Playboy Q1 2009 Earnings Call Transcript

Playboy Enterprises, Inc. (PLA)

Q1 2009 Earnings Call

May 11, 2009 11:00 am ET

Executives

Martha Lindeman - Investor Relations

Jerome H. Kern - Interim Chairman of the Board, Interim 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

Analysts

David Miller - Caris & Company

Analyst for David Bank - RBC Capital Markets

David Leibowitz - Horizon Asset Management

Presentation

Operator

Good day, everyone and welcome to today’s program. (Operator Instructions) It is now my pleasure to turn the conference over to Martha Lindeman. Please go ahead, Madam.

Martha Lindeman

Good morning, everyone, and welcome to the first quarter 2009 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 statements 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 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, as well as the risk factors in our securities filings, which describes some of the factors that could case our results to differ materially from today’s discussion.

Before we begin, you will have seen in our release that we changed the format of our financial reporting to reflect the integration which is taking place in our print and digital businesses. Also, on January 1, 2009, we adopted a new accounting pronouncement relating to cash settlement convertible debt, which we have applied retrospectively. New financials reflecting both of these changes to our prior year results will be filed on an 8-K and available on our website or by calling Jen. They are not available yet but they will be.

Let me turn you over to Jerry Kern, our interim Chairman and CEO.

Jerome H. Kern

Good morning, everyone. Playboy is all about the brand. We believe that the Playboy brand creates significant opportunities to this company’s profitable future growth. There’s no question that the past quarters have been difficult, in many cases due to industry or economic reasons that we cannot control. But this management team is committed to returning this company to profitability and I firmly believe that we will succeed. Since becoming interim Chairman, my primary goal has been to accelerate the pace of change. We’ve made good progress.

Our cost reduction initiatives have outpaced revenue declines and the improved margins across most of our media businesses demonstrate that our recent efforts are paying off in better financial results. We are pleased that we are making headway but we know that we still have lots of hard work ahead if we are to reach our goals. Before I go into more detail about the future, let me turn this over to Linda Havard and Alex Vaickus, who will provide some of the details on what we’ve been doing in our various businesses. Linda.

Linda G. Havard

Thanks, Jerry. There was a lot of noise in the quarter’s results related to changes in the way we record subscription acquisition expense, new FASB rules, restructuring and impairment charges. Looking through those items, however, you will see some positive underlying trends, particularly as they relate to the extensive cost-cutting measures we have undertaken and their effect on our operating margins.

As described in the earnings release, we took a restructuring charge of $3.2 million in the first quarter, which is in addition to the $4 million we recorded in the 2008 fourth quarter. In total, since October of last year, we have eliminated approximately $18 million in annual people related expense across the company, which includes salaries, benefits, and employer taxes.

In addition, we have reduced a range of other costs in each of our business segments, which I will discuss shortly.

As the operating results indicate, these cost reduction initiatives are already manifesting themselves in the improved margins that we reported in the entertainment and digital businesses, and in our ability to offset the revenue decline that we reported in print with significant savings.

Let me describe what we’ve accomplished in each of these businesses in a little more detail.

Starting with entertainment, unfortunately we are not seeing a change in the domestic TV revenue trends that we’ve experienced over the last few years, namely the expected slow demise of linear networks in favor of on-demand viewing, which is a more competitive platform where we have considerably less shelf space.

We’ve discussed the lack of visibility our distributors provide us, both in terms of the delay in reporting and their internal issues regarding what we are owed. This quarter’s reported revenue also includes a $2 million negative swing related to the [Andreta] television studio assets, which we sold in last year’s second quarter.

Subscription VOD revenues were essentially flat and we continued to work with cable operators to improve and target their marketing efforts and to increase consumer awareness of our products.

The 23% decline in international TV revenues was primarily due to foreign currency exchange rates resulting from a stronger U.S. dollar, while other revenues were essentially flat, as higher licensing revenues from the most recent season of The Girls Next Door offset the decline in DVD due to our exiting that business.

Entertainment group costs were favorable due to headcount reductions and the associated lower administrative expense. Entertainment G&A also benefited from three other areas, including the sale of our studio assets, our decision to exit the DVD business, and foreign currency fluctuations. As a result, despite the revenue decline, we were able to report higher segment profit and operating margins for entertainment compared to last year’s first quarter.

Entertainment industry trends indicate that we will not return to the higher revenue base that we enjoyed mid-decade. Our goal, therefore, is to maximize the cash flow inherent in this mature but still profitable business. Since programming is our largest TV expense and thus an important lever, our plan is to minimize our programming investment while meeting our consumers’ needs and our programming obligations.

This year we expect to reduce cash programming investment by 15% to 20% compared to last year’s $30.2 million cash spend. Because amortization trails across roughly two-and-a-half years, we will see a less than 10% decline in programming expense in 2009 versus last year, with the full effect of the lower spending recognized in 2010.

In print and digital, we’ve now integrated the publishing and online mobile businesses into one segment, as Martha mentioned, reflecting our belief that they will become ever more tightly woven in the future.

With that said, we feel it is important to give you some insight into how each of these businesses is doing.

In print, despite a significant decline in circulation and advertising revenues, our cost reduction actions led to improved domestic magazine operating results, excluding the change in how we record our subscription acquisition expense.

Previously, we capitalized the cost of direct response advertising and amortized those costs across the life of a subscription, typically 12 months. We are now expensing these costs as they are incurred.

Going forward, you are likely to see some lumpiness in the quarters as spending occurs. In the 2009 first quarter, direct response advertising costs were responsible for the increase in magazine expense. Excluding that increase, cost reductions more than offset the revenue decline, as we benefited from actions we took, including outsourcing our newsstand operations, reducing editorial pages and trim size, and in-sourcing pre-press for special editions.

As a result, we eliminate approximately $3 million in non-people related magazine costs in the 2009 first quarter compared to last year’s first quarter. And as Jerry said, we are not finished yet. We continue to look at our guaranteed circulation and are evaluating lower our rate base as market conditions warrant. In addition, we are outsourcing subscription operations. We are also combining the July and August issues into one bonus double issue, which will reduce overall printing, paper, and distribution expense.

As a result, and despite the difficult first quarter, we believe that the totality of our cost reduction efforts will lead to improved performance in the magazine and the entire print business for the full year of 2009 versus the 2008 year.

While print is a mature business with myriad challenges, its digital counterpart has multiple revenue streams with plenty of room to grow over the long-term. While first quarter digital revenues were down year over year, the decline primarily reflected the impact of outsourcing our e-commerce business.

On the expense side, the e-commerce outsourcing, combined with headcount reductions and lower marketing and promotional expense, contributed to higher digital profitability and margins in the first quarter compared to last year. While focusing on building a cost-effective business model, we recognize that we need to continue investing in playboy.com in order to appeal to the changing needs of consumers and advertisers.

Over the past few quarters, we’ve been working on a revamp of the site. Those of you who have visited playboy.com recently have seen a new look that provides consumers with an easy-to-navigate, multimedia experience that encourages click-thru to our pay sites while also offering advertisers a premium environment for their products.

It’s still to early to call any trends, but we are pleased with the significant improvement in response rates to both banners and video ads that we have seen since the design change.

On the corporate side, the small increase in expense in part reflects the costs associated with the search for a new CEO. The decrease in corporate headcount and related expenses are reflected primarily in lower allocations to the business group. We expect the first quarter then to be the high watermark for the year and anticipate that corporate expense in each of the remaining quarters this year will come in below the $6.3 million we reported for corporate in the first quarter.

The quarter’s results also included a non-cash goodwill impairment charge of $5.5 million, due to the reclassification of our business groups into different reporting segments. We had expected this charge and discussed it on our February conference call.

As I mentioned at the beginning of the call, this quarter’s results included a restructuring charge of $3.2 million, primarily for headcount reductions, including New York employees. In the second quarter, as we also noted on our February call, we anticipate taking an additional restructuring charge of approximately $4 million related to exiting our New York office on May 1st.

We should also note the effects of a new pronouncement relating to accounting for net share settlement convertible debt. Our $115 million of 3% notes falls into this category. As Martha mentioned earlier, beginning in the first quarter and going back to the issuance of the notes in 2005, we are recording non-cash imputed interest on the difference between the 3% coupon and the 7.75% non-convertible debt rate at the time the notes were issued. This new accounting pronouncement effectively doubles our recorded interest expense and reduces earnings per share by approximately $0.03 every quarter. APB14-1 also impacts the carrying value of our long-term financing obligations, unbelievably, which you will see on the investor supplement and which is explained in more detail in our 10-Q filings.

We ended the first quarter with no revolver borrowings and approximately $26 million in cash and cash equivalents, better than at March 31st last year but lower than our cash position at year-end due to the termination of the company’s deferred compensation plan.

And now let me turn you over to Alex who will talk about the licensing group’s results and outlook.

Alex L. Vaickus

Thanks, Linda. Good morning, everyone. The first quarter was challenging, as we, along with virtually every other consumer products company, suffered from the effects of the global economic meltdown. Product sales were down across Europe and parts of Asia, leading to a $1.2 million or 11% decline in licensing group revenues compared to last year’s first quarter. However, the trends are improving -- first quarter 2009 revenues were $1.4 million, or 18% better than we reported in the fourth quarter of 2008, when we had reported a 24% decline in year-over-year revenues. Because the first quarter is traditionally our toughest year-over-year comparison each year, these results give us hope that we have experienced the worst of this recession.

Given the high fixed cost nature of this business, the revenue decline translated nearly dollar-for-dollar to the group’s bottom line, meaning that profits were down year-over-year although again, up first quarter over fourth quarter and down significantly less than they were down in the fourth quarter.

While we have worked to control travel and marketing expense, our primary focus has been on growing our revenue base so that we can take full advantage of the up-turn when consumer spending returns to more normalized levels.

In our traditional consumer products business, during the past quarter we signed new licensing deals for men’s and women’s apparel, for women’s lingerie in the U.S., and for jewelry in Southeast Asia. We’ve also expanded our direct-to-retail partnerships, which is an important element of growth for us, adding a second major U.S. retailer, which has more than 400 mall stores. The product lines we sell through these DTR deals we created for each chain store and is now just rolling out.

Our goal is to create products and distribution deals that can work across a wide array of retailers, domestically and internationally, ranging from hip department stores to mass market retailers.

In terms of market distribution, in the second half of last year we began selling consumer products in Latin America in a major way, and the resulting growth helped offset lower first quarter sales in more established markets.

Beyond apparel and accessories, we are expanding distribution of the Playboy energy drink across the U.S. and expanding into Europe, Asia, and even Africa. Our Cody men’s fragrances continue to perform extremely well and we have achieved strong results in European and Canadian markets thus far. Cody recently began distribution in a major U.S. mass market retailer and sales there are outpacing any other new male Cody item this year. Cody will continue to launch in new markets for the remainder of the year and is adding a new fragrance variant, which we are calling Playboy [Avisa], as well as adding a body spray. We are very, very pleased with this relationship and the results to date.

In February, we announced a deal for a new entertainment venue in a Latin American resort location, which we said could open before Macau. Our partners have made tremendous progress in the past few months on this property and we now believe that the venue will open before the end of this year. This will be a smaller location than the Palms or Macau in terms both the size of the facility and the revenue to us. Similar to the Palms, however, it’s a pure licensing deal in the sense that we will not have an operating role or equity interest, although we will of course maintain oversight regarding the use of our brand and our trademarks.

The new venue will continue -- will include gaming as well as a lounge and a restaurant in a building that’s already built and is currently undergoing renovation in preparation for the opening.

As the quarter’s results demonstrate, the first half 2009 financial comparisons will continue to be tough. Given the deals we’ve made, however, we remain optimistic about the potential for year-over-year growth in the 2009 second half, barring any significant unforeseen deterioration in the global economy, and more importantly, we are continuing to build on a very solid foundation for growth in the years to come. And now let me turn it back over to Jerry.

Jerome H. Kern

Thanks, Alex. Linda and Alex have described some of our recent actions. Let me reiterate -- we are not finished yet. As the financial results from a range of other companies attest, the media industry continues to face significant challenges, particularly in the print business. We believe that Playboy Magazine, with its cross-generational appeal, is an important part of the company and an important image of the brand. However, it is clear that this company cannot continue to sustain significant losses in a business that now comprises less than one-quarter of the company’s revenue base. As a result, we are looking at making radical changes to the magazine business model from lowering the rate base to increasing prices to reducing frequency. At the same time, our editorial team is focused on creating an editorial product that resonates with consumers and beginning with the June issue, which goes on newsstands at the end of this week, you will see a younger and fresher look to the magazine.

In TV, we are working with our distributors to more effectively promote and sell our programming. Given the distributors’ historic leverage and our low margin splits, this business will remain difficult. But our distributors seem more cooperative because of the importance of this revenue stream to them. Our ability to control some of the expenses and our decision to exit unprofitable businesses will help improve margins.

In the other businesses, our focus has moved from streamlining operations to growing revenues and profitability. In digital, we’re exploiting new technologies to reach the key 18 to 30 year old demographic and to monetize that reach. In licensing, we’re continuing to make deals that will open new territories, create new product lines, and launch new entertainment venues. We expect to see year-over-year growth in the second half of this year as a result.

Before we open this to you, let me answer what will obviously be the first question -- what is the status of the CEO search? Our annual shareholder meeting will be held on Wednesday and the board meets immediately thereafter. The major topic of discussion at this meeting is slated to be the choice of a CEO. I am not sure when a decision will be announced but I am confident -- I say that again -- I am confident that there will be a full-time, not interim, CEO hosting the next earnings call in August.

And now we’ll take your questions. Martha.

Martha Lindeman

Okay, we’ll open it up now.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question today from David Miller from Caris & Company. Please go ahead.

David Miller - Caris & Company

Linda, just a housekeeping item on the asset impairment charge of $5.5 million -- is that sort of a twin charge related to the $3.2 million restructuring charge as per the New York office closing, or are you impairing something else? And then I have a follow-up. Thanks.

Linda G. Havard

No, it’s actually good will impairment, David, and it’s the result of actually what’s left over from some of the acquisitions that were related to digital, so when digital moved over to the print digital group, because that group is experiencing losses, the assets are immediately impaired.

David Miller - Caris & Company

Okay, great. And then Jerome, I know there’s only so much you can telegraph and it sounds like you guys sort of have an announcement on this new CEO fairly sort of imminently, but there’s some chatter going around that there’s sort of some conflict in the company between say what Mr. Hefner wants and what the board wants -- you know, between an internal candidate and an outside candidate and so on and so forth and I am wondering if you can confirm that and/or speak to that. Thanks.

Jerome H. Kern

I am not going to really speak, David, to the process at all because I don’t think it’s appropriate. I will tell you that the board is diligently proceeding and going through the process to satisfy everyone with whomever they choose, and that’s really all I am going to say on this call about the choice of the CEO.

David Miller - Caris & Company

Okay. Thank you.

Operator

And we’ll take our next question today from David Bank from RBC Capital Markets. Please go ahead.

Analyst for David Bank - RBC Capital Markets

Thank you. This is Jason [Brenner] in for David. A few questions -- first, talking again about domestic TV, it looked to stabilize in 4Q --

Jerome H. Kern

Can you speak louder, Jason?

Analyst for David Bank - RBC Capital Markets

Sure. Can you hear me now?

Jerome H. Kern

Yeah.

Analyst for David Bank - RBC Capital Markets

Going back to domestic TV, can you talk about what you saw maybe in 4Q where the business looked to stabilize and then maybe more specifically why the drop-off in 1Q? Second, you mentioned in the press release $18 million in personnel costs that you have taken out since October -- how much of that actually occurred in the first quarter? And then finally, following the relaunch of the website, do you expect the $9.3 million in digital revenues to be at the trough quarter in 2009? Thank you very much.

Linda G. Havard

Let me start with your question about the $18 million in costs. We would have seen minimal impacts in Q1, a little bit -- we’ll see a little bit more in Q2. Nearly half of the $18 million we ought to see in the second half with the rest occurring in 2010. That’s the first one.

With regard to domestic TV, we don’t -- every quarter is different. You don’t have ups -- you don’t just go one direction, unfortunately and a lot of times what we end up doing is adjusting for previous quarters once we get in the results from three or four months ago or a year ago in some cases from the operators. So what we are seeing in an overall trend is decline as a result of the linear networks basically going away.

Jerome H. Kern

The other one was the digital --

Linda G. Havard

The other one was the digital relaunch -- I don’t really want to comment on any particular quarter. We’ll have to see how the results look. We’ve just relaunched the site and we will see how that looks going forward.

Jerome H. Kern

I think the interesting thing that is happening in the TV side of the business is for the first time literally since the major MSOs and DBS providers were providing this kind of content to their consumers, they become concerned about the decline in this particular revenue stream. You have to recognize that this is a very lucrative revenue stream for the MSOs and DBS providers, since they keep the lion’s share of the revenue and have no costs associated with it. So now for the first time, they are much more interested in cooperating with us in promoting this content to their customers and we are hopeful that that will lead to better results during the balance of the year, although the area continues to decline.

Operator

(Operator Instructions) And our next question today will come from David Leibowitz from Horizon Asset Management.

David Leibowitz - Horizon Asset Management

Good morning. A couple of unrelated items -- first, you speak to the change at the magazine in terms of perhaps reducing frequency, increasing price, et cetera. Can any of these, even in conjunction, give you a profit on the magazine?

Jerome H. Kern

I think it’s too early to tell. Certainly the goal is to at least break even but -- and we keep looking at various scenarios in which we hope to do that but there’s certainly no way of predicting whether and when we can get there.

David Leibowitz - Horizon Asset Management

Okay. A second question -- you can cut costs to some level, whatever it may be, but if you don’t get the top line growing is there really reason to believe profitability is attainable for this company with all the business units that you possess?

Jerome H. Kern

That must be a trick question because obviously if we can’t grow revenue, we’re not going to get -- we’re not going to become profitable. We believe we can grow revenue -- we think we have a great brand. It’s almost in some ways analogizing the situation at the beginning of the year or when I got involved as a patient who comes into a hospital and is severely ill and the first thing you do is you try to stabilize them and get them healthy, and then you want them to get more healthy so you give them a regimen of exercise, et cetera. We’re not in this business not to make money -- we’re in this business to monetize the brand as quickly and as effectively and as profitably as we can. And I was just telling my colleagues in this room, because it became -- I became aware of it last Friday, that the largest selling piece of wallpaper on AT&T in the first quarter of 2009 was called the Pink Bunny Bling, which is the icon on a pink -- the bunny on a pink background. And I’ll repeat that -- that was on AT&T. So this is a mainstream company where we had the best-selling item in the first quarter.

Now to me, that says everything I need to know about the brand and its possibilities.

David Leibowitz - Horizon Asset Management

That being said, last question, if I may, is what is the revenue or critical mass needed on the top line to get to that level of profitability that you are hoping for?

Jerome H. Kern

Well, I don’t know what level we are hoping for. We sort of have unlimited expectations and I am not going to predict when we will turn profitable but we are in a very good liquidity position. We’ve got a lot of cash. We’ve got a $30 million revolver. There’s plenty of energy in the organization and we are focused on growing revenue and profitability.

The brand is the brand and it’s a fabulous brand.

Linda G. Havard

I think, David, you’ll have seen that we exited some businesses, which reduced revenues but also allowed us to increase profitability. So that’s really the first focus.

David Leibowitz - Horizon Asset Management

Okay. Thank you very much.

Operator

And it appears that we have no further questions at this time.

Martha Lindeman

Okay. Thank you all very much for joining us this morning. If you think of any other questions, follow-ups, I will be in my office all day and I will be happy to speak with you. Have a good day.

Operator

This concludes today’s teleconference. You may disconnect at any time. Thank you and have a great day.

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