UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------- --------------
Commission file number 001-14790
Playboy Enterprises, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-4249478
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
680 North Lake Shore Drive, Chicago, IL 60611
(Address of principal executive offices) (Zip Code)
(312) 751-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes |X| No |_|
At October 31, 2005, there were 4,864,102 shares of Class A common stock,
par value $0.01 per share, and 28,253,294 shares of Class B common stock, par
value $0.01 per share, outstanding.
PLAYBOY ENTERPRISES, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Condensed Consolidated Statements of Operations and
Comprehensive Income for the Quarters Ended September 30,
2005 and 2004 (Unaudited) 3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for the Nine Months Ended September 30,
2005 and 2004 (Unaudited) 4
Condensed Consolidated Balance Sheets at September 30,
2005 (Unaudited) and December 31, 2004 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2005 and 2004 (Unaudited) 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II
OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits 21
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the Quarters Ended September 30 (Unaudited)
(In thousands, except per share amounts)
2005 2004
- -------------------------------------------------------------------------------
Net revenues $ 80,884 $ 80,258
- -------------------------------------------------------------------------------
Costs and expenses
Cost of sales (62,180) (59,314)
Selling and administrative expenses (13,355) (14,239)
- -------------------------------------------------------------------------------
Total costs and expenses (75,535) (73,553)
- -------------------------------------------------------------------------------
Operating income 5,349 6,705
- -------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 661 114
Interest expense (1,425) (2,928)
Amortization of deferred financing fees (135) (275)
Minority interest (384) (364)
Other, net (294) (96)
- -------------------------------------------------------------------------------
Total nonoperating expense (1,577) (3,549)
- -------------------------------------------------------------------------------
Income before income taxes 3,772 3,156
Income tax expense (594) (1,229)
- -------------------------------------------------------------------------------
Net income 3,178 1,927
===============================================================================
Other comprehensive income (loss)
Unrealized gain on marketable securities 107 --
Unrealized loss on derivatives (55) (3)
Foreign currency translation adjustments (91) 99
- -------------------------------------------------------------------------------
Total other comprehensive income (loss) (39) 96
- -------------------------------------------------------------------------------
Comprehensive income $ 3,139 $ 2,023
===============================================================================
Weighted average number of common shares outstanding
Basic 33,102 33,371
===============================================================================
Diluted 33,366 33,384
===============================================================================
Basic and diluted earnings per common share $ 0.10 $ 0.06
===============================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
3
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
for the Nine Months Ended September 30 (Unaudited)
(In thousands, except per share amounts)
2005 2004
- -------------------------------------------------------------------------------
Net revenues $ 247,206 $ 239,845
- -------------------------------------------------------------------------------
Costs and expenses
Cost of sales (183,511) (179,742)
Selling and administrative expenses (40,143) (42,785)
- -------------------------------------------------------------------------------
Total costs and expenses (223,654) (222,527)
- -------------------------------------------------------------------------------
Gains on disposal 14 2
- -------------------------------------------------------------------------------
Operating income 23,566 17,320
- -------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 1,443 337
Interest expense (5,485) (10,737)
Amortization of deferred financing fees (501) (1,007)
Minority interest (1,124) (1,066)
Debt extinguishment expenses (19,280) (5,908)
Other, net (1,094) (793)
- -------------------------------------------------------------------------------
Total nonoperating expense (26,041) (19,174)
- -------------------------------------------------------------------------------
Loss before income taxes (2,475) (1,854)
Income tax expense (2,826) (2,622)
- -------------------------------------------------------------------------------
Net loss (5,301) (4,476)
- -------------------------------------------------------------------------------
Other comprehensive income (loss)
Unrealized gain on marketable securities 36 107
Unrealized gain on derivatives 202 34
Foreign currency translation adjustments 101 (209)
- -------------------------------------------------------------------------------
Total other comprehensive income (loss) 339 (68)
- -------------------------------------------------------------------------------
Comprehensive loss $ (4,962) $ (4,544)
===============================================================================
Net loss $ (5,301) $ (4,476)
Dividend requirements of preferred stock -- (428)
- -------------------------------------------------------------------------------
Net loss applicable to common shareholders $ (5,301) $ (4,904)
===============================================================================
Basic and diluted weighted average number
of common shares outstanding 33,178 30,978
===============================================================================
Basic and diluted loss per common share $ (0.16) $ (0.16)
===============================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited) (Unaudited)
Sept. 30, Dec. 31,
2005 2004
- ------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 27,504 $ 26,668
Marketable securities and short-term investments 36,882 24,052
Receivables, net of allowance for doubtful accounts of
$4,029 and $3,897, respectively 39,582 45,084
Receivables from related parties 1,280 1,281
Inventories, net 15,021 12,437
Deferred subscription acquisition costs 11,021 13,104
Other current assets 8,812 8,596
- ------------------------------------------------------------------------------------------------
Total current assets 140,102 131,222
- ------------------------------------------------------------------------------------------------
Property and equipment, net 13,087 11,491
Long-term receivables 2,562 2,755
Programming costs, net 52,482 55,997
Goodwill 121,897 111,893
Trademarks 60,007 57,296
Distribution agreements, net of accumulated amortization
of $2,589 and $1,935, respectively 30,552 31,206
Other noncurrent assets 18,271 18,721
- ------------------------------------------------------------------------------------------------
Total assets $ 438,960 $ 420,581
================================================================================================
Liabilities
Acquisition liabilities $ 11,998 $ 10,184
Accounts payable 22,437 21,796
Accrued salaries, wages and employee benefits 8,622 8,286
Deferred revenues 47,088 51,421
Accrued litigation settlement 1,000 1,000
Other liabilities and accrued expenses 14,947 18,040
- ------------------------------------------------------------------------------------------------
Total current liabilities 106,092 110,727
- ------------------------------------------------------------------------------------------------
Financing obligations 115,000 80,000
Acquisition liabilities 14,793 19,085
Net deferred tax liabilities 16,868 15,023
Accrued litigation settlement -- 1,000
Other noncurrent liabilities 12,974 13,779
- ------------------------------------------------------------------------------------------------
Total liabilities 265,727 239,614
- ------------------------------------------------------------------------------------------------
Minority interest 13,641 12,517
Shareholders' equity
Common stock, $0.01 par value
Class A voting - 7,500,000 shares authorized; 4,864,102 issued 49 49
Class B nonvoting - 75,000,000 shares authorized; 28,630,435
and 28,521,493 issued, respectively 286 285
Capital in excess of par value 223,388 222,285
Accumulated deficit (58,250) (52,949)
Treasury stock, at cost, 381,971 and 0 shares, respectively (5,000) --
Accumulated other comprehensive loss (881) (1,220)
- ------------------------------------------------------------------------------------------------
Total shareholders' equity 159,592 168,450
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 438,960 $ 420,581
================================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
5
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Nine Months Ended September 30 (Unaudited)
(In thousands)
2005 2004
- -----------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (5,301) $ (4,476)
Adjustments to reconcile net loss to net cash provided by
(used for) operating activities:
Depreciation of property and equipment 2,340 2,390
Amortization of intangible assets 1,260 1,711
Amortization of investments in entertainment programming 28,131 31,984
Amortization of deferred financing fees 501 1,007
Debt extinguishment expenses 19,280 5,908
Deferred income taxes 1,203 534
Net change in operating assets and liabilities (341) (435)
Investments in entertainment programming (24,276) (34,211)
Litigation settlement (1,875) (6,500)
Other, net 205 710
- -----------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities 21,127 (1,378)
- -----------------------------------------------------------------------------------------
Cash flows from investing activities
Payment for acquisition (8,283) --
Purchases of investments (41,494) (10,000)
Proceeds from sale of investments 28,700 --
Additions to property and equipment (4,010) (2,308)
Proceeds from disposals -- 150
Other, net -- 201
- -----------------------------------------------------------------------------------------
Net cash used for investing activities (25,087) (11,957)
- -----------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from financing obligations 115,000 --
Repayment of financing obligations (80,000) (35,000)
Proceeds from public equity offering -- 51,844
Payment of debt extinguishment expenses (15,197) (3,850)
Payment of acquisition liabilities (5,871) (8,691)
Purchase of treasury stock (5,000) --
Payment of deferred financing fees (5,057) --
Payment of preferred stock dividends -- (651)
Proceeds from stock plans 959 407
Other (38) (19)
- -----------------------------------------------------------------------------------------
Net cash provided by financing activities 4,796 4,040
- -----------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 836 (9,295)
Cash and cash equivalents at beginning of period 26,668 31,332
- -----------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 27,504 $ 22,037
=========================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
6
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(A) BASIS OF PREPARATION
The financial information included in these financial statements is
unaudited but, in the opinion of management, reflects all normal recurring and
other adjustments necessary for a fair presentation of the results for the
interim periods. The interim results of operations and cash flows are not
necessarily indicative of those results and cash flows for the entire year.
These financial statements should be read in conjunction with the financial
statements and notes to the financial statements contained in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2004. Certain amounts
reported for prior periods have been reclassified to conform to the current
year's presentation. At the end of the third quarter, we acquired an online
distribution business to complement our current online business for
consideration of $12.0 million, of which $8.0 million was paid at closing, with
an additional $2.0 million payable on each of the first and second anniversaries
of the closing. Pursuant to the asset purchase agreement, we are obligated to
pay future contingent earnout payments, payable over a five-year period, based
primarily on the financial performance of the acquired lines of business.
(B) RESTRUCTURING EXPENSES
During the nine-month period ended September 30, 2005, we made cash
payments of $0.8 million related to our various restructuring plans.
Approximately $9.8 million of the total restructuring charges was paid by
September 30, 2005, with most of the remaining $1.2 million related to the
consolidation of our facilities to be paid in the fourth quarter of the current
year with some payments continuing through 2007.
In 2004, we recorded a restructuring charge of $0.5 million relating to
the realignment of our entertainment and online businesses. In addition,
primarily due to excess office space, we recorded additional charges of $0.4
million related to the 2002 restructuring plan and reversed $0.2 million related
to the 2001 restructuring plan as a result of changes in plan assumptions.
Our 2002 restructuring initiative to reduce ongoing operating expenses
resulted in a $5.7 million charge, of which $2.9 million related to the
termination of employees and $2.8 million related to the consolidation of our
office spaces in Los Angeles and Chicago. Our 2001 restructuring plan resulted
in a $4.6 million charge, of which $2.6 million related to the termination of
employees and $2.0 million related to excess space in our Chicago and New York
offices.
The following table displays the activity and balances of the restructuring
reserve for the year ended December 31, 2004, and the nine months ended
September 30, 2005 (in thousands):
Consolidation
Workforce of Facilities and
Reduction Operations Total
- --------------------------------------------------------------------------------------
Balance at December 31, 2003 $ 630 $ 2,563 $ 3,193
Additional reserve recorded 466 -- 466
Adjustment to previous estimate -- 278 278
Cash payments (917) (1,014) (1,931)
- --------------------------------------------------------------------------------------
Balance at December 31, 2004 179 1,827 2,006
Cash payments (179) (588) (767)
- --------------------------------------------------------------------------------------
Balance at September 30, 2005 $ -- $ 1,239 $ 1,239
======================================================================================
7
(C) EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
share, or EPS (in thousands, except per share amounts):
(Unaudited)
Quarters Ended
September 30,
----------------------
2005 2004
- --------------------------------------------------------------------------------
Numerator:
For basic and diluted EPS - net income $ 3,178 $ 1,927
================================================================================
Denominator:
For basic EPS - weighted-average shares 33,102 33,371
Effect of dilutive potential common shares:
Employee stock options and other 264 13
- --------------------------------------------------------------------------------
Dilutive potential common shares 264 13
- --------------------------------------------------------------------------------
For diluted EPS - weighted-average shares 33,366 33,384
================================================================================
Basic and diluted earnings per common share $ 0.10 $ 0.06
================================================================================
The reconciliations of basic and diluted EPS for the nine-month periods
ending September 30, 2005 and 2004, were excluded as both periods resulted in a
net loss position; therefore, potential common shares would have been
antidilutive.
The following table represents the approximate number of shares related to
options to purchase our Class B common stock, or Class B stock, that were
outstanding, which were not included in the computation of diluted EPS, as the
inclusion of these shares would have been antidilutive (in thousands):
Quarters Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2005 2004 2005 2004
- --------------------------------------------------------------------------------
Stock options 1,866 3,262 2,576 2,636
- --------------------------------------------------------------------------------
Total 1,866 3,262 2,576 2,636
================================================================================
In addition, in accordance with Emerging Issues Task Force Issue 04-8,
"The Effect of Contingently Convertible Debt on Diluted Earnings per Share", the
shares used in the calculation of diluted EPS also exclude the potential shares
of Class B stock contingently issuable under our 3.00% convertible senior
secured notes because the shares are antidilutive. See Footnote (I), Debt
Refinancing, for additional information.
(D) INVENTORIES, NET
Inventories, net of reserves, which are stated at the lower of cost (specific
cost and average cost) or fair value, consisted of the following (in thousands):
(Unaudited)
Sept. 30, Dec. 31,
2005 2004
- -------------------------------------------------------------------------------
Paper $ 4,818 $ 2,573
Editorial and other prepublication costs 7,254 7,814
Merchandise finished goods 2,949 2,050
- -------------------------------------------------------------------------------
Total inventories, net $ 15,021 $ 12,437
===============================================================================
(E) INCOME TAXES
Our income tax provision consists of foreign income tax related to our
international networks and withholding tax on licensing income for which we do
not receive a current U.S. income tax benefit because of our net operating loss
position. The tax provision also includes deferred federal and state income
taxes related to the amortization of goodwill and other indefinite-lived
intangibles, which cannot be offset against deferred tax assets due to the
indefinite reversal period of the deferred tax liabilities. During the third
quarter, we recorded a $0.5 million adjustment to our tax provision due to a
refund related to our European television operations.
8
(F) CONTINGENCIES
In order to create opportunities to promote our websites to a broader
audience and enhance our current product offerings, at the end of the current
year quarter we acquired an online distribution business with an extensive
affiliate network. Pursuant to the asset purchase agreement, we are obligated to
pay future contingent earnout payments, payable over a five-year period, based
primarily on the financial performance of the acquired lines of business. As
contingencies have not been met as of September 30, 2005, these amounts are not
recorded. If future payments are made based on contingencies being met, amounts
will be recorded as a combination of additional purchase price and compensation
expense.
In the fourth quarter of 2003, we recorded $8.5 million related to the
settlement of the Logix litigation, which related to events prior to our 1999
acquisition of Spice Entertainment Companies, Inc., or Spice. We made a payment
of $6.5 million in February 2004 and a payment of $1.0 million in January 2005
and will make the remaining payment of $1.0 million in 2006.
In 2002, a $4.4 million verdict was entered against us by a state trial
court in Texas in a lawsuit with a former publishing licensee. We terminated the
license in 1998 due to the licensee's failure to pay royalties and other amounts
due to us under the license agreement. We have posted a bond in the amount of
$8.5 million, which represents the amount of the judgment, costs and estimated
pre- and post-judgment interest. We, on advice of legal counsel, believe that it
is not probable that a material judgment against us will be sustained and have
not recorded a liability for this case in accordance with Statement 5,
Accounting for Contingencies. We are currently pursuing an appeal.
(G) STOCK-BASED COMPENSATION
We account for stock options as prescribed by Accounting Principles Board
Opinion, or APB, No. 25, Accounting for Stock Issued to Employees, and disclose
pro forma information as provided by Statement 123, as amended by Statement 148,
Accounting for Stock Based Compensation. In December 2004, the Financial
Accounting Standards Board (the "FASB") issued Statement 123 (revised 2004),
Share-Based Payment ("Statement 123(R)"), which supersedes APB No. 25 and amends
Statement No. 95, Statement of Cash Flows. The implementation of Statement
123(R) has since been delayed and will be effective for the first fiscal year
beginning after June 15, 2005. We are required to adopt Statement 123(R) on
January 1, 2006, and will utilize the modified prospective method. We are
currently conducting an analysis of the impact on our financial statements.
Pro forma net income (loss) and net income (loss) per common share,
presented below (in thousands, except per share amounts), were determined as if
we had accounted for our stock options under the fair value method of Statement
123. The fair value of these options was estimated at the date of grant using an
option pricing model. Such models require the input of highly subjective
assumptions, including the expected volatility of the stock price. For pro forma
disclosures, the options' estimated fair value was amortized over their vesting
period. No stock-based employee compensation expense is recognized because all
options granted under those plans had an exercise price equal to or in excess of
the market value of the underlying common stock at the grant date. If we
accounted for our employee stock options under Statement 123, compensation
expense related to stock options would have been $0.7 million for each of the
quarters ended September 30, 2005 and 2004, and $2.2 million and $2.1 million
for the nine months ended September 30, 2005 and 2004, respectively.
Quarters Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2005 2004 2005 2004
- -------------------------------------------------------------------------
Net income (loss)
As reported $ 3,178 $ 1,927 $(5,301) $(4,476)
Pro forma 2,441 1,238 (7,460) (6,567)
Basic and Diluted EPS
As reported $ 0.10 $ 0.06 $ (0.16) $ (0.16)
Pro forma 0.07 0.04 (0.22) (0.23)
- -------------------------------------------------------------------------
Our restricted stock unit expense was $0.5 million and $0.1 million for
the quarters ended September 30, 2005 and 2004, respectively, and $1.2 million
and $0.4 million for the nine months ended September 30, 2005 and 2004,
respectively, as it is probable that the performance criteria will be met.
9
(H) SEGMENT INFORMATION
The following table represents financial information by reportable segment (in
thousands):
Quarters Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------
Net revenues
Entertainment $ 47,765 $ 46,153 $ 147,123 $ 136,017
Publishing 27,224 29,521 79,758 88,291
Licensing 5,895 4,584 20,325 15,537
- ----------------------------------------------------------------------------------------------------
Total $ 80,884 $ 80,258 $ 247,206 $ 239,845
====================================================================================================
Income (loss) before income taxes
Entertainment $ 7,289 $ 7,802 $ 29,099 $ 18,456
Publishing (704) 1,275 (3,444) 5,239
Licensing 3,165 2,614 10,648 7,564
Corporate Administration and Promotion (4,401) (4,986) (12,751) (13,941)
Gain on disposal -- -- 14 2
Investment income 661 114 1,443 337
Interest expense (1,425) (2,928) (5,485) (10,737)
Amortization of deferred financing fees (135) (275) (501) (1,007)
Minority interest (384) (364) (1,124) (1,066)
Debt extinguishment expenses -- -- (19,280) (5,908)
Other, net (294) (96) (1,094) (793)
- ----------------------------------------------------------------------------------------------------
Total $ 3,772 $ 3,156 $ (2,475) $ (1,854)
====================================================================================================
Prior period segment information has been restated as a result of the
realignment of our Entertainment and Online businesses into a combined
Entertainment segment, as announced during the fourth quarter of 2004.
(Unaudited)
Sept. 30, Dec. 31,
2005 2004
- --------------------------------------------------------------------------------
Identifiable assets
Entertainment $ 274,535 $ 266,736
Publishing 39,124 45,724
Licensing 6,553 5,344
Corporate Administration and Promotion (1) 118,748 102,777
- --------------------------------------------------------------------------------
Total (1) $ 438,960 $ 420,581
================================================================================
(1) The increase in identifiable assets since December 31, 2004, was primarily
due to our debt refinancing in March 2005. See Footnote (I), Debt
Refinancing.
(I) DEBT REFINANCING
On March 15, 2005, we issued and sold in a private placement $100.0
million aggregate principal amount of our 3.00% convertible senior subordinated
notes due 2025, or the convertible notes. On March 28, 2005, we issued and sold
in a private placement an additional $15.0 million aggregate principal amount of
the convertible notes due to the initial purchasers' exercise of the
over-allotment option. The net proceeds of approximately $110.3 million from the
issuance and sale of the convertible notes, after deducting the initial
purchasers' discount and estimated offering expenses payable by us, were used,
together with available cash, (i) to complete a tender offer and consent
solicitation for, and to purchase and retire, all $80.0 million outstanding
principal amount of the 11.00% senior secured notes of our subsidiary PEI
Holdings, Inc., or Holdings, for a total of approximately $95.2 million,
including the bond tender premium and consent fee of $14.9 million and other
expenses of $0.3 million, (ii) to purchase 381,971 shares of our Class B stock
for an aggregate purchase price of $5.0 million concurrently with the sale of
the convertible notes and (iii) for working capital and general corporate
purposes.
The convertible notes bear interest at a rate of 3.00% per annum on the
principal amount of the notes, payable semi-annually in arrears on March 15 and
September 15 of each year, beginning on September 15, 2005. In addition, under
certain circumstances beginning in 2012, if the trading price of the convertible
notes exceeds a specified threshold during a prescribed measurement period prior
to any semi-annual interest period, contingent interest will become payable on
the convertible notes for that semi-annual interest period at an annual rate of
0.25% per annum.
10
The convertible notes are convertible into cash and, if applicable, shares
of our Class B stock based on an initial conversion rate, subject to adjustment,
of 58.7648 shares per $1,000 principal amount of the convertible notes (which
represents an initial conversion price of approximately $17.02 per share) only
under the following circumstances: (1) during any fiscal quarter after the
fiscal quarter ending March 31, 2005, if the closing sale price of our Class B
stock for each of 20 or more consecutive trading days in a period of 30
consecutive trading days ending on the last trading day of the immediately
preceding fiscal quarter exceeds 130% of the conversion price in effect on that
trading day; (2) during the five business day period after any five consecutive
trading day period in which the average trading price per $1,000 principal
amount of convertible notes over that five consecutive trading day period was
equal to or less than 95% of the average conversion value of the convertible
notes during that period; (3) upon the occurrence of specified corporate
transactions, as set forth in the indenture governing the convertible notes; or
(4) if we have called the convertible notes for redemption. Upon conversion of a
convertible note, a holder will receive cash in an amount equal to the lesser of
the aggregate conversion value of the note being converted and the aggregate
principal amount of the note being converted. If the aggregate conversion value
of the convertible note being converted is greater than the cash amount received
by the holder, the holder will also receive an amount in whole shares of Class B
stock equal to the aggregate conversion value less the cash amount received by
the holder. A holder will receive cash in lieu of any fractional shares of Class
B stock.
The convertible notes mature on March 15, 2025. On or after March 15,
2010, if the closing price of our Class B stock exceeds a specified threshold,
we may redeem any of the convertible notes at a redemption price in cash equal
to 100% of the principal amount of the notes, plus any accrued and unpaid
interest up to, but excluding, the redemption date. On or after March 15, 2012,
we may at any time redeem any of the convertible notes at the same redemption
price. On each of March 15, 2012, March 15, 2015 and March 15, 2020, or upon the
occurrence of a fundamental change, as specified in the indenture governing the
convertible notes, holders may require us to purchase all or a portion of their
convertible notes at a purchase price in cash equal to 100% of the principal
amount of the notes, plus any accrued and unpaid interest up to, but excluding,
the purchase date.
The convertible notes are unsecured senior subordinated obligations of the
issuer, Playboy Enterprises, Inc., or Playboy, and rank junior to all of the
issuer's senior debt, including its guarantee of Holdings' borrowings under our
credit facility; equally with all of the issuer's future senior subordinated
debt; and senior to all of the issuer's future subordinated debt. In addition,
the assets of the issuer's subsidiaries are subject to the prior claims of all
creditors, including trade creditors, of those subsidiaries.
(J) SUBSEQUENT EVENT
On November 3, 2005, Playboy purchased the outstanding shares of
Playboy.com Series A Preferred Stock held by Hugh M. Hefner, our Editor-in-Chief
and Chief Creative Officer, for $6.9 million. The repurchase amount was equal to
the original issue price plus 8% per annum compounded annually from the issuance
date through October 31, 2005. As a result of the repurchase, Playboy now owns
approximately 97% of the outstanding equity of Playboy.com and is in discussions
with the one remaining preferred shareholder that owns Series A Preferred Stock
with an aggregate original purchase price of $5,147,778 about a repurchase of
its shares.
The shares of Playboy.com Series A Preferred Stock were issued on August
13, 2001 at an issue price of $7.1097 per share. From and after August 10, 2006,
the holders of the Series A Preferred Stock could require Playboy.com to redeem
any and all of their shares of Playboy.com Series A Preferred Stock at a
redemption price equal to the original issue price plus 8% per annum compounded
annually through the redemption date. At August 10, 2006,the redemption price
for Mr. Hefner's shares would have been $7.4 million.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table represents our results of operations (in millions, except
per share amounts):
Quarters Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2005 2004(1) 2005 2004(1)
- --------------------------------------------------------------------------------------------------------------------
Net revenues
Entertainment
Domestic TV networks $ 25.4 $ 24.5 $ 75.5 $ 71.4
International 12.2 11.3 37.5 32.2
Online subscriptions 5.4 5.3 16.9 15.4
E-commerce 3.6 3.4 13.9 12.0
Other 1.1 1.6 3.3 5.0
- --------------------------------------------------------------------------------------------------------------------
Total Entertainment 47.7 46.1 147.1 136.0
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Publishing
Playboy magazine 22.5 24.6 67.5 74.8
Other domestic publishing 3.2 3.4 7.4 8.9
International publishing 1.6 1.5 4.9 4.6
- --------------------------------------------------------------------------------------------------------------------
Total Publishing 27.3 29.5 79.8 88.3
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Licensing
International licensing 4.2 3.1 13.3 8.9
Domestic licensing 0.8 0.8 2.4 2.3
Entertainment licensing 0.5 0.5 1.5 1.5
Marketing events 0.2 0.2 2.8 2.7
Other 0.2 -- 0.3 0.1
- --------------------------------------------------------------------------------------------------------------------
Total Licensing 5.9 4.6 20.3 15.5
- --------------------------------------------------------------------------------------------------------------------
Total net revenues $ 80.9 $ 80.2 $247.2 $239.8
====================================================================================================================
Net income (loss)
Entertainment
Before programming amortization and online content expenses $ 17.0 $ 18.9 $ 58.8 $ 52.2
Programming amortization and online content expenses (9.7) (11.0) (29.7) (33.8)
- --------------------------------------------------------------------------------------------------------------------
Total Entertainment 7.3 7.9 29.1 18.4
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Publishing (0.7) 1.2 (3.4) 5.2
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Licensing 3.1 2.6 10.6 7.6
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Corporate Administration and Promotion (4.3) (5.0) (12.7) (13.9)
- --------------------------------------------------------------------------------------------------------------------
Operating income 5.4 6.7 23.6 17.3
- --------------------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 0.6 0.1 1.4 0.3
Interest expense (1.4) (2.9) (5.5) (10.7)
Amortization of deferred financing fees (0.1) (0.3) (0.5) (1.0)
Minority interest (0.4) (0.4) (1.1) (1.1)
Debt extinguishment expenses -- -- (19.3) (5.9)
Other, net (0.4) (0.1) (1.1) (0.8)
- --------------------------------------------------------------------------------------------------------------------
Total nonoperating expense (1.7) (3.6) (26.1) (19.2)
- --------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 3.7 3.1 (2.5) (1.9)
Income tax expense (0.5) (1.2) (2.8) (2.6)
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 3.2 $ 1.9 $ (5.3) $ (4.5)
====================================================================================================================
Basic and diluted EPS $ 0.10 $ 0.06 $(0.16) $(0.16)
====================================================================================================================
(1) Prior period information has been restated, as a result of the realignment
of our Entertainment and Online businesses, into a combined Entertainment
segment, as announced during the fourth quarter of 2004.
12
Our revenues increased $0.7 million, or 1%, and $7.4 million, or 3%, for
the quarter and nine-month period, respectively. Both periods were impacted by
expected lower revenues from our Publishing Group, more than offset by higher
Entertainment and Licensing Group revenues.
Our operating income decreased $1.3 million, or 20%, and increased $6.3
million, or 36%, for the quarter and nine-month period, respectively. The
quarter decreased due to lower results from our Publishing and Entertainment
Groups, partially offset by strong results from our Licensing Group. Operating
income increased for the nine-month period due to improved operating results
from our Entertainment and Licensing Groups, partially offset by lower results
from our Publishing Group.
Net income of $3.2 million for the quarter was $1.3 million higher than
the prior year quarter, reflecting a decrease in interest expense related to our
first quarter debt refinancing. Net loss for the current nine-month period of
$5.3 million includes $19.3 million of debt extinguishment expenses compared to
$5.9 million in the prior year period.
Several of our businesses can experience variations in quarterly
performance. As a result, our performance in any quarter is not necessarily
reflective of full-year or longer-term trends. Playboy magazine newsstand
revenues vary from issue to issue, with revenues generally higher for holiday
issues and any issues including editorial or pictorial features that generate
additional public interest. Advertising revenues also vary from quarter to
quarter depending on economic conditions, holiday issues and changes in
advertising buying patterns. Online subscription revenues and operating results
are impacted by decreased Internet traffic during the summer months, and
e-commerce revenues and operating results are typically strongest in the fourth
quarter due to the holiday buying season.
ENTERTAINMENT GROUP
The following discussion focuses on the revenue and profit contribution of
each of our Entertainment Group businesses before programming amortization and
online content expenses.
Revenues from our domestic TV networks business increased $0.9 million, or
4%, and $4.1 million, or 6%, for the quarter and nine-month period,
respectively. Direct-to-home, or DTH, revenues increased $1.1 million, or 20%,
and $3.0 million, or 19%, for the quarter and nine-month period, respectively,
due to subscriber growth and an increase in average pay-per-view, or PPV, buys.
Playboy TV cable revenues were relatively flat for the quarter and decreased
$0.5 million for the nine-month period. The quarter results were impacted by a
decrease in PPV buys, but mostly offset by an increase in Playboy TV monthly
subscription revenues. For the nine-month period, PPV buys decreased as certain
cable companies continued to migrate consumers from linear channels to
video-on-demand, or VOD. Also as a result of this transition to VOD, revenues
from our movie networks decreased $1.1 million and $2.4 million for the quarter
and nine-month period, respectively. VOD revenues increased $0.9 million, or
116%, for the quarter and increased $2.6 million, or 102%, for the nine-month
period. Our VOD business experienced this growth due to the continued roll out
of VOD service in additional cable systems as well as a growing number of
consumer buys in existing cable systems. Favorably impacting the nine-month
period was the discontinuation of a distributor's high-definition subscription
service agreement, which resulted in the accelerated recognition of the
remaining $1.4 million of deferred revenue associated with the service
agreement. Profit contribution from domestic TV networks decreased $1.4 million,
or 8%, for the quarter primarily due to a one-time, $1.3 million adjustment for
a contractual obligation related to licensed programming recorded in the current
quarter combined with an increase in cable and satellite marketing expenses due
to reimbursements received in the prior year quarter. Conversely, decreased
marketing and overhead expenses combined with the revenue activity described
above resulted in a $3.2 million increase in profit contribution for the
nine-month period.
International revenues increased $0.9 million, or 9%, and $5.3 million, or
17%, for the quarter and nine-month period, respectively. Revenues for the
quarter and nine-month period increased due to the launch of new networks in the
U.K., as well as in Australia and Germany, in the prior year quarter and
revenues from several third-party licensees. Increased royalties from wireless
agreements also contributed favorably in both periods. Profit contribution from
our international businesses was flat for the quarter and increased $2.6
million, or 21%, for the nine-month period, respectively, due to the higher
revenues mentioned above in both periods, mostly offset by increased marketing
and bad debt expenses during the quarter and partially offset by higher costs
related to the new U.K. channels in the nine-month period.
13
Online subscription revenues were relatively flat and increased $1.5
million, or 10%, for the quarter and nine-month period, respectively. Profit
contribution decreased $0.5 million or 5%, and increased $0.6 million, or 6%,
for the quarter and nine-month periods, respectively. Our increased technology
investments, new marketing initiatives and the recent acquisition of an online
distribution business are expected to return this business to its historical
growth rate.
E-commerce revenues increased $0.2 million, or 6%, and $1.9 million, or
16%, for the quarter and nine-month period, respectively. A $1.2 million payment
due to the termination of a marketing alliance favorably impacted revenues for
the nine-month period. Increased business-to-business revenues also contributed
favorably in both periods. Profit contribution from e-commerce decreased $0.4
million and $0.6 million for the quarter and nine-month period, respectively,
due to increased product fulfillment and system support costs and bad debt
expense combined with higher anticipated paper costs in the quarter and
nine-month period. Expenses associated with the production of a test catalog
also impacted the nine-month period.
Profit contribution from other businesses was flat for the quarter and
decreased $0.2 million for the nine-month period.
The group's administrative expenses decreased for both the quarter and
nine-month period due in part to lower legal costs in both periods and a
contractually obligated severance charge recorded in the nine-month period of
the prior year.
Segment income for the group decreased $0.6 million, or 7%, for the
quarter and increased $10.7 million, or 58%, for the nine-month period primarily
due to the previously mentioned revenue activity and a one-time adjustment.
Segment income was favorably impacted by both lower administrative expenses and
lower programming amortization and online content expenses, which were $1.3
million, or 12%, lower for the quarter and $4.1 million, or 12%, lower for the
nine-month period primarily due to the mix of programming. We continue to expect
that our cash programming investments for television will be approximately $38.0
million for the year, down nearly 10% from last year, and online content expense
will be approximately $2.0 million. We expect programming amortization expense
related to television to decline to about $38.0 million for the year, down from
$41.7 million in 2004, and online content amortization expense to be
approximately $2.0 million, down from $2.3 million in 2004.
PUBLISHING GROUP
Playboy magazine revenues decreased $2.1 million, or 8%, and $7.3 million,
or 10%, for the quarter and nine-month period, respectively. Newsstand revenues
were relatively flat for the quarter and declined $1.7 million for the
nine-month period, primarily due to fewer copies sold, partially offset by
higher display costs in both periods in the prior year. Additionally, the
current year nine-month period included an unfavorable adjustment of $0.1
million related to prior year issues compared to a $0.4 million favorable
adjustment in the prior year period. Subscription revenues were relatively flat
for the quarter and decreased $1.3 million for the nine-month period, primarily
due to lower average net revenue per copy in the current year periods, partially
offset by an increase in the number of subscription copies served in the current
year periods. Also contributing to the decrease for the nine-month period were
higher favorable adjustments recorded in the prior year to recognize revenues
for paid subscriptions that will not be served and lower list rental revenues in
the current year. Advertising revenues decreased $1.8 million and $4.4 million
for the quarter and nine-month period, respectively, due to fewer advertising
pages. Additionally, the decrease for the quarter was partially offset by higher
net revenue per page while the nine-month period reflected lower net revenue per
page. Advertising sales for the 2005 fourth quarter magazine issues are closed,
and we expect to report approximately 23% lower advertising revenues and 23%
fewer advertising pages compared to the 2004 fourth quarter.
Revenues from our other domestic publishing businesses decreased $0.2
million, or 8%, and $1.5 million, or 17%, for the quarter and nine-month period,
respectively, primarily due to fewer newsstand copies of special editions sold
in the current year periods and higher unfavorable adjustments to prior year
issues for the nine-month period. An expected decrease in royalties from books
published in prior periods also contributed to the revenue decrease for the
nine-month period.
International publishing revenues were relatively flat and increased $0.3
million, or 7%, for the quarter and nine-month period, respectively, primarily
due to higher royalties from the German edition.
14
The group's segment income decreased $1.9 million and $8.6 million for the
quarter and nine-month period, respectively, as a result of the lower revenues
discussed above combined with higher subscription acquisition expenses of $0.3
million and $1.3 million and higher paper costs of $0.6 million and $1.4 million
for the quarter and nine-month period, respectively, partially offset by a $1.0
million and $1.9 million decrease in editorial expenses for the quarter and
nine-month period, respectively.
LICENSING GROUP
Licensing Group revenues increased $1.3 million, or 29%, and $4.8 million,
or 31%, for the quarter and nine-month period, respectively, primarily due to
higher royalties from existing and new licensees in Europe and Asia. The group's
segment income increased $0.5 million, or 21%, and $3.0 million, or 41%, for the
quarter and nine-month period, respectively, due to the revenue increase,
partially offset by higher revenue-related expenses and development costs
related to our location-based entertainment business.
CORPORATE ADMINISTRATION AND PROMOTION
Corporate Administration and Promotion expenses decreased $0.7 million, or 12%,
for the quarter and $1.2 million, or 9%, for the nine-month period primarily due
to a legal settlement and the reclassification of a senior position from
Corporate to a division that impacted prior year periods, partially offset by an
increase in internal audit expenses in the current year periods.
NONOPERATING INCOME (EXPENSES)
The nine-month period included debt extinguishment expenses of $19.3
million related to our redemption of all $80.0 million of the 11.00% senior
secured notes due 2010, or the senior secured notes, issued by our subsidiary,
PEI Holdings, Inc., or Holdings. These expenses were comprised of $14.9 million
of bond redemption premium combined with $0.3 million of related expenses and
$4.1 million for the non-cash write-off of the related deferred financing costs.
The senior secured notes were repurchased using the proceeds of the issuance of
$115.0 million of 3.00% convertible senior subordinated notes due 2025, or the
convertible notes. The prior year nine-month period included $5.9 million of
debt extinguishment expenses related to our redemption of $35.0 million
aggregate principal amount of the senior secured notes. Reduced interest expense
of $1.5 million and $5.2 million for the quarter and nine-month period,
respectively, related to the lower interest rate on the new convertible notes,
partially offset the redemption expenses.
INCOME TAX EXPENSE
Our effective income tax rate differs from U.S. statutory rates. The
income tax provision consists of foreign income tax related to our international
networks and withholding tax on licensing income for which we do not receive a
current U.S. income tax benefit because of our net operating loss position. The
tax provision also includes deferred federal and state income taxes related to
the amortization of goodwill and other indefinite-lived intangibles, which
cannot be offset against deferred tax assets due to the indefinite reversal
period of the deferred tax liabilities. During the third quarter, we recorded a
$0.5 million adjustment to our tax provision due to a refund related to our
European television operations.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2005, we had $27.5 million in cash and cash equivalents
compared to $26.7 million in cash and cash equivalents at December 31, 2004. At
September 30, 2005, we had $32.1 million of auction rate securities, or ARS,
included in short-term investments compared to $20.0 million at December 31,
2004. ARS generally have long-term maturities; however, these investments have
characteristics similar to short-term investments because at predetermined
intervals, typically every 28 days, there is a new auction process. Total
financing obligations were $115.0 million and $80.0 million at September 30,
2005, and December 31, 2004, respectively.
At September 30, 2005, our liquidity requirements were being provided by
cash generated from our operating activities, existing cash and cash equivalents
and short-term investments. At September 30, 2005, we had a $50.0 million credit
facility, which can be used for revolving borrowings, issuing letters of credit
or a combination of both. At September 30, 2005, there were no borrowings and
$10.8 million in letters of credit outstanding under this facility, permitting
$39.2 million of available borrowings under this facility. See "Credit Facility"
for additional information.
15
DEBT FINANCINGS
On March 15, 2005, we issued and sold in a private placement $100.0
million aggregate principal amount of our 3.00% convertible senior subordinated
notes due 2025. On March 28, 2005, we issued and sold in a private placement an
additional $15.0 million aggregate principal amount of the convertible notes due
to the initial purchasers' exercise of the over-allotment option. The net
proceeds of approximately $110.3 million from the issuance and sale of the
convertible notes, after deducting the initial purchasers' discount and
estimated offering expenses payable by us, were used, together with available
cash, (i) to complete a tender offer and consent solicitation for, and to
purchase and retire, all $80.0 million outstanding principal amount of the
11.00% senior secured notes, for a total of approximately $95.2 million,
including the bond tender premium and consent fee of $14.9 million and other
expenses of $0.3 million, (ii) to purchase 381,971 shares of our Class B common
stock, or Class B stock, for an aggregate purchase price of $5.0 million
concurrently with the sale of the convertible notes and (iii) for working
capital and general corporate purposes. Also, on March 15, 2005, concurrently
with the convertible note offering, Hugh M. Hefner, our Editor-In-Chief and
Chief Creative Officer, purchased 381,971 shares of our Class B stock for an
aggregate purchase price of $5.0 million.
The convertible notes bear interest at a rate of 3.00% per annum on the
principal amount of the notes, payable semi-annually in arrears on March 15 and
September 15 of each year, beginning on September 15, 2005. In addition,
beginning in March 2012, if the trading price of the convertible notes exceeds a
specified threshold during a prescribed measurement period prior to any
semi-annual interest period, contingent interest will become payable on the
convertible notes for that semi-annual interest period at an annual rate of
0.25% per annum. The notes are convertible under specified circumstances into
cash and, if applicable, shares of our Class B stock based on an initial
conversion rate of 58.7648 shares per $1,000 principal amount of the convertible
notes (which represents an initial conversion price of approximately $17.02 per
share). In general, upon conversion of a convertible note, the holder of the
note will receive cash in an amount equal to the principal amount of the note
and Class B stock for the note's conversion value in excess of the principal
amount. See Footnote (I), Debt Refinancing, for additional information.
The convertible notes mature on March 15, 2025. On or after March 15,
2010, if the closing price of our Class B stock exceeds a specified threshold,
we may redeem any of the convertible notes at a redemption price in cash equal
to 100% of the principal amount of the notes, plus any accrued and unpaid
interest to, but excluding, the redemption date. On or after March 15, 2012, we
may at any time redeem any of the convertible notes at the same redemption
price. On each of March 15, 2012, March 15, 2015 and March 15, 2020, or upon the
occurrence of a fundamental change, as specified in the indenture governing the
convertible notes, holders may require us to purchase all or a portion of their
convertible notes at a purchase price in cash equal to 100% of the principal
amount of the notes, plus any accrued and unpaid interest up to, but excluding,
the purchase date.
The convertible notes are unsecured senior subordinated obligations of the
issuer, Playboy Enterprises, Inc., or Playboy, and rank junior to all of the
issuer's senior debt, including its guarantee of Holdings' borrowings under our
credit facility; equally with all of the issuer's future senior subordinated
debt; and senior to all of the issuer's future subordinated debt. In addition,
the assets of the issuer's subsidiaries are subject to the prior claims of all
creditors, including trade creditors, of those subsidiaries.
CREDIT FACILITY
Effective April 1, 2005, Holdings and its lenders amended and restated the
credit agreement governing our credit facility, primarily to increase the size
of the credit facility from $30.0 million to $50.0 million. Our credit facility
provides for revolving borrowings by Holdings of up to $50.0 million and the
issuance of up to $30.0 million in letters of credit, subject to a maximum of
$50.0 million in combined borrowings and letters of credit outstanding at any
time. Borrowings under the credit facility bear interest at a variable rate,
equal to a specified Eurodollar, LIBOR or base rate plus a specified borrowing
margin based on our Transactions Adjusted EBITDA, as defined in the credit
agreement. We pay fees on the outstanding amount of letters of credit under the
credit facility based on the margin that applies to borrowings that bear
interest at a rate based on LIBOR. All amounts outstanding under the credit
facility will mature on April 1, 2008. Holdings' obligations as borrower under
the credit facility are guaranteed by us and each of our other U.S.
subsidiaries, except for Playboy.com and its subsidiaries. The obligations of
the borrower and each of the guarantors under the credit facility are secured by
a first-priority lien on substantially all of the borrower's and the guarantors'
assets.
16
CALIFA ACQUISITION
The Califa acquisition agreement gave us the option of paying $17.5
million of the remaining $23.5 million purchase price consideration obligation,
as of September 30, 2005, in cash or in shares of Class B stock. We notified the
sellers that the $7.0 million of base consideration due in 2005 would be paid in
cash. Under the terms of the agreement, the base consideration was due in two
installments of $3.5 million, one of which was paid on May 2, 2005, and the
other which was paid on November 1, 2005.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $21.1 million for the
nine-month period, which represents an increase of $22.5 million from the prior
year period. This increase is primarily due to improved overall operating
results combined with a decrease in investments in television programming of
$9.9 million and a decrease in legal settlement payments of approximately $4.6
million compared to the prior year period.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used for investing activities increased $13.1 million primarily
due to investments made in auction rate securities during the nine-month period.
During the third quarter, $8.3 million was used to acquire an online
distribution business to complement our current business. An additional $2.0
million is payable on each of the first and second anniversaries of the closing.
Additionally, $4.0 million of cash was used for capital expenditures primarily
related to our Andrita and U.K. studios.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash provided by financing activities was $4.8 million for the
nine-month period primarily due to the proceeds from the sale of $115.0 million
aggregate principal amount of convertible notes, partially offset by the payment
of $94.9 million in connection with the purchase and retirement of all $80.0
million outstanding principal amount of Holdings' 11.00% senior secured notes
and the payment of $0.3 million in associated debt extinguishment expenses and
$5.1 million of related financing fees. Proceeds from the convertible note
offering were also used to purchase 381,971 shares of our Class B stock for an
aggregate purchase price of $5.0 million. See Footnote (I), Debt Refinancing,
for additional information.
17
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains "forward-looking statements,"
including statements in "Management's Discussion and Analysis of Financial
Condition and Results of Operations," as to expectations, beliefs, plans,
objectives and future financial performance, and assumptions underlying or
concerning the foregoing. We use words such as "may," "will," "would," "could,"
"should," "believes," "estimates," "projects," "potential," "expects," "plans,"
"anticipates," "intends," "continues" and other similar terminology. These
forward-looking statements involve known and unknown risks, uncertainties and
other factors which could cause our actual results, performance or outcomes to
differ materially from those expressed or implied in the forward-looking
statements. The following are some of the important factors that could cause our
actual results, performance or outcomes to differ materially from those
discussed in the forward-looking statements:
(1) Foreign, national, state and local government regulations, actions or
initiatives, including:
(a) attempts to limit or otherwise regulate the sale, distribution or
transmission of adult-oriented materials, including print,
television, video and online materials,
(b) limitations on the advertisement of tobacco, alcohol and other
products which are important sources of advertising revenue for us,
or
(c) substantive changes in postal regulations or rates which could
increase our postage and distribution costs;
(2) Risks associated with our foreign operations, including market acceptance
and demand for our products and the products of our licensees;
(3) Our ability to manage the risk associated with our exposure to foreign
currency exchange rate fluctuations;
(4) Changes in general economic conditions, consumer spending habits, viewing
patterns, fashion trends or the retail sales environment which, in each
case, could reduce demand for our programming and products and impact our
advertising revenues;
(5) Our ability to protect our trademarks, copyrights and other intellectual
property;
(6) Risks as a distributor of media content, including our becoming subject to
claims for defamation, invasion of privacy, negligence, copyright, patent
or trademark infringement, and other claims based on the nature and
content of the materials we distribute;
(7) The risk our outstanding litigation could result in settlements or
judgments which are material to us;
(8) Dilution from any potential issuance of common or convertible preferred
stock or convertible debt in connection with financings or acquisition
activities;
(9) Competition for advertisers from other publications, media or online
providers or any decrease in spending by advertisers, either generally or
with respect to the adult male market;
(10) Competition in the television, men's magazine, Internet and product
licensing markets;
(11) Attempts by consumers or private advocacy groups to exclude our
programming or other products from distribution;
(12) Our television and Internet businesses' reliance on third parties for
technology and distribution, and any changes in that technology and/or
unforeseen delays in its implementation which might affect our plans and
assumptions;
(13) Risks associated with losing access to transponders and competition for
transponders and channel space;
(14) The impact of industry consolidation, any decline in our access to, and
acceptance by, DTH and/or cable systems and the possible resulting
deterioration in the terms, cancellation of fee arrangements or pressure
on splits with operators of these systems;
(15) Risks that we may not realize the expected increased sales and profits and
other benefits from acquisitions, joint ventures and/or licensing
arrangements;
(16) Any charges or costs we incur in connection with restructuring measures we
may take in the future;
(17) Risks associated with the financial condition of Claxson Interactive
Group, Inc., our Playboy TV Latin America, LLC joint venture partner;
(18) Increases in paper, postage or printing costs;
(19) Effects of the national consolidation of the single-copy magazine
distribution system; and
(20) Risks associated with the viability of our primarily subscription- and
e-commerce-based Internet model.
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 2005, we did not have any floating interest rate
exposure. All of our outstanding debt as of that date consisted of the
convertible notes, which are fixed-rate obligations. The fair value of the
$115.0 million aggregate principal amount of the convertible notes will be
influenced by changes in market interest rates, the share price of our Class B
stock and our credit quality. As of September 30, 2005, the convertible senior
subordinated notes had an implied fair value of $119.3 million.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange
Act) as of the end of the period covered by this quarterly report. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by us in the reports that
we file or submit under the Exchange Act.
Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 17, 1998, Eduardo Gongora, or Gongora, filed suit in state
court in Hidalgo County, Texas against Editorial Caballero SA de CV, or EC,
Grupo Siete International, Inc., or GSI, collectively the Editorial Defendants,
and us. In the complaint, Gongora alleged that he was injured as a result of the
termination of a publishing license agreement, or the License Agreement, between
us and EC for the publication of a Mexican edition of Playboy magazine, or the
Mexican Edition. We terminated the License Agreement on or about January 29,
1998, due to EC's failure to pay royalties and other amounts due us under the
License Agreement. On February 18, 1998, the Editorial Defendants filed a
cross-claim against us. Gongora alleged that in December 1996 he entered into an
oral agreement with the Editorial Defendants to solicit advertising for the
Mexican Edition to be distributed in the United States. The basis of GSI's
cross-claim was that it was the assignee of EC's right to distribute the Mexican
Edition in the United States and other Spanish-speaking Latin American countries
outside of Mexico. On May 31, 2002, a jury returned a verdict against us in the
amount of approximately $4.4 million. Under the verdict, Gongora was awarded no
damages. GSI and EC were awarded $4.1 million in out-of-pocket expenses and
approximately $0.3 million for lost profits, respectively, even though the jury
found that EC had failed to comply with the terms of the License Agreement. On
October 24, 2002, the trial court signed a judgment against us for $4.4 million
plus pre- and post-judgment interest and costs. On November 22, 2002, we filed
post-judgment motions challenging the judgment in the trial court. The trial
court overruled those motions and we are vigorously pursuing an appeal with the
State Appellate Court sitting in Corpus Christi challenging the verdict. We have
posted a bond in the amount of approximately $8.5 million (which represents the
amount of the judgment, costs and estimated pre- and post-judgment interest) in
connection with the appeal. We, on advice of legal counsel, believe that it is
not probable that a material judgment against us will be sustained. In
accordance with Statement of Financial Accounting Standards, or Statement, 5,
Accounting for Contingencies, no liability has been accrued.
19
On May 17, 2001, Logix Development Corporation, or Logix, D. Keith
Howington and Anne Howington filed suit in state court in Los Angeles County
Superior Court in California against Spice Entertainment Companies, Inc., or
Spice, Emerald Media, Inc., or EMI, Directrix, Inc., or Directrix, Colorado
Satellite Broadcasting, Inc., New Frontier Media, Inc., J. Roger Faherty, or
Faherty, Donald McDonald, Jr., and Judy Savar. On February 8, 2002, plaintiffs
amended the complaint and added as a defendant Playboy, which acquired Spice in
1999. The complaint alleged 11 contract and tort causes of action arising
principally out of a January 18, 1997 agreement between EMI and Logix in which
EMI agreed to purchase certain explicit television channels broadcast over
C-band satellite. The complaint further sought damages from Spice based on
Spice's alleged failure to provide transponder and uplink services to Logix.
Playboy and Spice filed a motion to dismiss the plaintiffs' complaint. After
pre-trial motions, Playboy was dismissed from the case and a number of causes of
action were dismissed against Spice. A trial date for the remaining breach of
contract claims against Spice was set for December 10, 2003, and then continued,
first to February 11, 2004, and then to March 17, 2004. Spice and the plaintiffs
filed cross-motions for summary judgment or, in the alternative, for summary
adjudication, on September 5, 2003. Those motions were heard on November 19,
2003, and were denied. In February 2004, prior to the trial, Spice and the
plaintiffs agreed to a settlement in the amount of $8.5 million, which we
recorded as a charge in the fourth quarter of 2003, $6.5 million of which was
paid in 2004 and $1.0 million in 2005. The remaining $1.0 million will be paid
in 2006.
On April 12, 2004, Faherty filed suit in the United States District Court
for the Southern District of New York against Spice, Playboy, Playboy
Enterprises International, Inc., or PEII, D. Keith Howington, Anne Howington
(together, the "Howington defendants") and Logix. The complaint alleges that
Faherty is entitled to statutory and contractual indemnification from Playboy,
PEII and Spice with respect to defense costs and liabilities incurred by Faherty
in the litigation described in the preceding paragraph, or the Logix litigation.
The complaint further alleges that Playboy, PEII, Spice, D. Keith Howington,
Anne Howington and Logix conspired to deprive Faherty of his alleged right to
indemnification by excluding him from the settlement of the Logix litigation. On
June 18, 2004, a jury entered a special verdict finding Faherty personally
liable for $22.5 million in damages to the plaintiffs in the Logix litigation. A
judgment was entered on the verdict on or around August 2, 2004. Faherty filed
post-trial motions for a judgment notwithstanding the verdict and a new trial,
but these motions were both denied on or about September 21, 2004. On October
20, 2004, Faherty filed a notice of appeal from the verdict. In consideration of
this appeal Faherty and Playboy have agreed to seek a temporary stay of the
indemnification action filed in the United States District Court for the
Southern District of New York. On January 14, 2005, Logix and the Howington
defendants filed a motion to dismiss the Faherty action for, among other things,
lack of personal jurisdiction. On February 15, 2005, Faherty filed a
cross-motion to stay the action pending the outcome of his appeal. The motion
and cross-motions are pending. In the event Faherty's indemnification and
conspiracy claims go forward against us, we believe they are without merit and
that we have good defenses against them. As such, based on the information known
to us to date, we do not believe that it is probable that a material judgment
against us will result. In accordance with Statement 5, Accounting for
Contingencies, no liability has been accrued.
On September 26, 2002, Directrix filed suit in the U.S. Bankruptcy Court
in the Southern District of New York against Playboy Entertainment Group, Inc.
In the complaint, Directrix alleged that it was injured as a result of the
termination of a Master Services Agreement under which Directrix was to perform
services relating to the distribution, production and post-production of our
cable networks and a sublease agreement under which Directrix would have
subleased office, technical and studio space at our Los Angeles, California
production facility. Directrix also alleged that we breached an agreement under
which Directrix had the right to transmit and broadcast certain versions of
films through C-band satellite, commonly known as the TVRO market, and Internet
distribution. On November 15, 2002, we filed an answer denying Directrix's
allegations, along with counterclaims against Directrix relating to the Master
Services Agreement and seeking damages. On May 15, 2003, we filed an amended
answer and counterclaims. On July 30, 2003, Directrix moved to dismiss one of
the amended counterclaims, and on October 20, 2003, the Court denied Directrix's
motion. The parties are engaged in discovery. We believe that we have good
defenses against Directrix's claims. We believe it is not probable that a
material judgment against us will result. In accordance with Statement 5,
Accounting for Contingencies, no liability has been accrued.
In the fourth quarter of 2004, we received a $5.6 million insurance
recovery partially related to the prior year litigation settlement with Logix.
20
ITEM 6. EXHIBITS
Exhibit Number Description
- -------------- -----------
10.1 Affiliation Agreement between Spice, Inc., and Satellite
Services, Inc.
10.1.1* Affiliation Agreement, dated November 1, 1992, between Spice,
Inc., and Satellite Services, Inc.
10.1.2* Amendment No. 1, dated September 29, 1994, to Affiliation
Agreement, dated November 1, 1992, between Spice, Inc., and
Satellite Services, Inc.
10.1.3* Letter Agreement, dated July 18, 1997, amending the
Affiliation Agreement, dated November 1, 1992, between Spice,
Inc., and Satellite Services, Inc.
10.1.4* Letter Agreement, dated December 18, 1997, amending the
Affiliation Agreement between Spice, Inc., and Satellite
Services, Inc.
10.1.5* Amendment, effective September 26, 2005, to Affiliation
Agreement, dated November 1, 1992, between Spice, Inc., and
Satellite Services, Inc.
10.2 Affiliation Agreement between Playboy Entertainment Group,
Inc., and Satellite Services, Inc.
10.2.1* Affiliation Agreement, dated February 10, 1993, between
Playboy Entertainment Group, Inc., and Satellite Services,
Inc.
10.2.2* Amendment, effective September 26, 2005, to Affiliation
Agreement, dated February 10, 1993, between Playboy
Entertainment Group, Inc., and Satellite Services, Inc.
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Portions of this exhibit have been omitted and filed separately with the
Securities and Exchange Commission pursuant to a request for confidential
treatment pursuant to Rule 24b-2 of the Securities and Exchange Act of
1934 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PLAYBOY ENTERPRISES, INC.
(Registrant)
Date: November 8, 2005 By /s/ Linda Havard
----------------
Linda G. Havard
Executive Vice President,
Finance and Operations,
and Chief Financial Officer
(Authorized Officer and
Principal Financial and
Accounting Officer)
22