Playboy Q1 2007 Earnings Call Transcript

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Playboy Enterprises, Inc. (PLA)
Q1 2007 Earnings Call
May 8, 2007 11:00 am ET

Executives

Martha Lindeman - Investor Relations
Christie Hefner - Chairman of the Board, Chief Executive Officer
Linda G. Havard - Chief Financial Officer, Executive Vice President - Finance and Operations

Analysts

David Miller - Sanders Morris Harris Group
Michael Savner - Banc of America
Michael Kelman - Susquehanna Financial Group
David Bank - RBC Capital Markets

Presentation

Operator

Good day and welcome to Playboy Enterprises’ first quarter 2007 earnings conference call. At this time, I would like to turn the call over to your host for today, Martha Lindeman. Go ahead, please.

Martha Lindeman

Good morning, everyone, and welcome to the first quarter 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 call Arissa 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, which describes some of the factors that could case our results to differ materially from today’s discussion.

We will start with Linda Havard, who will describe in further detail the quarter’s results, and then we will turn this over to Christie. Linda.

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Linda G. Havard

Thank you, Martha. Good morning, everyone. Significant growth in our licensing business, combined with continued focus on controlling expenses, contributed to the first quarter results compared to last year. These results also demonstrate both the challenges and opportunities that we are facing throughout 2007, and both Christie and I will speak to those in our discussion today.

Looking first at our domestic TV business, in the first quarter we recorded revenues of $19.7 million, a 12% decline year over year. The lower revenues compared to last year reflected the same issues that we’ve discussed throughout most of 2006 -- namely, the loss of exclusivity on one satellite service and the transition from linear networks to the more competitive video-on-demand environment.

Revenues from VOD again rose significantly during the quarter compared to last year, although not enough to offset the linear network decline. In addition, there were approximately $1.9 million in positive cash adjustments related to prior periods which also partially offset the domestic TV revenue decrease.

The overall decrease in domestic TV revenues, and the leverage inherent in this business, which we’ve discussed over the years, as well as the additional expense of VOD distribution resulted in lower domestic TV profitability compared to last year.

In online and mobile, our pay sites posted a nearly 14% increase in revenues and drove the top and bottom line improvements in first quarter results compared to last year. E-commerce revenues in the current year quarter were lower than last year, with an improved contribution to the bottom line, reflecting our strategic decision, which we’ve also discussed with you before, to outsource the Spice catalog and website beginning late last year.

As we discussed in February and in today’s release, we are looking at and acting on ways to reduce entertainment group expenses, particularly in the domestic TV business. During the quarter, we recorded a severance charge of approximately $400,000, primarily due to a reduction in our programming staff.

While total TV programming amortization and online content expense rose $800,000 in the first quarter, this expense is expected to decline by nearly $2 million year over year to approximately $39.8 million. This total includes TV home entertainment amortization, which is declining, as well as online content, which will increase modestly.

Combined, these entertainment related content expenditures represent a nearly 10% decline from 2004 when we were servicing fewer distribution outlets than we have today, demonstrating our success at creating content that can be effectively, cost-efficiently shared across domestic and international TV platforms.

Turning now to publishing, Playboy Magazine posted an approximately $1 million increase in first quarter 2007 ad revenues, although we also saw a corresponding decrease in circulation revenues in the quarter. Additionally, first quarter results were impacted by a total of $1.3 million in charges related to severance, post-employment benefits and additional subscription collection costs. These higher charges were partially offset by lower manufacturing costs, primarily paper, compared to last year.

The licensing group reported record operating income of $7.7 million in the first quarter. Proceeds from the sale of artwork represented a year-over-year positive revenue swing of $900,000, due to the sale of one large piece of art in March of 2007, versus the sale of a collection of prints last year. These sales are reported on the other licensing line on the income statement.

The Palm’s venues also contributed to the growth in first quarter licensing revenues and profits compared to last year, as they first opened in October of 2006.

In addition, the core consumer products business continues to thrive, with first quarter revenue and profit growth in excess of 20% versus the same period last year.

It is important to note that the first quarter of each year generally reflects prior period adjustments, and this is the case in the first quarter. So the consumer products revenue that we reported this past quarter is higher than and therefore should not be used as the licensing group quarterly revenue baseline for the remainder of the year.

Corporate, administration and promotion expense declined 11%, $7 million. [inaudible] stock option expense was partially offset by the expensing of certain trademark costs. In addition, post-employment benefits related to publishing group employees were allocated as such, contributing to lower publishing group profits with a positive offset in corporate results.

Total 2007 corporate administration expense is expected to be up from 2006, reflecting both a small inflation related increase and higher trademark costs.

As a reminder, this year we will be expensing a number of items that had previously been capitalized or deferred, which will result in an additional $800,000 in quarter-over-quarter charges through the first three quarters of this year, and year-over-year additional expense of approximately $0.08 per share. These items include: first, a $300,000 non-cash quarterly charge related to the change in the estimated lives of certain carriage agreements, which we began recording in the entertainment group in the 2006 fourth quarter; and secondly, an approximately $500,000 quarterly charge related to expensing certain trademark costs, which we began recording in corporate administration and promotion in the fourth quarter of 2006.

In addition, the publishing group’s subscription acquisition costs will include an additional charge of approximately $300,000 in each quarter of this year related to collections costs.

Finally, you may have noted that we’ve made some minor modifications to our income statement. These are designed to simplify our reporting structure and hopefully help you better track our key businesses.

With that, I will turn you over to Christie.

Christie Hefner

Thank you, Linda. We are pleased with the progress that we made in the first quarter. Domestic TV revenues stabilized, licensing and new digital media businesses grew, and we made headway in terms of reducing the cost structure of our mature businesses. We believe that domestic TV revenues will remain in line with the first quarter, excluding the cash adjustments. This now gives us a base on which to develop an appropriate cost structure and improve profitability going forward.

We are pleased with what we are seeing in VOD, which is in part a result of the efforts that I discussed in February, namely strengthening the product and working on marketing, particularly the consumer interface.

For example, we were the only supplier asked to add product on a major MSO’s VOD adult movie platform and we think that reflects the strength of our competitive position. The VOD growth is offsetting declining revenues from the linear movie networks, as additional cable systems convert product to the newer platform.

While there are higher costs associated with supporting both linear and VOD, we will continue to do so as long as the linear networks are profitable.

On the Playboy TV side, growth potential lies with subscription VOD. Access to this service currently is limited to less then half the VOD capable cable television households in this country, and we are optimistic that we will see additional rollout of this premium television product over the year.

Our online and international TV businesses should continue to show solid top and bottom line growth year over year. And to sustain that growth, we are developing new products and services, optimizing existing content and expertise, and finding creative ways to reach new audiences.

We are continuing to look at the cost structure for domestic TV and publishing. As Linda noted, programming expense will be down by $2 million this year, and we’ve made overhead cuts that will generate another $1 million in annual savings.

Going forward, our focus includes looking at our TV operations, such as the number of networks we are broadcasting and overhead, such as utilization of our Andrita facility. We will continue to look for additional cuts and you will continue to see the effect of changes implemented this year and last going forward.

At this point, we believe the profit for the entertainment group in the remaining nine months of the year will be in line with those reported during the last three quarters of 2006.

Cost control measures extend to our publishing business as well, as we were able in this quarter to offset both the increases reported on a one-time basis that Linda spoke about, as well as decreases in circulation.

The challenge that we and other publishers face in terms of circulation, advertising and uncontrollable cost increases have been well-documented and continue. In response, we will continue to reduce our controllable expenses, including content and overhead.

We have reduced headcount through attrition and lay-offs already, with an expected annualized savings of $1 million.

As Linda noted, in the quarter we recorded severance and post-employment expense as a result, and you can expect to see additional post-employment benefit expense in the second quarter.

As I look at the second half, the publishing group should begin to benefit from these cost reduction efforts. While we anticipate weakness in circulation revenues, we believe that advertising revenues will increase in the second half despite what we saw as a soft second quarter.

We are also looking forward to improved year-over-year results from our international editions, both from the existing editions and the addition of new territories. Although the magazine market remains extraordinarily challenging, we continue to believe that our publishing group will report results consistent with what we have seen in the last two years.

Turning to licensing, we expect 2007 to be a banner year for the group. Given the strong first quarter performance, the Palms contribution, and the outlook for continued growth in consumer products, we are raising our guidance for licensing. We now expect to report 20% to 25% growth in 2007 revenues and segment income, excluding the proceeds from the art sales this year and last.

Looking ahead, we believe the continued growth of our consumer products business will be driven both by growth from our existing licensees into new territories and additional distribution outlets, as well as attracting new licensees, and we are making progress on all fronts. We have recently signed agreements in Europe, Asia, and Latin America, which cover such diverse categories as jewelry, apparel, lingerie, and outerwear.

In March, we opened our eighth Playboy concept store located in Auckland, New Zealand, and we will open a flagship store on Oxford Street in London this fall, which will be both our largest flagship store to date, approximately 4,000 square feet over three floors, and our first European store. We anticipate opening a third store also in Europe in 2007 and, as with the other flagship stores, this is a licensing deal with no financial risk to us.

A key focus of the licensing group is the development of another location-based entertainment venue. We remain very interested in both London and Macau. I’ve just returned from a trip to London and can attest from conversations I had there to the strong interest that exists among potential partners in a Playboy casino club product, both in London and elsewhere in Europe.

However, as some of you may know, there have been recent changes in U.K. gaming regulations, including raising taxes and eliminating proposed new licenses. So it appears to us that potential partners are going to slow their development progress.

At the same time as we continue those discussions, we are moving forward and making quite good progress with regard to Macau, which remains a very exciting new opportunity. Our goal remains to sign and announce another LBE deal this year.

Overall, we feel we are on track in terms of discussions for new deals in the pipeline, on track in terms of producing strong growth in our growth drivers of new digital media and licensing, on track to have stabilized and set a new base for our domestic TV revenues, and on track to continue to focus on expense reductions.

With that overview, we would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will first go to the site of David Miller with SMH Capital. Go ahead, please.

David Miller - Sanders Morris Harris Group

Good morning. Christie, a question about the guidance with regard to second quarter ad pages. You are expecting to report a 6% increase in ad pages, a 2% decline in ad revenues. That implies a fairly broad down-kick in CPMs in the quarter. What’s specifically behind that? Is it just simply because of a -- is it a circulation issue or did the demand curve move a little bit more to the left than you had figured prior to this announcement, just because of certain ad categories not coming through as you would have liked? If you can just flesh that out, that would be great. Thanks.

Christie Hefner

Absolutely. It has nothing to do with circulation. We remain consistent with our delivery of rate base. It is entirely a function of the mix. So as you alluded to, different categories have a different price per page. For example, categories like fashion are at a different level than categories like liquor, and direct response is a different pricing than say tobacco. So in any one quarter, the average net per page is a function of what that mix is.

David Miller - Sanders Morris Harris Group

Thank you.

Operator

Thank you. We will take our next question from Michael Savner with Banc of America Securities. Go ahead, please.

Michael Savner - Banc of America

Thanks. Good morning, Christie. A couple of questions about domestic television in your implicit guidance for the year, and whether it is maybe an issue of semantics, but a couple; one, if stabilization, is that realistically now the goal that we are looking for, to just be stable and not grow? Is that kind of out the door, at least for the next year or two?

When we look at your guidance, when you strip out the one-time benefit in the first quarter, we are still looking at pretty good year-over-year declines and sequential declines, and if you are guiding for operating profit for the next nine months to be consistent with where we were in the last nine months of last year, to me that sounds like domestic television is still eroding, right? Because we are assuming there’s still growth in international TV and online, and if domestic TV was stable and not declining further, than we would see some modest growth year over year. So again, maybe it’s semantics, but I would have thought with some of the cost initiatives and some of the reasons I just mentioned, we would have had slightly better expectations.

Christie Hefner

Right. Let me try and talk you through it, because it is a little confusing because there are a variety of moving parts, as I know you understand.

First of all, with regard to the question about stabilization. From our point of view, stabilization on domestic TV revenues is not the long term goal but it is a critical first step. And it’s a critical first step because as everybody on this call understands, we have recognized for over a year now that we are going to have a lower level of ongoing adult TV revenues because of the change in the amount of shelf space that we have in adult VOD versus adult linear. So finding what that level was, which in turn meant understanding what the potential VOD buy results were, as well as where we were going to settle in in terms of the platform was critical and we feel in monitoring, net of the cash adjustments, the first quarter results, both the monies collected and the results monitored as against the fourth quarter, that we have reached that critical first step of stabilization.

For purposes of trending, as you understand, what we look at is sequential quarters. We obviously report first to first, but we are looking at the trending of fourth to first, as we will second to first, et cetera.

On the issue of do we think that this is as far as we can get, no. I continue to believe that Playboy SVOD is a strong product that can achieve growth over the base of stable adult TV revenues. The critical issue there though, as you know, Mike, is at what rate do the MSOs roll out Playboy SVOD and what level of marketing support do we get so that the consumer is aware that this is a buying option.

We are spending a great deal of time on this. I have personally in the last several months been both with the highest levels within Comcast and the highest levels at Time Warner. I am here right now in Las Vegas at the MCTA, and I have my whole team here.

So while I am hopeful about starting to see some traction there, I know enough from experience that until they actually push the product out there with some level of promotion and communication to the consumer, we can’t count on it. So from our vantage point as we sit here today, the safest assumption is to operate with the belief that we are not going to see the consistent erosion quarter to quarter that we have been seeing, so we’ve achieved the first step of stabilization.

As soon as I see that we are getting the rollouts and the supports to generate the potential for take rates that we believe is there, based on our experience to date in a few SVOD systems, like in Time Warner in L.A. and Cablevision, we will be reporting that.

Now, I would remind everybody that for years now, we have said that domestic TV is a single digit revenue growth business, so it is not going to have the growth potential that international TV and online has.

On your point about last nine months and why wouldn’t we expect to see therefore growth quarter over quarter, we do expect to see growth quarter over quarter in terms of our performance from first through the remainder of the year, but on a comparative basis, remember that now that we are on a base line for domestic TV, the second quarter is still going to be below last year’s second quarter. So what we are saying we are feeling good about being able to do is that that delta between this year’s domestic TV business in terms of revenues and profitability is going to be offset in the last nine months by the growth of international and online.

So hopefully that helps.

Michael Savner - Banc of America

It does. Thanks for all that detail.

Operator

(Operator Instructions) We’ll now go to the site of Michael Kelman with Susquehanna Financial Group. Go ahead, please.

Michael Kelman - Susquehanna Financial Group

Thanks. Two quick questions; first, maybe you can continue focusing on the domestic TV side of the business. Can you talk a little bit, now that the new channels have been launched since November, so around six months, how these channels have been performing relative to the previously branded movie networks?

And then, just going on to guidance a little bit, obviously you haven’t given total earnings guidance for the company, but I want to just make sure I’m thinking about it correctly. Assuming the first quarter numbers and then if we assume that the corporate and admin expenses are roughly flat, I would get to a number of operating income growth of around 11%, and that is obviously assuming the fact that the last nine months of the year in entertainment are flat, assuming publishing has a flat operating income effect and licensing growth is around 25%. I want to make sure that that is the same way you are thinking about from a budgeting perspective.

Christie Hefner

Let me speak to the channel question and I will let Linda speak to the guidance question. We are feeling good, Michael, about the response we are seeing in these early months of the reconfiguration of the channels. Our people feel that the clearer focus around more differentiated programming concepts and, in the case of Club Jenna, a strong brand, is definitely paying off in terms of generating positive results.

Linda, I’ll let you try and help Michael speak to the guidance questions.

Linda G. Havard

Sure. Before I do that, Mike, I want to remind everyone that in spite of the fact that we launched our new channels in October and November, we really only have two months of data, so we are getting a lot of anecdotal data plus we do feel good about the channels, but it is still very early on.

In terms of guidance, I think we’ve gone as far as we feel comfortable going by giving you what we feel the operating income at the group level will be. We’ll let you work on your models and come to a total operating income at a bottom line, but there were a lot of ups and downs in the quarter and we wanted to clarify those so that you could take those out of the ongoing model, but that is about as far as we can go for today.

Michael Kelman - Susquehanna Financial Group

If you could just clarify one additional thing, the $1.9 million cash adjustment in the domestic TV line in the current quarter, can you explain again what that is and whether we will potentially see other adjustments like that in subsequent quarters?

Linda G. Havard

It is 1.9 vis-à-vis last year in the first quarter, and these are really just late reporting numbers, so when we get the numbers for the first quarter, we see that some of the cash that we received was as a result of our performance from last year from prior periods, so it’s --

Christie Hefner

It’s kind of a true-up.

Linda G. Havard

A prior period adjustment, is what it is.

Christie Hefner

And I wouldn’t -- my experience is that it’s unpredictable but I never assume that it will reoccur, so we treat it as a one-time true-up, which is why we are telling you to take it out of your numbers when you are looking at what that stabilized revenue and profit line is. Because remember, those are revenues that have 100% profit associated with them.

Michael Kelman - Susquehanna Financial Group

Thanks very much.

Linda G. Havard

Mike, we also have the same issue that we mentioned in licensing as well, so there are two places where you see that typically in the first quarter.

Michael Kelman - Susquehanna Financial Group

Okay, great.

Operator

(Operator Instructions)

We’ll go next to David Bank with RBC Capital. Go ahead, please.

David Bank - RBC Capital Markets

Thanks. Good morning. A couple of questions; first, a follow-up on the publishing side. Maybe a little bit more color in terms of why you had I think some substantial success in raising the advertising revenue in the first quarter and the outlook for the second quarter being a lot weaker, but sort of this underlying assumption that it is going to return back to maybe something along the lines of the first quarter. So just a little more color there.

The second is, can you give a little more detail on what the collections costs are?

The last is, what do you think is driving the out-performance on the licensing side? Can you give a little bit more color? I know you’ve taken up the guidance a little bit. Can you give a little bit more color surrounding that?

Christie Hefner

Sure. Let me try and help, David. On the ad side, it’s an extreme example but not different in nature of what we and all publishers have been seeing for a long time now, which is that we have long ago moved away from the idea of closing annual contracts with advertisers that give us predictability.

Every magazine, Playboy included, is selling every issue down to the wire and therefore the timing of when advertisers are in one month versus another is highly difficult to predict, so that is one of the reasons why we would never try and give you guidance on a quarter-to-quarter basis, even though we give you that visibility out one quarter.

So when you ask why do we feel that we are going to have a year of increased ad pages and revenues based on the see-sawing of the first and second quarter, that’s based on the fact that what we are always looking at from a bottoms-up salesperson-by-salesperson basis is what’s in the pipeline based on every account that we have. So in a way, we are less concerned whether a little more business falls into the first quarter and a little less in the second quarter than we planned, than whether the business that we think is coming in is coming in.

All I can tell you is we just completed a company-wide [realign] and the guidance that we are giving with regard to every part of the business, including advertising, is predicated on the most current reassessment of the business and therefore we have a fairly high degree of confidence in what we are trying to predict here.

On the subscription side, it’s a billing cost and it’s -- I’ll let Linda speak to it, but it’s a de minimis billing cost in the aggregate of all of our subscription acquisition costs, but it’s one where it now appears as if the majority of publishers treat it as an expense, not as one of the subscription acquisition costs that you amortize and write-off over the cost of the one-year subscription.

Linda, do you want to add anything to that?

Linda G. Havard

No, you did really well.

Christie Hefner

I’m an accountant in my spare time. On the licensing question, what I would say is I would point to the dynamic of the first quarter by way of helping you have both insight into why we feel bullish about these businesses and insight into where the growth is coming from, and I would note that the first quarter is entirely on target with what we’ve been talking about. So half of that year-over-year growth is in our core consumer products business, and the drivers of that are three -- new licenses, growth of existing licenses into new distribution outlets, and growth of existing and new licenses into new territories, and that is all happening in our global consumer products business.

A quarter of the growth is coming from location-based entertainment, which we’ve talked about for some time as being a great add-on opportunity for the company and we will benefit from having three quarters more of contributions from the Palms and hope to have a deal, although not the financial benefit of a deal, for our second location-based entertainment.

And then a quarter of the growth is from the not repeating, but as you all have heard us talk about before, always looking for opportunistic potential to monetize our art collection and we had such an opportunity with a piece of art this quarter.

David Bank - RBC Capital Markets

All right. Thanks, guys.

Operator

Thank you. It looks like we now have Michael Savner from Banc of America Securities with a follow-up question.

Michael Savner - Banc of America

Thanks. Christie, real quick -- do you have a rough appraisal of what you think the remaining art inventory is that could be for sale over the next two to three years?

Christie Hefner

Linda, do you want to handle that?

Linda G. Havard

Sure. Mike, what we do is insure the art as a whole, so we don’t have an appraisal painting by painting, and it is very opportunistic. If you put everything on the market at once, you would never get what you might get opportunistically for the sale of one painting.

In the past, people have estimated the art collection to be in the $20 million range. That includes now things like our cartoons and other artwork that was created not by artists necessarily but by our own people, photographs, et cetera. So it continues to be high, even though we sell individual pieces from time to time. Although we keep saying that is probably the last large individual piece of artwork.

Michael Savner - Banc of America

Okay. Thanks very much.

Operator

Thank you. It appears at this time that we have no further questions.

Christie Hefner

Martha, do you want to wrap up?

Martha Lindeman

You bet. Thank you all for joining us and I will be here all day, if anyone thinks of some additional follow-up questions they have, and I look forward to talking to you. Thanks. Bye.

Operator

This concludes today’s teleconference. You may now disconnect and have a nice day.

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