UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
OR
[] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 001-14790
Playboy Enterprises, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-4249478
(State of incorporation) (I.R.S. Employer Identification Number)
680 North Lake Shore Drive
Chicago, IL 60611
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (312) 751-8000
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Class A Common Stock, par value $0.01 per share New York Stock Exchange
Pacific Exchange
Class B Common Stock, par value $0.01 per share New York Stock Exchange
Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of Class A Common Stock held by nonaffiliates on June
30, 2005 (based upon the closing sale price on the New York Stock Exchange), was
$16,135,852. The aggregate market value of Class B Common Stock held by
nonaffiliates on June 30, 2005 (based upon the closing sale price on the New
York Stock Exchange), was $264,405,582.
At February 28, 2006, there were 4,864,102 shares of Class A Common Stock and
28,275,923 shares of Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required for Part II. Item 5 and Part III. Items 10-14 of
this report is incorporated herein by reference to the Notice of Annual Meeting
of Stockholders and Proxy Statement (to be filed) relating to the Annual Meeting
of Stockholders to be held in May 2006.
PLAYBOY ENTERPRISES, INC.
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business 3
Item 1A. Risk Factors 14
Item 1B. Unresolved Staff Comments 22
Item 2. Properties 23
Item 3. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 25
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 26
Item 6. Selected Financial Data 27
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 29
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 46
Item 8. Financial Statements and Supplementary Data 46
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 73
Item 9A. Controls and Procedures 73
Item 9B. Other Information 75
PART III
Item 10. Directors and Executive Officers of the Registrant 76
Item 11. Executive Compensation 76
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 76
Item 13. Certain Relationships and Related Transactions 76
Item 14. Principal Accounting Fees and Services 76
PART IV
Item 15. Exhibits, Financial Statement Schedules 77
2
PART I
Item 1. Business
Playboy Enterprises, Inc., together with its subsidiaries and
predecessors, will be referred to in this Annual Report on Form 10-K by terms
such as "we," "us," "our," "Playboy" and the "Company," unless the context
requires otherwise. We were organized in 1953 to publish Playboy magazine and
are now a worldwide leader in the development and distribution of multimedia
lifestyle entertainment for adult audiences. The Playboy brand is one of the
most widely recognized and popular brands in the world. The strength of our
brand drives the financial performance of our Entertainment, Publishing and
Licensing Groups. Our programming is carried in the U.S. by all six of the major
multiple system operators, or MSOs, and both of the largest satellite
direct-to-home, or DTH, providers. We have online operations consisting of a
network of websites with an established and growing subscriber and revenue base.
Playboy magazine is the best-selling monthly men's magazine in the United States
and in the world, based on the combined circulation of the U.S. and
international editions. Our licensing businesses leverage the Playboy name, the
Rabbit Head Design and our other trademarks in the worldwide licensing of a
variety of consumer products.
Our businesses are currently classified into the following three
reportable segments: Entertainment, Publishing and Licensing. Net revenues,
income (loss) before income taxes, depreciation and amortization and
identifiable assets of each reportable segment are set forth in Note (U),
Segment Information, to the Notes to Consolidated Financial Statements. Prior
periods presented have been restated for the realignment of our business
segments, which occurred in the fourth quarter of 2004.
Our trademarks and copyrights are critical to the success and potential
growth of all of our businesses. Our trademarks, which are renewable
periodically and which can be renewed indefinitely, include Playboy, the Rabbit
Head Design, Playmate and Spice. We also own numerous domain names related to
our online business.
ENTERTAINMENT GROUP
Our Entertainment Group operations include the production and marketing of
television programming for our domestic and international TV networks, web-based
entertainment experiences, wireless content distribution, e-commerce, worldwide
DVD products, satellite radio and online gaming under the Playboy, Spice and
other brand names.
Programming
Our Entertainment Group develops, produces, acquires and distributes a
wide range of high-quality lifestyle adult television programming for our
domestic and international TV networks, video-on-demand, or VOD, subscription
video-on-demand, or SVOD, and worldwide DVD products. Our proprietary
productions include magazine-format shows, reality-based and dramatic series,
documentaries, live events and celebrity and Playmate programs. Our programming
is featured in a variety of formats, enabling us to amortize our programming
costs over multiple distribution platforms. We have produced a number of shows
that air on the domestic and international Playboy TV networks and are
distributed internationally in countries where we do not have networks.
Additionally, some of our programming has been released into DVD titles and/or
has been licensed to other networks, such as HBO and Showtime. Our original
series programming includes Night Calls, Sexy Girls Next Door, Totally Busted
and 7 Lives Xposed. Additionally, we produce shows and series to air on
third-party networks, including Party @ the Palms and The Girls Next Door for
E!, Bullets Over Hollywood for Starz and Playboy's Celebrity Centerfolds for
A&E.
We invest in the creation and acquisition of high-quality, adult-oriented
programming to support our worldwide entertainment businesses. We invested $33.1
million, $41.5 million and $44.7 million in entertainment programming in 2005,
2004 and 2003, respectively. These amounts, which also include expenditures for
licensed programming, resulted in the domestic production of 129, 212 and 268
hours of original programming for Playboy TV in 2005, 2004 and 2003,
respectively. At December 31, 2005, our domestic library of primarily exclusive,
Playboy-branded original programming totaled approximately 2,800 hours. In
addition to investing in our productions, we also acquire high-quality adult
movies in various edit standards, as the majority of the programming
3
that airs on our movie networks is licensed, on an exclusive basis, from third
parties. We will continue to both acquire and produce original programming;
however, we continue to place a heavier emphasis on producing content in order
to take advantage of the economic benefits provided to us by producing and
owning programming that can be sold through a variety of distribution channels.
In addition to utilizing some of the programming we produce for our websites and
for licensing to wireless providers, we invested $2.2 million, $2.3 million and
$2.4 million in content specifically for online and wireless initiatives in
2005, 2004 and 2003, respectively. In 2006, we expect to invest approximately
$38.0 million and $5.7 million in entertainment programming and online content,
respectively, which could vary based on, among other things, the timing of
completing productions. The increase in online content investment results from
our acquisition of an affiliate network of websites and other new business
ventures.
Our programming is delivered to DTH and cable operators through satellite
transponders. We currently have four transponder service agreements related to
our domestic networks and two international transponder service agreements. The
terms of these agreements extend from 2006 through 2014. We are currently
evaluating our options for the two transponder service agreements that expire in
2006.
Our state-of-the-art studio in Los Angeles functions as a centralized
digital, technical and programming facility for the Entertainment Group. This
studio enables us to produce original programming in a more efficient and
cost-effective operating environment. In 2003, we upgraded our production
capabilities so that the programming we create is available in high-definition
format. We currently utilize this facility to provide playback, production
control and/or origination services for our own television networks. Most of
these services are also provided for third parties, offsetting some of our fixed
costs.
Domestic TV Networks
We currently operate multiple domestic TV networks, which include Playboy
TV, Playboy TV en Espanol, and nine Spice-branded movie networks. Playboy TV,
which airs a variety of original and proprietary programming as well as adult
movies under exclusive license from leading adult studios, is offered through
the DTH market and on cable through pay-per-view, or PPV, monthly subscription,
VOD and SVOD bases. Playboy TV en Espanol is offered on cable on a PPV basis and
on DTH as part of EchoStar's Dish Latino subscription package. Our movie
networks feature adult movies under exclusive licenses from leading adult
studios and are currently offered via cable and DTH on a PPV or VOD basis. We
also license our Playboy programming to other networks.
4
The following table illustrates certain information regarding approximate
household units and current average retail rates for our networks (in millions,
except average retail rates):
Household Units (1) Average Retail Rates
------------------- ---------------------
Dec. 31, Dec. 31, Monthly
2005 2004 PPV Subscription
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Playboy TV
DTH 26.8 24.4 $ 7.99 $ 15.76
Cable 20.1 21.8 9.76 14.95
SVOD 1.9 1.5 -- 4.94
Playboy TV en Espanol
DTH 10.3 9.3 -- -- (2)
Cable 2.6 2.9 9.80 --
Movie networks
DTH 53.0 48.2 10.74 --
Cable 43.8 46.0 11.69 --
VOD 8.6 5.0 10.52 --
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(1) Each household unit is defined as one household carrying one given network
per carriage platform. A single household can represent multiple household
units if two or more of our networks and/or multiple distribution
platforms (i.e., digital and analog) are available to that household.
(2) An average retail rate is not available as Playboy TV en Espanol is
offered with various other Spanish-language networks as part of EchoStar's
Dish Latino subscription package.
Most of our networks are provided through the DTH market in households
with small dishes receiving a Ku-band medium or high power digital signal, such
as those currently offered by DirecTV and EchoStar in the United States and
ExpressVu and Star Choice in Canada. Playboy TV is currently the only adult
network to be available on all four major DTH services in the United States and
Canada. Playboy TV en Espanol is offered as part of EchoStar's Dish Latino
subscription package. Paul Kagan Associates, Inc., or Kagan, an independent
media research firm, projects an average annual increase of approximately 6% in
total DTH households from 2006 through 2008. Our revenues reflect our
contractual share of the amounts received by the DTH operators, which are based
on both the retail rates set by the DTH operators and the number of buys and/or
subscribers.
Our networks are also available to consumers through cable providers. Most
cable services in the United States are distributed by MSOs through their
affiliated cable systems, or cable affiliates. Once arrangements are made with
an MSO, we negotiate channel space for our networks with each MSO's cable
affiliates. Individual cable affiliates determine the retail price of both PPV,
which can be dependent on the length of the block of programming, and monthly
subscription services, which are generally offered to consumers for an
additional fee on top of their basic cable service. Our revenues reflect our
contractual share of the amounts received by the cable affiliates, which are
based on both the retail rates set by the cable affiliates and the number of
buys and/or subscribers.
PPV programming can be delivered through any number of distribution
platforms, including (a) DTH, (b) digital and analog cable television, (c)
wireless cable systems and (d) technologies such as cable modem and the
Internet. In recent years, cable operators have shifted away from analog to
digital technology in order to counteract competition from DTH operators and to
upgrade their cable systems by utilizing digital compression and other bandwidth
expansion methods that provide cable operators additional channel capacity.
Digital cable television has several advantages over analog cable television,
including more channels, better audio and video quality, advanced set-top boxes
that are addressable, a secure, fully scrambled signal, integrated program
guides and advanced ordering technology. Our networks are delivered almost
exclusively on a digital basis, as analog delivery now represents only a small
portion of our overall network carriage. Kagan projects average annual increases
of less than 1% in total cable households and 14% in digital cable households
from 2006 through 2008. During this same period, Kagan projects an average
annual decrease of approximately 39% in analog addressable cable households, as
customers upgrade from older analog systems to the digital or DTH platforms. We
believe this shift has benefited us as there is more shelf space on digital
platforms and, therefore, fewer channel constraints.
5
Additionally, technological advances allow digital consumers to not only
order programs on a PPV basis, but also to choose VOD and SVOD. VOD differs from
traditional PPV in that it allows consumers to purchase a specific movie or
program for viewing, at a time selected by the viewer, for a limited duration of
time (typically 24 hours) and with DVD-like functionality. By contrast, SVOD
provides consumers with unlimited "on-demand" access to a menu of programs from
our featured libraries at a monthly, automatically renewable, subscription
price. The basic premise of both VOD and SVOD is that consumers have a number of
options and can choose to buy a program "on-demand" without having to adhere to
the schedule of a programmed network, and, in the case of SVOD, for a fixed
subscription price which does not vary based on consumption. MSOs, looking to
take advantage of the consumer benefits provided by VOD and SVOD, are currently
in the process of supplanting traditional linear networks and PPV services with
VOD and SVOD platforms. We are seeking to obtain a leading position in this new
phase of technology by leveraging the power of our brand names, our large
library of original programming and our relationships and agreements with
leading adult studios. We currently distribute VOD programming through 12 cable
operators and Playboy TV SVOD programming through two operators and are in the
process of negotiating agreements with the remaining operators. Overall, growth
of "on-demand" technology will be dependent on a number of factors, including,
but not limited to, operator investment, server/bandwidth capacity and consumer
acceptance. In 2005, Kagan reported total VOD and SVOD households of
approximately 23.9 million and projects an average annual increase of
approximately 19% from 2006 through 2008.
Our agreements with cable and DTH operators are renewed or renegotiated
from time to time in the ordinary course of business. In some cases, following
the expiration of an agreement, the respective operator and we agree to continue
to operate under the terms of the expired agreement until a new agreement is
negotiated. In any event, our agreements with MSOs and DTH operators generally
may be terminated on short notice without penalty.
International
We currently own and operate or license 23 Playboy-, Spice- and
locally-branded TV and movie networks. These include our television networks in
the United Kingdom, which are further distributed through DTH and cable
television throughout greater Europe. Additionally, we have networks in South
East Asia, Australia, New Zealand and Israel. Also, we have equity interests in
seven networks in Japan, Latin America, Brazil and Iberia through joint
ventures. We hold a 19.9% ownership interest in Playboy Channel Japan and a
local adult service, The Ruby Channel. These international networks are
generally available on both a PPV and monthly subscription basis. At December
31, 2005, our international TV networks were available in approximately 44.3
million household units outside of the United States and Canada, compared to
approximately 40.5 million household units at December 31, 2004. The increase in
household units is primarily due to new affiliate launches and growth in
existing markets. These networks principally carry U.S.-originated content,
which is subtitled or dubbed and complemented by local content. We also generate
revenues by licensing programming rights to our extensive library of content to
broadcasters internationally.
We own a 19.0% interest in Playboy TV-Latin America, LLC, or PTVLA, a
joint venture with Claxson Interactive Group, Inc., or Claxson, which operates
Playboy TV networks in Latin America, Brazil and Iberia, in addition to a local
adult service, Venus, in Latin America and Brazil. In these markets, PTVLA
operates four networks, distributes Spice Live and licenses content from the
Playboy library to broadcasters in the territory. Under the terms of our amended
PTVLA operating agreement, Claxson has management control of PTVLA, although we
have significant management influence. We provide both programming and the use
of our trademarks directly to PTVLA in return for 17.5% of the venture's net
revenues with a guaranteed annual minimum. The term of the program supply and
trademark agreement for PTVLA expires in 2012, unless terminated earlier in
accordance with the terms of the agreement. PTVLA provides the feed for Playboy
TV en Espanol and we pay PTVLA a 20% distribution fee for that feed based on the
network's net revenues in the United States Hispanic market. Neither Claxson nor
we are obligated to make any additional capital contributions to the PTVLA
venture. If the management committee of PTVLA determines that additional capital
is necessary for the conduct of PTVLA's business, we would have the option to
contribute our pro rata share of additional capital. We have an option to
purchase up to 49.9% of PTVLA at fair market value through December 23, 2012. In
addition, we have the option to purchase the remaining 50.1% of PTVLA at fair
market value, exercisable at any time during the period beginning December 23,
2007, and ending December 23, 2008, so long as we have previously or
concurrently exercised the 49.9% buy-up option. We have the option to pay the
purchase price for the 49.9% buy-up option in cash, shares of our Class B
6
common stock, or Class B stock, or a combination of cash and Class B stock.
However, if we exercise both options concurrently, we must use cash to pay the
entire purchase price for both options.
We seek the most appropriate and profitable manner in which to build on
the powerful Playboy and Spice brands in each international market. In addition,
we seek to generate synergies among our networks by combining operations where
practicable, through innovative programming and scheduling, through joint
programming acquisitions and by coordinating and sharing marketing activities
and materials efficiently throughout the territories in which our programming is
aired. We also look to develop and establish relationships with international
production companies on a local level in order to create original international
product for distribution to our various owned and licensed networks.
We believe we can grow our international television business through (a)
expanding the distribution reach of existing networks, (b) launching and
operating additional networks in existing and new markets and (c) increasing
subscription penetration and buy rates driven by new programming and scheduling
tactics as well as more targeted marketing activities. We also expect that the
continued roll out of digital in addressable households in our existing
international markets will favorably impact our growth.
We also have an international Internet presence providing compelling
content specifically tailored to individual international audiences. We
currently license Playboy sites internationally. Many of our international
websites have local editorial staffs that develop original adult-oriented
content, make use of content from the local edition of Playboy magazine and
translate appropriate Playboy.com content from our domestic website. We have
also entered into deals to provide content to wireless customers in over 30
countries. Demand for content delivered to wireless devices continues to grow as
wireless technology expands consumers' options.
Online Subscriptions
Domestically, we offer multiple subscription-based websites and two online
VOD theaters under the Playboy and Spice brands. Subscriptions will remain the
largest of our online revenue streams in 2006.
We currently offer four premium clubs with monthly prices ranging from
$19.95 to $29.95 and annual prices ranging from $95.40 to $179.40. Our largest
club, Playboy Cyber Club, offers access to over 100,000 photos, including
Playboy.com's Cyber Girls, many special features on Playmates, celebrities and
co-eds and an extensive archive of Playboy magazine interviews. The Playboy TV
Jukebox leverages our television and video assets and is geared toward giving
the broadband Internet user a unique and high-quality experience. The PlayboyNET
and SpiceNet clubs consist of pictorials and video clips organized by thematic
interests.
The Playboy Daily is a sampling that is updated daily and offered for
$12.00 a year. This is used as a marketing tool to introduce users to the world
of Playboy and to promote our higher-priced premium subscription offerings.
We also offer various reality clubs through our affiliate websites with
prices of $38.80, $58.80 and $95.76 for monthly, three-month and annual
subscriptions, respectively.
E-commerce
Our Playboy-branded e-commerce website, PlayboyStore.com, is the primary
destination for purchasing Playboy-branded fashions, calendars, DVDs, jewelry,
collectibles, back issues of Playboy magazine and special editions as well as
select non-Playboy-branded products. Our Spice-branded e-commerce website,
SpiceTVStore.com, offers adult-oriented products, including DVDs, lingerie and
sensual products. Our e-commerce business also generates sales from printed
catalog mailings of Playboy, Spice and other products not carrying one of our
brands.
7
Other Businesses
We distribute our original programming domestically in DVD format. We also
distribute various non-Playboy-branded movies and continue to re-package and
re-market our catalog of previously released DVD titles. These DVDs are sold in
video and music stores, other retail outlets, our and other catalogs and online,
including PlayboyStore.com. Image Entertainment, Inc., is the primary
distributor of our DVD products in the United States and Canada. Mammoth
Entertainment distributes our titles throughout Europe, Asia and South America.
The free area of the Playboy.com website is designed with a goal of
converting visitors to purchasers by directing them to our pay sites while also
generating revenues from outside advertisers. Playboy.com offers original
content and focuses on areas of interest to its target audience, including Arts
& Entertainment, On Campus, World of Playboy and Playmates.
In 2005, we entered into an agreement with SIRIUS Satellite Radio Inc., to
launch a new 24-hour Playboy-branded radio channel in 2006. The channel will
feature all-new and exclusive content and will leverage our entertainment assets
by expanding the Playboy brand on the satellite radio platform. We expect the
license fee to exceed our content costs. We also have the opportunity to share
in incremental subscriber and advertiser revenues. This agreement has replaced
our former agreement with XM Satellite Radio Inc.
Our online gaming business currently consists of PlayboySportsBook.com and
PlayboyCasino.com, which are, though a short-term agreement, licensed and
operated by Ladbroke eGaming Ltd. We have jointly implemented safeguards
designed to prevent illegal wagering on our sites.
Competition
Competition among television programming providers is intense for both
channel space and viewer spending. Our competition varies in both the type and
quality of programming offered, but consists primarily of other premium pay
services, such as general-interest premium channels and other adult movie pay
services. We compete with the other pay services as we (a) attempt to obtain or
renew carriage with DTH operators and individual cable affiliates, (b) negotiate
fee arrangements with these operators, (c) negotiate for VOD and SVOD rights and
(d) market our programming to consumers through these operators. Over the past
several years, all of the competitive factors described above have adversely
impacted us, as has consolidation in the DTH and cable systems industries, which
has resulted in fewer, but larger, operators. The availability of, and price
pressure from, more explicit content on the Internet and more pay television
options, both mainstream and adult, also present a significant competitive
challenge.
While there can be no assurance that we will be able to maintain our
current DTH and cable carriage or fee structures or maintain or grow our
viewership in the face of this competition, we believe that strong Playboy and
Spice brand recognition, the quality of our original programming and our ability
to appeal to a broad range of adult audiences are critical factors which
differentiate our networks from other providers of adult programming. Also, to
optimize revenue potential, we are encouraging DTH and cable operators to market
the full range of PPV, VOD, SVOD and monthly subscription options to consumers
and to offer our services in high-definition format.
Internationally, we experience even more significant competitive
challenges. Competition abroad results from both the availability of more
explicit adult content on free television that is much more prevalent,
specifically in Europe, than in the U.S., and competitive pay services. In the
U.K., six of our seven networks compete with a total of 34 other adult networks,
and in Japan, our two channels compete with 24 adult networks. There are often
low barriers to entry, which yield increasing competition, especially from
companies in Asia and parts of Europe providing "home grown" content as opposed
to dubbed American programs.
The Internet industry is highly competitive, and we continue to compete
for visitors, subscribers, shoppers and advertisers. We believe that the primary
competitive factors affecting our Internet operations include brand recognition,
the quality of our content and products, technology, including the number of
broadband homes, pricing, ease of use, sales and marketing efforts and consumer
demographics. We believe that we compete favorably with respect to each of these
factors. Additionally, we have the advantage of leveraging the power of the
Playboy and
8
Spice brands in multiple media with our content libraries and marketing to loyal
audiences. However, the availability of free content on the Internet continues
to provide competitive challenges for operators of pay sites.
PUBLISHING GROUP
Our Publishing Group operations include the publication of Playboy
magazine, as well as other domestic publishing businesses, including special
editions, books and calendars and the licensing of international editions of
Playboy magazine.
Playboy Magazine
Founded by Hugh M. Hefner, Editor-In-Chief and Chief Creative Officer, or
Mr. Hefner, in 1953, Playboy magazine continues to be the best-selling monthly
men's magazine in the United States and in the world, based on the combined
circulation of the U.S. and international editions. Circulation of the U.S.
edition is approximately 3.0 million copies monthly. Combined average
circulation of the 20 licensed international editions is approximately 1.0
million copies monthly. According to Fall 2005 data published by Mediamark
Research, Inc., or MRI, an independent market research firm, approximately one
in every eight men in the United States aged 18 to 34 reads the U.S. edition of
Playboy magazine.
Playboy magazine plays a key role in driving the continued popularity and
recognition of the Playboy brand. Playboy magazine is a general-interest
magazine, targeted to men, with a reputation for excellence founded on providing
high-quality photography, entertainment and articles on current issues,
interests and trends. Playboy magazine consistently includes in-depth, candid
interviews with high profile political, business, entertainment and sports
figures; pictorials of famous women; and content by leading authors, including
the following:
Interviews Pictorials Leading Authors
-------------- ----------------- ------------------
Halle Berry Pamela Anderson Jimmy Breslin
George Clooney Drew Barrymore William F. Buckley
Bill Gates Cindy Crawford Ethan Coen
Tommy Hilfiger Carmen Electra Michael Crichton
Michael Jordan Daryl Hannah David Halberstam
Nicole Kidman Rachel Hunter Norman Mailer
Jimmy Kimmel Elle Macpherson Jay McInerney
Les Moonves Jenny McCarthy Joyce Carol Oates
Jack Nicholson Denise Richards Scott Turow
Donald Trump Anna Nicole Smith John Updike
Jesse Ventura Katarina Witt Kurt Vonnegut
Playboy magazine has long been known for its quality of photography,
editorial content and illustration in publishing the work of top photographers,
writers and artists. Playboy magazine also features lifestyle articles on
consumer products, fashion, automobiles and consumer electronics and covers the
worlds of sports and entertainment. Three years ago, Playboy magazine was
redesigned to appeal to new, young readers while maintaining our existing
subscriber base. Literary and libertarian, Playboy magazine continues to upend
convention and delight its audience with a varied mix of elements, as it has for
over 50 years.
The net circulation revenues of the U.S. edition of Playboy magazine for
2005, 2004 and 2003 were $59.9 million, $65.2 million and $65.9 million,
respectively. Net circulation revenues are gross revenues less commissions,
discounts and provisions for newsstand returns, display costs and unpaid
subscriptions. Circulation revenue comparisons may be materially impacted with
respect to newsstand sales in any period based on sales of issues featuring
major celebrities.
According to the Audit Bureau of Circulations, or ABC, an independent
audit agency, for the six months ended December 31, 2005, Playboy magazine was
the 13th highest-ranking U.S. consumer publication, with a circulation rate base
(the total subscription and newsstand circulation guaranteed to advertisers) of
3.15 million. Playboy magazine's circulation rate base for the same period was
larger than each of GQ, Esquire, FHM and
9
Maxim. Our actual circulation for the six months ended December 31, 2005 was
4.6% below our circulation rate base. As the cost of acquiring new subscribers
to maintain that rate base was uneconomical, effective with the January 2006
issue of Playboy magazine, we adjusted, for the first time in ten years, the
magazine's circulation rate base to 3.0 million, a 4.8% decrease.
Playboy magazine has historically generated approximately two-thirds of
its revenues from subscription and newsstand circulation, with the remainder
primarily from advertising. Subscription copies represent approximately 91% of
total copies sold. We believe that managing Playboy's circulation to be
primarily subscription driven provides a stable and desirable circulation base,
which is attractive to advertisers. According to MRI, the median age of male
Playboy readers is 33, with a median annual household income of approximately
$58,000, a demographic that we believe is also attractive to advertisers. We
also derive revenues from the rental of Playboy magazine's subscriber list.
We attract new subscribers to Playboy magazine through our own direct mail
advertising campaigns, subscription agent campaigns and the Internet, including
the Playboy.com website. We recognize revenues from magazine subscriptions over
the terms of the subscriptions. Subscription copies of the magazine are
delivered through the U.S. Postal Service as periodical mail. We attempt to
contain these costs through presorting and other methods.
Playboy magazine launched a digital edition beginning with the October
2005 issue, in conjunction with Zinio Systems, Inc., the recognized leader in
digital publishing and marketing services. Each month, digital copies are
delivered to subscribers via the Internet.
Playboy magazine is one of the highest priced magazines in the United
States. The basic U.S. newsstand cover price was $4.99 ($5.99 for the December
2005 and January 2006 holiday issues) and the basic Canadian newsstand cover
price was CAN$6.99 (CAN$7.99 for the December 2005 and January 2006 holiday
issues). We generally increase the newsstand cover price by $1.00 when there is
a feature of special appeal. We price test from time to time and, effective with
the February 2006 issue, raised the U.S. and Canadian newsstand cover prices by
$1.00 and CAN$1.00, respectively.
Playboy magazine targets a wide range of advertisers. Advertising by
category, as a percent of total advertising pages, and the total number of
advertising pages for the last three years were as follows:
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
Category 12/31/05 12/31/04 12/31/03
------------------------------------------------------------------------------
Retail/Direct mail 27% 22% 25%
Beer/Wine/Liquor 22 23 20
Tobacco 10 17 19
Home electronics 6 8 8
Automotive 6 7 4
Personal hygiene/Haircare 6 4 2
Toiletries/Cosmetics 4 3 3
All other 19 16 19
------------------------------------------------------------------------------
Total 100% 100% 100%
==============================================================================
Total advertising pages 479 573 555
==============================================================================
We continue to focus on securing new advertisers, including expanding
advertising from underserved categories. The net advertising revenues of the
U.S. edition of Playboy magazine for 2005, 2004 and 2003 were $29.5 million,
$36.2 million and $36.1 million, respectively. Net advertising revenues are
gross revenues less advertising agency commissions, frequency and cash discounts
and rebates. We publish the U.S. edition of Playboy magazine in 15 advertising
editions: one upper income zip-coded, eight regional, two state and four
metropolitan editions. All contain the same editorial material but provide
targeting opportunities for advertisers. We implemented 8% and 4% cost per
thousand increases in advertising rates effective with the January 2006 and
January 2005 issues, respectively.
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Levels of advertising revenues may be affected by, among other things,
increased competition for and decreased spending by advertisers, general
economic activity and governmental regulation of advertising content, such as
tobacco products. However, since only approximately one-third of Playboy
magazine's revenues and less than 10% of the Company's total revenues are from
Playboy magazine advertising, we are not overly dependent on this source of
revenue.
Playboy magazine subscriptions are serviced by Communications Data
Services, Inc., or CDS. Pursuant to a subscription fulfillment agreement, CDS
performs a variety of services, including (a) processing orders or transactions,
(b) receiving, verifying, balancing and depositing payments from subscribers,
(c) printing forms and promotional materials, (d) maintaining master files on
all subscribers, (e) issuing bills and renewal notices to subscribers, (f)
issuing labels, (g) resolving customer service complaints as directed by us and
(h) furnishing various reports that enable us to monitor all aspects of the
subscription operations. The term of the current agreement with CDS has been
extended to June 30, 2006, and we are in negotiations to further extend the
agreement. Either party may terminate the agreement prior to expiration in the
event of material nonperformance by, or insolvency of, the other party. We pay
CDS specified fees and charges based on the types and amounts of service
performed under the agreement. The fees and charges increase annually based on
the consumer price index, to a maximum of six percent in one year. CDS's
liability to us for a breach of its duties under the agreement is limited to
actual damages of up to $140,000 per event of breach, except in cases of willful
breach or gross negligence, in which case the limit is $280,000. The agreement
provides for indemnification by CDS of our shareholders and us against claims
arising from actions or omissions by CDS in compliance with the terms of the
agreement or in compliance with our instructions.
Domestic distribution of Playboy magazine and special editions to
newsstands and other retail outlets is accomplished through Time/Warner Retail
Sales and Marketing, or TWRSM, our national distributor. The issues are shipped
in bulk to wholesalers, who are responsible for local retail distribution. We
receive a substantial cash advance from TWRSM 30 days after the date each issue
goes on sale. We recognize revenues from newsstand sales based on estimated copy
sales at the time each issue goes on sale and adjust for actual sales upon
settlement with TWRSM. These revenue adjustments are not material. Retailers
return unsold copies to wholesalers, who count and then shred the returned
copies and report the returns by affidavit. The number of copies sold on
newsstands varies from month to month, depending in part on consumer interest in
the cover, the pictorials and the editorial features. Our current agreement with
TWRSM expires with the April 2006 issue of Playboy magazine. We are currently in
negotiations to extend this agreement.
Playboy magazine and special editions are printed at Quad/Graphics, Inc.,
or Quad, at a single site located in Wisconsin, which ships the product to
subscribers and wholesalers. The print run varies each month based on expected
sales and is determined with input from TWRSM. Paper is the principal raw
material used in the production of these publications. We use a variety of types
of high-quality coated and uncoated paper that is purchased from a number of
suppliers.
Magazine publishing companies face intense competition for readers,
advertising and newsstand shelf space. Magazines and Internet sites primarily
aimed at men are Playboy magazine's principal competitors. Other types of media
that carry advertising, such as television, radio and newspapers, also compete
with Playboy magazine for advertising revenues.
Other Domestic Publishing
Our Publishing Group has also created media extensions, such as special
editions and calendars, which are primarily sold in newsstand outlets. We
published 25 special editions in each of 2005, 2004 and 2003, and we expect to
publish the same number in 2006. Due to successful price testing, which we
undertake from time to time, effective with the two issues on newsstands in
November 2005, the U.S. special editions newsstand cover price increased to
$8.99 from $7.99 and the Canadian special editions newsstand cover price
increased to CAN$9.99 from CAN$8.99. No cover price increases are currently
planned for 2006. Other domestic publishing also includes the production of
calendars and licensing rights to third parties to publish books for which we
receive royalties.
11
International Publishing
We license the right to publish 20 international editions of Playboy
magazine to local partners in the following countries: Argentina, Brazil,
Bulgaria, Croatia, the Czech Republic, France, Germany, Greece, Hungary, Japan,
Mexico, the Netherlands, Poland, Romania, Russia, Serbia, Slovakia, Slovenia,
Spain and Ukraine. Combined average circulation of the international editions is
approximately 1.0 million copies monthly.
Local publishing licensees tailor their international editions by mixing
the work of their national writers and artists with editorial and pictorial
material from the U.S. edition. We monitor the content of the international
editions so that they retain the distinctive style, look and quality of the U.S.
edition while meeting the needs of their respective markets. The license
agreements vary but, in general, are for terms of three to five years and carry
a guaranteed minimum royalty as well as a formula for computing earned royalties
in excess of the minimum. Royalty computations are based on both circulation and
advertising revenues. The German and Brazilian editions accounted for
approximately one-half of our total revenues from international editions in
2005, 2004 and 2003.
LICENSING GROUP
Our Licensing Group includes the licensing of consumer products carrying
one or more of our trademarks and/or images, Playboy-branded retail stores,
location-based entertainment destinations and certain revenue generating
marketing activities.
We license the Playboy name, the Rabbit Head Design and other images,
trademarks and artwork as well as the Spice name and trademarks for the
worldwide manufacture, sale and distribution of a variety of consumer products.
We work with licensees to develop, market and distribute high-quality Playboy-
and Spice-branded merchandise. Our licensed product lines include men's and
women's apparel, men's underwear and women's lingerie, accessories,
collectibles, cigars, watches, jewelry, fragrances, shoes, luggage, bath and
body products, small leather goods, stationery, music, eyewear, barware, home
fashions and slot machines. The group also licenses art-related products based
on our extensive collection of artwork, most of which were commissioned as
illustrations for Playboy magazine. Occasionally, we sell small portions of our
art and memorabilia collection through auction houses such as Butterfields,
Christie's and Sotheby's. Products are marketed primarily through retail outlets
that include department and specialty stores. Our first Playboy concept store,
located in an upscale Tokyo shopping district and funded by one of our
licensees, opened in 2002. It offers a full collection of Playboy-branded
fashion and accessories for men and women, as well as other Playboy-branded
products. Similarly, we opened three additional licensed stores in 2005, in Las
Vegas, Melbourne and Hong Kong. We expect to open three more stores in 2006.
We continually seek to license our brand name and images in order to enter
new markets and retail categories. In 2005, we launched our first foray into the
video game business with the release of Playboy: The Mansion. The
state-of-the-art game allows users to simulate the building of the Playboy
Empire into a powerful business brand and pursue the ultimate Playboy lifestyle
through traditional video game social role-playing and empire building.
We have recently expanded our licensing activities to include
location-based entertainment destinations. In 2004, we announced our
participation in location-based entertainment ventures that are currently being
developed in Las Vegas and Shanghai. In both cases, our venture partners are
providing the funding for the projects and we are contributing the Playboy brand
and trademarks and our marketing expertise. The Las Vegas project, located in
the new tower currently under construction at the Palms Casino Resort, will
include a nightclub, a boutique casino and lounge, a retail store and a sky
villa. We project the Las Vegas venture to open during the third quarter of
2006. The Shanghai project will feature restaurants, lounges, a cabaret, a
disco, a spa and a boutique.
While our branded products are unique, we operate in an intensely
competitive business that is extremely sensitive to economic conditions and
shifts in consumer buying habits or fashion and lifestyle trends, as well as
changes in the global retail sales environment.
Company-wide marketing operations consist of Alta Loma Entertainment, the
Playboy Jazz Festival and Playmate Promotions. Alta Loma Entertainment functions
as a production company that leverages our assets, including editorial material,
as well as icons such as the Playmates, the Playboy Mansion and Mr. Hefner, to
develop
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original programming for other television networks. We have produced the Playboy
Jazz Festival on an annual basis in Los Angeles at the Hollywood Bowl since June
1979 and continue our sponsorship of related community events. Playmate
Promotions represents the Playmates in advertising campaigns, trade shows,
endorsements, commercials, motion pictures, television and videos for us and for
outside clients. These businesses are primarily brand builders and are operated
at approximately a break-even level of profitability.
SEASONALITY
Our businesses are generally not seasonal in nature. Revenues and
operating results for the quarter ended December 31, however, are typically
impacted by higher newsstand cover prices of holiday issues. These higher
prices, coupled with typically higher sales of subscriptions of Playboy magazine
during that quarter, also result in an increase in accounts receivable.
E-commerce revenues and operating results are typically impacted by the holiday
buying season, and online subscription revenues and operating results are
impacted by decreased Internet traffic during the summer months.
PROMOTIONAL AND OTHER ACTIVITIES
We believe that our sales of products and services are enhanced by the
public recognition of the Playboy brand as symbolizing a lifestyle. In order to
establish public recognition, we, among other activities, purchased in 1971 the
Playboy Mansion in Los Angeles, California, where Mr. Hefner lives. The Playboy
Mansion is used for various corporate activities, including serving as a
valuable location for television production, magazine photography and for
online, advertising, marketing and sales events. It also enhances our image, as
we host many charitable and civic functions. The Playboy Mansion generates
substantial publicity and recognition, which increases public awareness of us
and our products and services. As indicated in Part II. Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations," or
MD&A, and Part III. Item 13. "Certain Relationships and Related Transactions,"
Mr. Hefner pays us rent for that portion of the Playboy Mansion used exclusively
for his and his personal guests' residence as well as for the per-unit value of
non-business meals, beverages and other benefits received by him and his
personal guests. The Playboy Mansion is included in our Consolidated Balance
Sheet at December 31, 2005, at a net book value of $1.5 million, including all
improvements and after accumulated depreciation. We incur all operating expenses
of the Playboy Mansion, including depreciation and taxes, which were $3.1
million, $3.0 million and $2.3 million for 2005, 2004 and 2003, respectively,
net of rent received from Mr. Hefner.
The Playboy Foundation provides financial support to many not-for-profit
organizations and projects throughout the country concerned with issues
historically of importance to Playboy magazine and its readers, including
anti-censorship efforts, civil rights, AIDS education, prevention and research,
reproductive freedom and women's leadership activities.
Our trademarks and copyrights are critical to the success and growth
potential of all of our businesses. We actively protect and defend our
trademarks and copyrights throughout the world and monitor the marketplace for
counterfeit products. Consequently, we defend our trademarks by initiating legal
proceedings, when warranted, to prevent their unauthorized use.
EMPLOYEES
We employed 725 full-time employees at February 28, 2006. This compares to
657 at February 28, 2005. No employees are represented by collective bargaining
agreements. We believe we maintain a satisfactory relationship with our
employees.
AVAILABLE INFORMATION
We make available free of charge on our website,
www.playboyenterprises.com, our annual, quarterly and current reports, and, if
applicable, amendments to those reports, filed or furnished pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934, or the Exchange Act, as soon
as reasonably practicable after we electronically file such material with, or
furnish it to, the United States Securities and Exchange Commission, or SEC.
13
Also posted on our website are the charters of the Audit Committee and
Compensation Committee of our Board of Directors, our Code of Business Conduct
and our Corporate Governance Guidelines. Copies of these documents are available
free of charge by sending a request to Investor Relations, Playboy Enterprises,
Inc., 680 North Lake Shore Drive, Chicago, Illinois 60611.
Item 1A. Risk Factors
In addition to the other information contained in this Annual Report on
Form 10-K, the following risk factors should be carefully considered in
evaluating our business and us.
We may not be able to protect our intellectual property rights.
We believe that our trademarks, particularly the Playboy name and Rabbit
Head Design, and other proprietary rights are critical to our success, growth
potential and competitive position. Accordingly, we devote substantial resources
to the establishment and protection of our trademarks and proprietary rights.
Our actions to establish and protect our trademarks and other proprietary
rights, however, may not prevent imitation of our products by others or prevent
others from claiming violations of their trademarks and proprietary rights by
us. Any infringement or related claims, even if not meritorious, may be costly
and time consuming to litigate, may distract management from other tasks of
operating the business and may result in the loss of significant financial and
managerial resources, which could harm our business, financial condition or
operating results. These concerns are particularly relevant with regard to those
international markets, such as China, in which it is especially difficult to
enforce intellectual property rights.
Failure to maintain our agreements with MSOs and DTH operators on
favorable terms could adversely affect our business, financial condition or
results of operations.
We currently have agreements with the nation's six largest MSOs. We also
have agreements with the principal DTH operators in the United States and
Canada. Our agreements with these operators may be terminated on short notice
without penalty. If one or more MSOs or DTH operators terminate or do not renew
these agreements, or do not renew them on terms as favorable as those of current
agreements, our business, financial condition or results of operations could be
materially adversely affected.
In addition, competition among television programming providers is intense
for both channel space and viewer spending. Our competition varies in both the
type and quality of programming offered, but consists primarily of other premium
pay services, such as general-interest premium channels and other adult movie
pay services. We compete with other pay services as we attempt to obtain or
renew carriage with DTH operators and individual cable affiliates, negotiate fee
arrangements with these operators, negotiate for VOD and SVOD rights and market
our programming through these operators to consumers. The competition with
programming providers has intensified as a result of consolidation in the DTH
and cable systems industries, which has resulted in fewer, but larger operators.
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 of agreements, cancellation of fee arrangements or pressure on
margin splits with operators of these systems could adversely affect our
business, financial condition or results of operations.
Limits on our access to satellite transponders could adversely affect our
business, financial condition or results of operations.
Our cable television and DTH operations require continued access to
satellite transponders to transmit programming to cable or DTH operators.
Material limitations on our access to these systems or satellite transponder
capacity could materially adversely affect our business, financial condition or
results of operations. Our access to transponders may be restricted or denied
if:
o we or the satellite owner are/is indicted or otherwise charged
as a defendant in a criminal proceeding;
o the Federal Communications Commission issues an order
initiating a proceeding to revoke the satellite owner's
authorization to operate the satellite;
14
o the satellite owner is ordered by a court or governmental
authority to deny us access to the transponder;
o we are deemed by a governmental authority to have violated any
obscenity law; or
o our satellite transponder providers fail to provide the
required services.
In addition to the above, the access of Playboy TV, Spice and our other
networks to transponders may be restricted or denied if a governmental authority
commences an investigation or makes an adverse finding concerning the content of
their transmissions. Technical failures may also affect our satellite
transponder providers' ability to deliver transmission services.
We are subject to risks resulting from our operations outside the United
States, and we face additional risks and challenges as we continue to expand
internationally.
The international scope of our operations may contribute to volatile
financial results and difficulties in managing our business. For the year ended
December 31, 2005, we derived approximately 27% of our consolidated revenues
from countries outside the United States. Our international operations expose us
to numerous challenges and risks, including, but not limited to, the following:
o adverse political, regulatory, legislative and economic
conditions in various jurisdictions;
o costs of complying with varying governmental regulations;
o fluctuations in currency exchange rates;
o difficulties in developing, acquiring or licensing programming
and products that appeal to a variety of different audiences
and cultures;
o scarcity of attractive licensing and joint venture partners;
o the potential need for opening and managing distribution
centers abroad; and
o difficulties in protecting intellectual property rights in
foreign countries.
In addition, important elements of our business strategy, including
capitalizing on advances in technology, expanding distribution of our products
and content and leveraging cross-promotional marketing capabilities, involve a
continued commitment to expanding our business internationally. This
international expansion will require considerable management and financial
resources.
We cannot assure you that one or more of these factors or the demands on
our management and financial resources would not harm any current or future
international operations and our business as a whole.
Any inability to identify, fund investment in and commercially exploit new
technology could have a material adverse impact on our business, financial
condition or results of operations.
We are engaged in a business that has experienced significant
technological change over the past several years and is continuing to undergo
technological change. Our ability to implement our business plan and to achieve
the results projected by management will depend on management's ability to
anticipate technological advances and implement strategies to take advantage of
technological change. Any inability to identify, fund investment in and
commercially exploit new technology or the commercial failure of any technology
that we pursue, such as VOD and SVOD, could result in our business becoming
burdened by obsolete technology and could have a material adverse impact on our
business, financial condition or results of operations.
The online subscription portion of our Entertainment Group may be
adversely affected by our failure to implement our business model or to satisfy
consumers, by the impact of free content and by any decline in use of the
Internet.
Our online subscription business model relies on expanding our online
subscriber base and increasing revenue per subscriber by selling premium content
to our online subscribers. There can be no assurance that we will be able to
provide the pricing and content necessary to attract new or retain existing
subscribers and operate the online portion of our Entertainment Group
profitably.
15
The Internet industry is highly competitive. If we fail to continue to
develop and introduce new content, features, functions or services effectively
or fail to improve the consumer experience, our business, financial condition or
results of operations could be materially adversely affected.
To the extent free or low-cost adult content on the Internet continues to
be available or increases, it may negatively affect our ability to attract
subscribers and other fee-paying customers.
If use of the Internet declines or fails to grow as projected, we may not
realize the expected benefits of our investments in the online business.
Internet usage may be inhibited by, among other factors:
o inadequate Internet infrastructure;
o unwillingness of customers to shift their purchasing to online
vendors;
o security and privacy concerns;
o the lack of compelling content;
o problems relating to the development of the required
technology infrastructure; and
o insufficient availability of cost-effective, high-speed
service.
Our online operations are subject to security risks and systems failures.
Online security breaches could materially adversely affect our business,
financial condition or results of operations. Any well-publicized compromise of
security could deter use of the Internet in general or use of the Internet to
conduct transactions that involve transmitting confidential information or
downloading sensitive materials in particular. In offering online payment
services, we may increasingly rely on technology licensed from third parties to
provide the security and authentication necessary to effect secure transmission
of confidential information such as customer credit card numbers. Advances in
computer capabilities, new discoveries in the field of cryptography or other
developments could compromise or breach the algorithms that we use to protect
our customers' transaction data. If third parties are able to penetrate our
network security or otherwise misappropriate confidential information, we could
be subject to liability, which could result in litigation. In addition,
experienced programmers or "hackers" may attempt to misappropriate proprietary
information or cause interruptions in our services that could require us to
expend significant capital and resources to protect against or remediate these
problems. Increased scrutiny by regulatory agencies, such as the Federal Trade
Commission and state agencies, of the use of customer information could also
result in additional expenses if we are obligated to reengineer systems to
comply with new regulations or to defend investigations of our privacy
practices.
The uninterrupted performance of our computer systems is critical to the
operations of our Internet sites. Our computer systems are located at Level 3
Communications in Chicago, Illinois, and, as such, may be vulnerable to fire,
loss of power, telecommunications failures and other similar catastrophes. In
addition, we may have to restrict access to our Internet sites to solve problems
caused by computer viruses or other system failures. Our customers may become
dissatisfied by any disruption or failure of our computer systems that
interrupts our ability to provide our content. Repeated system failures could
substantially reduce the attractiveness of our Internet sites and/or interfere
with commercial transactions, negatively affecting our ability to generate
revenues. Our Internet sites must accommodate a high volume of traffic and
deliver regularly-updated content. Our sites have, on occasion, experienced slow
response times and network failures. These types of occurrences in the future
could cause users to perceive our websites as not functioning properly and
therefore induce them to frequent Internet sites other than ours. We are also
subject to risks from failures in computer systems other than our own because
our customers depend on their own Internet service providers for access to our
sites. Our revenues could be negatively affected by outages or other
difficulties customers experience in accessing our Internet sites due to
Internet service providers' system disruptions or similar failures unrelated to
our systems. Our insurance policies may not adequately compensate us for any
losses that may occur due to any failures in our Internet systems or the systems
of our customers' Internet service providers.
Piracy of our television networks, programming and photographs could
materially reduce our revenues and adversely affect our business, financial
condition or results of operations.
The distribution of our subscription programming by MSOs and DTH operators
requires the use of encryption
16
technology to assure that only those who pay can receive programming. It is
illegal to create, sell or otherwise distribute mechanisms or devices to
circumvent that encryption. Nevertheless, theft of subscription television
programming has been widely reported. Theft of our programming reduces future
potential revenue. In addition, theft of our competitors' programming can also
increase our churn rate. Although MSOs and DTH operators continually review and
update their conditional access technology, there can be no assurance that they
will be successful in developing or acquiring the technology needed to
effectively restrict or eliminate signal theft.
Additionally, the development of emerging technologies, including the
Internet and online services, poses the risk of making piracy of our
intellectual property more prevalent. Digital formats, such as the ones we use
to distribute our programming through MSOs, DTH and the Internet, are easier to
copy, download or intercept. As a result, users can download, duplicate and
distribute unauthorized copies of copyrighted programming and photographs over
the Internet or other media, including DVDs. As long as pirated content is
available, many consumers could choose to download or purchase pirated
intellectual property rather than pay to subscribe to our services or purchase
our products.
National consolidation of the single-copy magazine distribution system may
adversely affect our ability to obtain favorable terms on the distribution of
Playboy magazine and special editions and may lead to declines in profitability
and circulation.
In the past decade, the single-copy magazine distribution system has
undergone dramatic consolidation. According to an economic study released by
Magazine Publishers of America in October 2001, the number of magazine
wholesalers has declined from more than 180 independent distribution owners to
just four large wholesalers that handle 90% of the single-copy distribution
business. Currently, we rely on a single national distributor, TWRSM, for the
distribution of Playboy magazine and special editions to newsstands and other
retail outlets. As a result of this industry consolidation, we face increasing
pressure to lower the prices we charge to wholesalers and increase our
sell-through rates. If we are forced to lower the prices we charge wholesalers,
we may experience declines in revenue. If we are unable to meet targeted
sell-through rates, we may incur greater expenses in the distribution process.
The combination of these factors could negatively impact the profitability and
newsstand circulation for Playboy magazine and special editions.
If we are unable to generate revenues from advertising and sponsorships,
or if we were to lose our large advertisers or sponsors, our business would be
harmed.
If companies perceive Playboy magazine or Playboy.com to be a limited or
ineffective advertising medium, they may be reluctant to advertise in our
products or to be a sponsor of our Company. Our ability to generate significant
advertising and sponsorship revenues depends upon several factors, including,
among others, the following:
o our ability to maintain a large, demographically attractive
subscriber base for Playboy magazine and Playboy.com;
o our ability to offer attractive advertising rates;
o our ability to attract advertisers and sponsors; and
o our ability to provide effective advertising delivery and
measurement systems.
Our advertising revenues are also dependent on the level of spending by
advertisers, which is impacted by a number of factors beyond our control,
including general economic conditions, changes in consumer purchasing and
viewing habits and changes in the retail sales environment. Our existing
competitors, as well as potential new competitors, may have significantly
greater financial, technical and marketing resources than we do. These companies
may be able to undertake more extensive marketing campaigns, adopt aggressive
advertising pricing policies and devote substantially more resources to
attracting advertising customers.
We rely on third parties to service our Playboy magazine subscriptions and
to print and distribute the magazine and special editions. If these third
parties fail to perform, our business could be harmed.
We rely on CDS to service Playboy magazine subscriptions. The magazine and
special editions are printed at Quad at a single site located in Wisconsin,
which ships the product to subscribers and wholesalers. We rely on a
17
single national distributor, TWRSM, for the distribution of Playboy magazine and
special editions to newsstands and other retail outlets. If CDS, Quad or TWRSM
is unable to or does not perform and we are unable to find alternative services
in a timely fashion, our business could be adversely affected.
Increases in paper prices or postal rates could adversely affect our
operating performance.
Paper costs are a substantial component of the manufacturing expenses of
our publishing business and the direct marketing expenses of our online
business. The market for paper has historically been cyclical, resulting in
volatility in paper prices. An increase in paper prices could materially
adversely affect our operating performance unless and until we can pass any
increases through to the consumer.
The cost of postage also affects the profitability of Playboy magazine and
our e-commerce catalog business. An increase in postage rates could materially
adversely affect our operating performance unless and until we can pass the
increase through to the consumer.
If we experience a significant decline in our circulation rate base, our
results could be adversely affected.
According to ABC, Playboy magazine was the 13th highest-ranking U.S.
consumer publication for the six months ended December 31, 2005. Our circulation
is primarily subscription driven, with subscription copies comprising
approximately 91% of total copies sold. If we either experience a significant
decline in subscriptions because we lose existing subscribers or do not attract
new subscribers, our results could be adversely affected.
We may not be able to compete successfully with direct competitors or with
other forms of entertainment.
We derive a significant portion of our revenues from subscriber-based
fees, advertising and licensing, for which we compete with various other media,
including magazines, newspapers, television, radio and Internet websites that
offer customers information and services similar to those that we provide. We
also compete with providers of alternative leisure-time activities and media.
Competition could result in price reductions, reduced margins or loss of market
share, any of which could have a material adverse effect on our business,
financial condition or results of operations.
We face competition on both country and regional levels. In addition, each
of our businesses competes with companies that deliver content through the same
platforms and with companies that operate in different media businesses. Many of
our competitors, including large entertainment and media enterprises, have
greater financial and human resources than we do. We cannot assure you that we
can remain competitive with companies that have greater resources or that offer
alternative entertainment and information options.
Government regulations could adversely affect our business, financial
condition or results of operations.
Our businesses are regulated by governmental authorities in the countries
in which we operate. Because of our international operations, we must comply
with diverse and evolving regulations. Regulation relates to, among other
things, licensing, access to satellite transponders, commercial advertising,
subscription rates, foreign investment, Internet gaming, use of confidential
customer information and content, including standards of decency/obscenity.
Changes in the regulation of our operations or changes in interpretations of
existing regulations by courts or regulators or our inability to comply with
current or future regulations could adversely affect us by reducing our
revenues, increasing our operating expenses and exposing us to significant
liabilities. While we are not able to reliably predict particular regulatory
developments that could affect us adversely, those regulations related to adult
content, the Internet, privacy and commercial advertising illustrate some of the
potential difficulties we face.
o Adult content. Regulation of adult content could prevent us
from making our content available in various jurisdictions or
otherwise have a material adverse effect on our business,
financial condition or results of operations. The governments
of some countries, such as China and India, have sought to
limit the influence of other cultures
18
by restricting the distribution of products deemed to
represent foreign or "immoral" influences. Regulation aimed at
limiting minors' access to adult content could also increase
our cost of operations and introduce technological challenges,
such as by requiring development and implementation of age
verification systems.
o Internet. Various governmental agencies are considering a
number of legislative and regulatory proposals that may lead
to laws or regulations concerning various aspects of the
Internet, including online content, intellectual property
rights, user privacy, taxation, access charges, liability for
third-party activities and jurisdiction. Regulation of the
Internet could materially adversely affect our business,
financial condition or results of operations by reducing the
overall use of the Internet, reducing the demand for our
services or increasing our cost of doing business.
o Regulation of commercial advertising. We receive a significant
portion of our advertising revenues from companies selling
tobacco and alcohol products. For the year ended December 31,
2005, beer/wine/liquor and tobacco represented 22% and 10%,
respectively, of the total advertising pages of Playboy
magazine. Significant limitations on the ability of those
companies to advertise in Playboy magazine or on our Internet
sites because of either legislative, regulatory or court
action could materially adversely affect our business,
financial condition or results of operations. In August 1996,
the Food & Drug Administration announced regulations that
prohibited the publication of tobacco advertisements
containing drawings, colors or pictures. While those
regulations were later held unconstitutional by the Supreme
Court of the United States, future attempts may be made by
other federal agencies to impose similar or other types of
advertising limitations.
Our business involves risks of liability claims for media content, which
could adversely affect our business, financial condition or results of
operations.
As a distributor of media content, we may face potential liability for:
o defamation;
o invasion of privacy;
o negligence;
o copyright or trademark infringement; and
o other claims based on the nature and content of the materials
distributed.
These types of claims have been brought, sometimes successfully, against
broadcasters, publishers, online services and other disseminators of media
content. We could also be exposed to liability in connection with material
available through our Internet sites. Any imposition of liability that is not
covered by insurance or is in excess of insurance coverage could have a material
adverse effect on us. In addition, measures to reduce our exposure to liability
in connection with material available through our Internet sites could require
us to take steps that would substantially limit the attractiveness of our
Internet sites and/or their availability in various geographic areas, which
would negatively affect their ability to generate revenues.
Private advocacy group actions targeted at our content could result in
limitations on our ability to distribute our products and programming and
negatively impact our brand acceptance.
Our ability to operate successfully depends on our ability to obtain and
maintain distribution channels and outlets for our products. From time to time,
private advocacy groups have sought to exclude our programming from local pay
television distribution because of the adult-oriented content of the
programming. In addition, from time to time, private advocacy groups have
targeted Playboy magazine and its distribution outlets and advertisers, seeking
to limit the magazine's availability because of its adult-oriented content. In
addition to possibly limiting our ability to distribute our products and
programming, negative publicity campaigns, lawsuits and boycotts could
negatively affect our brand acceptance and cause additional financial harm by
requiring that we incur significant expenditures
19
to defend our business or by discouraging investors from investing in our
securities.
In pursuing selective acquisitions, we may incur various costs and
liabilities and we may never realize the anticipated benefits of the
acquisitions.
If appropriate opportunities become available, we may acquire businesses,
products or technologies that we believe are strategically advantageous to our
business. Transactions of this sort could involve numerous risks, including:
o unforeseen operating difficulties and expenditures arising
from the process of integrating any acquired business, product
or technology, including related personnel;
o diversion of a significant amount of management's attention
from the ongoing development of our business;
o dilution of existing stockholders' ownership interest in us;
o incurrence of additional debt;
o exposure to additional operational risk and liability,
including risks arising from the operating history of any
acquired businesses;
o entry into markets and geographic areas where we have limited
or no experience;
o loss of key employees of any acquired companies;
o adverse effects on our relationships with suppliers and
customers; and
o adverse effects on the existing relationships of any acquired
companies, including suppliers and customers.
Furthermore, we may not be successful in identifying appropriate
acquisition candidates or consummating acquisitions on terms favorable or
acceptable to us or at all.
When we acquire businesses, products or technologies, our due diligence
reviews are subject to inherent uncertainties and may not reveal all potential
risks. We may therefore fail to discover or inaccurately assess undisclosed or
contingent liabilities, including liabilities for which we may have
responsibility as a successor to the seller or the target company. As a
successor, we may be responsible for any past or continuing violations of law by
the seller or the target company, including violations of decency laws. Although
we generally attempt to seek contractual protections, such as representations
and warranties and indemnities, we cannot be sure that we will obtain such
provisions in our acquisitions or that such provisions will fully protect us
from all unknown, contingent or other liabilities or costs. Finally, claims
against us relating to any acquisition may necessitate our seeking claims
against the seller for which the seller may not indemnify us or that may exceed
the scope, duration or amount of the seller's indemnification obligations.
Our significant debt could adversely affect our business, financial
condition or results of operations.
We have a significant amount of debt. At December 31, 2005, we had total
financing obligations of $115.0 million, all of which consisted of our 3.00%
convertible senior subordinated notes due 2025, or the convertible notes. In
addition, we have a $50.0 million revolving credit facility. At December 31,
2005, there were no borrowings and $9.8 million in letters of credit outstanding
under this facility, resulting in $40.2 million of available borrowings under
this facility.
The amount of our existing and future debt could adversely affect us in a
number of ways, including the following:
o we may be unable to obtain additional financing for working
capital, capital expenditures, acquisitions and general
corporate purposes;
o debt-service requirements could reduce the amount of cash we
have available for other purposes;
o we could be disadvantaged as compared to our competitors, such
as in our ability to adjust to changing market conditions; and
o we may be restricted in our ability to make strategic
acquisitions and to exploit
20
business opportunities.
Our ability to make payments of principal and interest on our debt depends
upon our future performance, general economic conditions and financial, business
and other factors affecting our operations, many of which are beyond our
control. If we are not able to generate sufficient cash flow from operations in
the future to service our debt we may be required, among other things:
o to seek additional financing in the debt or equity markets;
o to refinance or restructure all or a portion of our debt;
and/or
o to sell assets.
These measures might not be sufficient to enable us to service our debt.
In addition, any such financing, refinancing or sale of assets might not be
available on economically favorable terms.
The terms of our existing credit facility impose restrictions on us that
may affect our ability to successfully operate our business.
Our existing credit facility contains covenants that limit our actions.
These covenants could materially and adversely affect our ability to finance our
future operations or capital needs or to engage in other business activities
that may be in our best interests. The covenants limit our ability to, among
other things:
o incur or guarantee additional indebtedness;
o repurchase capital stock;
o make loans and investments;
o enter into agreements restricting our subsidiaries' abilities
to pay dividends;
o create liens;
o sell or otherwise dispose of assets;
o enter new lines of business;
o merge or consolidate with other entities; and
o engage in transactions with affiliates.
The credit facility also contains financial covenants requiring us to
maintain specified minimum net worth and interest coverage ratios.
Our ability to comply with these covenants and requirements may be
affected by events beyond our control, such as prevailing economic conditions
and changes in regulations, and if such events occur, we cannot be sure that we
will be able to comply.
We depend on our key personnel.
We believe that our ability to successfully implement our business
strategy and to operate profitably depends on the continued employment of some
of our senior management team. If these members of the management team become
unable or unwilling to continue in their present positions, our business,
financial condition or results of operations could be materially adversely
affected.
Ownership of Playboy Enterprises, Inc., is concentrated.
As of December 31, 2005, Mr. Hefner beneficially owned 69.53% of our Class
A common stock. As a result, given that our Class B stock is nonvoting, Mr.
Hefner possesses influence on matters including the election of directors as
well as transactions involving a potential change of control. Mr. Hefner may
support, and cause us to pursue, strategies and directions with which holders of
our securities disagree. The concentration of our share ownership may delay or
prevent a change in control, impede a merger, consolidation, takeover, or other
transaction involving us or discourage a potential acquirer from making a tender
offer or otherwise attempting to obtain control of us.
21
Future sales or issuances of equity could depress the market price of our
common stock and be dilutive and affect our ability to raise funds through
equity issuances.
If our stockholders sell substantial amounts of our common stock or if we
issue substantial additional amounts of our equity securities, or if there is a
belief that such sales or issuances could occur, the market price of our common
stock could fall. These factors could also make it more difficult for us to
raise funds through future offerings of equity securities. In July 2001, we
acquired The Hot Network, The Hot Zone and the related television assets of
Califa Entertainment Group, Inc., or Califa, and the Vivid TV network and
related television assets of V.O.D., Inc., or VODI, which we refer to as the
Califa acquisition. In connection with the Califa acquisition, we are obligated
to make remaining payments totaling approximately $19.8 million over the next
six years. We have the option to pay up to $14.0 million of these scheduled
payments in cash or shares of our Class B stock. In addition, we may be
obligated to pay cash or issue additional shares to the sellers in the Califa
acquisition as make-whole payments or as interest on unpaid portions of the
purchase price. The obligation to make these payments would arise in the event
that we opt to make scheduled payments by issuing shares of our Class B stock
and the shares are not registered under the Securities Act of 1933, as amended,
in a timely fashion or the proceeds from the sale of the shares to the sellers
in the Califa acquisition are less than the aggregate value of those shares at
the time of their issuance. The number of shares issued in satisfaction of each
payment will be based on the market price of Class B stock surrounding the
payment dates. See Note (C), Acquisition, to the Notes to Consolidated Financial
Statements for additional information.
In addition, if we exercise our option to buy 49.9% of PTVLA we may use
our Class B stock to do so. See Note (D), Restructuring of Ownership of
International TV Joint Ventures, to the Notes to Consolidated Financial
Statements for additional information.
Item 1B. Unresolved Staff Comments
None.
22
Item 2. Properties
Location Primary Use
-------- -----------
Office Space Leased:
Chicago, Illinois This space serves as our corporate headquarters
and is used by all of our operating groups and
executive and administrative personnel.
Los Angeles, California This space serves as our Entertainment Group's
headquarters and is utilized by executive and
administrative personnel.
New York, New York This space serves as our Publishing and
Licensing Groups' headquarters, and the
Entertainment Group and executive and
administrative personnel use a limited amount of
space.
London, England This space is used by our Playboy TV U.K.
executive and administrative personnel and as a
programming facility.
Operations Facilities Leased:
Los Angeles, California This space is used by our Entertainment Group as
a centralized digital, technical and programming
facility. We also utilize parts of this facility
to handle similar functions for other clients.
Santa Monica, California This space is used by our Publishing Group as a
photography studio and offices.
Rocklin, California This space is used by our Entertainment Group in
the production and distribution of online
content.
Property Owned:
Los Angeles, California The Playboy Mansion is used for various
corporate activities, including serving as a
valuable location for television production,
magazine photography and for online, advertising
and sales events. It also enhances our image as
host for many charitable and civic functions.
We have subleased a portion of our excess office space as a result of our
restructuring efforts.
23
Item 3. 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 $9.4 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 No. 5, Accounting
for Contingencies, or Statement 5, no liability has been accrued.
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 was paid in
January 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 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. 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,
24
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 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 through
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,
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.
Item 4. Submission of Matters to a Vote of Security Holders
None.
25
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Stock price information, as reported in the New York Stock Exchange
Composite Listing, is set forth in Note (W), Quarterly Results of Operations
(Unaudited), to the Notes to Consolidated Financial Statements. Our securities
are traded on the exchanges listed on the cover page of this Annual Report on
Form 10-K under the ticker symbols PLA A (Class A voting) and PLA (Class B
nonvoting). At February 28, 2006, there were 3,432 and 6,979 holders of record
of Class A and Class B common stock, respectively. There were no cash dividends
declared during 2005, 2004 or 2003.
As previously reported in our Current Report on Form 8-K, dated March 9,
2005 and filed March 15, 2005, and our Current Report on Form 8-K, dated March
28, 2005 and filed April 1, 2005 and as more fully described in Note (N),
Financing Obligations, to the Notes to Consolidated Financial Statements, in
March 2005, we issued and sold in a private placement $115.0 million aggregate
principal amount of our convertible notes.
Other information required under this Item is contained in our Notice of
Annual Meeting of Stockholders and Proxy Statement, or collectively, the Proxy
Statement (to be filed), relating to the Annual Meeting of Stockholders to be
held in May 2006, which will be filed within 120 days after the close of our
fiscal year ended December 31, 2005, and is incorporated herein by reference.
26
Item 6. Selected Financial Data
(in thousands, except per share amounts,
number of employees and advertising pages)
Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended Ended Ended
12/31/05 12/31/04 12/31/03 12/31/02 12/31/01
----------------------------------------------------------------------------------------------------------------------------------
Selected financial data (1)
Net revenues $ 338,153 $ 329,376 $ 315,844 $ 277,622 $ 287,583
Interest expense, net (4,769) (13,108) (15,946) (15,022) (13,184)
Income (loss) before
cumulative effect of change in accounting principle (735) 9,989 (7,557) (17,135) (29,323)
Net income (loss) (735) 9,989 (7,557) (17,135) (33,541)
Net income (loss) applicable to common shareholders (735) 9,561 (8,450) (17,135) (33,541)
Basic and diluted earnings (loss) per common share
Income (loss) before
cumulative effect of change in accounting principle (0.02) 0.30 (0.31) (0.67) (1.20)
Net income (loss) (0.02) 0.30 (0.31) (0.67) (1.37)
EBITDA: (2)
Net income (loss) (735) 9,989 (7,557) (17,135) (33,541)
Adjusted for:
Cumulative effect of change in accounting principle -- -- -- -- 4,218
Interest expense 6,986 13,687 16,309 15,147 13,970
Income tax expense 3,998 3,845 4,967 8,544 996
Depreciation and amortization 42,540 47,100 49,558 51,619 51,904
Amortization of deferred financing fees 635 1,266 1,407 993 905
Amortization of restricted stock awards 601 682 45 2,748 --
Equity in operations of investments 383 71 80 (279) 746
-----------------------------------------------------------------------
EBITDA $ 54,408 $ 76,640 $ 64,809 $ 61,637 $ 39,198
==================================================================================================================================
At period end (3)
Cash and cash equivalents and marketable securities
and short-term investments $ 52,052 $ 50,720 $ 34,878 $ 6,795 $ 7,792
Total assets 428,969 416,330 413,809 365,470 420,625
Long-term financing obligations 115,000 80,000 115,000 68,865 78,017
Redeemable preferred stock -- -- 16,959 -- --
Total shareholders' equity $ 157,247 $ 162,158 $ 100,344 $ 81,523 $ 73,869
Long-term financing obligations as a
percentage of total capitalization 41% 32% 52% 44% 49%
Number of common shares outstanding
Class A voting 4,864 4,864 4,864 4,864 4,864
Class B nonvoting 27,880 28,521 22,579 21,181 19,666
Number of full-time employees 709 645 592 581 610
----------------------------------------------------------------------------------------------------------------------------------
Selected operating data
Cash investments in Company-produced and
licensed entertainment programming $ 33,075 $ 41,457 $ 44,727 $ 41,717 $ 37,254
Cash investments in online content 2,242 2,317 2,436 4,434 4,739
-----------------------------------------------------------------------
Total cash investments in programming and content 35,317 43,774 47,163 46,151 41,993
Amortization of investments in Company-produced
and licensed entertainment programming 37,450 41,695 40,603 40,626 37,395
Amortization of investments in online content 2,626 2,317 2,436 4,434 4,739
-----------------------------------------------------------------------
Total amortization of programming and content $ 40,076 $ 44,012 $ 43,039 $ 45,060 $ 42,134
Domestic TV household units (at period end): (4)
Playboy TV networks
DTH 26,800 24,400 21,600 19,200 18,100
Cable 20,100 21,800 21,400 19,700 18,100
Movie networks
DTH 53,000 48,200 42,200 38,400 35,300
Cable 43,800 46,000 49,700 47,700 42,300
On-demand households:
VOD 8,600 5,000 1,600 1,500 --
SVOD 1,900 1,500 800 700 --
International TV household units (at period end) (4) 44,300 40,500 37,000 30,900 29,500
Playboy magazine advertising pages 479 573 555 515 618
----------------------------------------------------------------------------------------------------------------------------------
27
For a more detailed description of our financial position, results of
operations and accounting policies, please refer to Part II. Item 7. "MD&A" and
Part II. Item 8. "Financial Statements and Supplementary Data."
(1) 2005 included $19.3 million of debt extinguishment expense related to the
redemption of $80.0 million of our senior secured notes. 2004 included
$5.9 million of debt extinguishment expense related to the redemption of
$35.0 million of our senior secured notes and a $5.6 million insurance
recovery partially related to an $8.5 million charge recorded in 2003 for
a litigation settlement. 2003 included $3.3 million of debt extinguishment
expense related to prior financing obligations, which were paid upon
completion of our debt offering. 2002 included a $5.8 million noncash
income tax charge related to our adoption of Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets, and
$6.6 million in restructuring expenses. 2001 included a $4.2 million
noncash charge representing a "Cumulative effect of change in accounting
principle" related to the adoption of Statement of Position 00-2,
Accounting by Producers or Distributors of Films, and restructuring
expenses of $3.5 million. There were no cash dividends declared on our
common stock during the periods presented.
(2) EBITDA represents earnings from continuing operations before cumulative
effect of change in accounting principle, interest expense, income taxes,
depreciation of property and equipment, amortization of intangible assets,
amortization of investments in entertainment programming, amortization of
deferred financing fees, expenses related to the vesting of restricted
stock awards and equity in operations of investments. We evaluate our
operating results based on several factors, including EBITDA. We consider
EBITDA an important indicator of the operational strength and performance
of our ongoing businesses, including our ability to provide cash flows to
pay interest, service debt and fund capital expenditures. EBITDA
eliminates the uneven effect across business segments of noncash
depreciation of property and equipment and amortization of intangible
assets. Because depreciation and amortization are noncash charges, they do
not affect our ability to service debt or make capital expenditures.
EBITDA also eliminates the impact of how we fund our businesses and the
effect of changes in interest rates, which we believe relate to general
trends in global capital markets but are not necessarily indicative of our
operating performance. Finally, EBITDA is used to determine compliance
with some of the terms of our credit facility. EBITDA should not be
considered an alternative to any measure of performance or liquidity under
generally accepted accounting principles in the United States, or GAAP.
Similarly, EBITDA should not be inferred as more meaningful than any of
those measures.
(3) Certain adjustments to prior periods have been made to reflect the current
year's restatements. See Note (B), Restatements, to the Notes to
Consolidated Financial Statements.
(4) Each household unit is defined as one household carrying one given network
per carriage platform. A single household can represent multiple household
units if two or more of our networks and/or multiple distribution
platforms (i.e., digital and analog) are available to that household.
28
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 world leader in the development and distribution of multimedia
lifestyle entertainment for adult audiences. Today, our businesses are
classified into three reportable segments: Entertainment, Publishing and
Licensing. In the fourth quarter of 2004, we announced the realignment of our
existing Online and Entertainment segments into a combined Entertainment Group.
The new operating structure was designed to streamline operations, maximize
return on content creation and increase responsiveness to customers. Prior
periods have been restated to reflect the realignment of our reportable
segments. In the fourth quarter of 2005, we repurchased the remaining minority
interest in Playboy.com, Inc., or Playboy.com, that we did not own. Subsequent
to the repurchases, Playboy.com became a wholly owned subsidiary of ours.
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
Today we generate most of our Entertainment Group revenues from
pay-per-view, or PPV, fees for our television network offerings, including
Playboy- and Spice-branded domestic and international networks. Our network
revenues are affected by marketing and retail price, which are controlled by the
distributors, our revenue splits with distributors, which are negotiated, 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, technologies. Internationally, we own and operate or license 23 Playboy-,
Spice- and locally-branded television and movie networks, and we have equity
interests in seven additional networks through joint ventures. We also receive
licensing fees from Playboy websites and wireless providers outside of the
United States. Subscription revenues are from multiple club websites, which
offer unique content under the Playboy, Spice and other brand names. E-commerce
revenues include the sale of our branded and other consumer products, both
online and through direct mail. We monetize online traffic via advertising and
online gaming license fees. Entertainment Group revenues also include the sale
of DVDs.
The majority of our Publishing Group revenues are derived from
circulation, both subscription and newsstand sales, of Playboy magazine and
special editions. Additionally, the group generates sales from advertising in
Playboy magazine as well as from royalties on circulation and advertising from
our 20 licensed international editions. Our subscription revenues are fairly
consistent, while newsstand sales are typically higher for issues containing
celebrity pictorials or other special content, such as high-profile articles or
interviews. The group's revenues fluctuate with the general condition of the
local and national economies, which affect newsstand sales as well as
advertising buying patterns.
Licensing Group revenues are principally generated from royalties received
for the international and domestic licensing of our brands on consumer and
entertainment products as well as from periodic auction sales of small portions
of our art and memorabilia collection. In the future, revenues will also be
generated from location-based entertainment projects.
COSTS AND OPERATING EXPENSES
Entertainment Group expenses include television programming amortization,
online content, network distribution, hosting, sales and marketing and
administrative expenses. Trademark license and administrative fees to the parent
company, which had been charged to the Entertainment Group for Playboy.com's
use, will be eliminated in 2006 now that Playboy.com is a wholly owned
subsidiary. Amortization and content expenses relate to the expenditures
associated with the creation of Playboy programming, the licensing of
third-party programming for our movie networks and the creation of content for
our websites, wireless and satellite radio providers.
Publishing Group expenses include manufacturing, subscription promotion,
editorial, shipping and
29
administrative expenses. Manufacturing, which includes the production of the
magazine, represents the largest cost of the group and fluctuates by issue due
mainly to the cost of paper and the number of pages in the magazine.
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, investor
relations and communications, as well as company-wide marketing and promotions,
including expenses related to the Playboy Mansion.
30
RESULTS OF OPERATIONS (1)
The following table represents our results of operations (in millions, except
per share amounts):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
-------------------------------------------------------------------------------------------------------------------
Net revenues
Entertainment
Domestic TV networks $ 98.6 $ 96.9 $ 95.3
International 52.1 45.3 37.9
Online subscriptions 26.1 21.5 18.2
E-commerce 20.8 18.7 16.8
Other 5.8 6.8 7.5
-------------------------------------------------------------------------------------------------------------------
Total Entertainment 203.4 189.2 175.7
-------------------------------------------------------------------------------------------------------------------
Publishing
Playboy magazine 89.4 101.5 102.0
Other domestic publishing 10.5 11.9 13.0
International publishing 6.6 6.4 5.7
-------------------------------------------------------------------------------------------------------------------
Total Publishing 106.5 119.8 120.7
-------------------------------------------------------------------------------------------------------------------
Licensing
International licensing 18.9 12.1 8.0
Domestic licensing 3.5 3.1 3.2
Entertainment licensing 1.8 2.0 1.4
Marketing events 3.6 3.0 2.9
Other 0.5 0.2 3.9
-------------------------------------------------------------------------------------------------------------------
Total Licensing 28.3 20.4 19.4
-------------------------------------------------------------------------------------------------------------------
Total net revenues $ 338.2 $ 329.4 $ 315.8
===================================================================================================================
Net income (loss)
Entertainment
Before programming amortization and online content expenses $ 81.1 $ 77.1 $ 73.9
Programming amortization and online content expenses (40.1) (44.0) (43.0)
-------------------------------------------------------------------------------------------------------------------
Total Entertainment 41.0 33.1 30.9
-------------------------------------------------------------------------------------------------------------------
Publishing (6.5) 6.2 5.2
-------------------------------------------------------------------------------------------------------------------
Licensing 16.1 10.5 10.3
-------------------------------------------------------------------------------------------------------------------
Corporate Administration and Promotion (19.6) (18.2) (16.6)
-------------------------------------------------------------------------------------------------------------------
Total segment income 31.0 31.6 29.8
Restructuring expenses (0.1) (0.7) (0.3)
-------------------------------------------------------------------------------------------------------------------
Operating income 30.9 30.9 29.5
-------------------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 2.2 0.6 0.4
Interest expense (7.0) (13.7) (16.3)
Amortization of deferred financing fees (0.6) (1.3) (1.4)
Minority interest (1.6) (1.4) (1.7)
Debt extinguishment expenses (19.3) (5.9) (3.3)
Insurance/litigation settlements -- 5.6 (8.5)
Other, net (1.3) (1.0) (1.3)
-------------------------------------------------------------------------------------------------------------------
Total nonoperating expense (27.6) (17.1) (32.1)
-------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 3.3 13.8 (2.6)
Income tax expense (4.0) (3.8) (5.0)
-------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (0.7) $ 10.0 $ (7.6)
===================================================================================================================
Net income (loss) $ (0.7) $ 10.0 $ (7.6)
-------------------------------------------------------------------------------------------------------------------
Dividend requirements of preferred stock -- (0.4) (0.9)
-------------------------------------------------------------------------------------------------------------------
Income (loss) applicable to common shareholders $ (0.7) $ 9.6 $ (8.5)
===================================================================================================================
Basic and diluted earnings (loss) per common share $ (0.02) $ 0.30 $ (0.31)
===================================================================================================================
(1) Certain amounts reported for prior periods have been reclassified to
conform to the current year's presentation.
31
2005 COMPARED TO 2004
Our revenues increased $8.8 million, or 3%, compared to the prior year 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 the year, 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 the prior year for a
litigation settlement with Logix Development Corporation, or Logix. See the Debt
Financing section within Liquidity and Capital Resources for additional
information.
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. Direct-to-home, or DTH, revenues increased $2.9 million, or 13%, 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, or 8%, in 2005. Movie network revenues decreased $3.7
million, or 10%, primarily as a result of decreased PPV buys stemming from the
transition to VOD. Total VOD revenues increased $2.8 million, or 76%, in the
current year 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, or 28%, 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 network revenues were impacted by a $1.5 million unfavorable adjustment
from an unanticipated retroactive rate reduction related to the earlier
acquisition of one large MSO by another. Profit contribution from domestic TV
networks decreased $0.2 million, or 0.3%, for the year. 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, or 11%, 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, or 20%, in 2005 due to the higher revenues mentioned
above, partially offset by increased marketing and operating costs related to
the newly launched channels.
Domestic online subscription revenues increased $4.6 million, or 22%, in
2005 primarily due to the acquisition of an affiliate network of websites late
in the year. Profit contribution increased $0.7 million, or 5%, as increased
technology and marketing initiatives and expenses related to our newly acquired
affiliate network of websites mostly offset the revenue increase.
E-commerce revenues increased $2.1 million, or 11%, 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.
E-commerce profit contribution decreased $0.7 million, or 35%, as higher catalog
production, marketing, product, and fulfillment expenses more than offset the
revenue increase.
Profit contribution from other businesses decreased $0.5 million, or 26%,
in 2005. Higher online advertising revenues and lower worldwide DVD cost of
sales and marketing expenses were more than offset by a $1.1 million favorable
adjustment recorded in the prior year.
32
The group's administrative expenses decreased $0.8 million, or 3%, in 2005
primarily due to lower legal costs in the current year and a contractually
obligated severance charge recorded in the prior year, partially offset by
higher performance-based compensation expense in the current year.
Programming amortization and online content expenses decreased $3.9
million, or 9%, primarily due to the mix of programming. We will continue to
acquire and produce content that can be repurposed across our VOD, online,
wireless and satellite radio platforms. We anticipate programming amortization
expense to be approximately $37.0 million and online content expense to be
approximately $5.7 million in 2006, which could vary based on, among other
things, the timing of completing productions.
As a result of the above, segment income for the group increased $7.9
million, or 24%, in 2005 compared to 2004.
Publishing Group
Playboy magazine revenues decreased $12.1 million, or 12%, in 2005.
Advertising revenues decreased $6.7 million due to fewer advertising pages and
slightly lower net revenue per page. Newsstand revenues in 2005 were $3.6
million lower principally due to fewer copies sold in the current year,
partially offset by higher display costs in the prior year. Additionally, the
current year included an unfavorable adjustment of $0.1 million related to the
prior year's issues compared to a $0.5 million favorable adjustment in the prior
year. Subscription revenues decreased $1.8 million primarily due to lower
average net revenue per copy, partially offset by an increase in the number of
subscription copies served and lower bad debt expense in the current year.
Higher favorable adjustments recorded in the prior year to recognize revenues
for paid subscriptions that will not be served also contributed to the decrease
in 2005. Advertising sales for the 2006 first quarter magazine issues are
closed, and we expect to report approximately 33% lower advertising revenues and
30% fewer advertising pages compared to the 2005 first quarter as the result of
continuing softness in the market.
Revenues from our other domestic publishing businesses decreased $1.4
million, or 12%. This was primarily due to fewer newsstand copies of special
editions sold in the current year combined with higher unfavorable adjustments
to the prior year's issues in the current year, partially offset by higher
display costs in the prior year.
International publishing revenues increased $0.2 million, or 3%.
The group's segment profitability decreased $12.7 million in 2005 as a
result of the lower revenues discussed above combined with higher paper costs of
$1.7 million and higher subscription acquisition expenses of $1.0 million,
partially offset by a decrease of $3.2 million in editorial content expenses in
the current year.
We do not expect a material change in either the newsstand or advertising
environments, and we expect a decline in profitability from our subscriptions
business. Increased postage costs as well as the continued impact of 2005 paper
price increases will have an unfavorable impact on 2006 results but will be
mitigated by our decisions to reduce Playboy magazine's circulation rate base
effective with the January 2006 issue and increase the cover price by $1.00
effective with the February 2006 issue. We believe that the first quarter will
be the worst for our Publishing Group in 2006, and we will continue to work to
meet our goal of lower losses in 2006 compared to 2005.
Licensing Group
Licensing Group revenues increased $7.9 million, or 39%, in 2005 primarily
due to higher royalties from existing and new licensees in Europe and Asia. The
group's segment income increased $5.6 million, or 54%, due to the revenue
increase, partially offset by higher revenue-related expenses and development
costs related to our location-based entertainment business.
We are projecting 15 - 20% growth in the Licensing Group's 2006 segment
income because of the strength of the core licensing business.
33
Corporate Administration and Promotion
Corporate Administration and Promotion expenses for 2005 increased $1.4
million, or 8%, largely due to an increase in performance-based compensation and
audit expenses, partially offset by the impact of a legal settlement in the
prior year. In 2006, Corporate Administration and Promotion expenses are
expected to increase materially. This is largely due to the previously mentioned
minority interest repurchase, which resulted in the elimination of our
intra-company agreements related to trademark, content and administrative fees.
This will cause Corporate Administration and Promotion expenses to increase by
approximately $5.0 million, with a corresponding improvement primarily in the
Entertainment Group.
Restructuring Expenses
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. Of the total costs related to these restructuring
plans, approximately $10.0 million was paid by December 31, 2005, with the
remainder of $1.2 million to be paid 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.
In 2003, primarily due to excess space in our Chicago office, we recorded
unfavorable adjustments of $0.1 million and $0.2 million to the previous
estimates related to the 2002 and 2001 restructuring plans, respectively.
The following table displays the activity and balances of the
restructuring reserve account for the years ended December 31, 2005, 2004 and
2003 (in thousands):
Consolidation
Workforce of Facilities and
Reduction Operations Total
-------------------------------------------------------------------------------
Balance at December 31, 2002 (1) $ 2,772 $ 3,805 $ 6,577
Adjustment to previous estimate (168) 518 350
Cash payments (1,974) (1,760) (3,734)
-------------------------------------------------------------------------------
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
Adjustment to previous estimate 17 132 149
Cash payments (196) (749) (945)
-------------------------------------------------------------------------------
Balance at December 31, 2005 $ -- $ 1,210 $ 1,210
===============================================================================
(1) The balance at December 31, 2002, consisted of remaining cash payments
from our prior restructuring plans.
Nonoperating Income (Expense)
In 2005, we recorded total nonoperating expense of $27.6 million compared
to $17.1 million in the prior year. The current year included $19.3 million of
debt extinguishment expense, or a $13.4 million increase, compared to the prior
year, and $7.0 million, or a $6.7 million decrease in interest expense compared
to the prior year related to our first quarter debt refinancing. 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 the prior year for
a litigation settlement with Logix.
Income Tax Expense
Our effective income tax rate differs from U.S. statutory rates primarily
as a result of the increase in the valuation allowance related to the
recognition of our net operating loss, or NOL, carryforwards and the effect of
the
34
deferred tax treatment of certain indefinite-lived intangibles.
In 2005, we increased the valuation allowance, as adjusted, by $2.6
million related to the recognition of our NOLs and the effect of the deferred
tax treatment of certain acquired intangibles. In 2004, we decreased the
valuation allowance by $9.2 million, of which $4.8 million was due to the
reduction in the deferred tax asset related to 2004 net income and the remainder
was primarily due to the expiration of a portion of our capital loss
carryforward and the deferred tax treatment of certain acquired intangibles.
2004 COMPARED TO 2003
Our revenues increased approximately $13.6 million, or 4%, compared to
2003 primarily due to higher revenues from our Entertainment Group.
Operating income increased $1.4 million in 2004 primarily due to improved
operating results from each of our groups, offset in part by higher planned
Corporate Administration and Promotion expenses.
Net income of $10.0 million for 2004 included a $5.6 million insurance
recovery partially related to a charge recorded in 2003 for a litigation
settlement with Logix. 2004 included $5.9 million of debt extinguishment expense
related to the second quarter bond redemption comprised of $3.9 million for the
bond redemption premium and approximately $2.0 million for the noncash write-off
of the related deferred financing costs. 2003 included $3.3 million of debt
extinguishment expense related to prior financing obligations, which were paid
upon completion of our debt offering in 2003, as well as an $8.5 million charge
for the litigation settlement mentioned above.
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 $1.6 million, or 2%, for
2004. This improvement resulted from both a $2.2 million increase in DTH
revenues related to subscriber growth and a $2.2 million increase in VOD
revenues due to the rollout of VOD service in additional cable systems. The 2004
launch of Spice HD and revenues associated with renting our studio facility and
providing various related services to third parties also contributed favorably
to revenues. The revenue increases were partially offset by a decrease in PPV
buys as cable companies were migrating consumers from linear channels to VOD.
Additionally, certain affiliates of Time Warner Cable Inc., or Time Warner, one
of our MSOs, replaced our movie networks with other adult programming before we
signed a new carriage agreement with Time Warner in July. We have regained some
of our market share via VOD, and the Time Warner deal guarantees us a majority
of the adult VOD shelf space on its systems. The second quarter of 2004 was also
negatively impacted by a $1.5 million unfavorable adjustment to movie network
revenues from an unanticipated retroactive rate reduction related to the 2002
acquisition of one large MSO by another.
Profit contribution for domestic TV networks increased $0.2 million, or
0.3%, for the year, as the revenue activity described above was mostly offset by
higher distribution and overhead costs related to the operation of our
production facility, combined with increased marketing, promotional and legal
expenditures.
International revenues increased $7.4 million, or 20%, in 2004 primarily
attributable to higher DTH and cable revenues in the U.K. of approximately $6.6
million resulting from the launch of three new channels and the impact of
foreign currency. Higher international online revenues of approximately $0.8
million also contributed to the increase. Profit contribution from our
international business increased $2.1 million, or 13%, in 2004 based on the
higher revenues and offset in part by higher direct and overhead costs related
to the launch of the three new U.K. channels.
Online subscription revenues increased $3.3 million, or 18%, in 2004 due
to an increase in average monthly subscribers and an increase in our revenues
per subscriber as more customers continued to choose video-rich offerings via
broadband. Higher cost of sales and technology costs partially offset the
revenue increase.
E-commerce revenues increased $1.9 million, or 11%, in 2004 due to
increased catalog circulation combined with increased email campaigns. Profit
contribution from e-commerce was partially impacted by higher marketing and
circulation costs.
35
Profit contribution from other businesses increased $0.4 million, or 30%,
in 2004 due to a $1.1 million favorable adjustment in 2004 from the reversal of
an accrual recorded in 2001 and 2002 related to the termination of a service
agreement. Growth in our online advertising and online gaming businesses also
contributed to the increase. These increases were mostly offset by a decrease in
worldwide DVD profit contribution of $1.2 million, or 83%, as a result of fewer
titles released in 2004 combined with an increase in marketing expenses.
The group's administrative expenses increased 6% in 2004 mainly due to a
contractually obligated severance charge combined with higher legal expenses.
The group's results included net fees of $5.4 million in both 2004 and 2003 from
Playboy.com, to Corporate Administration and Promotion and the Publishing Group
related to the previously mentioned trademark, content and administrative fees.
Programming amortization and online content expenses increased $1.0
million, or 2%, compared to 2003 due to the mix of programming.
As a result of the above, segment income for the group increased $2.2
million, or 8%, in 2004 compared to 2003.
Publishing Group
Playboy magazine revenues decreased $0.5 million, or 1%, in 2004.
Newsstand revenues in 2004 were $1.7 million lower principally due to the 50th
Anniversary issue and more celebrity issues which sold at higher cover prices in
2003 combined with a decrease in the number of U.S. and Canadian newsstand
copies sold and higher display costs in 2004. Subscription revenues increased
$1.1 million primarily due to a favorable adjustment for subscriptions that will
not be served, higher net subscription revenue per copy as a result of a higher
proportion of direct-to-publisher subscriptions, higher list rental revenues and
a favorable bad debt reserve adjustment. A slight decrease in the number of
subscription copies served partially offset the above-mentioned revenue
increases. Advertising pages increased slightly while net revenue per page
decreased slightly, resulting in flat advertising revenues, as expected, mostly
due to the favorable impact of the Playboy 50th Anniversary issue in 2003.
Revenues from our other domestic publishing businesses decreased $1.1
million, or 8%, primarily due to fewer copies sold and higher display costs for
special editions. Two fewer calendars published in 2004 also contributed to the
decline, which was offset by higher royalties from books.
International publishing revenues increased $0.7 million, or 13%,
primarily due to higher revenues from several international editions.
The group's segment income increased $1.0 million in 2004 primarily due to
lower manufacturing and promotion costs as a result of the 50th Anniversary
issue combined with the costs associated with moving our editorial functions
from Chicago to New York in 2003. Partially offsetting the impact of these lower
costs were higher editorial costs related to celebrity pictorials in 2004 and
the lower revenues discussed above.
Licensing Group
Licensing Group revenues increased $1.0 million, or 5%, in 2004 mainly due
to higher royalties from our international and entertainment products
businesses. International revenues increased $4.1 million, or 51%, due to new
licensee agreements in addition to higher royalties from existing licensees in
Japan, Europe, South East Asia and Australia. Entertainment licensing revenues
increased $0.6 million, or 50%, primarily due to higher royalties from our
Bally's slot machine deal. Other revenues were $3.7 million lower than 2003, due
to the sale of an original Salvador Dali painting and the 50th Anniversary
auction of art, manuscripts and memorabilia in 2003.
Segment income for the Licensing Group in 2004 increased $0.2 million, or
1%, on the above-mentioned net revenue increase.
In the first quarter of 2004, we sold our Sarah Coventry trademarks and
service marks for their approximate book value, pursuant to an agreement under
which we will receive payments over a period not to exceed ten years.
36
Corporate Administration and Promotion
Corporate Administration and Promotion expenses for 2004 increased $1.6
million, or 10%, which was less than the expected increase and was related to
higher salary, marketing, consulting and legal expenses.
Restructuring Expenses
The following table displays the activity and balances of the
restructuring reserve account for the years ended December 31, 2004, 2003 and
2002 (in thousands):
Consolidation
Workforce of Facilities and
Reduction Operations Total
-------------------------------------------------------------------------------
Balance at December 31, 2001 (1) $ 1,579 $ 1,142 $ 2,721
Additional reserve recorded 2,938 2,799 5,737
Write-off leasehold improvements -- (437) (437)
Adjustment to previous estimate 100 806 906
Cash payments (1,845) (505) (2,350)
-------------------------------------------------------------------------------
Balance at December 31, 2002 2,772 3,805 6,577
Adjustment to previous estimate (168) 518 350
Cash payments (1,974) (1,760) (3,734)
-------------------------------------------------------------------------------
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
===============================================================================
(1) The balance at December 31, 2001, consisted of remaining cash payments
from our prior restructuring plans.
Nonoperating Income (Expense)
In 2004, we recorded total nonoperating expense of $17.1 million compared
to $32.1 million in 2003. 2004 included a $5.6 million insurance recovery
partially related to an $8.5 million charge recorded in 2003 for the Logix
settlement. Lower interest expense also contributed to the decrease. Debt
extinguishment expense of $5.9 million related to the redemption of $35.0
million aggregate principal amount of 11% senior secured notes, or senior
secured notes, issued by our subsidiary PEI Holdings, Inc., or Holdings. In
2003, we incurred $3.3 million of debt extinguishment expense related to the
retirement of debt obligations.
Income Tax Expense
Our effective income tax rate differs from U.S. statutory rates primarily
as a result of the reduction in the valuation allowance corresponding to the
utilization of our NOL carryforwards, the benefit from which 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.
In 2004, we decreased the valuation allowance by $9.2 million, of which
$4.8 million was due to the reduction in the deferred tax asset related to 2004
net income and the remainder was primarily due to the expiration of a portion of
our capital loss carryforward and the deferred tax treatment of certain acquired
intangibles. In 2003, we increased the valuation allowance by $3.3 million, of
which $1.5 million was due to the deferred tax treatment of certain acquired
intangibles and the remainder was primarily due to the deferred tax asset
related to the 2003 NOL.
37
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2005, we had $26.1 million in cash and cash equivalents
compared to $26.7 million in cash and cash equivalents at December 31, 2004. At
December 31, 2005, we had $21.0 million of auction rate securities, or ARS,
included in marketable securities and 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
December 31, 2005, and December 31, 2004, respectively.
At December 31, 2005, our liquidity requirements were being provided by
cash generated from our operating activities, existing cash and cash
equivalents, short-term investments and net proceeds from our March 2005 sale of
our 3.00% convertible senior subordinated notes due 2025, or the convertible
notes. At December 31, 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 December 31, 2005, there were no borrowings and $9.8 million in letters
of credit outstanding under this facility, permitting $40.2 million of available
borrowings under this facility. See Debt Financing for additional information.
We believe that cash on hand and operating cash flows, together with funds
available under our credit facility and potential access to credit and capital
markets, will be sufficient to meet our operating expenses, capital expenditures
and other contractual obligations as they become due.
DEBT FINANCING
On March 15, 2005, we issued and sold in a private placement $100.0
million aggregate principal amount of our 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 of the $80.0 million
outstanding principal amount of the 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 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 in arrears on March 15 and September 15
of each year, payment of which began on September 15, 2005. In addition, under
certain circumstances beginning in 2012, if the trading price of the convertible
notes exceeds a specified threshold during a prescribed measurement period prior
to any semi-annual interest period, contingent interest will become payable on
the convertible notes for that semi-annual interest period at an annual rate of
0.25% per annum.
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 maximum conversion rate, subject to adjustment, is 76.3942 shares
per $1,000 principal amount of convertible notes.
38
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 convertible notes plus any accrued and
unpaid interest up to, but excluding, the redemption date. On or after March 15,
2012, we may at any time redeem any of the convertible notes at the same
redemption price. On each of March 15, 2012, March 15, 2015 and March 15, 2020,
or upon the occurrence of a fundamental change, as specified in the indenture
governing the convertible notes, holders may require us to purchase all or a
portion of their convertible notes at a purchase price in cash equal to 100% of
the principal amount of the notes, plus any accrued and unpaid interest up to,
but excluding, the purchase date.
The convertible notes are unsecured senior subordinated obligations of
Playboy Enterprises, Inc., and rank junior to all of the issuer's senior debt,
including its guarantee of Holdings' borrowings under our credit facility;
equally with all of the issuer's future senior subordinated debt; and, senior to
all of the issuer's future subordinated debt. In addition, the assets of the
issuer's subsidiaries are subject to the prior claims of all creditors,
including trade creditors, of those subsidiaries.
CREDIT FACILITY
Effective April 1, 2005, Holdings and its lenders amended and restated the
credit agreement governing our credit facility, primarily to increase the size
of the credit facility from $30.0 million to $50.0 million. Our credit facility
provides for revolving borrowings by Holdings of up to $50.0 million and the
issuance of up to $30.0 million in letters of credit, subject to a maximum of
$50.0 million in combined borrowings and letters of credit outstanding at any
time. Borrowings under the credit facility bear interest at a variable rate,
equal to a specified Eurodollar, LIBOR or base rate plus a specified borrowing
margin based on our Transactions Adjusted EBITDA, as defined in the credit
agreement. We pay fees on the outstanding amount of letters of credit under the
credit facility based on the margin that applies to borrowings that bear
interest at a rate based on LIBOR. All amounts outstanding under the credit
facility will mature on April 1, 2008. Holdings' obligations as borrower under
the credit facility are guaranteed by us and each of our other U.S.
subsidiaries. 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. On March 10, 2006, Holdings and its
lenders entered into an amendment to the credit agreement that, among other
things, gives us additional time to add Playboy.com and specified newly formed
subsidiaries as guarantors and pledgors under the credit facility.
FINANCING FROM RELATED PARTY
At December 31, 2002, Playboy.com, Inc., or Playboy.com, had an aggregate
of $27.2 million of outstanding indebtedness to Hugh M. Hefner, Editor-In-Chief
and Chief Creative Officer, or Mr. Hefner, in the form of three promissory
notes. Upon the closing of the senior secured notes offering on March 11, 2003,
Playboy.com's debt to Mr. Hefner was restructured. One promissory note, in the
amount of $10.0 million, was extinguished in exchange for shares of Holdings
Series A Preferred Stock with an aggregate stated value of $10.0 million. The
two other promissory notes, in a combined principal amount of $17.2 million,
were extinguished in exchange for $0.5 million in cash and shares of Holdings
Series B Preferred Stock with an aggregate stated value of $16.7 million.
Pursuant to the terms of an exchange agreement between us, Holdings, Playboy.com
and Mr. Hefner and certificates of designation governing the Holdings Series A
and Series B Preferred Stocks, we were required to exchange the Holdings Series
A Preferred Stock for shares of Playboy Class B stock and to exchange the
Holdings Series B Preferred Stock for shares of Playboy Preferred Stock.
On May 1, 2003, we exchanged the Holdings Series A Preferred Stock plus
accumulated dividends for 1,122,209 shares of Playboy Class B stock and
exchanged the Holdings Series B Preferred Stock for 1,674 shares of Playboy
Preferred Stock with an aggregate stated value of $16.7 million. The Playboy
Preferred Stock accrued dividends at a rate of 8.00% per annum, which were paid
semi-annually.
The Playboy Preferred Stock was convertible at the option of Mr. Hefner,
the holder, into shares of our Class B stock at a conversion price of $11.2625,
which was equal to 125% of the weighted average closing price of our Class B
stock over the 90-day period prior to the exchange of Holdings Series B
Preferred Stock for Playboy Preferred Stock.
39
On April 26, 2004, Mr. Hefner converted his $16.7 million of Playboy
Preferred Stock into 1,485,948 shares of our Class B stock and sold these shares
as part of our public equity offering on that date. See Note (S), Public Equity
Offering, to the Notes to Consolidated Financial Statements for additional
information.
In 2005, we repurchased the remaining outstanding Playboy.com Series A
Preferred Stock that was held by Mr. Hefner and an unrelated third party. These
shares were part of the $15.3 million issued by our subsidiary Playboy.com in
2001 of which $5.0 million was purchased by Mr. Hefner. Pursuant to its terms,
the Playboy.com Series A Preferred Stock was canceled, retired and ceased to be
outstanding as a result of the repurchases. Subsequently, Playboy.com became a
wholly owned subsidiary of ours.
CALIFA ACQUISITION
The Califa Entertainment Group, Inc., or Califa, acquisition agreement
gives us the option of paying $14.0 million of the remaining $19.8 million
purchase price consideration in cash or Class B stock. We intend to make the
$8.0 million in payments that are due in 2006 in cash. We also have the option
of accelerating remaining acquisition payments. See the Contractual Obligations
table below for the future cash obligations related to our acquisitions. See
Note (C), Acquisition, to the Notes to Consolidated Financial Statements for
additional information relating to the Califa acquisition.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $27.4 million for 2005, an
increase of $11.0 million from 2004. The decrease in net income of $10.7
million, which included $19.3 million for debt extinguishment expense, was
partially offset by lower legal settlement payments of approximately $3.6
million combined with an increase in accounts payable and accrued employee
compensation. In addition, cash investments in entertainment programming
decreased $8.4 million from 2004. In 2006, we expect to invest approximately
$38.0 million and $5.7 million in entertainment programming and online content,
respectively, which could vary based on, among other things, the timing of
completing productions.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used for investing activities was $15.8 million for 2005. $8.3
million, which included $8.0 million for the initial purchase price and $0.3
million of acquisition-related costs, was used to acquire a network of affiliate
websites that requires additional payments of $2.0 million in each of 2006 and
2007. Additionally, $5.6 million was used for capital expenditures primarily
related to our Los Angeles and U.K. studios and $1.9 million was used for
purchases of net marketable securities and short-term investments.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash used for financing activities was $12.1 million for 2005
primarily due to payment of $95.2 million in connection with the purchase and
retirement of all of the $80.0 million outstanding principal amount of Holdings'
senior secured notes and $5.1 million of related financing fees. We also used
$5.0 million to purchase 381,971 shares of our Class B stock. Additionally, we
repurchased the remaining outstanding Playboy.com Series A Preferred Stock that
was held by Mr. Hefner and an unrelated third party for $14.1 million. Proceeds
from the sale of $115.0 million aggregate principal amount of our convertible
notes partially offset these uses of cash. See Debt Financing and Financing from
Related Party for additional information.
40
CONTRACTUAL OBLIGATIONS
The following table reflects a summary of our contractual obligations and
commercial commitments at December 31, 2005, as further discussed in the Notes
to Consolidated Financial Statements (in thousands):
2006 2007 2008 2009 2010 Thereafter Total
-----------------------------------------------------------------------------------------------------------------
Long-term financing obligations (1) $ 3,450 $ 3,450 $ 3,450 $ 3,450 $ 3,450 $ 165,025 $182,275
Operating leases 14,290 13,456 12,204 7,872 7,866 54,110 109,798
Purchase obligations:
Licensed programming
commitments (2) 7,060 5,272 5,224 4,000 4,667 4,000 30,223
Other (3):
Acquisition liabilities (1), (4) 13,097 10,050 1,000 1,000 1,000 750 26,897
Transponder service agreements 6,288 5,689 5,689 4,788 3,480 10,875 36,809
Litigation settlement (5) $ 1,000 $ -- $ -- $ -- $ -- $ -- $ 1,000
-----------------------------------------------------------------------------------------------------------------
(1) Includes interest and principal commitments related to our obligations.
(2) Represents our non-cancelable obligations to license programming from
other studios. Typically, the licensing of the programming allows us
access to specific titles or in some cases the studio's entire library
over an extended period of time. We broadcast this programming on our
networks throughout the world, as appropriate.
(3) We have obligations of $5.3 million recorded in "Other noncurrent
liabilities" at December 31, 2005, under two nonqualified deferred
compensation plans, which permit certain employees and all nonemployee
directors to annually elect to defer a portion of their compensation.
These amounts have not been included in the table, as the dates of payment
are not known at the balance sheet date.
(4) Includes liabilities related to the acquisitions of Califa, Playboy TV
International, LLC, or PTVI, and an affiliate network of websites.
(5) Paid in January 2006.
41
CRITICAL ACCOUNTING POLICIES
Our financial statements are prepared in conformity with GAAP, which
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. We believe that of
our significant accounting policies, the following are the more complex and
critical areas. For additional information about our accounting policies, see
Note (A), Summary of Significant Accounting Policies, to the Notes to
Consolidated Financial Statements.
REVENUE RECOGNITION
Domestic Television
Our domestic television network revenues were $98.6 million and $96.9
million for the years ended December 31, 2005 and 2004, respectively. In order
to record our revenues, we estimate the number of PPV buys and monthly
subscriptions using a number of factors including, but not exclusively, the
average number of buys and subscriptions in the prior three months based on
actual payments received and historical data by geographic location. Upon
recording the revenue, we also record the related receivable. We have reserves
for uncollectible receivables based on our experience and monitor and adjust
these reserves on an ongoing basis. At both December 31, 2005 and 2004, we had
receivables of $17.2 million related to domestic television. We record
adjustments to revenue on a monthly basis as we obtain actual payments from the
providers. Actual subscriber information and payment is generally received
within three months. Historically, our adjustments have not been material. At
any point, our exposure to a material adjustment to revenue is mitigated
because, generally, only the most recent two to three months would not have been
fully adjusted to actual based on payments received.
Playboy Magazine
Our Playboy magazine revenues were $89.4 million and $101.5 million for
the years ended December 31, 2005 and 2004, respectively, of which 11.7% and
13.9% were derived from newsstand sales in the respective years. Our print run,
which is developed with input from Time/Warner Retail Sales and Marketing, or
TWRSM, our national distributor, varies each month based on expected sales. Our
expected sales are based on historical analyses of demand based on a number of
variables, including content, time of year and the cover price. We record our
revenues for each month's issue utilizing our expected sales. Our revenues are
recorded net of a provision for estimated returns. Substantially all of the
magazines to be returned are returned within 90 days of the date that the
subsequent issue goes on sale. We adjust our provision for returns based on
actual returns of the magazine. Historically, our annual adjustments to Playboy
magazine newsstand revenues have not been material and are driven by differences
in actual consumer demand as compared to expected sales. At any point, our
exposure to a material adjustment to revenue is mitigated because, generally,
only the most recent two to three months would not have been fully adjusted to
actual based on actual returns received.
TRADEMARKS
Our trademarks are critical to the success and growth potential of all of
our businesses. We actively protect and defend our trademarks throughout the
world and monitor the marketplace for counterfeit products. Consequently, we
defend our trademarks by initiating legal proceedings, when warranted, to
prevent their unauthorized use, and we incur and capitalize costs associated
with acquisition, defense, registration and/or renewal of our trademarks. In
accordance with Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets, trademark-related costs are not being amortized,
since our trademarks have indefinite lives, but are subject to annual impairment
tests in accordance with the accounting standard.
DEFERRED REVENUES
As of December 31, 2005, $37.1 million and $3.0 million of deferred
revenues related to Playboy magazine subscriptions and online subscriptions,
respectively. Sales of Playboy magazine and online subscriptions, less estimated
cancellations, are deferred and recognized as revenues proportionately over the
subscription periods. Our estimates of cancellations are based on historical
experience and current marketplace conditions and are adjusted monthly on the
basis of actual results. We have not experienced significant deviations between
estimated and actual results.
42
RELATED PARTY TRANSACTIONS
HUGH M. HEFNER
We own a 29-room mansion located on 5 1/2 acres in Los Angeles,
California. The Playboy Mansion is used for various corporate activities,
including serving as a valuable location for television production, magazine
photography and for online, advertising, marketing and sales events. It also
enhances our image as host for many charitable and civic functions. The Playboy
Mansion generates substantial publicity and recognition, which increases public
awareness of us and our products and services. Its facilities include a tennis
court, swimming pool, gymnasium and other recreational facilities as well as
extensive film, video, sound and security systems. The Playboy Mansion also
includes accommodations for guests and serves as an office and residence for Mr.
Hefner. It has a full-time staff that performs maintenance, serves in various
capacities at the functions held at the Playboy Mansion and provides our and Mr.
Hefner's guests with meals, beverages and other services.
Under a 1979 lease entered into with Mr. Hefner, the annual rent Mr.
Hefner pays to us for his use of the Playboy Mansion is determined by
independent experts who appraise the value of Mr. Hefner's basic accommodations
and access to the Playboy Mansion's facilities, utilities and attendant services
based on comparable hotel accommodations. In addition, Mr. Hefner is required to
pay the sum of the per-unit value of non-business meals, beverages and other
benefits he and his personal guests receive. These standard food and beverage
per-unit values are determined by independent expert appraisals based on fair
market values. Valuations for both basic accommodations and standard food and
beverage units are reappraised every three years and are annually adjusted
between appraisals based on appropriate consumer price indexes. Mr. Hefner is
also responsible for the cost of all improvements in any Hefner residence
accommodations, including capital expenditures, that are in excess of normal
maintenance for those areas.
Mr. Hefner's usage of Playboy Mansion services and benefits is recorded
through a system initially developed by the professional services firm of
PricewaterhouseCoopers LLP and now administered by us, with appropriate
modifications approved by the audit and compensation committees of the Board of
Directors. The lease dated June 1, 1979, as amended, between Mr. Hefner and us
renews automatically at December 31 each year and will continue to renew unless
either Mr. Hefner or we terminate it. The rent charged to Mr. Hefner during 2005
included the appraised rent and the appraised per-unit value of other benefits,
as described above. Within 120 days after the end of our fiscal year, the actual
charge for all benefits for that year is finally determined. Mr. Hefner pays or
receives credit for any difference between the amount finally determined and the
amount he paid over the course of the year. We estimated the sum of the rent and
other benefits payable for 2005 to be $1.1 million, and Mr. Hefner paid that
amount during 2005. The actual rent and other benefits payable for 2004 and 2003
were $1.3 million and $1.4 million, respectively.
We purchased the Playboy Mansion in 1971 for $1.1 million and in the
intervening years have made substantial capital improvements at a cost of $13.9
million through 2005 (including $2.5 million to bring the Hefner residence
accommodations to a standard similar to the Playboy Mansion's common areas). The
Playboy Mansion is included in our Consolidated Balance Sheets at December 31,
2005 and 2004, at a net book value of $1.5 million and $1.6 million,
respectively, including all improvements and after accumulated depreciation. We
incur all operating expenses of the Playboy Mansion, including depreciation and
taxes, which were $3.1 million, $3.0 million and $2.3 million for 2005, 2004 and
2003, respectively, net of rent received from Mr. Hefner.
On April 26, 2004, Mr. Hefner converted his $16.7 million of Playboy
Preferred Stock into 1,485,948 shares of our Class B stock and sold these shares
as part of our public equity offering on that date. See Note (S), Public Equity
Offering, to the Notes to Consolidated Financial Statements for additional
information.
At December 31, 2002, and at the time of the Hefner debt restructuring,
Playboy.com had an aggregate of $27.2 million of outstanding indebtedness to Mr.
Hefner in the form of three promissory notes. Upon the closing of the senior
secured notes offering on March 11, 2003, Playboy.com's debt to Mr. Hefner was
restructured as previously discussed in Liquidity and Capital Resources.
As previously mentioned, in August 2001 our subsidiary Playboy.com, issued
$15.3 million of its Series A Preferred Stock, of which $5.0 million was
purchased by Mr. Hefner. See Financing From Related Party within Liquidity and
Capital Resources for additional information regarding the terms and redemption
of the Playboy.com Series A Preferred Stock.
43
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board, or the FASB,
issued Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment, or Statement 123(R), which is a revision of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation,
or Statement 123. Statement 123(R) supersedes Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and amends
Statement of Financial Accounting Standards No. 95, Statement of Cash Flows.
Statement 123(R) requires that all stock-based compensation to employees,
including grants of employee stock options, be recognized in the income
statement based on its fair value.
We adopted Statement 123(R) effective January 1, 2006, using the modified
prospective method. Stock-based compensation expense, adjusted for estimated
forfeitures, will be recognized against earnings for the portion of outstanding
unvested awards. For options granted in 2006 and after, we will be using a
Lattice Binomial option- pricing model for determining the stock-based
compensation expense. For options granted prior to 2006, we will continue to use
the Black-Scholes option pricing model to determine the expense related to
previous years' unvested awards. We are currently evaluating the transition of
this standard and expect to record total stock-based compensation expense of
approximately $3.5 million in 2006.
As permitted by Statement 123, in 2005 we accounted for stock-based
compensation to employees using the intrinsic value method under APB 25.
44
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains "forward-looking statements,"
including statements in Business and Management's Discussion and Analysis of
Financial Condition and Results of Operations, as to expectations, beliefs,
plans, objectives and future financial performance, and assumptions underlying
or concerning the foregoing. We use words such as "may," "will," "would,"
"could," "should," "believes," "estimates," "projects," "potential," "expects,"
"plans," "anticipates," "intends," "continues" and other similar terminology.
These forward-looking statements involve known and unknown risks, uncertainties
and other factors, which could cause our actual results, performance or outcomes
to differ materially from those expressed or implied in the forward-looking
statements. The following are some of the important factors that could cause our
actual results, performance or outcomes to differ materially from those
discussed in the forward-looking statements:
(1) Foreign, national, state and local government regulation, actions or
initiatives, including:
(a) attempts to limit or otherwise regulate the sale, distribution or
transmission of adult-oriented materials, including print,
television, video, and online materials,
(b) limitations on the advertisement of tobacco, alcohol and other
products which are important sources of advertising revenue for us,
or
(c) substantive changes in postal regulations or rates which could
increase our postage and distribution costs;
(2) Risks associated with our foreign operations, including market acceptance
and demand for our products and the products of our licensees;
(3) Our ability to manage the risk associated with our exposure to foreign
currency exchange rate fluctuations;
(4) Changes in general economic conditions, consumer spending habits, viewing
patterns, fashion trends or the retail sales environment which, in each
case, could reduce demand for our programming and products and impact our
advertising revenues;
(5) Our ability to protect our trademarks, copyrights and other intellectual
property;
(6) Risks as a distributor of media content, including our becoming subject to
claims for defamation, invasion of privacy, negligence, copyright, patent
or trademark infringement, and other claims based on the nature and
content of the materials we distribute;
(7) The risk our outstanding litigation could result in settlements or
judgments which are material to us;
(8) Dilution from any potential issuance of common or convertible preferred
stock or convertible debt in connection with financings or acquisition
activities;
(9) Competition for advertisers from other publications, media or online
providers or any decrease in spending by advertisers, either generally or
with respect to the adult male market;
(10) Competition in the television, men's magazine, Internet and product
licensing markets;
(11) Attempts by consumers or private advocacy groups to exclude our
programming or other products from distribution;
(12) Our television, Internet and wireless businesses' reliance on third
parties for technology and distribution, and any changes in that
technology and/or unforeseen delays in its implementation which might
affect our plans and assumptions;
(13) Risks associated with losing access to transponders and competition for
transponders and channel space;
(14) 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 margin splits with operators of these systems;
(15) Risks that we may not realize the expected increased sales and profits and
other benefits from acquisitions and the restructuring of our
international TV joint ventures;
(16) Any charges or costs we incur in connection with restructuring measures we
may take in the future;
(17) Risks associated with the financial condition of Claxson Interactive
Group, Inc., our Playboy TV-Latin America, LLC, joint venture partner;
(18) Increases in paper, printing or postage costs;
(19) 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.
45
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks, including changes in foreign
currency exchange rates. In order to manage the risk associated with our
exposure to such fluctuations, we enter into various hedging transactions that
have been authorized pursuant to our policies and procedures. We have derivative
instruments that have been designated and qualify as cash flow hedges, which are
entered into in order to hedge the variability of cash flows to be received
related to forecasted royalty payments denominated in the Japanese Yen and the
Euro. We hedge these royalties with forward contracts for periods not exceeding
12 months. We formally document all relationships between hedging instruments
and hedged items, as well as our risk management objectives and strategies for
undertaking various hedge transactions. We link all hedges that are designated
as cash flow hedges to forecasted transactions. We also assess, both at the
inception of the hedge and on an on-going basis, whether the derivatives used in
hedging transactions are effective in offsetting changes in cash flows of the
hedged items. Any hedge ineffectiveness is recorded in earnings. We do not use
financial instruments for trading purposes.
At December 31, 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. At December 31, 2004, our long-term debt
consisted of $80.0 million of senior secured notes with a coupon of 11.00%. On
March 15, 2005, we issued and sold in a private placement $100.0 million
aggregate principal amount of our convertible 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. A portion of the net proceeds was used to
complete a tender offer and consent solicitation for, and to purchase and retire
all of the $80.0 million outstanding principal amount of the senior secured
notes. 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 December 31,
2005, the convertible notes had an implied fair value of $116.7 million.
We prepared sensitivity analyses to determine the impact of a hypothetical
10% devaluation of the U.S. dollar relative to the foreign currencies of the
countries to which we have exposure, primarily Japan and Germany. Based on our
sensitivity analyses at December 31, 2005 and 2004, such a change in foreign
currency exchange rates would affect our annual consolidated operating results,
financial position and cash flows by approximately $0.5 million in each period.
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements and supplementary data are
set forth in this Annual Report on Form 10-K as follows:
Page
----
Consolidated Statements of Operations - Fiscal Years Ended
December 31, 2005, 2004 and 2003 47
Consolidated Balance Sheets - December 31, 2005 and 2004 48
Consolidated Statements of Shareholders' Equity - Fiscal Years
Ended December 31, 2005, 2004 and 2003 49
Consolidated Statements of Cash Flows - Fiscal Years Ended
December 31, 2005, 2004 and 2003 50
Notes to Consolidated Financial Statements 51
Report of Independent Registered Public Accounting Firm 72
The supplementary data regarding quarterly results of operations are set
forth in Note (W), Quarterly Results of Operations (Unaudited), to the Notes to
Consolidated Financial Statements.
46
PLAYBOY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
-------------------------------------------------------------------------------------------------------------------
Net revenues $ 338,153 $ 329,376 $ 315,844
-------------------------------------------------------------------------------------------------------------------
Costs and expenses
Cost of sales (250,319) (240,835) (229,216)
Selling and administrative expenses (56,838) (56,894) (56,826)
Restructuring expenses (149) (744) (350)
-------------------------------------------------------------------------------------------------------------------
Total costs and expenses (307,306) (298,473) (286,392)
-------------------------------------------------------------------------------------------------------------------
Gains on disposal 14 2 --
-------------------------------------------------------------------------------------------------------------------
Operating income 30,861 30,905 29,452
-------------------------------------------------------------------------------------------------------------------
Nonoperating income (expense)
Investment income 2,217 579 363
Interest expense (6,986) (13,687) (16,309)
Amortization of deferred financing fees (635) (1,266) (1,407)
Minority interest (1,557) (1,436) (1,660)
Debt extinguishment expenses (19,280) (5,908) (3,264)
Insurance/litigation settlements -- 5,638 (8,500)
Other, net (1,357) (991) (1,265)
-------------------------------------------------------------------------------------------------------------------
Total nonoperating expense (27,598) (17,071) (32,042)
-------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 3,263 13,834 (2,590)
Income tax expense (3,998) (3,845) (4,967)
-------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (735) $ 9,989 $ (7,557)
===================================================================================================================
Net income (loss) $ (735) $ 9,989 $ (7,557)
Dividend requirements of preferred stock -- (428) (893)
-------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common shareholders $ (735) $ 9,561 $ (8,450)
===================================================================================================================
Weighted average number of common shares outstanding
Basic 33,163 31,581 27,023
===================================================================================================================
Diluted 33,163 31,767 27,023
===================================================================================================================
Basic and diluted earnings (loss) per common share $ (0.02) $ 0.30 $ (0.31)
===================================================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
47
PLAYBOY ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
Dec. 31, Dec. 31,
2005 2004
(Restated)
-------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 26,089 $ 26,668
Marketable securities and short-term investments 25,963 24,052
Receivables, net of allowance for doubtful accounts of
$3,883 and $3,897, respectively 46,296 45,084
Receivables from related parties 1,928 1,281
Inventories, net 12,846 12,437
Deferred subscription acquisition costs 10,452 13,104
Other current assets 8,761 8,596
--------------------------------------------------------------------------------------------
Total current assets 132,335 131,222
--------------------------------------------------------------------------------------------
Property and equipment, net 13,771 11,491
Long-term receivables 2,628 2,755
Programming costs, net 52,683 55,997
Goodwill 122,448 111,893
Trademarks 61,139 57,296
Distribution agreements, net of accumulated
amortization of $2,779 and $1,935, respectively 30,362 31,206
Other noncurrent assets 13,603 14,470
--------------------------------------------------------------------------------------------
Total assets $ 428,969 $ 416,330
============================================================================================
Liabilities
Acquisition liabilities $ 11,782 $ 10,184
Accounts payable 25,429 21,796
Accrued salaries, wages and employee benefits 10,068 7,338
Deferred revenues 45,987 51,421
Accrued litigation settlement 1,000 1,000
Other liabilities and accrued expenses 16,396 18,040
--------------------------------------------------------------------------------------------
Total current liabilities 110,662 109,779
--------------------------------------------------------------------------------------------
Financing obligations 115,000 80,000
Acquisition liabilities 11,792 19,085
Net deferred tax liabilities 17,555 15,023
Accrued litigation settlement -- 1,000
Other noncurrent liabilities 16,713 16,768
--------------------------------------------------------------------------------------------
Total liabilities 271,722 241,655
--------------------------------------------------------------------------------------------
Minority interest -- 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;
28,261,472 and 28,521,493 issued, respectively 286 285
Capital in excess of par value 223,537 222,285
Accumulated deficit (59,976) (59,241)
Treasury stock, at cost, 381,971 and 0 shares, respectively (5,000) --
Accumulated other comprehensive loss (1,649) (1,220)
--------------------------------------------------------------------------------------------
Total shareholders' equity 157,247 162,158
--------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 428,969 $ 416,330
============================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
48
PLAYBOY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Unearned Accum.
Class A Class B Capital in Comp.- Other
Preferred Common Common Excess of Accum. Treasury Restricted Comp.
Stock Stock Stock Par Value Deficit Stock Stock Loss(1) Total
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31,
2002 (As reported) $ -- $ 49 $ 214 $ 146,091 $(54,060) $ -- $ (2,713) $(1,766) $ 87,815
Correction of errors -- -- -- -- (6,292) -- -- -- (6,292)
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002
(As restated) -- 49 214 146,091 (60,352) -- (2,713) (1,766) 81,523
Net loss -- -- -- -- (7,557) -- -- -- (7,557)
Shares issued or vested
under stock plans, net -- -- 12 380 -- -- 2,713 -- 3,105
Conversion of Holdings
preferred B to Playboy
preferred A 16,959 -- -- 10,100 -- -- -- -- 27,059
Preferred stock dividends -- -- -- -- (893) -- -- -- (893)
Shares issued related to
Califa acquisition -- -- -- (3,602) -- -- -- -- (3,602)
Other comprehensive income -- -- -- -- -- -- -- 709 709
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003
(As restated) 16,959 49 226 152,969 (68,802) -- -- (1,057) 100,344
Net income -- -- -- -- 9,989 -- -- -- 9,989
Shares issued or vested
under stock plans, net -- -- -- 619 -- -- -- -- 619
Conversion of Playboy
preferred A to Playboy
class B common (16,959) -- 15 16,721 -- -- -- -- (223)
Preferred stock dividends -- -- -- -- (428) -- -- -- (428)
Shares issued in public
equity offering -- -- 44 51,815 -- -- -- -- 51,859
Other comprehensive loss -- -- -- -- -- -- -- (163) (163)
Other -- -- -- 161 -- -- -- -- 161
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004
(As restated) -- 49 285 222,285 (59,241) -- -- (1,220) 162,158
Net loss -- -- -- -- (735) -- -- -- (735)
Shares issued or vested
under stock plans, net -- -- 1 1,219 -- -- -- -- 1,220
Minimum benefit liability
adjustment -- -- -- -- -- -- -- (341) (341)
Other comprehensive loss -- -- -- -- -- -- -- (88) (88)
Treasury stock purchase -- -- -- -- -- (5,000) -- -- (5,000)
Other -- -- -- 33 -- -- -- -- 33
----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 $ -- $ 49 $ 286 $ 223,537 $(59,976) $ (5,000) $ -- $(1,649) $157,247
==================================================================================================================================
(1) Accumulated other comprehensive loss consisted of the following:
Fiscal Year Fiscal Year
Ended Ended
12/31/05 12/31/04
--------------------------------------------------------------------
Unrealized gain on marketable securities $ 134 $ 158
Derivative gain (loss) 7 (80)
Minimum benefit liability adjustment (341) --
Foreign currency translation loss (1,449) (1,298)
--------------------------------------------------------------------
Accumulated other comprehensive loss $ (1,649) $ (1,220)
====================================================================
Comprehensive income (loss) was as follows:
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
-----------------------------------------------------------------------------------------
Net income (loss) $ (735) $ 9,989 $ (7,557)
-----------------------------------------------------------------------------------------
Unrealized gain (loss) on marketable securities (24) 423 817
Derivative gain (loss) 87 (52) 656
Minimum benefit liability adjustment (341) -- --
Foreign currency translation loss (151) (534) (764)
-----------------------------------------------------------------------------------------
Total other comprehensive income (loss) (429) (163) 709
-----------------------------------------------------------------------------------------
Comprehensive income (loss) $ (1,164) $ 9,826 $ (6,848)
=========================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
49
PLAYBOY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
----------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income (loss) $ (735) $ 9,989 $ (7,557)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation of property and equipment 3,188 3,169 3,698
Amortization of intangible assets 1,902 2,236 5,257
Amortization of investments in entertainment programming 37,450 41,695 40,603
Loss on disposals 38 331 --
Amortization of deferred financing fees 635 1,266 1,407
Minority interest 1,557 1,436 1,364
Debt extinguishment expenses 19,280 5,908 3,264
Equity in operations of investments 383 451 80
Insurance settlement -- 5,638 --
Deferred income taxes 2,532 1,146 1,502
Changes in current assets and liabilities
Receivables (1,112) 6,926 (10,340)
Receivables from related parties (647) (55) 316
Inventories (409) (420) (1,519)
Deferred subscription acquisition costs 2,652 (1,345) 279
Other current assets 299 1,596 (2,261)
Accounts payable 3,084 396 (1,921)
Accrued salaries, wages and employee benefits 2,776 (3,721) 3,394
Deferred revenues (5,434) (2,542) 2,732
Acquisition liability interest (55) (2,340) (407)
Accrued litigation settlements (1,875) (5,500) 6,500
Other liabilities and accrued expenses (719) (6,707) 1,820
----------------------------------------------------------------------------------------------------
Net change in current assets and liabilities (1,440) (13,712) (1,407)
----------------------------------------------------------------------------------------------------
Investments in entertainment programming (33,075) (41,457) (44,727)
Increase in trademarks (2,242) (2,014) (2,940)
(Increase) decrease in other noncurrent assets (69) 428 (1,561)
Increase (decrease) in accrued litigation settlement -- (1,000) 2,000
Increase (decrease) in other noncurrent liabilities (1,244) 852 2,485
Other, net (806) 1 1,411
----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 27,354 16,363 4,879
----------------------------------------------------------------------------------------------------
Cash flows from investing activities
Payments for acquisition (8,283) -- --
Proceeds from disposals -- 152 116
Purchases of investments (53,446) (20,000) --
Proceeds from sales of investments 51,511 -- --
Additions to property and equipment (5,590) (2,875) (2,342)
Other, net -- 137 179
----------------------------------------------------------------------------------------------------
Net cash used for investing activities (15,808) (22,586) (2,047)
----------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from equity offering -- 51,859 --
Proceeds from financing obligations 115,000 -- 115,000
Repayment of financing obligations (80,000) (35,000) (65,767)
Payment of debt extinguishment expenses (15,197) (3,850) (356)
Payment of acquisition liabilities (8,804) (11,271) (14,892)
Purchase of treasury stock (5,000) -- --
Payment of deferred financing fees (5,077) -- (9,205)
Payment of preferred stock dividends -- (651) (669)
Repurchase of minority interest in a controlled subsidiary (14,074) -- --
Proceeds from stock plans 1,066 490 272
Other, net (39) (18) (1)
----------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities (12,125) 1,559 24,382
----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (579) (4,664) 27,214
Cash and cash equivalents at beginning of year 26,668 31,332 4,118
----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 26,089 $ 26,668 $ 31,332
====================================================================================================
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(A) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization: Playboy Enterprises, Inc., together with its subsidiaries
through which we conduct business, is a worldwide leader in the development and
distribution of multimedia lifestyle entertainment for adult audiences with
operations in the following business segments: Entertainment, Publishing and
Licensing.
Principles of Consolidation: The consolidated financial statements include
our accounts and all majority-owned subsidiaries. Intercompany accounts and
transactions have been eliminated in consolidation.
Use of Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Although these estimates are
based on management's knowledge of current events and actions it may undertake
in the future, they may ultimately differ from actual results.
Reclassifications: Certain amounts reported for prior periods have been
reclassified to conform to the current year's presentation.
New Accounting Pronouncements: In December 2004, the Financial Accounting
Standards Board, or the FASB, issued Statement of Financial Accounting Standards
No. 123 (revised 2004), Share-Based Payment, or Statement 123(R), which is a
revision of Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, or Statement 123. Statement 123(R) supersedes
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, or APB 25, and amends Statement of Financial Accounting Standards No.
95, Statement of Cash Flows. Statement 123(R) requires that all stock-based
compensation to employees, including grants of employee stock options, be
recognized in the income statement based on its fair value.
We adopted Statement 123(R) effective January 1, 2006, using the modified
prospective method. Stock-based compensation expense, adjusted for estimated
forfeitures, will be recognized against earnings for the portion of outstanding
unvested awards. For options granted in 2006 and after, we will be using a
Lattice Binomial option- pricing model for determining the stock-based
compensation expense. For options granted prior to 2006, we will continue to use
the Black-Scholes option pricing model to determine the expense related to
previous years' unvested awards. We are currently evaluating the transition of
this standard and expect to record total stock-based compensation expense of
approximately $3.5 million in 2006.
As permitted by Statement 123, in 2005 we accounted for stock-based
compensation to employees using the intrinsic value method under APB 25.
Stock-based Compensation: At December 31, 2005 and 2004, we had various
stock plans for key employees and non-employee directors, which are more fully
described in Note (Q), Stock Plans. We account for stock options as prescribed
by APB 25 and disclose pro forma information as provided by Statement 123, as
amended by Statement of Financial Accounting Standards No.148, Accounting for
Stock-Based Compensation-Transition and Disclosure, under the intrinsic value
method.
Pro forma net income (loss) and earnings (loss) per common share,
presented below (in thousands, except per share amounts), were determined as if
we had accounted for our employee 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 had accounted for our employee stock options under Statement 123,
compensation expense would have been $3.0 million, $2.8 million and $2.1 million
for the years ended December 31, 2005, 2004 and 2003, respectively.
51
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
---------------------------------------------------------------------------------------------------
Net income (loss)
As reported $ (735) $ 9,989 $ (7,557)
Pro forma (3,685) 7,230 (9,699)
Basic and diluted earnings (loss) per share applicable to
common shareholders
As reported (0.02) 0.30 (0.31)
Pro forma $ (0.11) $ 0.22 $ (0.39)
---------------------------------------------------------------------------------------------------
For the pro forma disclosures above, the estimated fair value of the
options is amortized to expense over their respective vesting periods. The fair
value of each option grant was estimated on the grant date using the
Black-Scholes option pricing model with the following weighted average
assumptions:
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
---------------------------------------------------------------------------------------------------
Risk-free interest rate 3.86% 3.63% 3.33%
Expected stock price volatility 45.80% 54.90% 48.90%
Expected dividend yield -- -- --
---------------------------------------------------------------------------------------------------
For 2005, 2004 and 2003, an expected life of six years was used for all of
the stock options, and the weighted average per share fair value of options
granted was $5.85, $7.80 and $5.06, respectively.
Revenue Recognition: Domestic TV networks DTH and cable revenues are
recognized based on estimates of PPV buys and monthly subscriber counts reported
each month by the system operators and adjusted to actual. The net adjustments
to actual are not material. International TV revenues are recognized upon
identification of programming scheduled for networks, delivery of programming to
customers and/or upon the commencement of the license term. Revenues from the
sale of Playboy magazine and online subscriptions are recognized over the terms
of the subscriptions. Revenues from newsstand sales of Playboy magazine and
special editions (net of estimated returns) and revenues from the sale of
Playboy magazine advertisements are recorded when each issue goes on sale.
Revenues from e-commerce are recognized when the items are shipped, which is
when title passes. Royalties from licensing our trademarks in our international
publishing and product licensing businesses are generally recognized on a
straight-line basis over the terms of the related agreements.
Cash Equivalents: Cash equivalents are temporary cash investments with an
original maturity of three months or less at date of purchase and are stated at
cost, which approximates fair value.
Marketable Securities: Marketable securities are classified as
available-for-sale securities, stated at fair value and accounted for under the
specific identification method. Net unrealized holding gains and losses are
included in "Accumulated other comprehensive loss."
Accounts Receivable and Allowance for Doubtful Accounts: Trade receivables
are reported at their outstanding unpaid balances less an allowance for doubtful
accounts. The allowance for doubtful accounts is increased by charges to income
and decreased by chargeoffs (net of recoveries). We perform periodic evaluations
of the adequacy of the allowance based on our past loss experience and adverse
situations that may affect a customer's ability to pay.
Inventories: Inventories are stated at the lower of cost (specific cost
and average cost) or fair value.
Property and Equipment: Property and equipment are stated at cost. Costs
incurred for computer software developed or obtained for internal use are
capitalized for application development activities and are immediately expensed
for preliminary project activities or post-implementation activities.
Depreciation is recorded using the straight-line method over the estimated
useful lives of the assets. The useful life for building improvements is ten
52
years, furniture and equipment ranges from one to ten years and software ranges
from one to five years. Leasehold improvements are depreciated using a
straight-line basis over the shorter of their estimated useful lives or the
terms of the related leases. Repair and maintenance costs are expensed as
incurred and major betterments are capitalized. Sales and retirements of
property and equipment are recorded by removing the related cost and accumulated
depreciation from the accounts, after which any related gains or losses are
recognized.
Advertising Costs: We expense advertising costs as incurred, except for
direct-response advertising. Direct-response advertising consists primarily of
costs associated with the promotion of Playboy magazine subscriptions,
principally the production of direct-mail solicitation materials and postage,
and the distribution of direct and e-commerce catalog mailings. These
capitalized direct-response advertising costs are amortized over the period
during which the future benefits are expected to be received, generally six to
12 months.
Programming Amortization and Online Content Costs: Original programming
and film acquisition costs are primarily assigned to the domestic and
international networks and are capitalized and amortized utilizing the
straight-line method, generally over three years. Online content expenditures
are generally expensed as incurred. We believe that these methods provide a
reasonable matching of expenses with total estimated revenues over the periods
that revenues associated with films, programs and online content are expected to
be realized. Film and program amortization are adjusted periodically to reflect
changes in the estimates of amounts of related future revenues. Film and program
costs are stated at the lower of unamortized cost or estimated net realizable
value as determined on a specific identification basis and are classified on the
balance sheet as noncurrent assets. See Note (M), Programming Costs, Net.
Intangible Assets: In accordance with Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets, or Statement 142, we do
not amortize goodwill and intangible assets with indefinite lives, but subject
them to annual impairment tests. Our indefinite-lived intangible assets consist
of trademarks and certain acquired distribution agreements. Other intangible
assets continue to be amortized over their useful lives. Noncompete agreements
are being amortized using the straight-line method over the lives of the
agreements, either five or ten years. Distribution agreements deemed to have
definite lives are being amortized using the straight-line method over the lives
of the agreements, ranging from three months to eight years. Capitalized
trademark costs include recurring costs associated with the acquisition,
defense, registration, and/or renewal of our trademarks. A program supply
agreement is amortized using the straight-line method over the ten-year life of
the agreement. Copyright defense, registration and/or renewal costs are being
amortized using the straight-line method over 15 years. The noncompete
agreements, program supply agreement and copyright costs are all included in
"Other noncurrent assets."
During the first quarter of 2002, we completed the required transitional
impairment tests for goodwill and indefinite-lived intangible assets, which did
not result in an impairment charge. Deferred tax liabilities related to these
assets with indefinite lives will now be realized only if there is a disposition
or an impairment of the value of these intangible assets. We currently have net
operating losses, or NOLs, available to offset deferred tax liabilities realized
within the NOL carryforward period. However, we cannot be certain that NOLs will
be available when the deferred tax liabilities related to these intangible
assets are realized. Therefore, in 2002, we recorded a noncash income tax
provision of $7.1 million for these deferred tax liabilities, which included
$5.8 million related to the cumulative effect of changing the accounting for
amortization from prior years.
As a result of the restructuring of the ownership of Playboy TV
International, LLC, or PTVI, in December 2002, we acquired distribution
agreements of $3.4 million with a weighted average life of approximately four
years and a program supply agreement of $3.2 million with a life of ten years.
The weighted average life of the aggregate of the definite-lived intangible
assets acquired was approximately seven years. We also acquired indefinite-lived
distribution agreements of $9.0 million, which will not be amortized but are
subject to annual impairment testing.
In 2004, we sold our Sarah Coventry trademarks and service marks for their
approximate book value, pursuant to an agreement under which we will receive
payments over a period not to exceed ten years.
53
Amortizable intangible assets consisted of the following (in thousands):
December 31, 2005 December 31, 2004
------------------------------------ ------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
-----------------------------------------------------------------------------------------------
Noncompete
agreements $ 14,000 $ 13,185 $ 815 $ 14,000 $ 12,855 $ 1,145
Distribution
agreements 3,151 2,779 372 3,151 1,935 1,216
Program supply
agreement 3,226 968 2,258 3,226 645 2,581
Copyrights 2,047 1,011 1,036 1,979 875 1,104
Other 250 250 -- -- -- --
-----------------------------------------------------------------------------------------------
Total amortizable
intangible
assets $ 22,674 $ 18,193 $ 4,481 $ 22,356 $ 16,310 $ 6,046
===============================================================================================
At December 31, 2005 and 2004, our indefinite-lived intangible assets not
subject to amortization included goodwill of $122.4 million and $111.9 million,
respectively, and trademarks of $61.1 million and $57.3 million, respectively.
Also, of the $30.4 million and $31.2 million of distribution agreements on our
Consolidated Balance Sheets at December 31, 2005 and 2004, respectively, $30.0
million are indefinite-lived at both dates.
At December 31, 2005 and 2004, goodwill by reportable segment, reflected
entirely in the Entertainment Group, was $122.4 million and $111.9 million,
respectively.
The aggregate amortization expense for intangible assets with definite
lives for 2005, 2004 and 2003 was $1.9 million, $2.2 million and $5.3 million,
respectively, and is expected to total approximately $1.0 million in 2006 and
$0.6 million per year for 2007 through 2010.
We conduct our annual impairment testing of goodwill and indefinite-lived
intangible assets as of October 1st. If the carrying amount of the assets are
not recoverable based on a forecasted cash flow analysis or a market
capitalization approach, such assets would be reduced by the estimated shortfall
of fair value to recorded value. Based upon our impairment testing as of October
1, 2005, we determined that no impairments of intangible assets existed.
Derivative Financial Instruments: We account for derivative instruments in
accordance with Statement of Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities, as amended by Statement of
Financial Accounting Standards No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities, which requires all derivative
instruments to be recognized as either assets or liabilities on the balance
sheet at fair value regardless of the purpose or intent for holding the
derivative instrument. The accounting for changes in the fair value of a
derivative instrument depends on whether it has been designated as and qualifies
as part of a hedging relationship and, further, on the type of relationship.
We formally document all relationships between hedging instruments and
hedged items, as well as our risk management objectives and strategies for
undertaking various hedge transactions. At December 31, 2005, we had derivative
instruments that have been designated as and qualify as cash flow hedges, which
are entered into in order to hedge the variability of cash flows to be received
related to forecasted royalty payments denominated in the Japanese Yen and the
Euro. We hedge these royalties with forward contracts for periods not exceeding
12 months. The fair value and carrying value of our forward contracts are not
material. Since these derivative instruments are designated and qualify as cash
flow hedges, the effective portion of the gain or loss on the derivative
instruments is being deferred and reported as a component of "Accumulated other
comprehensive loss" and is reclassified into earnings in the same line item
where the royalty revenue is recognized.
We had net unrealized gains of $7 thousand and net unrealized losses of
$0.1 million in 2005 and 2004, respectively, included in "Accumulated other
comprehensive loss," which represents the effective portion of
54
changes in fair value of the cash flow hedges. We do not expect any significant
losses to be reclassified from "Accumulated other comprehensive loss" to
earnings within the next 12 months.
Earnings per Common Share: We compute basic and diluted earnings per
share, or EPS, in accordance with Statement of Financial Accounting Standards
No. 128, Earnings per Share. Basic EPS is computed by dividing net income (loss)
applicable to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted EPS adjusts basic EPS for the
dilutive effects of stock options and other potentially dilutive financial
instruments. See Note (G), Earnings Per Common Share.
Equity Investments: Prior to the 2002 restructuring of the ownership of
PTVI, the equity method was used to account for our 19.9% interest in the common
stock of PTVI due to our ability to exercise significant influence over PTVI's
operating and financial policies. Equity in operations of PTVI included our
19.9% interest in the results of PTVI, the elimination of unrealized profits on
certain transactions between us and PTVI and gains related to the transfer of
certain assets to PTVI. Beginning in 2003, the equity method is used to account
for our 19.0% investment in Playboy TV-Latin America, LLC, or PTVLA, since the
restructuring gave us the ability to exercise influence over PTVLA. The cost
method was used prior to the restructuring.
Minority Interest: In August 2001, our subsidiary Playboy.com, Inc., or
Playboy.com, issued $15.3 million of its Series A Preferred Stock, of which $5.0
million was purchased by Hugh M. Hefner, Editor-In-Chief and Chief Creative
Officer, or Mr. Hefner. In connection with the restructuring of our
international TV joint ventures, we received the Playboy.com Series A Preferred
Stock that was owned by an affiliate of Claxson Interactive Group, Inc., or
Claxson. During the fourth quarter of 2005, we repurchased the remaining
outstanding Playboy.com Series A Preferred Stock that was held by Mr. Hefner and
an unrelated third party for $14.1 million. Included in this amount was $3.9
million of accrued dividends. Pursuant to its terms, the Playboy.com Series A
Preferred Stock was canceled, retired and ceased to be outstanding as a result
of the repurchases. Subsequently, Playboy.com became a wholly owned subsidiary
of ours.
At December 31, 2004, "Minority interest" and "Other noncurrent
liabilities" included the accretion of dividends payable and professional fees
related to the Playboy.com Series A Preferred Stock. Also included in "Other
noncurrent liabilities" was minority interest associated with the Playboy.com
Series A Preferred Stock.
Foreign Currency Translation: Assets and liabilities in foreign currencies
related to our international TV foreign operations were translated into U.S.
dollars at the exchange rate existing at the balance sheet date. The net
exchange differences resulting from these translations were included in
"Accumulated other comprehensive loss." Revenues and expenses were translated at
average rates for the period.
(B) RESTATEMENTS
During the preparation of our 2005 financial statements, we elected to
restate prior period balance sheet amounts to (1) reflect the change from the
cost method to the equity method of accounting for our investment in PTVLA and
(2) to recognize additional liability relating to our salary continuation
policy. In connection with the restructuring of the ownership of our
international TV joint ventures with Claxson in 2002, we changed from the cost
method to the equity method of accounting for our investment in PTVLA. In
connection with the change in accounting method, we did not adjust the carrying
value of our investment in PTVLA or retroactively restate prior periods to
reflect the equity method of accounting from inception because the adjustments
were immaterial to the financial statements of prior interim or annual periods
taken as a whole. In 2003, we began to account for our share of PTVLA's earnings
(losses) on the equity method. We have now decided to restate prior periods to
give retroactive effect to the equity method of accounting in accordance with
Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock. This restatement effectively decreases the carrying
value of our investment in PTVLA and related impact on shareholders' equity by
$4.3 million. See Note (D), Restructuring of Ownership of International TV Joint
Ventures. We currently maintain a practice of paying a separation allowance
under our salary continuation policy to employees with at least five years of
continuous service who voluntarily terminate employment with us and are at age
60 or thereafter. In 2003, we began to recognize the expense and the liability
for our salary continuation policy on an accrual basis. We did not recognize the
actuarially computed beginning liability as it was immaterial to the financial
statements of prior interim or annual periods taken as a whole. Based on our
2005 actuarial assessment, we have decided to adjust the liability and
shareholders' equity
55
at December 31, 2005 and restate those amounts at prior balance sheets dates.
Additionally, we have reclassed the existing liability from "Accrued salaries,
wages and employee benefits" to "Other noncurrent liabilities." See Note (O),
Benefit Plans.
The cumulative effect of the restatements described above resulted in a
$4.3 million decrease in assets, a $2.0 million increase in liabilities and a
$6.3 million decrease in shareholders' equity. The restatements had no net
effect on our Consolidated Statements of Operations and Cash Flows for all
periods presented, and the adjustments did not have a material impact on
the financial statements taken as a whole.
(C) ACQUISITION
In July 2001, we acquired The Hot Network and The Hot Zone networks,
together with the related television assets of Califa Entertainment Group, Inc.,
or Califa. In addition, we acquired the Vivid TV network, now operated as Spice
Platinum, and the related television assets of V.O.D., Inc., or VODI, a separate
entity owned by the sellers. The addition of these networks into our television
networks portfolio enables us to offer a wider range of adult programming. We
accounted for the acquisition under the purchase method of accounting.
Accordingly, the results of these networks since the acquisition date have been
included in our Consolidated Statements of Operations. In connection with the
acquisition and purchase price allocations, the Entertainment Group recorded
goodwill of $27.4 million, which is deductible over 15 years for income tax
purposes. The purchase price was recorded at its net present value and is
reported in the Consolidated Balance Sheets as components of current and
noncurrent "Acquisition liabilities."
We recorded $30.8 million of intangible assets separate from goodwill
consisting of $28.5 million for distribution agreements and $2.3 million for
noncompete agreements. All of the noncompete agreements and $7.5 million of the
distribution agreements are being amortized over approximately eight and two
years, respectively, the weighted average lives of these agreements.
Distribution agreements totaling $21.0 million were deemed to have indefinite
lives and are not subject to amortization in accordance with Statement 142.
The total consideration for the acquisition was $70.0 million and is
required to be paid in installments over a ten-year period ending in 2011. The
nominal consideration for Califa's assets was $28.3 million. We also assumed the
obligations of Califa related to a note payable and noncompete liability. The
nominal consideration for VODI's assets was $41.7 million. We were obligated to
pay up to an additional $12.0 million in consideration upon the achievement of
specified financial performance targets, $5.0 million of which we paid on
February 28, 2003 and $7.0 million of which we paid on March 1, 2004. The
amounts were recorded at the acquisition date as part of acquisition
liabilities.
We may accelerate all or any portion of the remaining unpaid purchase
price, but only by making the accelerated payments in cash, at a discount rate
to be mutually agreed upon by the parties in good-faith negotiations. However,
if the parties are unable to agree on the discount rate, we may, at our sole
discretion, elect to accelerate the payment at a 12% discount rate.
The Califa acquisition agreement gave us the option of paying up to $71.0
million of the scheduled payments in cash or Class B stock. The number of
shares, if any, we issue in connection with a particular payment or particular
payments is based on the trading prices of the Class B stock surrounding the
applicable payment dates. Prior to each scheduled payment of consideration, we
must provide the sellers with written notice specifying the portion of the
purchase price payment that we intend to pay in cash and the portion in Class B
stock. If we notify the sellers that we intend to issue Class B stock, the
sellers must elect the portion of the shares that the sellers want us to
register under the Securities Act, referred to as the eligible shares. We are
then obligated to issue eligible shares registered under the Securities Act. The
sellers may sell the eligible shares received during the 90-day period following
the date the eligible shares are issued. If we do not get the registration
statement relating to the resale of our shares issued in connection with a
specified payment effective within the periods set forth in the agreement, we
are also obligated to pay the sellers interest on the amount of the payment
until the registration statement is declared effective. The interest payment can
be paid in cash or shares of Class B stock at our option. For purposes of this
discussion, references to eligible shares also include any shares of Class B
stock issued to pay any required interest payments, if applicable. The interest
rate will vary depending on the length of time required after the applicable
payment date to get the registration statement declared effective. The number of
eligible shares that may be sold on
56
any day during a selling period is limited under the purchase agreement for the
networks. A selling period will be extended if the applicable volume limitations
did not permit all of the eligible shares to be sold during that selling period,
assuming that the maximum number of shares was sold on each day during the
period.
If the sellers elect to sell eligible shares during the applicable selling
period, and the proceeds from the sales of those eligible shares are less than
the aggregate value of those eligible shares at the time of their issuance, we
have agreed to make the sellers whole for the shortfall by, at our option, (a)
paying the shortfall in cash, (b) issuing additional shares of Class B stock in
an amount equal to the shortfall, referred to as the make-whole shares, or (c)
increasing the next scheduled payment of consideration to the sellers in an
amount equal to the shortfall plus interest on the shortfall at a specified
interest rate until the next scheduled payment of consideration. The foregoing
make-whole mechanism will apply only to the extent the sellers have sold the
maximum number of shares they are entitled to sell during the applicable selling
period in accordance with the applicable volume limitations.
We are obligated to issue make-whole shares that are registered under the
Securities Act and the sellers are entitled to sell those shares during a 30-day
selling period that follows their issuance. Sales of make-whole shares are also
subject to volume limitations and the selling periods applicable to make-whole
shares will also be extended if the applicable volume limitations did not permit
all of the make-whole shares to be sold during the applicable selling period,
assuming that the maximum number of shares was sold on each day during the
period. If during the applicable selling period for eligible shares or
make-whole shares, the sales proceeds exceed the amount of the purchase price
payment or the amount of the make-whole payment, the sellers will immediately
cease the offering and sale of the remaining eligible shares or make-whole
shares, as applicable, and the remaining eligible shares or make-whole shares,
as applicable, will be returned promptly to us along with any excess sales
proceeds.
On April 17, 2002, a registration statement for the resale of
approximately 1,475,000 shares became effective. These shares were issued in
payment of the first two installments of consideration, which totaled $22.5
million plus $0.3 million of accrued interest. The sellers elected to sell the
shares and realized net proceeds from the sale of $19.2 million. As a result, we
were required to provide them with a make-whole payment in either cash or Class
B stock of approximately $3.6 million, plus interest until the date payment was
made. On March 14, 2003, we paid the sellers $17.3 million in cash, in
satisfaction of $8.5 million of base consideration due in 2003, a $5.0 million
performance-based payment due in 2003 and the $3.6 million make-whole payment,
plus accrued interest of $0.2 million thereon. The amounts were recorded at the
acquisition date as part of acquisition liabilities. In 2005 and 2004, we paid
the sellers $8.0 million and $15.0 million in cash, respectively. In 2004, we
paid $7.0 million in performance-based payments. In 2005, we had no such
performance-based payments.
At December 31, 2005, the remaining installments of consideration were due
as follows (in thousands):
2006 $ 8,000
2007 8,000
2008 1,000
2009 1,000
2010 1,000
2011 750
-------------------------------------------------------------------------------
Total future payments $ 19,750
===============================================================================
(D) RESTRUCTURING OF OWNERSHIP OF INTERNATIONAL TV JOINT VENTURES
On December 24, 2002, we completed the restructuring of the ownership of
our international TV joint ventures with Claxson. The restructuring resulted in
our acquiring full ownership of Playboy TV and movie networks outside of the
United States and Canada other than Latin America, Brazil, Iberia and Japan. The
Claxson joint ventures originated when PTVI and PTVLA were formed in 1999 and
1996, respectively, as joint ventures between us and a member of the Cisneros
Group, or Cisneros, for the ownership and operation of Playboy TV networks
outside of the United States and Canada. In 2001, Claxson succeeded Cisneros as
our joint venture partner.
Under the terms of the restructuring transaction, we (a) increased our
ownership in PTVI to 100%, (b) acquired the 19.9% equity in two Japanese
networks previously owned by PTVI, (c) retained our existing 19.0% ownership in
PTVLA, (d) acquired an option to increase our percentage ownership of PTVLA, (e)
obtained 100%
57
distribution rights to Playboy TV en Espanol in the U.S. Hispanic market, (f)
restructured our Latin American Internet joint venture with Claxson in favor of
revenue share and promotional agreements for our respective Internet businesses
in Latin America and (g) received from Claxson its preferred stock ownership in
Playboy.com, which subsequently became a wholly owned subsidiary in the fourth
quarter of 2005.
The equity method is used to account for our investment in PTVLA since the
restructuring gave us the ability to exercise influence over PTVLA. The cost
method was used prior to the restructuring. Equity loss in operations of PTVLA
was $0.4 million, $0.1 million and $0.1 million in 2005, 2004 and 2003,
respectively. Investment in equity interest of PTVLA totaled $4.5 million and
$4.9 million at December 31, 2005 and 2004, respectively.
(E) RESTRUCTURING EXPENSES
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 leased space. There were no additional charges related to the 2001
restructuring plan. Of the total costs related to these restructuring plans,
approximately $10.0 million was paid by December 31, 2005, with the remainder of
$1.2 million to be paid 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.
In 2003, primarily due to excess space in our Chicago office, we recorded
unfavorable adjustments of $0.1 million and $0.2 million to the previous
estimates related to the 2002 and 2001 restructuring plans, respectively.
The following table displays the activity and balances of the
restructuring reserve account for the years ended December 31, 2005, 2004 and
2003 (in thousands):
Consolidation
Workforce of Facilities and
Reduction Operations Total
-------------------------------------------------------------------------------
Balance at December 31, 2002 (1) $ 2,772 $ 3,805 $ 6,577
Adjustment to previous estimate (168) 518 350
Cash payments (1,974) (1,760) (3,734)
-------------------------------------------------------------------------------
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
Adjustment to previous estimate 17 132 149
Cash payments (196) (749) (945)
-------------------------------------------------------------------------------
Balance at December 31, 2005 $ -- $ 1,210 $ 1,210
===============================================================================
(1) The balance at December 31, 2002, consisted of remaining cash payments from
our prior restructuring plans.
58
(F) INCOME TAXES
The income tax provision consisted of the following (in thousands):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
-------------------------------------------------------------------------------
Current:
Federal $ -- $ -- $ 67
State 105 93 152
Foreign 1,361 2,606 3,246
-------------------------------------------------------------------------------
Total current 1,466 2,699 3,465
-------------------------------------------------------------------------------
Deferred:
Federal 2,302 1,042 1,365
State 230 104 137
Foreign -- -- --
-------------------------------------------------------------------------------
Total deferred 2,532 1,146 1,502
-------------------------------------------------------------------------------
Total income tax provision $ 3,998 $ 3,845 $ 4,967
===============================================================================
The U.S. statutory tax rate applicable to us for each of 2005, 2004 and
2003 was 35%. The income tax provision differed from a provision computed at the
U.S. statutory tax rate as follows (in thousands):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
---------------------------------------------------------------------------------------------------
Statutory rate tax provision (benefit) $ 1,142 $ 4,842 $ (907)
Increase (decrease) in taxes resulting from:
Foreign income and withholding tax on licensing income 1,629 2,606 3,246
State income taxes 335 197 289
Nondeductible expenses 295 661 507
Increase (decrease) in valuation allowance 2,632 (9,163) 3,307
Tax benefit of foreign taxes paid or accrued (1,843) (1,341) (1,556)
Tax benefit of state/foreign NOLs (188) -- --
Expiration of capital loss carryforward -- 5,969 --
Other (4) 74 81
---------------------------------------------------------------------------------------------------
Total income tax provision $ 3,998 $ 3,845 $ 4,967
===================================================================================================
Deferred tax assets and liabilities are recognized for the expected future
tax consequences attributable to differences between the financial statement and
tax bases of assets and liabilities using enacted tax rates expected to apply in
the years in which the temporary differences are expected to reverse.
In 2005, the valuation allowance, as adjusted, increased by $2.6 million
related to the recognition of the deferred tax benefit of our NOLs and to the
effect of the deferred tax treatment of certain acquired intangibles. In 2004,
we decreased the valuation allowance by $9.2 million, of which $4.8 million was
due to the reduction in the deferred tax asset related to 2004 net income and
the remainder was primarily due to the expiration of a portion of our capital
loss carryforward and the deferred tax treatment of certain acquired
intangibles.
59
The significant components of our deferred tax assets and deferred tax
liabilities at December 31, 2005 and 2004 are presented below (in thousands):
Dec. 31, Dec. 31,
2005 2004
-------------------------------------------------------------------------------
Deferred tax assets:
NOL carryforwards $ 45,263 $ 41,452
Capital loss carryforwards 1,870 1,947
Tax credit carryforwards 11,001 9,233
Temporary difference related to PTVI 7,423 8,978
Other deductible temporary differences 27,731 27,464
-------------------------------------------------------------------------------
Total deferred tax assets 93,288 89,074
Valuation allowance (75,295) (72,663)
-------------------------------------------------------------------------------
Deferred tax assets 17,993 16,411
-------------------------------------------------------------------------------
Deferred tax liabilities:
Deferred subscription acquisition costs (4,594) (5,811)
Intangible assets (23,530) (20,839)
Other taxable temporary differences (7,424) (4,784)
-------------------------------------------------------------------------------
Deferred tax liabilities (35,548) (31,434)
-------------------------------------------------------------------------------
Deferred tax liabilities, net $(17,555) $(15,023)
===============================================================================
December 31, 2004 amounts in the above schedule are grossed up to reflect
additional state and foreign NOLs and the corresponding valuation allowance.
At December 31, 2005, we had federal NOLs of $96.9 million expiring from
2009 through 2025, state and local NOLs of $86.8 million expiring from 2006
through 2024 and foreign NOLs of $14.6 million that have no expiration date.
Also at December 31, 2005, we had capital loss carryforwards of $5.3 million
expiring in 2008. In addition, foreign tax credit carryforwards of $9.9 million
and minimum tax credit carryforwards of $1.1 million are available to reduce
future U.S. federal income taxes. The foreign tax credit carryforwards expire in
2014 and 2015 and the minimum tax credit carryforwards have no expiration date.
(G) EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted EPS
(in thousands, except per share amounts):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
---------------------------------------------------------------------------------------
Numerator:
For basic EPS - net income (loss) $ (735) $ 9,561 $ (8,450)
Preferred stock dividends -- 428 893
---------------------------------------------------------------------------------------
For diluted EPS - net income (loss) $ (735) $ 9,989 $ (7,557)
=======================================================================================
Denominator:
For basic EPS - weighted-average shares 33,163 31,581 27,023
Effect of dilutive potential common shares:
Employee stock options and other -- 186 --
---------------------------------------------------------------------------------------
Dilutive potential common shares -- 186 --
---------------------------------------------------------------------------------------
For diluted EPS - weighted-average shares 33,163 31,767 27,023
=======================================================================================
Basic and Diluted EPS $ (0.02) $ 0.30 $ (0.31)
=======================================================================================
60
The following table represents the approximate number of shares related to
options to purchase our Class B common stock, or Class B stock, and convertible
preferred stock that were outstanding and not included in the computation of
diluted EPS for the years presented, as the inclusion of these shares would have
been antidilutive (in thousands):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
-------------------------------------------------------------------------------
Stock options 2,371 2,336 2,835
Convertible preferred stock -- 743 1,506
-------------------------------------------------------------------------------
Total 2,371 3,079 4,341
===============================================================================
On May 1, 2003, $10.0 million of the Series A Preferred Stock of our
subsidiary PEI Holdings, Inc., or Holdings, held by Mr. Hefner, along with
accumulated dividends of $0.1 million, were exchanged for 1,122,209 shares of
Playboy Class B stock.
On April 26, 2004, we completed a public offering of 6,021,340 shares of
our Class B stock. Included in this offering were 1,485,948 shares sold by Mr.
Hefner. 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
Series A convertible preferred stock, which we refer to as the Playboy Preferred
Stock, at the time of the offering. See Note (S), Public Equity Offering.
In addition, in accordance with Emerging Issues Task Force Issue No. 04-8,
The Effect of Contingently Convertible Instruments 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 subordinated notes due 2025, or the convertible notes,
because the inclusion of these shares would have been antidilutive. See Note
(N), Financing Obligations.
(H) FINANCIAL INSTRUMENTS
Fair Value: The fair value of a financial instrument represents the amount
at which the instrument could be exchanged in a current transaction between
willing parties, other than in a forced sale or liquidation. For cash and cash
equivalents, receivables, certain other current assets and current maturities of
long-term debt and short-term debt, the amounts reported approximated fair value
due to their short-term nature. At December 31, 2004, our long-term debt
consisted of $80.0 million of 11.00% senior secured notes issued by Holdings, or
senior secured notes. The fair value of these notes was determined to be $92.9
million at December 31, 2004. As described in Note (N), Financing Obligations,
in March 2005, we issued and sold in a private placement $115.0 million
aggregate principal amount of our convertible notes. As of December 31, 2005,
the fair value of the convertible notes was determined to be $116.7 million. For
foreign currency forward contracts, the fair value was estimated using quoted
market prices established by financial institutions for comparable instruments,
which approximated the contracts' values.
Concentrations of Credit Risk: Concentration of credit risk with respect
to accounts receivable is limited due to the wide variety of customers to whom
and segments from which our products are sold and/or licensed.
61
(I) MARKETABLE SECURITIES AND SHORT-TERM INVESTMENTS
Marketable securities, primarily purchased in connection with our deferred
compensation plans, and short-term investments, which represent auction rate
securities, consisted of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
------------------------------------------------------------------------------------
Cost of marketable securities $ 4,829 $ 3,894
Cost of short-term investments 21,000 20,000
Gross unrealized holding gains 215 217
Gross unrealized holding losses (81) (59)
------------------------------------------------------------------------------------
Fair value of marketable securities and short-term investments $ 25,963 $ 24,052
====================================================================================
We purchased $49.1 million and $4.3 million of short-term investments and
marketable securities, respectively, in 2005. We received proceeds of $48.1
million and $3.4 million from the sales of short-term investments and marketable
securities, respectively, in 2005, with realized gains totaling $0.1 million.
There were no such proceeds in 2004 or 2003 and, therefore, no gains or losses
were realized. Included in "Comprehensive income (loss)" for 2005 were net
unrealized holding losses of $24 thousand and for 2004 and 2003 net unrealized
holding gains of $0.4 million and $0.8 million, respectively. We recognized
interest income of $0.9 million and $0.1 million on the auction rate securities
during 2005 and 2004, respectively. No such interest income was recognized
during 2003.
(J) INVENTORIES, NET
Inventories, net, which are stated at the lower of cost (specific cost and
average cost) or fair value, consisted of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
-------------------------------------------------------------------------------
Paper $ 3,939 $ 2,573
Editorial and other prepublication costs 6,529 7,814
Merchandise finished goods 2,378 2,050
-------------------------------------------------------------------------------
Total inventories, net $ 12,846 $ 12,437
===============================================================================
(K) ADVERTISING COSTS
At December 31, 2005 and 2004, advertising costs of $8.1 million and $7.9
million, respectively, were deferred and included in "Deferred subscription
acquisition costs" and "Other current assets." For 2005, 2004 and 2003, our
advertising expense was $38.6 million, $35.8 million and $34.5 million,
respectively.
(L) PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consisted of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
-------------------------------------------------------------------------------
Land $ 292 $ 292
Buildings and improvements 8,712 8,706
Furniture and equipment 20,658 18,337
Leasehold improvements 11,564 11,090
Software 10,169 8,214
-------------------------------------------------------------------------------
Total property and equipment 51,395 46,639
Accumulated depreciation (37,624) (35,148)
-------------------------------------------------------------------------------
Total property and equipment, net $ 13,771 $ 11,491
===============================================================================
62
(M) PROGRAMMING COSTS, NET
Programming costs, net, consisted of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
-------------------------------------------------------------------------------
Released, less amortization $ 38,044 $ 38,279
Completed, not yet released 4,589 10,471
In-process 10,050 7,247
-------------------------------------------------------------------------------
Total programming costs, net $ 52,683 $ 55,997
===============================================================================
Based on management's estimate at December 31, 2005, of future total gross
revenues, approximately 60% of the completed original programming costs is
expected to be amortized during 2006. We expect to amortize virtually all of the
released, original programming costs during the next three years. At December
31, 2005, we had $17.3 million of film acquisition costs, which are typically
amortized using the straight-line method, generally over three years or less,
which is our estimate of the length of time during which we plan to re-air a
film or program on our television networks.
(N) FINANCING OBLIGATIONS
Financing obligations consisted of the following (in thousands):
Dec. 31, Dec. 31,
2005 2004
-------------------------------------------------------------------------------
Convertible senior subordinated notes, interest of 3.00% $115,000 $ --
Senior secured notes, interest of 11.00% -- 80,000
-------------------------------------------------------------------------------
Total financing obligations $115,000 $ 80,000
===============================================================================
DEBT FINANCINGS
On March 15, 2005, we issued and sold in a private placement $100.0
million aggregate principal amount of our 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 of the $80.0 million
outstanding principal amount of the 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 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 in arrears on March 15 and September 15
of each year, payment of which began on September 15, 2005. In addition, under
certain circumstances beginning in 2012, if the trading price of the convertible
notes exceeds a specified threshold during a prescribed measurement period prior
to any semi-annual interest period, contingent interest will become payable on
the convertible notes for that semi-annual interest period at an annual rate of
0.25% per annum.
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;
63
(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 maximum conversion rate, subject to adjustment, is 76.3942 shares per
$1,000 principal amount of the convertible notes.
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 convertible notes, plus any accrued and
unpaid interest up to, but excluding, the redemption date. On or after March 15,
2012, we may at any time redeem any of the convertible notes at the same
redemption price. On each of March 15, 2012, March 15, 2015 and March 15, 2020,
or upon the occurrence of a fundamental change, as specified in the indenture
governing the convertible notes, holders may require us to purchase all or a
portion of their convertible notes at a purchase price in cash equal to 100% of
the principal amount of the notes, plus any accrued and unpaid interest up to,
but excluding, the purchase date.
The convertible notes are unsecured senior subordinated obligations of
Playboy Enterprises, Inc., and rank junior to all of the issuer's senior debt,
including its guarantee of Holdings' borrowings under our credit facility;
equally with all of the issuer's future senior subordinated debt; and, senior to
all of the issuer's future subordinated debt. In addition, the assets of the
issuer's subsidiaries are subject to the prior claims of all creditors,
including trade creditors, of those subsidiaries.
CREDIT FACILITY
Effective April 1, 2005, Holdings and its lenders amended and restated the
credit agreement governing our credit facility, primarily to increase the size
of the credit facility from $30.0 million to $50.0 million. Our credit facility
provides for revolving borrowings by Holdings of up to $50.0 million and the
issuance of up to $30.0 million in letters of credit, subject to a maximum of
$50.0 million in combined borrowings and letters of credit outstanding at any
time. Borrowings under the credit facility bear interest at a variable rate,
equal to a specified Eurodollar, LIBOR or base rate plus a specified borrowing
margin based on our Transactions Adjusted EBITDA, as defined in the credit
agreement. We pay fees on the outstanding amount of letters of credit under the
credit facility based on the margin that applies to borrowings that bear
interest at a rate based on LIBOR. All amounts outstanding under the credit
facility will mature on April 1, 2008. Holdings' obligations as borrower under
the credit facility are guaranteed by us and each of our other U.S.
subsidiaries. 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.
FINANCING FROM RELATED PARTY
At December 31, 2002, Playboy.com had an aggregate of $27.2 million of
outstanding indebtedness to Mr. Hefner in the form of three promissory notes.
Upon the closing of the senior secured notes offering on March 11, 2003,
Playboy.com's debt to Mr. Hefner was restructured. One promissory note, in the
amount of $10.0 million, was extinguished in exchange for shares of Holdings
Series A Preferred Stock with an aggregate stated value of $10.0 million. The
two other promissory notes, in a combined principal amount of $17.2 million,
were extinguished in exchange for $0.5 million in cash and shares of Holdings
Series B Preferred Stock with an aggregate stated value of $16.7 million.
Pursuant to the terms of an exchange agreement between us, Holdings, Playboy.com
and Mr. Hefner and certificates of designation governing the Holdings Series A
and Series B Preferred Stocks, we were required to exchange the Holdings Series
A Preferred Stock for shares of Playboy Class B stock and to exchange the
Holdings Series B Preferred Stock for shares of Playboy Preferred Stock.
On May 1, 2003, we exchanged the Holdings Series A Preferred Stock plus
accumulated dividends for 1,122,209 shares of Playboy Class B stock and
exchanged the Holdings Series B Preferred Stock for 1,674 shares of Playboy
Preferred Stock with an aggregate stated value of $16.7 million. The Playboy
Preferred Stock accrued dividends at a rate of 8.00% per annum, which were paid
semi-annually.
64
The Playboy Preferred Stock was convertible at the option of Mr. Hefner,
the holder, into shares of our Class B stock at a conversion price of $11.2625,
which is equal to 125% of the weighted average closing price of our Class B
stock over the 90-day period prior to the exchange of Holdings Series B
Preferred Stock for Playboy Preferred Stock.
On April 26, 2004, we completed a public offering of 6,021,340 Class B
shares 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 Christie Hefner, our Chairman and Chief
Executive Officer, or Ms. Hefner. Playboy's shares included 3,600,000 initial
shares, plus 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 based on the
number of shares each sold proportionate to the total number of shares sold in
the offering.
In 2005, we repurchased the remaining outstanding Playboy.com Series A
Preferred Stock that was held by Mr. Hefner and an unrelated third party. These
shares were part of the $15.3 million issued by our subsidiary Playboy.com in
2001 of which $5.0 million was purchased by Mr. Hefner. Pursuant to its terms,
the Playboy.com Series A Preferred Stock was canceled, retired and ceased to be
outstanding as a result of the repurchases. Subsequently, Playboy.com became a
wholly owned subsidiary of ours.
(O) BENEFIT PLANS
Our Employees Investment Savings Plan is a defined contribution plan
consisting of two components: a profit sharing plan and a 401(k) plan. The
profit sharing plan covers all employees who have completed 12 months of service
of at least 1,000 hours. Our discretionary contribution to the profit sharing
plan is distributed to each eligible employee's account in an amount equal to
the ratio of each eligible employee's compensation, subject to Internal Revenue
Service limitations, to the total compensation paid to all such employees. Total
contributions for 2005, 2004 and 2003 were $1.5 million, $1.3 million and $1.0
million, respectively.
Eligible employees may participate in our 401(k) plan upon their date of
hire. Our 401(k) plan offers several mutual fund investment options. The
purchase of our stock is not an option. We make matching contributions to our
401(k) plan based on each participating employee's contributions and eligible
compensation. Our matching contributions for 2005, 2004 and 2003 related to this
plan were $1.3 million, $1.2 million and $1.0 million, respectively.
We have two nonqualified deferred compensation plans, which permit certain
employees and all nonemployee directors to annually elect to defer a portion of
their compensation. A match is provided to employees who participate in the
deferred compensation plan, at a certain specified minimum level, and whose
annual eligible earnings exceed the salary limitation contained in the 401(k)
plan. All amounts contributed and earnings credited under these plans are
general unsecured obligations. Such obligations totaled $5.3 million and $4.7
million for 2005 and 2004, respectively, and are included in "Other noncurrent
liabilities."
We currently maintain a practice of paying a separation allowance under
our salary continuation policy to employees with at least five years of
continuous service who voluntarily terminate employment with the Company and are
at age 60 or thereafter. Payments in 2005, 2004 and 2003 under this policy were
approximately $0.2 million, $40 thousand and $10 thousand, respectively. In
2005, 2004 and 2003 we recorded expenses, based on an actuarial estimate, of
$0.5 million for each period. At December 31, 2005, and 2004, the accumulated
benefit obligation was $3.6 million and $3.0 million, respectively, which is
reflected in "Other noncurrent liabilities." At December 31, 2005, and 2004, the
projected benefit obligation was $5.0 million and $4.2 million, respectively. In
2005, we recorded an additional minimum liability of $0.3 million to accumulated
other comprehensive income. Our estimated future benefit payments are $0.5
million, $0.6 million, $0.6 million, $0.6 million and $0.7 million for years
ending December 31, 2006 through 2010, respectively, and $3.5 million for the
five-year period ending December 31, 2015.
65
(P) COMMITMENTS AND CONTINGENCIES
Our principal lease commitments are for office space, operations
facilities and furniture and equipment. Some of these leases contain renewal or
end-of-lease purchase options. Our restructuring initiatives in 2002 and 2001
included the consolidation of office space in our Chicago, New York and Los
Angeles locations. In our restructuring efforts, we have subleased a portion of
our excess office space. See Note (E), Restructuring Expenses.
Rent expense, net was as follows (in thousands):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
-------------------------------------------------------------------------------
Minimum rent expense $ 14,670 $ 13,495 $ 13,755
Sublease income -- (419) (842)
-------------------------------------------------------------------------------
Rent expense, net $ 14,670 $ 13,076 $ 12,913
===============================================================================
There was no contingent rent expense in any of these periods. The minimum
future commitments at December 31, 2005, under operating leases with initial or
remaining noncancelable terms in excess of one year, were as follows (in
thousands):
2006 $ 14,741
2007 13,718
2008 12,204
2009 7,872
2010 7,866
Later years 54,110
Less minimum sublease income (713)
-------------------------------------------------------------------------------
Minimum lease commitments, net $ 109,798
===============================================================================
Our entertainment programming is delivered to DTH and cable operators
through communications satellite transponders. We currently have four
transponder service agreements related to our domestic networks and two
international transponder service agreements. The terms of these agreements
extend from 2006 through 2014. At December 31, 2005, future commitments related
to these six agreements were $6.3 million, $5.7 million, $5.7 million, $4.8
million and $3.5 million for 2006, 2007, 2008, 2009 and 2010, respectively, and
$10.9 million thereafter.
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 are currently pursuing an appeal. We
have posted a bond in the amount of approximately $9.4 million, which represents
the amount of the judgment, costs and estimated pre- and post-judgment interest.
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 of Financial Accounting Standards No. 5,
Accounting for Contingencies.
In 2003, we recorded $8.5 million for the settlement of the Logix
litigation, which related to events prior to our 1999 acquisition of Spice. We
made payments of $1.0 million and $6.5 million in 2005 and 2004, respectively.
In January 2006, we made a final payment of $1.0 million.
In the third quarter of 2005 we acquired an affiliate network of websites
to complement our existing online business. $8.3 million, which included $8.0
million for the initial purchase price and $0.3 million of acquisition-related
costs, was paid in 2005 and additional payments of $2.0 million are required in
each of 2006 and 2007. Additionally, pursuant to the asset purchase agreement,
we are obligated to pay future contingent earnout payments, payable over a
five-year period, based primarily on the financial performance of the acquired
business. When contingent earnout payments are achieved, amounts will be
recorded as a combination of additional purchase price and compensation expense.
66
(Q) STOCK PLANS
We have stock plans for key employees and nonemployee directors, which
provide for the grant of nonqualified and incentive stock options and/or shares
of restricted stock units, deferred stock and other performance-based equity
awards. The exercise price of options granted equals or exceeds the fair value
at the grant date. In general, options vest over a two- to four-year period from
the grant date and expire ten years from the grant
date. Restricted stock units have been granted to key employees and provide for
the issuance of Class B stock if three-year cumulative operating income target
thresholds are met. In addition, one of the plans pertaining to nonemployee
directors also allows for the issuance of Class B stock as awards and payment
for annual retainer, committee and meeting fees.
At December 31, 2005, a total of 1,093,134 shares of Class B stock were
available for future grants under the various stock plans combined. Stock option
transactions are summarized as follows:
Weighted Average
Shares Exercise Price
------------------------------------------------------- -------------------
Class A Class B Class A Class B
------------------------------------------------------- -------------------
Outstanding at December 31, 2002 -- 2,615,886 $ -- $ 17.51
Granted -- 701,000 -- 10.03
Exercised -- (17,500) -- 10.95
Canceled -- (455,500) -- 14.33
------------------------------------------------------
Outstanding at December 31, 2003 -- 2,843,886 -- 16.22
Granted -- 549,500 -- 14.20
Exercised -- (41,334) -- 7.84
Canceled -- (119,332) -- 12.69
------------------------------------------------------
Outstanding at December 31, 2004 -- 3,232,720 -- 16.09
Granted -- 532,000 -- 11.93
Exercised -- (176,252) -- 9.62
Canceled -- (214,333) -- 14.22
------------------------------------------------------
Outstanding at December 31, 2005 -- 3,374,135 $ -- $ 15.85
====================================================== -----------------
The following table summarizes information regarding stock options at
December 31, 2005:
Options Outstanding Options Exercisable
-------------------------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Life In Years Price Exercisable Price
------------------------------------------------------------------------- ----------------------
Class B
$9.75-$16.72 2,448,635 6.65 $ 12.60 1,467,983 $ 12.89
$21.00-$24.13 583,500 3.31 21.84 583,500 21.84
$26.25-$31.50 342,000 3.05 28.89 342,000 28.89
---------------------------------------------- -----------
Total Class B 3,374,135 5.71 $ 15.85 2,393,483 $ 17.36
==============================================--------------------------- ===========-----------
The weighted average exercise prices for Class B exercisable stock options
at December 31, 2004 and 2003 were $17.65 and $18.79, respectively.
We issued 182,000 and 173,000 shares of restricted stock units at a
weighted average per share fair value of $11.91 and $14.04 in 2005 and 2004,
respectively. We canceled 27,000 and 9,000 of those shares during 2005 and 2004,
respectively. As it was probable that the performance criteria would be met for
the 2004 plan, we recorded $0.6 million and $0.7 million of compensation expense
related to this plan in 2005 and 2004, respectively. Additionally, as it was
probable that the performance criteria would not be met for the 2005 plan, no
compensation expense was recorded.
We have an Employee Stock Purchase Plan to provide substantially all
regular full- and part-time employees an opportunity to purchase shares of our
Class B stock through payroll deductions. The funds are withheld and then
67
used to acquire stock on the last trading day of each quarter, based on that
day's closing price less a 15% discount. At December 31, 2005, a total of
approximately 17,000 shares of Class B stock were available for future purchases
under this plan. The adoption of Statement 123(R) will have minimal impact on
our expenses related to the Employee Stock Purchase Plan.
(R) SALE OF SECURITIES
The Califa acquisition agreement gave us the option of paying up to $71.0
million of the purchase price in cash or Class B stock through 2007. On April
17, 2002, a registration statement for the resale of approximately 1,475,000
shares became effective. These shares were issued in payment of the first two
installments of consideration, which totaled $22.5 million plus $0.3 million of
accrued interest. The sellers elected to sell the shares and realized net
proceeds from the sale of $19.2 million. As a result, we were required to
provide them with a make-whole payment in either cash or Class B stock of
approximately $3.6 million, plus interest until the date payment was made. On
March 14, 2003, we paid the sellers $17.3 million in cash, in satisfaction of
$8.5 million of base consideration due in 2003, a $5.0 million performance-based
payment due in 2003 and the $3.6 million make-whole payment, plus accrued
interest of $0.2 million thereon. The amounts were recorded at the acquisition
date as part of acquisition liabilities. In 2005 and 2004, we paid the sellers
$8.0 million and $15.0 million in cash, respectively. See Note (C), Acquisition.
(S) PUBLIC EQUITY OFFERING
On April 26, 2004, we completed a public offering of 6,021,340 Class B
shares 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 their over-allotment option. The shares sold by Mr.
Hefner consisted of all of 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 based on the number of shares each sold proportionate to the
total number of shares sold in 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 the outstanding
senior secured notes, 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 the net proceeds to pay accrued and unpaid dividends on the Playboy Preferred
Stock up to the time of conversion. The balance of the net proceeds was used for
general corporate purposes on an ongoing basis.
(T) CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash paid for interest and income taxes was as follows (in thousands):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
--------------------------------------------------------------------------------
Interest $ 10,949 $ 20,267 $ 13,720
Income taxes $ 2,416 $ 2,544 $ 3,668
--------------------------------------------------------------------------------
In 2005, we used the net proceeds from the convertible notes to, among
other things, complete a tender offer and consent solicitation for, and to
purchase and retire all of the $80.0 million outstanding principal amount of the
senior secured notes. See Note (N), Financing Obligations. In 2003, we had
noncash activities related to the conversion of three related party promissory
notes. The notes were first converted to Holdings Series A and Series B
Preferred Stocks. Subsequently, the Holdings Series A Preferred Stock was
converted to Playboy Class B stock and the Series B Preferred Stock was
converted to Playboy Preferred Stock. See Note (N), Financing Obligations.
(U) SEGMENT INFORMATION
Our businesses are currently classified into the following three
reportable segments: Entertainment, Publishing and Licensing. During the fourth
quarter of 2004, we announced the realignment of our existing TV,
68
DVD, online and wireless businesses. As a result of the new operating structure,
we have changed our reportable business segments to include in the Entertainment
Group segment the operations formerly reported in the Online Group segment. The
new operating structure is designed to streamline operations, maximize return on
content creation and increase responsiveness to customers. As required by
Statement of Financial Accounting Standards No. 131, Disclosure about Segments
of an Enterprise and Related Information, all prior period segment information
has been reclassified to reflect this change.
Entertainment Group operations include the production and marketing of
television programming for our domestic and international TV networks, web-based
entertainment experiences, wireless content distribution, e-commerce, worldwide
DVD products, satellite radio and online gaming under the Playboy, Spice and
other brand names. Publishing Group operations include the publication of
Playboy magazine, as well as other domestic publishing businesses, including
special editions, books and calendars and the licensing of international
editions of Playboy magazine. Licensing Group operations include the licensing
of consumer products carrying one or more of our trademarks and/or images,
Playboy-branded retail stores, location-based entertainment destinations and
certain revenue generating marketing activities.
These reportable segments are based on the nature of the products offered.
Our chief operating decision maker evaluates performance and allocates resources
based on several factors, of which the primary financial measure is segment
operating results. The accounting policies of the reportable segments are the
same as those described in Note (A), Summary of Significant Accounting Policies.
The following table represents financial information by reportable segment
(in thousands):
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
12/31/05 12/31/04 12/31/03
--------------------------------------------------------------------------------
Net revenues (1)
Entertainment $ 203,370 $ 189,157 $ 175,735
Publishing 106,513 119,816 120,678
Licensing 28,270 20,403 19,431
--------------------------------------------------------------------------------
Total $ 338,153 $ 329,376 $ 315,844
================================================================================
Income (loss) before income taxes
Entertainment $ 40,962 $ 33,145 $ 30,823
Publishing (6,471) 6,233 5,160
Licensing 16,137 10,476 10,358
Corporate Administration and Promotion (19,632) (18,207) (16,539)
Restructuring expenses (149) (744) (350)
Gains on disposal 14 2 --
Nonoperating expense (27,598) (17,071) (32,042)
--------------------------------------------------------------------------------
Total $ 3,263 $ 13,834 $ (2,590)
================================================================================
Depreciation and amortization (2) (3)
Entertainment $ 41,603 $ 45,847 $ 47,892
Publishing 159 231 397
Licensing 13 28 33
Corporate Administration and Promotion 765 994 1,236
--------------------------------------------------------------------------------
Total $ 42,540 $ 47,100 $ 49,558
================================================================================
Identifiable assets (2) (4)
Entertainment $ 274,197 $ 262,485 $ 266,298
Publishing 38,833 45,724 48,462
Licensing 7,815 5,344 8,199
Corporate Administration and Promotion 108,124 102,777 90,850
--------------------------------------------------------------------------------
Total $ 428,969 $ 416,330 $ 413,809
================================================================================
(1) Net revenues include revenues attributable to foreign countries of
approximately $89,731, $78,337 and $69,478 in 2005, 2004 and 2003,
respectively. Revenues from the U.K. were $34,451, $29,657 and $24,600 in
2005, 2004 and 2003, respectively. No other individual foreign country's
revenue was material. Revenues are
69
generally attributed to countries based on the location of customers,
except licensing royalties for which revenues are attributed based upon
the location of licensees.
(2) The majority of our property and equipment and capital expenditures are
reflected in Corporate Administration and Promotion; depreciation,
however, is partially allocated to the reportable segments.
(3) Amounts include depreciation of property and equipment, amortization of
intangible assets and amortization of investments in entertainment
programming.
(4) Our long-lived assets located in foreign countries were not material.
(V) RELATED PARTY TRANSACTIONS
In 1971, we purchased the Playboy Mansion in Los Angeles, California,
where our founder, Mr. Hefner, lives. The Playboy Mansion is used for various
corporate activities, including serving as a valuable location for television
production, magazine photography and for online, advertising and sales events.
It also enhances our image, as we host many charitable and civic functions. The
Playboy Mansion generates substantial publicity and recognition, which increase
public awareness of us and our products and services. Mr. Hefner pays us rent
for that portion of the Playboy Mansion used exclusively for his and his
personal guests' residence as well as the per-unit value of non-business meals,
beverages and other benefits received by him and his personal guests. The
Playboy Mansion is included in our Consolidated Balance Sheets at December 31,
2005 and 2004 at a net book value, including all improvements and after
accumulated depreciation, of $1.5 million and $1.6 million, respectively. The
operating expenses of the Playboy Mansion, including depreciation and taxes,
were $3.1 million, $3.0 million and $2.3 million for 2005, 2004 and 2003,
respectively, net of rent received from Mr. Hefner. We estimated the sum of the
rent and other benefits payable for 2005 to be $1.1 million, and Mr. Hefner paid
that amount during 2005. The actual rent and other benefits payable for 2004 and
2003 were $1.3 million and $1.4 million, respectively.
At December 31, 2002 and at the time of the Hefner debt restructuring,
Playboy.com had an aggregate of $27.2 million of outstanding indebtedness to Mr.
Hefner in the form of three promissory notes. Upon the closing of the senior
secured notes offering on March 11, 2003, Playboy.com's debt to Mr. Hefner was
restructured as previously discussed in Note (N), Financing Obligations.
On April 26, 2004, Mr. Hefner converted his $16.7 million of Playboy
Preferred Stock into 1,485,948 shares of our Class B stock and sold these shares
as part of our public equity offering on that date. See Note (S), Public Equity
Offering.
In 2005, we repurchased the remaining outstanding Playboy.com Series A
Preferred Stock that was held by Mr. Hefner and an unrelated third party. These
shares were part of $15.3 million issued by our subsidiary Playboy.com in 2001,
of which $5.0 million was purchased by Mr. Hefner. See Note (N), Financing
Obligations.
70
(W) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of
operations for 2005 and 2004 (in thousands, except per share amounts):
Quarters Ended
---------------------------------------------
2005 Mar. 31 June 30 Sept. 30 Dec. 31
---------------------------------------------------------------------------------------------------------
Net revenues $ 83,451 $ 82,871 $ 80,884 $ 90,947
Operating income 10,908 7,309 5,349 7,295
Net income (loss) (13,119) 4,640 3,178 4,566
Net income (loss) applicable to
common shareholders (13,119) 4,640 3,178 4,566
Basic and diluted earnings (loss) per share applicable to
common shareholders (0.39) 0.14 0.10 0.14
Common stock price
Class A high 13.55 12.20 12.80 13.49
Class A low 10.51 10.85 11.15 11.30
Class B high 14.85 13.37 14.41 15.88
Class B low $ 11.33 $ 11.80 $ 12.57 $ 13.14
---------------------------------------------------------------------------------------------------------
Quarters Ended
---------------------------------------------
2004 Mar. 31 June 30 Sept. 30 Dec. 31
---------------------------------------------------------------------------------------------------------
Net revenues $ 80,870 $ 78,717 $ 80,258 $ 89,531
Operating income 7,452 3,163 6,705 13,585
Net income (loss) 1,888 (8,291) 1,927 14,465
Net income (loss) applicable to
common shareholders 1,553 (8,384) 1,927 14,465
Basic and diluted earnings (loss) per share applicable to
common shareholders 0.06 (0.26) 0.06 0.43
Common stock price
Class A high 14.78 13.26 11.25 12.35
Class A low 12.10 11.00 7.60 9.60
Class B high 16.48 14.55 12.00 13.25
Class B low $ 13.05 $ 11.43 $ 8.00 $ 9.96
---------------------------------------------------------------------------------------------------------
Quarterly and year-to-date computations of per share amounts are made
independently, therefore, the sum of per share amounts for the quarters may not
equal per share amounts for the year.
Net loss for the quarter ended March 31, 2005, included $19.3 million of
debt extinguishment expense related to the redemption of $80.0 million aggregate
principal amount of our senior secured notes. See Note (N), Financing
Obligations.
Net income for the quarter ended December 31, 2004, included a $5.6
million insurance recovery related to litigation.
Net loss for the quarter ended June 30, 2004, included $5.9 million of
debt extinguishment expense related to the redemption of $35.0 million aggregate
principal amount of our senior secured notes. See Note (N), Financing
Obligations.
71
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Playboy Enterprises, Inc.
We have audited the accompanying consolidated balance sheets of Playboy
Enterprises, Inc. as of December 31, 2005 and 2004, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 2005. Our audits also included the
financial statement schedule listed in the Index at Item 15(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Playboy
Enterprises, Inc. at December 31, 2005 and 2004, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Playboy
Enterprises, Inc.'s internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control--Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 10, 2006, expressed an unqualified opinion thereon.
As discussed in Note (B), the consolidated balance sheet as of December
31, 2004 and the consolidated statement of shareholders' equity as of December
31, 2002 have been restated.
Ernst & Young LLP
Chicago, Illinois
March 10, 2006
72
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and 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(f) under the Securities Exchange Act of 1934, as
amended, or the Exchange Act) as of December 31, 2005. Based on that evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that, as
of December 31, 2005, our disclosure controls and procedures are effective.
(b) Management's Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f) and 15d-15(f). Our internal control system was designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of the consolidated financial statements for external
purposes in accordance with generally accepted accounting principles.
Under the supervision of and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting as of December 31, 2005. In making this evaluation, management used
the criteria set forth in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
evaluation, our management believes that our internal control over financial
reporting is effective as of December 31, 2005.
Management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005, has been audited by Ernst & Young
LLP, an independent registered public accounting firm, as stated in their
report, which is included herein.
(c) Management's Consideration of the Restatements
In coming to the conclusion that our disclosure controls and procedures
and our internal control over financial reporting were effective as of December
31, 2005, management considered, among other things, the restatements disclosed
in Note (B), Restatements, to the accompanying Consolidated Financial Statements
included in this Annual Report on Form 10-K. Management reviewed and analyzed
the guidance in the Public Company Accounting Oversight Board's Auditing
Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed
in Conjunction With an Audit of Financial Statements and the Securities and
Exchange Commission's Staff Accounting Bulletin, or SAB, No. 99, Materiality.
The restatements had no effect on our Consolidated Statements of Operations and
Cash Flows for all periods presented because management has been accounting for
the income statement effects of these items appropriately since 2003.
Additionally, the effects on our Consolidated Balance Sheets and Statements of
Shareholders' Equity were immaterial at December 31, 2005 and 2004. Taking into
consideration that (i) the adjustments did not have a material impact on the
financial statements taken as a whole; (ii) we were aware of the issues and had
concluded in prior years that the financial statement effect of any
misstatements were immaterial; and (iii) the adjustments had no effect on income
or cash flows because we had been accounting for the income effects of these
items appropriately since 2003 and we had effective controls over the accounting
for the income impact of these items since 2002, management concluded that these
matters individually and in the aggregate did not constitute a material
weakness.
73
(d) Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
To the Board of Directors and Shareholders of Playboy Enterprises, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that Playboy
Enterprises, Inc. maintained effective internal control over financial reporting
as of December 31, 2005, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Playboy
Enterprises, Inc.'s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Playboy Enterprises, Inc.
maintained effective internal control over financial reporting as of December
31, 2005, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, Playboy Enterprises, Inc. maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of Playboy Enterprises, Inc. as of December 31, 2005 and 2004, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2005, and our
report dated March 10, 2006, expressed an unqualified opinion thereon.
Ernst & Young LLP
Chicago, Illinois
March 10, 2006
74
(e) Change in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial
reporting during the fiscal quarter ended December 31, 2005, that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Item 9B. Other Information
None.
75
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by Item 10 is included in our Proxy Statement (to
be filed) relating to the Annual Meeting of Stockholders to be held in May 2006,
which will be filed within 120 days after the close of our fiscal year ended
December 31, 2005, and is incorporated herein by reference, pursuant to General
Instruction G(3).
We have adopted a code of ethics that applies to our Chief Executive
Officer, Chief Financial Officer and Corporate Controller. That code is part of
our Code of Business Conduct, which is available free of charge through our
website, www.playboyenterprises.com, and is available in print to any
shareholder who sends a request for a paper copy to: Investor Relations, Playboy
Enterprises, Inc., 680 North Lake Shore Drive, Chicago, Illinois 60611. We
intend to include on our website any amendment to, or waiver from, a provision
of the Code of Business Conduct that applies to our Chief Executive Officer,
Chief Financial Officer and Corporate Controller that relates to any element of
the code of ethics definition enumerated in Item 406(b) of Regulation S-K.
Item 11. Executive Compensation
The information required by Item 11 is included in our Proxy Statement (to
be filed) relating to the Annual Meeting of Stockholders to be held in May 2006,
which will be filed within 120 days after the close of our fiscal year ended
December 31, 2005, and is incorporated herein by reference (excluding the Report
of the Compensation Committee and the Performance Graph), pursuant to General
Instruction G(3).
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth information regarding outstanding options
and shares reserved for future issuance as of December 31, 2005:
Class B Stock
----------------------------------------------
Weighted
Average Number
Number of Exercise Price of Shares
Options of Options Remaining for
Outstanding Outstanding Future Issuance
--------------------------------------------------------------------------------------------
Total equity compensation plans approved by
security holders 3,374,135 $ 15.85 1,093,134
============================================================================================
The other information required by Item 12 is included in our Proxy
Statement (to be filed) relating to the Annual Meeting of Stockholders to be
held in May 2006, which will be filed within 120 days after the close of our
fiscal year ended December 31, 2005, and is incorporated herein by reference,
pursuant to General Instruction G(3).
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is included in our Proxy Statement (to
be filed) relating to the Annual Meeting of Stockholders to be held in May 2006,
which will be filed within 120 days after the close of our fiscal year ended
December 31, 2005, and is incorporated herein by reference, pursuant to General
Instruction G(3).
Item 14. Principal Accounting Fees and Services
The information required by Item 14 is included in our Proxy Statement (to
be filed) relating to the Annual Meeting of Stockholders to be held in May 2006,
which will be filed within 120 days after the close of our fiscal year ended
December 31, 2005, and is incorporated herein by reference, pursuant to General
Instruction G(3).
76
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS
Page
----
(1) Financial Statements
Our Financial Statements and Supplementary Data following are
as set forth under Part II. Item 8. of this Annual Report on
Form 10-K:
Consolidated Statements of Operations - Fiscal Years Ended
December 31, 2005, 2004 and 2003 47
Consolidated Balance Sheets - December 31, 2005 and 2004 48
Consolidated Statements of Shareholders' Equity - Fiscal
Years Ended December 31, 2005, 2004 and 2003 49
Consolidated Statements of Cash Flows - Fiscal Years Ended
December 31, 2005, 2004 and 2003 50
Notes to Consolidated Financial Statements 51
Report of Independent Registered Public Accounting Firm 72
(2) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts 87
All other schedules have been omitted because they are not required,
are not applicable or the required information is shown in the
Consolidated Financial Statements or notes thereto.
(3) Exhibits
See Exhibit Index, which appears at the end of this document and
which is incorporated herein by reference.
77
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
March 16, 2006
By /s/ Linda Havard
---------------
Linda G. Havard
Executive Vice President,
Finance and Operations,
and Chief Financial Officer
(Authorized Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Christie Hefner March 16, 2006
-----------------------------------------------
Christie Hefner
Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Richard S. Rosenzweig March 16, 2006
-----------------------------------------------
Richard S. Rosenzweig
Executive Vice President and Director
/s/ Dennis S. Bookshester March 16, 2006
-----------------------------------------------
Dennis S. Bookshester
Director
/s/ David I. Chemerow March 16, 2006
-----------------------------------------------
David I. Chemerow
Director
/s/ Donald G. Drapkin March 16, 2006
-----------------------------------------------
Donald G. Drapkin
Director
/s/ Jerome H. Kern March 16, 2006
-----------------------------------------------
Jerome H. Kern
Director
/s/ Russell I. Pillar March 16, 2006
-----------------------------------------------
Russell I. Pillar
Director
/s/ Sol Rosenthal March 16, 2006
-----------------------------------------------
Sol Rosenthal
Director
/s/ Linda Havard March 16, 2006
-----------------------------------------------
Linda G. Havard
Executive Vice President,
Finance and Operations,
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
78
EXHIBIT INDEX
-------------
All agreements listed below may have additional exhibits which are not
attached. All such exhibits are available upon request, provided the requesting
party shall pay a fee for copies of such exhibits, which fee shall be limited to
our reasonable expenses incurred in furnishing these documents.
Exhibit
Number Description
------- -----------
#2.1 Asset Purchase Agreement, dated as of June 29, 2001, by and among
Playboy Enterprises, Inc., Califa Entertainment Group, Inc., V.O.D.,
Inc., Steven Hirsch, Dewi James and William Asher (incorporated by
reference to Exhibit 2.1 from the Current Report on Form 8-K dated
July 6, 2001)
3.1 Certificate of Incorporation of Playboy Enterprises, Inc.
(incorporated by reference to Exhibit 3 from our quarterly report on
Form 10-Q dated March 31, 2003)
3.2 Amended and Restated Bylaws of Playboy Enterprises, Inc.
(incorporated by reference to Exhibit 3.4 from the Current Report on
Form 8-K dated March 15, 1999)
3.3 Certificate of Amendment of the Amended and Restated Certificate of
Incorporation of Playboy Enterprises, Inc. (incorporated by
reference to Exhibit 3.2 from our quarterly report on Form 10-Q
dated June 30, 2004, or the June 30, 2004 Form 10-Q)
4.1 Indenture, dated March 15, 2005, between Playboy Enterprises, Inc.
and LaSalle Bank National Association, as Trustee (incorporated by
reference to Exhibit 4.1 from the Current Report on Form 8-K dated
March 9, 2005)
4.2 Form of 3.00% Convertible Senior Subordinated Notes due 2025
(included in Exhibit 4.1)
4.3 Registration Rights Agreement, dated March 15, 2005, among Playboy
Enterprises, Inc. and the Initial Purchasers named therein
(incorporated by reference to Exhibit 4.2 from the Current Report on
Form 8-K dated March 9, 2005)
10.1 Playboy Magazine Printing and Binding Agreement
#a October 22, 1997 Agreement between Playboy Enterprises,Inc.
and Quad/Graphics, Inc. (incorporated by reference to Exhibit
10.4 from our transition period report on Form 10-K for the
six months ended December 31, 1997, or the Transition Period
Form 10-K)
#b Amendment to October 22, 1997 Agreement dated as of March 3,
2000 (incorporated by reference to Exhibit 10.1 from our
quarterly report on Form 10-Q for the quarter ended March 31,
2000)
c Second Amendment to October 22, 1997 Agreement dated as of
March 2, 2004 (incorporated by reference to Exhibit 10.1 from
our annual report on Form 10-K for the year ended December 31,
2003, or the 2003 Form 10-K)
10.2 Playboy Magazine Distribution Agreement
a July 2, 1999 Agreement between Warner Publisher Services, Inc.
and Playboy Enterprises, Inc. (incorporated by reference to
Exhibit 10.4 from our quarterly report on Form 10-Q for the
quarter ended September 30, 1999)
#b May 4, 2004 Agreement between Warner Publisher Services, Inc.
and Playboy Enterprises, Inc. (incorporated by reference to
Exhibit 10.1 from the June 30, 2004 Form 10-Q)
@c Amendment to May 4, 2004 Agreement dated as of December 12,
2005
@d Amendment to December 12, 2005 Agreement dated as of January
13, 2006
79
10.3 Playboy Magazine Subscription Fulfillment Agreement
a July 1, 1987 Agreement between Communications Data Services,
Inc. and Playboy Enterprises, Inc. (incorporated by reference
to Exhibit 10.12(a) from our annual report on Form 10-K for
the year ended June 30, 1992, or the 1992 Form 10-K)
b Amendment dated as of June 1, 1988 to said Fulfillment
Agreement (incorporated by reference to Exhibit 10.12(b) from
our annual report on Form 10-K for the year ended June 30,
1993, or the 1993 Form 10-K)
c Amendment dated as of July 1, 1990 to said Fulfillment
Agreement (incorporated by reference to Exhibit 10.12(c) from
our annual report on Form 10-K for the year ended June 30,
1991, or the 1991 Form 10-K)
d Amendment dated as of July 1, 1996 to said Fulfillment
Agreement (incorporated by reference to Exhibit 10.5(d) from
our annual report on Form 10-K for the year ended June 30,
1996, or the 1996 Form 10-K)
#e Amendment dated as of July 7, 1997 to said Fulfillment
Agreement (incorporated by reference to Exhibit 10.6(e) from
the Transition Period Form 10-K)
#f Amendment dated as of July 1, 2001 to said Fulfillment
Agreement (incorporated by reference to Exhibit 10.1 from our
quarterly report on Form 10-Q for the quarter ended September
30, 2001, or the September 30, 2001 Form 10-Q)
10.4 Transponder Service Agreements
a SKYNET Transponder Service Agreement dated March 1, 2001
between Playboy Entertainment Group, Inc. and LORAL SKYNET
(incorporated by reference to Exhibit 10.1 from our quarterly
report on Form 10-Q for the quarter ended March 31, 2001)
b SKYNET Transponder Service Agreement dated February 8, 1999 by
and between Califa Entertainment Group, Inc. and LORAL SKYNET
c Transfer of Service Agreement dated February 22, 2002 between
Califa Entertainment Group, Inc., LORAL SKYNET and Spice Hot
Entertainment, Inc.
d Amendment One to the Transponder Service Agreement between
Spice Hot Entertainment, Inc. and LORAL SKYNET dated February
28, 2002
(items (b), (c) and (d) incorporated by reference to Exhibits
10.4(b), (c) and (d), respectively, from our annual report on Form
10-K for the year ended December 31, 2001, or the 2001 Form 10-K)
e Transponder Service Agreement dated August 12, 1999 between
British Sky Broadcasting Limited and The Home Video Channel
Limited (incorporated by reference to Exhibit 10.4(e) from our
annual report on Form 10-K for the year ended December 31,
2002, or the 2002 Form 10-K)
f First Amendment dated as of May 7, 2004 between Playboy and
LORAL SKYNET extending its current term expiration of January
31, 2010 to January 31, 2013
g Intelsat LLC acquired assets of LORAL SKYNET effective March
17, 2004
(items (f) and (g) incorporated by reference to Exhibits 10.4(f) and
(g), respectively, from our annual report on Form 10-K for the year
ended December 31, 2004, or the 2004 Form 10-K)
#10.5 Playboy TV - Latin America, LLC Agreements
a Second Amended and Restated Operating Agreement for Playboy TV
- Latin America, LLC, effective as of April 1, 2002, by and
between Playboy Entertainment Group, Inc. and Lifford
International Co. Ltd. (BVI)
b Playboy TV - Latin America Program Supply and Trademark
License Agreement, dated as of December 23, 2002 and effective
as of April 1, 2002, by and between Playboy Entertainment
Group, Inc. and Playboy TV - Latin America, LLC
(items (a) and (b) incorporated by reference to Exhibits 10.1 and
10.2, respectively, from the Current Report on Form 8-K dated
December 23, 2002 and filed with the SEC on February 12, 2003)
10.6 Transfer Agreement, dated as of December 23, 2002, by and among
Playboy Enterprises, Inc., Playboy Entertainment Group, Inc.,
Playboy Enterprises International, Inc., Claxson Interactive Group
Inc., Carlyle Investments LLC (in its own right and as a successor
in interest to Victoria Springs Investments Ltd.), Carlton
Investments LLC (in its own right and as a successor in interest to
Victoria Springs Investments Ltd.), Lifford International Co. Ltd.
(BVI) and Playboy TV International, LLC.
80
(incorporated by reference to Exhibit 2.1 from the Current Report on
Form 8-K dated December 23, 2002 and filed with the SEC on January
7, 2003)
#10.7 Amended and Restated Affiliation and License Agreement dated May 17,
2002 between DirecTV, Inc. and Playboy Entertainment Group, Inc.,
Spice Entertainment, Inc., Spice Hot Entertainment, Inc. and Spice
Platinum Entertainment, Inc. regarding DBS Satellite Exhibition of
Programming (incorporated by reference to Exhibit 10.1 from our
quarterly report on Form 10-Q dated June 30, 2002, or the June 30,
2002 Form 10-Q)
#10.8 Affiliation Agreement dated July 8, 2004 between Playboy
Entertainment Group, Inc., Spice Entertainment, Inc., Spice Hot
Entertainment, Inc., and Time Warner Cable Inc. (incorporated by
reference to Exhibit 10.1 from our quarterly report on Form 10-Q
dated September 30, 2004, or the September 30, 2004 Form 10-Q)
10.9 Affiliation Agreement between Spice, Inc., and Satellite Services,
Inc.
a Affiliation Agreement, dated November 1, 1992, between Spice,
Inc., and Satellite Services, Inc.
b Amendment No. 1, dated September 29, 1994, to Affiliation
Agreement, dated November 1, 1992, between Spice, Inc., and
Satellite Services, Inc.
c Letter Agreement, dated July 18, 1997, amending the
Affiliation Agreement, dated November 1, 1992, between Spice,
Inc., and Satellite Services, Inc.
d Letter Agreement, dated December 18, 1997, amending the
Affiliation Agreement, dated November 1, 1992, between Spice,
Inc., and Satellite Services, Inc.
e Amendment, effective September 26, 2005, to Affiliation
Agreement, dated November 1, 1992, between Spice, Inc., and
Satellite Services, Inc.
(items (a) through (e) incorporated by reference to Exhibits 10.1.1
through 10.1.5, respectively, from our quarterly report on Form 10-Q
dated September 30, 2005, or the September 30, 2005 Form 10-Q)
10.10 Affiliation Agreement between Playboy Entertainment Group,Inc.,
and Satellite Services, Inc.
a Affiliation Agreement, dated February 10, 1993, between
Playboy Entertainment Group, Inc., and Satellite Services,
Inc.
b Amendment, effective September 26, 2005, to Affiliation
Agreement, dated February 10, 1993, between Playboy
Entertainment Group, Inc., and Satellite Services, Inc.
(items (a) and (b) incorporated by reference to Exhibits 10.2.1 and
10.2.2, respectively, from the September 30, 2005 Form 10-Q)
10.11 Master Lease Agreement dated December 22, 2003 between The Walden
Asset Group, LLC and Playboy Entertainment Group, Inc.
a Master Lease Agreement
b Equipment Schedule No. 1
c Acceptance Certificate for Equipment Schedule No. 1
(items (a) through (c) incorporated by reference to Exhibit 10.8
from the 2003 Form 10-K)
10.12 Acknowledgement of Assignment dated December 22, 2003 among Playboy
Entertainment Group, Inc., The Walden Asset Group, LLC and General
Electric Capital Corporation (incorporated by reference to Exhibit
10.9 from the 2003 Form 10-K)
#10.13 Corporate Guaranty dated December 22, 2003 executed by General
Electric Capital Corporation regarding the Master Lease Agreement
dated December 22, 2003 (incorporated by reference to Exhibit 10.10
from the 2003 Form 10-K)
#10.14 Fulfillment and Customer Service Services Agreement dated January
2, 2004 between Infinity Resources, Inc. and Playboy.com, Inc.
(incorporated by reference to Exhibit 10.2 from the June 30, 2004
Form 10-Q)
81
10.15 Amended and Restated Credit Agreement, effective April 1, 2005, or
the Credit Agreement, among PEI Holdings, Inc., as borrower, and
Bank of America, N.A., as Agent and the other lenders from time to
time party thereto
a Credit Agreement (incorporated by reference to Exhibit 10.1 to
our quarterly report on Form 10-Q dated March 31, 2005)
@b First Amendment to April 1, 2005 Credit Agreement dated March
10, 2006 among PEI Holding, Inc., as borrower, Bank of
America, N.A., as Agent, and the other Lenders Party Hereto
c Master Corporate Guaranty, dated March 11, 2003
d Security Agreement, dated as of March 11, 2003, between PEI
Holdings, Inc. and Bank of America, N.A., as Agent under the
Credit Agreement
e Security Agreement, dated as of March 11, 2003, among Playboy
Enterprises, Inc. and each of the domestic subsidiaries of PEI
Holdings, Inc. set forth on the signature pages thereto and
Bank of America, N.A., as Agent under the Credit Agreement
f Pledge Agreement, dated as of March 11, 2003, between PEI
Holdings, Inc. and Bank of America, N.A., as agent for the
various financial institutions from time to time parties to
the Credit Agreement
g Pledge Agreement, dated as of March 11, 2003, among Chelsea
Court Holdings LLC, as the limited partner in 1945/1947 Cedar
River C.V., Candlelight Management LLC, as the general partner
in 1945/1947 Cedar River C.V., and Bank of America, N.A., as
agent for the various financial institutions from time to time
parties to the Credit Agreement
h Pledge Agreement, dated as of March 11, 2003, between Claridge
Organization LLC and Bank of America, N.A., as agent for the
various financial institutions from time to time parties to
the Credit Agreement
i Pledge Agreement, dated as of March 11, 2003, between Playboy
Clubs International, Inc. and Bank of America, N.A., as agent
for the various financial institutions from time to time
parties to the Credit Agreement
j Pledge Agreement, dated as of March 11, 2003, between CPV
Productions, Inc. and Bank of America, N.A., as agent for the
various financial institutions from time to time parties to
the Credit Agreement
k Pledge Agreement, dated as of March 11, 2003, between Playboy
Entertainment Group, Inc. and Bank of America, N.A., as agent
for the various financial institutions from time to time
parties to the Credit Agreement
l Pledge Agreement, dated as of March 11, 2003, between Playboy
Gaming International, Ltd. and Bank of America, N.A., as agent
for the various financial institutions from time to time
parties to the Credit Agreement
m Pledge Agreement, dated as of March 11, 2003, between Playboy
Entertainment Group, Inc. and Bank of America, N.A., as agent
for the various financial institutions from time to time
parties to the Credit Agreement
n Pledge Agreement, dated as of March 11, 2003, between Playboy
Enterprises, Inc. and Bank of America, N.A., as agent for the
various financial institutions from time to time parties to
the Credit Agreement
o Pledge Agreement, dated as of March 11, 2003, between Playboy
Enterprises International, Inc. and Bank of America, N.A., as
agent for the various financial institutions from time to time
parties to the Credit Agreement
p Pledge Agreement, dated as of March 11, 2003, between Planet
Playboy, Inc. and Bank of America, N.A., as agent for the
various financial institutions from time to time parties to
the Credit Agreement
q Pledge Agreement, dated as of March 11, 2003, between Spice
Entertainment, Inc. and Bank of America, N.A., as agent for
the various financial institutions from time to time parties
to the Credit Agreement
r Pledge Agreement, dated as of March 11, 2003, between Playboy
TV International, LLC and Bank of America, N.A., as agent for
the various financial institutions from time to time parties
to the Credit Agreement
82
s Pledge Agreement, dated as of March 11, 2003, between Playboy
TV International, LLC and Bank of America, N.A., as agent for
the various financial institutions from time to time parties
to the Credit Agreement
t Trademark Security Agreement, dated as of March 11, 2003, by
AdulTVision Communications, Inc., Alta Loma Entertainment,
Inc., Lifestyle Brands, Ltd., Playboy Entertainment Group,
Inc., Spice Entertainment, Inc., Playboy Enterprises
International, Inc. and Spice Hot Entertainment, Inc. in favor
of Bank of America, N.A., as Agent under the Credit Agreement
u Copyright Security Agreement, dated March 11, 2003, by After
Dark Video, Inc., Alta Loma Distribution, Inc., Alta Loma
Entertainment, Inc., Impulse Productions, Inc., Indigo
Entertainment, Inc., MH Pictures, Inc., Mystique Films, Inc.,
Playboy Entertainment Group, Inc., Precious Films, Inc. and
Women Productions, Inc. in favor of Bank of America, N.A., as
Agent under the Credit Agreement
v Lease Subordination Agreement, dated as of March 11, 2003, by
and among Hugh M. Hefner, Playboy Enterprises International,
Inc. and Bank of America, N.A., as Agent for various lenders
w Deed of Trust with Assignment of Rents, Security Agreement and
Fixture Filing, dated as of March 11, 2003, made and executed
by Playboy Enterprises International, Inc. in favor of
Fidelity National Title Insurance Company for the benefit of
Bank of America, N.A., as Agent for Lenders under the Credit
Agreement
(items (c) through (w) incorporated by reference to Exhibits 10.9
(b) through (u), respectively, from the 2002 Form 10-K)
x Pledge Amendment, dated July 22, 2003, between Playboy
Entertainment Group, Inc. and Bank of America, N.A., as agent
for the various financial institutions from time to time
parties to the Credit Agreement (incorporated by reference to
Exhibit 10.9(i)-1 from our May 19, 2003 Form S-4).
y First Amendment, dated September 15, 2004, to Deed of Trust
With Assignment of Rents, Security Agreement and Fixture
Filing, dated as of March 11, 2003, made and executed between
Playboy Enterprises International, Inc. and Bank of America,
N.A., as Agent (incorporated by reference to Exhibit 10.4 from
the September 30, 2004 Form 10-Q)
10.16 Exchange Agreement, dated as of March 11, 2003, among Hugh M.
Hefner, Playboy.com, Inc., PEI Holdings, Inc. and Playboy
Enterprises, Inc. (incorporated by reference to Exhibit 4.2 from the
2002 Form 10-K)
10.17 Playboy Mansion West Lease Agreement, as amended, between Playboy
Enterprises, Inc. and Hugh M. Hefner
a Letter of Interpretation of Lease
b Agreement of Lease
(items (a) and (b) incorporated by reference to Exhibits 10.3(a) and
(b), respectively, from the 1991 Form 10-K)
c Amendment to Lease Agreement dated as of January 12, 1998
(incorporated by reference to Exhibit 10.2 from our quarterly
report on Form 10-Q for the quarter ended March 31, 1998, or
the March 31, 1998 Form 10-Q)
d Lease Subordination Agreement, dated as of March 11, 2003, by
and among Hugh M. Hefner, Playboy Enterprises International,
Inc. and Bank of America, N.A., as Agent for various lenders
(see Exhibit 10.15(v))
(item (d) incorporated by reference to Exhibit 10.9(t) from the 2002
Form 10-K)
10.18 Los Angeles Office Lease Documents
a Agreement of Lease dated April 23, 2002 between Los Angeles
Media Tech Center, LLC and Playboy Enterprises, Inc.
(incorporated by reference to Exhibit 10.4 from the June 30,
2002 Form 10-Q)
b First Amendment to April 23, 2002 Lease dated June 28, 2002
(incorporated by reference to Exhibit 10.4 from our quarterly
report on Form 10-Q for the quarter ended September 30, 2002,
or the September 30, 2002 Form 10-Q)
83
c Second Amendment to April 23, 2002 Lease dated September 23,
2004 (incorporated by reference to Exhibit 10.2 from the
September 30, 2004 Form 10-Q)
10.19 Chicago Office Lease Documents
a Office Lease dated April 7, 1988 by and between Playboy
Enterprises, Inc. and LaSalle National Bank as Trustee under
Trust No. 112912 (incorporated by reference to Exhibit 10.7(a)
from the 1993 Form 10-K)
b First Amendment to April 7, 1988 Lease dated October 26, 1989
(incorporated by reference to Exhibit 10.15(b) from our annual
report on Form 10-K for the year ended June 30, 1995, or the
1995 Form 10-K)
c Second Amendment to April 7, 1988 Lease dated June 1, 1992
(incorporated by reference to Exhibit 10.1 from our quarterly
report on Form 10-Q for the quarter ended December 31, 1992)
d Third Amendment to April 7, 1988 Lease dated August 30, 1993
(incorporated by reference to Exhibit 10.15(d) from the 1995
Form 10-K)
e Fourth Amendment to April 7, 1988 Lease dated August 6, 1996
(incorporated by reference to Exhibit 10.20(e) from the 1996
Form 10-K)
f Fifth Amendment to April 7, 1988 Lease dated March 19, 1998
(incorporated by reference to Exhibit 10.3 from the March 31,
1998 Form 10-Q)
10.20 New York Office Lease Documents
a Agreement of Lease dated August 11, 1992 between Playboy
Enterprises, Inc. and Lexington Building Co. (incorporated by
reference to Exhibit 10.9(b) from the 1992 Form 10-K)
b Second Amendment to August 11, 1992 Lease dated June 28, 2004
(incorporated by reference to Exhibit 10.4 from the June 30,
2004 Form 10-Q)
10.21 Los Angeles Studio Facility Lease Documents
a Agreement of Lease dated September 20, 2001 between Kingston
Andrita LLC and Playboy Entertainment Group, Inc.
(incorporated by reference to Exhibit 10.3(a) from the
September 30, 2001 Form 10-Q)
b First Amendment to September 20, 2001 Lease dated May 15, 2002
(incorporated by reference to Exhibit 10.3 from the June 30,
2002 Form 10-Q)
c Second Amendment to September 20, 2001 Lease dated July 23,
2002 (incorporated by reference to Exhibit 10.6 from the
September 30, 2002 Form 10-Q)
d Third Amendment to September 20, 2001 Lease dated October 31,
2002
e Fourth Amendment to September 20, 2001 Lease dated December 2,
2002
f Fifth Amendment to September 20, 2001 Lease dated December 31,
2002
g Sixth Amendment to September 20, 2001 Lease dated January 31,
2003
(items (d) through (g) incorporated by reference to Exhibits
10.17(d) through (g), respectively, from the 2002 Form 10-K)
h Guaranty dated September 20, 2001 by Playboy Entertainment
Group, Inc. in favor of Kingston Andrita LLC (incorporated by
reference to Exhibit 10.3(c) from the September 30, 2001 Form
10-Q)
i Seventh Amendment to September 20, 2001 Lease dated July 23,
2003 (incorporated by reference to Exhibit 10.1 from our
quarterly report on Form 10-Q dated September 30, 2003)
@10.22 Rocklin Studio Facility Lease Documents
a Agreement of Lease dated September 21, 2005 between Joseph H.
Lackey and ICS Entertainment, Inc.
*10.23 Selected Company Remunerative Plans
a Executive Protection Program dated March 1, 1990 (incorporated
by reference to Exhibit 10.18(c) from the 1995 Form 10-K)
b Amended and Restated Deferred Compensation Plan for Employees
effective January 1, 1998
c Amended and Restated Deferred Compensation Plan for Board of
Directors effective January 1, 1998
84
(items (b) and (c) incorporated by reference to Exhibits 10.2(a) and
(b), respectively, from our quarterly report on Form 10-Q for the
quarter ended June 30, 1998)
*10.24 1991 Directors' Plan
a Playboy Enterprises, Inc. 1991 NonQualified Stock Option Plan
for NonEmployee Directors, as amended
b Playboy Enterprises, Inc. 1991 NonQualified Stock Option
Agreement for NonEmployee Directors
(items (a) and (b) incorporated by reference to Exhibits 10.4(rr)
and (nn), respectively, from the 1991 Form 10-K)
c Playboy Enterprises, Inc. 1991 NonQualified Stock Option Plan
for NonEmployee Directors, as amended (incorporated by
reference to Exhibit 10.23(c) from the 2004 Form 10-K)
*10.25 1995 Stock Incentive Plan
a Second Amended and Restated Playboy Enterprises, Inc. 1995
Stock Incentive Plan
b Form of NonQualified Stock Option Agreement for NonQualified
Stock Options which may be granted under the Plan
c Form of Incentive Stock Option Agreement for Incentive Stock
Options which may be granted under the Plan
d Form of Restricted Stock Agreement for Restricted Stock issued
under the Plan
(items (b), (c) and (d) incorporated by reference to Exhibits 4.3,
4.4 and 4.5, respectively, from our Registration Statement No.
33-58145 on Form S-8 dated March 20, 1995)
e Form of Section 162(m) Restricted Stock Agreement for Section
162(m) Restricted Stock issued under the Plan (incorporated by
reference to Exhibit 10.1(e) from the 1997 Form 10-K)
f Amendment to the Second Amended and Restated Playboy
Enterprises, Inc. 1995 Stock Incentive Plan (incorporated by
reference to Exhibit 10.24(f) from the 2004 Form 10-K)
*10.26 1997 Directors' Plan
a Amended and Restated 1997 Equity Plan for NonEmployee
Directors of Playboy Enterprises, Inc.
b Form of Restricted Stock Agreement for Restricted Stock issued
under the Plan (incorporated by reference to Exhibit 10.1(b)
from our quarterly report on Form 10-Q for the quarter ended
September 30, 1997)
c Amendment to the Amended and Restated 1997 Equity Plan for
NonEmployee Directors of Playboy Enterprises, Inc.
(incorporated by reference to Exhibit 10.25(c) from the 2004
Form 10-K).
*10.27 Form of Nonqualified Option Agreement between Playboy Enterprises,
Inc. and each of Dennis S. Bookshester and Sol Rosenthal
(incorporated by reference to Exhibit 4.4 from our Registration
Statement No. 333-30185 on Form S-8 dated June 27, 1997)
*10.28 Employee Stock Purchase Plan
a Playboy Enterprises, Inc. Employee Stock Purchase Plan, as
amended and restated (incorporated by reference to Exhibit
10.2 from our quarterly report on Form 10-Q for the quarter
ended March 31, 1997)
b Amendment to Playboy Enterprises, Inc. Employee Stock Purchase
Plan, as amended and restated (incorporated by reference to
Exhibit 10.4 from our quarterly report on Form 10-Q for the
quarter ended June 30, 1999)
*10.29 Selected Employment, Termination and Other Agreements
a Form of Severance Agreement by and between Playboy
Enterprises, Inc. and each of James Griffiths, Linda Havard,
Christie Hefner, Martha Lindeman, Richard Rosenzweig, Howard
Shapiro and Alex Vaickus (incorporated by reference to Exhibit
10.23(a) from the 2001 Form 10-K)
b Memorandum dated May 21, 2002 regarding severance agreement
for Linda Havard (incorporated by reference to Exhibit 10.6
from the June 30, 2002 Form 10-Q)
85
c Employment Agreement dated January 8, 2004 regarding
employment of James Griffiths (incorporated by reference to
Exhibit 10.29 from the 2003 Form 10-K)
@21 Subsidiaries
@23 Consent of Ernst & Young LLP
@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
----------
* Indicates management compensation plan
# Certain information omitted pursuant to a request for confidential
treatment filed separately with and granted by the SEC
@ Filed herewith
86
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
============================================================================================================================
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
----------------------------------------------------------------------------------------------------------------------------
Additions
---------------------------
Balance at Charged to Charged to Balance at
Beginning Costs and Other End
Description of Period Expenses Accounts Deductions of Period
---------------------------------------- ---------- ---------- ---------- ---------- ----------
Allowance deducted in the balance sheet
from the asset to which it applies:
Fiscal Year Ended December 31, 2005:
Allowance for doubtful accounts $ 3,897 $ 890 $ 706(a) $ 1,610(b) $ 3,883
========== ========== ========== ========== ==========
Allowance for returns $ 28,284 $ 260 $ 44,960(c) $ 45,727(d) $ 27,777
========== ========== ========== ========== ==========
Deferred tax asset valuation allowance $ 72,663 $ 2,632(f) $ -- $ -- $ 75,295
========== ========== ========== ========== ==========
Fiscal Year Ended December 31, 2004:
Allowance for doubtful accounts $ 4,364 $ 239 $ 1,133(a) $ 1,839(b) $ 3,897
========== ========== ========== ========== ==========
Allowance for returns $ 27,137 $ 203 $ 43,766(c) $ 42,822(d) $ 28,284
========== ========== ========== ========== ==========
Deferred tax asset valuation allowance $ 84,454 $ -- $ (2,628)(g) $ 9,163(e) $ 72,663
========== ========== ========== ========== ==========
Fiscal Year Ended December 31, 2003:
Allowance for doubtful accounts $ 5,124 $ 1,409 $ 1,451(a) $ 3,620(b) $ 4,364
========== ========== ========== ========== ==========
Allowance for returns $ 24,595 $ -- $ 47,536(c) $ 44,994(d) $ 27,137
========== ========== ========== ========== ==========
Deferred tax asset valuation allowance $ 80,891(h) $ 3,307(f) $ 256(g) $ -- $ 84,454
========== ========== ========== ========== ==========
Notes:
(a) Primarily represents provisions for unpaid subscriptions charged to net
revenues.
(b) Primarily represents uncollectible accounts written off less recoveries.
(c) Represents provisions charged to net revenues for estimated returns of
Playboy magazine, other domestic publishing products and domestic
DVD products.
(d) Represents settlements on provisions previously recorded.
(e) Represents noncash federal income tax benefit related to reducing the
valuation allowance.
(f) Represents noncash federal income tax expense related to increasing the
valuation allowance.
(g) Represents adjustments to net operating loss and tax credit carryovers.
(h) Balance is grossed-up to reflect adjustment to prior year net operating
loss and tax credit carryovers.
87