Playboy Enterprises, Inc. (PLA)
Q1 2006 Earnings Conference Call
May 4, 2006 10:00 a.m. EST

Executives

Martha Lindeman - SVP of Corporate Communications & Investor Relations
Linda Havard - EVP of Finance & Operations, Principal Accounting Officer and CFO
Christie Hefner - Chairman and CEO

Analysts

Mike Savner - Banc of America Securities
Lucas Binder - UBS
David Bank - RBC Capital Markets
David Miller - Sanders Morris Harris
Robert Routh - Jefferies & Company
David Leibowitz - Burnham Securities
Dennis McAlpine - McAlpine Associates
Matthew Harrigan - Janco
Scott Coleman - Credence Capital - Analyst
Mike Elkin - Knott Partners
Nader Tavakoli - Eagle Rock

Presentation

Operator

Good day. All sites are online in a listen-only mode. Please note that today's call may be recorded. At this time, I would like to turn the program over to your host, Martha Lindeman. Go ahead please.

Martha Lindeman

Good morning, everyone, and welcome to our first quarter conference call. If you do not have a copy of our release and the earnings supplement, please look on our website, peiinvestor.com.

During the call today, we will be making forward-looking statements pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act. These statements reflect our current beliefs and plans. They are not guaranteed and involve risks and uncertainties that could cause our actual results to differ materially from those discussed today.

We are under no obligation to update these statements. I refer you to the Safe Harbor language in today's release, which describes some of the factors that could cause our results to differ materially from today's discussion. During this call, we also may make reference to non-GAAP measures. This information, including a reconciliation to the related GAAP measure, is available in today's release.

With me today are Linda Havard, who will take you through the details of the quarter, and Christie Hefner, who will discuss the outlook for the remainder of the year. Turning to you first, Linda.

Linda Havard

Thanks, Martha. Coming into the year, we fully expected the first quarter to be challenging and we were not proven wrong. With a projection of a 30% decline in ad pages and higher paper and postage costs, we knew the Publishing Group would be under significant pressure in the first quarter.

These difficulties were exacerbated by continued weakness in the newsstand market, where men's titles have already suffered three consecutive reporting periods with lower newsstand sales. We were able to partially offset some of the effects of the $3.5 million decline in publishing revenues, with reductions in editorial and operating expenses, with the result of a $2.3 million operating loss for the group.

Turning to entertainment, a variety of factors led to the decline in segment profitability compared to last year's very strong first quarter. Primary among them was the decline in pay per view revenues resulting from the loss of carriage as cable operators increasingly eliminate linear networks in favor of VOD, a more competitive platform with low barriers to entry.

Moreover, we have yet to see our movies launched on Comcast VOD platforms, which we expect could more than double our VOD household reach. We are also still waiting for the roll out of Playboy TV as a subscription VOD service in both Comcast and Time Warner systems. Right now, Playboy on Demand is available only in Cablevision systems. Our belief in the growth potential of Playboy SVOD is supported by the gains in Playboy TV subscription revenues that we saw in the first quarter.

In online, revenues increased nearly 20% to $13.2 million, although increased investments in technology, infrastructure and people resulted in lower profit margins. The online revenue growth came from the subscription side of the business and was the result of the acquisition that we made last fall.

The international digital businesses reported in the Entertainment Group enjoyed a strong quarter compared to last year in terms of both top and bottom line growth with our UK networks responsible for the strongest revenue gains.

As expected, the Licensing Group continues to perform very well and first quarter was no exception. Increased royalties from Europe, along with the sale of prints from our art collection were responsible for the 25% increase in revenues compared to the 2005 first quarter.

Segment income increased to $4.3 million for the quarter which only a few years ago, 2002 to be exact, was the group's total annual segment income. As required and as we discussed on our fourth quarter conference call, we began expensing stock options in the first quarter. The charge totaled approximately $700,000 this quarter, recorded in each of the groups and in corporate as appropriate.

In addition, with the repurchase of the remaining minority interest in Playboy.com in 2005 fourth quarter, the inter-company agreements for trademark and associated fees that had been in place since 2000 were eliminated, resulting in an increase in first quarter corporate expense, also as we discussed on our last quarter conference call. Now I will turn you over to Christie who will talk about the outlook for the remainder of the year.

Christie Hefner

Thank you, Linda. I want to start by recognizing that this change in guidance is unusual and unexpected, and I want to speak to that first. On a standalone basis, the first quarter was actually consistent with our plan. In fact, from the beginning this year was heavily back loaded. However, in looking ahead and gathering market intelligence as part of our reforecasting process, it became clear that a cumulative effect of changes was going to require us to reset expectations.

That was a combination of one-time resets, like the DirecTV change; timing issues like the postponement of launches of SVOD; and structural performance issues, specifically domestic VOD.

It is clear to us that domestic TV remained a large, profitable but increasingly mature business. It is experiencing major industry-wide structural changes and they affect us and others going forward. We intend to manage that business such that it continues to perform to expectations, and at the same time sharpen our focus on the major growth opportunities in the newer digital media of international, online and wireless where we are already operating profitable businesses.

I am going to spend a few minutes describing what we are doing in all of our businesses so that we can give you a clearer picture of our goals and how we see the year shaping up. We have a very focused objective of delivering results in the second half of 2006 that will be markedly better than the second half of 2005 and will put us in a position for profitable growth in 2007 and beyond.

In Publishing, seeing the second quarter results in ad sales, it is clear that the weakness in the industry is continuing. Indeed, the newsstand market remains very difficult for the men's segment. All but a handful of titles are soft on the newsstand, and all but a handful of titles are continuing to face the pressure of the shift of ad dollars to online, cable TV and sponsorship. That is particularly prevalent among some of our leading categories, such as liquor.

The good news, however, is that the circulation remains strong for the magazine as subscriber renewal rates are good and we continue to attract new, younger readers. We recognize however that our growth potential is limited in that business, and are continuing to focus on making sure that the business model for the costs of publishing is in line with the reality of today's environment.

Consequently, as you know at the beginning of this year we raised the magazine's cover price and lowered the rate base. Additionally, we were able to reduce the newsstand draw which contributed to a decline in first quarter manufacturing and distribution expense, despite the fact that per copy costs are up year-over-year due to higher paper and postage expense.

We also reduced editorial costs and expect that reduction to continue throughout the year. As Linda noted, this allowed us to offset much of the decline in revenues in the first quarter. We are basically closed with advertising for the second quarter and the ad revenues will be down 16% but we are encouraged by the fact that they are up compared to the first quarter, and we believe that trend will continue into the second half of the year.

Turning to domestic TV. We have spoken for some time about this as a mature business, and that we did not see the transition from pay per view to VOD for our movie products likely to grow the pie. Indeed it is clear from talking to the major MSOs that the adult category in VOD is not growing. In fact, since we have less shelf space in VOD than we had in pay per view; plus we know that we will be losing two channels on DirecTV, this is resulting in a decline in the domestic TV business, both in revenues and profit.

However, what we do believe is that we have a major US TV growth opportunity in Playboy TV as a subscription VOD service. The challenge here is one simply of timing. We remain hopeful that Comcast and Time Warner will begin offering the SVOD service later this year, but we are not in control of the timing and the ramp up. It is our best estimate that will be slower than when we put our plan together and that is a major factor contributing to our change in guidance. But also on the positive side, contributing to our confidence in delivering the strong second half performance that we are forecasting.

As important as what we are doing to ensure growth in our existing businesses is our focus on the future, and that is predicated on our having been both global and platform agnostic for many years. That has put us in a position where we are benefiting from online, international TV and mobile growth. In fact, one of the potential contributors to the flattening of domestic TV is the increasing availability of video content online, and we expect to be well-positioned to capitalize on that direct to the consumer trend.

We've already launched a successful pay per minute service on our website, and expect to continue expanding our broadband and other subscription-based video offerings, all of which are expected to contribute to the strength of the second half.

In addition, we are also increasing the lifestyle elements of our free site, which will allow us to capitalize on the growth in online advertising sales in the second half. These new elements will include lifestyle non-nude features, and will include capabilities such as interactivity and community-based services that we are developing and will be launching mid-year.

There are investments required in technology, people and marketing but these will be offset by the growth in revenues and we expect to report both increased revenues and profits in online in 2006.

We are similarly optimistic based on the performance we continue to see on both revenue and profit outlooks for our international digital media businesses in 2006. That will be a function of continuing to launch in new markets, the results of closing new deals and as well as adding new product.

I want to note here that while many of you are familiar with the size and importance of domestic TV, these other new media digital platforms of international, online and wireless have become significant in size. Indeed, in the fourth quarter of last year their combined revenues equaled domestic TV and in this year's first quarter, surpassed domestic TV by more than $4 million. These are far from ancillary businesses anymore.

At the core of our business is content creation. While we are managing our growth businesses, we also understand that it is important to manage the costs of all of our businesses. We believe there is an opportunity to reduce our total costs for the creation and acquisition of video programming. As you know, our original 2006 budget was $38 million. We are now revisiting the both overhead structure to create that content and the cost of creation and acquisition of that content and believe that we can lower that total number.

Moreover, as a part of the strategy, we will be allocating a bigger percentage of our total content spending towards content for online and mobile. Beginning this year, we will report a content budget that includes all digital media, not just TV. Moreover, our goal is that total budget will represent an ever decreasing percentage of the Digital Entertainment Group's revenue.

To additionally help offset the expected lower domestic TV revenues this year, and the continued losses in publishing, we are also already looking at expense reductions across the Company. In addition to reductions in content creation, but on the Publishing and the Digital Entertainment side that I previously mentioned, we are making cuts in all categories of discretionary spending, including overhead and marketing; yet, preserving and maintaining our focus on the growth businesses, including the planned investment in technology to capitalize on the growth in direct to consumer video delivery online.

I also want to note that we are continuing to see very strong results from our licensing business and expect that the 15% to 20% segment income growth we had projected at the beginning of the year, based on our continued success in our fashion products and stores businesses, as well as the third quarter opening of The Palms, we believe will be achieved.

Looking ahead, it is obvious that we have a challenge as a result of the combination of timing of rollout of Playboy SVOD and VOD; the adjustment of our expectations from DirecTV and the performance on the VOD platforms. We are confident however, that we can meet the challenge of maintaining reasonable results from those maturer businesses while generating significant growth from our new digital media businesses, and from our ongoing Licensing Group.

As a consequence of our expectations of strong second half performance, which includes improved year-over-year performance for all three businesses, we believe we will be able to deliver a 50% improvement in EPS for the second half of 2006 compared to last year. That will allow us, we believe, to put ourselves in a position where even though we are unlikely to meet our overall projection for the year of EPS growth of $0.67 to $0.70 per year, looking at the second half as the basis for the businesses going forward will put ourselves in a position where we can return to the kinds of profitable growth that our multimedia strategy and brand success will allow us to achieve.

Moreover I want to note that last year's financing has put us in a much more solid position to weather this transitional year, both in terms of significantly lower interest expense and in terms of a strong balance sheet. With that overview of how we see the year and what our expectations are for the year, I will open it up to questions. Thank you.

Question-and-Answer Period

Operator

(Operator Instructions)

We will take our first question from the site of Mike Savner with Banc of America. Go ahead, please.

Mike Savner - Banc of America Securities

Thank you. Christie, a few questions, if that is okay, and maybe first start at kind of a 50,000 foot view. Can you tell us a little bit about the internal controls and the forecasting procedure that you and Linda have in place? Because obviously I think people are going to be rightfully concerned that you came forth with guidance for the full year in the middle of February, and these are pretty massive changes two months later.

I guess what would be helpful, if for no other reasons so the people on the call could have confidence that you have transparency into your business, help quantify on a line-by-line basis, or at least a business segment basis, where the reductions are coming. For example, how much did you have for DirecTV that has been cut, from the New Frontier Carriage, how much were you expecting from Comcast to contribute, that you have now pushed out, presumably for the last half of the year, or maybe into ’07, so we can have more clarity on where each of these changes are coming from. That’s the first one.

The second one, you talk about the cost-cutting that you have planned. Again, if we could get into more specificity of how quickly and to what degree of magnitude you expect those changes to come, that would be very helpful. Thank you.

Christie Hefner

Yes, Mike, and I appreciate the question and I understand the importance of giving you all the information that will give you confidence in what we are saying we see the remainder of the year being.

So let me sort of back up to your first 50,000 foot question. The two most significant contributors to the change, overwhelmingly are DirecTV, which until we were on notice, shortly in the recent past that we would be unable to retain the unique de facto exclusivity we had, we did not anticipate. As I mentioned in my remarks, we have not yet closed the deal, so that was significant and unanticipated adjustment.

The good news is once we go through a year of absorbing that, then we reset the base and that doesn’t affect us going forward.

The second most significant adjustment is the delay from Comcast and Time Warner. I can tell you that we are in regular conversation with them. I am personally with the heads of their cable divisions and their top programming people, down through our organization to our sales people. They are less than precise, to be candid, about their timing on launches.

We believe there are a number of factors that run the gamut from what their own priorities are in terms of focus of programming, some of their own marketing and technology issues in the category of SVOD, and I think it may be reasonable to expect that there is a distraction factor going on right now with the need to close the Adelphia acquisition.

It seemed clear as we were looking ahead to when our original expectations were for launch that those were not going to be made based on the conversations that we have weekly with Comcast and Time Warner. So in the re-forecast, the only thing to do is push those out to late in the year so that we can marry our own forecast with what seems to be the most likely outcome.

But as we did say at the beginning of the year, the driver for domestic TV would be the rollout of our VOD product, and we are not in control of that. So on the one hand, I cannot promise you the timing of that. I can tell you that I believe we have been prudent in the re-forecast, but it is certainly not in the category of a knowable number that if we had a better system, we would do a better job of forecasting. It is in the category of something where we are dependent on the timing controls of the MSO’s.

The other factors that contributed certainly were not helpful, but were dwarfed by those two, and I feel we actually have a pretty solid track record on an annual basis of delivering on expectations and of managing both our revenue expectations and our cost expectations.

In terms of your related question of the cost-cutting, we are obviously already on top of this, which is why more than a third of the way through -- practically half the way through the second quarter, I’m saying to you guys that it is our view that whatever changes we are going to make, our goal is to make them in the second quarter, so that whatever costs that may need to be taken as one-time costs will be taken in the second quarter, thereby clearing the path for a pure and strong second half performance.

I want to underscore, however, that the second half expectation of 50% growth is not driven by cost-savings that we have yet to identify. It is driven by the fact that we expect to see the contribution of growth in VOD and SVOD, which we will not see in the first half, that we expect to see the contribution of the opening of the Palms, which we will not see in the first half, and that, based on the trending second quarter over first quarter, we expect to see continued favorable trending in advertising.

When we combine all of those factors with continued strong growth in licensing, with continued strong growth in our new media businesses of online, international and wireless, and some lower costs in the second half in the discretionary areas of overhead, marketing and content creation, that’s the dynamic that gives us the belief that we can deliver the EPS 50% growth that we are projecting.

Mike Savner - Banc of America Securities

Thanks, Christie, and one last small one. Can you just give us, so we understand what your definition of a substantial loss is in the second quarter, is it $0.05, $0.05 to $0.10 -- I don’t know what substantial means to you versus what it may mean to me.

Christie Hefner

I appreciate that. Believe me, we wrestled with how to handle that. All I can say is that the conclusion we came to is, as we have consistently said, it is not we think useful or ultimately in anybody’s best interest for us to try and parse quarterly guidance. We are violating our own rule in giving less than full year guidance because of our recognition that this has become an unusual year with two extremely different halves.

A first half in which we have seen this combination of timing issues and some resetting of expectations in domestic TV and advertising, the ability and need to respond to those expectations in order to deliver a strong second half, and therefore our belief that we needed to give you some quantifiable guidance for the second half for you to understand where we think we are going.

At this point, I am not comfortable giving you anything more than the characterization of the second quarter.

Mike Savner - Banc of America Securities

Okay, thanks very much.

Operator

Thank you. We’ll take our next question from the site of Lucas Binder with UBS. Go ahead please.

Lucas Binder - UBS

Good morning. Focusing in on the outlook for the second half, can you take a moment and maybe talk about what you have seen from Cablevision, for instance, where they already have SVOD launched, that you can feel comfortable that once you get SVOD launched in these other businesses, can you talk a little bit more about how successful it has been in Cablevision and what gives you that comfort going into the second half? Then I might have one follow-up after that.

Christie Hefner

It’s a very good question because it is our one MSO SVOD experience. I can tell you we are extremely pleased with the performance. I can also tell you to the point of expectations -- that you asked about and Mike asked about, and believe me, I understand why you guys are asking these questions -- that in our own forecast for the second half, we are assuming a slower ramp up and not yet achieving the level of penetration in SVOD for Time Warner and Comcast that we are already seeing in Cablevision.

We think that we are calibrating reasonably in terms of market performance, which includes as Linda mentioned in her remarks, just an absolute increase in revenues in the first quarter from our even subscription pay-per-view monthly business for Playboy. So that is how I would try and respond.

Lucas Binder - UBS

So what you are saying is that you do see -- basically, when you look at VOD, it essentially marginalizes your content because they will list your content next to anybody else’s, and not necessarily focus into Playboy content as available versus stuff from New Frontiers or another participant.

Christie Hefner

Well, you have to distinguish -- I am glad you asked the question because it really highlights the difference that is growing between the adult business and the Playboy business in cable, because the comment you made about the lack of sharper distinction with regard to the programmer and the brand, that is absolutely true in the movie business. So on that VOD platform, all of the content, whether it comes from Playboy via Spice or New Frontier or Hustler, is simply listed by title.

However, on the Playboy side, the SVOD model is a different model. It is a brand-driven linear channel, much like HBO is, with the added capability of going back and seeing favorite episodes of series that are original series on Playboy bundled in with the subscription. That is why in spite of the more commoditization, if you will, of the adult business in a VOD technology, we have remained confident in the opportunity for us to grow what is already a mature business through Playboy SVOD. And, as we just talked about, we have seen that in Comcast and we have even seen that with our Playboy monthly business.

Lucas Binder - UBS

The last question, if I may, on the programming expense, the guidance of $38 million, where do you think your overall programming expense, including the digital expense, is going to probably come out? Do you think it could be on a total basis below the $38 million, including digital?

Christie Hefner

Well, right now we are at $43 million, so that’s the new number that we said that we would be reporting in terms of all digital expenses, and that is a cash number. That is what was built into our plan.

What we are saying is that we believe there are two things that we need to do. One is we need to lower that total number, and we working on that now -- and no, I cannot give you what the goal is, only to tell you that we can do that and we think the combination of lower overhead, which is a part of that number, and lower actual acquisition and content creation costs, which is a part of that number.

The second thing is that the division between content creation for online and mobile, and content creation for the core television business, we think will shift -- as it should -- in light of the growth that is being achieved in those newer media businesses, as I mentioned, to the extent that on a revenue basis, even in this first quarter, those new media businesses of online and international TV and mobile actually were generating higher revenues than domestic TV.

Linda Havard

Lucas, I just want to remind everybody that the cash expense will be impacted first, and because of the amortization of the way the television programming piece of that works, you will see less impact on the P&L, but we will explain those differences once we come up with that number.

Lucas Binder - UBS

Thank you very much.

Operator

Thank you. We will take our next question from the site of David Bank with RBC Capital Markets. Go ahead, please.

David Bank - RBC Capital Markets

Thank you and good morning. Guys, I am trying to get a little bit better sense of how much here is a fundamental change in the domestic TV business versus how much is a timing issue. It sounds like you did not lose DirecTV until April 4th, so DirecTV is really not an impact on the first quarter. Just piecing together what you said, Christi, it sort of sounds like if the VOD ramp had been quicker on other systems, primarily Comcast, you probably would have been about in line with what you had expected. But is there more going on? Is that too optimistic? Is there more going on competitively?

Secondly, in the back half when you ramp VOD, you lose DirecTV, can you give us a sense of how much you think you lose from DirecTV, and how does everything get back to normal after losing DirecTV and ramping VOD? Or does it not really get back to normal? Is it not a low single digit grower like it is historically? Can you give us a sense, as a mature business, is it a low single digit decliner, you think, long-term? Can you give us a little bit more sense of what is going on fundamentally versus timing wise.

Christie Hefner

Right. Well, I think that your perhaps implicit assumption in the way you asked the question, I would agree with. By which I mean that based on what we are seeing in the marketplace, in spite of the lower performance of the adult business in VOD than pay-per-view, and in spite of the loss of the pay-per-view revenue -- see, it’s sort of a double thing going on there -- and in spite of the recalibration of the DirecTV business, when we get traction on Playboy SVOD and the Comcast VOD rollout, we will be at the place we thought we would be at, which is single-digit revenue growth from domestic TV.

So the biggest difference for the year is that where we had hoped to get traction in both VOD rollout and SVOD rollout earlier in the year, and had not anticipated the recalibration of the DirecTV deal, we now have to take those factors into account.

The reason why I say I believe the year is in effect going to be two years is that the fundamental dynamic that we believe, which of course included our strong belief in the newer media businesses, is unchanged. But the cost of timing, along with having to absorb the resetting of DirecTV, is clearly impacting especially the second quarter.

The first quarter, as I said upfront, actually was on our plan. But we are not going to get the benefits of these rollouts in the second quarter. That’s very clear, and we are going to, to your point, have to start absorbing the costs of the DirecTV piece.

David Bank - RBC Capital Markets

So can you give us a sense then -- I know you are not going to want to do this, but DirecTV, what kind of impact does that have? That should be pretty easy to isolate.

Christie Hefner

It is easy to isolate. It’s just not a number we are comfortable sharing. It’s material, it’s the single largest contributor to the change in guidance, followed by the delays in the VOD and SVOD rollouts, which is why while, believe me, I appreciate how disappointing in the immediate future this year looks as we sit here on this phone call. I just want to underscore that my alignment here in terms of what I am looking to achieve is entirely consistent with you guys, and we should not lose sight of the fact that the drivers for performance that have made this an attractive company are unchanged. That will be single digit growth in domestic TV driven by SVOD rollout. That will be significant double-digit growth in the new media businesses that are performing very well for us. That will be robust growth with the overlay of new revenue and profit sources like location-based entertainment in licensing. That dynamic has not changed as a result of what we have to recalibrate this year because of absorbing the delays and the DirecTV reset.

David Bank - RBC Capital Markets

Can I ask two follow-ups, and then I’ll stop? Linda, where will the restructuring type expenses, will they hit divisionally or will they sort of be a corporate charge?

The second question is I have to come back to you, Christi, on the last conference call, first quarter, publishing was going to be the bottom. Is that still the case? Is this the bottom of publishing or do you see it kind of getting incrementally worse in the second quarter?

Linda Havard

David, let me go ahead and answer your expense reduction question first. Wherever we have expense reduction, those will be reflected in the group. The rules have changed and we do not know yet whether there will even be a charge that you can call restructuring, but the expense reductions will be where the appropriate expense reductions occur. So to the extent that they occur in the television content area, those will be lower in those lines to the extent that there will be positions that are not filled, to the extent that there will be marketing costs -- those will show up in each of the lines in each of the groups where those costs are reduced.

Christie Hefner

On the publishing question, yes, it was expectation, based on the first two months of advertising sales in the second quarter, that the first quarter publishing loss would be the largest loss for the year, but given where the last month of the second quarter ad sales have come in, which has been reflected in the decline in the quarter against the plan and against last year.

It is clear to me at this point that it is more reasonable to expect a loss that is comparable and maybe slightly greater in the second quarter, and that the publishing performance that we had hoped would be largely better for the year will probably be consistent with last year, and that will be a mix of weaker first half with, what we hope to see on a trend basis, continuing growth in ad sales from the second half as compared to the first half.

That is what is built into the forecast that we are sharing.

David Bank - RBC Capital Markets

I appreciate it.

Operator

Thank you. We will take our next question from the site of David Miller with Sanders Morris Harris. Go ahead please.

David Miller - Sanders Morris Harris

Hi, following up on David’s question, Linda, I just want to make sure I understand. The lower cost of the creation and the acquisition of programming going forward is an operational matter. That is something that is going to improve operationally for you on the entertainment expense line. The cuts in overhead imply a charge against earnings. But what you are saying is that you are not going to take a charge, you are just going to sort of bundle all of this together and report a “substantially reduced earnings per share number”.

I just want to make sure I understand. When you report second quarter, you are not going to report an organic EPS number and a number inclusive of the charge. You’ll just take the big hit and report one earnings per share number, including the overhead reductions. Is that correct?

Linda Havard

It’s both. You are correct. It is a combination of if there are just reductions in spending, those will show up in the areas. We have to follow whatever the accounting rules are in terms of a restructuring charge, if there is a restructuring charge, and that will show up in a line, but it shows up in operating income as opposed to in non-operating, as it used to.

Christie Hefner

What I would say which might be helpful, because at least it’s directional, is that I think the smallest contributor to the second quarter will be a one-time restructuring charge. I think going forward the bigger contributor to recalibrating the cost structure of the company will be changes that will flow through on an ongoing basis in the P&L without a one-time restructuring charge, and obviously, as we’ve spoken about, the second quarter performance improvement is very much going to be impacted by the growth in revenues from SVOD, from location-based entertainment, from VOD rollout, and from digital media as well as from the Palms opening.

David Miller - Sanders Morris Harris

One quick follow-up, Christi, in your negotiations so far this year with Comcast and the Time Warner cable systems in terms of trying to migrate your offerings on the VOD and SVOD tier, how much in control would you say you guys are in terms of the pricing of those offerings going forward?

Christie Hefner

Very little. The pricing of channels and any other delivery through the cable companies like VOD has historically been in the complete control of the cable companies, and as you know, right now in the category of basic cable, there is a serious battle going on with regard to both bundling and pricing.

So the best that we can do, and it is what we do, is to try and share best practices by taking systems that we think are performing optimally, and demonstrating that to other systems, and the same with MSO’s. But the final control is entirely under the purview of the MSO’s.

David Miller - Sanders Morris Harris

Let me just frame the question a little differently. Are you satisfied with the way Cablevision has priced your offerings?

Christie Hefner

Candidly, although we are very pleased with the results in Cablevision, I continue to believe that the best model for SVOD is a one-price model, where the VOD capabilities become a key factor in creating stickiness in terms of the subscriber base.

So we do not favor the up-sell model that Cablevision has been using, although I have to acknowledge that in total, the results that they are generating for us, we are pleased with, but we think the bundled, say $15 as a rough number subscription price including VOD, is a better model for us and for HBO.

It is my belief, although until they launch it, I can’t be certain, that that will be the model, i.e. the one price model that Time Warner will follow.

David Miller - Sanders Morris Harris

Thank you.

Operator

Thank you. Our next question comes from the site of Robert Routh with Jefferies & Company. Go ahead please.

Robert Routh - Jefferies & Company

Just a few quick questions for you guys. Obviously you are revising guidance for the full year in terms of earnings if you are not going to meet your initial expectations. What are your expectations now for ’06 in terms of earnings per share?

Second, if you could comment a little bit, obviously a New Frontier Media got carriage on DirecTV, Penthouse is entering the business, Hustler is entering the business -- there are a lot of guys entering into your business that are likely to cannibalize what you are doing. I am wondering if you could quantify what you are seeing in terms of their success at getting distribution and what the impact could be from this continued process that we have been seeing with these other competitors.

Linda Havard

Let me take your first question first in terms of guidance for the full year. We can’t give it to you because of the second quarter. That is a combination of what Christi said in terms of the loss in the second quarter plus just the unknowable at this point in terms of what we are working on to reduce the costs.

The second half is pretty clear, and the first quarter is clear, so it is really just the second quarter that will be refined. As soon as we know something, we will let you know.

Robert Routh - Jefferies & Company

Okay, so for now, we are kind of flying blind on the full year?

Linda Havard

You are flying blind to the extent that we have given you as much as we can in terms of what to expect in the second quarter on the operating side.

Robert Routh - Jefferies & Company

Okay.

Christie Hefner

What I would say on the second question, Rob, is that I completely agree with your characterization of the dynamic. There are clearly different and lower barriers to entry for smaller producers of adult programming to sell a few shows to the MSO’s for a VOD platform then in the old, linear model where in order to be able to buy enough content, you have to program a network. You pretty much had a marketplace with two players. You had Playboy, which between Playboy and Spice had a 75% market share, and you had New Frontier, which had pretty much the remaining market share.

We believe, based on the deals we have and what we see in the market place, that we will remain the largest supplier of adult programming in the VOD market place, but we also see that we will have a lower share than the 75% that we had in the linear channels. I would say to you that that is a range in the adult platform of between 40% and 50%.

Robert Routh - Jefferies & Company

Okay, great. Just two quick follow-ups. In terms of VOD and the rollouts, you keep talking about Time Warner and Comcast. I am wondering if you could comment on any of the other MSO’s that you are talking to, and how any conversations may be going with them, and obviously Cablevision, but we know that one, in terms of Charter and MediaComm, and Insight, whether there are opportunities there that nobody is really looking at?

Also, if you tell in terms of the domestic networks, which of the networks is really getting impacted more right now? Is it the Playboy television or is it the movie network that is really causing the domestic decline that we are seeing? Which one is being impacted more and which one do you think will be impacted more going forward?

Finally, given where your stock is trading today, and the uncertainty with earnings, but your belief in the second half in ’07 and your balance sheet where you have $52 million in cash, why isn’t the company buying back stock?

Christie Hefner

In terms of the question about which part of the business is impacted, it is the movie networks business. That is a really important distinction for all of us to keep in mind. VOD as a platform that has resulted in more competition, a little less shelf space, although still the majority of the shelf space, and not a growing of the pie as compared to pay-per-view, impacts us on the Spice side. That is what we are seeing. We started seeing it in the fourth quarter. We saw it in the first quarter. We are going to continue to see it and we consider that a permanent structural change.

What we believe will offset that, which is why we have believed there is the potential for single-digit revenue growth in domestic TV, is Playboy, where we are not negatively impacted on the VOD side because we are not just putting individual titles on an adult platform, and in fact, will be positively impacted by the rollout of Playboy as a subscription product with VOD capability.

In terms of Charter and [Cox], they are obviously smaller, but yes, we are working with them in terms of looking for a rollout, but I think it is fair to say that the big opportunity in SVOD and VOD, as you would imagine in cable, knowing the relative size of the MSO’s, remains with Comcast and Time Warner.

On the stock side, we always look at uses of capital. We have a board meeting in two weeks. I am sure the board will discuss it, and if we think it is the right thing to do, we will pursue that.

Linda Havard

In the meantime, what we have said is that we do have other opportunities with we think high returns for the use of that cash, including additional acquisitions.

Robert Routh - Jefferies & Company

Sure, I appreciate that, and it makes sense, but given where your stock price is now, it would seem to me that it would be hard for you to find a better use of that cash.

Linda Havard

And that is certainly new information, and as Christi said, we will take that into the board meeting, but it is all -- we look at that every day.

Robert Routh - Jefferies & Company

Thank you very much.

Operator

Thank you. Our next question comes from the site of David Leibowitz with Burnham Securities. Go ahead please.

David Leibowitz - Burnham Securities

Good morning. Briefly, are we going to be cash flow positive for the year, given the magnitude of what is going on in the second quarter?

Linda Havard

Yes.

David Leibowitz - Burnham Securities

Good. Second, could you go into anymore detail about Palm in terms of hopes and aspirations in terms of how much accretive you expected to be in ’07?

Linda Havard

What we said before, David, is that on an annualized basis, we think the Palms will generate approximately $4 million in incremental royalty income to the company, which is a combination of guarantee and a percentage and profit participation on the store, and that incremental royalty income will come into the company at an 80% profit margin.

David Leibowitz - Burnham Securities

Okay, and the last question, are there going to be ongoing, one-time charges in the second half?

Linda Havard

In terms of restructuring, I think what Christi said was is our goal is to try to get that out of the way in the second quarter.

David Leibowitz - Burnham Securities

Understood, but is it possible that some of these things, especially if it is personnel related, may drag into the second half?

Christie Hefner

All I can say, David, is that our guidance is predicated in our belief that we can make the changes we need to make within the second quarter.

David Leibowitz - Burnham Securities

Okay, thank you very much.

Operator

Thank you. We will take our next question from the site of Dennis McAlpine with McAlpine Associates. Please go ahead.

Dennis McAlpine - McAlpine Associates

Thank you, and good morning. Christi, you are holding up well so far.

Christie Hefner

Thank you, Dennis.

Dennis McAlpine - McAlpine Associates

You said I think ad revenues for the second quarter would be down 15%. I am not sure of the number. If that were the case, what are you looking at for ad pages for the quarter?

Christie Hefner

Yes, pages for the quarter compared to last year will be approximately 103 pages as against 128 pages. So we actually have gained some on pricing, so the page decline is greater than the dollar decline, which is of course what we hoped to see. As you now, we thought we could be a little more aggressive on the CPM as a function of the trimming of the rate base, and then as I mentioned in my remarks, on a trending basis, if you will, our first quarter ’06 pages were 86 pages, so the 103 pages does show some positive momentum in terms of the year.

Dennis McAlpine - McAlpine Associates

Good, thank you. Mobile revenue, can you talk about how sizable that is at this point, both domestically and internationally, and what sort of growth you expect to see in that area?

Linda Havard

There isn’t really any domestic mobile business at this point. We continue to do our best to lock deals up with the appropriate partners, but there is no adult really on the domestic side at the moment.

The deals and the revenue is coming from international right now, and it’s supported in that international group, and we do not break out the difference between international TV and mobile. All we can say is that it is a growing business. We also said when we talked in the fourth quarter conference call in February, that our largest partner overseas, Hutchinson, which has multiple territories, was experiencing a technical difficulty in Italy, which actually caused a depression in the growth in the Italian business for a two-quarter period, sort of the fourth quarter, first quarter, into the second quarter. So we should see the ramp up faster in the second part of the year.

Dennis McAlpine - McAlpine Associates

Then on the SVOD, can you talk about the relative revenue per subscriber and the splits that you expect to get from SVOD, relative to pay-per-view or VOD?

Christie Hefner

I can say that the splits are the same. I can’t really speak to the relative revenue because as we were discussing, while we are quite pleased with the Cablevision experience, that is all we have right now. So my goal had been that by the end of this year, we would have enough real market experience in SVOD to find some way that would be helpful to you all, and that we would use to monitor the business to calibrate expectations of how to match revenue growth with rollout, but until we actually get some traction in the Time Warner and Comcast markets, I am not in a position to try and quantify that.

Dennis McAlpine - McAlpine Associates

Lastly, on DTV, it may be a little early, but since you have gone through a month without the two channels, can you talk about the impact of losing those two channels, whether it was the 40% drop, which would have been the two out of five, or more. Secondly, I think you said something about your agreement is not signed with DTV yet. Does that mean there is a possibility that you could lose additional channels to somebody else?

Christie Hefner

On the first question, because of the lag time in matching periods with payments from both satellite and cable distributors, the reality is we have received no payment for the post-resetting of the channel allocation, and will not for several for months.

We think the expectations we have built into our forecast are realistic in terms of what those channels generating and what the loss of them will represent. But we will not have actual collection of payments in the reset channel allocation from DirecTV for several more months.

Dennis McAlpine - McAlpine Associates

Okay, and the agreement is yet to be signed?

Christie Hefner

Well I guess the way I would answer that is I think that the agreement that is being papered, which is for Playboy TV and two channels is the agreement that will be signed. I think we are all aware of the fact that in the distributor-driven businesses of satellite and cable, regardless of what the contracts specify, the distributors are in control of how they choose to allocate their channels.

What is important from our point of view is that Playboy is a unique tent pole that everybody wants that all of the deals that we've done retain our position as the majority supplier and quite frankly, that the future is increasingly going to be one in which consumers access video content directly from the Internet, eliminating the middleman and changing dramatically the margins on video content from what historically has been.

Dennis McAlpine - McAlpine Associates

One of the things that hasn't happened in the past, to a large extent on cable has been marketing of the adult channels not just by you but by New Frontier and all the others. Given what is going on, does it make sure for you -- you collectively, the industry -- to do more advertising about the channels and SVOD and VOD? If so, would the cable operators even allow you to do that?

Christie Hefner

They are not very willing marketing partners, is the answer to that. There are two ways to go at it. One is to go after people who have an affinity for Playboy and we do that aggressively through magazine and through our online sites; the other is to go after the market of people who are cable subscribers to try and sell them Playboy and for that we need the cooperation of the distributors.

As you point out, the MSOs have historically not been very willing to do that. We do some marketing, for example, of Playboy with DirecTV in terms of on-air promotion and guide. We certainly take those programs out to all of our distribution partners.

Dennis McAlpine - McAlpine Associates

Good, thank you.

Operator

Our next question comes from Matthew Harrigan - Janco.

Matthew Harrigan - Janco

Essentially you have commented about as exhaustively as you can on the projections for 2006, so I will ask something more conceptual. With all the attention on the gambling activity, not just in Vegas and Macau but some of the developing markets like Southern Spain, London, Edinborough, Singapore -- although I am sure that wouldn't be applicable to Playboy -- do you see anything in the timeline this year for more licensing deals? Or do you think you are going to be tied up with some of the issues related to Q2 that might somewhat distract you from advancing any licensing arrangements that would kick in on the gaming side in 2007, 2008?

Christie Hefner

I think it is really important, given the magnitude of the opportunity, not to allow ourselves to be distracted which is why we added a full-time executive whose costs are running through the Licensing Group's expense whose sole focus is on location-based entertainment. I think, actually he is doing an outstanding job. So we want to make sure that we have dedicated resources to developing that gaming driven business, both location-based and in the territories where it is legal online.

I do think because they are the most significant markets in those regions, that we are right to put our near-term focus this year on seeing if we can't secure good deals for London and Macau but I share your view that it is clear that the potential for a larger scale entertainment gaming facilities in more markets than historically have had them, whether that is Southeast Asia or Europe is a growth opportunity.

And one I think that bodes well for our ability as we did in the deal with The Palms, to put a package together that trades on the entertainment, club and gaming aspects of bringing the brand to life.

Matthew Harrigan - Janco

Thanks, Christie.

Operator

Our next question comes from Scott Coleman - Credence Capital.

Scott Coleman - Credence Capital

Hi, asked and answered. Thank you.

Operator

Our next question comes from Mike Elkin - Knott Partners.

Mike Elkin - Knott Partners

You talked about increasing the free lifestyle content to increasing the online ad opportunities. How much advertising do you do online now, and how big do you think the opportunity can be?

Linda Havard

We don't disclose that separately, it is in other in Entertainment, Mike. But it is in the seven digits and it has increased as a result of the acquisition of the website business that we bought in the fall, so we have gotten subscription revenue increases as well as advertising increases there.

Then as Christie had mentioned, we expect the free site, lifestyle type advertising to increase as we provide more opportunity for inventory on our site.

Mike Elkin - Knott Partners

It looks like you bundled the online subscription and e-commerce this quarter. Can you break that out?

Linda Havard

What I can tell you is that e-commerce was basically flat and the growth was in subscriptions, and that is pretty much what we expect and frankly what we want to see. We like the e-commerce business because it provides an opportunity to sell our own products online, and I have said that I do believe over time we will have the capability of selling other people's products online as well.

But the core of our online business is the sale of content on the one hand, and the growth of the capability of people to access via broadband, whether it is the pay per minute that we spoke about briefly on the conference call or whether it is a monthly subscription, that content which we are investing in a digital rights and digital asset management system to deliver is really, for us, a significant growth.

The corollary would be what we just talked about which is, we think we are well-positioned to capitalize on both the migration of consumers to online for entertainment and the migration of advertising to online by increasing the presence of what I will call lifestyle and Playboy style non-pay content online and at adjacencies.

Mike Elkin - Knott Partners

Great, thank you.

Operator

We will take our last question from Nader Tavakoli - Eagle Rock.

Nader Tavakoli - Eagle Rock

Thank you for taking the question. We are relatively new. Most of the questions were answered. What I haven't heard is you have one of the most recognized brands in the world in a relatively content-starved world, trading $400 million today. I guess from a bigger picture perspective, are you considering anything that would transformational, anything that would be radical? What are you going to do to turn this brand into what it should be worth?

I guess the second question is, are you considering share buybacks?

Christie Hefner

What I would say in answer to the first question is we think what is transforming the Company is the fact that we have identified two sectors. One, Digital New Media, globally and the other our Licensing approach to fashion, retail and location-based entertainment that can have sustainable 15-20% annual growth. I don't know very many companies that have that capability.

As we achieve those numbers and make sure, per our whole discussion this morning, that we are appropriately structured and have the correct cost structure against our mature businesses, we believe that will transform the value of the Company based on the results of the Company.

On the stock buyback, I would give the same answer as I did before which is that we look at it periodically while being conscious of the fact that liquidity for our institutional shareholders is an important factor, and we will look at it in the future as well.

Nader Tavakoli - Eagle Rock

Thank you.

Operator

At this time I would like to turn the program back over to the hosts.

Martha Lindeman

Thank you all very much for joining us this morning. Excellent questions. For those of you who didn't get a chance to get your questions in the queue or have some additional follow ups I will certainly be in my office all day -- it is Martha. Feel free to give me a call. Thank you all. Good bye.

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