Playboy Enterprises Q4 2007 Earnings Call Transcript

Playboy Enterprises (PLA)

Q4 2007 Earnings Call

February 13, 2008 11:00 am ET

Executives

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

Christie Hefner - Chairman and Chief Executive Officer

Bob Meyers - Executive Vice President and President, Media

Alex L. Vaickus - Executive Vice President and President, Global Licensing

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

Analysts

David Bank - RBC Capital Markets

Lucas Binder - UBS

David Miller - SMH Capital

Presentation

Operator

Welcome to today’s teleconference. At this time, all participants are in a listen-only mode. Later, there will be an opportunity to ask questions during our Q&A session. Please note, this call may be recorded.

I’ll now turn the program over to your moderator, Ms. Lindeman.

Martha O. Lindeman

Good morning, everyone, and welcome to the fourth quarter 2007 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 Erisa at 312-373-2432.

During the call today, we will be making forward-looking statements pursuant to the Safe Harbor provisions of the Security 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, which describes some of the factors that could cause our results to differ materially from today’s discussion.

We’re going to start today with Christie Hefner, followed by our Co-President, Bob Meyers and Alex Vaickus, and end with our Chief Financial Officer, Linda Havard. So, I will turn it now over to Christie.

Christie Hefner

Thank you, Martha. Good morning. While we were pleased to report improved operating and net income for the year, I want to assure you that we are not satisfied with the performance. 2007 was a year of mixed results, with strong growth in Licensing, but lower profits in some of the media businesses.

Clearly, we faced some serious challenges that are not unique to our company, and they include managing a mature traditional print business, as well as developing optimal online and mobile products and business models.

We are focused on improving performance, and I’ve asked Bob and Alex to join us today to help detail the challenges and opportunities we face, as well as the actions we are taking as a result.

The Licensing Group turned in a stellar 2007 performance, reporting 30% revenue and 40% segment income growth. The first full year of results from our licensing agreement with the Palms Casino Resort and the sale of art early in 2007 contributed to the Group’s record results.

But the core of the Licensing business, the sale of consumer products carrying the Playboy brand and imagery, remains vital and growing. We expanded our product lines, increased retail distribution, and grew our geographic reach, thereby positioning the business for continued growth in 2008 and beyond.

A 2007 milestone was the completion of another licensing deal for a location-based entertainment venue. This will open next year in Macao. There are multiple opportunities for these kinds of experiential venues that bring the brand to life and provide the consumer the opportunity to go to a cool Playboy party.

Our goal is to close and announce a third deal for this year to continue to build the pipeline. We are confident that the Licensing Group’s revenues and profits will continue to grow in 2008 and beyond.

As we look at the media businesses, it’s clear that these are businesses in transformation. Technological innovations, shifting consumer patterns, new advertising opportunities and rapid growth in content providers all are profoundly changing the media landscape. These dynamics affected our media performance in 2007, resulting in year-over-year declines in both publishing and domestic TV.

Domestic TV is facing the challenges of an intensely competitive market made possible by the advent of on-demand technology. This has led to an overall decline in our share of the market, increased pressure on splits, and limited marketing.

Thus while we continue our efforts to grow the number of monthly subscribers to Playboy TV and stabilize revenues at present levels, we are also focusing on improving margins. Toward that end, Bob will describe, in a minute, some of the specific actions we are taking, both with regard to growth for Playboy TV and with regard to a deal we expect to close regarding our Andrita Studio.

On the print side, with uncontrollable costs like postage, paper, and ink going up, and both circulation and advertising revenues in the industry under siege, the domestic magazine business remains extraordinarily difficult.

Our ability to reduce controllable expenses in 2007 helped us offset some of the revenue declines, plus we successfully completed higher-margin initiatives such as the launch of new international additions.

With RJR’s decision to eliminate print advertising, we start the year with the overhang of knowing that we will lose approximately 20 ad pages that we carried last year. In addition, our ad price per page will be lower as a result of our decision to lower the rate base.

Like other publishers, we will continue to search for ways to reduce controllable costs to help offset these revenue declines. Unlike other publishers, however, we also have the advantage of a successful and profitable online business. We are leveraging that asset to grow both our total Playboy audience as well as our total advertising revenues.

Already we are seeing results. The combined Playboy print and online audience last year grew 9%, creating access to more consumers whom we can monetize across the company’s businesses. And our focus on selling combined print and online packages last year led to a 10% increase in total ad sales.

As the early results indicate, there is untapped potential in our digital media of online and mobile, which represent significant opportunities for growth. Last year’s online ad growth was driven, in part, from changes to our website in late 2006. And we will be following that up with bigger changes and additional enhancements to both our free and our pay sites this year.

This will entail investments in technology, content and marketing. We believe that these investments will begin to generate meaningful growth starting in the fourth quarter.

We are working through some difficult transitional issues and laying the groundwork for the future. It’s important to remember that the Playboy brand is stronger and more popular than at any time in the company’s history. We have a solid balance sheet, significant assets, and the plans in place to return this company to increasing levels of profitability.

And now, let me turn you over first to Bob and then to Alex so that they can describe in more detail their businesses.

Bob Meyers

Thank you, Christie. Good morning everyone. For the year, the Entertainment Group posted segment income of $21.3 million versus $23.3 million in 2006, and a $2 million increase in revenues to $203 million.

The weakest quarter of the year was the fourth, where we saw a decline in both segment income and revenues for the Group as compared to the prior year.

Taking the Entertainment business piece by piece, let’s start with domestic television, where we have been working hard to stabilize our revenue base as well as reduce our costs. Our top line objectives are two-fold: grow Playboy TV as a monthly subscription service and stabilize the movie services.

On Playboy TV, we have been gaining subscriptions through roll-outs of an attractive SVOD product. Last year, we recorded a 15% increase in the number of monthly Playboy TV cable subscribers, and we will build on that gain with the continued roll-out of SVOD as well as new marketing campaign this year.

On the movie side, we’ve seen tremendous pressure on revenues caused by continuing declines in pay-per-view orders as cable operators have all but abandoned that delivery option in favor of VOD.

We will fight aggressively for every buy, through a strong product line up and improved scheduling and merchandising. The decline in pay-per-view has been partially offset by gains in VOD, which last year almost doubled, reflecting the roll-out in new systems.

We are working on cost reduction actions as well as revenue enhancements, and we continue to look at ways to reduce our cost base without undermining our ability to serve our customers and distribution partners.

Through better asset management, we expect to decrease our overall cash investment in TV programming by a small amount, and in addition, we expect to conclude a deal this quarter to sell our assets related to the Andrita Studio in California. This deal will be immediately cash-flow positive and begin to favorably impacting the bottom line in 2009, while preserving our access to that state-of-the-art facility.

The global appeal of our brand and programming are evidenced by the year-over-year double-digit revenue and profit growth reported by our international TV business last year.

Even though mobile revenues declined year-over-year due to increased competition in overseas markets, total revenues from our digital media businesses of online and mobile rose slightly to nearly $18 million in the fourth quarter, and more than $60 million for the year.

Looking ahead, a recently completed mobile deal in Europe will help us expand into new territories and provide us the operational and marketing support needed to grow. We also recently announced a deal with THQ Wireless for the development of the series of mobile games that will be distributed globally beginning this summer.

In online, as Christie described, we are focused on growing our total print and digital audience and better monetizing those consumers. We are working on a redesign of our website, which should be completed this year, and we intend to expand our content offerings and advertising opportunities both in conjunction with the magazine.

In addition to our advertising and pay revenue streams, we have a solid e-commerce business, which right now generates just under a third of our total digital revenues.

When we look at the scale of other brands’ e-commerce sales, we conclude that there is a significant growth potential in the business and we are completing a deal to outsource these operations to a partner who has had great success in handling other well-known lifestyle brands.

While this transition will lead to a sizable reduction in total 2008 e-commerce revenues, we expect profitability will increase immediately as a result, and both we and the Licensing Group should benefit from the sales growth.

Publishing reported lower revenues and segment results in the fourth quarter compared to the prior year due to declines in circulation and advertising. Effective with the January issue, we reduced our rate base to $2.6 million, reflecting the realities of how and where our target audience of young men is consuming media.

While we also increased our CPMs by 4% effective with the January issue, the lower rate base will result in a 13% decrease in ad rates. Rising commodity prices are putting pressure on our largest expense of paper and printing, although the reduction in each month’s print run is helping to neutralize those increases.

And now, let me turn it over to Alex, who will talk about Licensing.

Alex L. Vaickus

Thanks, Bob and good morning. As Christie indicated the 2007 was a record year for us in terms of revenues, profit, retail distribution outlets, number of licensing agreements, SKUs and just about any measure you could use against our business.

Global retail sales now total more than $800 million and we rank as one of the 50 largest licensers in the world. Our improved fourth quarter results were a continuation of trends seen across all of last year, mainly revenue gains in virtually every category including domestic and international consumer products, but also retail stores, games and leisure licensing and even the Palms.

Looking ahead, we foresee continued growth, although we’re cautious about the economy and its potential impact on consumers around the world. Retailers globally saw a slowdown in the fourth quarter holiday sales and we don’t yet know if this will continue.

With that said, we have some very exciting launches on the consumer products line. We expect to introduce new men’s grooming products this year and are very excited about new items for our lingerie line. We’ll also continue rolling our Playboy Physical, which is our line of active wear and Playboy Icon, our higher price fashion line.

New products help drive success as does the addition of new territories to our geographic reach. In 2008, we expect to increase our presence in Eastern Europe as well as the Scandinavian and Benelux countries, and we also plan to expand in the U.S., Central America, Brazil and South Africa in particular.

Our retail approach is two fold. We first try to place products in so called halo retailers like [inaudible] for example that can play an important role in creating buzz and positioning for the brand.

As a next step, we expand into retail chains, which generate significant sales volume. We also expect to open three additional Playboy concept boutiques in 2008, including a second European store on top of the eight that we already have open. In our location-based entertainment business, we’re pleased with how well the Palms venue is doing and especially with our relationship with the Maloofs.

As you might have noticed, revenues from the Palms were up slightly in the fourth quarter compared to the prior year, we think demonstrating that the club should do better in the second year than it did in its first.

In Macao, the Studio City project is under construction and we’re on track for the anticipated opening late next year. We’re also working hard on other deals and expect to close the next deal and announce it this year.

Each of these high margin deals should result in an attractive step up in annual earnings. As Christie noted, we want to fill the pipeline so that you can look forward to a new deal coming on stream every year.

And now, I’ll turn it over to Linda.

Linda G. Havard

Thanks, Alex. Let me start with corporate administration and promotion expense which rose in the fourth quarter due to increased compensation compared to 2006 when we benefited in the fourth quarter from a reversal of stock-based compensation expense. The 2007 fourth quarter also reflected higher marketing expense primarily related to brand research that we’re doing.

In addition, we recorded a charge of $1.9 million below the segment income line in the 2007 fourth quarter, which is primarily related to the expected sale of our Andrita Studio assets that Bob discussed.

We believe that this charge captures the bulk of the expenses related to that deal and therefore we expect a minimal additional ‘08 P&L impact. Assuming the asset sale is completed as planned next month, the Andrita deal will be cash positive to us in 2008.

Fourth quarter results also included a small charge related to the other transaction that Bob discussed today, mainly the outsourcing of our Playboy e-commerce and catalog business.

We expect less than $1 million in additional charges in ‘08, which likely will be taken in the first half of this year and those are mainly related to early contract terminations. For the full year, the e-commerce deal will be in a net positive out of the gate.

Looking ahead, we expect to see an approximately $2.5 million decline in television programming amortization expense in 2008; that’s on top of the $2.7 million decline we reported in ‘07 versus ‘06.

This savings in TV programming amortization expense will be offset by higher online content spending. As a result, total programming and content expense in 2008 should again be below $40 million, about flat with 2007.

On the tax side, as the release indicated, we recorded a $2.6 million tax benefit in the 2007 fourth quarter, which was primarily related to our European TV networks and which we do not expect to recur in 2008.

Finally turning to the balance sheet, as Christie noted and the supplement to your earnings release shows, we ended the year with a healthy $33.6 million in cash and cash equivalents and $115 million of 3% debt. Complete balance sheet information will be available when we file our 10-K in the middle of next month.

And now, we’d like to open it up to your questions.

Question-and-Answer Session

Operator

We’ll take our first question from David Bank - RBC Capital Markets.

David Bank - RBC Capital Markets

I have about six questions. Thanks in advance for your patience. Let me start with the first one. The first one is on the Andrita deal, overall the studio. Can you give a little bit more color into, you’re saying it’s free cash-flow positive this year, but net income statement positive the following year.

What’s the difference there? Is it just the proceeds from the sale? Can you quantify them? Can you talk about what OpEx are you saving? What OpEx do you pick up in rental? A little bit more clarity on the economics of that deal.

The second question is on the e-commerce side, what quarter will this actually take effect? And can you give a little bit more quantitative clarity there?

The third question, Linda, you said something on the international side, there was a one-timer in there. I didn’t quite catch what it was, and maybe that partially answers this question. There was a sequential deceleration in growth on the international TV side, and I was just wondering if you had any thoughts around that.

And then on publishing, we’re looking at a 30% decline in advertising in the first quarter, but the circ is only down 13%. So, is it RJR that’s attributing for the bulk of the other 17%? Or what’s going on there?

Christie Hefner

Bob, do you want to speak to a little bit more about the Andrita transaction?

Bob Meyers

Let me talk generally about the Andrita deal. For us, this is an opportunity to help us focus on our core business going forward and also take advantage of the fact that by putting the facility in the hands of someone who it is their core business, they’re able to monetize it in a way that for us would be a distraction.

It allows us to off load the obligation related to our transponder service agreements, as well as obligations for us to find third parties to fill the excess capacity that results generally from us reducing and changing the mix of television programming that we produce out of Andrita.

So, it will be, as Linda mentioned, cash-flow positive for us this year. We expect the deal to close in this first quarter of this year and going forward, because of the way we capitalize expenses, we should see increasing savings over the next several years for us not being in a position of operating that facility and taking all the costs ourselves.

Christie Hefner

So David, to your question about the gap between cash and P&L, it has nothing to do with the transaction of the sale. It has to do with the fact the previous costs are already built into programming and therefore it’s the reverse of the amortization cash on the programming side. So we’ll start to see the P&L benefit of…

David Bank - RBC Capital Markets

I’m sorry. Is it on the depreciation of the facility or the amortization of programming cost?

Christie Hefner

It’s the amortization of basically capitalized overhead that related to our productions there and we amortize over three years.

David Bank - RBC Capital Markets

Any order of magnitude that you can give us a little more color on?

Christie Hefner

It’s, as Linda says, over three years. It’s going to work its level up to a couple million dollars annually. With a lower level of risk.

David Bank - RBC Capital Markets

And that’s netted against the additional rent that you’ll have to pay?

Christie Hefner

We’re not having to pay any additional rent. The rent will be a pass through.

Bob, do you want to speak about the timing of the e-commerce deal?

Bob Meyers

Yes. The e-commerce deal we expect to close in March, and we should see the effect of that throughout ‘08 and continuing going forward. For us, we think this is a terrific way to monetize in a way that we haven’t to-date, what we think is going to be a great opportunity on the merchandising side.

Christie Hefner

I think what’s exciting about that deal David, is that it’s a great combination of recognizing that as e-commerce, in general, has grown for brands. There are now companies whose core competence is the management of the merchandising and the web interface and the fulfillment. And one such company is the one we’ve chosen.

So it takes us from a business that’s marginally profitable to a business that has significant minimum guarantees and overages from the perspective of our digital portfolio, while continuing to be integrated in terms of traffic and then gives us what we think will be meaningful upside in terms of simply the growth of the sale of more of our licensed products online.

If you look at the experience that other brands have in terms of what they do at retail and what percentage they can do in e-commerce and catalog, we’re way below that. So we see top-line opportunity, which will be captured both in the percentage of sales that’s the deal for digital and will be captured in increased royalties through licensing as our licensees are able to sell more product online.

Do you want to talk a little bit about the international dynamic, Bob, international TV?

Bob Meyers

International TV continues to be a strong performer for us. So David, you mentioned, I’m not sure.

David Bank - RBC Capital Markets

You went from in the previous quarter 15% year-over-year growth to 9% year-over-year growth in this quarter, certainly a pretty good showing. But sequentially a deceleration, and I was just wondering if there was, as we think about the business, we try and think about what it looks like next year. And it’s a little bit easier when you see a consistent trend in year-over-year growth.

Bob Meyers

I don’t think that you can read a lot into that. I think that the revenues tend to be a bit lumpy quarter-by-quarter, specifically because of the some of the deals we do on the international side. So I won’t read too much into that.

Christie Hefner

David, you mentioned the one-time that you heard. That’s related to the tax benefit in Q4.

David Bank - RBC Capital Markets

So that was below the line?

Christie Hefner

That was below the line, right.

And then on the ad question, David, as you surmise, it is a combination of pages and the lower price as a result of the rate base reduction, so only about half the decline is from the rate base reduction. The other half is pages. And that is a combination of loss of pages from print, but it also involves flighting, i.e. what quarters are advertisers putting their money behind.

David Bank - RBC Capital Markets

So RJR, has that actually started to impact the magazine yet or does that occur later in the year?

Bob Meyers

That’s already started to impact.

Operator

We’ll take our next question from Lucas Binder - UBS.

Lucas Binder - UBS

A couple of questions for you, starting with Linda. Can you talk about what the cash obligations are in 2008 for prior acquisitions and maybe walk us through what some of those obligations are looking out over the next year?

And then for Martha and Bob, when you think about cost cutting and saving opportunities in 2008, looking at the business with a little bit more sense of urgency to get back to better profitability. Are there any sacred cows?

Would you ever consider licensing the TV business outright? Would you ever consider maybe closing the Chicago offices and just operating out of New York and LA? Some other things that would be a little bit more large in scale?

Linda G. Havard

Let me just ground everybody with what we had in 2007 in the way of some of the deferred acquisition purchase price cash outflows. We had $8 million in Califa payments for the acquisition of our networks back in 2001.

We had $2 million for the ICS acquisition and the U.K. acquisition. We had about $8.5 million of capital expenditures, and we had about $1.5 million for the CJI acquisition. 2007 marked the last large payment for the Califa acquisition, so we’ll just have $1 million going forward, $250,000 a quarter for that partway through 2011.

We paid our last payment for the ICS acquisition in 2007. We don’t have any more for that. And we have less than $2 million for the CJI acquisition. So that will just be a small CJI payment, a small Califa payment and whatever CapEx turns out to be for 2008, and $8.5 million is probably a good number for you to use.

Christie Hefner

Let me try and speak to the second question. No, I don’t think there are sacred cows. I think that we are demonstrably committed to taking a hard look at how we do all of our businesses and where we find opportunities to be more efficient, or change how we do business, we are more than willing to do that.

As you know, we’ve taken millions of dollars of costs out of our TV programming because we felt that that was doable and the right thing to do. We’ve taken millions of dollars out of our editorial acquisition costs and in terms of pages in the magazine because we felt that that was the right thing to do.

We talked today about two transactions that reflect exactly that kind of thinking regarding what’s the right way to do our businesses. Andrita where we’re getting out of the business of having to manage a facility and attract and service third-party tenants, and e-commerce where we think we have both more top-line opportunity, and a company that’s in that business in a focused way can do it more efficiently than we can.

Looking ahead, we think that there are opportunities, for example, in the number of channels that we put up and the change in the relationship with Andrita will allow us to move more aggressively in that direction. We’re looking hard at overhead across the company and what kind of staff support we have, both at corporate and on our different businesses.

I would as an example, because you asked the question, note that before we signed our new deal for our Chicago office, we did a very comprehensive analysis of exactly the question you asked, i.e., would it be more efficient to simply operate in New York and LA?

And while it’s counter intuitive and was for me as well, because the cost of rent occupancy and salaries is so much lower in Chicago than on either coast, separate from moving costs and separate from any attempt to assess the “cost” of losing some people, which always happens when you give up a office location, just on a running rate basis, we actually run on a lower cost basis with the third office in Chicago than we would with just offices in New York or LA.

So, I’d say that by way of saying that we indeed do and are looking at everything.

Operator

We’ll take our next question from David Miller - SMH Capital.

David Miller - SMH Capital

Just a couple of general questions. Christie, correct me if I’m wrong, but this is usually the call where you issue some sort of prognostication on the forward year on the EPS line. I think that’s what you’ve done traditionally.

Are you not doing that today just because of the transitional issues that you outlined? And just the murkiness surrounding everything that’s going on in publishing? Or is there some other structural reason?

And then also just a general topical question. What is the total circulation nowadays for Playboy Magazine domestically? And how many of those subs are monthly subs?

Christie Hefner

The answer to why are we not giving guidance at this point is exactly what you surmised it is; that as we’re working through these transitional issues, which include both the murkiness in publishing on the ad side as well as the timing of traction in what we’re doing in digital, we don’t feel that we have the visibility to be helpful yet. On the publishing side, of the 2.6 million roughly 2.3 million are subscribers.

Operator

We appear to have no further questions at this time.

Martha O. Lindeman

Thank you all very much. You are unusually shy this morning, but if you think of any follow-up questions that you would like to ask, please do not hesitate to call. I’m actually on the road, but Erisa will make sure that she tracks me down, and that we’re able to talk with you. So thank you very much for your attention this morning.

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