Playboy Enterprises Inc. Q3 2008 Earnings Call Transcript

Playboy Enterprises Inc. (PLA)

Q3 2008 Earnings Call

November 6, 2008 11:00 am ET

Executives

Christie Hefner – Chairman of the Board, Chief Executive Officer

Linda G. Havard – Chief Financial Officer, Executive Vice President – Finance and Operations

Alex L. Vaickus – Executive Vice President and President – Global Licensing

Robert Meyers – Executive Vice President and President – Media

Martha O. Lindeman – Senior Vice President – Corporate Communications and Investor Relations

Analysts

David Bank – RBC Capital Markets

Steven Marascia – Anderson & Strudwick

David W. Wright – Henry Investment Trust

David Leibowitz – Horizon Asset Management

Presentation

Operator

Welcome to today's teleconference. (Operator Instructions) It is now my pleasure to turn the call over to Martha Lindeman.

Martha O. Lindeman

Welcome to the third quarter 2008 conference call. If you need a copy of our press release and earnings supplement you can look on our website at www.peiinvestor.com or you can call Jennifer at 312-373-2432.

During the call today we will be making forward-looking statement pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act. These statements reflect our current beliefs and plans. They are not guaranteed and they involve risks and uncertainties that could cause our actual results to differ materially from those discussed today. We are under no obligation to update these statements. I refer you to the Safe Harbor language in today’s release which describes some of the factors that could cause our results to differ materially from today’s discussion.

We are going to start today with our Chairman and Chief Executive Officer, Christie Hefner. She will be followed by Bob Meyers, President of Media, who will be followed by Alex Vaickus the President of Licensing, and finally Linda Havard, our Chief Financial Officer.

And with that I will turn it over to Christie.

Christie Hefner

Given the difficult operating environment we were pleased to be able to show a profit in the third quarter excluding the restructuring charges and provisions for reserves. This is a good first step and we believe that we can build on this to improve our future performance. Our confidence is based on the following.

One, we have a brand that resonates with young people around the world. Two, the licensing business model continues to work very well for us. Three, our proven ability to create content on various platforms that appeals to young men positions us well against a changing media landscape. Four, there are many large and fast growing overseas markets where we have only a limited presence right now. Five, we will benefit from the cost reduction actions that we've announced and from our ongoing expense management efforts. And six, our current financial position is sound.

In an increasingly cluttered media environment the power of a brand is almost beyond measure, which is why we continue to believe that single digit losses in the magazine, our most powerful brand driver, are a worthwhile and necessary investment. We have leveraged the Playboy brand domestically and overseas beyond pure media into the leisure industries. It is the driving force behind our licensing business.

The consumer products segment of that business alone has grown steadily since 2001, recording solid year-over-year gain every quarter for the past seven years. We continue to execute on new opportunities as demonstrated most recently by our recent fragrance launch with Coty and our entry into India via the licensing business. Moreover, location-based venues like Las Vegas and Macao represent additional significant value creation.

The global appeal of the brand opens new doors internationally in media as well. Just two weeks ago we launched a Lithuanian edition of the magazine and before year-end we expect to add an Italian edition, which will bring to 25 the number of overseas editions of Playboy magazine. These editions are all immediately profitable and also serve as brand drivers in their respective markets.

Domestically we are focused on integrating our print and digital media properties in order to grow our total audience, total ad sales, and total profits. We have invested time and money this year to build a new site that will premiere in the first quarter of 2009. We believe the online redesign will drive higher traffic levels to the site that will in turn result in growth in revenues. Equally importantly, we believe that playboy.com is the glue between our other media and the world of Playboy that comes alive at events, the Playboy store, and venues like the Palms.

The print and online editorial teams are working closely together sharing content and ideas and the end result will be a magazine and website that better respond to how and where media is consumed today. It's worth remembering that we saw the potential of online early and created a profitable multi-stream online model when conventional wisdom called that feat unlikely. We're enthusiastic about this next stage online initiative and you'll be hearing more details about the changes over the next few months as we near the first quarter launch date.

Now let me turn you over to Bob to discuss the media businesses this quarter.

Robert Meyers

The entertainment group reported a decline in third quarter 2008 segment income of $4.4 million on an $11.4 million dip in revenues. The revenue decline was primarily due to the sale of our Andrita television studio assets and the outsourcing of e-commerce, both of which had a modestly positive effect on the bottom line.

The primary reasons for the weaker year-over-year segment profitability included the following, planned investments, and the re-launch of playboy.com, lower contribution from international television partly due to foreign exchange losses, losses in our DVD business and the comparison with last year when we booked high margin license fees related to the movie House Bunny.

Let me take a minute to talk about some of these items. Our playboy.com re-launch initiative has had both top and bottom line ramifications. As anticipated subscription revenues have suffered as traffic declined reflecting the shift in the focus of our marketing and technology staffs to building the new playboy.com site. The resulting decline in revenues combined with planned increased investments in technology and content led to lower online contributions in the quarter.

In international television the growth and scale of our UK and European networks has made us more vulnerable to foreign currency fluctuations. The weakening of the British pound as well as increased competition in the UK adult TV market led to softer results in the international TV business in the third quarter, although higher revenues from Playboy TV networks in northern Europe partially offset the shortfall.

With more and more video content being accessed online, and with TV viewers able to buy programs a la carte via on-demand technology, the DVD business, including our own, has declined dramatically. DVD revenues in 2007 were roughly only one-third of those we reported in 2002 and some years ago we began reporting the results of that business in the other category. We expect these trends to continue and therefore we have decided to exit this business and focus on digital distribution of our video content.

Domestic TV remains the largest revenue contributor in the entertainment group. At $14.6 million our third quarter domestic TV revenues were in line with quarterly revenues that we have reported thus far this year if you exclude Andrita from the first quarter. Pay-per-view movie network revenues were down as anticipated, reflecting the transition of consumers to on-demand viewing. More importantly, third quarter Playboy TV revenues were up both year-over-year and quarter-over-quarter driven by the cable and telco platforms that offer Playboy TV with subscription video on demand or SVOD option.

We continue to believe that Playboy TV will benefit from carriage as an SVOD service and the quarter-over-quarter revenue growth is encouraging. With distribution increasing our programming team is cost effectively developing new content, and we plan to launch either a new series or a new season of a returning favorite each month which should further increase Playboy TV's SVOD appeal to consumers.

Turning to print, cost reductions in the publishing group during the third quarter more than offset a $1.3 million decline in revenues, leading to a modest improvement in quarterly results compared to last year. As Christie mentioned, we believe the magazine is a vital brand driver. We also recognize, however, that we cannot support double-digit losses in a business that faces serious and ongoing challenges. In line with other publications we have seen significant declines in circulation and advertising revenues.

Through aggressive expense reductions we have been able to offset most of those revenue losses. On the circulation side we reduced our rate base at the beginning of this year which has lowered our year-to-date paper and manufacturing costs, but also negatively impacted advertising revenues. We have also lowered our editorial and overhead expense. In addition, we recently announced a staff reduction and the outsourcing of certain functions such as newsstand sales which we previously handled in-house.

We continue to look at ways to evolve the traditional print business model to balance the financial constraints of today's publishing business with the needs of our consumers and advertisers. As part of this effort, we are looking at changing how we deliver the magazine, for example, and next year we will introduce a special summer double issue that will incorporate the July and August issues in one package.

Now let me turn you over to Alex to discuss the licensing business.

Alex L. Vaickus

Strong sales in our southeast Asian and Latin American markets drove the nearly 12% increase in third quarter apparel and accessories royalties compared to last year, resulting in a 7% increase in total third quarter consumer products revenues. This growth was partially offset by lower royalties from our games and leisure businesses.

We are encouraged that our efforts in Latin America have begun to yield results as this is a market that we identified as having rich growth potential for us. A major new licensee launched lines of men's and women's clothing, swimwear and lingerie in Central and South America at the beginning of this year with good results so far.

In addition, we've recently finalized a partnership with a licensee in Mexico with the expectation of launching several product lines there in the spring of 2009. Christie mentioned our recent launch with Coty and just last week we held a party in New York to celebrate the introduction of Playboy-branded men's fragrances. Coty has an enviable success record and they are supporting our four variant fragrance launch with a strong advertising and marketing campaign. The fragrances already have been introduced to the U.S., in Canada, Spain, Italy, and the Netherlands and we are pleased with the very strong early results.

The Playboy fragrances are the number one brand at CVS already in the U.S., as well as at a major Italian retailer, and we are very pleased at the extensive distribution in a variety of outlets including perfumeries, drug stores, and mass merchants. Coty's distribution plans include further rollout to the rest of Europe and into Asian and Latin America all by the end of next year.

We also recently launched another product that we think could have true global appeal. It's the bunny bra. The bunny bra was created in anticipation of the 50th anniversary of the bunny costume and pays homage to that iconic costume. Developed with matching panties and two sets of insertable ears the bra comes in a full range of colors inspired by the original bunny costumes.

Launched last month to great reviews and strong sales in Australia, the bunny bra just went on sale in the UK last week. While it's too early for sales figures there, the product launch has generated major positive publicity and we already have plans to launch entirely before year end and expect the bunny bra to appear in at least one other Asian market in next year's first half, and then further rollouts are anticipated, including the U.S. market within a 12 to 15-month timeframe.

On the LBE front, our venue at the Palms continues to do well despite an overall softening of the Las Vegas market. Progress also continues on the Macao project, both in terms of construction and project approvals. We signed a deal for a third location months ago but have been waiting for our partners to complete financing and related transactions before announcing the details of that deal.

One effect of the financial meltdown that we already have experienced is the inability of our partners to receive definitive financing commitments, specifically as it relates to additional entertainment venue deals that are currently in the pipeline. Our goal is still to bring a new location-based entertainment venue online each year starting with Macao, and we remain committed to doing that.

While we have great licensees in diverse and appealing product lines, it is probably obvious to everyone on this call that the global economy is playing and will continue to play an important role in terms of our performance. We have already seen retail weaknesses in the U.S. and Europe reflecting the significant softening of consumer spending which will continue to impact retail sales for at least the near-term.

However, we're very fortunate in that our licensing business is geographically diverse with approximately 80% of our sales split between Europe and Asia and the remaining 20% coming from the Americas. That diversity has allowed us to report 8% growth in segment income through the first nine months of this year excluding last year's art sales.

I'll now turn it over to Linda who will describe the quarter's results in more detail.

Linda G. Havard

I'd like to start by addressing the restructuring and other charges we recorded below the segment income line in the third quarter. The third quarter restructuring resulted in a charge of $2.2 million and a headcount reduction of 55 employees or approximately 7% of our workforce. Since the beginning of this year we have eliminated a total of approximately 140 positions or 17% of our full and part-time employees. The annual savings from the third quarter restructuring will be approximately $5 million the bulk of which will be realized in 2009.

The restructuring primarily affected corporate, domestic, and international TV, publishing and the DVD business. In corporate, we've eliminated positions; we've combined functions and reduced service levels in areas like human resources and technology. In the media businesses, the cuts reflect changes in editorial, in production, marketing, and circulation. We are outsourcing some non-core activities as well as changing the way we do business in other areas. And as Bob mentioned, we are exiting the DVD business with the staffing for that operation included in the third quarter restructuring charge.

Beyond the $5 million in annualized headcount savings that we expect from the restructuring, we have identified an additional $7 million in annual savings, principally in domestic publishing and DVD. This $7 million figure is on top of the $12 million in magazine-related cost reductions that we implemented in the 2005 to 2007 time period. Our managers will also forego incentive compensation this year.

In addition to the third quarter restructuring charge, we also recorded two non-cash provisions for reserves totaling approximately $4 million. The larger of the two charges resulted from our decision to reserve for a receivable related to the sale of a non-Playboy-branded asset. While the buyer is not in arrears, the payments are coming more slowly than anticipated causing us to take the most conservative accounting position.

The smaller charge relates to archival materials for which we continue to receive revenues but have carried on the balance sheet for quite some time, and again, decided to take the most conservative accounting position. We had approximately $28 million in cash and marketable securities on the balance sheet at September 30th, 2008. This compares to just over $29 million at June 30th, 2008. In addition to this cash, we have access to a $50 million revolving line of credit with Bank of America which is undrawn other than $1 million in letters of credit outstanding. Our only debt, $115 million of convertible senior subordinated notes, carries a below market coupon of 3%.

I'd also like to take this time to remind everyone that the company has a large number of what amount to hidden assets which are either not on the balance sheet at all or are on the balance sheet but at a very nominal value. The Playboy Mansion is among these and it is on the balance sheet for under $2 million. In addition, none of our large libraries of photos, interviews, cartoons or other content that was created for the magazine, and more recently for playboy.com, are even on our balance sheet at all as if content is expensed immediately.

We've also thousands of hours of video programming. In general, TV content is expensed over a roughly 2.5 year period even though we continue to utilize much of this content in new markets and on new technology platforms long after it's been expensed. In addition we have approximately 5,000 works of fine art along with 55 years of memorabilia which we do monetize from time to time, a practice that we plan to continue going forward depending on demand or favorable market conditions.

For example, this October we organized an auction entitled Playboy the Art of Beauty in which Heritage Auction sold 17 pieces of fine art by 11 artists. The sale, which generated approximately $200,000 in revenues, represented a very small fraction of the artwork we own and demonstrates again the hidden potential of that asset. The artwork is on the balance sheet for a deminimus amount.

I am going to now give you back to Christie, who has some final comments before we open the floor to questions.

Christie Hefner

Looking ahead it's clear that an evolving media industry and a weak economy pose significant challenges. But we believe that we can generate profitable growth and create shareholder value because on the media side we have the opportunity to create innovative brand appropriate content that will appeal to a large global audience, and to distribute that content through a range of integrated distribution platforms. This will allow us to better serve our consumers and our advertisers while using our assets more effectively.

With our focus on content creation we can search out new ways to further streamline our operations. We will continue to look at opportunities to outsource non-core functions as exemplified by our e-commerce deal, eliminate non-performing businesses such as the DVD business and reallocate resources to our highest potential Playboy-branded businesses as we are doing in online and licensing.

We are seeing the results of our efforts. We are getting traction on Playboy TV carriage and buys as an SVOD product. The new playboy.com is nearing its launch date and we have reduced the magazine's cost structure. The cost savings in operational initiatives we've undertaken this year will benefit us in 2009 and we are not finished yet.

With that said we recognize that the weakening global economy is likely to affect virtually all companies in the year ahead including ours. We are anticipating a weak advertising market in both print and online and softer consumer spending, which as Alex described is likely to slow the growth of our licensing business. Yet at the same time the fundamentals are strong.

We believe that the power of the brand will continue to resonate with customers across the globe, create new licensing opportunities such as the recent Coty fragrance launch and the bunny bra, and over the long term the licensing business will remain a key growth and profit driver. Our management team is committed to returning this company to significantly higher levels of profitability and we look forward to reporting our progress to you in the coming quarters.

And now the conference operator will explain how to ask questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Bank – RBC Capital Markets.

David Bank – RBC Capital Markets

A couple of questions, I guess the first one, thanks for giving us the color on the expense reduction sort of split between the headcount and infrastructure. Can you give us a sense of the $12 million how much actually occurred in the third quarter and how much we're expecting to see in the fourth quarter and a kind of a general split, some sort of proportion between the divisions you highlighted, corporate, publishing and entertainment?

The second question I think is kind of a Bob-focused question which is, can you give us some color on where you think you can target margins in entertainment now that it looks like domestic TV is stabilizing a little bit, and also the subscription business in the UK. What do you think is happening there and can you give us a little more comfort that what sort of happened on the VOD market domestically isn't about to happen in the UK in terms of maybe some sort of a trend.

Then the last question for Alex is there any material effects, impact in licensing? Have you historically been benefiting and is there any impact there on the business as you look forward?

Linda G. Havard

David, this is Linda. Why don't I start with your first and maybe go to your last question too, and if Alex wants to add anything he can do that. Virtually none of the cost savings measures that we've announced have any impact in the third quarter other than the restructuring charge. Related to people, you'll really see that going forward in 2009. There will be some impact in the fourth quarter. I can't really quantify that at this point.

David Bank – RBC Capital Markets

So if you look at the expense base today it really should be $12 million lower in 2009?

Linda G. Havard

If you hold all revenues constant that's correct. There are two areas that we decided not to pursue this year that we have in the past so those will on a quarter-over-quarter, year-over-year basis look better; our incentive compensation and profit sharing. But in the third quarter there's really nothing there.

In terms of foreign exchange impact, really the largest impact that we see there has been and will probably continue to be in the UK as that business grows larger and that's in Bob's areas on the television side. To some degree we have seen that in Alex's area but it's much smaller. We tend to get paid in dollars and so we have little impact there. Bob, do you want to speak to the margin question?

Robert Meyers

We should see margins increase as we go forward and our margins in entertainment have increased considerably in quarter-to-quarter basis from quarter two to quarter three and I expect that to continue as the full effect of the recent cost reductions kick in and we get the benefit from our new website redesign and launch in the first quarter of next year.

I can jump to the UK question just briefly and talk about the challenging environment. It's a very crowded environment in the UK. There are a couple things we're doing there. We have recently launched a new service, Paul Raymond TV service which is getting some early traction, but we're reevaluating our position there in terms of diversifying more into the European market.

As I talked about in my formal remarks, there is growth in Playboy in the European market and we are looking to increase that exposure and decrease the exposure to the narrow UK market, which I said is crowded, competitive, and now with the weakness of the pound difficult to operate in.

David Bank – RBC Capital Markets

I know it's hard to put numbers around it. Do you think at some point you are going to be able to update us with maybe some more specific quantitative targets for those margins because over the last year they've really been kind of bouncing around a bit. I know it's hard to do today but will you be able to come back to us at some point over the next couple of months you think and give us a little more quantitative answer?

Robert Meyers

I'll leave that to Linda to determine whether or not we're going to come up with some targets for that, but I can tell you that they have bounced around a bit. I think that the last couple of quarters of last year we had some one-time only expenses and we had some marketing expenses that got lumped into the third and fourth quarters which had a tendency to decrease our margins. But right now in terms of the dynamics of our business what I described I think is something that we can look forward to increased margins going forward.

Linda G. Havard

David, what I would add is we do have margin targets and they are above what we're achieving and the kinds of actions that we're taking, which are a combination of reducing our own operating costs and outsourcing contribute to that as well as obviously the opportunity to grow the top line through Playboy SVOD. When we release fourth quarter earnings I think we'll be in a better position to be talking about expectations for next year.

Operator

Your next question comes from Steven Marascia – Anderson & Strudwick.

Steven Marascia – Anderson & Strudwick

Give me, with the entertainment sector and sort of the shifting business model that you guys have, what would you guys say would be a scenario down the road where we might see an improvement in the entertainment sector's operating income?

Christie Hefner

I think that the dynamic is the same dynamic that we've been watching. So we have to get to a steady state, which we think we are pretty close to based on, as Bob indicated, kind of a run rate if you will of domestic revenues and then from that the improvement will come from the Playboy-branded service, which as you know we've been focused on here in the U.S. And we're still only in front of about half the digital homes with Playboy SVOD. We got some nice traction in this quarter from support in Time Warner and support from some of the telcos but that's I think going to continue to be the opportunity for growth.

Steven Marascia – Anderson & Strudwick

Any potential for expansion into new cable systems?

Christie Hefner

Internationally, yes. Bob alluded to the fact that given how mature the UK part of our operation is we've been concentrating on growth elsewhere in Europe including Eastern Europe. We do very little business in countries as big as Russia and India and we think that those are growth markets. And then of course remember that we report our online business as a part of entertainment, which we brought together because of the convergence of the delivery of video content and we clearly see our online and mobile businesses as significant growth drivers, top line, profit, and margin.

Operator

(Operator Instructions) Your next call comes from David W. Wright – Henry Investment Trust.

David W. Wright – Henry Investment Trust

I appreciate the going over of the various hidden assets and it ties into my question. On Fox Business Channel last week Mr. Hefner was speaking and said that he thought the stock was, I don't remember his exact phrase, substantially undervalued from what he thought the company was worth. I wondered if management and the board shared that view and if so given the discount to book, given the substantial liquidity that the company has and given your hopes for higher profitability, whether a share repurchase was something under consideration?

Christie Hefner

I can answer that by saying that management and the board regularly evaluate all options that affect shareholder value including that. We certainly all believe that the stock is severely undervalued, although I suppose that puts us in very good company right now. We also do put a premium on the fact that we have cash on the balance sheet and I think that you can assume that we will continue to be conservative with our resources, but we are evaluating all options and not surprisingly have a policy of not commenting on any particular option being evaluated.

Operator

(Operator Instructions) Your next call comes from David Leibowitz – Horizon Asset Management.

David Leibowitz – Horizon Asset Management

Apropos the prior question, can you set some sort of dollar value on the non-core assets that you hope to monetize over the next couple of years?

Christie Hefner

I'm not sure I understand the question, David; it's Christie.

David Leibowitz – Horizon Asset Management

Briefly, the statement was made during the conference call proper that you are looking to perhaps monetize some of the non-core assets without identifying whether it was artwork or whatever else it might be. Do you have some sense of the value of these assets that could in fact be monetized?

Christie Hefner

Well, they're in different categories and the answer to your question is no. To try and be responsive I think that you can go back in time and see what we've been able to do with the opportunities to sell from our art collection and indeed we believe that once or Macao property is open that will create a very exciting opportunity to do a major art auction in Asia based in Macao. So you can go backwards and kind of take a look at that and that should give you some context.

With regard to things like, for example our adult assets, there our key monetization is to continue to generate the most possible value for them generating incremental profits off of both the assets in the TV and assets in the online businesses.

Linda G. Havard

David, let me just add that my comment, this is Linda, on the conference call related to assets that are not on the balance sheet are on the balance sheet for substantially below their value in anyone's estimation and I was relating to monetizing artwork only.

David Leibowitz – Horizon Asset Management

Second of all, you did just mention, Christie, Macao. Can you give us any further updates on gaming overall and the impact it will have on Playboy over the next 18 to 24 months?

Christie Hefner

Well, as Alex mentioned we remain very positive about what we see in terms of quality partners in very good locations very interested in partnering with us to create in each market unique multifaceted Playboy-branded entertainment destinations that as you've seen with what we've described in Las Vegas and Macao, bringing into play the opportunity to bring the brand to life with gaming, with dance clubs, with lounges, with dining, with retail, with both membership and admission charges, with hospitality, etc. But I think it's fairly obvious that the present financing environment is just going to slow that down.

The capital market conditions are such that the best projects are having a very difficult time getting financing, and so as Alex alluded to in his comments, we have held off announcing a deal that was done many months ago because work on closing the financing is still ongoing. So I think it's safe to say that we like everybody else that is engaged in real estate-related projects are going to see that pipeline slow over the next 12 months until the capital markets are back on solid footing.

Fortunately we are not principally engaged in investing our own capital in them so we do not have the kind of cost of capital tied up that maybe some other companies in the hospitality industry have. And I do not think from everything that I see that the present financing market is one that is going to be so crippled that it's going to prevent us when I look out 12, 24, 36 months from being able to successfully complete and open Macao and more importantly successfully complete, announce and open a number of other projects.

Operator

It appears that we have no further questions in the queue at this time.

Martha O. Lindeman

Thank you all very much for joining us this morning and we look forward to reporting to you on our progress in the future. Thank you.

Operator

This does conclude today's teleconference. Thank you for your participation.

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