Playboy Enterprises Q4 2005 Earnings Conference Call Transcript (PLA)

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Playboy Enterprises Q4 2005 Earnings Conference Call Transcript (PLA) February 14, 2006 ET

Executives

Christie Hefner, Chairman of the Board and Chief Executive Officer

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

Analysts

Michael L. Savner with Banc of America Securities

Dennis McAlpine with McAlpine Associates

David Bank with RBC Capital Markets

David Miller with Sanders Morris Harris Group

Lucas Binder with UBS

Scott Coleman with Credence Capital

Melissa Otto

David Leibowtiz

Operator

Good day. All sites are online in listen only mode. At this time it is my pleasure to hand off the conference to your moderator, Miss Martha Lindeman.

Martha Lindeman

Good morning everyone and welcome to the 4th quarter conference call. If you need a copy of our release or earnings supplement, you can look on our website at www. peiinvestor.com or you can call the lovely Erisa at 312-373-2432. During the call today, we will be making forward looking statements pursuant to the safe harbor provision 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 which describes some of the factors which could cause our results to differ from today’s discussion.

During this call we also may make reference to non-gap measures. This information, including a reconciliation to the related gap measure is available on today’s release.

With me today are Linda Havard who will walk you through the details of the quarter and Christie Hefner who will discuss the outlook for the year.

Starting with you Linda.

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

Thank you Martha and good morning everyone. We’re pleased that we were able to deliver on our guidance for the year, despite the challenges in the domestic magazine business. As we projected in November, the Publishing Group experienced it’s weakest quarter of the year in the 4th quarter beset by higher non-controllable costs and continued pressure on advertising and newsstand sales. Playboy magazine ad revenues declined nearly 24% in the quarter reflecting the same industry trends we have seen through the year. Including the shift of advertising dollars to the Internet, to cable, and to sponsorships as well as to consolidation among advertisers. These challenges extend to newsstand sales as well where our decline was emblematic of what other men’s titles are experiencing. On the expense side, manufacturing is our largest cost and paper prices are now nearly 25% higher than they were a year ago.

Turning now to entertainment, we had a very strong 2005 4th quarter. The comparisons, however, are somewhat skewed by last year’s unusual 28% 4th quarter operating margin which included the reversal of more than a million dollars in previously accrued expenses. Fourth quarter domestic TV revenues declined, reflecting the transition from pay-per-view to video on demand technology as we wait for Comcast to roll out our content on its VOD and subscription VOD platform. We expect both Comcast and Time Warner to launch Playboy TV as an on-demand service in their systems in 2006. In the mean time, as consumers have adapted to and begun appreciating the convenience of on-demand programming, some carriers are dropping linear channels in favor of video on demand.

Looking at our other entertainment businesses, we recorded an 11% increase in 4th quarter international TV and wireless revenues which included better performance in Latin America, the UK and Germany.

In online, our subscription revenues grew 51%, benefiting from the immediate accreted acquisition we made last fall which now allows us to access an affiliate network of Webmasters through which we are able to now reach a much larger consumer audience. The margins on this new business are lower than what we enjoy through our traditional type-in traffic, however as the quarter’s results demonstrate, the increase in both distribution and additional product offerings continue to accelerate the growth in our online business.

With a nearly 90% increase in operating income, the Licensing Group enjoyed a remarkable quarter. Significantly higher product sales and thus royalties primarily in Western Europe but also in Australia and the US drove the profit gains. As we describe in the release, we benefited in both the quarter and the year from lower interest expense as a result of the refinancing that we completed in March of last year. We will see a beneficial comparison again in the first quarter of 2006 until we reach the first anniversary of that refinancing. Also, as mentioned in the release, in the first quarter we will begin expensing stock options as required by recording a non-cash expense that will flow through each of the business segments and the corporate group. We expect that expense to total approximately $3.5 million or $0.10 per share for the full year.

During the quarter we also purchased the remaining minority interest in Playboy.com. As a result, the inter-company agreements related to trademark, licensing fees, and content that had been in place since 2000 have been eliminated. This will cost corporate administration expense to increase to approximately $5 million in 2006 with a corresponding improvement primarily in the entertainment group’s segment results, also in 2006.

Before closing, let me note that while our cash programming spending was down considerably in 2005 versus 2004, primarily due to timing, we continue to project cash programming investments of $38 million in 2006 with programming amortization expense of approximately $37 million in line with 2005. Now let me turn you over to Christie.

Christie Hefner, Chairman of the Board and Chief Executive Officer

Thanks Linda. Our 2005 accomplishments included significant profit gains in our growth businesses, a refinancing that dramatically improved our financial position, the completion of key transactions. And despite the challenges in the publishing world, our ability to deliver on our guidance with an 87% increase in EPS excluding the debt charge to $0.56 a share.

Looking ahead, let me talk about how we expect to continue this momentum in 2006. Starting first with publishing, as we indicated in December when we gave 2006 guidance, we don’t see the environment getting better in the near term. On top of continued increases of paper prices we are now faced with the 5.4% increase in postal rates effective last month. With 2.8 million copies mailed to our subscribers every month this is a substantial expense. We have taken steps to address these continuing challenges. We have reduced our rate base to help address rising printing and postage costs, and we raised the cover price of the magazine. We also launched an extremely cost effective digital edition of the magazine. We increased our CPM to advertisers and reduced our editorial expense. Most recently we hired Lou Moen as publisher. Through his broad industry experience, particularly in the automotive field, Lou is both attuned to the interests of men and knowledgeable about using brand assets to grow revenues. We are very pleased to have Lou on our team and he and I are optimistic about working together and the opportunities for Playboy and we look forward to introducing him to you.

Moreover, Playboy magazine continues to expand globally through its licensing model. We launched three new foreign editions in 2005 and are in discussion to launch several more in 2006. Most of our investors understand and endorse our strategy of using Playboy magazine as a brand driver to grow our higher margin entertainment and licensing businesses. Based on our advertising projection, we think that the first quarter 2006 publishing loss will be larger than the loss we reported in the 2005 4th quarter and the largest in 2006. We remain committed to improving the publishing results as 2006 unfolds. We expect to see continued good performance in our two growth business of entertainment and licensing. In domestic TV we anticipate revenue growth in the second half of the year as we get VOD traction in additional cable systems. And we look forward to the 2006 launches of Playboy TV as on-demand product.

As the 4th quarter results show, international TV and mobile remain revenue and profit growth drivers. We now offer wireless product in 32 countries and have just signed our first wireless deal in Japan. We also recently launched a mobile website in Latin America. With more than 2 billion wireless subscribers globally, this is a large market and one where our brand and content have proved appeal. Additionally, we expect to see continued strong growth in the sale of our content online.

Our fastest growing and highest margin business, licensing, will remain a significant part of the growth story. We will continue to expand our core licensing business and are particularly focused on adding new territories and licensees in Latin America and the emerging consumer markets of Eastern Europe and Southeast Asia.

We are also increasing our lines of higher priced point products including a new upscale lingerie line which will be sold in Henri Bendel’s in New York, Harvey Nichols in the UK, SoGo in Hong Kong, and Das Lou in Brazil among other retail outlets.

In 2006 we plan to open an additional three new Playboy concept stores, bringing to eight our total number. And in 2006 we look forward to the grand opening of our first location-based entertainment project, the Playboy Tower at The Palms in Las Vegas. We have been told the opening will take place in the 3rd quarter, but we do not yet have a formal date.

In spite of the fact that The Palms will only contribute minimally to earnings in 2006 and in spite of the fact that 2005 was such a strong year, we are still projecting 15-20% growth in the group’s 2006 segment income because of the strength of the core licensing business.

We continue to believe that we will report a 20-25% growth in earnings per share in 2006 inclusive of the expensing of stock options that Linda talked about. That comparison excludes the 2005 debt extinguishment expense. Our brand and our content are more popular and reach more consumers today than at any time in our company’s history. We have a distinct, differentiated, and highly popular brand plus a mix of businesses that are benefiting from technological changes and globalization. And we have the financial strength to support the company’s needs and capitalize on the company’s opportunities.

With that, we are happy to take your questions.

Questions-and-Answer Sesssion

Operator

At this time ladies and gentlemen, should you have an audio question simply press *1 on your touch tone phone. You may withdraw your question at any time by pressing the # key.

We’ll take our first question from the site of David Miller, with Sanders Morris Harris.

David Miller

Hi. Good morning. Just one question, on the corporate administration promotional line expenses, the increase you talked about for 2006 is that because of a switchover to a piece-rate compensation system for the folks over there or is it just a function of more people, or is there something else behind that?

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

All it is, is a switch from reduction in expense that was flowing to corporate as a result of trademark expense because it is having to have these arm’s length agreements that just no longer exist, so we’ve had the same expense in reduction in corporate since 2000 so that will just go away. And then it benefits the Entertainment Group and a little bit in Publishing.

David Miller

Okay, thanks.

Michael Savner, Banc of America

Good morning. I have two questions. One, going back to the Entertainment Group and the decline in domestic revenue. I guess it wasn’t exactly clear to me, because you are talking about not seeing much benefit from the VOD launch, but are people, are there systems that are dropping your pay-per-view prior to rolling out VOD? I guess if that is the case, it makes sense, but I am not sure why they would be doing that. So, what are you seeing from Time Warner because we got this on some previous calls that you were starting to see some VOD pick up from Time Warner and Comcast. I guess they haven’t rolled out yet. So what’s the status there. But I guess still the explanation on the decline is not clear.

The second question, your ad guidance for the magazine for the 1st quarter is 30% down, which you are talking about 80 pages, which would be a new benchmark for you at least over the last couple years. Given your explanation on publishing, it doesn’t seem like you optimistic that it is improving so is that kind of the outlook for the remainder of the year? And if you don’t want to comment on that specifically, I am still unsure how you are getting to your full year guidance if publishing is eroding at that level. I might be missing some stuff here so if you can go into a little bit more detail on those two items I think that would be helpful. Thank you.

Christie Hefner, Chairman of the Board and Chief Executive Officer

Sure, on the domestic TV, yes what you are surmising is correct. That is, that there are both linear channels being dropped and consumers are gravitating more to the VOD platform. So the lag in getting rollout on VOD on Spice and getting Playboy SVOD launched hurts us in both regards which is why I think that for the year, we achieve some revenue growth but to see revenue growth domestically is really going to require getting traction on the rollout of VOD and playboy SVOD. On the advertising, you are right in assuming that if we felt the 30% decline in the 1st quarter was going to be consistent with the remainder of the year, we would not be able to hold to our guidance. Consequently, while we don’t give quarterly guidance, we can surmise that in consultation with the new publisher and a bottoms-up assessment of our ad prospects and clients, we don’t think that will be typical of the remainder of the year. So the combination of the steps that we had taken that will impact the year favorably that I ticked off in my remarks with what we hope will be the prospects for the remainder of the year in advertising gives us the basis for holding to the guidance.

Michael Savner

OK, thanks, that’s helpful. I just want to make sure I understood your first answer. There are consumers in the marketplace that are losing access to pay-per-view prior to getting VOD access?

Christie Hefner

Yes.

Michael Savner

Why in the world would the MSO’s be doing that?

Christie Hefner

That is not a question I can answer, but I will say that it’s a pattern we’ve seen in the past. With digital being rolled out, our services were being taken off of analog before they were available on digital.

Melissa Otto

Hi. Good morning. Just a couple of questions. First of all, on the domestic entertainment. Could you give a little bit more color on the new deal that you signed with Japan on the wireless front? I would like to understand a little bit more about how the deal is structured, etc.

Christie Hefner

What I can tell you is, it is consistent with past deals in that we are not investment spending. We are being paid fees for the use of our content and the structure of those generally is a guaranteed fee with overages based on usage. And in those markets we’ve been in for several years, we are collecting overages as well.

Melissa Otto

Is it similar to the way the deal with Hong Kong is structured?

Christie Hefner

Similar.

Melissa Otto

Could you talk a little bit about your competitive positioning there in terms of where your deck is and just a little bit more color in terms of what the strategy is behind it in Japan?

Linda Harvard

We are in about 32 countries internationally. Japan is a small piece of that. It is important, obviously; Japan is a good country for us in the licensing business and the television business, etc. But I don’t think this is a make or break deal, this one of 32 countries we are in; focus unnecessarily on it.

Melissa Otto

I would like to get a little bit more color on the clubs they are rolling out for next year. You talked about The Palms. What is going on with the club in Shanghai?

Linda Harvard

At this time, we are working through the permitting process so I don’t know what the date will be. But you will remember that the estimate we gave of $5 million annual incremental royalty benefit to the company from the two projects was 80% from Las Vegas so that is obviously the larger of the opportunities and that will be open this year.

David Bank

Good morning. A couple of questions. The first one, can you comment on the download rate you have seen on the product you have launched on Cingular in December. Are you seeing a meaningful number of downloads on the wallpaper product? And trying to get a sense of when you might hit the decks of Sprint and Verizon and if you have any thoughts for us there.

The second is, in terms of the cash investment in programming, it was definitely a little bit lower than for the full year than I think some of us were looking for and if I heard your guidance right for ’06 it sounds like it’s going to be in the similar kind of range. And maybe my expectations were a just out of whack, but is there anything that is sort of driving the costs down?

And lastly, if you could talk about the private media international transaction where you merged some of the cable operations and how that might impact margins.

Linda Harvard

Let me start first with your question about programming. Cash investments in programming were lower in 2005 than what we had said and what we expected and some of that is just carryover spending that will go into 2006, so we expect that that cash spending will be up to $38 million level which is what we have been projecting for 2005 and 2006. So there is really nothing there other than timing. And you saw the expenses up a little bit in the 4th quarter and we’ll see that in the 1st quarter as well.

David Bank

For the full year, you did $33 million of cash investments and then for the following you are still looking for the same kind, a million higher than you were originally looking for in 2006?

Linda Harvard

We had said the 38 million range for cash, the 37 million is the expense. So the expense and the cash are close.

David Bank

So, for cash in 2006 it is going to be about 5 million higher than it is in 2005.

Linda Harvard

I am sorry.

David Bank

The 2005 cash investments and programming number is 33 million.

Linda Harvard

Correct. We are not going to pick up an additional 5 in 2006, we are going to go back up to what we said the original level was which was 38 million.

David Banks

OK, and amortization should track that pretty closely?

Linda Harvard

Right, amortization will track that rate closely.

Linda Harvard

On the mobile questions, I don’t have an estimate for when we might have a carriage deal to announce, because I don’t ever make an estimate of when we would have a deal to announce. When we have a deal, we’ll announce it.

The download rates are pleasing, but nothing that we would talk about in terms of specifics. And at this point, I think our bigger opportunity will remain over the next 12-24 months internationally, just because the platform that is available to us internationally is more advanced and therefore allows for better downloading of video which is our single largest category of content.

On the private, we are very pleased with the private Spice deal we made in Europe. It is going to give us both cost savings and we think the potential to grow revenues. We are in control of the joint venture and our people think that it is a natural fit since the footprints of the brands were very complimentary.

David Banks

Can you say anything more specific about what the venture achieves? What exactly are the cost synergies being driven by and what are you so excited about?

Linda Harvard

I don’t really think I can say anything more specific. One of the many steps we were taking to ensure the continued double digit growth of international TV, as I say it is a combination of reducing costs because of shared infrastructure with, we believe expectation of benefiting on the top line.

David Leibowtiz

Good morning. Briefly. What one time startup expenses will the company face this year beyond Palm?

Linda Harvard

There won’t be any one time startup expenses including for The Palms. We have a marketing commitment to support the property that is likely to begin before the property opens in the form of pages in the magazine and other marketing events. But I wouldn’t call them one time expenses, David; they are just built into the budget in terms of cost associated with the cost of royalties.

David Leibowtiz

Will The Palm venture, who is responsible for the inventory? Is that something Playboy Corporation is responsible for?

Linda Harvard

What do you mean by inventory, David?

David Leibowitz

The products that will be sold in the boutique.

Linda Harvard

No, we don’t own the inventory in any of the stores. The retail partner owns them. And in the case of The Palms store, The Palms will be the retailer.

David Leibowitz

Excellent, thank you very much.

Lucas Binder

A couple of quick questions. One for Linda on the stock option expense. Is that a straight line number or is that something that will build over the year?

Linda Harvard

That is most likely a straight line number, Lucas. That’s what we’re planning. Obviously if there are new executives who come in, then we have to recalculate.

Lucas Binder

But as far as the guidance is concerned, it’s assuming about 1.9 million a quarter or 1.8 million a quarter.

Linda Harvard

Just divide that annual number by 4,

Lucas Binder

Okay. And one other question, the online business. The $9 million obviously part of those is due to this recent acquisition. How comfortable do you feel that that’s a good run rate to be using going into 2006?

Linda Harvard

Well, I don’t want to give a number specifically, but we have talked about accelerating growth in the online business and continuing that growth and I don’t see why that wouldn’t continue at what you are seeing.

Lucas Binder

So when you say, accelerating growth, meaning you did 20+% last year and it would be a higher percentage growth in 2006.

Linda Harvard

Twenty plus percent is a pretty good number. That is the number we have talked about for some time.

Operator

Just a reminder ladies and gentlemen, should you wish to ask a question, simply press *1. We’ll move right along onto the site of Dennis McAlpine of McAlpine Associates.

Dennis McAlpine

On following up on that question, what was the run rate at the end of the year? In other words, how much of the growth in the 4th quarter came from the acquisition? And is that 20% on top of some base we haven’t seen yet?

Second, would you talk about the VOD revenue on a per capita basis? What sort of history are you seeing as the subscribers get more used to the system. Are they doubling their buy rates? In other words, what are they doing from what appears to be a pretty slow start?

And then, lastly, on the magazine, you talked about a 30% decline in both ad revenue and ad pages in the 1st quarter. Can you talk about what the inference is for the CPM increases that you put in?

Christie Hefner

Let me try and respond to the question. On the online subscription question, you may remember that coming off a weak 3rd quarter we had given guidance that we thought we would be returning to the 15-20% annual growth rate in online subscriptions that we had experienced for a number of years. And that would be a combination of factors contributing. One would be the acquisition, but not just the revenues acquired but also the marketing expertise acquired that would apply to our Playboy business as well as initiatives in technology and marketing we ourselves had undertaken including search engine optimization. Indeed it was a combination of all of those things that generated the good results in the 4th quarter and that as Linda mentioned a moment ago, we believe will allow us to, in 2006, again generate a 15-20% growth in online subscription revenues.

On the VOD side, I would just reiterate what I have long said which is that I don’t believe VOD is a business that will generate growth for the company. I think it is a different way of buying content than pay-per-view and while it is arguably potentially better for the consumer, at this point neither the pricing nor the marketing are so optimal that I have any confidence in saying that it will result in higher revenues for either the MSOs or for us. Where I do think there will be growth is when we rollout this year from the Playboy on a subscription VOD basis. But what amount of growth that will represent we won’t know until probably late in the year.

On the CPMs, we took CPMs up 8% effective with the first issue of this year. That was possible because on an out of pocket basis, that was a much smaller increase, roughly 3% because we trimmed the rate bases, as you will remember from 3.150 to 3.0; that CPM increase is sticking.

Dennis McAlpine

On the VOD, can you say what the VOD revenues and SVOD revenues were for the quarter and year?

Christie Hefner

I don’t know. We don’t break those out Dennis.

Operator

Once more, *1 to ask a question.

Scott Coleman

Hi and good morning. And Happy Valentines Day to you. A couple of questions. One is on your organic web growth? You talked about how the acquisitions helped a lot. I am wondering if you can give us some color on how it is growing organically?

And second is on the digital magazine, how that’s taking the digital distribution of the magazine. And are we looking for any changes in the way it is delivered in the software that is used to view it. Any upgrades or anything like that? Thanks.

Christie Hefner

On the question of organic growth, we are growing from all sources which includes all sources which includes cross promotion with the magazine as well as conversion of visitors to the website as well as marketing through Webmaster affiliate programs now given the expertise as a result of the ICS acquisition. We expect growth in all areas to continue as well as to start to benefit from our first large distribution deal with MSN which will give us the opportunity to start to generate traffic off their site. So they should all be continuing contributors.

On the digital Playboy we are over 16,000 subscriptions. I am told that that is the most successful launch today through Zineo. It continues to grow both domestically and internationally at the rate of about 50-100 a week. At this point, we would expect to remain with Zineo through this year. The enhancements will be those that we add editorially as well as those that our advertisers add and the software capability, in other ways the ability to embed URLs and video clips is built into the system. And Linda is reminding me that the 50-100 is actually a daily subscriber growth number.

Operator

Once more ladies and gentlemen, *1 to ask a question.

It appears we have no further questions at this time.

Martha Lindeman

Thank you all for joining us and I hope you have a lovely Valentine’s Day. I will be in my office all day if I can help clarify anything you heard on the phone today. I am happy to do so.

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