-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Adw9tsRGesHFSrjHy6Wb4zo7CXmitGXc4X1Kmrw8Ho9R8ze5XuFLTSxlss4C2ACe 5UCVZEaZ0DxROmm1lrOoxA== 0000950131-98-006122.txt : 19981118 0000950131-98-006122.hdr.sgml : 19981118 ACCESSION NUMBER: 0000950131-98-006122 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PLAYBOY ENTERPRISES INC CENTRAL INDEX KEY: 0000079114 STANDARD INDUSTRIAL CLASSIFICATION: PERIODICALS: PUBLISHING OR PUBLISHING AND PRINTING [2721] IRS NUMBER: 362258830 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-06813 FILM NUMBER: 98751416 BUSINESS ADDRESS: STREET 1: 680 N LAKE SHORE DR CITY: CHICAGO STATE: IL ZIP: 60611 BUSINESS PHONE: 3127518000 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from .................... to .................... Commission file number 1-6813 Playboy Enterprises, Inc. (Exact name of registrant as specified in its charter) Delaware 36-2258830 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification Number) 680 North Lake Shore Drive, Chicago, IL 60611 (Address of principal executive offices) (Zip Code) (312) 751-8000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- As of October 31, 1998, there were 4,748,954 shares of Class A Common Stock, par value $0.01 per share, and 15,812,759 shares of Class B Common Stock, par value $0.01 per share, outstanding. PLAYBOY ENTERPRISES, INC. FORM 10-Q TABLE OF CONTENTS PART I FINANCIAL INFORMATION Page ---- Item 1. Financial Statements Condensed Consolidated Statements of Operations for the Quarters Ended September 30, 1998 and 1997 (Unaudited) 3 Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 1998 and 1997 (Unaudited) 4 Condensed Consolidated Balance Sheets at September 30, 1998 (Unaudited) and December 31, 1997 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1997 (Unaudited) 6 Notes to Condensed Consolidated Financial Statements 7-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-19 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 PART II OTHER INFORMATION Item 1. Legal Proceedings 20 Item 6. Exhibits and Reports on Form 8-K 21 2 PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS for the Quarters Ended September 30 (Unaudited) (In thousands, except per share amounts)
1998 1997 ---- ---- Net revenues $ 75,655 $ 68,214 -------- -------- Costs and expenses Cost of sales (66,558) (57,093) Selling and administrative expenses (11,539) (8,793) -------- -------- Total costs and expenses (78,097) (65,886) -------- -------- Operating income (loss) (2,442) 2,328 -------- -------- Nonoperating income (expense) Investment income 19 22 Interest expense (429) (121) Other, net (79) 92 -------- -------- Total nonoperating expense (489) (7) -------- -------- Income (loss) before income taxes (2,931) 2,321 Income tax benefit (expense) 242 (1,226) -------- -------- Net income (loss) $ (2,689) $ 1,095 ======== ======== Weighted average number of common shares outstanding Basic 20,552 20,454 ======== ======== Diluted 21,003 20,772 ======== ======== Net income (loss) per common share Basic $ (0.13) $ 0.05 ======== ======== Diluted $ (0.13) $ 0.05 ======== ========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements. 3 PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS for the Nine Months Ended September 30 (Unaudited) (In thousands, except per share amounts)
1998 1997 --------- --------- Net revenues $ 225,237 $ 218,834 --------- --------- Costs and expenses Cost of sales (191,786) (180,054) Selling and administrative expenses (30,658) (28,401) --------- --------- Total costs and expenses (222,444) (208,455) --------- --------- Operating income 2,793 10,379 --------- --------- Nonoperating income (expense) Investment income 70 60 Interest expense (989) (249) Other, net (535) (450) --------- --------- Total nonoperating expense (1,454) (639) --------- --------- Income before income taxes 1,339 9,740 Income tax benefit (expense) (1,889) 8,887 --------- --------- Net income (loss) $ (550) $ 18,627 ========= ========= Weighted average number of common shares outstanding Basic 20,541 20,383 ========= ========= Diluted 21,053 20,819 ========= ========= Net income (loss) per common share Basic $ (0.03) $ 0.91 ========= ========= Diluted $ (0.03) $ 0.89 ========= =========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements. 4 PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
(Unaudited) Sept. 30, Dec. 31, 1998 1997 -------- -------- Assets Cash and cash equivalents $ 2,150 $ 947 Marketable securities 441 - Receivables, net of allowance for doubtful accounts of $6,353 and $4,467, respectively 37,518 33,324 Inventories 28,496 25,376 Programming costs 45,415 41,504 Deferred subscription acquisition costs 12,848 12,143 Other current assets 14,450 11,910 -------- -------- Total current assets 141,318 125,204 -------- -------- Property and equipment, at cost 38,368 37,945 Accumulated depreciation (29,354) (27,892) -------- -------- Property and equipment, net 9,014 10,053 -------- -------- Programming costs - noncurrent 5,906 8,329 Trademarks 16,364 14,978 Net deferred tax assets 13,247 13,688 Other noncurrent assets 18,697 13,695 -------- -------- Total assets $204,546 $185,947 ======== ======== Liabilities Short-term borrowings $ 29,000 $10,000 Accounts payable 30,892 32,258 Accrued salaries, wages and employee benefits 4,860 4,499 Reserves for losses on disposals of discontinued operations 607 610 Income taxes payable 558 627 Deferred revenues 41,958 43,216 Other liabilities and accrued expenses 9,819 7,706 -------- -------- Total current liabilities 117,694 98,916 Noncurrent liabilities 8,435 8,348 -------- -------- Total liabilities 126,129 107,264 -------- -------- Shareholders' Equity Common stock, $0.01 par value Class A voting - 7,500,000 shares authorized; 5,042,381 issued 50 50 Class B non-voting - 30,000,000 shares authorized; 17,112,672 and 17,076,518 issued, respectively 171 171 Capital in excess of par value 44,207 43,539 Retained earnings 44,707 45,257 Foreign currency translation adjustment (168) (131) Unearned compensation restricted stock (3,901) (3,511) Unrealized loss on marketable securities (59) - Less cost of treasury stock (6,590) (6,692) -------- -------- Total shareholders' equity 78,417 78,683 -------- -------- Total liabilities and shareholders' equity $204,546 $185,947 ======== ========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements. 5 PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS for the Nine Months Ended September 30 (Unaudited) (In thousands)
1998 1997 -------- -------- Cash Flows From Operating Activities Net income (loss) $ (550) $ 18,627 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Depreciation of property and equipment 1,488 1,599 Amortization of intangible assets 1,298 1,428 Amortization of investments in entertainment programming 16,750 17,468 Investments in entertainment programming (18,238) (22,828) Net change in operating assets and liabilities (14,833) (13,089) Net cash used for discontinued operations (3) (59) Other, net (4) 717 -------- -------- Net cash provided by (used for) operating activities (14,092) 3,863 -------- -------- Cash Flows From Investing Activities Additions to property and equipment (801) (434) Acquisitions and funding of equity interests in international ventures (1,598) (1,524) Loan to international venture (1,193) - Purchase of marketable securities (500) - Other, net 32 21 -------- -------- Net cash used for investing activities (4,060) (1,937) -------- -------- Cash Flows From Financing Activities Increase (decrease) in short-term borrowings 19,000 (3,000) Proceeds from exercise of stock options 199 391 Proceeds from sales under employee stock purchase plan 156 147 -------- -------- Net cash provided by (used for) financing activities 19,355 (2,462) -------- -------- Net increase (decrease) in cash and cash equivalents 1,203 (536) Cash and cash equivalents at beginning of period 947 1,061 -------- -------- Cash and cash equivalents at end of period $ 2,150 $ 525 ======== ========
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements. 6 PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (A) BASIS OF PREPARATION The financial information included herein is unaudited, but in the opinion of management, reflects all normal recurring adjustments necessary for a fair presentation of the results for the interim periods. The interim results of operations and cash flows are not necessarily indicative of such results and cash flows for the entire year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Transition Report on Form 10-K for the period from July 1, 1997 through December 31, 1997, as amended (the "Transition Report"), of Playboy Enterprises, Inc. and its subsidiaries (the "Company"). (B) INCOME TAXES The Company's net deferred tax asset declined to $13.5 million at September 30, 1998 based on taxable income for the current nine-month period and management's projection of calendar year 1998 taxable income. As reported in the Company's Transition Report, the deferred tax asset includes principally the anticipated benefit of net operating loss carryforwards ("NOLs"). Of the $13.5 million and $14.0 million net deferred tax assets included in the Condensed Consolidated Balance Sheets at September 30, 1998 and December 31, 1997, respectively, $0.3 million is included in "Other current assets" with the remainder segregated as "Net deferred tax assets." Realization of the net deferred tax asset is dependent upon the Company's ability to generate taxable income in future years. The recognition of benefits in the financial statements is based upon projections by management of future operating income and the anticipated reversal of temporary differences that will result in taxable income. Projections of future earnings were based on adjusted historical earnings. In order to fully realize the net deferred tax asset of $14.0 million at December 31, 1997, the Company will need to generate future taxable income of approximately $41.2 million prior to the expiration, beginning in 2004, of the Company's NOLs. Management believes that it is more likely than not that the required amount of such taxable income will be realized. Management will periodically reconsider the assumptions utilized in the projection of future earnings and, if warranted, increase or decrease the amount of deferred tax assets through an adjustment to the valuation allowance. 7 (C) INCOME (LOSS) PER COMMON SHARE The following table sets forth the computation of basic and diluted earnings per share ("EPS") (in thousands, except per share amounts):
(Unaudited) (Unaudited) Quarters Ended Nine Months Ended September 30, September 30, -------------- ----------------- 1998 1997 1998 1997 - ---------------------------------------------------------------------------------------- Numerator: For basic and diluted EPS--net income (loss) available to common shareholders $(2,689) $1,095 $(550) $18,627 ======================================================================================== Denominator: Denominator for basic EPS-- weighted-average shares 20,552 20,454 20,541 20,383 - ---------------------------------------------------------------------------------------- Effect of dilutive potential common shares: Stock options 451 318 512 356 Nonvested restricted stock awards - - - 80 - ---------------------------------------------------------------------------------------- Dilutive potential common shares 451 318 512 436 - ---------------------------------------------------------------------------------------- Denominator for diluted EPS-- adjusted weighted-average shares 21,003 20,772 21,053 20,819 ======================================================================================== Basic EPS $(0.13) $0.05 $(0.03) $0.91 ======================================================================================== Diluted EPS $(0.13) $0.05 $(0.03) $0.89 ========================================================================================
During the quarter and nine months ended September 30, 1998, approximately 345,000 and 340,000 weighted-average shares of Class B restricted stock awards outstanding, respectively, were not included in the computation of diluted EPS as the operating income objectives applicable to these restricted awards were not met during those periods. Additionally, options to purchase approximately 217,000 and 75,000 weighted-average shares of Class B common stock were outstanding during the quarter and nine months ended September 30, 1998, respectively, but were not included in the computation of diluted EPS as the options' exercise prices were greater than the average market price of the Class B common stock, the effect of which was antidilutive. (D) MARKETABLE SECURITIES The Company's marketable securities, purchased in connection with the Company's Deferred Compensation Plans, are classified as available-for-sale securities as defined by Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. As a result, these securities are stated at fair value and unrealized holding gains and losses are reflected as a net amount in a separate component of shareholders' equity. Securities available for sale at September 30, 1998 consisted of the following (in thousands):
Gross Gross Unrealized Unrealized Holding Holding Fair Cost Gains Losses Value - ----------------------------------------------------------------- Equity Securities $500 $ - $ 59 $441 - -----------------------------------------------------------------
8 (E) INVENTORIES Inventories, which are stated at the lower of cost (average cost and specific cost) or market, consisted of the following (in thousands):
(Unaudited) Sept. 30, Dec. 31, 1998 1997 ---------- -------- Paper $ 9,011 $ 7,573 Editorial and other prepublication costs 6,930 6,002 Merchandise finished goods 12,555 11,801 ------- ------- Total inventories $28,496 $25,376 ======= =======
(F) TREASURY STOCK Treasury stock consisted of 293,427 Class A common shares and 954,500 Class B common shares at September 30, 1998. At December 31, 1997, treasury stock consisted of 293,427 Class A common shares and 974,227 Class B common shares. (G) ACCOUNTING STANDARDS The Company will adopt the provisions of Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income Summary ("Statement 130") for financial statements issued for fiscal years beginning after December 15, 1997. Statement 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Management is evaluating the effect that adoption of Statement 130 will have on the Company's financial statements. The Company will adopt the provisions of Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement 131") for financial statements issued for periods beginning after December 15, 1997. Statement 131, which is based on the management approach to segment reporting, includes requirements to report selected segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. Management is evaluating the effect that adoption of Statement 131 will have on the Company's financial statements. The Company will adopt the provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("Statement 133"), for financial statements issued for fiscal years beginning after June 15, 1999. Statement 133 provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. Management is evaluating the effect that adoption of Statement 133 will have on the Company's financial statements. (H) CONTINGENCIES In January 1993, the Company received a General Notice from the United States Environmental Protection Agency (the "EPA") as a "potentially responsible party" ("PRP") in connection with a site identified as the Southern Lakes Trap & Skeet Club, located at the Resort-Hotel in Lake Geneva, Wisconsin (the "Resort"), formerly owned by a subsidiary of the Company. The Resort was sold by the Company's subsidiary to LG Americana- GKP Joint Venture in 1982. Two other entities were also identified as PRPs in the notice. The notice relates to actions that may be ordered taken by the EPA to sample for and remove contamination in soils and sediments, purportedly caused by skeet shooting activities at the Resort property. During fiscal year 1994, the EPA advised the Company of its position that the area of land requiring remediation is approximately twice the size of the initial site. The Company believes that it has established adequate reserves, which totaled $0.6 million at September 30, 1998, to cover the eventual cost of its anticipated share (based on an agreement with one of the other PRPs) of any agreed upon remediation. 9 In February 1996, the Company filed suit challenging Section 505 of the Telecommunications Act of 1996 (the "Telecommunications Act") which, among other things, regulates the cable transmission of adult programming, such as the Company's domestic pay television programs. Management believes that the Company's revenues attributable to its domestic pay television cable services may continue to be materially adversely affected as a result of enforcement of Section 505 of the Telecommunications Act ("Section 505"), which commenced May 18, 1997, due to reduced buy rates from the systems that roll back carriage to a 10:00 p.m. start time, subscriber declines and reduced carriage from cable operators due to aggressive competition for carriage from all program suppliers. The Company has estimated that the Entertainment Group's calendar year 1998 revenues will be reduced by approximately $3.5 million, and approximately $25 million (discounted to present value at a rate of 6%) over the next ten years, due to Section 505. These amounts do not take into account the loss of revenues due to the slowing of access to new homes and of upgrading of old homes from ten to 24 hours. (I) PROPOSED ACQUISITION On July 29, 1998, the Company and Spice Entertainment Companies, Inc. ("Spice") filed with the Securities and Exchange Commission ("SEC") preliminary proxy materials in connection with the Company's proposed acquisition of Spice, announced on February 3, 1998. The Company and Spice have responded to comments on the preliminary proxy materials from the staff of the SEC, are in the process of responding to additional comments, and are working on obtaining all other necessary consents and approvals. The Company has received a financing commitment from a major financial institution which provides that, subject to satisfaction of customary conditions contained in the commitment letter, the Company will be entitled to draw upon the commitment from and after February 12, 1999. The Company and Spice have agreed to amend their merger agreement to extend from December 31, 1998 to March 1, 1999, the date on which either party may terminate the merger agreement, to adjust the top of the collar from a maximum value of $2.88 per Spice share to $2.81 while leaving the bottom of the collar of $2.20 per Spice share unchanged, and to amend certain other terms. The Company and Spice are finalizing the specific terms of the amendment which will be described in and annexed to the proxy materials to be filed shortly with the SEC and which will be mailed after SEC clearance to stockholders of Spice. The Company expects the merger to be effected during the first two months of calendar year 1999. (J) SUBSEQUENT EVENT In October 1998, the Company settled litigation in the amount of $1.4 million related to BrandsElite International Corporation ("BrandsElite"). The settlement was recorded in cost of sales in the quarter ended September 30, 1998. See "Legal Proceedings." 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In millions of dollars, except per share amounts) RESULTS OF OPERATIONS The Company's revenues increased to $75.7 for the quarter ended September 30, 1998 compared to $68.2 for the quarter ended September 30, 1997. For the nine months ended September 30, 1998, revenues increased to $225.2 compared to $218.8 for the nine months ended September 30, 1997. The increase for the quarter was driven by higher Entertainment and Catalog Group revenues, combined with an increase in Playboy magazine revenues. For the nine-month period, the increase was primarily due to higher revenues for the Entertainment and Playboy Online Groups, partially offset by lower revenues from other domestic publishing businesses. The Company reported an operating loss of $2.4 for the quarter ended September 30, 1998 compared to operating income of $2.3 in the prior year quarter. For the nine months ended September 30, 1998, the Company's operating income was $2.8 compared to $10.4 in the prior year. The current year quarter and nine-month period reflected higher operating income for the Entertainment Group, which was more than offset by planned investments in the Playboy Online Group and Corporate Administration and Promotion and lower operating performance for the Publishing and Product Marketing Groups. The lower operating performance for the Product Marketing Group was principally due to a settlement of litigation reflected in the current year quarter and nine-month period. The higher Corporate Administration and Promotion expenses were largely due to increased investments in systems technology, including Year 2000 expenses, and corporate marketing. For the quarter ended September 30, 1998, the Company reported a net loss of $2.7, or basic and diluted net loss per common share of $0.13, compared to net income of $1.1, or basic and diluted EPS of $0.05, for the prior year quarter. The net loss for the nine months ended September 30, 1998 was $0.6, or basic and diluted net loss per common share of $0.03, compared to net income of $18.6, or basic EPS of $0.91 and diluted EPS of $0.89, for the prior year. Net income for the nine months ended September 30, 1997 included a federal income tax benefit of $13.5 related to NOLs and tax credit carryforwards. Excluding the impact of the $13.5 federal income tax benefit, net income for the nine months ended September 30, 1997 was $5.1, or basic and diluted EPS of $0.25. The net loss for the quarter ended September 30, 1998, adjusted to eliminate noncash federal income tax items due to the Company's NOLs and tax credit carryforwards ("tax-adjusted net loss"), was $2.9, or basic and diluted net loss per common share of $0.15. Net income for the quarter ended September 30, 1997, adjusted to eliminate noncash federal income tax items due to the Company's NOLs and tax credit carryforwards ("tax-adjusted net income"), was $1.8, or basic and diluted EPS of $0.09. For the nine months ended September 30, 1998, the tax- adjusted net loss was $0.1, or basic and diluted net loss per common share of $0.01, compared to tax-adjusted net income of $7.8, or basic EPS of $0.39 and diluted EPS of $0.38, for the nine months ended September 30, 1997. Several of the Company's businesses can experience variations in quarterly performance. As a result, the Company's performance in any quarterly period is not necessarily reflective of full-year or longer-term trends. For example, Playboy magazine newsstand revenues vary from issue to issue, with revenues generally higher for holiday issues and any issues including editorial or pictorial features that generate unusual public interest. Advertising revenues also vary from quarter to quarter, depending on product introductions by advertising customers, changes in advertising buying patterns and economic conditions. In addition, Entertainment Group revenues vary with the timing of international sales. 11 Publishing Group The revenues and operating income of the Publishing Group were as follows for the periods indicated below:
Quarters Nine Months Ended Ended September 30, September 30, ------------- ------------- 1998 1997 1998 1997 ----- ----- ----- ------ Revenues Playboy Magazine........... $26.2 $24.3 $77.4 $ 77.5 Other Domestic Publishing.. 5.6 5.6 14.1 15.9 International Publishing... 2.2 2.2 7.4 6.9 ----- ----- ----- ------ Total Revenues............ $34.0 $32.1 $98.9 $100.3 ===== ===== ===== ====== Operating Income........... $ 1.4 $ 2.5 $ 4.5 $ 7.5 ===== ===== ===== ======
Publishing Group revenues increased $1.9, or 6%, for the quarter ended September 30, 1998 compared to the prior year due to higher revenues from Playboy magazine. For the nine months ended September 30, 1998, revenues decreased $1.4, or 1%, compared to the prior year primarily due to lower revenues from newsstand specials. For the quarter ended September 30, 1998, Playboy magazine revenues increased $1.9, or 8%, compared to the prior year. Circulation revenues increased $1.8 primarily due to a $1.6, or 32%, increase in newsstand revenues principally due to sales of the October 1998 issue featuring Cindy Crawford, which also carried a higher cover price. Additionally, the quarter was favorably impacted by higher subscription revenues of $0.2, or 2%. Advertising revenues remained relatively flat. For the nine months ended September 30, 1998, Playboy magazine revenues remained relatively flat. Circulation revenues increased $0.5, or 1%, due to $1.1, or 3%, higher subscription revenues. The higher subscription revenues were partially offset by $0.6, or 4%, lower newsstand revenues primarily due to 6% fewer U.S. and Canadian newsstand copies sold in the current year. In general, newsstand revenues have been, and are expected to continue to be, adversely affected by the consolidation taking place nationally in the single-copy magazine distribution system. Advertising revenues decreased $1.0, or 5%, primarily due to 4% fewer ad pages. Advertising sales for the calendar year 1998 fourth quarter issues of the magazine are closed, and the Company expects to report 35% more ad pages and 40% higher ad revenues compared to the quarter ended December 31, 1997, resulting in expected 6% increases in both ad pages and ad revenues for calendar year 1998 compared to calendar year 1997. Revenues from other domestic publishing businesses were flat for the quarter and decreased $1.8, or 12%, for the nine-month period compared to the prior year. The decrease for the nine-month period was principally due to fewer copies of newsstand specials sold. International publishing revenues were flat for the quarter and increased $0.5, or 7%, for the nine-month period compared to the prior year. The increase for the nine-month period primarily reflected higher revenues from the Polish edition of Playboy magazine, in which the Company owns a majority interest. For the quarter ended September 30, 1998, Publishing Group operating income decreased $1.1, or 43%, compared to the prior year due to higher average paper prices and higher editorial costs associated with the Cindy Crawford feature combined with lower subscription profitability. Operating income declined $3.0, or 40%, for the nine months ended September 30, 1998 largely due to the lower revenues from newsstand specials and Playboy magazine advertising and newsstand combined with higher average paper prices and lower subscription profitability. Operating income in calendar year 1998 has been, and is expected to continue to be, materially adversely impacted by an average paper price increase of approximately 5% compared to calendar year 1997. 12 The National Defense Authorization Act of 1997 was signed into law in September 1996. One section of that legislation that began as the Military Honor and Decency Act (the "Military Act") bans the sale or rental of "sexually explicit material" on property under the jurisdiction of the Department of Defense. A federal district court found the Military Act to be unconstitutional and permanently enjoined its enforcement. The district court's decision also prohibited the Department of Defense from modifying its acquisition and stocking practices as a result of the Military Act. The government appealed the district court's decision and the decision was stayed during this appeal. On November 21, 1997, the United States Court of Appeals (the "Court of Appeals") vacated the district court's decision and ordered the district court to hold the Military Act constitutional. The Court of Appeals' decision was stayed pending appeal to the United States Supreme Court (the "Supreme Court"). On June 27, 1998, the Supreme Court, without comment, refused to hear the appeal and the stay was lifted. On September 21, 1998, the Department of Defense issued a directive that the Military Act was not applicable to the Company's publications and that the sale of Playboy magazine, newsstand specials and most of the Company's videos would not be prohibited at commissaries, PX's and ship stores. Entertainment Group The revenues and operating income of the Entertainment Group were as follows for the periods indicated below:
Quarters Nine Months Ended Ended September 30, September 30, ------------- --------------- 1998 1997 1998 1997 ----- ----- ------ ------ Revenues Playboy TV Cable................................... $ 5.3 $ 4.4 $ 15.7 $ 15.2 Satellite Direct-to-Home................ 8.5 7.2 24.8 20.4 Off-Network Productions and Other....... 0.2 0.9 0.7 1.9 ----- ----- ------ ------ Total Playboy TV......................... 14.0 12.5 41.2 37.5 Domestic Home Video...................... 3.2 1.7 9.0 6.4 International TV and Home Video.......... 3.1 2.6 9.0 10.4 ----- ----- ------ ------ Total Playboy Businesses................. 20.3 16.8 59.2 54.3 AdulTVision.............................. 1.5 1.1 4.3 3.2 Movies and Other......................... 0.1 0.3 1.5 1.5 ----- ----- ------ ------ Total Revenues.......................... $21.9 $18.2 $ 65.0 $ 59.0 ===== ===== ====== ====== Operating Income Profit Contribution Before Playboy Businesses Programming Expense.. $11.3 $ 9.1 $ 33.9 $ 30.7 Playboy Businesses Programming Expense... (5.5) (5.5) (15.6) (16.6) ----- ----- ------ ------ Total Operating Income.................. $ 5.8 $ 3.6 $ 18.3 $ 14.1 ===== ===== ====== ======
The following discussion focuses on the profit contribution of each Playboy business before Playboy businesses programming expense ("profit contribution"). Playboy TV Revenues from the Company's domestic pay television service, Playboy TV, increased $1.5, or 12%, for the quarter and $3.7, or 10%, for the nine-month period compared to the prior year. Cable revenues increased $0.9, or 19%, for the quarter ended September 30, 1998 primarily due to an increase in the number of cable addressable households to which Playboy TV was available combined with higher retail rates. For the nine months ended September 30, 1998, cable revenues increased $0.5, or 3%, primarily due to higher retail rates and larger favorable adjustments to prior months, partially offset by fewer monthly subscribers and some system drops, due in part to the implementation of Section 505 of the Telecommunications Act. At September 30, 1998, Playboy TV was available to approximately 11.9 million cable addressable households, a 9% increase compared to September 30, 1997 and a 2% decrease compared to June 30, 1998. Management believes that the Company's revenues attributable to its domestic pay television cable services may continue to be materially adversely affected as a result of enforcement of Section 505, which commenced May 18, 1997, due to reduced buy rates from the systems that roll back carriage to a 10:00 p.m. start time, subscriber declines and reduced 13 carriage from cable operators due to aggressive competition for carriage from all program suppliers. The Company has estimated that the Entertainment Group's calendar year 1998 revenues will be reduced by approximately $3.5, and approximately $25 (discounted to present value at a rate of 6%) over the next ten years, due to Section 505. These amounts do not take into account the loss of revenues due to the slowing of access to new homes and of upgrading of old homes from ten to 24 hours. The Company is pursuing in the United States District Court in Wilmington, Delaware (the "Delaware District Court") its case challenging on constitutional grounds the validity of Section 505 and is seeking a permanent injunction against the enforcement of Section 505. The Company's full case on the merits was heard by the Delaware District Court in March 1998. The Company is currently waiting for the Delaware District Court to render a decision. See "Legal Proceedings." Additionally, management believes that the growth in cable access for the Company's domestic pay television businesses has slowed in recent years due to the effects of cable reregulation by the Federal Communications Commission (the "FCC"), including the "going-forward rules" which provide cable operators with incentives to add basic services. As cable operators have utilized available channel space to comply with "must-carry" provisions, mandated retransmission consent agreements and "leased access" provisions, competition for channel space has increased. Further, the delay of new technology, primarily digital set-top converters which would dramatically increase channel capacity, has contributed to the slowdown. The major reason for this delay has been the unexpected engineering problems and expenses associated with developing an affordable digital set-top converter. Management believes that growth will continue to be slow in the next two to three years as the cable television industry responds to the FCC's rules and subsequent modifications, and develops new technology. As digital technology (which is unaffected by the relevant sections of the Telecommunications Act) becomes more available, however, the Company believes that ultimately its pay television networks will be available to the majority of cable households on a 24-hour basis. Satellite direct-to-home ("DTH") revenues increased $1.3, or 18%, for the quarter and $4.4, or 22%, for the nine-month period. These improvements were primarily due to significant increases in addressable universes for DirecTV and PrimeStar, combined with revenues in the current year periods as a result of calendar year 1998 launches on EchoStar and two Canadian DTH services, ExpressVu and Star Choice. DTH is unaffected by Section 505. Revenues from TVRO, or the big-dish market, continued to decline, as expected, due to the maturity of this platform. Playboy TV was available to approximately 9.2 million DTH households at September 30, 1998, an increase of 44% and 6% compared to September 30, 1997 and June 30, 1998, respectively. Revenues from off-network productions and other decreased $0.7 for the quarter and $1.2 for the nine-month period primarily due to revenues in the prior year periods from licensing episodes of Women: Stories of Passion to Showtime Networks Inc. Profit contribution for Playboy TV increased $0.7 for the quarter and $2.0 for the nine-month period primarily due to the net increases in revenues discussed above, partially offset by higher marketing expenses. The current year quarter also included legal fees related to the Section 505 lawsuit. The nine- month comparison also reflected expenses in the prior year for a pay-per-view special featuring Farrah Fawcett and favorable music licensing settlements and an adjustment to bad debt in the prior year. Domestic Home Video Domestic home video revenues and profit contribution increased $1.5 and $1.4, respectively, for the quarter ended September 30, 1998, and increased $2.6 and $2.5, respectively, for the nine months ended September 30, 1998, compared to the prior year. These increases were primarily due to sales of The Eros Collection of movies and higher revenues from the sale of digital video discs ("DVDs") in the current year periods. For the quarter, partially offsetting the above were sales in the prior year of Farrah Fawcett: All of Me. 14 International TV and Home Video For the quarter ended September 30, 1998, profit contribution from the international business increased $0.3 primarily due to higher international home video revenues. For the nine months ended September 30, 1998, revenues and profit contribution from the international business decreased $1.4 and $1.7, respectively, primarily due to lower international television and home video sales, partially offset by higher international network sales and contractual revenues. Variations in quarterly performance are caused in part by revenues and profit contribution from tier sales being recognized depending upon the timing of program delivery, license periods and other factors. Playboy Businesses Programming Expense Programming amortization expense associated with the Entertainment Group's Playboy businesses discussed above remained flat for the quarter and decreased $1.0 for the nine-month period. The decrease for the nine-month comparison was primarily due to the net decrease in international revenues discussed above. AdulTVision AdulTVision revenues increased $0.4 for the quarter and $1.1 for the nine- month period compared to the prior year. These increases were primarily due to higher revenues from the domestic network principally as a result of a significant increase in the addressable universe. At September 30, 1998, the network was available domestically to approximately 9.7 million cable addressable and DTH households, an increase of 76% and 2% compared to September 30, 1997 and June 30, 1998, respectively. Operating income increased $0.3 for the quarter and $0.4 for the nine-month period primarily due to the increases in revenues discussed above, partially offset by increased distribution costs. The nine-month comparison also reflected higher contractual marketing costs in the current year. Movies and Other Operating income from movies and other businesses remained relatively stable for both the quarter and nine months ended September 30, 1998, as revenues decreased $0.2 for the quarter and remained stable for the nine-month period. The Entertainment Group's administrative expenses increased $0.3 for the quarter and remained flat for the nine-month period compared to the prior year. The higher expenses for the quarter comparison were primarily due to higher performance-related variable compensation and new business development expenses. Product Marketing Group The revenues and operating performance of the Product Marketing Group were as follows for the periods indicated below:
Quarters Nine Months Ended Ended September 30, September 30, ------------- ------------- 1998 1997 1998 1997 ----- ---- ---- ---- Revenues........................ $ 1.6 $2.4 $5.8 $6.1 ===== ==== ==== ==== Operating Income (Loss)......... $(1.0) $1.5 $0.1 $2.8 ===== ==== ==== ====
Revenues decreased $0.8, or 35%, for the quarter and $0.3, or 5%, for the nine-month period compared to the prior year. Both the current year quarter and nine-month period reflect lower international product licensing royalties, principally from Asia. Higher revenues from Special Editions, Ltd. ("SEL") as a result of a barter agreement related to the sale of prints and posters from the Company's art publishing inventory partially offset the decline for the nine- month period. The Product Marketing Group reported an operating loss of $1.0 for the quarter ended September 30, 1998 compared to operating income of $1.5 in the prior year quarter. Operating income of $0.1 for the nine months ended September 30, 1998 decreased $2.7, or 96%, compared to the prior year. The decreases in the current year periods were largely due to a $1.4 settlement of litigation related to BrandsElite. See "Legal Proceedings." Also unfavorably impacting the current year periods were the lower Asian royalties previously discussed. For the nine-month period, the higher SEL revenues were mostly offset by higher associated costs. 15 Catalog Group The revenues and operating performance of the Catalog Group were as follows for the periods indicated below:
Quarters Nine Months Ended Ended September 30, September 30, ------------- ------------- 1998 1997 1998 1997 ----- ----- ----- ----- Revenues........................ $16.3 $14.7 $50.8 $51.0 ===== ===== ===== ===== Operating Income (Loss)......... $ 0.6 $(0.2) $ 2.1 $ 1.6 ===== ===== ===== =====
Revenues for the quarter ended September 30, 1998 increased $1.6, or 11%, compared to the prior year largely due to the timing of sales cut-offs resulting in an additional week of sales recorded in the current year quarter for all of the catalogs. Sales volume for the Critics' Choice Video catalog was also higher as a result of sales in the current year quarter from The Big Book of Movies catalog (the "Big Book"), first available in October 1997. Also favorably impacting the current year quarter were revenues from the Spice catalog which launched in July 1998 under license from Spice, containing adult video tapes. Partially offsetting the above were lower sales volume for the Playboy fall catalog and the Collectors' Choice Music summer catalog. For the nine months ended September 30, 1998, revenues remained relatively stable compared to the prior year. Revenues in the current year from the Big Book and the Spice catalog discussed above were basically offset by lower sales volume for the quarterly Critics' Choice Video catalogs, primarily as a result of planned lower circulation and slightly lower response rates, and the Playboy fall catalog. For the quarter ended September 30, 1998, operating performance increased $0.8 compared to the prior year primarily due to the higher revenues, which were partially offset by higher related costs. Operating income for the nine months ended September 30, 1998 increased $0.5, or 35%, compared to the prior year as a result of lower expenses due in part to expenses in the prior year related to the group's move to a new facility. Casino Gaming Group The Company anticipates the opening of the Playboy Casino and Beach Hotel in Rhodes, Greece by the end of calendar year 1998 or the first quarter of calendar year 1999. The Company is also exploring additional casino gaming opportunities. Operating losses of $0.2 and $0.6, respectively, were reported for the quarter and nine months ended September 30, 1998 as a result of staffing and overhead costs. Playboy Online Group Beginning with the quarter ended March 31, 1998, Playboy Online results, which were previously reported in the Publishing and Catalog Groups, are reported as a separate operating group. The group's results include advertising sales from Playboy.com, the Company's free site on the Internet; subscription sales to Playboy Cyber Club, the Company's pay site on the Internet; and e- commerce sales. The revenues and operating losses of the Playboy Online Group were as follows for the periods indicated below:
Quarters Nine Months Ended Ended September 30, September 30, ------------- ------------- 1998 1997 1998 1997 ----- ----- ----- ----- Revenues......................... $ 1.8 $ 0.9 $ 4.8 $ 2.4 ===== ===== ===== ===== Operating Loss................... $(2.1) $(0.5) $(4.3) $(0.7) ===== ===== ===== =====
Playboy Online Group revenues doubled for both the quarter and nine-month period compared to the prior year. These increases come from higher subscription revenues related to Playboy Cyber Club, which launched in the summer of 16 1997, combined with higher e-commerce revenues primarily due to the launches of CCVideo and CCMusic, online versions of the Critics' Choice Video and Collectors' Choice Music catalogs, in the fall and summer of 1997, respectively. For the quarter and nine months ended September 30, 1998, the Playboy Online Group reported operating losses of $2.1 and $4.3, respectively, compared to operating losses of $0.5 and $0.7 in the prior year quarter and nine-month period, respectively. The current year quarter and nine-month period included higher planned investments related to the group's continued growth and development. Corporate Administration and Promotion Corporate administration and promotion expenses of $6.9 for the quarter and $17.3 for the nine-month period both increased $2.4 compared to the prior year periods. These increases were primarily due to increased investments in systems technology, including Year 2000 expenses, combined with increased investment spending on corporate marketing and promotion. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, the Company had $2.2 in cash and cash equivalents and $29.0 in short-term borrowings, compared to $0.9 in cash and cash equivalents and $10.0 in short-term borrowings at December 31, 1997. The Company expects to finance its short- and long-term cash requirements through its revolving credit agreement, cash generated from operations and additional facilities. Cash Flows From Operating Activities Net cash used for operating activities was $14.1 for the nine months ended September 30, 1998 compared to net cash provided of $3.9 for the prior year. The Company reported a net loss of $0.6 in the current year compared to net income of $5.1 in the prior year, excluding the $13.5 federal income tax benefit recorded in the prior year. Cash used for operating assets and liabilities was $14.8 in the current year compared to $13.1 in the prior year, despite the increase in the net deferred tax asset in the prior year which offset the federal income tax benefit. Cash used for accounts receivable in the current year compared to cash provided in the prior year was largely due to the higher revenues from domestic home video and international TV networks combined with the timing of cash receipts from the Entertainment Group's domestic home video and international businesses. The Company invested $18.2 in Company-produced and licensed entertainment programming during the current year compared to $22.8 in the prior year, and expects to invest approximately $8.4 in such programming during the remainder of calendar year 1998. Cash Flows From Investing Activities Net cash used for investing activities was $4.1 for the nine months ended September 30, 1998 compared to $1.9 in the prior year largely due to a loan to one of the Company's international ventures in the current year period. Cash Flows From Financing Activities Net cash provided by financing activities was $19.4 for the nine months ended September 30, 1998 compared to net cash used of $2.5 for the prior year. This increase was principally due to a $19.0 increase in the level of short-term borrowings under the Company's revolving line of credit in the current year to finance ongoing operations, compared to a $3.0 decrease in the level of short- term borrowings in the prior year. Income Taxes Based on current tax law, the Company will need to generate approximately $41.2 of future taxable income prior to the expiration of the Company's NOLs for full realization of the $14.0 net deferred tax asset recorded at December 31, 1997. At December 31, 1997, the Company had NOLs of $23.2 for tax purposes, with $1.1 expiring in 2004, $2.1 expiring in 2007, $1.1 expiring in 2008, $16.4 expiring in 2009 and $2.5 expiring in 2012. Management believes that it is more likely than not that the required amount of such taxable income will be generated in years subsequent to December 31, 1997 and prior to the expiration of the Company's NOLs to realize the $14.0 net deferred tax asset at December 31, 1997. The Company's net deferred tax asset declined to $13.5 at September 30, 1998 based on taxable income for the current nine-month period and management's projection of calendar year 1998 taxable income. Following is a summary of the bases for management's belief that a valuation allowance of $16.5 at December 31, 1997 is adequate, and that it is more likely than not that the net deferred tax asset of $14.0 at December 31, 1997 will be realized: 17 . In establishing the net deferred tax asset, management reviewed the components of the Company's NOLs and determined that they primarily resulted from several nonrecurring events, which were not indicative of the Company's ability to generate future earnings. . Several of the Company's operating groups continue to generate meaningful earnings, particularly the Entertainment Group, and the Company's substantial investments in the Entertainment and Playboy Online Groups are anticipated to lead to increased earnings in future years. . The Company has opportunities to accelerate taxable income into the NOL carryforward period. Tax planning strategies would include the capitalization and amortization versus immediate deduction of circulation expenditures, the immediate inclusion versus deferred recognition of prepaid subscription income, the revision of depreciation and amortization methods for tax purposes and the sale-leaseback of certain property that would generate taxable income in future years. Other In January 1993, the Company received a General Notice from the EPA as a PRP in connection with a site identified as the Southern Lakes Trap & Skeet Club, located at the Resort, formerly owned by a subsidiary of the Company. The Resort was sold by the Company's subsidiary to LG Americana-GKP Joint Venture in 1982. Two other entities were also identified as PRPs in the notice. The notice relates to actions that may be ordered taken by the EPA to sample for and remove contamination in soils and sediments, purportedly caused by skeet shooting activities at the Resort property. During fiscal year 1994, the EPA advised the Company of its position that the area of land requiring remediation is approximately twice the size of the initial site. The Company believes that it has established adequate reserves, which totaled $0.6 at September 30, 1998, to cover the eventual cost of its anticipated share (based on an agreement with one of the other PRPs) of any agreed upon remediation. On December 18, 1995, BrandsElite, an Ontario, Canada corporation, filed a complaint against the Company in the Circuit Court of Cook County, Illinois (the "Illinois Circuit Court"). In the complaint, BrandsElite, an international distributor of premium merchandise, including liquor, perfume, cosmetics and luxury gifts, principally to duty-free retailers, alleged that the Company breached a product license agreement, shortly after its execution by the Company in October 1995. The agreement provided for the appointment of BrandsElite as the exclusive, worldwide licensee of the Playboy trademark and tradename with respect to the sale of cognac and possibly some deluxe whiskeys. The Company had advised BrandsElite that it had determined not to proceed with the transaction and disputed strongly BrandsElite's allegation that as a result of the Company's breach, BrandsElite suffered millions of dollars of damages in future lost profits and diminished value of its stock. BrandsElite also sought to recoup out-of-pocket expenses, fees and costs incurred in bringing the action. The license agreement provided for recovery by a party in any judgment entered in its favor of attorneys' fees and litigation expenses, together with such court costs and damages as are provided by law. On October 22, 1997, the Company filed a motion for partial summary judgment challenging BrandsElite's claims for future lost profits and stock market valuation damages. On March 4, 1998, the Illinois Circuit Court granted the portion of the Company's motion relating to stock market valuation damages but denied the portion of the motion relating to future lost profits. BrandsElite's expert reports on damages asserted future lost profits damages ranging from $3.5 to $12.5. The case was dismissed with prejudice on October 16, 1998 in exchange for a settlement payment by the Company of $1.4. The Company will adopt the provisions of Statement 130, Reporting Comprehensive Income Summary for financial statements issued for fiscal years beginning after December 15, 1997. Statement 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Management is evaluating the effect that adoption of Statement 130 will have on the Company's financial statements. The Company will adopt the provisions of Statement 131, Disclosures about Segments of an Enterprise and Related Information for financial statements issued for periods beginning after December 15, 1997. Statement 131, which is based on the management approach to segment reporting, includes requirements to report selected segment information quarterly and entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues. Management is evaluating the effect that adoption of Statement 131 will have on the Company's financial statements. 18 The Company will adopt the provisions of Statement 133, Accounting for Derivative Instruments and Hedging Activities, for financial statements issued for fiscal years beginning after June 15, 1999. Statement 133 provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. Management is evaluating the effect that adoption of Statement 133 will have on the Company's financial statements. In response to the Year 2000 problem, the Company has begun to identify, evaluate and implement changes to its existing computerized business systems. The Company is addressing the issue through a combination of modifications to existing programs and conversions to Year 2000 compliant software. In addition, the Company is communicating with its vendors and other service providers to ensure that their products and business systems will be Year 2000 compliant. If modifications and conversions by the Company and those it conducts business with were not made in a timely manner, the Year 2000 problem could have a material adverse affect on the Company's business, financial condition and results of operations. Certain key systems of the Company have already been identified as Year 2000 compliant, including financial applications and Playboy Online operations. Although the Company is still quantifying the impact, the current estimate of the total costs associated with the required modifications and conversions are expected to be approximately $1.0, of which approximately $0.7 is expected to be expensed in calendar year 1998. These costs are being expensed as incurred. As a contingency plan for the most reasonably likely worst case scenario, the Company has addressed all major elements related to this issue. The Company believes its technology systems will be ready for the Year 2000, but the Company may experience isolated incidences of non-compliance. The Company plans to allocate internal resources and retain dedicated consultants and vendor representatives to be ready to take action if these events occur. Although the Company values its established relationships with key vendors and other service providers, if certain vendors are unable to perform on a timely basis due to their own Year 2000 issues, the Company believes that substitute products or services are obtainable from other vendors. The Company also recognizes the risks if other key suppliers in utilities, communications, transportation, banking and government are not ready for the Year 2000, and is approaching this issue in the same manner. FORWARD-LOOKING STATEMENTS This Form 10-Q Report contains "forward-looking statements," including statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations," as to expectations, beliefs, plans, objectives and future financial performance, and assumptions underlying or concerning the foregoing. Such forward-looking statements involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. The following are some of the important factors that could cause actual results or outcomes to differ materially from those discussed in the forward-looking statements: (1) government actions or initiatives, including (a) attempts to limit or otherwise regulate the sale of adult-oriented materials, including print, video and online materials or businesses such as casino gaming, (b) regulation of the advertisement of tobacco products, or (c) substantive changes in postal regulations or rates, (2) further increases in paper prices, (3) changes in distribution technology and/or unforeseen delays in the implementation of that technology by the cable and satellite industries, which might affect the Company's plans and assumptions regarding carriage of its program services, (4) increased competition for advertisers from other publications and media or any significant decrease in spending by advertisers generally or with respect to the adult male market, (5) increased competition for transponders and channel space and any decline in the Company's access to, and acceptance by, cable and DTH systems, (6) the effects of the consolidation taking place nationally in the single-copy magazine distribution system, (7) new competition in the adult cable television market, (8) uncertainty of market acceptance of the Internet as a medium for information, entertainment, e-commerce and advertising, an increasingly competitive environment for advertising sales, the impact of competition from other content and merchandise providers, as well as the Company's reliance on third parties for technology and distribution for its online business, and (9) potential adverse effects of unresolved Year 2000 problems including external key suppliers. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This disclosure is currently not required as the Company's market capitalization was less than $2.5 billion as of January 28, 1997. 19 LEGAL PROCEEDINGS In February 1996, the Telecommunications Act was enacted. Certain provisions of the Telecommunications Act are directed exclusively at cable programming in general and adult cable programming in particular. In some cable systems, audio or momentary bits of video of premium or pay-per-view channels may accidentally become available to nonsubscribing cable customers. This is called "bleeding." The practical effect of Section 505 is to require many existing cable systems to employ additional blocking technology in every household in every cable system that offers adult programming to prevent any possibility of bleeding, or to restrict the period during which adult programming is transmitted from 10:00 p.m. to 6:00 a.m. Penalties for violation of the Telecommunications Act are significant and include fines and imprisonment. Based on the limited information received, the Company believes that most of the cable operators that were not in compliance with Section 505 have complied by restricting the hours of transmission. On February 26, 1996, one of the Company's subsidiaries filed a civil suit in the Delaware District Court challenging Section 505 on constitutional grounds. The suit names as defendants The United States of America, The United States Department of Justice, Attorney General Janet Reno and the FCC. On March 7, 1996, the Company was granted a Temporary Restraining Order ("TRO") staying the implementation and enforcement of Section 505. In granting the TRO, the Delaware District Court found that the Company had demonstrated it was likely to succeed on the merits of its claim that Section 505 is unconstitutional. On November 8, 1996, eight months after the TRO was granted, a three-judge panel in the Delaware District Court denied the Company's request for preliminary injunction against enforcement of Section 505 and, in so denying, found that the Company was not likely to succeed on the merits of its claim. The Company appealed the Delaware District Court's decision to the Supreme Court and enforcement of Section 505 was stayed pending that appeal. On March 24, 1997, without opinion, the Supreme Court summarily affirmed the Delaware District Court's denial of the Company's request for a preliminary injunction. On July 22, 1997, the Company filed a motion for summary judgment on the ground that Section 505 is unconstitutionally vague based on the Supreme Court's decision on June 26, 1997 that certain provisions of the Telecommunications Act regulating speech on the Internet were invalid for numerous reasons, including vagueness. On October 31, 1997, the Delaware District Court denied the motion on the grounds that further discovery in the case was necessary to assist it in resolving the issues posed in the motion. Management believes that the Company's revenues attributable to its domestic pay television cable services may continue to be materially adversely affected as a result of enforcement of Section 505, which commenced May 18, 1997, due to reduced buy rates from the systems that roll back carriage to a 10:00 p.m. start time, subscriber declines and reduced carriage from cable operators due to aggressive competition for carriage from all program suppliers. The Company has estimated that the Entertainment Group's calendar year 1998 revenues will be reduced by approximately $3.5 million, and approximately $25 million (discounted to present value at a rate of 6%) over the next ten years, due to Section 505. These amounts do not take into account the loss of revenues due to the slowing of access to new homes and of upgrading of old homes from ten to 24 hours. The Company is pursuing in the Delaware District Court its case challenging on constitutional grounds the validity of Section 505 and is seeking a permanent injunction against the enforcement of Section 505. The Company's full case on the merits was heard by the Delaware District Court in March 1998. The Company is currently waiting for the Delaware District Court to render a decision. On December 18, 1995, BrandsElite, an Ontario, Canada corporation, filed a complaint against the Company in the Illinois Circuit Court. In the complaint, BrandsElite, an international distributor of premium merchandise, including liquor, perfume, cosmetics and luxury gifts, principally to duty-free retailers, alleged that the Company breached a product license agreement, shortly after its execution by the Company in October 1995. The agreement provided for the appointment of BrandsElite as the exclusive, worldwide licensee of the Playboy trademark and tradename with respect to the sale of cognac and possibly some deluxe whiskeys. The Company had advised BrandsElite that it had determined not to proceed with the transaction and disputed strongly BrandsElite's allegation that as a result of the Company's breach, BrandsElite suffered millions of dollars of damages in future lost profits and diminished value of its stock. BrandsElite also sought to recoup out-of-pocket expenses, fees and costs incurred in bringing the action. The license agreement provided for recovery by a party in any judgment entered in its favor of attorneys' fees and litigation expenses, together with such court costs and damages as are provided by law. On October 22, 1997, the Company filed a motion for partial summary judgment challenging BrandsElite's claims for future lost profits and stock market valuation damages. On March 4, 1998, the Illinois Circuit Court granted the portion of the Company's motion relating to stock market valuation damages but denied the portion of the motion relating to future lost profits. BrandsElite's expert reports on damages asserted future lost profits damages ranging from $3.5 million to $12.5 million. The case was dismissed with prejudice on October 16, 1998 in exchange for a settlement payment by the Company of $1.4 million. 20 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number Description - ------- ----------- 10.1 Fourth Amendment to February 10, 1995 Credit Agreement by and among Playboy Enterprises, Inc., Harris Trust and Savings Bank and LaSalle National Bank dated as of November 5, 1998 but effective as of September 30, 1998 27 Financial Data Schedule _________ (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended September 30, 1998. 21 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. ------------------------- (Registrant) Date November 16, 1998 By /s/ Linda Havard -------------------- ------------------------ Linda Havard Executive Vice President, Finance and Operations, and Chief Financial Officer (Authorized Officer and Principal Financial and Accounting Officer) 22 EX-10.1 2 FOURTH AMENDMENT TO CREDIT AGREEMENT EXHIBIT 10.1 Playboy Enterprises, Inc. Fourth Amendment to Credit Agreement Harris Trust and Savings Bank Chicago, Illinois LaSalle National Bank Chicago, Illinois Ladies and Gentlemen: Reference is hereby made to the Credit Agreement dated as of February 10, 1995, as amended by the First Amendment to Credit Agreement dated as of March 31, 1995, the Second Amendment to Credit Agreement dated as of March 5, 1996, and the Third Amendment to the Credit Agreement dated as of September 11, 1997, (said Credit Agreement as so amended being referred to herein as the "Credit Agreement") currently in effect by and among, Playboy Enterprises, Inc., a Delaware corporation (the "Company"), and you (the "Lenders"). All capitalized terms used herein without definition shall have the same meanings herein as such terms have in the Credit Agreement. The Company hereby applies to the Lenders to amend a certain financial covenant contained therein and make certain other amendments to the Credit Agreement, and the Lenders are willing to do so under the terms and conditions set forth in this Amendment. 1. Amendment. Upon the satisfaction of the conditions precedent set forth in Section 2 hereof, effective as of September 30, 1998, the Credit Agreement shall be and hereby is amended as follows: 1.01. EBITDA Requirement. Section 8.9 of the Credit Agreement is hereby amended and as so amended shall be restated in its entirety to read as follows: "Section 8.9. EBITDA. The Company will, as of the last day of each fiscal quarter ending during each of the periods specified below, maintain EBITDA for the four fiscal quarters then ended of not less than:
From and To and EBITDA shall Including Including not be less than --------- --------------------- ---------------- 7/1/98 9/30/98 $29,000,000 10/1/98 all times thereafter $30,000,000"
1.02. Applicable Margin. The definition of "Applicable Margin" appearing in Section 5.1 of the Credit Agreement is hereby amended and as so amended shall be restated in its entirety to read as follows: " 'Applicable Margin' means 0% with respect to the Domestic Rate Portion of the Notes and 2.00% with respect to each LIBOR Portion of the Notes." 2. Conditions Precedent. The effectiveness of this Amendment is subject to the satisfaction of all of the following conditions precedent: 2.01. The Company, the Agent and the Lenders shall have executed and delivered this Amendment. 2.02. The Company shall have paid to the Agent for the ratable benefit of the Lenders a transaction fee in the amount of $25,000. 2.03. No Default or Event of Default shall have occurred and be continuing as of the date this Amendment would otherwise take effect. 2.04. Legal matters incident to the execution and delivery of this Amendment shall be satisfactory to the Lenders and their counsel. Upon the satisfaction of the above conditions precedent, this Amendment shall be effective as of September 30, 1998. 3. Representations. In order to induce the Lenders to execute and deliver this Amendment, the Company hereby represents to the Lenders that as of the date hereof, the representations and warranties set forth in Section 6 of the Credit Agreement are and shall be and remain true and correct (except that for purposes of this paragraph, (i) the representations contained in Section 6.3 shall be deemed to include this Amendment as and when it refers to Loan Documents and (ii) the representations contained in Section 6.5 shall be deemed to refer to the most recent financial statements of the Company delivered to the Lenders) and the Company is in full compliance with all of the terms and conditions of the Credit Agreement and no Default or Event of Default has occurred and is continuing under the Credit Agreement or shall result after giving effect to this Amendment. 4. Miscellaneous. 4.01. The Company acknowledges and agrees that all of the Collateral Documents to which it is a party remain in full force and effect for the benefit and security of, among other things, the Revolving Credit as modified hereby. The Company further acknowledges and agrees -2- that all references in such Collateral Documents to the Revolving Credit shall be deemed a reference to the Revolving Credit as so modified. The Company further agrees to execute and deliver any and all instruments or documents as may be required by the Agent or Required Lenders to confirm any of the foregoing. 4.02. Except as specifically amended herein, the Credit Agreement shall continue in full force and effect in accordance with its original terms. Reference to this specific Amendment need not be made in the Credit Agreement, the Notes, or any other instrument or document executed in connection therewith, or in any certificate, letter or communication issued or made pursuant to or with respect to the Credit Agreement, any reference in any of such items to the Credit Agreement being sufficient to refer to the Credit Agreement as amended hereby. 4.03. This Amendment may be executed in any number of counterparts, and by the different parties on different counterpart signature pages, all of which taken together shall constitute one and the same agreement. Any of the parties hereto may execute this Amendment by signing any such counterpart and each of such counterparts shall for all purposes be deemed to be an original. This Amendment shall be governed by the internal laws of the State of Illinois. -3- Dated as of November 5, 1998 but effective as of September 30, 1998. Playboy Enterprises, Inc. By /s/ Linda Havard -------------------------------------- Its EVP & CFO ----------------------------------- Each of the undersigned acknowledges and agrees that while the following is not required, each confirms that: (i) all of the Collateral Documents to which it is a party remain in full force and effect for the benefit and security of, among other things, the Revolving Credit as modified hereby; (ii) all references in such Collateral Documents to the Credit Agreement shall be deemed a reference to the Credit Agreement as amended hereby; (iii) each of the undersigned will continue to execute and deliver any and all instruments or documents as may be required by the Agent or Required Lenders to confirm any of the foregoing. Playboy Entertainment Group, Inc. By /s/ Robert D. Campbell -------------------------------------- Its Vice President, Treasurer ----------------------------------- Critics' Choice Video, Inc. By /s/ Robert D. Campbell -------------------------------------- Its Vice President, Treasurer ---------------------------------- Lifestyle Brands, Ltd. By /s/ Robert D. Campbell -------------------------------------- Its Vice President, Treasurer ----------------------------------- Accepted and agreed to in Chicago, Illinois as of the date and year last above written. Harris Trust And Savings Bank By /s/ Scott F. Geik -------------------------------------- Its Vice President ---------------------------------- LaSalle National Bank By /s/ Melissa Bleiweis -------------------------------------- Its Assistant Vice President ---------------------------------- -4- EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 2,150 441 43,871 6,353 28,496 141,318 38,368 29,354 204,546 117,694 0 0 0 221 78,196 204,546 225,237 225,237 191,786 222,444 0 0 989 1,339 1,889 (550) 0 0 0 (550) (0.03) (0.03)
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