------------------- ---------------------------------- d. Not Used d. Not Used - ---------------- --------------------------------------- ---------------------------------- HVAC a. Furnish and install base a. Furnish and install separate air building heating and cooling conditioning or air handling units system. for non-standard loads (.i.e., computer room, UPS, etc.). Cooling ratio: min. 400 sq.ft./ton. Exterior Zones: 1 per 1,200 sq. ft. Interior Zones: 1 per 2,000 sq. ft. VVT System Natural Gas Heating Capacity at RTU's: 20.9 BTU per hour - sq. ft. Cooling Load Allowances on a zone basis:
40
o Lighting: 2.0 watts per sq. ft. o Office Equipment: 1.5 watts per sq. ft. o People: 150 sq. ft. per person (The electric and natural gas heating capacity values are not additive. The natural gas in the rooftop units will be utilized for heating outdoor air for b. No requirement. ventilation during occupied hours, and for hybrid heating during unoccupied hours.) b. Furnish and install primary trunk ducts per SMACNA Duct c. Furnish and install secondary Construction Standards from air ductwork and VVT boxes. Furnish and handlers to vicinity of each install runouts, diffusers and RA tenant space. grilles. Provide modifications as c. Furnish and install code required by tenant's space plan. required fire dampers. d. Provide additional modifications as required by tenant's space plan. d. Furnish and install base building energy management system with DDC temperature control system connections to terminal devices. The control system will e. Install exhaust systems for provide the capability to monitor conference rooms, etc. desired by each Zone and provide for tenant. off-hour HVAC. e. Provide exhaust systems for base building space as required, i.e., common area restrooms and janitor's closets. Each toilet room shall be ventilated to 2 CFM/SF. - ---------------- --------------------------------------- ----------------------------------- Plumbing a. Furnish rough-ins at core a. No requirement service areas. b. Furnish underground sanitary b Furnish and install convenience capped connections for tenant use sinks, water supply coffee/vending to at tenant locations. areas, etc. - ---------------- --------------------------------------- ----------------------------------- FIRE PROTECTION a. Furnish and install complete fire a. Relocate or add sprinkler for proper SPRINKLER SYSTEM protection system per NFPA coverage as dictated by the tenant's requirements for office occupancy. space plan. - ---------------- --------------------------------------- ----------------------------------- ELECTRICAL a. Furnish and install complete a. No requirement. 277, 3-phase building power distribution system. o 6.9 watts per sq. ft. allocated for HVAC loads. o 3 watts per sq. ft. allocated for interior lighting.
41
o 9.8 watts per sq. ft. spare power. b. Furnish 220 volt power and b. Lighting circuits distributed lighting panel in each electrical from central panel to tenant fixtures room. c. Provide 2x4 parabolic fixtures. c. Furnish and install fixtures as as per core plans. required by tenant's space plan. Fluorescent fixtures are to be 2'x4' 4" deep cell parabolic. Fixture and install connection to J-Box, switching and accent lighting. d. Furnish and install lighting d. No requirement. in base building rooms. e. Furnish and install step down e. Furnish and install branch circuits for transformers and 120/208V panels 120V power to tenant spaces from and 3 electrical rooms, size to electrical roms, Furnish and provide 7 watts per square foot install convenience outlets as for office equipment loads and desired along with any additional conveniencepower. distribution panels or step down transformers f. Furnish and install code f. Furnish and install code required exit and emergency required exit and emergency lighting for all public areas. lighting for all public areas. g. Service from provider panel e. Furnish and install phone board, in main telephone room. vertical and horizontal distribution from service entry by tenant h. Furnish and install fire alarm h. Fire alarm provisions, if any, in system as required by code, including addition to code requirements hornand strobe devices. i. Furnish and install exterior site i. No Requirement lighting. j. Not Used j. Not Used - ---------------- --------------------------------------- ----------------------------------- SIGNAGE a Furnish and install general a. Furnish and install identification identification/directional signage at tenant entrances. signage at public toilet rooms and exits. b.Furnish and install a building b. No requirement. directory in the main lobby. c.Furnish and install exterior c. No requirement. monument signage for building identification, ground level only. - ---------------- --------------------------------------- ----------------------------------- FIRE a. No requirement. a. urnish and install fire EXTINQUISHERS extinguishers and cabinets as required by the tenant's space plan. - ---------------- --------------------------------------- ----------------------------------- WINDOW BLINDS a. No requirement. a. Furnish and install standard horizontal mini-blinds on all exterior windows. - ---------------- --------------------------------------- ----------------------------------- SERVICE AREAS a. Provide a 48" high dock with a. No requirement. bumper guards. b. Provide a trash enclosure on b. No requirement. concrete pad. - ---------------- --------------------------------------- ----------------------------------- Security a. Not Used a. Not Used - ---------------- --------------------------------------- -----------------------------------
EX-10 5 s11-4473_ex1022.txt EXHIBIT 10.22 Page 1 of 1 LEASE MODIFICATION AGREEMENT LANDLORD: LakeCentre Plaza Ltd., LLLP TENANT: New Frontier Media, Inc. LEASE: That certain Lease Agreement between Landlord and Tenant dated August 12, 1998, and Lease Modification Agreement dated January 9, 1999, for the premises known as 5435 Airport Blvd., Suite 100, Boulder, Colorado 80301. In consideration of the covenants, terms, conditions, agreements and payments as herein set forth, Landlord and Tenant hereby enter into the following: CURRENT LEASE EXPIRATION: OCTOBER 1, 2003 NEW LEASE EXPIRATION: OCTOBER 1, 2013 NEW BASE MONTHLY RENT DURING LEASE TERM:
For Period Starting: To Period Ending: A Base Monthly rent of: -------------------- ----------------- ---------------------- October 1, 2003 October 1, 2004 $16,520 October 1, 2004 October 1, 2005 $17,181 October 1, 2005 October 1, 2006 $17,868 October 1, 2006 October 1, 2007 $18,583 October 1, 2007 October 1, 2008 $19,326 October 1, 2008 October 1, 2009 $20,099 October 1, 2009 October 1, 2010 $20,903 October 1, 2010 October 1, 2011 $21,739 October 1, 2011 October 1, 2012 $22,609 October 1, 2013 October 1, 2013 $23,513
ADDITIONAL TERMS AND CONDITIONS: See EXHIBIT "B". TERMINATION DATE OF AMENDMENT OFFER: This Agreement offer expires July 31, 2003 if not executed by tenant and delivered to this office. OTHER TERMS AND CONDITIONS: All other terms and conditions of the above referenced Lease dated August 12, 1998, and Lease Modification Agreement dated January 9, 1999, for the premises known as 5435 Airport Blvd., Suite 100, Boulder, Colorado, shall remain the same except as modified herein. LANDLORD: TENANT: - ------------------ ------ LakeCentre Plaza Ltd., LLLP New Frontier Media, Inc. /s/ William Reynolds /s/ Karyn Miller - ------------------------------- ----------------------------- BY: William W. Reynolds, Partner BY: Karyn Miller Dated this 30 day of July 2003. EXHIBIT "B" TO LEASE MODIFICATION AGREEMENT DATED JULY _____, 2003, BETWEEN LAKECENTRE PLAZA LTD., LLLP, AS LANDLORD, AND NEW FRONTIER MEDIA, INC., AS TENANT. 1. Landlord's Construction Obligations. Landlord agrees to upgrade, at its sole cost and expense, the current electrical transformer servicing the Leased Premises from 300 KVA to 500 KVA. Landlord shall commence efforts to procure the new transformer upon execution of this Lease Modification Agreement and shall cause same to be installed promptly following delivery, at Landlord's cost and expense. 2. Tenant Improvement Allowance. Landlord shall provide to Tenant a $500,000.00 allowance for installation of Tenant Improvements (as defined below). Such allowance shall be funded in installments (not more than one per calendar month), payable thirty (30) business days following submittal of invoices to Landlord reflecting the extent of Tenant Improvements completed, lien waivers for same, and such other evidence as Landlord may reasonably request to evidence the extent of, and payment for, the Tenant Improvements completed. Tenant acknowledges that the anticipated cost of Tenant Improvements will exceed $500,000.00, and that Tenant shall be solely responsible for all costs and expenses of completing Tenant Improvements in excess of $500,000.00, and Tenant covenants and agrees to timely pay all such excess amounts and to provide to Landlord lien waivers showing payment of all such excess amounts. 3. Tenant Improvements. The parties acknowledge and agree that Tenant has elected to engage its own Contractor(s) and arrange for construction and installation of Tenant Improvements on Tenant's behalf. "Tenant Improvements" shall mean all interior walls, partitions, doors, wall coverings, lighting fixtures, electrical fixtures, outlets and switches, outlets, dropped ceilings, floor and window coverings, plumbing fixtures and any and all other items that Tenant desires to have installed in the interior of the Leased Premises (including, without limitation, all consultant fees and other soft costs associated with design and delivery of such improvements). In addition, Tenant shall upgrade the existing electrical transformer servicing the Leased Premises from 300 KVA to 500 KVA, or install a new transformer. Tenant shall provide not less than seven (7) days advance written notice of its intent to install such transformer to Landlord, and to existing tenants located at 5435 Airport Boulevard and 5445 Airport Boulevard. Tenant acknowledges that the electrical service to such other tenants shares the use of existing transformer. Tenant shall therefore take such action as is necessary during the course of installing the new transformer to provide uninterrupted utility service to such other tenants, including, if necessary, providing an auxiliary source of electrical power. Landlord will provide Tenant a Rent Credit up to $8,000.00 for transformer upgrade, or installation of a new transformer. This Rent Credit will be applied after transformer upgrade or new install is completed and Tenant provides Landlord paid invoice(s) and Lien Waivers for such. Any costs above the $8,000.00 will be at Tenants sole cost and expense. Tenant agrees that all contracts with respect to the completion of Tenant Improvements will include provisions whereby the Contractor, for itself and its subcontractors, and the subcontractors of each of them, and for all parties acting through or under each of them will (i) covenant and agree that no mechanic's liens will be filed by it or any of them against the Leased Premises or the Building for or on account of any work done or material furnished by said Contractor or subcontractors and all parties acting through or under any of them in connection with the Tenant Improvements, and (ii) specifically waive and relinquish the right to have, file and maintain any mechanic's liens or claim against the Leased Premises or the Building (provided that such parties need not waive the right to lien the Tenant Improvements to the extent that same can be severed from the Leased Premises without harm or damage to the Leased Premises). Any such contract shall also provide that all subcontracts with subcontractors and materialmen must contain waiver of lien provisions similar to those required to be contained in any contract to be executed by Tenant with a Contractor. Said contract shall also contain language to the effect that said waiver clause is for the benefit of the Landlord. Any contract pertaining to Tenant Improvements which does not contain the provisions set forth above, shall be deemed void and of no force and effect. Notice is furthermore hereby given that Landlord shall not be liable for any labor or materials furnished or to be furnished to the Tenant with regard to Tenant Improvements, and that no mechanic's or other lien for any such labor or materials shall attach to or affect the reversion or any other estate or interest of the Landlord in and to the Leased Premises. Subject only to paragraph 2, above, any and all Tenant Improvement shall be the responsibility and at the cost of Tenant. Tenant agrees to pay or cause to be paid promptly all bills and charges for any material, labor or otherwise in connection with or arising out of any Tenant Improvements, and Tenant agrees to hold Landlord free and harmless against all liens and claims of liens for labor and materials, or either of them, filed against the Leased Premises, or any part thereof, and against any expense or liability in connection therewith. Tenant shall, however, have the right to contest any mechanic's liens or claims of such liens filed against the Leased Premises, provided Tenant shall diligently prosecute any such contest and at all times effectively stay or prevent any sale of the Leased Premises under execution or otherwise and pay or otherwise satisfy any final judgment judging or enforcing such contested lien and thereafter procure record of satisfaction or release thereof. Landlord shall also retain the right, but shall not have an obligation, to post the Leased Premises or take such other action as is then permitted by law to protect Landlord and the Leased Premises against mechanic's liens. Tenant shall be responsible for obtaining any and all necessary permits or licenses required in connection with the Tenant Improvements and shall complete all Tenant Improvements with reasonable diligence and in a good and workmanlike manner. 4. Plans. Tenant shall engage and pay for the services of an architect, contractor or contractors to prepare a space layout, working drawings and specifications for all Tenant Improvements. Tenant shall devote such time in consultation with the architect and/or contractors as shall be necessary to enable the architects and/or contractors to develop complete working drawings and specifications for the construction of the Tenant Improvements, showing thereon partitions, doors, electrical and telephone outlets, light fixture locations, wall finishes, floor coverings and special requirements ("Plans"). Tenant hereby acknowledges and agrees that it shall ensure that the Plans comply with all applicable laws, including, ordinances, orders, rules, regulations and requirements of all governmental authorities having jurisdiction thereof, including, but not limited to, ADA requirements. 5. Landlord's Approval. Tenant shall submit to Landlord complete and final Plans for the Tenant Improvements within sixty (60) days of Tenant's execution of this Lease Modification Agreement. The Plans shall be subject to the approval of Landlord, which approval shall not be unreasonably withheld or delayed. If Landlord should disapprove such Plans, Landlord shall specify to Tenant the reasons for its disapproval and Tenant shall cause the same to be revised to meet Landlord's objections and shall resubmit the same to Landlord, as so revised for approval. If any governmental authority requires a change or addition to the Plans, as previously approved by Landlord, Tenant shall cause such government required modifications to be made to the Plans and shall resubmit the same to Landlord for its concurrence therewith. 6. Contractors. Tenant shall submit to Landlord the names of the architect, general contractor and the electrical, ventilation, plumbing and heating subcontractors (hereinafter collectively "Contractors") for Landlord's approval, which approval shall not be unreasonably withheld or delayed. If Landlord shall reject any Contractors, Tenant shall choose other Contractors. 7. Tenant's Construction of the Tenant Improvements. Tenant shall commence construction of the Tenant Improvements within thirty (30) days of receiving building permits from the City of Boulder. Subject only to paragraph 2, above, Tenant shall promptly pay any and all costs and expenses in connection with or arising out of the performance of Tenant's construction of the Tenant Improvements (including the costs of permits therefore) and shall furnish to Landlord evidence of such payment upon request. Upon completion of the Tenant Improvements, Tenant shall deliver to Landlord a release and waiver of lien executed by all of the Tenant's Contractors (including any architect or other design or engineer professional used in the preparation of the Plans) and each and every subcontractor and materialman concerned with the Tenant Improvements. Tenant shall indemnify, defend (with counsel satisfactory to Landlord) and hold Landlord harmless from and against any and all suits, claims, actions, loss, cost or expense (including claims for workers' compensation, attorneys' fees and costs) based on personal injury or property damage caused in, or contract claims (including, but not limited to, claims for breach of warranty) arising from the construction of the Tenant's Improvements. Tenant shall repair or replace (or, at Landlord's election, reimburse Landlord for the cost of repairing or replacing) any portion of the Leased Premises or Building or item of Landlord's equipment or any of Landlord's real or personal property damaged, lost or destroyed in the construction of the Tenant Improvements. Tenant and Tenant's Contractors shall obtain and provide Landlord with certificates evidencing Workers' Compensation, public liability and property damage insurance in amounts and forms and with companies satisfactory to Landlord. Tenant's agreement with its Contractors shall require such Contractors to provide daily clean up of the Building to the extent such clean up is necessitated by the construction of the Tenant Improvements. Tenant shall notify Landlord at least five (5) days prior to the commencement of construction of any Tenant Improvements and permit Landlord to post on the Leased Premises such notices of nonresponsibility as may be required or otherwise available to Landlord. 8. Changes. Tenant may request reasonable changes in the Plans; provided, however, that (a) no material change shall be made to the Plans without Landlord's prior written approval, which approval shall not be unreasonably withheld or delayed; (b) no such request shall effect any structural change in the Building or otherwise render the Leased Premises or building in violation of applicable laws; (c) Tenant shall pay any additional costs required to implement such change, including, without limitation, loss of rents, architecture and other consultant fees, increases in construction costs and other charges payable hereunder caused by such delay; and (d) such requests shall constitute an agreement by Tenant to any delay in completion caused by Landlord's reviewing, processing and implementing such change. If Tenant requests or causes any change, addition or deletion to the Leased Premises to be necessary after approval of the Plans, a request for the change shall be submitted to Landlord's Representative, accompanied by revised plans, all at Tenant's sole expense. Tenant acknowledges that any Contractors engaged by Tenant are not the Landlord's agent and have no authority to enter into agreements on Landlord's behalf or otherwise bind Landlord. 9. Tenant's Representative. Tenant has designated ______________as the Tenant's Representative, to be its sole representative with respect to the matters set forth in this Lease Modification Agreement, who shall have full authority and responsibility to act on behalf of the Tenant as required in this Lease Modification Agreement. Tenant shall not change the Tenant's Representative without notice to and the prior approval of Landlord. 10. Landlord's Representative. Landlord has designated Keith Fitzgerald as Landlord's Representative, to be its sole representative with respect to the matters set forth in this Lease Modification Agreement, who shall have full authority and responsibility to act on behalf of Landlord as required in this Lease Modification Agreement. Landlord shall not change Landlord's Representative without notice to Tenant. 11. No Representations or Warranties. Notwithstanding anything to the contrary contained in the Lease or herein, Landlord's review of or participation in the preparation of the Plans, the cost estimates for the Tenant Improvements, if at all, shall not constitute any representation or warranty, express or implied, that (1) the Plans are in conformity with applicable governmental codes, regulations or rules, or (ii) the Tenant Improvements, if built in accordance with the Plans, will be suitable for Tenant's intended purpose. Tenant acknowledges and agrees that the Tenant Improvements are intended for use by Tenant and the specification and design requirements for such improvements are not within the special knowledge or experience of Landlord. 12. HVAC Maintenance. The following terms and conditions shall be in effect beginning August 1, 2003, or, if after such date, the date that this Lease Modification Agreement is signed, and throughout the remaining term of the Lease. Section 15 of the Lease shall be amended to add the following: K. HVAC SYSTEMS. Tenant, at its sole cost and expense, agrees to maintain in good working order all of the HVAC unit systems, controls, and related systems for the Leased Premises. Tenant agrees to make all repairs, periodic servicing, and replacement to these HVAC units with a reputable licensed contractor. Tenant shall not hold Landlord liable for interruption of service, nor hold Landlord liable for damages incurred due to the interruption of service for these units. Tenant, upon receiving written request from Landlord, shall provide records of all maintenance contracts, repairs, and replacements on a yearly basis to Landlord. 13. Section 16, Paragraph 1 of the Lease shall be amended as follows: 16. Common Area Maintenance. Tenant shall be responsible for Tenant's Prorata share of the total costs incurred for the operation, maintenance and repair of the Common Areas actually paid for by Landlord, including, but not limited to, the costs and expenses incurred for the operation, maintenance and repair of parking areas (including restriping and repaving); removal of snow; all utilities including water, gas, and electric for the building; janitorial for common areas and tenant occupied space; normal HVAC maintenance and elevator maintenance (if applicable); trash removal; security to protect and secure the Area; common entrances, exits, and lobbies of the Building; all common utilities, including water to maintain landscaping; replanting in order to maintain a smart appearance of landscape areas; supplies; depreciation on the machinery and equipment used in such operation, maintenance and repair; the cost of personnel to implement such services; the cost of maintaining in good working condition the HVAC system(s) for the Leased premises; the cost of maintaining in good working condition the elevator(s) for the Leased Premises, if applicable; and costs to cover Landlord's management fees paid for the management of the property. These costs shall be estimated on an annual basis by the Landlord and shall be adjusted upwards or downwards depending on the actual costs for the preceding twelve months. Tenant shall pay monthly, commencing with the first month of the Lease Term, as additional rent due under the terms hereof, a sum equal to Tenant's Prorata Share of the estimated costs for said twelve (12) month period, divided by 12. The estimated initial monthly costs are $ 1,244.00. Once each year the Landlord shall determine the actual costs of the foregoing expenses for the prior year and if the actual costs are greater than the estimated costs, the Tenant shall pay its Tenant's Prorata Share of the difference between the estimated costs and the actual costs to the Landlord with the next payment of Base Monthly Rent, or, if the actual costs are less than the estimated costs, the Landlord shall forthwith refund the amount of the Tenant's excess payment to the Tenant.
EX-10 6 s11-4473ex_1023.txt EXHIBIT 10.23 EXHIBIT 10.23 CATALOG LICENSE AGREEMENT This License Agreement (the "Agreement") is made and entered into this 12th, day of June 2003, by and between: Pleasure Productions, Inc. and Pleasure Licensing, LLC, 59 Lake Drive, Hightstown, NJ 08520 (individually and collectively "Licensor") and COLORADO SATELLITE BROADCASTING, INC., 7007 Winchester Circle, Suite 200, Boulder, CO 80301 ("CSB" or "Licensee") with reference to the following facts and circumstances: WHEREAS, Licensor owns or otherwise controls certain rights to certain motion pictures intended for viewing by adult audiences, a list of which such motion pictures is attached hereto as Exhibit "A" and incorporated herein by this reference. WHEREAS, Licensee performs, displays and broadcasts motion pictures and other content intended for viewing by adult audiences; and WHEREAS, Licensee desires to obtain from Licensor, and Licensor desires to grant to Licensee, the right to publicly perform, display and broadcast up to two thousand (2,000) of said motion pictures to be selected by Licensee from those listed on Exhibit "A", subject to the terms and conditions set forth herein, it being understood that a list of the motion pictures selected by Licensee shall be attached hereto as Exhibit "B" once such selections have been made by Licensee. NOW, THEREFORE, in consideration of the promises and mutual covenants and agreements set forth herein, the parties agree as follows: 1. DEFINITIONS As used in this Agreement, certain capitalized terms not otherwise defined in the body of the Agreement shall have the following meanings: 1.01 "Cable Systems" means systems by which Content is delivered to addressable subscribers for display on television receivers or video monitors located in Private Dwellings by Satellite Master Antenna Television system, Multipoint Distribution system, Multichannel Multipoint Distribution system, Local to Multipoint Distribution system, and Open Video System (as all such terms are commonly utilized in the industry or defined herein) now known or hereafter created or discovered, whether such Content is provided at some times, at all times, or upon demand, for free or for consideration, and regardless of the billing or payment method (if any) used. 1 .02 "Content" means text, graphics, photographs, video, audio and/or other data or information contained in, identified as or related to a Title. 1 .03 "Documentation" means (i) any and all documentation required by U.S. law or regulation, including without limitation copies of photo identification reflecting the age of each individual appearing in each Title at the time of production to the extent required by law, and all related documentation required by 18 U.S.C. ss.2257 and 28 C.F.R., Part 75, as amended from time to time; (ii) all chain-of-title documentation, including without limitation Certificates of Registration of Copyright and license agreements, in Licensor's possession or control; and (iii) talent releases containing all customary consents, representations, and waivers (including without limitation waivers of claims based on rights of privacy, publicity, and false light) signed by each individual appearing in each Title, in Licensor's possession or control. For purposes of delivery of Documentation to Licensee hereunder, Licensee shall not require Licensor to deliver the chain of title documents set forth above in this section 1.03 (ii) unless (x) Licensee, in its good faith business judgment, determines that such chain of title documents are necessary or desirable in order for Licensee to comply with any law or regulation, for use in connection with any actual or threatened regulatory action or inquiry, or lawsuit or inquiry of a customer or (y) in the event Licensee makes a reasonable request (other than in the situations set forth in clause (x) above) for such chain of title documents and Licensor consents to deliver such documents, which consent shall not be unreasonably withheld. Licensor acknowledges that if such request is made in connection with a Change of Control (as defined in Section 16 hereof) such request by Licensee shall be deemed reasonable. 1 .04 "Download" means to copy data from a source to a peripheral device. 1.05 "Dub" means the best quality version of a Title that is available to Licensor in the format set forth on Exhibit "A" hereto for such Title or a first generation copy of such version. 1 .06 "Exhibit" or "Exhibition" means to publicly perform, display, broadcast cm transmit Content. 1 .07 "Internet" means the global network of interconnected computer networks utilizing the Transmission Control Protocol/Internet Protocol (TCP/IP), and/or such other standard network interconnection protocol(s) as may be adopted from time to time, to transmit Content to a computer or other digital electronic device for display to an end user, whether such Content is delivered through online browsers, offline browsers, "push" technology, "on demand" technology, electronic mail, streaming media, satellite, wireless or cellular device, cable, or otherwise, and including without limitation Content provided to end users for free or for consideration; at some times, all times or upon demand; and regardless of the billing or payment method (if any) used. Delivery of Content via the "Internet" shall also mean and refer to Content delivered to and displayed on devices or computers, whether hand-held or portable or not, utilizing extensible markup language (XML). 1 .08 "Person" means any natural person, legal entity, or other organized group of persons or entities. (All pronouns, whether personal or impersonal, which refer to Persons, include natural persons and other Persons.) 1 .09 "Private Dwellings" means: (i) residential dwellings (including but not limited to houses, private residential apartments, cooperatives, condominiums, and mobile homes); (ii) individual private rooms and bars and lounges in hotels and motels, inns and lodges and other venues; and (iii) other locations and institutions not accessible to the general public such as corporations, firms, penal institutions, oil rigs, military bases, ships, dormitories, fraternity and sorority houses, hospitals, nursing and convalescent homes, schools and libraries. 1.10 "Satellite Systems" means systems by which Content is delivered via satellite transmission for display on television receivers or video monitors located in Private Dwellings, including without limitation Content delivered by or through Digital Broadcast Satellite systems, C-Band Satellite Direct to Home systems (as all such terms are commonly used in the industry) now known or hereafter created or discovered, and scrambled low power television stations. 1.11 "Stand Alone Systems" means systems whereby Content is delivered to a system operator on tape or other technology, and the tape or other technology now known or hereafter created and is inserted in a playback system at the system headend for delivery or otherwise delivered over a closed network utilizing fiber optic, twisted pair, coaxial cable and/or other technology for display on television receivers or video monitors located in Private Dwellings. 1.12 "Still Images" means images relating to a Title contained in the following media or medium which Licensor possesses or creates during the Term hereof: negatives, prints, transparencies, slides, chromes, and digital images in any and all formats (including, without limitation, VHS, DVD and/or any other technical formats) and/or transfer protocols now known or hereafter created or discovered, depicting, or promoting a Title and any Persons appearing in a Title whether such images are actually depicted in a Title or created separately for the purposes of advertising and/or publicizing a Title. 1.13 "Term" means the term specified in paragraph 3.01 below and any extensions agreed to by the parties hereto in accordance with the terms hereof. 1.14 "Title" means each motion picture or motion picture segment of any length listed or otherwise identified with reasonable particularity in Exhibit "B" which will be attached hereto and o incorporated herein by this reference, including all Versions of each such Title existing as of the date 2 hereof and any Versions created by Licensee hereunder that do not include any material or content not contained in any Title, Version existing as of the date hereof or otherwise provided by Licensor to Licensee pursuant to this Agreement. 1.15 As to each Title, "Territory" means all countries in North America, Central America and South America including the respective territories, possessions, and commonwealths of all such countries, except with respect to the exercise of the Rights in connection with the Internet, in which case "Territory" shall refer to the entire universe. 1.16 "Version" means any version of a Title existing as of the date hereof and/or which is created by Licensee from a Dub, including but not limited to the following: A. X Version: traditionally referred to a "soft cable master"; contains no explicit sex material, male erections or close-ups of male and/or female genitalia, B. XX Version: shows male erections and/or close-ups of male and/or female genitalia but no extreme close-ups, anal penetration and/or ejaculations, and C. XXX Version: the least-edited or unedited standard, including extreme close-ups, anal penetration and ejaculation. 1.17 "Video on Demand (VOD)" shall mean the Exhibition delivered by all means know known or hereafter discovered including but not limited to the Internet, Satellite Systems, Cable Systems and/or Stand Alone Systems capable of video storage which in turn enables Subscribers to manipulate the Exhibition of Titles at the Subscriber's discretion including but not limited to pausing, reversing, forwarding and stopping the Exhibition. 2. GRANT OF RIGHTS 2.01 For each Title, Licensor hereby grants to Licensee, in the Territory during the License Period (as defined below) and subject to the terms and conditions contained herein: (a) The exclusive right and license, in the United States, and its territories, possessions and commonwealths to Exhibit the Title and/or any excerpts therefrom or Versions thereof (whether existing now or created by Licensee in accordance with the terms hereof) by means of Satellite Systems and Cable Systems (including, without limitation, the exclusive right and license to Exhibit the Title and/or any excerpts therefrom or Versions thereof (whether existing now or created by Licensee in accordance with the terms hereof) via VOD and the Internet delivered by Satellite Systems and Cable Systems) whether such means are now known or hereafter devised; (b) The non-exclusive right and license, outside the United States, and its territories, possessions and commonwealths but within the Territory, to Exhibit the Title and/or any excerpts therefrom or Versions thereof (whether existing now or created by Licensee in accordance with the terms hereof) by means of Satellite Systems and Cable Systems (including, without limitation, the non-exclusive right and license to Exhibit the Title and/or any excerpts therefrom or Versions thereof (whether existing now or created by Licensee in accordance with the terms hereof) via VOD and the Internet delivered by Satellite Systems and Cable Systems) whether such means are now known or hereafter devised; (c) The non-exclusive right and license throughout the Territory to Exhibit Titles and/or any excerpts therefrom or Versions thereof (whether existing now or 3 created by Licensee in accordance with the terms hereof) by all means now known or later discovered via Stand Alone Systems and the Internet, with the understanding that for purposes of the Internet, the Territory shall be deemed to be the entire universe, subject in the case of Internet rights to the provisions of Section 2(h) below; (d) The non-exclusive right and license to duplicate each Title and to distribute such Title, to and only to the extent necessary or desirable to effectuate the Exhibition and exploitation of that Title in accordance with the terms hereof; (e) The non-exclusive right to advertise, promote and publicize Licensee's Exhibition of the Titles and all matters relating thereto in all media and/or medium now known or hereafter devised, to use Still Images and/or excerpts from the Titles in connection with such advertising, promotion, and publicity and to market, advertise, promote and publicize Licensee's exhibition of Titles and Still Images; (f) In connection with the exercise of the other Rights hereunder, the non-exclusive right to use the names and likenesses of all Persons appearing in the Titles and the Still Images, and the names of those persons who rendered services in connection with the Titles; (g) The non-exclusive right to change the name of a Title, and the non-exclusive right to edit and modify each of the Titles hereunder in order to create derivative Versions of each of the Titles including, without limitation, XX Versions of each Title and any variations of such Versions in Licensee's discretion; the non-exclusive right to include one or more segments from a Title and to combine same with one or more segments from another Title or from segments of motion pictures not subject to this Agreement in order to create a new compilation work (herein referred to as a "Clip"), it being understood that Licensee shall have the right to distribute, market, advertise, promote, publicize, Exhibit and otherwise exploit any such Clip on the same basis and subject to the same terms that apply to Titles and Versions hereunder; provided, however, Licensee shall not change the existing name title of the Titles to a new name title that includes the name "Pleasure" (other than the use of the word pleasure in a manner that could not be reasonably construed to refer to the company name Pleasure) or any other trademark or trade name now owned or controlled by Licensor listed on Exhibit "C" attached hereto and incorporated herein by this reference without the prior written consent of Licensor; nor shall Licensee use the name "Pleasure" or any other tradename or trademark listed on Exhibit "C" to identify any Clip unless such Clip is comprised solely of segments from Titles licensed hereunder and/or licensed pursuant to that certain New Release License Agreement between the parties of even date herewith; and (h) The right to sublicense any of Licensee's rights hereunder (other than the rights contained in Section 2(g) hereunder to edit and modify Titles and include one or more segments in order to create a Clip) for the purpose of distribution, promotion, advertising, publicizing, marketing, Exhibition and exploitation of each Title or any Version or portion thereof; provided, however, no such sublicense shall be for a term beyond the License Period and Licensee shall not otherwise grant any rights with respect to a Title, Version or portion thereof which exceed the Rights Licensee has with respect to such Title, Version or portion thereof pursuant to this Agreement. Except as provided in the immediately succeeding two sentences Licensee shall have no right to sublicense any Right relating to the Internet or otherwise provide others with access to the Titles, Versions or portions thereof through the Internet. Subject to the proviso contained in the first sentence of this Section 2(h), Licensee shall be permitted to grant a sublicense related to the Internet or otherwise provide others with access to any of the Titles, Versions or any portion thereof through the Internet provided (x) pursuant 4 to such sublicense or other access parties can only access such Titles, Versions or portions thereof through the servers of Ten.com or a successor, derivative or mirror site of Ten.com that has a substantially similar platform as Ten.com, as such may be changed from time to time and (y) such sublicense or other access relates to a majority of content on or available on Ten.com or such other site other than the Titles, Versions or any portion thereof. Notwithstanding the foregoing, Licensee shall not resell, sublicense or otherwise permit access to the Titles, Versions or any portion thereof through the Internet to any webmaster, third party aggregator or content provider or any other party other than (a) any of the foregoing who provide access to consumers through a Ten.com, as such may be changed from time to time, or (ii) Cable System, Satellite System or Stand Alone System operators. All of the rights granted under this Section may be referred to collectively as the "Rights." 2.02 Notwithstanding anything to the contrary contained herein, Licensor hereby specifically reserves any and all rights, which are not specifically granted hereunder. The parties acknowledge and agree that the grant of Rights hereunder shall be subject to and limited by any preexisting license or similar right granted to any third party by any party from which Licenser acquired rights to the Tiltes, Versions or Still Images. Without limiting the generality of the foregoing, Licensor specifically reserves the right (and Licensee shall have no right in any manner) to sell or distribute Titles in videocassette or digital versatile disk (DVD) formats for sale or resale to third parties. Additionally, Licensee covenants and agrees that if in connection with any exercise of the Rights hereunder any third party is permitted or has the ability to download any Title, Version, excerpt therefrom or any Still Image, Licensee shall use commercially reasonable efforts to ensure that such Title, Version, excerpt or Still Image, as the case may be, contains coding or other adequate technology to provide that access to such information by any such third party is terminated within 30 days from the date of delivery to any such third party; provided, however, Licensor hereby acknowledges and agrees that even if Licensee makes such efforts, there is no guarantee that such efforts will be effective in terminating such information within any such time frame because of technology which may now exist or hereafter be devised. Notwithstanding anything to the contrary contained herein, the parties acknowledge and agree that if and to the extent Stand Alone Systems can be accessed through any technology now known or hereafter created or discovered that is or could be deemed to be within the definition of Cable Systems and/or Satellite Systems, notwithstanding the grant of exclusive Rights in Section 2.01(a) hereof, Licensor or its sublicensees or assignees shall have the right to use such technology in connection with accessing Stand Alone Systems. Pleasure acknowledges that an inadvertent breach by CSB of the restrictions contained in the proviso of the first sentence of Section 2(h) shall not, in and of itself, be cause to terminate or vitiate this entire Agreement. 2.03 Both Parties acknowledge and agree that except for Licensee's exercise of the Rights during the Term and each applicable License Period hereof in accordance with the terms and conditions hereof, Licenser shall own all right, title and interest in and to all Titles, Still Images, Versions and excerpts thereof (but excluding any segments of Clips which are not subject to this Agreement), including without limitation rights of trademark and copyright and nothing herein shall be construed to grant Licensee any ownership rights, rights to sublicense (except as provided in Section 2.01(h) hereof) or similar rights in and to the Titles, Still Images, Versions or any excerpts thereof. 3. LICENSE PERIOD; TERM 3.01 The term of this Agreement and the period of time in which Licensee and/or its permitted assignees or sublicensees may exercise the Rights shall be for a period commencing on the date hereof and extending up through and that date that is five years and six months from the date hereof (the "Term" or the "License Period"). The parties agree to comply with the delivery, selection and licensing process to take place in accordance with paragraph 5 below and to use their good faith efforts to complete said process no event later than that date which is fifteen months from the date hereof. 5 3.02 Licensee agrees that upon termination of the applicable License Period for a particular Title it shall, at its sole cost and expense, destroy or return (in Licensee's discretion) to Licensor all copies of Still Images and Dubs in its or its sublicensee's possession, provided however with respect to Dubs in lieu of destroying or returning such Dubs, Licensee may efface all Dubs provided Licensee shall upon request of Licensor provide Licenser with (i) a certificate executed by a third party or by an officer of Licensee confirming that such effacing has occurred or (ii) any other commercially reasonable evidence satisfactory to Licensor. 4. CONSIDERATION 4.01 The parties acknowledge and agree that they have each delivered to the other fair and adequate consideration for this Agreement including, without limitation, the execution and delivery of the Settlement Agreement dated as of the date hereof to which this Agreement is attached as "Exhibit 6" and all terms, provisions and consideration contained in said Settlement Agreement. 5. DELIVERY OF TITLES 5.01 Licenser shall have the following obligations at its own cost and expense except where otherwise specified: (a) Licensor shall be obligated to deliver to Licensee, within ten (10) business days of Licensee's written request, up to two hundred (200) screening VHS tapes from those motion picture Titles listed in Exhibit "A" ("Screeners") as requested by Licensee for Licensee's review. Licensee shall have a period of thirty (30) days from Licensee's receipt of same within which to select and/or identify which of such Titles it wishes to make its own copies from the Dubs. For purposes hereof "Edit Dubs" shall mean those Titles Licensee has selected and/or identified as Titles of which it wishes to make its own copies from Dubs. Licensee shall then have the right to make the Edit Dubs itself or select a third party facility to do so, and it is presently contemplated that Licensee will request New Age Conversions, a studio located in North Hollywood, California ("New Age"), to make the Edit Dubs, although Licensee shall not be obligated to do so. Licenser agrees to deliver Dubs of Titles selected to Licensee, New Age, or any other third party facility chosen by Licensee within ten (10) business days of Licensee's written instructions for the purpose of making Edit Dubs. Once the Edit Dubs are made and reviewed by Licensee, Licensee shall identify each such Edit Dub as either a Broadcast on a Non-Broadcast Title, in its discretion. Licensee shall then instruct New Age (or any other applicable third party facility) to duplicate each Non-Broadcast Title identified by Licensee and to ship same directly to the offices of Licensee located in Boulder, Colorado; and Licensee shall also instruct New Age (or any other applicable third party facility) to marshal and deliver each Broadcast Title identified by Licensee directly to Pegasus Post, a facility located in Chatsworth, California ("Pegasus") or to any other third party selected by Licensee. The foregoing process shall be repeated every thirty (30) days until such time as Licensee has selected all Titles it desires from Exhibit "A" but in no event shall Licensee select more than two thousand (2,000) motion pictures to become Titles hereunder and in no event may Licensee request more than two hundred (200) Screeners in any thirty day period. Licensee shall endeavor to select Titles in such a manner so it requests blocks of no less than fifty (50) Titles at a time and that not more than one hundred fifty (150) of Licensor's Dubs are out of Licenser's possession during each of the aforesaid thirty (30) day periods. Licenser shall not be obligated to comply with such request for additional Dubs if Licensee has not returned to Licenser at least fifty (50) Dubs which were the subject of any prier request; and Licensee shall pay all costs and expenses of redelivering all Dubs to Licensor and all costs of copying and duplicating Dubs. (b) Licensor's failure to meet its delivery obligations in a timely manner (other than an inadvertent, non-material failure) as set forth above shall be deemed to be a 6 breach of this Agreement unless Licenser cures such failure within fourteen (14) business days following the date which Licensee gives Licensor written notice of such failure. Provided Licensor delivers all of the Screeners and Dubs to Licensee in a timely manner in compliance with the foregoing provisions (other than a non-material, inadvertent failure), Licensee may not select any Screeners from Exhibit "A" and accordingly no additional motion pictures will become Titles after the date which is fifteen (15) months following the date hereof. Licensee agrees that in the event of an inadvertent, non-material failure of Licenser to meet its delivery obligations in Section 5.01(a) the fifteen (15) month period described above shall be extended for a period of time equal to the aggregate period of time of all such delivery failures that exceed five (5) business days after Licensor receives notice of such failure. (c) Licensor, upon the written request of Licensee, shall, not later than fifteen (15) business days after receipt of such written request, deliver to Licensee (i) an 18 USC 2257 Statement Of Compliance for a Title, executed by the Custodian of Records, (ii) a talent release executed by each performer in a Title, if and to the extent such talent release is available and (iii) one (1) trailer in XXX and cable version for each Title, if and to the extent available; 5.02 Upon loss, theft or destruction of any Dub provided by Licensor while in the possession of Licensee, Licensee shall promptly advise the Licenser of such loss, theft or destruction by affidavit setting forth the facts thereof and will provide Licenser a replacement of such Dub at Licensee's sole cost, if requested by Licenser. If at any time hereunder an Edit Dub or a Dub is lost, stolen or destroyed, Licensor agrees to provide Licensee (or its authorized representative) access to the Dub (or a new Dub), if available, at no cost in order for Licensee to make a new Edit Dub, and the actual cost of making such new Edit Dub shall be borne by Licensee. If Licenser delivers an original edition of the source material of an individual Title (or Licensor's only copy of an individual Title for which the source material is damaged or no longer exists), Licenser shall assume the risk and take sole and full responsibility for any loss, theft or destruction of same while in the possession or control of Licensee or any facility utilized by Licensee. 6. REPRESENTATIONS AND WARRANTIES 6.01 Licensor hereby represents and warrants to Licensee that (i) all persons depicted in each Title were 18 years of age or older at the time each Title was produced, (ii) it has the right and power to grant all Rights granted to Licensee hereunder, (iii) it has obtained all consents, approvals and licenses from all actors, musicians and other persons who provided services in connection with or appear in a Title or entity whose products appear in a Title, (iv) all costs of production of each Title, and all artists, actors, musicians and persons rendering services in connection with the production of each Title have been or will be paid any sums due to them by Licenser, and (v) Licenser has acquired all music rights and music clearances which are required with respect to the music contained in each Title and that no supplemental or additional use payments shall be required with respect to the Exhibition and exploitation of any Title and/or any advertising or promotion thereof which contains the music embodied in any Title. 6.02 Licensee represents and warrants to Licenser that it has and/or will obtain and maintain all required licenses, permits and approvals, if any, for Licensee's direct Exhibition of each Title and for the exercise of Licensee's Rights hereunder. 6.03 Licensor represents and warrants that (i) it has the right to grant all Rights granted to Licensee hereunder; (ii) it has not as of the date of this Agreement, and will not during the Term and applicable License Period assign, license, pledge, or otherwise encumber, restrict or otherwise take action that would diminish the Rights granted to Licensee hereunder; (iii) to its knowledge no third party from whom Licensor has acquired any Titles, assigned, licensed, pledged, or otherwise encumbered, restricted, or otherwise took any action that would diminish the Rights granted to Licensee hereunder and to Licenser's knowledge there is no threatened, pending or active claim or suit with respect to the same, (iv) neither the Titles, the Documentation, nor any parts thereof, nor any materials contained therein or 7 synchronized therewith, nor the exercise of any Right granted hereunder, violates or will violate or will infringe any contract or agreement to which Licensor is a party, any trademark, trade name, copyright (whether common law or statutory), patent, literary, artistic, or dramatic right or right of privacy of (or slanders, libels or is defamatory with respect to) any person, firm, corporation, or association whatsoever or, (v) all Titles were produced in accordance with applicable work place safety laws and other laws and regulations requiring a permit or other approval to use a specific set or location and (vi) to Licenser's knowledge Licensor has not received any written notice from a state or federal regulatory agency or authority that any Title is in violation of obscenity laws. 6.04 EXCEPT AS SPECIFICALLY SET FORTH HEREIN, AND WITHOUT LIMITATION OF ANY REPRESENTATIONS AND WARRANTIES MADE BY LICENSOR AND LICENSEE IN THIS AGREEMENT, ALL WARRANTIES, EXPRESS OR IMPLIED ARE EXPRESSLY EXCLUDED AND DECLINED BY LICENSOR OR LICENSEE, AS THE CASE MAY BE. 6.05 Licenser acknowledges and agrees that notwithstanding the grant of Rights hereunder Licensee has no obligation to Exhibit, promote, publicize, market or otherwise exploit the Titles or Still Images. Accordingly, Licensor will have no claim against Licensee based solely upon a failure of Licensee to Exhibit, promote publicize, market or otherwise exploit the Titles or Still Images or any particular Title or Still Image. 7. INDEMNIFICATION 7.01 Licenser agrees to fully indemnify and hold Licensee and its directors, officers, members and agents harmless from and against any proceeding, action or claim that may arise out of or relate to the breach by Licenser of any representation or warranty hereunder, including, but not limited to, any and all damages, claims, losses and/or expenses (including reasonable attorneys' fees and costs) incurred by Licensee arising out of any such proceeding, action or claim. 7.02 Licensee agrees to fully indemnify and hold Licensor and its directors, officers, members and agents harmless from and against any proceeding, action or claim that may arise out of or relate to the breach by Licensee of any representation or warranty hereunder or any material or content added to a Title or Version which is deemed to violate any applicable obscenity laws including, but not limited to, any and all damages, claims, losses and/or expenses (including reasonable attorneys' fees and costs) incurred by Licenser arising out of any such proceeding, action or claim. 7.03 Licensee agrees to fully indemnify and hold Licensor and its directors, officers, members and agents harmless from and against any proceeding, action or claim that may arise out of any content added to a Title or Version by Licensee, other than content of Licenser, including but not limited to, any and all damages, claims, losses and/or expense (including reasonable attorneys' fees and costs) incurred by Licensor arising out of any such proceeding, action or claim. 7.04 In the event of any claim, action, or proceeding for which a party hereunder is entitled to indemnity under Section 7, the other party (an "Indemnifying Party"), shall have the right to defend the same through counsel of its own choosing at its sole expense, and the Indemnifying Party shall indemnify and hold harmless the other party, including any of its officers, directors, partners, employees, and agents, from and against any and all damages, claims, losses, or expenses (including reasonable attorneys' fees) incurred in connection therewith. 8. FORCE MAJEURE Neither party shall be liable or responsible for any failure or inability to perform or delay caused by reason of one or more so-called "force majeure" contingencies (e.g. any act of God, fire, earthquake, strike, labor disturbance, civil commotion, acts of government, it's agencies, or governmental officers, any order, regulation, ruling or action of any labor union or association effecting a party hereto or the industry in which such party is engaged, delays in the delivery of materials or supplies, satellite transponder failure, terrorist attack, any act of sabotage, etc.). The Term of this Agreement and any applicable License Period for a particular Title shall be extended hereunder for a period equal to the duration of any such contingencies to the extent that such contingencies interfere with or disrupt Licenser's ability to perform its 8 obligations hereunder or interfere with Licensee's exercise of its Rights hereunder. In the event any such force majeure contingency, the effected party shall promptly notify the other party in writing of same and the parties will determine in good faith the amount of time, if any, that the Term of this Agreement and any applicable License Period for a particular Title shall be extended in accordance with the terms of this paragraph 8. 9. SEVERABILITY Subject to this section, if any provision of this Agreement or the application thereof to any party or circumstance shall, to any extent, be invalid and/or unenforceable, the remainder of this Agreement and the application of such provision to any other parties or circumstances other than those as to which it is held invalid and/or unenforceable, shall not be affected thereby, and each such other term and provision of this Agreement shall be valid and be enforceable to the fullest extent permitted by law. 10. FURTHER DOCUMENTS The Licenser and Licensee shall promptly execute, acknowledge, and deliver or promptly procure the execution, acknowledgment and delivery of any and all further assignments, agreements and instruments, which may be deemed necessary or expedient to effectuate the purposes of this Agreement. 11. WAIVERS No waiver by either party of any breach or default under this Agreement shall be deemed to be a waiver of any proceeding or subsequent breach or default. 12. NOTICES 12.01 All notices or remittances which either party may wish to serve or may be required to serve on the other under this Agreement shall be in writing, and shall be served by personal delivery thereof, or by prepaid certified mail, return receipt requested, or by prepaid overnight air express delivery, addressed to the respective parties at their addresses set forth below, with a copy transmitted by email (provided that all written requests to provide Screeners and Dubs pursuant to Section 5.01(a) need only be delivered by e-mail) to MKMAINMAN@AOL.com and Debbie@PleasureProductions.com), to the following individuals: (a) If to Licensee, to Colorado Satellite Broadcasting, Inc. 7007 Winchester Circle, #200 Boulder, CO 80301 Attn: Michael Weiner mweiner@noof.com With a copy to: Frank W. Visciano, Esq. Luis Toro, Esq. Senn Visciano Kirschenbaum P.C. 1801 California Street, #4300 Denver, CO 80202 fvisciano@sennlaw. corn ltoro@sennlaw.com (b) If to Pleasure, to Pleasure Licensing, LLC 9 Pleasure Productions, Inc. 59 Lake Drive P.O. Box 946 Hightstown, NJ 08520 Attn: Michael Koretsky mkmainman@aoI.com With a copy to: Ira Rosenau, Esq. and Barry J. Siegel, Esq. KLEHR, HARRISON, HARVEY, BRANZBURG & ELLERS 260 5. Broad Street Philadelphia, Pennsylvania 19102 irosenau@klehr.com bsiegeI~klehr.com The above persons' addresses, attorneys, and emails to which notices will be sent pursuant to this Settlement Agreement may be changed by any party by giving ten (10) days' notice in writing to the other Parties specified in Subparagraph (a) above. The parties acknowledge and agree that in the event of any breach or alleged breach of this Agreement, each party will give the other party written notice of such breach or alleged breach and such party shall have twenty-one (21) business days (except as specifically provided herein to the contrary) to cure such breach. If such party cures such breach or alleged breach within such period then the other party will have no claim for damages or cause to terminate the term of this Agreement as such relates to such breach or alleged breach. 13. RELATIONSHIP OF THE PARTIES Nothing contained in this Agreement shall be deemed to constitute either of the parties a joint venturer, partner, or agent of the other. Neither party shall hold itself out contrary to the terms of this Agreement and neither party shall become liable by reason of any representation, act or omission of the other contrary to the provisions hereof. 14. ENTIRE AGREEMENT This Catalog License Agreement, together with that certain Settlement Agreement between the parties referred to in paragraph 4 above, and that certain New Release License Agreement dated as of the date hereof between the parties, contain the full and complete understanding between the parties hereto and supersedes all prior understandings, whether written or oral, pertaining to the subject matter hereof and cannot be modified except by a written instrument signed by the parties hereto. 15. APPLICABLE LAWS This Agreement shall be governed by the laws of Colorado and the federal laws of the United States of America applicable therein. In the event of any dispute between the parties, the prevailing party shall be entitled to recover all costs (including reasonable attorneys' fees) from the other party. The parties agree that any dispute shall be resolved in the state or federal courts of the United States, as may be applicable, located in Denver, Colorado, Philadelphia, Pennsylvania or New Jersey provided such court determines that subject matter jurisdiction is appropriate and the parties do hereby submit themselves to the sole and exclusive venue and jurisdiction of such courts located in Denver, Colorado, Philadelphia, Pennsylvania or New Jersey without protest or challenge. 16. ASSIGNMENT Except as specifically provided in Section 2.01(h), neither party may assign, sublicense or convey this Agreement or any part thereof without the prior written consent of the other party, which consent shall 10 not be unreasonably withheld, provided, however, either party may assign their rights and obligations hereunder (i) in connection with a merger, consolidation or similar transaction where shareholders of such party prior to such merger, consolidation or similar transaction will own less than fifty percent (50%) of the voting power after such merger, consolidation or other transaction, (ii) in connection with a sale of all or substantially all of their assets or (iii) to a majority-owned subsidiary or an entity which owns a majority of the voting power of such entity (a "Change of Control"). Pleasure agrees that in the event it assigns its obligations hereunder on or prior to that date which is fifteen (15) months after the date hereof, it shall guarantee the performance by such assignee of the obligations to deliver Dubs and Screeners as provided in Section 5.01 hereof. 17. COUNTERPARTS This Agreement may be executed in counterparts, each of which shall constitute an original and all of which, when taken together, shall constitute one agreement. 18. PARTIES BOUND BY AGREEMENT This Agreement is binding upon the parties hereto and upon their respective successors and permitted assigns. IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Agreement as of June 12, 2003. LICENSEE; COLORADO SATELLITE LICENSOR: PLEASURE LICENSING, LLC BROADCASTING, INC. /s/ Michael Weiner /s/ Frank Koretsky - --------------------------------- --------------------------------- By: Michael Weiner By: PLEASURE PRODUCTIONS, INC. /s/ Frank Koretsky --------------------------------- 11 Exhibit "C" PLEASURE LIMITED EDITIONS PLUM LIMITED EDITIONS PLEASURE PRODUCTIONS(R) PLEASURE FOREIGN HIP VIDEO(R) HEAT SEEKER VIDEO(R) TOP HEAVY PRODUCTIONS(R) TORRID VIDEO AUSTRALIAN EROTICA PARLIAMENT VIDEO PHANTOM VIDEO HORNE BOI PRODUCTIONS SCANDINAVIAN VIDEO PRODUCTIONS PLEASURE'S NASTIES MOMENTS(R) VALLEY GIRL COLLECTION OUTLAW PRODUCTIONS AL BORDA VIDEO AL BORDA FOREIGN PLUM PRODUCTIONS(R) WESTERN VISUALS LAS VEGAS VIDEO TOPPERS(R) ROSEBUD PRODUCTIONS ARMAGEDDON ENTERTAINMENT MAYt ZANE PRODUCTIONS BEDTIME PRODUCTIONS TORI WELLS/PAUL NORMAN IN HAND VIDEO SUN FILMS STREET TRASH VIDEO HARDON PRODUCTIONS NEW VISION VIDEO(R) AUGUST WEST PRODUCTIONS DUNGEON VIDEO INTERNATIONAL GRIND `EM OUT PRODUCTIONS IN FURS PRODUCTIONS SHACKLE VIDEO BRUCE 7 By: 12 EX-23 7 s11-4473_ex231.txt EXHIBIT 23.01 Exhibit 23.01 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have issued our report dated May 20, 2004, accompanying the consolidated financial statements and schedule included in the Annual Report of New Frontier Media, Inc. on Form 10-K for the years ended March 31, 2004 and 2003. We hereby consent to the incorporation by reference of said report in the Registration Statement of New Frontier Media, Inc. on Form S-8 (File No. 333-102694). GRANT THORNTON LLP New York, New York May 20, 2004 EX-31 8 s11-4473_ex3101.txt EXHIBIT 31.01 EXHIBIT 31.01 CHIEF EXECUTIVE OFFICER CERTIFICATION I, Michael Weiner, Chief Executive Officer of New Frontier Media, Inc., certify that: 1. I have reviewed this Annual Report on Form 10-K of New Frontier Media, Inc. (the "Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and materially weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Dated: June 14, 2004 /s/ Michael Weiner - ------------------------------------ Chief Executive Officer (Principal Executive Officer) EX-28 9 s11-4473_ex3102.txt EXHIBIT 31.02 EXHIBIT 31.02 CHIEF FINANCIAL OFFICER CERTIFICATION I, Karyn Miller, Chief Financial Officer of New Frontier Media, Inc., certify that: 1. I have reviewed this Annual Report on Form 10-K of New Frontier Media, Inc. (the "Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and materially weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Dated: June 14, 2004 /s/ Karyn L. Miller - -------------------------- Chief Financial Officer (Principal Financial Officer) EX-32 10 s11-4473_ex3201.txt EXHIBIT 32.01 EXHIBIT 32.01 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of New Frontier Media, Inc. (the "Company") on Form 10-K for the year ending March 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael Weiner, Chief Executive Officer of the Company, certify, pursuant to Section 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Michael Weiner - ------------------------------------ Michael Weiner Chief Executive Officer DATED: June 14, 2004 EX-32 11 s11-4473_ex3202.txt EXHIBIT 32.02 EXHIBIT 32.02 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of New Frontier Media, Inc. (the "Company") on Form 10-K for the year ending March 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Karyn L. Miller, Chief Financial Officer of the Company, certify, pursuant to Section 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Karyn L. Miller - ------------------------------------ Karyn L. Miller Chief Financial Officer DATED: June 14, 2004 -----END PRIVACY-ENHANCED MESSAGE-----