10-Q 1 d10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2000 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________. Commission file number: 333-78957 -------------------------- TVN ENTERTAINMENT CORPORATION (Exact name of Registrant as specified in its charter) Delaware 95-4138203 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 2901 West Alameda Avenue, Fifth Floor Burbank, California 91505 (Address of principal executive offices, including zip code) (818) 526-5000 (Registrant's telephone number, including area code) -------------------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [_] There was one share of the Company's Common Stock, par value $.001, outstanding on June 29, 2001. ================================================================================ TVN ENTERTAINMENT CORPORATION TABLE OF CONTENTS

2 PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements TVN Entertainment Corporation Consolidated Balance Sheets (In thousands)

The accompanying notes are an integral part of the financial statements. 3 TVN Entertainment Corporation Consolidated Statements of Operations (In thousands, except per share data) (Unaudited)

The accompanying notes are an integral part of the financial statements. 4 TVN Entertainment Corporation Consolidated Statements of Cash Flows (In thousands) (Unaudited)

5 TVN Entertainment Corporation Notes to Consolidated Financial Statements (In thousands, except share data) (Unaudited) 1. Basis of Presentation The financial statements are unaudited, other than the balance sheet at March 31, 2000, and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the Company's financial condition, operating results and cash flows for the interim periods. Certain items shown in the prior financial statements have been reclassified to conform with the presentation of the current period. Since inception, the Company has incurred operating losses. The Company has a working capital deficit and a total stockholders' deficit of approximately $43.0 million and $265.4 million, respectively at December 31, 2000. In March 2001, the Company completed a recapitalization with its principal shareholder, Morgan Stanley. The recapitalization included the conversion of the Senior Notes into equity, the renegotiation of key vendor relationships and additional funding of new working capital of $23.0 million (see note 8). Additionally, the Company is actively working to restructure its remaining debt, reduce expenses, seek new funding from potential strategic partners as well as expand its new business segments. The ability of the Company to restructure its remaining debt, reduce its expenses, receive funding from potential strategic partners and to achieve positive operating cash flows is uncertain. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result in the Company being unable to continue as a going concern. These financial statements should be read in conjunction with the Company's audited financial statements for the year ended March 31, 2000 and the notes thereto. 2. Commitments and Contingencies Commitments Leases In April 2000, the Company amended one of its capital lease agreements with its satellite transponder vendor by reducing the number of primary C Band transponders leased from eight to two. In June 2000, the Company amended another lease agreement with its satellite transponder vendor by reducing the number of primary C-Band transponders from five to three, adding one reserve C-Band transponder and adding one Ku-Band transponder. The effect of these transactions was to reduce fixed assets and capitalized leases by a non-cash reduction of $14.1 million. In December 2000, the Company amended one of its facilities leases which resulted in changing the classification of the lease from a capital lease to an operating lease. The effect of this transaction was to reduce fixed assets by $10.8 million and capitalized leases and accrued interest by $12.1 million. The balance of $1.3 million was recorded as a deferred gain and will be amortized over the remaining term of the lease. Contingencies The Company was a development stage enterprise from its incorporation in 1987 until March 5, 1991. On March 6, 1991, the Company entered into a limited partnership, TVN Entertainment L.P. (the "Partnership"), comprised of itself as a limited partner and two general partners. The Partnership was an operating entity and was accounted for on the equity basis during the period from March 6, 1991, to May 15, 1992. 6 TVN Entertainment Corporation Notes to Consolidated Financial Statements (In thousands, except share data) (Unaudited) On May 15, 1992, the Company acquired the general partners' interests in the Partnership, which was dissolved pursuant to a partnership dissolution agreement which provided that the Company receive all partnership assets and assume certain liabilities as of the dissolution date for an effective purchase price of $1. These liabilities included notes payable to the former general partners and certain Company shareholders totaling $16.5 million and $1.1 million, respectively. Interest accrues on these obligations at prime plus 1% and totaled $13.1 million and $1.0 million, respectively, at December 31, 2000. Repayment of these loans and related accrued interest (collectively the "Contingent Debt") will be paid on a pari-passu basis out of Available Cash Flow as defined in the Restated Limited Partnership Agreement dated March 7, 1991. The dissolution agreement also provides that the Company will not make any distributions or pay any dividends in respect of its capital stock or other equity interests prior to the payment in full of these obligations to TVN's former general partners and that these obligations will not be subordinated to any debt obligations of the Company. Because payment of these obligations is dependent upon Available Cash Flow, as defined, this debt represents contingent consideration related to the acquisition of net assets. The Company has had and continues to have negative operating cash flows and payment of these obligations does not appear to be probable at this time. Accordingly, these obligations have not been recorded as a liability in accordance with Accounting Principles Board Opinion No. 16, "Business Combinations", because the outcome of the contingency is not determinable beyond a reasonable doubt. The Company will record these obligations when the contingency is resolved. From time to time, the Company has been party to legal and administrative proceedings related to claims arising from its operations in the normal course of business. On the advice of counsel, the Company believes it has adequate legal defenses and believes that the ultimate outcome of these actions will not require large cash outlays. However, based on the Company's current financial condition, there can be no assurance that the impact of any judgment would not be material to the Company's cash flow. 7 TVN Entertainment Corporation Notes to Consolidated Financial Statements (In thousands, except share data) (Unaudited) 3. Operating Segments The Company's operating segments are strategic operating units that are managed separately due to their different products and/or services. The digital cable operating segment markets and sells the Company's Digital Cable Television ("DCTV") service that provides programming content, including up to 32 channels of pay-per-view movies and events. The satellite transmission operating segment markets and sells transponder capacity and uplinking services to the Company's other operating segments and to third parties. The media time sales operating segment, GRTV Network, Inc., sells media time on its 24-hour broadcast network. Panda Shopping Network, Inc. ("PSN"), the Company's home satellite dish service and New Media Network, Inc. have been classified as discontinued operations and are not included in the revenue and operating losses for the Company's operating segments as of December 31, 2000 and 1999. The Company's measure of profit or loss for its operating segments reviewed by the chief operating decision maker and executive management is operating loss, excluding depreciation and amortization (and also excludes interest and other income and expense). The chief operating decision maker does not use asset information. Revenue and operating losses for the Company's operating segments are as follows (in thousands):

(1) Includes charges to the Company's other operating segments for the use of transponder time. (2) Included charges to PSN and the home satellite dish service for transponder and media time which are included in loss from discontinued operations. 8 TVN Entertainment Corporation Notes to Consolidated Financial Statements (In thousands, except share data) (Unaudited) 4. Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." The staff accounting bulletin is effective no later than the fourth quarter of the Company's fiscal year 2001. The Company is in the process of determining the impact that adoption will have on its consolidated financial statements. 5. Earnings Per Share The following table sets forth the computation of basic and diluted net loss per share applicable to common stockholders for the three months ended and nine months ended December 31, 2000 and 1999:

6. Income Taxes As a result of net losses for the three and nine months ended December 31, 2000 and 1999, and the Company's inability to recognize a benefit for its deferred income tax assets, the Company did not record a provision for income taxes as of December 31, 2000 and 1999. 7. Discontinued operations During the nine months ended December 31, 2000, the Company decided to cease operations of PSN and close the segment. The Company has included in the financial statements the estimated loss of $2.7 million for the wind down of PSN operations for the nine months ended December 31, 2000. The loss from discontinued operations for this segment was $2.5 million for the three months ended December 31, 1999 and $5.0 million for the nine months ended December 31, 1999. There were no revenues for the three months ended December 31, 2000 and the nine months ended December 31, 2000. Revenues were $4.0 million for the three months ended December 31, 1999 and $13.8 million for the nine months ended December 31, 1999. 9 TVN Entertainment Corporation Notes to Consolidated Financial Statements (In thousands, except share data) (Unaudited) 7. Discontinued operations (continued) During the nine months ended December 31, 2000, the Company decided to cease operations of the home satellite dish service and close the segment. The Company has included in the financial statements a loss from operations of $440 and an estimated loss on disposal of $300 for the nine months ended December 31, 2000. The loss from discontinued operations for this segment was $817 for the three months ended December 31, 1999 and $3.3 million for the nine months ended December 31, 1999. There were no revenues for the three months ended December 31, 2000 and the nine months ended December 31, 2000. Revenues were $3.6 million for the three months ended December 31, 1999 and $11.6 million for the nine months ended December 31, 1999. During the nine months ended December 31, 2000, the Company decided to cease operations of New Media Network. The Company has included in the financial statements a loss from operations of $4.0 and an estimated loss on disposal of $3.9 for the nine months ended December 31, 2000. The loss from discontinued operations for this segment was $1.5 million for the three months ended December 31, 1999 and $2.3 million for the nine months ended December 31, 1999. There were no revenues for the three months ended December 31, 2000 and $135 for the nine months ended December 31, 2000. Revenues were $14 for the three months ended December 31, 1999 and $230 for the nine months ended December 31, 1999. The Company has presented the operations of these segments as discontinued operations for all periods presented. 8. Subsequent Events On March 30, 2001, the Company closed a recapitalization, including without limitation a 192.3 reverse stock split and a reclassification and subdivision of the Company's then-existing common stock and then-existing preferred stock, as well as the issuance of new common stock and new preferred stock. As part of the recapitalization: (a) each holder of our 14% senior notes due 2008 and associated warrants exchanged those securities for shares of new series a preferred stock; (b) an additional investor subscribed for shares of new series a preferred stock; (c) members of the Company's management received shares of new series b preferred stock; and (d) our then outstanding common stock and preferred stock were subdivided and reclassified into, and exchanged for, shares of new preferred stock and one investor was issued one share of new common stock. As a result of these transactions, among other things, the indenture underlying the Senior Notes and related documentation including a pledge agreement were terminated, and approximately $23.0 million pledged thereunder were released back to the Company. Additionally, in connection with the recapitalization of the Company in March 2001 and in efforts to improve its financial position, the Company renegotiated down a portion of its outstanding liabilities with a number of its key vendors. As a result of these renegotiations, the Company was able to obtain forgiveness of amounts owed of approximately $23.0 million. In March 2001, the Company amended one of its lease agreements with its satellite transponder vendor which consisted of the return of two analog transponders as well as one Ku-Band transponder. 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THIS FILING IS QUALIFIED IN ITS ENTIRETY BY THE RESTRUCTURING AND RECAPITALIZATION DESCRIBED IN NOTE 8 (SUBSEQUENT EVENTS) TO THE FINANCIAL STATEMENTS FILED HEREWITH. RESULTS OF OPERATIONS In addition to the other information in this report, certain statements in the following Management's Discussion and Analysis of Financial Condition and Results of Operation (MD&A) are forward looking statements. When used in this report, the word "expects," "anticipates," "estimates," and similar expressions are intended to identify forward looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties are set forth below under "Factors Affecting Future Results." The following discussion should be read in conjunction with the Consolidated Financial Statements and notes thereto included elsewhere in this report. Overview Our business plan contemplates that a substantial portion of future revenues will be generated by our Video-On-Demand business and our Digital Content Express business. Video-on-Demand (VOD) is a subset of the broader Content-on-Demand market, which includes products such as Subscription Video-on-Demand, News-on-Demand and various syndication products. These products all require content to be loaded onto geographically-dispersed servers, which can then be accessed by the end-user customer. This service allows consumers to view video content through their cable systems with full VCR functionality (i.e., the ability to start, pause, rewind, fast-forward, etc., whenever they wish). Providing this service requires the ability to distribute professional grade digital video content to cable head-ends and other VOD operators in a highly secure manner, and to manage the real-time distribution of this content as required by the customer. The distribution, monitoring and management of such content are among our core competencies. We are also currently in the process of re-positioning ourself for our new Digital Content Express (DCX) business, whose primary goal is to be a leading system for the delivery and management of digital content, including Video-on-Demand. With our DCX Service, customers such as movie studios, television and Internet programmers and other content originators and distributors, will be able to send content to us in any format and have us convert it to digital format for shipment by us anywhere in the world. Our existing integrated, end-to-end content management and delivery capabilities are sufficient to offer this service within the United States, but providing global coverage will require additional satellite transmitter capacity. Regardless of the geographic points of delivery, the Company's sophisticated ADONISS Content Management System allows all content deliveries to be remotely controlled, scheduled and managed from the Company's Burbank, California Digital Network Operations Center. Content will remain within our transmission system end-to-end, thereby facilitating content security and reliability. Our Video-On-Demand business and our Digital Content Express business have not commercially launched and have generated no revenues to date. We believe that our future ability to service our indebtedness and to achieve profitability is dependent upon our success in generating substantial revenues from our Video-on-Demand and Digital Content Express businesses. We expect to continue experiencing negative operating margins and EBITDA while our Video-on-Demand and Digital Content Express businesses are being marketed to cable systems and content originators and distributors. The continued roll out of our Video-on-Demand and Digital Content Express businesses requires significant capitalized lease payments for satellite transmitter capacity and operating expenditures, in particular selling expenses, a large portion of which will be expended before any revenue is generated. We have experienced negative operating cash flows and significant losses as we have marketed our historical businesses. These losses will likely continue until we can establish a customer base of cable systems and content originators and distributors that will generate revenue sufficient to cover our costs. 11 Results of Operations The table below sets forth for the periods indicated certain data regarding expenses expressed as a percentage of total revenues:

Three Months Ended December 31, 2000 Compared with Three Months Ended December 31, 1999 Revenue. Total revenue increased $2.1 million, or 19.1%, to $13.1 million in the three months ended December 31, 2000 from $11.0 million in the three months ended December 31, 1999. The increase was primarily attributable to an increase in revenues generated by the GRTV Network for media time, partially offset by a slight decrease in Marquee Mix revenues for the three months ended December 31, 2000 as compared to the three months ended December 31, 1999. Operating Expenses Cost of Revenue. Cost of revenue increased $1.2 million, or 13.8%, to $9.9 million in the three months ended December 31, 2000 from $8.7 million in the three months ended December 31, 1999 and, as a percentage of revenue, decreased to 75.8% in the three months ended December 31, 2000 from 78.5% in the three months ended December 31, 1999. The increase in absolute dollars is primarily attributable to fixed costs such as uplink expenses that were previously absorbed by the home shopping and home satellite dish business units in the three months ended December 31, 1999 that were not eliminated upon discontinuing the operations of these business units in during the nine months ended December 31, 2000. The decrease as a percentage of revenue is primarily attributable to the increase in revenue. Selling. Selling expenses increased $0.4 million, or 16.7%, to $2.8 million in the three months ended December 31, 2000 from $2.4 million in the three months ended December 31, 1999, and as a percentage of revenue, increased to 21.7% in the three months ended December 31, 2000 from 21.3% in the three months ended December 31, 1999. The increase in absolute dollars and as a percentage of revenue is primarily attributable to increased expenditures incurred to market and sell GRTV Network media time and new programming movie and event content to cable systems. 12 General and Administrative. General and administrative expenses increased $2.8 million, or 116.7%, to $5.2 million in the three months ended December 31, 2000 from $2.4 million in the three months ended December 31, 1999 and, as a percentage of revenue, increased to 40.0% in the three months ended December 31, 2000 from 21.6% in the three months ended December 31, 1999. The increase in absolute dollars and as a percentage of revenue is primarily due to increased payroll and associated costs, as well as increased legal and other professional fees incurred to pursue strategic financial initiatives contemplated by management, including the restructuring of our existing debt, raising of additional capital and seeking-out of new funding from potential strategic partners. Depreciation and Amortization. Depreciation and amortization decreased $1.0 million, or 27.8%, to $2.6 million in the three months ended December 31, 2000 from $3.6 million in the three months ended December 31, 1999. The decrease is primarily attributable to the decrease in property and equipment resulting from the amendments to our capitalized leases for satellite transmitters in the three months ended June 30, 2000. Amortization of Intangible Assets. Amortization of intangible assets decreased $0.2 million or 18.2% to $0.9 million in the three months ended December 31, 2000 from $1.1 million in the three months ended December 31, 1999. The decrease is primarily attributable to the write-off of goodwill as of March 31, 2000 associated with the Panda Shopping Network acquisition. Interest Expense/Interest Income. Interest expense decreased $0.8 million or 7.7%, to $9.6 million in the three months ended December 31, 2000 from $10.4 million in the three months ended December 31, 1999. The decrease is attributable to the redemption of approximately $33.9 million of senior notes in October 1999. Interest income decreased $0.7 million or 63.6%, to $0.4 million in the three months ended December 31, 2000 from $1.1 million in the three months ended December 31, 1999. The decrease is attributable to lower operating cash balances during the three months ended December 31, 2000 as compared to the three months ended December 31, 1999. Loss from Discontinued Operations. During the nine months ended December 31, 2000, we ceased operations of the Panda Shopping Network ("PSN") and closed the division. We have reflected the operations of PSN as a discontinued operation. Operating losses for PSN totaled zero and approximately $2.5 million for the three months ended December 31, 2000 and 1999, respectively. During the nine months ended December 31, 2000, we ceased operations of our home satellite dish operating segment and closed the division. We have reflected the operations of the home satellite dish operating segment as a discontinued operation. Operating losses for the home satellite dish operating segment totaled zero and $0.8 million for the three months ended December 31, 2000 and 1999, respectively. During the nine months ended December 31, 2000, we ceased operations of New Media Network ("NMN"). We have reflected the operations of NMN as a discontinued operation. Operating losses for NMN totaled $0.6 million and $1.5 million for the three months ended December 31, 2000 and 1999, respectively. Estimated Loss on Disposal of Discontinued Operations. For the three months ended December 31, 2000, we recorded an estimated loss on disposal of PSN of $0.6 million and $3.9 million for the loss on disposal for NMN. Provision for Income Taxes. As a result of net losses and the Company's inability to recognize a benefit for its deferred income tax assets, the Company did not record a provision for income taxes in the three months ended December 31, 2000 or the three months ended December 31, 1999. Nine Months Ended December 31, 2000 Compared with Nine Months Ended December 31, 1999 13 Revenue. Total revenue increased $9.9 million, or 36.9%, to $36.7 million in the nine months ended December 31, 2000 from $26.8 million in the nine months ended December 31, 1999. The increase was primarily attributable to an increase in revenues generated by the GRTV Network for media time for the nine months ended December 31, 2000 as compared to the nine months ended December 31, 1999. GRTV Network generated revenue for only six of the nine months ended December 31, 1999 as the Company acquired its interest in the GRTV Network on July 1, 1999. Operating Expenses Cost of Revenue. Cost of revenue increased $7.6 million, or 32.5%, to $31.0 million in the nine months ended December 31, 2000 from $23.4 million in the nine months ended December 31, 1999 and, as a percentage of revenue, decreased to 84.5% in the nine months ended December 31, 2000 from 87.1% in the nine months ended December 31, 1999. The increase in absolute dollars is primarily attributable to the inclusion of the operations of GRTV Network for nine of the nine months ended December 31, 2000 as compared to six of the nine months ended December 31, 1999. We acquired our interest in GRTV Network on July 1, 1999. The decrease, as a percentage of revenue, is primarily attributable to the slightly higher margins realized by GRTV Network as compared to our other operating segments for the full nine months ended December 31, 2000 as compared to only six months during the nine months ended December 31, 1999. Selling. Selling expenses increased $1.3 million or 19.1%, to $8.1 million in the nine months ended December 31, 2000 from $6.8 million in the nine months ended December 31, 1999 and, as a percentage of revenue, decreased to 22.1% in the nine months ended December 31, 2000 from 25.4% in the nine months ended December 31, 1999. The increase in absolute dollars is primarily attributable to the inclusion of operations of GRTV Network for the full nine months ended December 31, 2000 as compared to only six months during the nine months December 31, 1999. The decrease as a percentage of revenue is due to the increase in revenue for the nine months ended December 31, 2000 as compared to the nine months ended December 31, 1999. General and Administrative. General and administrative expenses increased $5.5 million, or 69.6%, to $13.4 million in the nine months ended December 31, 2000 from $7.9 million in the nine months ended December 31, 1999 and, as a percentage of revenue, increased to 36.5% in the nine months ended December 31, 2000 from 29.6% in the nine months ended December 31, 1999. The increase in absolute dollars and as a percentage of revenue is primarily due to the inclusion of GRTV Network for the full nine months ended December 31, 2000 as compared to only six months during the nine months ended December 31, 1999, increased payroll and associated costs including signing bonuses to new management and increased legal, accounting and other professional fees incurred to pursue strategic financial initiatives. Depreciation and Amortization. Depreciation and amortization decreased $2.4 million, or 23.5%, to $7.8 million in the nine months ended December 31, 2000 from $10.2 million in the nine months ended December 31, 1999. The decrease is primarily attributable to the decrease in property and equipment resulting from the amendments to our capitalized leases for satellite transmitters in the three months ended June 30, 2000. Amortization of Intangible Assets. Amortization of intangible assets increased $0.1 million to $2.4 million in the nine months ended December 31, 2000 as compared to $2.3 million in the nine months ended December 31, 1999. The increase is attributable to the amortization of goodwill generated upon the acquisition of our interest in GRTV on July 1, 1999, offset by a reduction in amortization expense as a result of the write-off of goodwill as of March 31, 2000 associated with the Panda Shopping Network acquisition. Interest Expense/Interest Income. Interest expense decreased $3.2 million, or 9.9%, to $29.1 million in the nine months ended December 31, 2000 from $32.3 million in the nine months ended December 31, 1999. The decrease is primarily attributable to the redemption of $33.9 million in senior notes in October 1999. Interest income decreased $2.8 million, or 60.9%, to $1.8 million in the nine months ended December 31, 2000 from $4.6 million in the nine months ended December 31, 1999. The decrease is attributable to lower operating cash balances during the nine months ended December 31, 2000 as compared to the nine months ended December 31, 1999. 14 Loss from Discontinued Operations. During the nine months ended December 31, 2000, we ceased operations of the Panda Shopping Network ("PSN") and closed the division. We have reflected the operations of PSN as a discontinued operation. Operating losses for PSN totaled zero and approximately $5.0 million for the nine months ended December 31, 2000 and 1999, respectively. During the nine months ended December 31, 2000, we ceased operations of our home satellite dish operating segment and closed the division. We have reflected the operations of the home satellite dish operating segment as a discontinued operation and have recorded a loss from operations of the segment totaling $0.4 million and $3.3 million for the nine months ended December 31, 2000 and 1999, respectively. During the nine months ended December 31, 2000, we ceased operations of New Media Network ("NMN"). We have reflected the operations of NMN as a discontinued operation. Operating losses for NMN totaled 4.0 and $2.3 million for the nine months ended December 31, 2000 and 1999, respectively. Estimated Loss on Disposal of Discontinued Operations. For the nine months ended December 31, 2000, we recorded an estimated loss on disposal of PSN of $2.7 million, $0.3 million for the loss on disposal of the home satellite dish operating segment and $3.9 million for the loss on disposal for NMN. Provision for Income Taxes. As a result of net losses and the Company's inability to recognize a benefit for its deferred income tax assets, the Company did not record a provision for income taxes in the nine months ended December 31, 2000 or the nine months ended December 31, 1999. 15 Liquidity and Capital Resources The Company has been funded through a combination of equity, debt and lease financing. As of December 31, 2000, the Company had current assets of $36.3 million, including $6.5 million of cash and cash equivalents and current liabilities of $79.2 million, resulting in a working capital deficit of approximately $43.0 million. The Company invests excess funds in short-term, interest bearing investment grade securities until such funds are needed to fund the operating needs and capital expenditures of the Company's business. Since inception, we have incurred operating losses and as of December 31, 2000, have a total deficit of $ 288.2 million. In March 2001, we completed a recapitalization with our principal shareholder, Morgan Stanley. The recapitalization included the conversion of the Senior Notes into equity, the renegotiation of key vendor relationships and additional funding of new working capital of $23.0 million (as described in note 8 (subsequent events) to the financial statements filed herewith). Additionally, we are actively working to restructure our existing debt, reduce expenses, seek new funding from potential strategic partners as well as expand our new business segments. Our ability to restructure our existing debt, reduce our expenses, receive funding from potential strategic partners and to achieve positive operating cash flows is uncertain. We believe that current cash on hand and cash that may be generated from operations will be sufficient for us to fund our operating deficits through October 2001. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. If current cash on hand and cash that may be generated from operations are insufficient to satisfy our liquidity requirements, we will likely seek to sell additional equity or debt securities or to obtain a line of credit. In addition, we will from time to time consider the acquisition of or investment in complimentary businesses, products, services and technologies which might impact our liquidity requirements or cause us to issue additional debt or equity securities. There can be no assurance that financing will be available in amounts or on terms acceptable to us, if at all. Cash Used For Operating Activities The Company's operating activities used $28.3 million and $38.5 million in the nine months ended December 31, 2000 and 1999, respectively. Cash used for operations in the nine months ended December 31, 2000 is primarily attributable to the net loss of $65.5 million, partially offset by non-cash expenses such as depreciation and amortization and accretion of note discount, other changes in working capital items such as accrued interest and accounts payable and net cash used for discounted operations of $3.0 million. Cash used for operations in the nine months ended December 31, 1999 is primarily due to the net loss of $42.6 million and gain on senior note redemption of $20.0 million, partially offset by non-cash expenses such as depreciation and amortization and accretion of note discount, other changes in working capital items and net cash used for discontinued operations of $10.3 million. Cash Provided From and Used For Investing Activities Cash provided from investing activities was $11.0 million and $15.0 million in the nine months ended December 31, 2000 and 1999, respectively. Cash provided from investing activities for the nine months ended December 31, 2000 primarily consisted of approximately $10.5 million in proceeds from the maturity of securities purchased as security for the senior notes and proceeds from restricted cash released from restriction of $1.4 million, partially offset by $1.5 million used for capital expenditures. Cash provided from investing activities for the nine months ended December 31, 1999 primarily consists of approximately $20.7 million in proceeds from the maturity of securities purchased as security for the senior notes, partially offset by $4.0 million used for capital expenditures. Cash Used For Financing Activities Cash used for financing activities was $2.8 million and $23.6 million in the nine months ended December 31, 2000 and December 31, 1999, respectively. Cash used for financing activities for the nine months ended December 31, 2000 consists of capitalized lease payments and repayments of notes payable totaling $1.7 million and $1.1 million, respectively. Cash used for financing activities for the nine months ended December 31, 1999 consists of repurchase of senior notes and warrants of $11.8 million as well as repayments of capitalized leases and notes payable totaling $5.7 million and $6.2 million, respectively. 16 THIS FILING IS QUALIFIED IN ITS ENTIRETY BY THE RESTRUCTURING AND RECAPITALIZATION DESCRIBED IN NOTE 8 (SUBSEQUENT EVENTS) TO THE FINANCIAL STATEMENTS FILED HEREWITH. Factors Affecting Future Results We anticipate that our existing capital and cash from operations may be inadequate to satisfy our capital requirements beyond October 2001. Our cash on hand and amounts expected to be available through vendor financing arrangements may not be sufficient for us to expand our digital content businesses, new or existing, as currently planned and to fund our operating deficits beyond October 2001. We cannot be certain, moreover, that we will not require additional capital sooner than currently anticipated. We are currently engaged in a coordinated mutual effort with our investment banker, Morgan Stanley Dean Witter, to restructure our existing debt and/or raise additional capital through a private placement of new securities. We are seeking new funding from potential strategic partners, and from financial entities such as venture capital funds and investment companies or from the sale of the business. However, we are unable to predict the precise amount of future capital that we will require and whether additional financing will be available on acceptable terms or at all. Our inability to obtain required financing could significantly reduce the value of our business assets and impair our ability to continue the normal operation of our business. Consequently, we could be required to significantly reduce or suspend our operations. We have substantial existing debt and may incur substantial additional debt which could adversely affect our financial health and prevent us from fulfilling our obligations under the notes. We have borrowed a significant amount of funds. As of December 31, 2000, we had outstanding indebtedness of approximately $319.1 million and a stockholders' deficit of approximately $265.4 million. We cannot be certain that our operations will generate sufficient cash flow to pay our obligations, including our obligations on the notes issued by us in our 1998 debt financing ("the notes"). Earnings were inadequate to cover fixed charges by the amount of $54.6 million and $76.6 million, for the years ended March 31, 1999 and March 31, 2000, respectively, and $53.8 million for the nine months ended December 31, 2000. The degree to which we have borrowed funds could have important consequences. For example, it could: . make it more difficult for us to satisfy our obligations with respect to the notes and to satisfy our obligations under other indebtedness; . increase our vulnerability to general adverse economic and cable industry conditions, including interest rate fluctuations; . require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, which will reduce our funds available for working capital, capital expenditures, acquisitions of additional systems and other general corporate requirements; . limit our flexibility in planning for, or reacting to, changes in our business and the cable industry generally; . Place us at a competitive disadvantage compared to our competitors that have proportionately less debt; . limit our ability to borrow additional funds, if we need them, due to applicable financial and restrictive covenants in our indebtedness; and . increase our interest expenses above current levels due to increases in interest rates, since much of our borrowings are and will continue to be at variable rates of interest; and . limit our ability to redeem the notes in the event of a change of control. We may also incur additional indebtedness to finance the continued development, commercial deployment and expansion of our businesses and for funding operating losses or to take advantage of unanticipated opportunities. 17 Absent a restructuring of our existing debt, we will not be able to service our indebtedness. Absent a restructuring of our existing debt, we will not be able to fully service and make any payments due on our indebtedness beyond the near future. We cannot be certain that we will be successful in developing and maintaining positive cash flow from operations. If we are unable to generate sufficient cash flow from operations and financings we may have to reduce or delay the deployment of our digital content express services. We cannot be certain that any or additional debt or equity financings can be accomplished on satisfactory terms, if at all. If we cannot restructure our existing debt, there will likely be a default under the indenture and could cause a default under agreements governing our other indebtedness. In the event of default, the holders of our indebtedness would have enforcement rights, including the right to accelerate our debt and the right to commence an involuntary bankruptcy proceeding against us. Accordingly, upon any default, insolvency, bankruptcy or similar situation, we may have only limited assets remaining after paying the prior claims of our secured creditors and may be unable to repay the notes. We have incurred net losses in every fiscal year since inception. We may be unable to become profitable, or to be so consistently. We experienced net losses of $29.9 million, $53.8 million and $72.7 million in fiscal 1998, fiscal 1999 and fiscal 2000, respectively, and $65.5 million for the nine months ended December 31, 2000. These net losses are attributable to the significant costs incurred to develop, market and implement our TVN Digital Cable Television business plan and to develop, install and integrate our digital programming and services. We expect that net losses will continue and increase for the foreseeable future as we plan to continue to incur substantial sales and marketing expenses to build our customer base and make substantial capitalized lease payments for our satellite transponders. We have not achieved profitability on a quarterly or annual basis, and we anticipate that we will continue to incur net losses for at least the next several years. We also expect to continue to incur significant product development and administrative expenses. We cannot be certain that any of our business strategies will be successful or that significant revenues or profitability will ever be achieved or, if they are achieved, that they can be consistently sustained or increased on a quarterly or annual basis in the future. Our existing capital and cash from operations may be inadequate to satisfy obligations resulting from the discontinuance of certain of our business units. We have discontinued or scaled back certain businesses and operations, resulting in the layoff of a significant number of employees and the termination or renegotiation of existing affiliate contracts, written and oral, with vendors, suppliers and affiliates. We have taken certain accounting charges therefore on our financial statements, but we may incur substantial additional liabilities, costs and expenses in connection with the (i) shutdown or reduced operations of such businesses, (ii) layoff of employees and (iii) termination and/or renegotiation of existing contracts. We cannot be certain that the additional funds currently anticipated for such obligations will be available to us as and when needed. This may result in claims being asserted by such employees, vendors, suppliers and/or affiliates, which could lead to litigation against us, or the commencement of an involuntary bankruptcy proceeding, if we are unable to satisfy such obligations as they come due. We are a holding company for our subsidiaries and will depend on our subsidiaries for repayment of the notes. The notes are our obligations exclusively. As separate and distinct legal entities, our subsidiaries have no obligation to pay any amounts due under the notes or to make any distributions or other payments to us to enable us to repay the notes. We anticipate that in the future a significant portion of our operations will be conducted through our direct and indirect subsidiaries. Our cash flow and, consequently, our ability to repay our indebtedness, including the notes, may therefore depend in part upon our subsidiaries making payments of dividends, distributions, loans or other payments to us. 18 We anticipate that our subsidiaries may become parties to financing arrangements, including secured financing arrangements. Such financing arrangements will likely restrict our subsidiaries' ability to pay dividends or distributions, or make loans or other payments to us. Because our subsidiaries are not guarantors of the notes, holders of the notes will not have any direct claim on assets of any of our subsidiaries in the event of our liquidation or reorganization. The indenture permits us to make substantial investments in our subsidiaries. However, unless we make loans or extend credit to our subsidiaries, our only claim, and consequently the only claim of holders of the notes, to the assets of our subsidiaries would be through our equity. Our equity claim and any claim of holders of our notes would be effectively subordinated to all of our subsidiaries' indebtedness and liabilities, including trade payables and subordinated debt. Even if we do extend credit to our subsidiaries, our claims could be subordinated to other indebtedness of our subsidiaries. The indenture permits our subsidiaries to incur substantial additional indebtedness. The notes are unsecured and will be effectively subordinated to secured debt. The notes are unsecured and therefore will be effectively subordinated to any secured indebtedness we incur with respect to the assets securing such indebtedness. The indenture permits us and our subsidiaries to incur secured indebtedness to finance, among other things, the acquisition of equipment, inventory and network assets. The holders of secured indebtedness will have claims against the assets that constitute their collateral which will be prior to the claims of unsecured creditors, including holders of the notes. The prior claims of secured creditors could adversely effect the holders of the notes in any of the following events: o in the event of default under other indebtedness or the indenture, any holders of our secured . indebtedness would have certain rights to repossess, foreclose upon and sell the assets securing that indebtedness; . in the event that we became subject to bankruptcy, liquidation, dissolution, reorganization or similar, the holders of our secured indebtedness will be entitled to receive proceeds from the sale and other distributions in respect of their collateral prior to payments to other creditors, including holders of the notes; . to the extent that the collateral is insufficient to repay all of our secured indebtedness, the holders of our secured indebtedness would have a claim for any shortfall that would rank equally in priority with the notes. Accordingly, upon any default, insolvency, bankruptcy or similar situation, we may have only limited assets remaining after paying the prior claims of our secured creditors and may be unable to repay the notes. The indenture governing the notes contains restrictions and limitations which could significantly impact our ability to operate our business and repay the notes. The indenture governing the notes contains a number of significant covenants that, among other things, restrict our ability and the ability of our subsidiaries: . to pay dividends or distributions to our shareholders; . to dispose of assets or merge; . to incur or guarantee additional indebtedness; . to redeem or repurchase our equity or subordinated debt; . our subsidiaries' ability to issue equity; . to create liens; 19 . to enter into certain kinds of transactions; and . to make certain investments or acquisitions, particularly with our stockholders and affiliates. The ability to comply with these provisions may be affected by events beyond our control. The breach of any of these covenants will result in an event of default under the indenture. Our historical financial information largely reflects losses sustained from our digital cable programming and service business, so it may be of limited use in predicting the future financial results from our new businesses. Our current business plans will result in significant changes in our financial performance. The historical financial information included herein for the fiscal years ending 1996 to 1999 primarily reflects our large home satellite dish and digital cable television businesses. The historical financial information for the fiscal years ended 1999 and 2000 does not fully reflect the many significant changes in our financial results that will occur as a result of the launch of our digital content delivery and video-on-demand products and services, nor the changes that will occur in our funding and operations in connection with the such launch and roll-out. The continued roll out of these new products and services requires significant operating expenditures, particularly marketing expenses, a large portion of which are expended before any revenue is generated. We plan to significantly increase our operating expenses to expand our sales and marketing operations, broaden our digital content and video-on-demand products and services, develop new distribution channels, fund greater levels of research and development and establish additional strategic alliances. We have experienced, and expect to continue experiencing, negative cash flows and significant losses while we continue to market these new products and services to establish a sufficient revenue generating customer base, end users and other customers. We cannot be certain that we will be able to successfully roll out these new products and services or establish a sufficient customer base. Our operations are influenced by many factors we cannot fully control. This may cause our quarterly financial results to vary significantly in the future. Factors which can cause our quarterly results to fluctuate include, but are not limited to: . failure to add customers for our new digital content products and services; . customer expenditures and other costs relating to the expansion and penetration of their respective digital content offerings; . failure to maintain our affiliates for our existing DCTV and PPV Feeds businesses; . seasonal trends in home entertainment; . the mix of satellite delivered digital content products and services sold and the distribution channels for those products and services; . with respect to our planned digital content delivery and management business, our ability to react quickly to changing customer trends and the need for some categories of such products and services; . the general expansion of the digital content transmission and business-to-business categories of services; . general economic conditions; and . specific economic conditions in the digital content, video-on-demand, digital cable television, Internet and related industries. 20 Additionally, as a strategic response to a changing competitive environment, we may elect from time to time to make pricing, service, product, marketing or acquisition decisions that could reduce our revenues and our quarterly financial results. Moreover, because our expense levels in any given quarter are based, inpart, on management's expectations regarding future contracts for these new products and services and the revenue to be derived therefrom, if such revenues are below expectations, the effect on our operating results may be magnified by our inability to adjust spending in a timely manner to compensate for a revenue shortfall. The extent to which expenses are not subsequently followed by increased revenues would reduce our operating results and could seriously impair our business. As a result of these and other factors, we believe that period to period comparisons of our operating results may not be meaningful and should not be relied upon as an indication of future performance. Due to all of the foregoing factors, it is likely that in one or more future quarters, our operating results may be below the expectations of analysts and investors, which could cause the value of the notes to fall. If we fail to achieve a significant customer base for our new digital content delivery and video-on demand products and services, we may be unable to cover our costs or to repay the notes. The continued roll out of our digital content delivery and video-on-demand products and services requires significant operating expenditures, in particular selling expenses, a large portion of which will be expended before any revenue is generated. We have experienced, and expect to continue experiencing, negative cash flows and significant losses while we continue to market our digital cable television programming and services and it remains unlikely that we will establish a customer base of cable operators and their subscribers that will generate revenue sufficient to cover these costs. We cannot be certain that we will be able to successfully roll out our new digital content delivery and video-on-demand products and services or establish a sufficient VOD customer base therefore, or that we will generate significant revenues from our digital cable programming, video-on-demand, or electronic commerce products and services. If we fail to adequately address any of these risks, it could harm our business, financial condition and results of operations. Until late 1997, our efforts focused on providing national satellite pay-per-view and related services to large home satellite dish owners, however, since then we have devoted an increasing percentage of our personnel and financial resources, and will need to continue to devote some more resources, to the our digital cable television business, the related transactional services and delivery systems, and our electronic commerce products and services. Although our digital cable programming and services launched in late 1997, it has thus far generated only modest revenues. In fiscal 2000, $16.0 million of our total revenues were derived from our digital cable programming and services. We believe that our future ability to service our indebtedness including the notes, and to achieve profitability, is dependent upon our success in generating substantial revenues from our new digital content delivery and video-on-demand products and services. We expect to continue experiencing negative operating margins and EBITDA while our Video-on-Demand and Digital Content Express businesses are being marketed to cable systems and content originators and distributors. Because our new Digital Content Express and Video-on-Demand products and services must succeed in markets new to us, we may encounter difficulties achieving the level of revenue we have forecast for these businesses. These new products and services will need to find acceptance in new and newly evolving markets. We expect to expend and will continue to expend substantial sums for our sales and marketing efforts to promote customer and subscriber awareness of our Digital Content Express (DCX) and Video-on- Demand (VOD) products and services. The digital content delivery and VOD markets are new, but rapidly evolving. Therefore, it is difficult to predict the rate at which these markets will grow, if at all. If these markets fail to grow, or grow more slowly than anticipated, our sales will be lower than expected and our operating results will be harmed. Even if the markets do grow, we cannot be certain that these products and services will realize market acceptance or will meet the technical or other requirements of cable operators or their subscribers. The failure of our DCX or VOD Services to gain market acceptance would cause our sales to be lower than expected and seriously harm our business prospects. Our marketing efforts to date with regard to our DCX and VOD products and services have involved identifying specific market segments that we believe will be the most receptive to these products and services. We cannot be certain that we have correctly identified these markets or that our DCX and/or VOD products and services will adequately address the needs of these markets. 21 Broad commercialization of our digital cable programming and services will require us to overcome significant market development hurdles, many of which may not currently be foreseen. Our success will depend in large part on our ability to sign long-term agreements with cable operators to implement our Video-on-Demand Service and with digital content distributors to utilize our DCX products and services. To date, we have entered into agreements with only two affiliates in which we have an equity interest for our DCX services and we do not yet have an agreement with a cable operator, or other entity, for delivery of our VOD products and services. Our ability to obtain additional agreements will depend upon, among other things, the successful commercial deployment of our DCX products and services pursuant to our initial agreements and our ability to demonstrate that our digital VOD programming and services are reliable and more attractive to cable operators and their subscribers than alternative VOD services. We cannot be certain that we will be able to enter into new agreements with non-affiliated customers or that the ongoing economic viability of our DCX or VOD products and services will be successfully demonstrated. We do not set the prices charged by cable operators to their subscribers for VOD service or for the pay-per-view movies and events so delivered. The level at which such prices are set may adversely affect the number of subscribers and/or the rate at which subscribers purchase VOD delivered pay-per-view movies or events. Therefore, we cannot be certain that we will be able to achieve projected rates of return. The market for digital VOD programming and services is new, and our VOD Service is only one possible means available to cable operators for providing pay-per-view movies and events in the home. Although we believe that our new VOD Service offers a comprehensive and economically viable digital cable solution, we cannot be certain that we will be successful in obtaining a sufficient number of cable operators or other distributors of VOD programming and services who are willing: . to be early adopters of new technology rather than waiting for widespread industry implementation; . to risk subscriber dissatisfaction if the removal of existing analog channels is required to accommodate new digital VOD channels that will only be available to digital subscribers and not to the system's entire subscriber base; . to bear the costs of purchasing new digital television set-top cable boxes and installing and supporting required receiving equipment at their facilities; or . to sign and remain party to long-term agreements with us for our digital VOD programming and services, including an arrangement to share revenue from pay-per-view movie and event buys. Our failure to enter into or to sustain additional long-term agreements with cable operators or other distributors of digital cable television and/or VOD programming and services, and/or their lack of acceptance of such programming and services, would harm our operating results and our ability to achieve sufficient cash flow to service our indebtedness, including the notes. Selling and installing our Video-on-Demand service may require lengthy sales and implementation cycles, with delays that could cause actual revenue and earnings to be less than expected. The decision by a cable or other VOD operator to deploy our VOD service is often viewed as an important and strategic decision that may require us to engage in a lengthy sales cycle. During this process, we will provide a significant level of explanation to prospective cable and other VOD operators regarding the use and benefits of our digital VOD programming and services to cable and other VOD operators and their respective subscribers. Additionally, the sales cycle can be delayed by the size of the transaction and prospective implementation costs including purchasing, installing and maintaining new digital television set-top cable boxes, installing and supporting required digital server and related equipment at the operator's facility, as well as the potential complexity of financing or other arrangements. The cable operator's implementation of our VOD service involves a significant commitment of resources over an extended period of time which may lead prospective operators to defer indefinitely the decision to implement our VOD service or to delay implementation despite having agreed to do so. For these and other reasons, the sales and customer implementation cycles are subject to significant delays over which we have little 22 or no control. Delay in the sale or implementation of even a limited number of our VOD system installations would reduce our operating results and could harm our business prospects. Because we expect cable operator agreements to generate a significant portion of our Video-on-Demand revenue, the loss or deferral of even a small number of agreements could cause our operating results to vary significantly. We expect that a significant portion of our future VOD revenues will be generated from long-term agreements with cable operators. A delay in generating or recognizing revenue from a limited number of these agreements could cause significant variations in our operating results and could result in further operating losses. We expect to recognize revenues under our cable operator agreements only when our VOD Service is successfully integrated and operating and subscriber billing by the operator commences. Accordingly, the recognition of revenues will lag the announcement of a new cable operator agreement by at least the time necessary to install the VOD Service and to achieve a meaningful number of subscribers and/or the rate at which subscribers purchase pay-per-view movies or events offered in a VOD format. We expect that the number and timing of such cable operator agreements and the effect of anticipated lagging revenues, all of which are difficult to forecast, may cause significant fluctuations in our operating results, particularly on a quarterly basis. Because we expect our agreements with digital content originators and distributors to generate a significant portion of our Digital Content Express and management service revenue, the loss or deferral of even a small number of agreements could cause our operating results to vary significantly. We expect that a significant portion of our future DCX content delivery and management service revenues will be generated from long-term agreements with digital content originators, programmers and distributors. A delay in generating or recognizing revenue from a limited number of these agreements could cause significant variations in our operating results and could result in further operating losses. We expect to recognize revenues under our such agreements only when our DCX products and services are successfully integrated and operating. Accordingly, the recognition of revenues will lag the announcement of a new agreement by at least the time necessary to implement the specific DCX service and to achieve a meaningful number of customers. We expect that the number and timing of such agreements and the effect of any lagging revenues, all of which are difficult to forecast, may cause significant fluctuations in our operating results, particularly on a quarterly basis. We will operate in highly competitive markets and will face intense competition from existing and potential competitors, which could limit our ability to gain market share. Our competitors for DCX and VOD products and services include a broad range of companies engaged in communications and home entertainment, including small dish satellite services and programming providers, wired and wireless cable operators, Internet operators, television programmers, music, entertainment and other digital content distributors, broadcast television networks, home video companies featuring videocassette and digital video disk hard drive recording and playback technologies, as well as companies developing new in-home entertainment technologies, such as the video-on-demand service being marketed by DIVA Systems Corporation. We expect that competition will increase substantially as a result of these and other new products and services, as well as from industry consolidations and alliances. As a result, we may be unable to achieve our sales and market share goals. In addition, we expect that an increasingly competitive environment may result in price reductions that could reduce profit margins and cause loss of market share. We cannot be certain that we will be able to compete successfully with new or existing competitors or that competitive pressures will not reduce our revenues and operating results. Because we are significantly smaller than most cable and telecommunication companies and other distributors of digital content, we may lack the financial and other resources to obtain sufficient market share.We expect to encounter a number of challenges in competing with large cable and telephone companies and other distributors of digital content that generally have large installed subscriber bases and significant investments in, and access to, competitive programming sources. In addition, these large companies have the financial and technological resources to create their own digital content delivery and management services and/or VOD services, including delivery of per-per-view movies in a VOD format. We also face the risk that the current trend of industry consolidation will continue with the result that smaller and medium size cable and telephone company operators and/or content distributors that might otherwise become our customers will be acquired by large companies. 23 Currently, the most likely available alternative for cable operators that wish to offer digital services similar to those provided by small satellite dish is a digital programming delivery service known as DIVA. Certain telephone companies have also announced initiatives and have made significant investments to become digital television providers. We cannot be certain that we will be able to compete effectively against (i) DIVA, cable or telephone companies, or other companies that provide digital cable television programming and services in a VOD format, or (ii) other digital content delivery and management systems or distributors. Moreover, we cannot be certain that large cable and/or telephone companies developing their own digital tiers of programming will not offer such services to our target markets. Because small dish satellite companies may introduce digital Video-on-Demand programming and services to viewers, we may emerge from this initial phase of introducing such television programming with only a limited market share. We compete with companies offering digital television programming direct-to-the-home via various small dish satellite systems. Increased competition by small dish satellite companies could lower our profit margins and reduce our market share. Small satellite dishes offer consumers the appeal of significantly expanded channel capacity, features such as an interactive on-screen program guide, digital pictures without the signal disruption often seen in analog video, CD quality digital music channels and many channels of movies and sports available on a pay-per-view basis. Several well capitalized small dish satellite companies pose a substantial threat to cable operators. DirecTV, owned by Hughes Electronics, was the first all-digital small dish satellite service. Two other satellite small dish services are currently in operation: EchoStar, which markets its digital television service under the "Dish Network" brand name and USSB, which formerly had its own small satellite dish programming service, is now owned by and is operated in tandem with DirecTV offering premium subscription programming such as multiple HBO and Showtime channels. A former medium sized satellite dish service, PrimeStar, was also acquired by DirecTV, and is no longer in service. During the past fiscal year, local programming has generally unavailable through small dish satellite services; however, recently enacted legislation has facilitated the ability of small dish satellite companies to include local broadcasts in their digital programming services and that service is now available from DirecTV and the Dish Network in certain markets. Given small dish satellite systems' ability to market directly to viewers, these companies may be better positioned to introduce new digital television programming and services. Because they have large subscriber bases, small dish satellite companies may also be able to devote significantly greater resources to the development and marketing of new competitive products and services. If our relationships with our programming providers falter, we may not be able to obtain sufficient popular programming to offer to cable, telephone and other television distribution systems and their subscribers, and our revenues would fall. We depend on all the major and many independent movie studios to provide us with hit movies that appeal to mass audiences. Our current pay-per-view movie programming is obtained largely through on going, unwritten arrangements that have no specific renewal provisions. We also have relationships with the Playboy Entertainment Group, supplier of the Spice pay-per-view adult movie service and the Playboy Channel that we distribute, ESPN, for our ESPN Game Plan college football programming packages, and Guthy-Renker, creator of direct response television "infomercials" which sell various products direct to the viewer, including self-improvement tapes and home exercise equipment. We cannot be certain that any of our existing relationships will continue, that we would be able to obtain or develop substitute programming or that such substitute programming would be comparable in quality or profitability to our existing programming. Because our ability to succeed in the digital VOD television market will depend on our ability to continue obtaining desirable programming and successfully market it to cable, telephone and other television distribution operators and their subscribers, the termination of sales and operating results. If we cannot deliver programming to our customers and their subscribers within time periods which may be advertised, our revenue will fall and our ability to offer our programming and services will be harmed. Our failure to deliver VOD television programming within the time periods which may be advertised, whether or not within our control, could result in dissatisfied subscribers and in lost orders for content which otherwise could have been sold. Dissatisfied 24 cable, telephone and other television distribution operators and their subscribers may no longer choose to utilize our digital VOD programming and services, which could reduce our current and future revenue. Although we maintain insurance against business interruption, we cannot be certain that such insurance will be adequate to protect us from significant loss in these circumstances, or that a major catastrophe such as an earthquake or other natural disaster would not result in a prolonged interruption of our business. In particular, our digital operations center is located in the Los Angeles area, which has in the past and will in the future experience significant, destructive seismic activity that could damage or destroy the operations center. In addition, our ability to make deliveries to subscribers within the time periods advertised depends on a number of factors, some of which are outside of our control, including equipment or software failure and our inability to provide programming to cable subscribers due to service outages experienced by cable systems that comprise our distribution network. The loss of even a limited number of our satellite transmitters, and our Galaxy X satellite transmitters in particular, could prevent us from offering our digital programming and services and harm our results of operations. We transmit our, and will transmit others', programming and other digital content via our transponders leased on two PanAmSat satellites, Galaxy IIIR and Galaxy X, both of which have desirable geostationary orbital positions with transmission coverage of the continental United States. Our failure to maintain sufficient, well-located satellite transponder capacity would impair our ability to offer our digital VOD programming and services and would harm our results of operations. We cannot be certain that we will be able to obtain replacement transponder capacity on terms acceptable to us or at all. If either satellite was destroyed or became inoperable prior to the expiration of our lease, we would need to obtain replacement satellite transponder capacity. We cannot be certain that such replacement capacity will be available when required or, if available, that it will be on terms acceptable to us. The satellites now used by us are also subject to the risks of all satellites, including damage or destruction by space debris, military actions or acts of war, anti-satellite devices, electrostatic storms, solar flares, loss of location or other extraterrestrial events. In addition, satellite signal transponders may malfunction or become inoperative in the ordinary course as a result of faulty operation or latent faults in design or construction. If, for these or any other reason, we were unable to transmit our programming on one or more of our satellite transponders, our revenues and operating results would fall and our business could be seriously harmed. Because we rely on PanAmSat satellites for transmission of all our programming and other digital content, we could lose substantial revenue if PanAmSat were unable to meet our needs. Our relationship with PanAmSat is important to our business. We could lose substantial revenue if PanAmSat were unable for any reason to satisfy our satellite transmission commitments, or if any of these transmissions failed to satisfy our quality requirements. In the event that we were unable to continue to use our PanAmSat satellite capacity or obtain comparable replacement satellite capacity via PanAmSat, we would have to identify, qualify and transition deliveries to an acceptable alternative satellite transmission vendor. This identification, qualification and transition process could take six months or longer, and we cannot be certain that an alternative satellite transmission vendor would be available to us or be in a position to satisfy our delivery requirements on a timely and cost effective basis. Because we rely on Motorola (as successor by acquisition to General Instrument) for technology and services which may be essential to our ongoing Digital Cable Television and Video-On-Demand businesses, some of which are available only from Motorola. We might be unable to operate our business if Motorola fails to meet our expectations or if these technologies and services are no longer available to us. We are dependent on Motorola, which recently acquired General Instrument, for services needed to turn on and off the showings of cable operators' pay-per-view movies and events ordered by their subscribers, and for the continued development and standardization of equipment and the analog and digital cable transmission technologies, known as DCII technology, that is used by the cable industry. Our relationship with Motorola, to whom we owe substantial sums of money for digital and other equipment purchased by us, includes not only the use of its DCII technology and encoding equipment to digitally process our programming, but also includes its manufacture and supply of DCII cable system equipment and television set-top cable boxes that are important to the successful deployment of our VOD Service. We have no written agreement with Motorola for the provision of its services to cable operators to turn on and off their showings of the pay-per-view movies and events we plan to 25 transmit in VOD format, for which they are the only provider. If cable operators were unable to continue to receive these services from Motorola on acceptable terms, they would have no other readily available alternative. If Motorola were unable for any reason to meet cable operators' deployment needs, development schedule or delivery commitments with respect to either cable system equipment or television set-top cable boxes, we would be unable to meet our revenue goals and our operating results would be harmed. If we are unable to continue to obtain and use their DCII technology, we would have to identify, qualify and transition digital processing to an acceptable alternative vendor. This identification, qualification and transition process could take a very long time, at least six months or more, and we cannot be certain that an alternative vendor would be available to us or be in a position to satisfy our delivery requirements on a timely and cost effective basis. We depend on technology and services provided by third parties. If we were unable to access these technologies and services, our ability to operate our business would be impaired and our results of operations would be harmed. Our technical infrastructure features in-house production, storage and digital processing, encryption and other outsourced services supervised by our personnel. Our revenue and our ability to offer our DCX and VOD products and services would be harmed if our service providers were unable for any reason to meet our scheduling or delivery requirements or if any of our uplink transmissions failed to satisfy customer quality requirements. For instance, our replay, editing and satellite transmission uplink facilities were custom built to our specifications and continue to be operated by Four Media Company, a video editing and facilities service and management company, which owns and operates those facilities for our use under a renewable service agreement. Four Media Company was recently acquired by Liberty Media Corp. If we are unable to continue relying on Four Media Company's operational expertise and technology, we would have to identify, qualify and transition such operations to an acceptable alternative vendor or perform such operations ourselves. This identification, qualification and transition process could take six months or longer, and we cannot be certain that we could perform these services or that an alternative vendor would be available to us or be in a position to satisfy our requirements on a timely and cost effective basis. Because we rely on third party vendors to provide us with transactional services, the inability of these vendors to meet our requirements could prevent us from providing our services cost effectively, or at all. Our ability to collect our revenue and our results of operations would be harmed if our third party vendors were unable for any reason to meet our transactional service commitments, service management requirements or customer service quality requirements to our cable operator customers. We contract with CSG Systems, Inc. to provide customer billing and subscriber management services. These systems and resources are part of the transactional services that we offer with our TVN Digital Cable Television. If we are unable to continue using these systems and technological resources, we would have to identify, qualify and transition such operations to an acceptable alternative vendor or arrange for in-house operations. This identification, qualification and transition process could take six months or longer, and we cannot be certain that we could perform such functions or that analternative vendor would be available to us or be in aposition to satisfy our requirements on a timely and cost effective basis. In addition, we rely on the services of a credit card processor, telephone service providers and shipping companies. Should we lose or experience interruptions in the services of any of these service providers, we may not be able to replace these providers and our revenues and results of operations could suffer. The market for electronic delivery of home television entertainment and digital content is characterized by rapidly changing technology. As a result, our digital Video-on-Demand and Digital Content Express products and services may become outdated. Our future success and ability to remain competitive will depend in significant part upon the technological quality of our VOD and DCX products and processes relative to those of our competitors, and our ability to both develop new and enhanced products and services and to introduce products and services at competitive prices in a timely and cost effective fashion. We cannot be certain that our technological development will remain competitive. We rely substantially on third party vendors for the continued development of these technologies. We cannot be certain that our vendors will be able to develop technologies in a manner that meets our needs and those of our customers and subscribers. The 26 failure to implement these technologies or to obtain licenses on favorable economic terms from other vendors, individually or in combination, could impair our prospects for future growth. We cannot be certain that we will be successful in identifying, developing, contracting for the manufacture, and marketing of product enhancements or new services or programming that are responsive to technological change, that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or services or that our new products and product enhancements will adequately meet the challenges of emerging technologies, the requirements of the marketplace and achieve market acceptance. Delays in commercial availability of new products and services and enhancements to existing products and services may result in results could decline. If our digital signals are pirated, we could lose substantial revenue. While we use digital and analog encryption systems designed by Motorola's predecessor, General Instrument, to minimize the risk of signal piracy, we could lose substantial revenue if signal piracy were to become widespread. The General Instrument encryption system that we use is based on the use of cards inserted into the television set-top cable box, which can be changed periodically to thwart commercial piracy efforts. In addition, electronic countermeasures can be transmitted over the cable system at any time in an effort to counter some types of piracy. However, we cannot be certain that this encryption technology, electronic countermeasures and other efforts designed to prevent signal piracy will be effective. Moreover, we cannot be certain that future technological developments will not render our anti-piracy features less effective or completely useless. Any significant piracy of our programming would substantially reduce our revenues and harm our results of operations. We rely on a combination of trade secret, copyright and trademark laws, confidentiality and nondisclosure agreements and other such arrangements to protect our proprietary rights and confidential information. The loss of our proprietary rights or confidential information would harm our competitiveness and reduce the value of our business assets. We consider our software, management scheduling system, telephone ordering system, trademarks, logos, copyrights, know-how, advertising, and promotion design and artwork to be of substantial value and importance to our business. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or obtain and use information that we regard as proprietary. We cannot be certain that the steps taken by us to protect our proprietary information will prevent misappropriation of such information and such protection may not preclude competitors from developing confusingly similar brand names or promotional materials, technology, or developing products and services similar to ours. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. While we believe that our proprietary software, trademarks, copyrights, advertising and promotion design and artwork do not infringe upon the proprietary rights of third parties, we cannot be certain that we will not receive future communications from third parties asserting that our software, systems, trademarks, copyrights, advertising and promotion design and artwork infringe, or may infringe, on the proprietary rights of third parties. Any such claims, with or without merit, could be time consuming, require us to enter into royalty arrangements or result in costly litigation and diversion of management personnel. We cannot be certain that any necessary licenses can be obtained or that, if obtainable, can be obtained on terms acceptable to us. Our failure or inability to develop non-infringing technology or license necessary proprietary rights on a timely basis and in a cost-effective manner would harm our business. See "Business--Intellectual property and proprietary rights." Rapid growth of either of our Video-on-Demand or Digital Content Express businesses could place a significant strain on our managerial, operational and financial resources and on our internal systems and controls. We cannot be certain that we would have adequate resources to effectively manage rapid growth of our VOD and/or DCX businesses, and our inability to do so could increase our costs and harm our business. Our financial and management controls, reporting systems and procedures are constrained by limited resources. Although some new controls, systems and procedures have been implemented, our growth, if any, will depend on our ability to continue to implement and improve operational, financial and management information and control systems on a timely basis, together with maintaining effective cost controls. Further, we will be required to manage multiple relationships with various customers and other third parties. We cannot be 27 certain that our systems, procedures or controls will be adequate to support our operations or that our management will be able to successfully offer our services and implement our business plan. If we fail to attract and retain qualified management, sales, operations, marketing and technology personnel, our ability to meet our business goals will be impaired and our financial condition and results of operations will suffer. In particular, our success depends on the continued contributions of Stuart Z. Levin, our Chairman, Ian Aaron, our President and Chief Executive Officer and other senior level operating, financial and legal officers. Our business plan was developed in large part by these senior level officers and requires skills and knowledge they possess in order to implement. In addition, our products and technologies are complex and we are substantially dependent upon the continued service of our existing engineering personnel. Competition for qualified personnel is intense, and we cannot be certain that we will be able to attract, assimilate, train or retain additional highly qualified personnel in the future. If we are unable to hire and retain such personnel, particularly those in key positions, our business prospects may be harmed and our results of operations may suffer. A substantial portion of our revenues to date have been generated by pay-per- view fees paid by subscribers to our satellite transmitted analog programming for the large home satellite dish market and to our digital cable television programming for the cable market. These revenues have not been sustainable. Revenues from our large home satellite dish business substantially declined in fiscal 1998, in fiscal 1999, in fiscal 2000 and will be de minimus in fiscal 2001 since we have discontinued that business. Revenue from our digital cable television programming business will likely decline in fiscal 2001 because we have been repositioning that business so our historical revenues therefrom may not be sustainable. The digital television home entertainment business faces severe competition from competing forms of content delivery, including digital content transmitted via small satellite dishes and the Internet, and has not experienced growth as projected. Morgan Stanley Dean Witter has significant influence over us, and may have an interest in pursuing actions adverse to the interests of the holders of the notes. Decisions concerning our operations or financial structure may present conflicts of interest between the owners of capital stock and the holders of the notes. For example, the holders of capital stock may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to the holders of the notes. Princes Gate Investors II and its affiliates own 89.3% of our Series B Preferred Stock, which ownership represents 54.8% of our outstanding voting capital stock on an as- converted basis or 44.4% of the voting capital stock on an as-converted, diluted basis including currently outstanding options and warrants exercisable for voting capital stock. The general partners of Princes Gate Investors II (PGI) and Morgan Stanley, our investment banker, are both wholly owned subsidiaries of Morgan Stanley Dean Witter, and several of our directors are employees of Morgan Stanley and/or PGI. Our Securityholders Agreement dated as of August 29, 1997 provides that under certain circumstances specified therein the holders of a majority of the shares of PGI stock may elect to appoint a majority of our Board of Directors. As a result of these relationships, Princes Gate Investors II, Morgan Stanley Dean Witter and its affiliates have, and will continue to have, significant influence over our management policies and our corporate affairs. Our certificate of incorporation requires us, upon demand, to redeem all of the outstanding shares of our Series B Preferred Stock in August 2002. We may be unable to satisfy this requirement, and our creditworthiness, business condition and value of our equity could be harmed as a result. Our certificate of incorporation requires us, upon demand, to redeem all of the outstanding shares of our Series B Preferred Stock in August 2002, the mandatory redemption date, for $54.4 million, unless such shares of Series B Preferred Stock have previously been converted into our common stock at the option of the holders thereof, or automatically converted upon our initial public offering. Notwithstanding this requirement, the terms of the notes significantly limit a redemption by us from 28 available cash, but will permit us to redeem the Series B Preferred Stock with the proceeds of an equity financing. If we fail to redeem the Series B Preferred Stock, we would continue to be in breach under our certificate of incorporation from the redemption date until the date of a refinancing, if any. Although a breach of this type has been excluded from the cross default provisions of the notes, it may trigger default provisions in other financial instruments to which we may then be a party. We cannot be certain that holders of Series B Preferred Stock will not take legal action against us in an attempt to enforce their redemption right, demand that we renegotiate the terms of the Series B Preferred Stock or sell additional equity to finance the redemption. Although these actions may not directly effect the notes, they may harm our financial condition and have a dilutive effect on the interests of our equity holders. A substantial majority of our Series B Preferred Stock is held by Princes Gate Investors II. The notes are subject to original issue discount tax treatment and may be subject to high-yield discount obligation tax rules. The notes will be treated as issued with original issue discount for U.S.federal income tax purposes, so that holders of the notes generally will be required to include amounts in gross income for U.S. federal income tax purposes in advance of receipt of the cash payments to which the income is attributable. Furthermore, the notes may be subject to the high yield discount obligation rules, which will defer and may, in part, eliminate our ability to deduct for U.S. federal income tax purposes the original issue discount attributable to the notes. Accordingly, our after-tax cash flow might be less than if the original issue discount on the notes was deductible when it accrued. If a bankruptcy case were commenced by or against us under the Bankruptcy Code of 1978, as amended, after the issuance of the notes, the claim of a note holder with respect to the principal amount thereof may be limited to an amount equal to the sum of: . the initial offering price and . that portion of the original issue discount that is not deemed to constitute "unmatured interest" for purposes of the bankruptcy code. . Any original issue discount that was not amortized as of the date of any such bankruptcy filing would constitute "unmatured interest." Our obligations under the notes may be diminished if the transfer of the notes was fraudulent or made us insolvent. Under applicable provisions of the federal bankruptcy law or comparable provisions of state fraudulent transfer law, if, at the time we issued the notes or made any payment in respect of the notes, either: (1) we received less than reasonably equivalent value or fair consideration for such issuance; and . we were insolvent or were rendered insolvent by such issuance; or . were engaged or about to engage in a business or transaction for which our assets constituted unreasonably small capital; or . intended to incur, or believed that we would incur, debts beyond our ability to pay our debts as they matured; or (2) we issued the notes or made any payment thereunder with intent to hinder, defraud or delay any of our creditors, then our obligations under some or all of the notes could be voided or held to be could be unenforceable by a court or could be subordinated to claims of other creditors, or the note holders required to return payments already received. 29 In particular, if we caused a subsidiary to pay a dividend in order to enable us to make payments in respect of the notes, and such transfer were deemed a fraudulent transfer, the holders of the notes could be required to return the payment. The measure of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in ...any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, we would be considered insolvent if: . the sum of our debts, including contingent liabilities, was greater than all of our assets at a fair valuation; or . we had unreasonably small capital to conduct our business; or . the present fair salable value of our assets were less than the amount that would be required to pay the probable liability on our existing debts, including contingent liabilities, as they become absolute and mature. We believe that we will not be insolvent at the time of or as a result of the issuance of the notes, that we will not engage in a business or transaction for which our remaining assets constitute unreasonably small capital, and that we will not incur debts beyond our ability to pay such debts as they mature. We cannot assure you, however, that a court passing on such questions would agree with our analysis. Under certain circumstances, our subsidiaries will be required to guarantee our obligations under the indenture and the notes. If any subsidiary enters into such a guarantee, and bankruptcy or insolvency proceedings are initiated by or against that subsidiary within 90 days or, possibly, one year, after that subsidiary issued a guarantee or after that subsidiary incurred obligations under its guarantee in anticipation of insolvency, then all or a portion of the guarantee could be avoided as a preferential transfer under federal bankruptcy or applicable state law. In addition, a court could require holders of the notes to return all payments made within any such 90 day or, possibly, one year, period as preferential transfer. Applicable bankruptcy law is likely to impair the trustee's right to foreclose upon the pledged securities. The right of the trustee under the indenture and the pledge agreement relating to the notes to foreclose upon and sell the pledged securities upon the occurrence of an event of default on the notes is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy or reorganization case were to be commenced by or against us or one of our subsidiaries. Under applicable bankruptcy law, secured creditors such as the holders of the notes are prohibited from foreclosing upon or disposing of a debtor's property without prior bankruptcy court approval. 30 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Due to the nature and maturity of our short-term investments we do not believe such investments present significant market risk. PART II. OTHER INFORMATION ITEM I. LEGAL PROCEEDINGS From time to time, we have been party to legal and administrative proceedings related to claims arising from our operations in the normal course of business. On the advice of counsel, we believe we have adequate legal defenses and believe that the ultimate outcome of these actions will not require large cash flows. However, based on the Company's current financial condition, there can be no assurance that the impact of any judgment would not be material to the Company's cash flows. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None. (b) Reports on Form 8-K There were no reports on Form 8-K filed during the three month period ended December 31, 2000. 31 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. TVN ENTERTAINMENT CORPORATION Date: June 29, 2001 By: /s/ Ian Aaron -------------------------------- Ian Aaron President and Chief Executive Officer Date: June 29, 2001 By: /s/ Sheldon Rabinowitz -------------------------------- Sheldon Rabinowitz Chief Financial Officer and Senior Executive Vice President Date: June 29, 2001 By: /s/ Lourie Zak -------------------------------- Vice President, Corporate Controller (Principal Accounting Officer) 32

TVN ENTERTAINMENT CORP 10-Q