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 June 30, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 001-14790
Playboy Enterprises, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-4249478
(State of incorporation) (I.R.S. Employer Identification Number)
680 North Lake Shore Drive
Chicago, IL 60611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (312) 751-8000
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
Yes |_| No |X|
At July 31, 2006, there were 4,864,102 shares of Class A common stock and
28,302,525 shares of Class B common stock outstanding.
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 regulation, 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, Internet and wireless 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) Failure to maintain our agreements with multiple system operators and
direct-to-home operators on favorable terms, as well as any decline in our
access to, and acceptance by, direct-to-home 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;
(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, printing or postage costs;
(19) Risks associated with revenue guarantees under our cable distribution
agreements;
(20) Effects of the national consolidation of the single-copy magazine
distribution system; and
(21) Risks associated with the viability of our primarily subscription- and
e-commerce-based Internet model.
2
PLAYBOY ENTERPRISES, INC.
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Quarters Ended June 30, 2006 and 2005 (Unaudited) 4
Condensed Consolidated Statements of Operations and Comprehensive
Loss for the Six Months Ended June 30, 2006 and 2005 (Unaudited) 5
Condensed Consolidated Balance Sheets at June 30, 2006 (Unaudited)
and December 31, 2005 6
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2006 and 2005 (Unaudited) 7
Notes to Condensed Consolidated Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 22
PART II
OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 1A. Risk Factors 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits 24
3
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PLAYBOY ENTERPRISES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
for the Quarters Ended June 30 (Unaudited)
(In thousands, except per share amounts)
2006 2005
- --------------------------------------------------------------------------------------------------------
Net revenues $ 80,477 $ 82,871
- --------------------------------------------------------------------------------------------------------
Costs and expenses
Cost of sales (65,567) (62,055)
Selling and administrative expenses (14,257) (13,521)
Restructuring expenses (1,906) -
- --------------------------------------------------------------------------------------------------------
Total costs and expenses (81,730) (75,576)
- --------------------------------------------------------------------------------------------------------
Gains on disposal 29 14
- --------------------------------------------------------------------------------------------------------
Operating income (loss) (1,224) 7,309
- --------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 602 595
Interest expense (1,281) (1,412)
Amortization of deferred financing fees (134) (133)
Minority interest - (370)
Other, net 50 (324)
- --------------------------------------------------------------------------------------------------------
Total nonoperating expense (763) (1,644)
- --------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (1,987) 5,665
Income tax expense (1,320) (1,025)
- --------------------------------------------------------------------------------------------------------
Net income (loss) (3,307) 4,640
- --------------------------------------------------------------------------------------------------------
Other comprehensive income (loss)
Unrealized loss on marketable securities (111) (46)
Unrealized gain (loss) on derivatives (59) 46
Foreign currency translation gain (loss) 502 (84)
- --------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss) 332 (84)
- --------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ (2,975) $ 4,556
========================================================================================================
Weighted average number of common shares outstanding
Basic 33,158 33,080
========================================================================================================
Diluted 33,158 33,265
========================================================================================================
Basic and diluted earnings (loss) per common share $ (0.10) $ 0.14
========================================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4
PLAYBOY ENTERPRISES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
for the Six Months Ended June 30 (Unaudited)
(In thousands, except per share amounts)
2006 2005
- --------------------------------------------------------------------------------------------------------
Net revenues $ 162,597 $ 166,322
- --------------------------------------------------------------------------------------------------------
Costs and expenses
Cost of sales (128,819) (121,331)
Selling and administrative expenses (29,594) (26,788)
Restructuring expenses (1,906) --
- --------------------------------------------------------------------------------------------------------
Total costs and expenses (160,319) (148,119)
- --------------------------------------------------------------------------------------------------------
Gains on disposal 29 14
- --------------------------------------------------------------------------------------------------------
Operating income 2,307 18,217
- --------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 1,209 782
Interest expense (2,709) (4,060)
Amortization of deferred financing fees (268) (366)
Minority interest -- (740)
Debt extinguishment expenses -- (19,280)
Other, net (146) (800)
- --------------------------------------------------------------------------------------------------------
Total nonoperating expense (1,914) (24,464)
- --------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 393 (6,247)
Income tax expense (2,911) (2,232)
- --------------------------------------------------------------------------------------------------------
Net loss (2,518) (8,479)
- --------------------------------------------------------------------------------------------------------
Other comprehensive income (loss)
Unrealized gain (loss) on marketable securities 9 (71)
Unrealized gain (loss) on derivatives (61) 257
Foreign currency translation gain 417 192
- --------------------------------------------------------------------------------------------------------
Total other comprehensive income 365 378
- --------------------------------------------------------------------------------------------------------
Comprehensive loss $ (2,153) $ (8,101)
========================================================================================================
Weighted average number of common shares outstanding
Basic and diluted 33,149 33,216
========================================================================================================
Basic and diluted loss per common share $ (0.08) $ (0.26)
========================================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
5
PLAYBOY ENTERPRISES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
June 30, Dec. 31,
2006 2005
- --------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 25,556 $ 26,089
Marketable securities and short-term investments 15,308 25,963
Receivables, net of allowance for doubtful accounts of
$4,102 and $3,883, respectively 38,477 46,296
Receivables from related parties 1,475 1,928
Inventories, net 12,554 12,846
Deferred subscription acquisition costs 9,767 10,452
Other current assets 9,354 8,761
- --------------------------------------------------------------------------------------------------------
Total current assets 112,491 132,335
- --------------------------------------------------------------------------------------------------------
Property and equipment, net 14,814 13,771
Long-term receivables 2,777 2,628
Programming costs, net 56,340 52,683
Goodwill 133,056 122,448
Trademarks 62,055 61,139
Distribution agreements, net of accumulated amortization
of $2,945 and $2,779, respectively 30,196 30,362
Other noncurrent assets 15,844 13,603
- --------------------------------------------------------------------------------------------------------
Total assets $ 427,573 $ 428,969
========================================================================================================
Liabilities
Acquisition liabilities $ 12,074 $ 11,782
Accounts payable 24,919 25,429
Accrued salaries, wages and employee benefits 5,449 10,068
Deferred revenues 44,285 45,987
Accrued litigation settlement -- 1,000
Other liabilities and accrued expenses 16,274 16,396
- --------------------------------------------------------------------------------------------------------
Total current liabilities 103,001 110,662
- --------------------------------------------------------------------------------------------------------
Financing obligations 115,000 115,000
Acquisition liabilities 15,041 11,792
Net deferred tax liabilities 19,706 17,555
Other noncurrent liabilities 16,291 16,713
- --------------------------------------------------------------------------------------------------------
Total liabilities 269,039 271,722
- --------------------------------------------------------------------------------------------------------
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;
28,680,804 and 28,643,443 issued, respectively 287 286
Capital in excess of par value 226,976 223,537
Accumulated deficit (62,494) (59,976)
Treasury stock, at cost, 381,971 shares (5,000) (5,000)
Accumulated other comprehensive loss (1,284) (1,649)
- --------------------------------------------------------------------------------------------------------
Total shareholders' equity 158,534 157,247
- --------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 427,573 $ 428,969
========================================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
6
PLAYBOY ENTERPRISES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Six Months Ended June 30 (Unaudited)
(In thousands)
2006 2005
- --------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (2,518) $ (8,479)
Adjustments to reconcile net loss to net cash provided by
operating activities
Depreciation of property and equipment 1,827 1,542
Amortization of intangible assets 612 868
Amortization of investments in entertainment programming 17,561 18,968
Amortization of deferred financing fees 268 366
Debt extinguishment expenses -- 19,280
Deferred income taxes 2,151 498
Net change in operating assets and liabilities 1,275 (207)
Investments in entertainment programming (19,545) (15,984)
Litigation settlement (1,000) (1,875)
Stock-based compensation 1,794 74
Other, net 1,275 363
- --------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,700 15,414
- --------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Payments for acquisitions (7,761) --
Purchases of investments (267) (34,107)
Proceeds from sales of investments 11,000 18,700
Additions to property and equipment (2,826) (2,164)
Other, net (95) -
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities 51 (17,571)
- --------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from financing obligations -- 115,000
Repayment of financing obligations -- (80,000)
Payment of debt extinguishment expenses -- (15,197)
Payment of acquisition liabilities (4,511) (4,558)
Purchase of treasury stock -- (5,000)
Payment of deferred financing fees -- (4,040)
Proceeds from stock-based compensation 227 784
Other, net -- (39)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities (4,284) 6,950
- --------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (533) 4,793
Cash and cash equivalents at beginning of period 26,089 26,668
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 25,556 $ 31,461
========================================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
7
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 for the fiscal year ended December 31, 2005. Certain amounts
reported for the prior periods have been reclassified to conform to the current
year's presentation.
(B) RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2006, the Financial Accounting Standards Board, or the FASB,
issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB Statement No. 109, or FIN 48. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in a company's financial
statements and prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
description, classification, interest and penalties, accounting in interim
periods, disclosure and transition. We are required to adopt FIN 48 effective at
the beginning of 2007. We are currently evaluating the impact of adopting FIN 48
on our future results of operations and financial condition.
In March 2006, the FASB issued Statement of Financial Accounting Standards
No. 156, Accounting for Servicing of Financial Assets, or Statement 156.
Statement 156 permits an entity to choose either the amortization method or fair
value method for each class of separately recognized servicing assets and
servicing liabilities. At June 30, 2006, we did not have any financial assets or
liabilities relating to servicing rights subject to Statement 156. We are
required to adopt Statement 156 effective at the beginning of 2007. We do not
expect the adoption of Statement 156 to have a significant impact on our future
results of operations or financial condition.
In February 2006, the FASB issued Statement of Financial Accounting
Standards No. 155, Accounting for Certain Hybrid Financial Instruments, or
Statement 155. Statement 155 resolves issues addressed in FASB Statement 133
Implementation Issue No. D1, Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets. Amongst other things, it permits fair
value remeasurement for any hybrid financial instrument that contains an
embedded derivative that otherwise would require bifurcation. At June 30, 2006,
we did not have any hybrid financial instruments subject to the fair value
election under Statement 155. We are required to adopt Statement 155 effective
at the beginning of 2007. We do not expect the adoption of Statement 155 to have
a significant impact on our future results of operations or financial condition.
(C) RESTRUCTURING EXPENSES
In the current quarter, we implemented a cost reduction plan that reduces
our annual programming and editorial investments while also lowering other
discretionary expenses. As a result of this 2006 restructuring plan, we reported
a charge of $2.1 million related to costs associated with a workforce reduction
of 15 employees. We reduced our 2002 restructuring plan estimate by $0.3 million
and recorded an additional charge of $0.1 million related to our 2001
restructuring plan in the current quarter as a result of changes in assumptions
related to leased space.
In the fourth quarter of 2005, we recorded an additional charge of $0.1
million related to our 2002 restructuring plan as a result of changes in
assumptions related to leased space.
During the six-month period ended June 30, 2006, we made cash payments of
$0.3 million related to our 2002 restructuring plan. Of the total costs related
to our restructuring plans, approximately $10.3 million was paid by June 30,
2006, with the remaining $2.8 million to be paid through 2007.
8
The following table sets forth the activity and balances of our
restructuring reserves for the year ended December 31, 2005 and for the
six-month period ended June 30, 2006 (in thousands):
Consolidation
of Facilities
Workforce and
Reduction Operations Total
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 $ 179 $ 1,827 $ 2,006
Adjustments to previous estimates 17 132 149
Cash payments (196) (749) (945)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 -- 1,210 1,210
Reserve recorded 2,108 -- 2,108
Adjustments to previous estimates -- (202) (202)
Cash payments -- (294) (294)
- -----------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2006 $ 2,108 $ 714 $ 2,822
=======================================================================================================================
(D) EARNINGS PER COMMON SHARE
The following table sets forth the computations of basic and diluted
earnings (loss) per share, or EPS (in thousands, except per share amounts):
Quarters Ended
June 30,
-----------------------
2006 2005
- ----------------------------------------------------------------------------------------------------------------------
Numerator:
For basic and diluted EPS - net income (loss) $ (3,307) $ 4,640
======================================================================================================================
Denominator:
For basic EPS - weighted average shares 33,158 33,080
Effect of dilutive potential common shares:
Employee stock options and other -- 185
- ----------------------------------------------------------------------------------------------------------------------
Dilutive potential common shares -- 185
- ----------------------------------------------------------------------------------------------------------------------
For diluted EPS - weighted average shares 33,158 33,265
======================================================================================================================
Basic and diluted EPS $ (0.10) $ 0.14
======================================================================================================================
The computations of basic and diluted EPS for the six-month periods ended
June 30, 2006 and 2005, were excluded as both periods resulted in a net loss,
and therefore, potential common shares would have been antidilutive.
The following table sets forth the number of shares related to outstanding
options to purchase our Class B common stock, or Class B stock, and the
potential shares of Class B stock contingently issuable under our 3.00%
convertible senior subordinated notes due 2025, or convertible notes. These
shares were not included in the computations of diluted EPS for the quarters and
six-month periods ended June 30, 2006 and 2005, as their inclusion would have
been antidilutive (in thousands):
Quarters Ended Six Months Ended
June 30, June 30,
----------------------------------------------
2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------------------
Stock options 3,975 1,982 3,192 2,864
Convertible notes 6,758 6,758 6,758 6,758
- ---------------------------------------------------------------------------------------------------------------------
Total 10,733 8,740 9,950 9,622
=====================================================================================================================
9
(E) INVENTORIES, NET
Inventories, net, which are stated at the lower of cost (specific cost and
average cost) or fair value, consisted of the following (in thousands):
June 30, Dec. 31,
2006 2005
- -------------------------------------------------------------------------------
Paper $ 3,310 $ 3,939
Editorial and other prepublication costs 6,533 6,529
Merchandise finished goods 2,711 2,378
- -------------------------------------------------------------------------------
Total inventories, net $ 12,554 $ 12,846
===============================================================================
(F) INCOME TAXES
Our income tax provision consists of foreign income tax, which relates to
our international networks and withholding tax on licensing income for which we
do not receive a current U.S. income tax benefit due to our net operating loss
position. Our income 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.
(G) CONTINGENCIES
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 us under the license agreement. We vigorously pursued an appeal with the
State Appellate Court sitting in Corpus Christi challenging the verdict. We have
posted a bond in the amount of approximately $9.4 million, which represents the
amount of the judgment, costs and estimated pre- and post-judgment interest, in
connection with the appeal. On May 25, 2006, the State Appellate Court reversed
the judgment by the trial court, rendered judgment for us on the majority of the
plaintiffs' claims and remanded the remaining claims for a new trial. On July
14, 2006, the plaintiffs filed a motion for rehearing and en banc
reconsideration, which we are opposing. We, on advice of legal counsel, believe
that it is not probable that a material judgment against us will be obtained. In
accordance with Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies, no liability has been accrued.
In 2003, we recorded $8.5 million for the settlement of the Logix
litigation, which related to events prior to our 1999 acquisition of Spice. We
made payments of $1.0 million, $1.0 million and $6.5 million in 2006, 2005 and
2004, respectively, and have no further obligations under the settlement.
In the third quarter of 2005, we acquired an affiliate network of websites
to complement our existing online business. We paid $8.3 million at closing,
which included $8.0 million for the initial purchase price and $0.3 million of
acquisition-related costs. Additional payments of $2.0 million are required in
each of 2006 and 2007. Pursuant to the asset purchase agreement, we are also
obligated to make future contingent earnout payments over a five-year period
based primarily on the financial performance of the acquired business. If the
required performance benchmarks are achieved, any contingent earnout payments
will be recorded as additional purchase price and/or compensation expense. As of
June 30, 2006, an earnout payment of approximately $0.1 million was made and
recorded as additional purchase price.
Late in the current quarter of 2006, we acquired a multi-media adult
entertainment business to complement our existing television and online
businesses. As the pro forma results would not be materially different from
actual results, they are not presented. We paid $7.7 million at closing with
additional payments of $1.6 million, $1.7 million, $2.3 million and $4.3 million
required in 2007, 2008, 2009 and 2010, respectively. Pursuant to the acquisition
agreement, we are also obligated to make future contingent earnout payments
based primarily on sales of existing content of the acquired business over a
ten-year period after the closing of the acquisition and based on content
produced by the acquired business during the five-year period after the closing
of the acquisition. As of June 30, 2006, no earnout payments have been made.
10
(H) STOCK-BASED COMPENSATION
On January 1, 2006, we adopted the provisions of Statement of Financial
Accounting Standards No. 123 (revised 2004), Share-Based Payment, or Statement
123(R), which is a revision of Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation, or Statement 123, under the
modified prospective method. Statement 123(R) supersedes Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and
amends Statement of Financial Accounting Standards No. 95, Statement of Cash
Flows. Statement 123(R) requires that all stock-based compensation to employees,
including grants of employee stock options, be recognized in the income
statement based on its fair value. Under the modified prospective method,
results for prior periods have not been restated.
Stock-based compensation expense for the quarter and six-month period
ended June 30, 2006, is based on awards ultimately expected to vest, reduced for
estimated forfeitures. Statement 123(R) requires forfeitures to be estimated at
the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Forfeitures were estimated based on
historical experience. In our pro forma information required under Statement 123
for the periods prior to fiscal 2006, we accounted for forfeitures as they
occurred. Under the fair value recognition provisions of Statement 123(R), we
measure stock-based compensation cost at the grant date based on the value of
the award and recognize the expense over the vesting period. Compensation
expense for all stock-based payment awards granted prior to and subsequent to
January 1, 2006, is recognized using the straight-line attribution method.
Stock-based compensation expense is reflected in our Condensed Consolidated
Statements of Operations and Comprehensive Income (Loss) in selling and
administrative expenses and the proceeds are reflected in our Condensed
Consolidated Statements of Cash Flows in proceeds from stock-based compensation.
We have stock plans for key employees and nonemployee directors, which
provide for the grant of nonqualified and incentive stock options and/or shares
of restricted stock units, deferred stock and other performance-based equity
awards in our Class B stock. The Compensation Committee of the Board of
Directors, which is composed entirely of independent nonemployee directors,
administers all the plans. These plans are designed to further our growth,
development and financial success by providing key employees with strong
additional incentives to maximize long-term stockholder value. The Compensation
Committee believes that this objective can be best achieved through assisting
key employees to become owners of our stock, which aligns their interests with
our interests. As stockholders, key employees will benefit directly from our
growth, development and financial success. These plans also enable us to attract
and retain the services of those executives whom we consider essential to our
long-range success by providing these executives with a competitive compensation
package and an opportunity to become owners of our stock. At June 30, 2006, we
had 387,861 shares of our Class B stock available for grant under these plans.
Stock options, exercisable for shares of Class B stock, generally vest
over a two- to four-year period from the grant date and expire ten years from
the grant date. It is our policy that options are priced based on the closing
price on the day prior to the date of grant.
Restricted stock unit grants provide for the issuance of Class B stock if
three-year cumulative operating income target thresholds are met. If the
operating income minimum threshold is not obtained, the restricted stock units
for that grant are forfeited.
One of our stock plans pertaining to nonemployee directors also allows for
the issuance or deferral of Class B stock as awards and payments for retainer,
committee and meeting fees.
Finally, we also have an Employee Stock Purchase Plan that provides
substantially all regular full- and part-time employees an opportunity to
purchase shares of our Class B stock through payroll deductions. The funds are
withheld and then used to acquire stock on the last trading day of each quarter,
based on that day's closing price less a 15% discount. Employee Stock Purchase
Plan expense is reflected in our Condensed Consolidated Statements of Operations
and Comprehensive Income (Loss) in selling and administrative expenses and the
proceeds are reflected in our Condensed Consolidated Statements of Cash Flows in
proceeds from stock-based compensation. At June 30, 2006, we had 9,152 shares of
our Class B stock available for purchase under this plan.
11
Valuation Information
Upon adoption of Statement 123(R), we began estimating the value of stock
options on the date of grant using a Lattice Binomial model, or Lattice model.
Prior to the adoption of Statement 123(R), the value of each employee stock
option was estimated on the date of grant using the Black-Scholes model for the
purpose of pro forma financial information in accordance with Statement 123. The
Lattice model requires extensive analysis of actual exercise behavior data and a
number of complex assumptions including expected volatility, risk-free interest
rate, expected dividends and option cancellations.
The following assumptions were used for the Lattice model in 2006 and the
Black-Scholes model in 2005:
Quarters Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------
Expected volatility 38% 46% 38% 46%
Risk-free interest rate 4.32% - 4.51% 3.80% 4.32% - 4.51% 3.80% - 4.18%
Expected dividends -- -- -- --
- ---------------------------------------------------------------------------------------------------------
The expected life of stock options represents the weighted average period
the stock options are expected to remain outstanding and is a derived output of
the Lattice model. The expected life of stock options is impacted by all of the
underlying assumptions and calibration of the Lattice model. The Lattice model
assumes that exercise behavior is a function of the option's remaining vested
life and the extent to which the option's fair value exceeds the exercise price.
The Lattice model estimates the probability of exercise as a function of these
two variables based upon the entire history of exercises and cancellations on
all past option grants.
The weighted average expected life for options granted during the first
quarter of 2006 using the Lattice model was 5.8 years. There were no options
granted in the current quarter. The weighted average expected life for options
granted during the prior year quarter and six-month period using the
Black-Scholes model was 6.0 years. The weighted average fair value per share for
stock options granted during the first quarter of 2006 was $6.40 using the
Lattice model, and the weighted average fair value per share for stock options
granted during the prior year quarter and six-month period was $5.84 and $5.98,
respectively, using the Black-Scholes model.
Stock Option Activity
This table sets forth stock option activity for the six-month period ended
June 30, 2006:
Weighted Average
Shares Exercise Price
- ----------------------------------------------------------------------- -------------------------
Class A Class B Class A Class B
- ----------------------------------------------------------------------- -------------------------
Outstanding at December 31, 2005 - 3,374,135 $ - $ 15.85
Granted - 670,500 - 14.50
Exercised - (13,666) - 10.84
Canceled - (149,220) - 14.20
- -----------------------------------------------------------------------
Outstanding at June 30, 2006 - 3,881,749 $ - $ 15.70
======================================================================= -------------------------
12
At June 30, 2006, the weighted average remaining contractual lives of
options outstanding and options exercisable were 6.1 years and 4.8 years,
respectively. At June 30, 2006, the number of options exercisable and the
weighted average exercise price of options exercisable were 2,759,083 and
$16.54, respectively.
There were no options granted or exercised in the current quarter.
However, for the six-month period ended June 30, 2006, we had proceeds of $0.1
million from exercises of stock options. There was no aggregate intrinsic value
for options granted in the six-month period ended June 30, 2006, since the
closing price of our Class B stock on that date was less than the exercise price
on the date of grant. The aggregate intrinsic value for options exercised during
the six-month period ended June 30, 2006, was approximately $0.1 million. The
aggregate intrinsic value of options outstanding and exercisable at June 30,
2006, was $1 thousand. The aggregate intrinsic value for options granted during
the quarter and six-month period ended June 30, 2005, was $2 thousand and $0.7
million, respectively. The aggregate intrinsic value for options exercised
during the quarter and six-month period ended June 30, 2005, was $0.1 million
and $0.4 million, respectively.
As a result of adopting Statement 123(R) on January 1, 2006, our income
(loss) from continuing operations before income taxes, income (loss) from
continuing operations and net income (loss) for the quarter and six-month period
ended June 30, 2006, were $0.8 million and $1.5 million lower, respectively,
than if we had continued to account for stock-based compensation under APB 25.
Basic and diluted EPS for the quarter and six-month period ended June 30, 2006,
were $0.02 and $0.05 lower, respectively, than if we had continued to account
for stock-based compensation under APB 25.
The following table sets forth stock-based compensation expense related to
stock options and to our Employee Stock Purchase Plan for the current quarter
and six-month period and pro forma amounts for the prior year quarter and
six-month period (in thousands, except per share amounts):
Quarters Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2006 2005 2006 2005
- ----------------------------------------------------------------------------------------------------------------
Stock options $ 796 $ 718 $ 1,505 $ 1,422
Employee stock purchase plan 8 -- 14 --
- ----------------------------------------------------------------------------------------------------------------
Total $ 804 $ 718 $ 1,519 $ 1,422
================================================================================================================
Net income (loss)
As reported $ (3,307) $ 4,640 $ (2,518) $ (8,479)
Fair value of stock-based compensation
excluded from net income, gross (718) (1,422)
----------- -----------
Pro forma $ 3,922 $ (9,901)
=========== ===========
Basic and diluted EPS
As reported $ (0.10) $ 0.14 $ (0.08) $ (0.26)
Pro forma $ 0.12 $ (0.30)
- ----------------------------------------------------------------------------------------------------------------
As of June 30, 2006, there was $5.2 million of unrecognized stock-based
compensation expense related to non-vested stock options, which will be
recognized over a weighted average period of 1.5 years.
13
Restricted Stock Unit Activity
At June 30, 2006, we had 488,000 restricted stock units outstanding, none
of which were vested, and all of which were performance-based restricted stock
awards contingent upon meeting certain performance goals.
Weighted
Average
Number of Grant-Date
Shares Fair Value
- --------------------------------------------------------------------------------
Outstanding at December 31, 2005 319,000 $ 13.07
Granted 188,500 14.51
Canceled (19,500) 13.16
- --------------------------------------------------------------
Outstanding at June 30, 2006 488,000 $ 13.62
================================================================================
Stock-based compensation expense related to restricted stock units was
$0.2 million and $0.4 million for the quarters ended June 30, 2006 and 2005,
respectively, and $0.2 million and $0.7 million for the six-month periods ended
June 30, 2006 and 2005, respectively. As of June 30, 2006, there was $2.1
million of unrecognized stock-based compensation expense related to non-vested
restricted stock units, which will be recognized over a weighted average period
of 1.6 years.
Employee Stock Purchase Plan Activity
The Employee Stock Purchase Plan had minimal impact on our expenses as a
result of the adoption of Statement 123(R).
Income Taxes
On November 10, 2005, the FASB issued Staff Position No. 123(R)-3,
Transition Election Related to Accounting for Tax Effects of Share-Based Payment
Awards, or Staff Position 123(R)-3. We have elected to adopt the alternative
transition method provided in Staff Position 123(R)-3 for calculating the tax
effects of stock-based compensation pursuant to Statement 123(R). The
alternative transition method simplifies the calculation of the beginning
balance of the additional paid-in-capital pool, or APIC pool, related to the tax
effect of employee stock-based compensation. This method also has subsequent
impact on the APIC pool and Condensed Consolidated Statements of Cash Flows
relating to the tax effects of employee stock-based compensation awards that are
outstanding upon adoption of Statement 123(R).
Under Statement 123(R), the income tax effects of share-based payments are
recognized for financial reporting purposes only if such awards would result in
deductions on our income tax returns. The settlement of share-based payments to
date that would have resulted in an excess tax benefit would have increased our
existing net operating loss, or NOL, carry forward. Under Statement 123(R), no
excess tax benefits resulting from the settlement of a share payment can result
in a tax deduction before realization of the tax benefit, i.e., the recognition
of excess tax benefits cannot be recorded until the excess benefit reduces
current income taxes payable. Additionally, as a result of our existing NOL
carry forward position, no tax benefit relating to share-based payments has been
recorded for the quarter and six-month period ended June 30, 2006.
(I) BENEFIT PLANS
We currently maintain a practice of paying a separation allowance under
our salary continuation policy to employees with at least five years of
continuous service who voluntarily terminate employment with us and are at age
60 or thereafter. For the quarter and six-month period ended June 30, 2006,
payments made under this policy were $0.1 million and $0.2 million,
respectively.
14
(J) SEGMENT INFORMATION (1)
The following table sets forth financial information by reportable segment
(in thousands):
Quarters Ended Six Months Ended
June 30, June 30,
---------------------- -----------------------
2006 2005 2006 2005
- -------------------------------------------------------------------------------------------------------------------
Net revenues
Entertainment $ 47,545 $ 48,908 $ 98,722 $ 99,390
Publishing 23,790 25,530 47,285 52,534
Licensing 9,142 8,433 16,590 14,398
- -------------------------------------------------------------------------------------------------------------------
Total $ 80,477 $ 82,871 $ 162,597 $ 166,322
===================================================================================================================
Income (loss) before income taxes
Entertainment $ 4,881 $ 9,866 $ 12,754 $ 21,686
Publishing (1,752) (2,356) (4,049) (2,740)
Licensing 4,076 3,929 8,422 7,607
Corporate Administration and Promotion (6,552) (4,144) (12,943) (8,350)
Restructuring expenses (1,906) -- (1,906) --
Gains on disposal 29 14 29 14
Investment income 602 595 1,209 782
Interest expense (1,281) (1,412) (2,709) (4,060)
Amortization of deferred financing fees (134) (133) (268) (366)
Minority interest -- (370) -- (740)
Debt extinguishment expenses -- -- -- (19,280)
Other, net 50 (324) (146) (800)
- ------------------------------------------------------------------------------------------------------------------
Total $ (1,987) $ 5,665 $ 393 $ (6,247)
===================================================================================================================
June 30, Dec. 31,
2006 2005
- -------------------------------------------------------------------------------------------------------------------
Identifiable assets
Entertainment $ 286,343 $ 274,473
Publishing 34,415 38,833
Licensing 8,448 7,539
Corporate Administration and Promotion 98,367 108,124
- -------------------------------------------------------------------------------------------------------------------
Total $ 427,573 $ 428,969
===================================================================================================================
(1) Certain amounts reported for the prior periods have been reclassified to
conform to the current year's presentation.
(K) SUBSEQUENT EVENT
On August 4, 2006, the Sixth Amendment to our Chicago lease, or the Sixth
Amendment, with Golub LSP Investors, LP was signed. The Sixth Amendment was
effective May 1, 2006, and extends our lease through August 31, 2022. Our
current lease was to expire August 31, 2007. This space serves as our corporate
headquarters and is used by all of our operating groups and executive and
administrative personnel.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and accompanying notes and with our Annual
Report on Form 10-K for the year ended December 31, 2005. All period references
are to our fiscal periods unless otherwise indicated.
RESULTS OF OPERATIONS (1)
The following table sets forth our results of operations (in millions,
except per share amounts):
Quarters Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------------------------------
Net revenues
Entertainment
Domestic TV $ 20.9 $ 24.9 $ 43.2 $ 50.1
International 13.2 11.9 27.0 25.3
Online subscriptions and e-commerce 11.4 10.8 24.6 21.8
Other 2.0 1.3 3.9 2.2
- ---------------------------------------------------------------------------------------------------------------------------------
Total Entertainment 47.5 48.9 98.7 99.4
- ---------------------------------------------------------------------------------------------------------------------------------
Publishing
Playboy magazine 20.2 22.1 39.4 45.0
Special editions and other 2.0 1.9 4.6 4.2
International publishing 1.6 1.5 3.3 3.3
- ---------------------------------------------------------------------------------------------------------------------------------
Total Publishing 23.8 25.5 47.3 52.5
- ---------------------------------------------------------------------------------------------------------------------------------
Licensing
International licensing 5.6 4.7 11.1 9.2
Domestic licensing 1.3 1.2 2.6 2.5
Marketing events 2.3 2.4 2.5 2.6
Other -- 0.1 0.4 0.1
- ---------------------------------------------------------------------------------------------------------------------------------
Total Licensing 9.2 8.4 16.6 14.4
- ---------------------------------------------------------------------------------------------------------------------------------
Total net revenues $ 80.5 $ 82.8 $ 162.6 $ 166.3
=================================================================================================================================
Net income (loss)
Entertainment
Before programming amortization and online content expenses $ 15.2 $ 20.0 $ 32.5 $ 41.7
Programming amortization and online content expenses (10.3) (10.2) (19.7) (20.0)
- ---------------------------------------------------------------------------------------------------------------------------------
Total Entertainment 4.9 9.8 12.8 21.7
- ---------------------------------------------------------------------------------------------------------------------------------
Publishing (1.8) (2.3) (4.1) (2.7)
- ---------------------------------------------------------------------------------------------------------------------------------
Licensing 4.1 4.0 8.4 7.6
- ---------------------------------------------------------------------------------------------------------------------------------
Corporate Administration and Promotion (6.5) (4.2) (12.9) (8.4)
- ---------------------------------------------------------------------------------------------------------------------------------
Segment income 0.7 7.3 4.2 18.2
Restructuring expenses (1.9) -- (1.9) --
- ---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) (1.2) 7.3 2.3 18.2
- ---------------------------------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 0.6 0.6 1.2 0.8
Interest expense (1.3) (1.5) (2.7) (4.1)
Amortization of deferred financing fees (0.2) (0.2) (0.3) (0.4)
Minority interest -- (0.3) -- (0.7)
Debt extinguishment expenses -- -- -- (19.3)
Other, net 0.1 (0.2) (0.1) (0.7)
- ---------------------------------------------------------------------------------------------------------------------------------
Total nonoperating expense (0.8) (1.6) (1.9) (24.4)
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (2.0) 5.7 0.4 (6.2)
Income tax expense (1.3) (1.1) (2.9) (2.3)
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (3.3) $ 4.6 $ (2.5) $ (8.5)
=================================================================================================================================
Basic and diluted earnings (loss) per common share $ (0.10) $ 0.14 $ (0.08) $ (0.26)
=================================================================================================================================
(1) Certain amounts reported for the prior periods have been reclassified to
conform to the current year's presentation.
16
Our revenues decreased $2.3 million, or 3%, and $3.7 million, or 2%, for
the quarter and six-month period, respectively, primarily due to expected lower
revenues from our Publishing and Entertainment Groups, partially offset by
higher revenues from our Licensing Group.
Segment income decreased $6.6 million, or 91%, and $14.0 million, or 77%,
for the quarter and six-month period, respectively, primarily due to lower
results from our Entertainment Group and higher Corporate Administration and
Promotion expenses. The six-month comparison also was impacted by expected lower
results from our Publishing Group, partially offset by improved results from our
Licensing Group. Our segment income also was impacted by $0.8 million and $1.5
million for the quarter and six-month period, respectively, of stock option
expense as a result of our implementation of Statement of Financial Accounting
Standards No. 123 (revised 2004), Share-Based Payment, at the beginning of 2006.
The operating loss of $1.2 million for the quarter and operating income of
$2.3 million for the six-month period included $1.9 million of restructuring
expenses primarily related to a cost reduction plan we implemented during the
current quarter.
The net loss of $3.3 million for the quarter was $7.9 million unfavorable
compared to the prior year period as a result of the lower operating results
discussed above. The net loss of $2.5 million for the six-month period was a
$6.0 million improvement over the prior year period as the lower operating
results previously discussed were more than offset by debt extinguishment
expense of $19.3 million in the prior year and a $1.4 million decrease in
interest expense in the current year.
Several of our businesses may 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
before programming amortization and online content expenses of each of our
Entertainment Group businesses.
Revenues from our domestic TV business decreased $4.0 million, or 16%, and
$6.9 million, or 14%, for the quarter and six-month period, respectively. Movie
network revenues decreased $2.0 million and $3.7 million for the quarter and
six-month period, respectively, primarily due to a decrease in pay-per-view, or
PPV, buys as a result of DirecTV, the satellite provider that currently
generates the largest portion of our domestic TV revenues, reducing our channel
carriage. A new contract with DirecTV is currently under negotiation, however,
we expect the loss of carriage will continue to unfavorably impact domestic TV
revenues and profitability. The decline was partially offset by adjustments to
previously estimated revenues during the current quarter. Playboy TV network
revenues decreased $1.8 million and $2.7 million for the quarter and six-month
period, respectively, as the prior year periods were favorably impacted by the
discontinuation of a distributor's high-definition subscription service
agreement, which resulted in the accelerated recognition of $1.4 million of
deferred revenues associated with the agreement. Cable revenues decreased $0.5
million and $1.5 million for the quarter and six-month period, respectively, due
to decreases in PPV buys for both periods. These decreases were partially offset
by increases in monthly subscription revenues for both periods. Revenues from
video-on-demand, or VOD, decreased $0.5 million and $0.9 million for the quarter
and six-month period, respectively, primarily due to a decrease in buys and
adjustments to previously estimated revenues. The decreases in Playboy TV and
movie network PPV buys were also impacted by consumers migrating from linear
channels to VOD. We continue to expect this trend to negatively impact our
networks as we have less shelf space in the VOD environment than in the linear
network environment. We also expect Playboy TV to be favorably impacted by the
launch of our monthly subscription service with an on-demand component. Revenues
associated with our studio facility increased $0.3 million and $0.4 million for
the quarter and six-month period, respectively, primarily due to the addition of
new clients. Direct-to-home, or DTH, revenues increased $0.3 million and $0.4
million for the quarter and six-month period, respectively, primarily due to
increased monthly
17
subscriptions.
Profit contribution from our domestic TV business decreased $6.1 million
and $10.8 million for the quarter and six-month period, respectively, as a
result of the lower revenues previously discussed combined with increased
expenses largely due to marketing, revenue sharing and staffing.
International revenues increased $1.3 million, or 11%, and $1.7 million,
or 7%, for the quarter and six-month period, respectively. International
television revenues increased $1.0 million for the quarter primarily due to
increased DTH and cable revenues from our U.K. networks combined with favorable
foreign currency exchange rate fluctuations. International television revenues
increased $1.9 million for the six-month period primarily as a result of
increased DTH and cable revenues from our U.K. networks, partially offset by
unfavorable foreign currency exchange rate fluctuations and lower revenues from
several third-party network licensees. International online and wireless
revenues increased $0.3 million for the quarter and decreased $0.2 million for
the six-month period. International profit contribution was flat for the quarter
and increased $0.4 million for the six-month period principally due to the
higher revenues previously discussed, offset by increased television network
distribution expenses, in part related to our additional networks, and increased
marketing expenses.
Online subscriptions and e-commerce revenues increased $0.6 million, or
6%, and $2.8 million, or 13%, for the quarter and six-month period,
respectively, primarily due to our acquisition of an affiliate network of
websites late in the third quarter of the prior year, partially offset by a
decrease in revenues from our existing sites. The prior year periods were also
favorably impacted by a $1.2 million payment we received due to the
discontinuation of a marketing alliance. Costs associated with the acquired
websites and increased investments in technology and marketing initiatives more
than offset the increases in revenues.
Revenues from other businesses increased $0.7 million, or 47%, and $1.7
million, or 74%, for the quarter and six-month period, respectively, primarily
due to advertising revenues from the acquired websites combined with revenues
from the current-year launch of Playboy Radio on SIRIUS Satellite Radio. Profit
contribution was flat and increased $0.6 million for the quarter and six-month
period, respectively, primarily due to the revenue increases previously
discussed. Both periods were impacted by costs associated with our acquired
websites as well as project development.
The group's administrative expenses decreased $1.7 million and $2.4
million for the quarter and six-month period, respectively. These decreases were
primarily due to the elimination of our intra-company agreements related to
trademark, content and administrative fees that had been paid by Playboy.com,
Inc., or Playboy.com, to us as a result of our October 2005 repurchase of the
remaining minority interest of Playboy.com, largely offset by increases in other
administrative expenses.
Programming amortization and online content expenses were flat for the
quarter and decreased $0.3 million for the six-month period primarily due to the
mix of television programming, partially offset by new programming costs
associated with Playboy Radio and the acquired websites. We now expect our
programming and online content cash investments to be approximately $43.0
million. Our original projection of $43.7 million excluded approximately $1.4
million of programming for Playboy Radio. We anticipate that our programming and
online content amortization expenses will improve slightly.
Segment income for the group decreased $4.9 million, or 51%, and $8.9
million, or 41%, for the quarter and six-month period, respectively, due to the
previously discussed operating results.
PUBLISHING GROUP
Playboy magazine revenues decreased $1.9 million, or 9%, and $5.6 million,
or 12%, for the quarter and six-month period, respectively. Advertising revenues
decreased $1.2 million and $3.5 million for the quarter and six-month period,
respectively, primarily due to 19% and 24% fewer advertising pages,
respectively. Advertising sales for the 2006 third quarter magazine issues are
closed, and we expect to report approximately 17% lower advertising revenues and
7% fewer advertising pages compared to the 2005 third quarter as a result of
continued softness in the market. Subscription revenues decreased $1.1 million
and $1.8 million for the quarter and six-month period, respectively, primarily
due to lower average revenue per copy, partially offset by revenues from our new
Playboy
18
magazine digital edition in the current year periods. For the six-month period,
subscription revenues were favorably impacted by a lower provision for unpaid
copies as a result of improved payment experience. Newsstand revenues increased
$0.4 million for the quarter primarily due to the impact of a $1.00 and C$1.00
cover price increase effective with the February 2006 issue and a favorable
variance related to prior issue adjustments, partially offset by 6% fewer copies
sold. For the six-month period, newsstand revenues were $0.3 million lower
primarily due to 18% fewer copies sold, partially mitigated by the previously
discussed cover price increase and a favorable variance related to prior issue
adjustments.
Revenues from special editions and other were flat and increased $0.4
million, or 9%, for the quarter and six-month period, respectively. Special
editions revenues increased $0.3 million and $0.5 million for the quarter and
six-month period, respectively, primarily due to the impact of a $1.00 and
C$1.00 cover price increase effective with the November 2005 issues, favorable
variances related to prior issue adjustments and higher revenues from our
special editions digital edition in the current year periods, partially offset
by 12% and 13% fewer newsstand copies sold for the quarter and six-month period,
respectively. The current year periods also included unfavorable revenue
adjustments related to prior years' calendars.
International publishing revenues were relatively flat for the quarter and
six-month period.
The group's segment loss decreased $0.5 million, or 26%, for the quarter
as the lower revenues previously discussed were more than offset by lower
editorial content, subscription acquisition amortization and manufacturing
expenses. The group's segment loss increased $1.4 million, or 48%, for the
six-month period primarily due to the lower revenues previously discussed,
partially offset by lower subscription acquisition amortization, editorial
content, manufacturing, advertising sales and marketing expenses.
Despite industry trends, our goal this year is to maintain a loss that is
consistent with that of the prior year.
LICENSING GROUP
Licensing Group revenues increased $0.8 million, or 8%, and $2.2 million,
or 15%, for the quarter and six-month period, respectively, principally due to
higher royalties from existing and new international licensees. The current
six-month period also reflects higher revenues from the sale of art from our
collection. The group's segment income was flat and increased $0.8 million, or
11%, for the quarter and six-month period, respectively, due to the revenue
increases previously discussed, offset by higher growth-related costs.
CORPORATE ADMINISTRATION AND PROMOTION
Corporate Administration and Promotion expenses increased $2.3 million, or
58%, and $4.5 million, or 55%, for the quarter and six-month period,
respectively, largely due to the elimination of our intra-company agreements
related to trademark, content and administrative fees as a result of the
previously discussed Playboy.com minority interest repurchase. The current year
periods also reflected higher marketing expenses.
RESTRUCTURING EXPENSES
In the current quarter, we implemented a cost reduction plan that reduces
our annual programming and editorial investments while lowering other
discretionary expenses. As a result of this 2006 restructuring plan, we reported
a charge of $2.1 million related to costs associated with a workforce reduction
of 15 employees. Partially offsetting this charge was a net favorable adjustment
of $0.2 million related to prior plans.
INCOME TAX EXPENSE
Our effective income tax rate differs from U.S. statutory rates. Our
income tax provision consists of foreign income tax, which relates to our
international networks and withholding tax on licensing income for which we do
not receive a current U.S. income tax benefit due to our net operating loss
position. Our income 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.
19
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2006, we had $25.6 million in cash and cash equivalents
compared to $26.1 million in cash and cash equivalents at December 31, 2005. We
also had $10.0 million of auction rate securities included in marketable
securities and short-term investments at June 30, 2006, compared to $21.0
million at December 31, 2005. The decrease is primarily related to our
acquisition of a multi-media adult entertainment business. Total financing
obligations were $115.0 million at both June 30, 2006 and December 31, 2005.
At June 30, 2006, cash generated from our operating activities, existing
cash and cash equivalents and marketable securities and short-term investments
were fulfilling our liquidity requirements. We also have a $50.0 million credit
facility, which can be used for revolving borrowings, issuing letters of credit
or a combination of both. At June 30, 2006, there were no borrowings and $10.6
million in letters of credit outstanding under this facility, resulting in $39.4
million of available borrowings under this facility.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $3.7 million, a decrease of
$11.7 million compared to the prior year period primarily due to the operating
results previously discussed.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash provided by investing activities increased $17.6 million compared
to the prior year period primarily due to a $33.8 million decrease in investment
purchases, partially offset by a $7.7 million decrease in proceeds from sales of
investments and payments of $7.8 million primarily related to the acquisition of
a multi-media adult entertainment business in the current year. This acquisition
requires additional payments of $1.6 million, $1.7 million, $2.3 million and
$4.3 million in 2007, 2008, 2009 and 2010, respectively.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash used for financing activities was $4.3 million in the current
year period compared to net cash provided by financing activities of $7.0
million in the prior year period. The current and prior year periods reflect
payments of acquisition liabilities of $4.5 million and $4.6 million,
respectively. The prior year period also reflects the issuance of $115.0 million
of 3.00% convertible senior subordinated notes due 2025, or convertible notes,
and the use of the proceeds to pay $95.2 million in connection with the purchase
and retirement of all of the $80.0 million outstanding principal amount of
11.00% senior secured notes issued by one of our subsidiaries and $4.0 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 $5.0 million.
20
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2006, the Financial Accounting Standards Board, or the FASB,
issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB Statement No. 109, or FIN 48. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in a company's financial
statements and prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. FIN 48 also provides guidance on
description, classification, interest and penalties, accounting in interim
periods, disclosure and transition. We are required to adopt FIN 48 effective at
the beginning of 2007. We are currently evaluating the impact of adopting FIN 48
on our future results of operations and financial condition.
In March 2006, the FASB issued Statement of Financial Accounting Standards
No. 156, Accounting for Servicing of Financial Assets, or Statement 156.
Statement 156 permits an entity to choose either the amortization method or fair
value method for each class of separately recognized servicing assets and
servicing liabilities. At June 30, 2006, we did not have any financial assets or
liabilities relating to servicing rights subject to Statement 156. We are
required to adopt Statement 156 effective at the beginning of 2007. We do not
expect the adoption of Statement 156 to have a significant impact on our future
results of operations or financial condition.
In February 2006, the FASB issued Statement of Financial Accounting
Standards No. 155, Accounting for Certain Hybrid Financial Instruments, or
Statement 155. Statement 155 resolves issues addressed in FASB Statement 133
Implementation Issue No. D1, Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets. Amongst other things, it permits fair
value remeasurement for any hybrid financial instrument that contains an
embedded derivative that otherwise would require bifurcation. At June 30, 2006,
we did not have any hybrid financial instruments subject to the fair value
election under Statement 155. We are required to adopt Statement 155 effective
at the beginning of 2007. We do not expect the adoption of Statement 155 to have
a significant impact on our future results of operations or financial condition.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At June 30, 2006, we did not have any floating interest rate exposure. All
of our outstanding debt at that date consisted of the 3.00% convertible senior
subordinated notes due 2025, or 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. At June 30, 2006,
the convertible notes had an implied fair value of $102.1 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.
22
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 vigorously pursued an appeal with the State
Appellate Court sitting in Corpus Christi challenging the verdict. We have
posted a bond in the amount of approximately $9.4 million, which represents the
amount of the judgment, costs and estimated pre- and post-judgment interest, in
connection with the appeal. On May 25, 2006, the State Appellate Court reversed
the judgment by the trial court, rendered judgment for us on the majority of the
plaintiffs' claims and remanded the remaining claims for a new trial. On July
14, 2006, the plaintiffs filed a motion for rehearing and en banc
reconsideration, which we are opposing. We, on advice of legal counsel, believe
that it is not probable that a material judgment against us will be obtained. In
accordance with Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies, no liability has been accrued.
ITEM 1A. RISK FACTORS
There have been no material changes to our Risk Factors as contained in
our Annual Report on Form 10-K for the year ended December 31, 2005.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of shareholders was held on May 17, 2006, in which the
holders of our Class A common stock ratified the appointment of Ernst & Young
LLP as our independent registered public accounting firm for 2006 and elected
the following individuals as directors:
Withheld
Proposals For Against or Abstained
- -------------------------------------------------------------------------------------------------------
Election of Directors
Dennis S. Bookshester 4,592,495 N/A 77,558
David I. Chemerow 4,569,646 N/A 100,407
Donald G. Drapkin 4,592,398 N/A 77,655
Christie Hefner 3,920,543 N/A 749,510
Jerome H. Kern 4,592,397 N/A 77,656
Russell I. Pillar 4,592,398 N/A 77,655
Sol Rosenthal 4,592,488 N/A 77,565
Richard S. Rosenzweig 3,920,660 N/A 749,393
Appointment of Ernst & Young LLP 4,599,746 70,074 233
- -------------------------------------------------------------------------------------------------------
23
ITEM 6. EXHIBITS
Exhibit Number Description
- -------------- -----------
10.1 Second Amendment to the Amended and Restated Credit Agreement,
effective April 1, 2005, or the Credit Agreement, among PEI Holdings,
Inc., as borrower, and Bank of America, N.A., as Agent and the other
lenders from time to time party thereto
10.1.1 Second Amendment, dated as of April 27, 2006, to the Credit
Agreement, or the Second Amendment
10.1.2 Reaffirmation of Guaranty, dated as of April 27, 2006, by each of
the Guarantors, pursuant to the Second Amendment
10.2 Third Amendment to the Credit Agreement
10.2.1 Third Amendment, dated as of May 15, 2006, to the Credit Agreement
10.2.2 Pledge Amendment, dated as of May 15, 2006, from Playboy
Enterprises International, Inc.
10.2.3 Pledge Amendment, dated as of May 15, 2006, from Playboy
Entertainment Group, Inc.
10.2.4 Joinder to Master Corporate Guaranty, dated as of May 15, 2006, by
Playboy.com, Inc., Playboy.com Internet Gaming, Inc., Playboy.com
Racing, Inc., SpiceTV.com, Inc., and CJI Holdings, Inc., and
accepted by Bank of America, N.A., as agent for the Lenders
10.2.5 Joinder to Security Agreement, dated as of May 15, 2006, by
Playboy.com, Inc., Playboy.com Internet Gaming, Inc., Playboy.com
Racing, Inc., SpiceTV.com, Inc., and CJI Holdings, Inc., and
accepted by Bank of America, N.A., as agent for the Lenders
10.2.6 Pledge Agreement, dated as of May 15, 2006, between Playboy.com,
Inc. and Bank of America, N.A., as agent for the Lenders
10.2.7 Pledge Agreement, dated as of May 15, 2006, between Playboy.com
Internet Gaming, Inc. and Bank of America, N.A., as agent for the
Lenders
10.2.8 Trademark Security Agreement, dated as of May 15, 2006, by
Playboy.com, Inc. in favor of Bank of America, N.A., as agent for
the Lenders
10.2.9 Copyright Security Agreement, dated as of May 15, 2006, by
Playboy.com, Inc. in favor of Bank of America, N.A., as agent for
the Lenders
10.3 Playboy Enterprises, Inc. Employee Stock Purchase Plan, as amended and
restated through April 25, 2006
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
24
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: August 9, 2006 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)
25
EXHIBIT INDEX
Exhibit Number Description
10.1 Second Amendment to the Amended and Restated Credit Agreement,
effective April 1, 2005, or the Credit Agreement, among PEI Holdings,
Inc., as borrower, and Bank of America, N.A., as Agent and the other
lenders from time to time party thereto
10.1.1 Second Amendment, dated as of April 27, 2006, to the Credit
Agreement, or the Second Amendment
10.1.2 Reaffirmation of Guaranty, dated as of April 27, 2006, by each of
the Guarantors, pursuant to the Second Amendment
10.2 Third Amendment to the Credit Agreement
10.2.1 Third Amendment, dated as of May 15, 2006, to the Credit Agreement
10.2.2 Pledge Amendment, dated as of May 15, 2006, from Playboy
Enterprises International, Inc.
10.2.3 Pledge Amendment, dated as of May 15, 2006, from Playboy
Entertainment Group, Inc.
10.2.4 Joinder to Master Corporate Guaranty, dated as of May 15, 2006, by
Playboy.com, Inc., Playboy.com Internet Gaming, Inc., Playboy.com
Racing, Inc., SpiceTV.com, Inc., and CJI Holdings, Inc., and
accepted by Bank of America, N.A., as agent for the Lenders
10.2.5 Joinder to Security Agreement, dated as of May 15, 2006, by
Playboy.com, Inc., Playboy.com Internet Gaming, Inc., Playboy.com
Racing, Inc., SpiceTV.com, Inc., and CJI Holdings, Inc., and
accepted by Bank of America, N.A., as agent for the Lenders
10.2.6 Pledge Agreement, dated as of May 15, 2006, between Playboy.com,
Inc. and Bank of America, N.A., as agent for the Lenders
10.2.7 Pledge Agreement, dated as of May 15, 2006, between Playboy.com
Internet Gaming, Inc. and Bank of America, N.A., as agent for the
Lenders
10.2.8 Trademark Security Agreement, dated as of May 15, 2006, by
Playboy.com, Inc. in favor of Bank of America, N.A., as agent for
the Lenders
10.2.9 Copyright Security Agreement, dated as of May 15, 2006, by
Playboy.com, Inc. in favor of Bank of America, N.A., as agent for
the Lenders
10.3 Playboy Enterprises, Inc. Employee Stock Purchase Plan, as amended and
restated through April 25, 2006
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
26