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, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 001-14790
Playboy Enterprises, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-4249478
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
680 North Lake Shore Drive, Chicago, IL 60611
(Address of principal executive offices) (Zip Code)
(312) 751-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes |X| No |_|
At July 31, 2005, there were 4,864,102 shares of Class A common stock, par
value $0.01 per share, and 28,229,950 shares of Class B common stock, par value
$0.01 per share, outstanding.
PLAYBOY ENTERPRISES, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Condensed Consolidated Statements of Operations and
Comprehensive Income (Loss) for the Quarters Ended June 30,
2005 and 2004 (Unaudited) 3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for the Six Months Ended June 30,
2005 and 2004 (Unaudited) 4
Condensed Consolidated Balance Sheets at June 30,
2005 (Unaudited) and December 31, 2004 5
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2005 and 2004 (Unaudited) 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Item 4. Controls and Procedures 20
PART II
OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 6. Exhibits 22
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
for the Quarters Ended June 30 (Unaudited)
(In thousands, except per share amounts)
2005 2004
-----------------------------------------------------------------------------------
Net revenues $ 82,871 $ 78,717
-----------------------------------------------------------------------------------
Costs and expenses
Cost of sales (62,055) (61,444)
Selling and administrative expenses (13,521) (14,112)
-----------------------------------------------------------------------------------
Total costs and expenses (75,576) (75,556)
-----------------------------------------------------------------------------------
Gain on disposal 14 2
-----------------------------------------------------------------------------------
Operating income 7,309 3,163
-----------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 595 133
Interest expense (1,412) (3,651)
Amortization of deferred financing fees (133) (357)
Minority interest (370) (351)
Debt extinguishment expenses -- (5,908)
Other, net (324) (238)
-----------------------------------------------------------------------------------
Total nonoperating expense (1,644) (10,372)
-----------------------------------------------------------------------------------
Income (loss) before income taxes 5,665 (7,209)
Income tax expense (1,025) (1,082)
-----------------------------------------------------------------------------------
Net income (loss) 4,640 (8,291)
-----------------------------------------------------------------------------------
Other comprehensive (loss) income
Unrealized loss on marketable securities (46) (25)
Unrealized gain on derivatives 46 65
Foreign currency translation adjustments (84) 112
-----------------------------------------------------------------------------------
Total other comprehensive (loss) income (84) 152
-----------------------------------------------------------------------------------
Comprehensive income (loss) $ 4,556 $ (8,139)
===================================================================================
Net income (loss) $ 4,640 $ (8,291)
Dividend requirements of preferred stock -- (93)
-----------------------------------------------------------------------------------
Net income (loss) applicable to common shareholders $ 4,640 $ (8,384)
===================================================================================
Weighted average number of common shares outstanding
Basic 33,080 32,098
===================================================================================
Diluted 33,265 32,098
===================================================================================
Basic and diluted earnings (loss) per common share $ 0.14 $ (0.26)
===================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
3
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
for the Six Months Ended June 30 (Unaudited)
(In thousands, except per share amounts)
2005 2004
-----------------------------------------------------------------------------------
Net revenues $ 166,322 $ 159,587
-----------------------------------------------------------------------------------
Costs and expenses
Cost of sales (121,331) (120,428)
Selling and administrative expenses (26,788) (28,546)
-----------------------------------------------------------------------------------
Total costs and expenses (148,119) (148,974)
-----------------------------------------------------------------------------------
Gain on disposal 14 2
-----------------------------------------------------------------------------------
Operating income 18,217 10,615
-----------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 782 223
Interest expense (4,060) (7,809)
Amortization of deferred financing fees (366) (732)
Minority interest (740) (702)
Debt extinguishment expenses (19,280) (5,908)
Other, net (800) (697)
-----------------------------------------------------------------------------------
Total nonoperating expense (24,464) (15,625)
-----------------------------------------------------------------------------------
Loss before income taxes (6,247) (5,010)
Income tax expense (2,232) (1,393)
-----------------------------------------------------------------------------------
Net loss (8,479) (6,403)
-----------------------------------------------------------------------------------
Other comprehensive income (loss)
Unrealized (loss) gain on marketable securities (71) 107
Unrealized gain on derivatives 257 37
Foreign currency translation adjustments 192 (308)
-----------------------------------------------------------------------------------
Total other comprehensive income (loss) 378 (164)
-----------------------------------------------------------------------------------
Comprehensive loss $ (8,101) $ (6,567)
===================================================================================
Net loss $ (8,479) $ (6,403)
Dividend requirements of preferred stock -- (428)
-----------------------------------------------------------------------------------
Net loss applicable to common shareholders $ (8,479) $ (6,831)
===================================================================================
Basic and diluted weighted average number
of common shares outstanding 33,216 29,788
===================================================================================
Basic and diluted loss per common share $ (0.26) $ (0.23)
===================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
4
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
June 30, Dec. 31,
2005 2004
----------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 31,461 $ 26,668
Marketable securities and short-term investments 39,388 24,052
Receivables, net of allowance for doubtful accounts of
$3,595 and $3,897, respectively 39,064 45,084
Receivables from related parties 1,857 1,281
Inventories, net 13,118 12,437
Deferred subscription acquisition costs 11,527 13,104
Other current assets 9,773 8,596
----------------------------------------------------------------------------------------------------
Total current assets 146,188 131,222
----------------------------------------------------------------------------------------------------
Property and equipment, net 12,010 11,491
Long-term receivables 2,495 2,755
Programming costs, net 53,390 55,997
Goodwill 111,893 111,893
Trademarks 57,706 57,296
Distribution agreements, net of accumulated amortization
of $2,398 and $1,935, respectively 30,743 31,206
Other noncurrent assets 18,600 18,721
----------------------------------------------------------------------------------------------------
Total assets $ 433,025 $ 420,581
====================================================================================================
Liabilities
Acquisition liabilities $ 11,156 $ 10,184
Accounts payable 21,900 21,796
Accrued salaries, wages and employee benefits 8,159 8,286
Deferred revenues 49,048 51,421
Accrued litigation settlement 1,000 1,000
Other liabilities and accrued expenses 15,056 18,040
----------------------------------------------------------------------------------------------------
Total current liabilities 106,319 110,727
----------------------------------------------------------------------------------------------------
Financing obligations 115,000 80,000
Acquisition liabilities 13,084 19,085
Net deferred tax liabilities 16,253 15,023
Accrued litigation settlement -- 1,000
Other noncurrent liabilities 12,873 13,779
----------------------------------------------------------------------------------------------------
Total liabilities 263,529 239,614
----------------------------------------------------------------------------------------------------
Minority interest 13,257 12,517
Shareholders' equity
Common stock, $0.01 par value
Class A voting - 7,500,000 shares authorized; 4,864,102 issued 49 49
Class B nonvoting - 75,000,000 shares authorized; 28,609,057
and 28,521,493 issued, respectively 286 285
Capital in excess of par value 223,174 222,285
Accumulated deficit (61,428) (52,949)
Treasury stock, at cost, 381,971 and 0 shares, respectively (5,000) --
Accumulated other comprehensive loss (842) (1,220)
----------------------------------------------------------------------------------------------------
Total shareholders' equity 156,239 168,450
----------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 433,025 $ 420,581
====================================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
5
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Six Months Ended June 30 (Unaudited)
(In thousands)
2005 2004
--------------------------------------------------------------------------------------------
Cash flows from operating activities
Net loss $ (8,479) $ (6,403)
Adjustments to reconcile net loss to net cash provided by
(used for) operating activities:
Depreciation of property and equipment 1,542 1,624
Amortization of intangible assets 868 1,264
Amortization of investments in entertainment programming 18,968 21,504
Amortization of deferred financing fees 366 732
Debt extinguishment expenses 19,280 5,908
Deferred income taxes 498 40
Net change in operating assets and liabilities (207) (412)
Investments in entertainment programming (15,984) (23,121)
Litigation settlement (1,875) (6,500)
Other, net 437 923
--------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities 15,414 (4,441)
--------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchases of investments (34,107) --
Proceeds from sale of investments 18,700 --
Additions to property and equipment (2,164) (1,450)
Proceeds from disposals -- 150
Other, net -- 201
--------------------------------------------------------------------------------------------
Net cash used for investing activities (17,571) (1,099)
--------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from financing obligations 115,000 --
Repayment of financing obligations (80,000) (35,000)
Proceeds from public equity offering -- 51,858
Payment of debt extinguishment expenses (15,197) (3,850)
Payment of acquisition liabilities (4,558) (7,801)
Purchase of treasury stock (5,000) --
Payment of deferred financing fees (4,040) --
Payment of preferred stock dividends -- (651)
Proceeds from stock plans 784 385
Other (39) --
--------------------------------------------------------------------------------------------
Net cash provided by financing activities 6,950 4,941
--------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 4,793 (599)
Cash and cash equivalents at beginning of period 26,668 31,332
--------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 31,461 $ 30,733
============================================================================================
The accompanying Notes to Condensed Consolidated Financial Statements are an
integral part of these statements.
6
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(A) BASIS OF PREPARATION
The financial information included in these financial statements is
unaudited but, in the opinion of management, reflects all normal recurring and
other adjustments necessary for a fair presentation of the results for the
interim periods. The interim results of operations and cash flows are not
necessarily indicative of those results and cash flows for the entire year.
These financial statements should be read in conjunction with the financial
statements and notes to the financial statements contained in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2004. Certain amounts
reported for prior periods have been reclassified to conform to the current
year's presentation.
(B) RESTRUCTURING EXPENSES
During the six-month period ended June 30, 2005, we made cash payments of
$0.6 million related to our various restructuring plans. Approximately $9.6
million of the total restructuring charges was paid by June 30, 2005, with most
of the remainder related to the consolidation of our facilities to be paid in
the current year and some payments continuing through 2007.
In 2004, we recorded a restructuring charge of $0.5 million relating to
the realignment of our entertainment and online businesses. In addition,
primarily due to excess office space, we recorded additional charges of $0.4
million related to the 2002 restructuring plan and reversed $0.2 million related
to the 2001 restructuring plan as a result of changes in plan assumptions.
Our 2002 restructuring initiative to reduce ongoing operating expenses
resulted in a $5.7 million charge, of which $2.9 million related to the
termination of employees and $2.8 million related to consolidation of our office
space in Los Angeles and Chicago. Our 2001 restructuring plan resulted in a $4.6
million charge, of which $2.6 million related to the termination of employees
and $2.0 million related to excess space in our Chicago and New York offices.
The following table displays the activity and balances of the restructuring
reserve for the year ended December 31, 2004 and the six months ended June 30,
2005 (in thousands):
Consolidation
Workforce of Facilities and
Reduction Operations Total
-------------------------------------------------------------------------------
Balance at December 31, 2003 $ 630 $ 2,563 $ 3,193
Additional reserve recorded 466 -- 466
Adjustment to previous estimate - 278 278
Cash payments (917) (1,014) (1,931)
-------------------------------------------------------------------------------
Balance at December 31, 2004 179 1,827 2,006
Cash payments (179) (380) (559)
-------------------------------------------------------------------------------
Balance at June 30, 2005 $ -- $ 1,447 $ 1,447
===============================================================================
7
(C) EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share, or EPS (in thousands, except per share amounts):
(Unaudited)
Quarters Ended
June 30,
-----------------------
2005 2004
--------------------------------------------------------------------------------------
Numerator:
For basic EPS - net income (loss) $ 4,640 $ (8,384)
Preferred stock dividends -- 93
--------------------------------------------------------------------------------------
For diluted EPS - net income (loss) $ 4,640 $ (8,291)
=====================================================================================
Denominator:
For basic EPS - weighted-average shares 33,080 32,098
Effect of dilutive potential common shares:
Employee stock options and other 185 --
--------------------------------------------------------------------------------------
Dilutive potential common shares 185 --
--------------------------------------------------------------------------------------
For diluted EPS - weighted-average shares 33,265 32,098
======================================================================================
Basic and diluted earnings (loss) per common share $ 0.14 $ (0.26)
======================================================================================
The reconciliations of basic and diluted EPS for the six-month periods
ending June 30, 2005 and 2004 were excluded as both periods were in a net loss
position, and therefore, potential common shares would have been antidilutive.
The following table represents the approximate number of shares related to
options to purchase our Class B common stock, or Class B stock, that were
outstanding which were not included in the computation of diluted EPS as the
inclusion of these shares would have been antidilutive (in thousands):
Quarters Ended Six Months Ended
June 30, June 30,
------------------ -------------------
2005 2004 2005 2004
--------------------------------------------------------------------------------------
Stock options 1,982 3,324 2,864 2,323
--------------------------------------------------------------------------------------
Total 1,982 3,324 2,864 2,323
======================================================================================
In addition, in accordance with Emerging Issues Task Force Issue 04-8,
"The Effect of Contingently Convertible Debt on Diluted Earnings per Share", the
shares used in the calculation of diluted EPS also exclude the potential shares
of Class B stock contingently issuable under our 3.00% convertible senior
secured notes because they are antidilutive. See Footnote (I), Debt Refinancing,
for additional information.
On April 26, 2004, we completed a public offering of 6,021,340 shares of
our Class B stock at $12.69 per share, before underwriting discounts. Included
in this offering were 4,385,392 shares sold by Playboy Enterprises, Inc., or
Playboy, 1,485,948 shares sold by Hugh M. Hefner, our Founder and
Editor-in-Chief, and 150,000 shares sold by Christie Hefner, our Chairman and
Chief Executive Officer. Playboy's shares included 3,600,000 initial shares, and
an additional 785,392 shares due to the underwriters' exercise of their
over-allotment option. The shares sold by Mr. Hefner consisted of all the shares
of Class B stock he received upon conversion, at the time of the offering, of
all of the outstanding shares of Playboy Preferred Stock. Mr. Hefner and Ms.
Hefner paid for expenses related to this transaction proportionate to the number
of shares each sold to the total number of shares sold in the offering.
8
(D) INVENTORIES, NET
Inventories, net of reserves, which are stated at the lower of cost (specific
cost and average cost) or fair value, consisted of the following (in thousands):
(Unaudited)
June 30, Dec. 31,
2005 2004
--------------------------------------------------------------------------------
Paper $ 3,849 $ 2,573
Editorial and other prepublication costs 6,835 7,814
Merchandise finished goods 2,434 2,050
--------------------------------------------------------------------------------
Total inventories, net $ 13,118 $ 12,437
================================================================================
(E) INCOME TAXES
Our income tax provision consists of foreign income tax related to our
international networks and withholding tax on licensing income for which we do
not receive a current U.S. income tax benefit. The tax provision also includes
deferred federal and state income tax 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.
(F) CONTINGENCIES
In the fourth quarter of 2003, we recorded $8.5 million related to the
settlement of the Logix litigation, which related to events prior to our 1999
acquisition of Spice Entertainment Companies, Inc., or Spice. We made a payment
of $6.5 million in February 2004 and a payment of $1.0 million in January 2005
and will make the remaining payment of $1.0 million in 2006.
In 2002, a $4.4 million verdict was entered against us by a state trial
court in Texas in a lawsuit with a former publishing licensee. We terminated the
license in 1998 due to the licensee's failure to pay royalties and other amounts
due to us under the license agreement. We have posted a bond in the amount of
$8.5 million, which represents the amount of the judgment, costs and estimated
pre- and post-judgment interest. We, on advice of legal counsel, believe that it
is not probable that a material judgment against us will be sustained and have
not recorded a liability for this case in accordance with Statement 5,
Accounting for Contingencies. We are currently pursuing an appeal.
(G) STOCK-BASED COMPENSATION
We account for stock options as prescribed by Accounting Principles Board
Opinion, or APB, No. 25, Accounting for Stock Issued to Employees, and disclose
pro forma information as provided by Statement 123, as amended by Statement 148,
Accounting for Stock Based Compensation. In December 2004, the Financial
Accounting Standards Board (the "FASB") issued Statement 123 (revised 2004),
Share-Based Payment ("Statement 123(R)"), which supersedes APB No. 25, and
amends Statement No. 95, Statement of Cash Flows. The implementation of
Statement 123(R) has since been delayed and will be effective for the first
fiscal year beginning after December 15, 2005. We are required to adopt
Statement 123(R) on January 1, 2006 and will utilize the modified prospective
method. We are currently conducting an analysis of the impact on our financial
statements.
9
Pro forma net income (loss) and net income (loss) per common share,
presented below (in thousands, except per share amounts), were determined as if
we had accounted for our stock options under the fair value method of Statement
123. The fair value of these options was estimated at the date of grant using an
option pricing model. Such models require the input of highly subjective
assumptions, including the expected volatility of the stock price. For pro forma
disclosures, the options' estimated fair value was amortized over their vesting
period. No stock-based employee compensation expense is recognized because all
options granted under those plans had an exercise price equal to or in excess of
the market value of the underlying common stock at the grant date. If we
accounted for our employee stock options under Statement 123, compensation
expense related to stock options would have been $0.7 million and $1.4 million
for each of the quarters and six months ended June 30, 2005 and 2004,
respectively.
(Unaudited) (Unaudited)
Quarters Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2005 2004 2005 2004
------------------------------------------------------------------------------------------------------
Net income (loss)
As reported $ 4,640 $ (8,291) $ (8,479) $ (6,403)
Pro forma 3,922 (8,944) (9,901) (7,805)
Basic EPS
As reported $ 0.14 $ (0.26) $ (0.26) $ (0.23)
Pro forma 0.12 (0.28) (0.30) (0.28)
Diluted EPS
As reported $ 0.14 $ (0.26) $ (0.26) $ (0.23)
Pro forma 0.12 (0.28) (0.30) (0.28)
------------------------------------------------------------------------------------------------------
Our restricted stock unit expense was $0.4 million and $0.1 million for
the quarters ended June 30, 2005 and June 30, 2004, respectively, and $0.7
million and $0.3 million of compensation expense for the six months ended June
30, 2005 and 2004, respectively, as it was probable that the performance
criteria would be met.
(H) SEGMENT INFORMATION
The following table represents financial information by reportable segment (in
thousands):
(Unaudited) (Unaudited)
Quarters Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2005 2004 2005 2004
------------------------------------------------------------------------------------------------------
Net revenues
Entertainment $ 48,882 $ 43,420 $ 99,358 $ 89,864
Publishing 25,530 29,093 52,534 58,770
Licensing 8,459 6,204 14,430 10,953
------------------------------------------------------------------------------------------------------
Total $ 82,871 $ 78,717 $ 166,322 $ 159,587
======================================================================================================
Income (loss) before income taxes
Entertainment $ 9,914 $ 3,101 $ 21,810 $ 10,654
Publishing (2,356) 2,065 (2,740) 3,964
Licensing 3,881 2,379 7,483 4,950
Corporate Administration and Promotion (4,144) (4,384) (8,350) (8,955)
Gain on disposal 14 2 14 2
Investment income 595 133 782 223
Interest expense (1,412) (3,651) (4,060) (7,809)
Amortization of deferred financing fees (133) (357) (366) (732)
Minority interest (370) (351) (740) (702)
Debt extinguishment expenses -- (5,908) (19,280) (5,908)
Other, net (324) (238) (800) (697)
------------------------------------------------------------------------------------------------------
Total $ 5,665 $ (7,209) $ (6,247) $ (5,010)
======================================================================================================
Prior period segment information has been restated as a result of the
realignment of our Entertainment and Online businesses, into a combined
Entertainment segment, as announced during the fourth quarter of 2004.
10
(Unaudited)
June 30, Dec. 31,
2005 2004
--------------------------------------------------------------------------------
Identifiable assets
Entertainment $ 262,119 $ 266,736
Publishing 38,549 45,724
Licensing 8,042 5,344
Corporate Administration and Promotion (1) 124,315 102,777
--------------------------------------------------------------------------------
Total (1) $ 433,025 $ 420,581
================================================================================
(1) The increase in identifiable assets since December 31, 2004 was primarily
due to our debt refinancing in March 2005. See Footnote (I), Debt Refinancing.
(I) DEBT REFINANCING
On March 15, 2005, we issued and sold in a private placement $100.0
million aggregate principal amount of our 3.00% convertible senior subordinated
notes due 2025, or the convertible notes. On March 28, 2005, we issued and sold
in a private placement an additional $15.0 million aggregate principal amount of
the convertible notes due to the initial purchasers' exercise of the
over-allotment option. The net proceeds of approximately $110.3 million from the
issuance and sale of the convertible notes, after deducting the initial
purchasers' discount and estimated offering expenses payable by us, were used,
together with available cash, (i) to complete a tender offer and consent
solicitation for, and to purchase and retire, all $80.0 million outstanding
principal amount of the 11.00% senior secured notes of our subsidiary PEI
Holdings, Inc., or Holdings, for a total of approximately $95.2 million,
including the bond tender premium and consent fee of $14.9 million and other
expenses of $0.3 million, (ii) to purchase 381,971 shares of our Class B stock
for an aggregate purchase price of $5.0 million concurrently with the sale of
the convertible notes and (iii) for working capital and general corporate
purposes.
The convertible notes bear interest at a rate of 3.00% per annum on the
principal amount of the notes, payable semi-annually in arrears on March 15 and
September 15 of each year, beginning on September 15, 2005. In addition, under
certain circumstances beginning in 2012, if the trading price of the convertible
notes exceeds a specified threshold during a prescribed measurement period prior
to any semi-annual interest period, contingent interest will become payable on
the convertible notes for that semi-annual interest period at an annual rate of
0.25%.
The convertible notes are convertible into cash and, if applicable, shares
of our Class B stock based on an initial conversion rate, subject to adjustment,
of 58.7648 shares per $1,000 principal amount of the convertible notes (which
represents an initial conversion price of approximately $17.02 per share), only
under the following circumstances: (1) during any fiscal quarter after the
fiscal quarter ending March 31, 2005, if the closing sale price of our Class B
stock for each of 20 or more consecutive trading days in a period of 30
consecutive trading days ending on the last trading day of the immediately
preceding fiscal quarter exceeds 130% of the conversion price in effect on that
trading day; (2) during the five business day period after any five consecutive
trading day period in which the average trading price per $1,000 principal
amount of convertible notes over that five consecutive trading day period was
equal to or less than 95% of the average conversion value of the convertible
notes during that period; (3) upon the occurrence of specified corporate
transactions, as set forth in the indenture governing the convertible notes; or
(4) if we have called the convertible notes for redemption. Upon conversion of a
convertible note, a holder will receive cash in an amount equal to the lesser of
the aggregate conversion value of the note being converted and the aggregate
principal amount of the note being converted. If the aggregate conversion value
of the convertible note being converted is greater than the cash amount received
by the holder, the holder will also receive an amount in whole shares of Class B
stock equal to the aggregate conversion value less the cash amount received by
the holder. A holder will receive cash in lieu of any fractional shares of Class
B stock.
The convertible notes mature on March 15, 2025. On or after March 15,
2010, if the closing price of our Class B stock exceeds a specified threshold,
we may redeem any of the convertible notes at a redemption price in cash equal
to 100% of the principal amount of the notes, plus any accrued and unpaid
interest up to, but excluding, the redemption date. On or after March 15, 2012,
we may at any time redeem any of the convertible notes at the same redemption
price. On each of March 15, 2012, March 15, 2015 and March 15, 2020, or upon the
occurrence of a fundamental change, as specified in the indenture governing the
convertible notes, holders may require us to purchase all or a portion of their
convertible notes at a purchase price in cash equal to 100% of the principal
amount of the notes, plus any accrued and unpaid interest up to, but excluding,
the purchase date.
11
The convertible notes are unsecured senior subordinated obligations of the
issuer, Playboy, and rank junior to all of the issuer's senior debt, including
its guarantee of Holdings' borrowings under our credit facility; equally with
all of the issuer's future senior subordinated debt; and senior to all of the
issuer's future subordinated debt. In addition, the assets of the issuer's
subsidiaries are subject to the prior claims of all creditors, including trade
creditors, of those subsidiaries.
On July 5, 2005, the Securities and Exchange Commission declared effective
our registration statement on Form S-3 relating to the resales of the
convertible notes and the underlying shares of our class B common stock issuable
upon conversion of the convertible notes.
(J) EQUITY OFFERING
On April 26, 2004, we completed a public offering of 6,021,340 shares of
our Class B stock at $12.69 per share, before underwriting discounts. Included
in this offering were 4,385,392 shares sold by Playboy, 1,485,948 shares sold by
Mr. Hefner and 150,000 shares sold by Ms. Hefner. Playboy's shares included
3,600,000 initial shares, plus an additional 785,392 shares due to the
underwriters' exercise of the over-allotment option. The shares sold by Mr.
Hefner consisted of all of the shares of Class B stock he received upon
conversion of all of the outstanding shares of Playboy's Series A convertible
preferred stock, which we refer to as the Playboy Preferred Stock, at the time
of the offering.
Net proceeds to us from the sale of our shares were approximately $51.9
million. On June 11, 2004, we used $39.8 million of the net proceeds of this
sale to redeem $35.0 million in aggregate principal amount of our outstanding
11.00% senior secured notes due 2010, which included a $3.9 million bond
redemption premium and accrued and unpaid interest of $0.9 million. We used
approximately $0.7 million of net proceeds to pay accrued and unpaid dividends
on the Playboy Preferred Stock up to the time of conversion.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table represents our results of operations (in millions, except
per share amounts):
Quarters Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2005 2004(1) 2005 2004(1)
-----------------------------------------------------------------------------------------------------------------------------
Net revenues
Entertainment
Domestic TV networks $ 24.9 $ 22.5 $ 50.1 $ 46.9
International 11.9 10.4 25.3 20.9
Online subscriptions 5.7 4.9 11.5 10.1
E-commerce 5.1 3.8 10.3 8.6
Other 1.3 1.8 2.2 3.4
-----------------------------------------------------------------------------------------------------------------------------
Total Entertainment 48.9 43.4 99.4 89.9
-----------------------------------------------------------------------------------------------------------------------------
Publishing
Playboy magazine 22.1 24.8 45.0 50.2
Other domestic publishing 1.9 2.8 4.2 5.5
International publishing 1.5 1.5 3.3 3.1
-----------------------------------------------------------------------------------------------------------------------------
Total Publishing 25.5 29.1 52.5 58.8
-----------------------------------------------------------------------------------------------------------------------------
Licensing
International licensing 4.7 2.6 9.1 5.8
Domestic licensing 0.8 0.7 1.6 1.5
Entertainment licensing 0.4 0.5 1.0 1.0
Marketing events 2.4 2.3 2.6 2.5
Other 0.1 0.1 0.1 0.1
-----------------------------------------------------------------------------------------------------------------------------
Total Licensing 8.4 6.2 14.4 10.9
-----------------------------------------------------------------------------------------------------------------------------
Total net revenues $ 82.8 $ 78.7 $ 166.3 $ 159.6
=============================================================================================================================
Net income (loss)
Entertainment
Before programming amortization and online content expenses $ 20.1 $ 14.9 $ 41.8 $ 33.4
Programming amortization and online content expenses (10.2) (11.9) (20.0) (22.8)
-----------------------------------------------------------------------------------------------------------------------------
Total Entertainment 9.9 3.0 21.8 10.6
-----------------------------------------------------------------------------------------------------------------------------
Publishing (2.3) 2.1 (2.7) 4.0
-----------------------------------------------------------------------------------------------------------------------------
Licensing 3.9 2.4 7.5 5.0
-----------------------------------------------------------------------------------------------------------------------------
Corporate Administration and Promotion (4.2) (4.4) (8.4) (9.0)
-----------------------------------------------------------------------------------------------------------------------------
Operating income 7.3 3.1 18.2 10.6
-----------------------------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 0.6 0.1 0.8 0.2
Interest expense (1.5) (3.6) (4.1) (7.8)
Amortization of deferred financing fees (0.2) (0.3) (0.4) (0.7)
Minority interest (0.3) (0.3) (0.7) (0.7)
Debt extinguishment expenses -- (5.9) (19.3) (5.9)
Other, net (0.2) (0.3) (0.7) (0.7)
-----------------------------------------------------------------------------------------------------------------------------
Total nonoperating expense (1.6) (10.3) (24.4) (15.6)
-----------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 5.7 (7.2) (6.2) (5.0)
Income tax expense (1.1) (1.1) (2.3) (1.4)
-----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 4.6 $ (8.3) $ (8.5) $ (6.4)
=============================================================================================================================
Basic and Diluted EPS $ 0.14 $ (0.26) $ (0.26) $ (0.23)
-----------------------------------------------------------------------------------------------------------------------------
(1) Prior period segment information has been restated as a result of the
realignment of our Entertainment and Online businesses, into a combined
Entertainment segment, as announced during the fourth quarter of 2004.
13
Our revenues increased $4.1 million, or 5%, and $6.7 million, or 4%, for
the quarter and six-month period, respectively, and our operating income
increased $4.2 million, or 131%, and $7.6 million, or 72%, for the quarter and
six-month period, respectively, primarily due to strong results from our
Entertainment and Licensing Groups, partially offset by expected lower results
from our Publishing Group.
Net income of $4.6 million for the quarter represented a $12.9 million
increase over the prior year quarter due to the above-mentioned improvement in
operating results combined with a decrease in interest expense related to our
debt refinancing completed during the first quarter of 2005 and debt
extinguishment expenses recorded in the prior year quarter. Net loss for the
current six-month period of $8.5 million includes $19.3 million of debt
extinguishment expenses compared to $5.9 million in the prior year period.
Several of our businesses can experience variations in quarterly
performance. As a result, our performance in any quarter is not necessarily
reflective of full-year or longer-term trends. Playboy magazine newsstand
revenues vary from issue to issue, with revenues generally higher for holiday
issues and any issues including editorial or pictorial features that generate
additional public interest. Advertising revenues also vary from quarter to
quarter depending on economic conditions, holiday issues and changes in
advertising buying patterns. Online subscription revenues and operating results
are impacted by decreased Internet traffic during the summer months, and
e-commerce revenues and operating results are typically strongest in the fourth
quarter due to the holiday buying season.
ENTERTAINMENT GROUP
The following discussion focuses on the profit contribution of each of our
Entertainment Group businesses before programming amortization and online
content expenses.
Revenues from our domestic TV networks business increased $2.4 million, or
11%, and $3.2 million, or 7%, for the quarter and six-month period,
respectively. Direct-to-home, or DTH, revenues increased $1.1 million and $1.9
million for the quarter and six-month period, respectively, due to subscriber
growth and an increase in average pay-per-view, or PPV, buys. Video-on-demand,
or VOD, revenues increased $0.9 million, or 113%, and $1.6 million, or 95%, for
the quarter and six-month period, respectively, due to the continued roll out of
VOD service in additional cable systems as well as a growing number of consumer
buys in existing cable systems. The discontinuation of a service agreement with
a distributor of our high-definition service, which resulted in the accelerated
recognition of the remaining $1.4 million of deferred revenue associated with
the agreement, also favorably impacted the quarter and six-month period. These
revenue increases were partially offset by a $0.6 million and $1.8 million
decrease in cable revenues for the quarter and six-month period, respectively,
primarily due to a decrease in cable PPV buys for both periods as certain cable
companies migrate consumers from linear channels to VOD. Profit contribution
from domestic TV networks increased $3.1 million, or 22%, and $4.6 million, or
15%, for the quarter and six-month period, respectively, primarily due to the
revenue activity described above combined with a decrease in cable marketing and
overhead expenses.
International revenues increased $1.5 million, or 14%, and $4.4 million,
or 21%, for the quarter and six-month period, respectively. DTH revenues from
our networks in the U.K., several of which launched in the prior year quarter,
contributed favorably to revenues in both periods. Additionally, increased
revenues from new networks launched in Australia and Germany during the second
half of 2004 and increased royalties from wireless agreements, principally in
Europe, contributed favorably to revenues in both periods. Profit contribution
from our international businesses increased $1.0 million, or 30%, and $2.6
million, or 34%, for the quarter and six-month period, respectively, due to the
higher international revenues mentioned above, partially offset by higher costs
related to the new channels in the U.K.
Online subscription revenues increased $0.8 million, or 15%, and $1.4
million, or 14%, for the quarter and six-month period, respectively, due to
growth in the number of subscribers for our online clubs. Profit contribution
for the online subscription business increased $0.4 million, or 13%, for the
quarter and $1.1 million, or 16%, for the six-month period, due to the revenue
increase described above, partially offset by higher technology costs.
14
E-commerce revenues increased $1.3 million, or 35%, and $1.7 million, or
20%, for the quarter and six-month period, respectively. A $1.2 million payment
due to the termination of a marketing alliance is reflected in the current
quarter's revenues. Excluding this termination fee, e-commerce revenues were
flat for the quarter and increased $0.5 million for the six-month period as the
prior year periods experienced higher traffic to the online catalog in response
to our 50th Anniversary. Profit contribution from e-commerce increased $0.2
million for the quarter and decreased $0.3 million for the six-month period as
the favorable termination fee was offset by higher anticipated paper costs
combined with increased circulation costs and marketing expenses associated with
the production of a test catalog.
Profit contribution from other businesses was flat for the quarter and
decreased $0.3 million for the six-month period primarily due to the expected
decline in worldwide DVD sales.
The group's administrative expenses decreased for both the quarter and
six-month period due in part to lower legal costs and a contractually obligated
severance charge recorded in the prior year quarter.
Segment income for the group increased $6.9 million, or 220%, and $11.2
million, or 105%, for the quarter and six-month period, respectively, primarily
due to the previously mentioned higher revenues and lower administrative
expenses. Segment income was also favorably impacted by lower programming
amortization and online content expenses of $1.7 million, or 14%, for the
quarter and $2.8 million, or 12%, for the six-month period. This is due to both
the mix of programming and the number of program premieres. We continue to
expect that our cash programming investments will be approximately $38.0 million
for the year, down nearly 10% from last year, and cash investments in online
content will be approximately $2.0 million. We expect programming amortization
to decline to about $38.0 million for the year, down from $41.7 million in 2004,
and online content amortization to be approximately $2.0 million, down from $2.3
million in 2004.
PUBLISHING GROUP
Playboy magazine revenues decreased $2.7 million, or 11%, and $5.2
million, or 10%, for the quarter and six-month period, respectively. Newsstand
revenues declined $0.6 million for the quarter and $1.5 million for the
six-month period primarily due to fewer copies sold. Additionally, the current
year six-month period included an unfavorable adjustment of $0.3 million related
to prior year issues compared to a $0.3 million favorable adjustment in the
prior year period. Subscription revenues decreased $0.2 million and $1.1 million
for the quarter and six-month period, respectively, primarily due to lower
average net revenue per copy in the current year periods, higher favorable
adjustments recorded in the prior year periods to recognize revenues for paid
subscriptions that will not be served and lower list rental revenues in the
current year periods, partially offset by an increase in the number of
subscription copies in the current year periods. Advertising revenues decreased
$1.9 million and $2.6 million for the quarter and six-month period,
respectively, due to fewer advertising pages, as a result of a shift in
advertising media, and lower average net revenue per page, due to the mix in
advertisements. Advertising sales for the 2005 third quarter magazine issues are
closed, and we expect to report approximately 20% lower advertising revenues and
29% fewer advertising pages compared to the 2004 third quarter.
Revenues from our other domestic publishing businesses decreased $0.9
million, or 32%, and $1.3 million, or 23%, for the quarter and six-month period,
respectively, primarily due to fewer special editions copies sold on the
newsstand in the current year periods combined with higher unfavorable
adjustments to prior period issues in the current periods. An expected decrease
in royalties from books published in prior periods also contributed to the
revenue decrease.
International publishing revenues were flat for the quarter and increased
$0.2 million, or 8%, for the six-month period primarily due to higher royalties
from the German edition.
The group's segment income decreased $4.4 million and $6.7 million for the
quarter and six-month period, respectively, as a result of the lower revenues
discussed above combined with higher subscription acquisition expense of $0.5
million for the quarter and $1.0 million for the six-month period and higher
paper costs of $0.4 million for the quarter and $0.8 million for the six-month
period, partially offset by a $0.9 million decrease in editorial expenses for
the six-month period.
15
LICENSING GROUP
Licensing Group revenues increased $2.2 million, or 36%, and $3.5 million,
or 32%, for the quarter and the six-month period, respectively, primarily due to
higher royalties from existing licensees and new licensee agreements in Europe
and Asia. The group's segment income increased $1.5 million, or 63%, and $2.5
million, or 51%, for the quarter and six-month period, respectively, due to the
revenue increase, partially offset by higher revenue-related expenses, including
agency fees.
CORPORATE ADMINISTRATION AND PROMOTION
Corporate Administration and Promotion expenses decreased $0.2 million, or
5%, for the quarter and $0.6 million, or 7%, for the six-month period related to
lower variable compensation expense, the reclassification of a senior position
from Corporate to a division and lower marketing expenses, partially offset by
an increase in internal audit expenses.
NONOPERATING INCOME (EXPENSES)
The six-month period included debt extinguishment expenses of $19.3
million related to our redemption of all $80.0 million of the 11.00% senior
secured notes due 2010, or the senior secured notes, issued by our subsidiary,
PEI Holdings, Inc., or Holdings. These expenses were comprised of $14.9 million
of bond redemption premium combined with $0.3 million of related expenses and
$4.1 million for the non-cash write-off of the related deferred financing costs.
The senior secured notes were repurchased using the proceeds of the issuance of
$115.0 million of 3.00% convertible senior subordinated notes due 2025, or the
convertible notes. The prior quarter and six-month period included $5.9 million
of debt extinguishment expenses related to our redemption of $35.0 million
aggregate principal amount of the senior secured notes. A reduction of interest
expenses of $2.1 million and $3.7 million for the quarter and six-month period,
respectively, related to the lower interest rate on the new 3.00% convertible
notes, partially offset the redemption expenses.
INCOME TAX EXPENSE
Our effective income tax rate differs from U.S. statutory rates. The
income tax provision consists of foreign income tax related to our international
networks and withholding tax on licensing income for which we do not receive a
current U.S. income tax benefit. The tax provision also includes deferred
federal and state income tax 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.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2005, we had $31.5 million in cash and cash equivalents
compared to $26.7 million in cash and cash equivalents at December 31, 2004. At
June 30, 2005, we had $34.8 million of auction rate securities, or ARS, included
in short-term investments compared to $20.0 million at December 31, 2004. ARS
generally have long-term maturities; however, these investments have
characteristics similar to short-term investments because at predetermined
intervals, typically every 28 days, there is a new auction process. Total
financing obligations were $115.0 million and $80.0 million at June 30, 2005 and
December 31, 2004, respectively.
At June 30, 2005, our liquidity requirements were being provided by cash
generated from our operating activities, our existing cash and cash equivalents
and short-term investments. At June 30, 2005, we had a $50.0 million credit
facility, which can be used for revolving borrowings, issuing letters of credit
or a combination of both. At June 30, 2005, there were no borrowings and $10.8
million in letters of credit outstanding under this facility, permitting $39.2
million of available borrowings under this facility. See "Credit Facility" for
additional information.
16
DEBT FINANCINGS
On March 15, 2005, we issued and sold in a private placement $100.0
million aggregate principal amount of our 3.00% convertible senior subordinated
notes due 2025. On March 28, 2005, we issued and sold in a private placement an
additional $15.0 million aggregate principal amount of the convertible notes due
to the initial purchasers' exercise of the over-allotment option. The net
proceeds of approximately $110.3 million from the issuance and sale of the
convertible notes, after deducting the initial purchasers' discount and
estimated offering expenses payable by us, were used, together with available
cash, (i) to complete a tender offer and consent solicitation for, and to
purchase and retire, all $80.0 million outstanding principal amount of the
11.00% senior secured notes, for a total of approximately $95.2 million,
including the bond tender premium and consent fee of $14.9 million and other
expenses of $0.3 million, (ii) to purchase 381,971 shares of our Class B common
stock, or Class B stock, for an aggregate purchase price of $5.0 million
concurrently with the sale of the convertible notes and (iii) for working
capital and general corporate purposes. Also, on March 15, 2005, concurrently
with the convertible note offering, Hugh M. Hefner, our Founder and
Editor-In-Chief, purchased 381,971 shares of our Class B stock for an aggregate
purchase price of $5.0 million.
The convertible notes bear interest at a rate of 3.00% per annum on the
principal amount of the notes, payable semi-annually in arrears on March 15 and
September 15 of each year, beginning on September 15, 2005. In addition,
beginning in March 2012, if the trading price of the convertible notes exceeds a
specified threshold during a prescribed measurement period prior to any
semi-annual interest period, contingent interest will become payable on the
convertible notes for that semi-annual interest period at an annual rate of
0.25%. The notes are convertible under specified circumstances into cash and, if
applicable, shares of our Class B stock based on an initial conversion rate of
58.7648 shares per $1,000 principal amount of the convertible notes (which
represents an initial conversion price of approximately $17.02 per share). In
general, upon conversion of a convertible note, the holder of the note will
receive cash in an amount equal to the principal amount of the note and Class B
stock for the note's conversion value in excess of the principal amount. See
Footnote (I), Debt Refinancing, for additional information.
The convertible notes mature on March 15, 2025. On or after March 15,
2010, if the closing price of our Class B stock exceeds a specified threshold,
we may redeem any of the convertible notes at a redemption price in cash equal
to 100% of the principal amount of the notes, plus any accrued and unpaid
interest to, but excluding, the redemption date. On or after March 15, 2012, we
may at any time redeem any of the convertible notes at the same redemption
price. On each of March 15, 2012, March 15, 2015 and March 15, 2020, or upon the
occurrence of a fundamental change, as specified in the indenture governing the
convertible notes, holders may require us to purchase all or a portion of their
convertible notes at a purchase price in cash equal to 100% of the principal
amount of the notes, plus any accrued and unpaid interest up to, but excluding,
the purchase date.
The convertible notes are unsecured senior subordinated obligations of the
issuer, Playboy Enterprises, Inc., or Playboy, and rank junior to all of the
issuer's senior debt, including its guarantee of Holdings' borrowings under our
credit facility; equally with all of the issuer's future senior subordinated
debt; and senior to all of the issuer's future subordinated debt. In addition,
the assets of the issuer's subsidiaries are subject to the prior claims of all
creditors, including trade creditors, of those subsidiaries.
On July 5, 2005, the Securities and Exchange Commission declared effective
our registration statement on Form S-3 relating to resales of the convertible
notes and the underlying shares of our class B common stock issuable upon
conversion of the convertible notes.
CREDIT FACILITY
Effective April 1, 2005, Holdings and its lenders amended and restated the
credit agreement governing our credit facility, primarily to increase the size
of our credit facility from $30.0 million to $50.0 million. The credit facility
provides for revolving borrowings by Holdings of up to $50.0 million and the
issuance of up to $30.0 million in letters of credit, subject to a maximum of
$50.0 million in combined borrowings and letters of credit outstanding at any
time. Borrowings under the credit facility bear interest at a variable rate,
equal to a specified Eurodollar, LIBOR or base rate plus a specified borrowing
margin based on our Transactions Adjusted EBITDA, as defined in the credit
agreement. We pay fees on the outstanding amount of letters of credit under the
credit facility based on the borrowing margin that applies to borrowings that
bear interest at a rate based on LIBOR. All amounts outstanding under the credit
facility will mature on April 1, 2008. Holdings' obligations as borrower under
the credit facility are guaranteed by Playboy and each of our other U.S.
subsidiaries, except for Playboy.com and its subsidiaries. The obligations of
the borrower and each of the guarantors under the credit facility are secured by
a first-priority lien on substantially all of the borrower's and the guarantors'
assets.
17
CALIFA ACQUISITION
The Califa acquisition agreement gives us the option of paying $17.5
million of the remaining $23.8 million purchase price consideration obligation,
as of June 30, 2005, in cash or in shares of Class B stock. We have notified the
sellers that the $7.0 million of base consideration due in 2005 will be paid in
cash. Under the terms of the agreement, the base consideration is due in two
installments of $3.5 million, one of which was paid on May 2, 2005 and the other
of which will be paid on November 1, 2005.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $15.4 million for the
six-month period, which represents an increase of $19.9 million from the prior
year period. This increase is primarily due to better overall operating results
combined with a decrease in investments in entertainment programming of $7.1
million and a decrease in legal settlement payments of approximately $4.6
million compared to the prior period.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used for investing activities increased $16.5 million due to
investments made in auction rate securities during the six-month period. There
was no such investment activity in the prior year period.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash provided by financing activities was $7.0 million for the
six-month period primarily due to the proceeds from our sale of $115.0 million
aggregate principal amount of convertible notes partially offset by the payment
of $94.9 million in connection with the purchase and retirement of all $80.0
million outstanding principal amount of Holdings' 11.00% senior secured notes
and the payment of $0.3 million in associated debt extinguishment expenses and
$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 an
aggregate purchase price of $5.0 million. See Footnote (I), Debt Refinancing,
for additional information.
18
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 and Internet businesses' reliance on third parties for
technology and distribution, and any changes in that technology and/or
unforeseen delays in its implementation which might affect our plans and
assumptions;
(13) Risks associated with losing access to transponders and competition for
transponders and channel space;
(14) The impact of industry consolidation, any decline in our access to, and
acceptance by, DTH and/or cable systems and the possible resulting
deterioration in the terms, cancellation of fee arrangements or pressure
on splits with operators of these systems;
(15) Risks that we may not realize the expected increased sales and profits and
other benefits from acquisitions, joint ventures and/or licensing
arrangements;
(16) Any charges or costs we incur in connection with restructuring measures we
may take in the future;
(17) Risks associated with the financial condition of Claxson Interactive
Group, Inc., our Playboy TV-Latin America, LLC joint venture partner;
(18) Increases in paper, postage or printing costs;
(19) Effects of the national consolidation of the single-copy magazine
distribution system; and
(20) Risks associated with the viability of our primarily subscription- and
e-commerce-based Internet model.
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At June 30, 2005, we did not have any floating interest rate exposure. All
of our outstanding debt as of that date consisted of the convertible notes,
which are fixed-rate obligations. The fair value of the $115.0 million aggregate
principal amount of the convertible notes will be influenced by changes in
market interest rates, the share price of our Class B stock and our credit
quality. As of June 30, 2005, the convertible senior subordinated notes had an
implied fair value of $112.6 million.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange
Act) as of the end of the period covered by this quarterly report. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by us in the reports that
we file or submit under the Exchange Act.
Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 17, 1998, Eduardo Gongora, or Gongora, filed suit in state
court in Hidalgo County, Texas against Editorial Caballero SA de CV, or EC,
Grupo Siete International, Inc., or GSI, collectively the Editorial Defendants,
and us. In the complaint, Gongora alleged that he was injured as a result of the
termination of a publishing license agreement, or the License Agreement, between
us and EC for the publication of a Mexican edition of Playboy magazine, or the
Mexican Edition. We terminated the License Agreement on or about January 29,
1998 due to EC's failure to pay royalties and other amounts due us under the
License Agreement. On February 18, 1998, the Editorial Defendants filed a
cross-claim against us. Gongora alleged that in December 1996 he entered into an
oral agreement with the Editorial Defendants to solicit advertising for the
Mexican Edition to be distributed in the United States. The basis of GSI's
cross-claim was that it was the assignee of EC's right to distribute the Mexican
Edition in the United States and other Spanish-speaking Latin American countries
outside of Mexico. On May 31, 2002, a jury returned a verdict against us in the
amount of approximately $4.4 million. Under the verdict, Gongora was awarded no
damages. GSI and EC were awarded $4.1 million in out-of-pocket expenses and
approximately $0.3 million for lost profits, respectively, even though the jury
found that EC had failed to comply with the terms of the License Agreement. On
October 24, 2002, the trial court signed a judgment against us for $4.4 million
plus pre- and post-judgment interest and costs. On November 22, 2002, we filed
post-judgment motions challenging the judgment in the trial court. The trial
court overruled those motions and we are vigorously pursuing an appeal with the
State Appellate Court sitting in Corpus Christi challenging the verdict. We have
posted a bond in the amount of approximately $8.5 million (which represents the
amount of the judgment, costs and estimated pre- and post-judgment interest) in
connection with the appeal. We, on advice of legal counsel, believe that it is
not probable that a material judgment against us will be sustained. In
accordance with Statement of Financial Accounting Standards, or Statement, 5,
Accounting for Contingencies, no liability has been accrued.
20
On May 17, 2001, Logix Development Corporation, or Logix, D. Keith
Howington and Anne Howington filed suit in state court in Los Angeles County
Superior Court in California against Spice Entertainment Companies, Inc., or
Spice, Emerald Media, Inc., or EMI, Directrix, Inc., or Directrix, Colorado
Satellite Broadcasting, Inc., New Frontier Media, Inc., J. Roger Faherty, or
Faherty, Donald McDonald, Jr., and Judy Savar. On February 8, 2002, plaintiffs
amended the complaint and added as a defendant Playboy, which acquired Spice in
1999. The complaint alleged 11 contract and tort causes of action arising
principally out of a January 18, 1997 agreement between EMI and Logix in which
EMI agreed to purchase certain explicit television channels broadcast over
C-band satellite. The complaint further sought damages from Spice based on
Spice's alleged failure to provide transponder and uplink services to Logix.
Playboy and Spice filed a motion to dismiss the plaintiffs' complaint. After
pre-trial motions, Playboy was dismissed from the case and a number of causes of
action were dismissed against Spice. A trial date for the remaining breach of
contract claims against Spice was set for December 10, 2003, and then continued,
first to February 11, 2004 and then to March 17, 2004. Spice and the plaintiffs
filed cross-motions for summary judgment or, in the alternative, for summary
adjudication, on September 5, 2003. Those motions were heard on November 19,
2003 and were denied. In February 2004, prior to the trial, Spice and the
plaintiffs agreed to a settlement in the amount of $8.5 million, which we
recorded as a charge in the fourth quarter of 2003, $6.5 million of which was
paid in 2004 and $1.0 million in 2005. The remaining $1.0 million will be paid
in 2006.
On April 12, 2004, Faherty filed suit in the United States District Court
for the Southern District of New York against Spice, Playboy, Playboy
Enterprises International, Inc., or PEII, D. Keith Howington, Anne Howington
(together, the "Howington defendants") and Logix. The complaint alleges that
Faherty is entitled to statutory and contractual indemnification from Playboy,
PEII and Spice with respect to defense costs and liabilities incurred by Faherty
in the litigation described in the preceding paragraph, or the Logix litigation.
The complaint further alleges that Playboy, PEII, Spice, D. Keith Howington,
Anne Howington and Logix conspired to deprive Faherty of his alleged right to
indemnification by excluding him from the settlement of the Logix litigation. On
June 18, 2004, a jury entered a special verdict finding Faherty personally
liable for $22.5 million in damages to the plaintiffs in the Logix litigation. A
judgment was entered on the verdict on or around August 2, 2004. Faherty filed
post-trial motions for a judgment notwithstanding the verdict and a new trial,
but these motions were both denied on or about September 21, 2004. On October
20, 2004, Faherty filed a notice of appeal from the verdict. In consideration of
this appeal Faherty and Playboy have agreed to seek a temporary stay of the
indemnification action filed in the United States District Court for the
Southern District of New York. On January 14, 2005, Logix and the Howington
defendants filed a motion to dismiss the Faherty action for, among other things,
lack of personal jurisdiction. On February 15, 2005, Faherty filed a
cross-motion to stay the action pending the outcome of his appeal. The motion
and cross-motions are pending. In the event Faherty's indemnification and
conspiracy claims go forward against us, we believe they are without merit and
that we have good defenses against them. As such, based on the information known
to us to date, we do not believe that it is probable that a material judgment
against us will result. In accordance with Statement 5, Accounting for
Contingencies, no liability has been accrued.
On September 26, 2002, Directrix filed suit in the U.S. Bankruptcy Court
in the Southern District of New York against Playboy Entertainment Group, Inc.
In the complaint, Directrix alleged that it was injured as a result of the
termination of a Master Services Agreement under which Directrix was to perform
services relating to the distribution, production and post production of our
cable networks and a sublease agreement under which Directrix would have
subleased office, technical and studio space at our Los Angeles, California
production facility. Directrix also alleged that we breached an agreement under
which Directrix had the right to transmit and broadcast certain versions of
films through C-band satellite, commonly known as the TVRO market, and Internet
distribution. On November 15, 2002, we filed an answer denying Directrix's
allegations, along with counterclaims against Directrix relating to the Master
Services Agreement and seeking damages. On May 15, 2003, we filed an amended
answer and counterclaims. On July 30, 2003, Directrix moved to dismiss one of
the amended counterclaims, and on October 20, 2003, the Court denied Directrix's
motion. The parties are engaged in discovery. We believe that we have good
defenses against Directrix's claims. We believe it is not probable that a
material judgment against us will result. In accordance with Statement 5,
Accounting for Contingencies, no liability has been accrued.
In the fourth quarter of 2004, we received a $5.6 million insurance
recovery partially related to the prior year litigation settlement with Logix.
21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of shareholders was held on May 11, 2005. At the
meeting, the following director nominees were elected by the holders of our
Class A common stock, who were the only holders entitled to vote on the matter:
Votes Votes
Nominee For Withheld
--------------------------------------------------------------------------------
Dennis S. Bookshester 4,690,283 8,766
David I. Chemerow 4,667,433 31,616
Donald G. Drapkin 4,690,183 8,866
Christie A. Hefner 4,364,194 334,855
Jerome H. Kern 4,690,183 8,866
Russell I. Pillar 4,690,158 8,891
Sol Rosenthal 4,364,159 334,890
Richard S. Rosenzweig 4,364,166 334,883
--------------------------------------------------------------------------------
Also at the meeting, the holders of our Class A common stock approved the
ratification of Ernst & Young LLP as independent auditors, with voting as set
forth below:
Class A Common Stock
------------------------------------------------------
Votes Votes Votes
For Against Withheld Non-Vote
------------------------------------------------------
4,691,315 5,993 1,741 N/A
------------------------------------------------------
ITEM 6. EXHIBITS
Exhibit Number Description
-------------- -----------
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
22
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 5, 2005 By /s/ Linda Havard
-------------- ----------------------------
Linda G. Havard
Executive Vice President,
Finance and Operations,
and Chief Financial Officer
(Authorized Officer and
Principal Financial and
Accounting Officer)
23