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PLA > SEC Filings for PLA > Form 10-K on 16-Mar-2007All Recent SEC Filings

Show all filings for PLAYBOY ENTERPRISES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for PLAYBOY ENTERPRISES INC


16-Mar-2007

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Since our inception in 1953 as the publisher of Playboy magazine, we have become a brand-driven, international multimedia entertainment company. Today, our businesses are classified into three reportable segments: Entertainment, Publishing and Licensing.

The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our results of operations and financial condition. The discussion should be read in conjunction with the financial statements and the accompanying notes.

REVENUES

We currently generate most of our Entertainment Group revenues from pay-per-view, or PPV, fees for our television programming offerings, including Playboy- and Spice-branded domestic and international television programming. Our television revenues are affected by factors including shelf space, retail price and marketing, which are controlled by the distributors, as well as the revenue splits we negotiate with distributors and the demand for our programming. We believe television revenues will increasingly be generated from video-on-demand, or VOD, and subscription video-on-demand, or SVOD, purchases by consumers. Internationally, we own and operate or license Playboy-, Spice- and locally-branded television networks or blocks of programming and we have equity interests in additional networks through joint ventures. In the Internet space, we also receive licensing fees from Playboy- and other-branded websites and from content delivered via wireless devices to providers outside of the United States. We derive subscription revenues from multiple online clubs, which offer unique content under various brands, including Playboy and Spice. E-commerce revenues include the sale of our branded and third-party consumer products, both online and through direct mail. In addition, we monetize online traffic via advertising in conjunction with our magazine ad sales efforts. Entertainment Group revenues are also generated from the sale of DVDs and from license fees for Playboy Radio on SIRIUS Satellite Radio.

Publishing Group revenues are primarily circulation driven for Playboy magazine and special editions and include both subscription and newsstand sales. Additionally, the group generates revenues from advertising sales in Playboy magazine as well as from circulation and advertising royalties from our licensed international editions.

Licensing Group revenues are principally generated from royalties on the wholesale sale of our branded products around the world, as well as from location-based entertainment. We also generate revenues from periodic auction sales of small portions of our art and memorabilia collection and from marketing events such as the annual Playboy Jazz Festival.

COSTS AND OPERATING EXPENSES

Entertainment Group expenses include television programming amortization, online content, network distribution, hosting, sales and marketing and administrative expenses. Programming amortization and content expenses are expenditures associated with the creation of Playboy programming, the licensing of third-party programming for our adult movie business and the creation of content for our websites and wireless and satellite radio providers.

Publishing Group expenses include manufacturing, subscription promotion, editorial, shipping and administrative expenses. Manufacturing, which includes the production of the magazine, represents the largest cost for the group.

Licensing Group expenses include agency fees, promotion, development and administrative expenses.

Corporate Administration and Promotion expenses include general corporate costs such as technology, legal, security, human resources, finance and investor relations and communications, as well as expenses related to company-wide marketing, promotions and the Playboy Mansion.

RESULTS OF OPERATIONS (1)

The following table sets forth our results of operations (in millions, except per share amounts):

                                                                 Fiscal Year   Fiscal Year   Fiscal Year
                                                                       Ended         Ended         Ended
                                                                    12/31/06      12/31/05      12/31/04
---------------------------------------------------------------------------------------------------------
Net revenues
Entertainment
   Domestic TV                                                   $      82.5   $      98.6   $      96.9
   International                                                        55.7          52.1          45.3
   Online subscriptions and e-commerce                                  52.1          46.9          40.2
   Other                                                                10.7           6.4           6.9
---------------------------------------------------------------------------------------------------------
   Total Entertainment                                                 201.0         204.0         189.3
---------------------------------------------------------------------------------------------------------
Publishing
   Playboy magazine                                                     80.7          89.4         101.5
   Special editions and other                                            9.8          10.5          11.9
   International publishing                                              6.6           6.6           6.4
---------------------------------------------------------------------------------------------------------
   Total Publishing                                                     97.1         106.5         119.8
---------------------------------------------------------------------------------------------------------
Licensing
   International licensing                                              22.8          19.0          12.4
   Domestic licensing                                                    5.4           5.2           4.9
   Marketing events                                                      3.0           3.0           2.8
   Other                                                                 1.8           0.5           0.2
---------------------------------------------------------------------------------------------------------
   Total Licensing                                                      33.0          27.7          20.3
---------------------------------------------------------------------------------------------------------
Total net revenues                                               $     331.1   $     338.2   $     329.4
=========================================================================================================

Net income (loss)
Entertainment
   Before programming amortization and online content expenses   $      65.1   $      81.2   $      77.0
   Programming amortization and online content expenses                (41.8)        (40.1)        (44.0)
---------------------------------------------------------------------------------------------------------
   Total Entertainment                                                  23.3          41.1          33.0
---------------------------------------------------------------------------------------------------------
Publishing                                                              (5.4)         (6.5)          6.2
---------------------------------------------------------------------------------------------------------
Licensing                                                               18.9          16.0          10.6
---------------------------------------------------------------------------------------------------------
Corporate Administration and Promotion                                 (25.7)        (19.6)        (18.2)
---------------------------------------------------------------------------------------------------------
Segment income                                                          11.1          31.0          31.6
Restructuring expenses                                                  (2.0)         (0.1)         (0.7)
---------------------------------------------------------------------------------------------------------
Operating income                                                         9.1          30.9          30.9
---------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
   Investment income                                                     2.4           2.2           0.6
   Interest expense                                                     (5.6)         (7.0)        (13.7)
   Amortization of deferred financing fees                              (0.5)         (0.6)         (1.3)
   Minority interest                                                      --          (1.6)         (1.4)
   Debt extinguishment expenses                                           --         (19.3)         (5.9)
   Insurance settlement                                                   --            --           5.6
   Other, net                                                           (0.6)         (1.3)         (1.0)
---------------------------------------------------------------------------------------------------------
Total nonoperating expense                                              (4.3)        (27.6)        (17.1)
---------------------------------------------------------------------------------------------------------
Income before income taxes                                               4.8           3.3          13.8
Income tax expense                                                      (2.5)         (4.0)         (3.8)
---------------------------------------------------------------------------------------------------------
Net income (loss)                                                $       2.3   $      (0.7)  $      10.0
=========================================================================================================

Net income (loss)                                                $       2.3   $      (0.7)  $      10.0
---------------------------------------------------------------------------------------------------------
Dividend requirements of preferred stock                                  --            --          (0.4)
---------------------------------------------------------------------------------------------------------
Income (loss) applicable to common shareholders                  $       2.3   $      (0.7)  $       9.6
=========================================================================================================

Basic and diluted earnings (loss) per common share               $      0.07   $     (0.02)  $      0.30
=========================================================================================================

(1) Certain amounts reported for prior periods have been reclassified to conform to the current year's presentation.

2006 COMPARED TO 2005

Our revenues decreased $7.1 million, or 2%, compared to the prior year due to a continued decrease in revenues from our Publishing Group combined with lower revenues from our Entertainment Group, partially offset by higher revenues from our Licensing Group.

Segment income decreased $19.9 million, or 64%, compared to the prior year due to significantly lower results from our Entertainment Group combined with higher Corporate Administration and Promotion expenses, partially offset by improved results from our Licensing and Publishing Groups.

Operating income of $9.1 million for the current year included $2.0 million of restructuring expenses primarily related to a cost reduction plan implemented during the year.

Net income of $2.3 million improved $3.0 million over the prior year as the lower operating results previously discussed were more than offset by debt extinguishment and minority interest expenses of $19.3 million and $1.6 million, respectively, in the prior year and decreases of $1.5 million and $1.4 million in income tax and interest expenses, respectively, in the current year.

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 networks decreased $16.1 million, or 16%, in 2006.

Playboy TV network revenues decreased $6.0 million in 2006 with cable revenues decreasing $3.0 million and direct-to-home, or DTH, revenues decreasing $1.2 million. These decreases were largely due to the continued impact of a consumer shift from PPV to VOD purchasing.

Movie business revenues decreased $12.2 million in 2006 primarily due to the decline of PPV as a result of less overall carriage of adult linear networks and less shelf space in VOD compared to linear PPV. We expect these trends to continue to negatively impact our movie networks. The loss of two channels to a competitor on the largest satellite TV provider also contributed to the lower movie revenues. We expect the loss of carriage and the impact of less shelf space to unfavorably impact movie business revenues and profitability through 2007. Additionally, 2007 will also include an increase in expense of approximately $1.3 million related to a change in the estimated useful lives of certain distribution agreements.

The prior year was 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.

Revenues from VOD increased $0.9 million in 2006.

Revenues associated with our studio facility increased $1.2 million in 2006 primarily due to the addition of new third-party networks.

Profit contribution from our domestic TV networks decreased $22.4 million as a result of the lower revenues previously discussed combined with a $1.8 million legal settlement in the fourth quarter of the current year and increased expenses primarily related to marketing and staffing. See Part I. Item 3. "Legal Proceedings" for additional information.

International revenues increased $3.6 million, or 7%, in 2006. International television revenues increased $2.7 million in 2006 primarily due to increased DTH and cable revenues from our U.K. television business combined with favorable foreign currency exchange rates, partially offset by lower revenues from several third-party licensees. International online and wireless revenues increased $0.9 million due to higher royalties combined with revenues from our acquisition of Club Jenna, Inc. and related companies, or Club Jenna, a multimedia adult entertainment

business, in the current year. International profit contribution was flat as a result of the higher revenues previously discussed, offset mostly by higher international distribution and staffing expenses.

Online subscriptions and e-commerce revenues increased $5.2 million, or 11%, in 2006. Positive results from our acquisitions of an affiliate network of websites late in the prior year and Club Jenna in the current year were partially offset by the impacts of a termination payment we received in the prior year related to the discontinuation of a marketing alliance and the licensing of our Spice Catalog in the current year. Online subscriptions and e-commerce profit contribution decreased $0.2 million, or 1%, as the revenue increases previously discussed were more than offset by costs associated with the acquired businesses and higher marketing expenses. We expect our online subscription business to continue its year-over-year growth in 2007 as broadband penetration increases and as we continue to expand our product offerings, particularly in video.

Revenues from other businesses increased $4.3 million, or 69%, in 2006, driven by worldwide DVD sales and advertising revenues from the acquired businesses combined with revenues resulting from the current-year launch of Playboy Radio on SIRIUS Satellite Radio. Profit contribution increased $1.5 million, or 100%, in 2006 due to the revenue increases previously discussed, partially offset by higher costs largely related to the acquired businesses.

The group's administrative expenses decreased $5.0 million, or 20%, in 2006 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, partially offset by higher staffing-related expenses, in large part associated with the acquired businesses.

Programming amortization and online content expenses increased $1.7 million, or 4%, in 2006, primarily due to new programming costs to support our acquired businesses and Playboy Radio, partially offset by a change in the mix of television programming.

Segment income for the group decreased $17.8 million, or 43%, in 2006 compared to 2005 due to the previously discussed operating results.

Publishing Group

Playboy magazine revenues decreased $8.7 million, or 10%, in 2006. Advertising revenues decreased $4.0 million due to 10% fewer advertising pages coupled with a 4% decrease in average net revenue per page. Advertising sales for the 2007 first quarter magazine issues are closed, and we expect to report approximately 22% higher advertising revenues and a 15% increase in advertising pages compared to the 2006 first quarter. Subscription revenues also decreased $4.0 million primarily due to lower average revenue per copy combined with fewer copies served. Newsstand revenues decreased $0.7 million primarily due to 15% fewer copies sold in the current year. This decrease was partially mitigated by the impact of a $1.00 cover price increase effective with the February 2006 issue.

Revenues from special editions and other decreased $0.7 million, or 7%, in 2006. Special editions revenues decreased $0.5 million primarily due to 15% fewer newsstand copies sold in the current year, partially offset by the impact of a $1.00 cover price increase effective with the November 2005 issues and by a favorable variance related to prior issues.

International publishing revenues were flat for the year.

The group's segment loss improved $1.1 million, or 17%, as lower subscription acquisition amortization, editorial content, manufacturing, advertising sales, marketing and administration expenses were partially offset by the lower revenues previously discussed and by higher operating expenses related to international publishing in the current year.

We believe that the Publishing Group's 2007 segment profitability will be consistent with the financial performance of the last two years.

Licensing Group

Licensing Group revenues increased $5.3 million, or 19%, in 2006 primarily due to higher international royalties, principally from Europe, and royalties from our new location-based entertainment venue at the Palms Casino Resort in Las Vegas, which opened in the fourth quarter of the current year. The group's segment income increased $2.9 million, or 19%, due to the increased revenues previously discussed, partially offset by higher growth-related costs. We expect that in 2007 the Licensing Group will report 15-20% increases versus 2006 in revenues and segment income.

Corporate Administration and Promotion

Corporate Administration and Promotion expenses increased $6.1 million, or 31%, in 2006 primarily due to the elimination of our intra-company agreements related to trademark, content and administrative fees as a result of the Playboy.com minority interest repurchase previously discussed and higher promotional spending. In 2007, Corporate Administration and Promotion expenses will include an increase of approximately $2.0 million related to expensing certain trademark costs that we previously capitalized.

Restructuring Expenses

In 2006, we implemented a cost reduction plan that will result in lower overhead costs and annual programming and editorial expenses. As a result of the 2006 restructuring plan, we reported a charge of $2.1 million related to costs associated with a workforce reduction of 15 employees. In addition, we recorded a favorable adjustment of $0.2 million and an unfavorable adjustment of $0.1 million related to the 2002 and 2001 restructuring plans, respectively, as a result of changes in plan assumptions primarily related to excess office space. During the year, we made cash payments of $1.7 million, $0.2 million and $26 thousand related to our 2006, 2002 and 2001 restructuring plans, respectively. Of the total costs related to our restructuring plans, approximately $11.9 million was paid by December 31, 2006, with the remaining $0.7 million to be paid through 2008.

In 2005, we recorded an additional charge of $0.1 million related to the 2002 restructuring plan as a result of changes in plan assumptions primarily related to excess office space. There were no additional charges related to the 2001 restructuring plan.

In 2004, we recorded a restructuring charge of $0.5 million related 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.

Nonoperating Income (Expense)

Nonoperating expense decreased $23.3 million, or 84%, in 2006. The prior year included $19.3 million of debt extinguishment expense related to a debt refinancing and $1.6 million of minority interest expense related to the previously discussed repurchase of the remaining minority interest in Playboy.com. The current year reflects a decrease in interest expense of $1.4 million, which is also a result of our 2005 debt refinancing.

Income Tax Expense

Our effective income tax rate differs from the U.S. statutory rate primarily as a result of foreign income and withholding tax, for which no current U.S. income tax benefit is recognized, and the deferred tax treatment of certain indefinite-lived intangibles.

In 2006, we modified the assumptions related to the useful lives of certain distribution agreements that previously were classified as indefinite-lived. As these distribution agreements are now being amortized, the deferred tax liability related to the distribution agreements that is expected to be realized within the net operating loss, or NOL, carryforward period may be netted against our deferred tax asset. In 2006, we recorded an income tax benefit for $2.6 million of the $3.9 million deferred tax liability related to the distribution agreement modification. In 2005, our effective income tax rate differed from the U.S. statutory rate primarily as a result of the reduction in

the valuation allowance corresponding to the utilization of our NOL carryforwards. The benefit of our NOL carryforwards was partially offset by foreign income and withholding tax, for which no current U.S. income tax benefit is recognized, and the deferred tax treatment of certain indefinite-lived intangibles.

2005 COMPARED TO 2004

Our revenues increased $8.8 million, or 3%, compared to 2004 due to higher revenues from our Entertainment and Licensing Groups, partially offset by expected lower revenues from our Publishing Group.

Operating income of $30.9 million was flat for 2005, reflecting improved results from our Entertainment and Licensing Groups, offset by significantly lower results from our Publishing Group and higher Corporate Administration and Promotion expenses.

The net loss of $0.7 million for 2005 included $19.3 million of debt extinguishment expense. A decrease in interest expense related to our first quarter debt refinancing favorably impacted 2005. In 2004, we recorded $5.9 million of debt extinguishment expense and received a $5.6 million insurance recovery partially related to a charge recorded in 2004 for a litigation settlement with Logix Development Corporation, or Logix.

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 networks increased $1.7 million, or 2%, in 2005. DTH revenues increased $2.9 million primarily due to subscriber growth and an increase in average PPV buys. The revenue increases were partially offset by decreased Playboy TV cable PPV buys, as certain cable companies continue migrating consumers from linear channels to VOD. As a result of this transition to VOD, revenues from Playboy TV cable decreased $2.0 million in 2005. Movie business revenues decreased $3.7 million primarily as a result of decreased PPV buys stemming from the transition to VOD. Total VOD revenues increased $2.8 million in 2005 due to the continued roll out of VOD service in additional cable systems as well as to a growing number of consumer buys in existing cable systems. Revenues associated with renting our studio facility and providing various related services to third parties increased $0.8 million in 2005. Domestic TV network revenues were favorably impacted by 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. In 2004, movie business revenues were impacted by a $1.5 million unfavorable adjustment from an unanticipated retroactive rate reduction related to the earlier acquisition of one large multiple system operator by another. Profit contribution from domestic TV networks decreased $0.2 million for 2005. A $1.3 million adjustment for a contractual obligation related to licensed programming combined with higher overhead costs related to the operation of our production facility more than offset the revenue increases described above.

International revenues increased $6.8 million, or 15%, in 2005. International television revenues increased $4.7 million in 2005 primarily due to increased revenues from several third-party licensees and new networks in operation for a full year in Australia and Germany. Additionally, the launch of three DTH channels in the U.K. contributed favorably to 2005 revenues. International online and wireless revenues increased $2.1 million, or 67%, due to increased royalties from existing wireless partners and new license agreements. Profit contribution from our international entertainment businesses increased $3.7 million in 2005 due to the higher revenues previously discussed, partially offset by increased marketing and operating costs related to the newly launched channels.

Online subscriptions and e-commerce revenues increased $6.7 million, or 17%, in 2005. Online subscription revenues increased $4.6 million in 2005 primarily due to the acquisition of an affiliate network of websites late in the year. E-commerce revenues increased $2.1 million in 2005 as a result of a $1.2 million payment we received related to the termination of a marketing alliance combined with increased catalog and business-to-business revenues. Profit contribution was flat for 2005 as the revenue increases discussed above were mostly offset by higher online subscription expenses primarily due to increased technology and marketing initiatives and expenses related to our newly acquired affiliate network of websites. Also offsetting were higher e-commerce expenses primarily due to catalog production, marketing, product and fulfillment expenses.

Profit contribution from other businesses decreased $0.1 million in 2005. . . .

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