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 March 31, 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 April 30, 1998, there were 4,748,954 shares of Class A Common Stock, par
value $0.01 per share, and 15,792,588 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 March 31, 1998 and 1997 (Unaudited) 3
Condensed Consolidated Balance Sheets at March 31,
1998 (Unaudited) and December 31, 1997 4
Condensed Consolidated Statements of Cash Flows for the
Quarters Ended March 31, 1998 and 1997 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
PART II
OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 17
2
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
for the Quarters Ended March 31 (Unaudited)
(In thousands, except per share amounts)
1998 1997
-------- --------
Net revenues $ 71,762 $ 73,247
-------- --------
Costs and expenses
Cost of sales (61,760) (58,853)
Selling and administrative expenses (8,758) (9,727)
-------- --------
Total costs and expenses (70,518) (68,580)
-------- --------
Operating income 1,244 4,667
-------- --------
Nonoperating income (expense)
Investment income 34 17
Interest expense (215) (87)
Other, net (419) (193)
-------- --------
Total nonoperating expense (600) (263)
-------- --------
Income before income taxes 644 4,404
Income tax expense (584) (1,894)
-------- --------
Net income $ 60 $ 2,510
======== ========
Weighted average number of common shares outstanding
Basic 20,531 20,330
======== ========
Diluted 21,035 20,831
======== ========
Basic and diluted net income per common share $ 0.00 $ 0.12
======== ========
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of these statements.
3
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
March 31, Dec. 31,
1998 1997
---------- --------
Assets
Cash and cash equivalents $ 982 $ 947
Receivables, net of allowance for doubtful accounts of
$5,137 and $4,467, respectively 31,425 33,324
Inventories 25,703 25,376
Programming costs 41,708 41,504
Deferred subscription acquisition costs 13,000 12,143
Other current assets 9,941 11,910
-------- --------
Total current assets 122,759 125,204
-------- --------
Property and equipment, at cost 38,051 37,945
Accumulated depreciation (28,356) (27,892)
-------- --------
Property and equipment, net 9,695 10,053
-------- --------
Programming costs - noncurrent 9,953 8,329
Trademarks 15,288 14,978
Net deferred tax assets 13,519 13,688
Other noncurrent assets 14,252 13,695
-------- --------
Total assets $185,466 $185,947
======== ========
Liabilities
Short-term borrowings $ 14,500 $ 10,000
Accounts payable 24,911 32,258
Accrued salaries, wages and employee benefits 3,498 4,499
Reserves for losses on disposals of discontinued operations 610 610
Income taxes payable 516 627
Deferred revenues 47,065 43,216
Other liabilities and accrued expenses 6,913 7,706
-------- --------
Total current liabilities 98,013 98,916
Other noncurrent liabilities 8,575 8,348
-------- --------
Total liabilities 106,588 107,264
-------- --------
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; 17,098,582
and 17,076,518 issued, respectively 171 171
Capital in excess of par value 43,933 43,539
Retained earnings 45,317 45,257
Foreign currency translation adjustment (139) (131)
Unearned compensation restricted stock (3,780) (3,511)
Less cost of treasury stock (6,674) (6,692)
-------- --------
Total shareholders' equity 78,878 78,683
-------- --------
Total liabilities and shareholders' equity $185,466 $185,947
======== ========
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of these statements.
4
PLAYBOY ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Quarters Ended March 31 (Unaudited)
(In thousands)
1998 1997
-------- --------
Cash Flows From Operating Activities
Net income $ 60 $ 2,510
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Depreciation of property and equipment 478 576
Amortization of intangible assets 438 483
Amortization of investments in entertainment programming 4,702 4,919
Investments in entertainment programming (6,530) (7,446)
Net change in operating assets and liabilities (3,056) 7,416
Net cash used for discontinued operations - (19)
Other, net (3) (17)
------- -------
Net cash provided by (used for) operating activities (3,911) 8,422
------- -------
Cash Flows From Investing Activities
Additions to property and equipment (141) (139)
Acquisitions and funding of equity
interests in international ventures (572) (419)
Other, net 23 20
------- -------
Net cash used for investing activities (690) (538)
------- -------
Cash Flows From Financing Activities
Increase (decrease) in short-term borrowings 4,500 (7,000)
Proceeds from exercise of stock options 88 12
Proceeds from sales under employee stock purchase plan 48 44
------- -------
Net cash provided by (used for) financing activities 4,636 (6,944)
------- -------
Net increase in cash and cash equivalents 35 940
Cash and cash equivalents at beginning of period 947 1,061
------- -------
Cash and cash equivalents at end of period $ 982 $ 2,001
======= =======
The accompanying Notes to Condensed Consolidated Financial Statements
are an integral part of these statements.
5
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 (the "Transition Report") of Playboy
Enterprises, Inc. and its subsidiaries (the "Company").
(B) INCOME TAXES
The Company's net deferred tax asset declined to $13.8 million at March 31,
1998 based on taxable income for the current quarter 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 $13.8 million and $14.0 million net deferred tax assets included in the
Condensed Consolidated Balance Sheets at March 31, 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.
6
(C) INCOME 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)
Quarters Ended
March 31,
---------
1998 1997
----------------------------------------------------------------------
Numerator:
For basic and diluted EPS--net income
available to common shareholders $ 60 $ 2,510
======================================================================
Denominator:
Denominator for basic EPS--
weighted-average shares 20,531 20,330
----------------------------------------------------------------------
Effect of dilutive potential common shares:
Stock options 504 376
Nonvested restricted stock awards - 125
----------------------------------------------------------------------
Dilutive potential common shares 504 501
----------------------------------------------------------------------
Denominator for diluted EPS--
adjusted weighted-average shares 21,035 20,831
======================================================================
Basic and diluted EPS
Net income $ 0.00 $ 0.12
======================================================================
During the quarter ended March 31, 1998, approximately 340,000 weighted-
average shares of Class B restricted stock awards outstanding were not
included in the computation of diluted EPS as the operating income
objectives applicable to these restricted awards were not met during that
period.
(D) INVENTORIES
Inventories, which are stated at the lower of cost (average cost and
specific cost) or market, consisted of the following (in thousands):
(Unaudited)
March 31, Dec. 31,
1998 1997
---- ----
Paper $ 9,415 $ 7,573
Editorial and other prepublication costs 5,690 6,002
Merchandise finished goods 10,598 11,801
------- -------
Total inventories $25,703 $25,376
======= =======
(E) TREASURY STOCK
Treasury stock consisted of 293,427 Class A common shares and 970,716 Class
B common shares at March 31, 1998. At December 31, 1997, treasury stock
consisted of 293,427 Class A common shares and 974,227 Class B common
shares.
7
(F) 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, apparently 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 March 31,
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.
(G) SUBSEQUENT EVENT
On April 20, 1998, the Company and Spice Entertainment Companies, Inc.
("Spice"), a competitor in the adult movie service industry, announced that
they had modified the terms of their February 4, 1998 agreement whereby the
Company will acquire all of the outstanding shares of Spice, subject to the
satisfactory completion of the items discussed below. For each share of
Spice stock, shareholders will receive the sum of $3.60 in cash and
approximately 0.1371 shares of the Company's Class B stock. The total
transaction value, including the assumption of debt, is expected to be
approximately $100 million (subject to a collar designed to provide a
minimum value of $2.20 or a maximum value of $2.88 per Spice share). It is
expected that the acquisition will be accounted for under the purchase
method of accounting. The Company expects to initially finance the cash
portion of the purchase price through a new bank credit agreement.
Under the terms of the agreement, Spice's shareholders will retain
ownership of Spice's digital operations center, its option to acquire the
outstanding stock of Emerald Media, Inc., a provider of adult entertainment
in the C-Band market, and certain rights to a library of adult films.
Spice's domestic networks, Spice and Adam & Eve, reached approximately 22.4
million households at December 31, 1997 and reported revenues of $33.6
million for the 12 months ended December 31, 1997.
Consummation of the proposed transaction is subject to definitive
documentation, approval by the shareholders of Spice, receipt of a fairness
opinion by Spice and other customary closing conditions. The waiting period
under the Hart-Scott Rodino Antitrust Improvements Act has expired. Closing
of the transaction is expected to occur during the third quarter of
calendar year 1998, however, there is no assurance that any definitive
agreement regarding the sale of Spice will be reached or that the
transaction will be completed.
8
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 decreased 2% to $71.8 for the quarter ended March
31, 1998 compared to $73.2 for the quarter ended March 31, 1997 (the "prior year
quarter"). The decrease was primarily as a result of lower Publishing Group
revenues as well as lower revenues from the Entertainment Group as higher
revenues from Playboy TV were more than offset by a guarantee recognized in the
prior year quarter related to domestic home video backlist titles.
The Company reported operating income of $1.2 for the quarter ended March
31, 1998 compared to $4.7 in the prior year quarter. The decrease was primarily
due to lower operating income for the Publishing and Entertainment Groups.
Net income for the quarter ended March 31, 1998 was $0.1, or basic and
diluted EPS of $0.00, compared to $2.5, or basic and diluted EPS of $0.12, for
the prior year quarter.
Net income for the quarter ended March 31, 1998, adjusted to eliminate
federal income tax expense that will not be paid due to the Company's net
operating loss and tax credit carryforwards, was $0.2, or basic and diluted EPS
of $0.01, compared to $3.8, or basic EPS of $0.19 and diluted EPS of $0.18, for
the prior year quarter.
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
sales to international customers, particularly on a tier basis.
Publishing Group
The revenues and operating income of the Publishing Group were as follows
for the periods indicated below:
Quarters Ended
March 31,
--------------
1998 1997
----- -----
Revenues
Playboy Magazine................................................ $24.0 $24.3
Other Domestic Publishing....................................... 3.8 5.1
International Publishing........................................ 2.2 2.4
----- -----
Total Revenues.............................................. $30.0 $31.8
===== =====
Operating Income................................................ $ 0.1 $ 1.6
===== =====
Publishing Group revenues decreased $1.8, or 5%, for the quarter ended
March 31, 1998 compared to the prior year quarter largely due to lower revenues
from newsstand specials.
For the quarter ended March 31, 1998, Playboy magazine revenues declined
$0.3, or 1%, compared to the prior year quarter. Advertising revenues were $0.8,
or 11%, lower primarily due to 12% fewer ad pages in the current year quarter.
Advertising sales for the calendar year 1998 second quarter issues of the
magazine are closed, and the Company expects to report 5% fewer ad pages and 4%
lower ad revenues compared to the quarter ended June 30, 1997. Playboy magazine
circulation revenues remained relatively stable for the quarter ended March 31,
1998 as higher subscription revenues were basically offset by lower newsstand
revenues. Subscription revenues were $1.2, or 9%, higher largely due to more
subscription copies served while newsstand revenues were $1.3, or 30%, lower
principally as the result of 26% fewer U.S. and Canadian newsstand copies sold
in the current year quarter. The lower newsstand
9
revenues are due in part to the consolidation taking place nationally in the
single-copy magazine distribution system which the Company expects will continue
to adversely affect newsstand revenues. Licensing revenues of $0.5 favorably
impacted the current year quarter.
Revenues from other domestic publishing businesses decreased $1.3, or 24%,
compared to the prior year quarter primarily due to lower revenues from
newsstand specials principally due to fewer copies sold in the current year
quarter.
International publishing revenues decreased $0.2, or 6%, compared to the
prior year quarter primarily due to lower royalties from Russia and Taiwan,
partially offset by higher royalties from Brazil.
For the quarter ended March 31, 1998, Publishing Group operating income
decreased $1.5, or 91%, compared to the prior year quarter primarily due to the
net decrease in revenues discussed above. Operating income is expected to be
materially adversely impacted later in calendar year 1998 due to a 7% paper
price increase effective January 1, 1998. As a result of the timing of
production schedules and paper inventory levels, this increase did not impact
the group's results for the quarter ended March 31, 1998.
Entertainment Group
The revenues and operating income of the Entertainment Group were as
follows for the periods indicated below:
Quarters Ended
March 31,
--------------
1998 1997
----- -----
Revenues
Playboy TV
Cable....................................................... $ 5.4 $ 5.7
Satellite Direct-to-Home.................................... 7.9 6.1
Off-Network Productions and Other........................... 0.2 0.2
----- -----
Total Playboy TV................................................ 13.5 12.0
Domestic Home Video............................................. 1.5 3.2
International TV and Home Video................................. 1.7 2.3
----- -----
Total Playboy Businesses........................................ 16.7 17.5
AdulTVision..................................................... 1.4 1.1
Movies and Other................................................ 0.2 0.6
----- -----
Total Revenues.............................................. $18.3 $19.2
===== =====
Operating Income
Profit Contribution Before Playboy Businesses
Programming Expense............................................ $ 9.4 $10.7
Playboy Businesses Programming Expense.......................... (4.5) (4.5)
----- -----
Total Operating Income...................................... $ 4.9 $ 6.2
===== =====
The following discussion focuses on the profit contribution of each Playboy
business before Playboy businesses programming expense ("profit contribution").
Playboy TV
For the quarter ended March 31, 1998, revenues of $13.5 from the Company's
branded domestic pay television service, Playboy TV, were $1.5, or 12%, higher
compared to the prior year quarter.
Cable revenues were $0.3, or 7%, lower compared to the prior year quarter
largely due to the estimated negative effect of the enforcement of Section 505
of the Telecommunications Act of 1996 (the "Telecommunications Act"), including
a decline in the average number of subscribing households due to some system
drops, partially offset by higher retail rates. At March 31, 1998, Playboy TV
was available to approximately 11.3 million cable addressable households, a 3%
increase compared to March 31, 1997. Of the 11.3 million cable addressable
households, only an estimated 2.3 million could receive Playboy TV on a 24-hour
basis, a 2.6 million, or 53%, decrease compared to March 31, 1997. The drop in
households with 24-hour availability began in the fourth quarter of fiscal year
1997 concurrent with enforcement of Section 505 of the Telecommunications Act
("Section 505"). The number of total cable addressable households to which
Playboy TV was available at March 31, 1998 decreased 3% from December 31, 1997,
while households with 24-hour availability increased 0.3 million, or 15%, over
the same period.
10
Management believes that the Company's revenues attributable to its
domestic pay television cable services will 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, and approximately $25 (at
present value at 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. A decision is expected by summer
1998. There can be no assurance that the Delaware District Court will grant such
an injunction. 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" announced in fiscal year 1995 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, has constrained the
expected increase in channel capacity. Management believes that growth will
continue to be affected in the near term until digital technology (which is
unaffected by Section 505) becomes more available. Ultimately, the Company
believes that its pay television networks will be available to the vast majority
of cable households on a 24-hour basis.
Higher satellite direct-to-home ("DTH") revenues more than offset the cable
decline and were $1.8, or 30%, higher for the quarter ended March 31, 1998
primarily due to significant increases in addressable universes for DirecTV and
PrimeStar and, beginning in March 1997, the availability of monthly
subscriptions through PrimeStar. DTH is unaffected by Section 505. As expected,
revenues from TVRO, or the big-dish market, continued to decline. Playboy TV was
available to approximately 8.4 million DTH households, including approximately
275,000 monthly subscribers, at March 31, 1998, an increase of 40% and 24%
compared to March 31, 1997 and December 31, 1997, respectively.
Profit contribution for Playboy TV increased $0.7 for the quarter ended
March 31, 1998 primarily due to the net increase in revenues discussed above,
partially offset by favorable music licensing settlements in the prior year
quarter.
Domestic Home Video
Domestic home video revenues and profit contribution decreased $1.7 and
$1.6, respectively, for the quarter ended March 31, 1998 compared to the prior
year quarter. These decreases were primarily due to a guarantee recorded in the
prior year quarter related to the final year of a three-year backlist
distribution agreement with Universal Music & Video Distribution that was
extended through June 1998. The Company is currently in negotiations for a new
distribution agreement which it anticipates executing in the second quarter.
International TV and Home Video
For the quarter ended March 31, 1998, revenues and profit contribution from
the international TV and home video business decreased $0.6 and $0.7,
respectively, compared to the prior year quarter. These decreases were largely
due to lower international home video sales to Taiwan, primarily as a result of
poor economic conditions in that country. Variations in quarterly performance
are caused by revenues and profit contribution from the recognition of tier
sales 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 was flat for the quarter ended March 31, 1998
compared to the prior year quarter.
11
AdulTVision
AdulTVision revenues increased $0.3, or 25%, for the quarter ended March
31, 1998 compared to the prior year quarter primarily due to higher revenues
from the domestic network principally due to an increase in the addressable
universe, despite the estimated negative effect of the enforcement of Section
505 as previously discussed. At March 31, 1998, the network was available
domestically to approximately 7.7 million cable addressable and DTH households,
a 57% and 31% increase from March 31, 1997 and December 31, 1997, respectively.
AdulTVision is also available internationally. For the quarter ended March 31,
1998, operating income increased $0.1 as the higher revenues were largely offset
by higher marketing costs.
Movies and Other
For the quarter ended March 31, 1998, revenues and operating income from
movies and other businesses decreased $0.4 and $0.1, respectively, primarily due
to lower revenues related to feature films. The Entertainment Group's
administrative expenses for the quarter ended March 31, 1998 decreased $0.3
compared to the prior year quarter primarily due to lower performance-related
variable compensation expense.
Product Marketing Group
The revenues and operating income of the Product Marketing Group were as
follows for the periods indicated below:
Quarters Ended
March 31,
--------------
1998 1997
----- -----
Revenues........................................................ $ 2.6 $ 2.0
===== =====
Operating Income................................................ $ 0.7 $ 0.9
===== =====
Revenues for the quarter ended March 31, 1998 increased $0.6, or 29%,
compared to the prior year quarter. The increase was primarily due to 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 by lower international product licensing royalties,
principally from China.
Operating income of $0.7 for the quarter ended March 31, 1998 decreased
$0.2, or 26%, compared to the prior year quarter primarily due to the lower
international royalties. The higher SEL revenues were mostly offset by higher
associated costs.
Catalog Group
The revenues and operating income of the Catalog Group were as follows for
the periods indicated below:
Quarters Ended
March 31,
--------------
1998 1997
----- -----
Revenues........................................................ $19.4 $19.5
===== =====
Operating Income................................................ $ 1.0 $ 1.2
===== =====
For the quarter ended March 31, 1998, revenues of the Catalog Group were
relatively stable compared to the prior year quarter as higher revenues from the
Collectors' Choice Music catalog, primarily attributable to higher circulation,
were offset by lower revenues from the Critics' Choice Video catalog. Critics'
Choice Video was favorably impacted by sales in the current year quarter from
the The Big Book of Movies catalog first available in October 1997, however
these sales were more than offset by lower circulation and lower response rates.
Catalog Group operating income decreased $0.2, or 10%, for the quarter
ended March 31, 1998 compared to the prior year quarter primarily due to
slightly higher costs.
12
Casino Gaming Group
The Company anticipates the opening of the Playboy Casino and Beach Hotel
in Rhodes, Greece in calendar year 1998. The Company is also exploring
additional casino gaming opportunities. Expenses of $0.2 were incurred in the
quarter ended March 31, 1998 principally related to executive staffing.
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 now
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 from all of the Company's online catalog offerings. The revenues
and operating loss of the Playboy Online Group were as follows for the periods
indicated below:
Quarters Ended
March 31,
--------------
1998 1997
----- -----
Revenues........................................................ $ 1.4 $ 0.8
===== =====
Operating Loss.................................................. $(0.7) $ -
===== =====
For the quarter ended March 31, 1998, Playboy Online Group revenues
increased $0.6, or 84%, compared to the prior year quarter primarily due to
subscription revenues in the current year quarter related to Playboy Cyber Club,
which launched in the summer of 1997. Additionally, e-commerce revenues
increased compared to the prior year quarter primarily due to the launches of
CCMusic and CCVideo, online versions of the Collectors' Choice Music and
Critics' Choice Video catalogs, in the summer and fall of 1997, respectively.
For the quarter ended March 31, 1998, the Playboy Online Group reported an
operating loss of $0.7 compared to breakeven results in the prior year quarter.
The current year quarter included higher planned investments related to the
group's continued growth and development.
Corporate Administration and Promotion
Corporate administration and promotion expense of $4.6 for the quarter
ended March 31, 1998 decreased $0.6, or 11%, compared to the prior year quarter
primarily due to performance-related variable compensation expense and higher
investment spending on corporate marketing in the prior year quarter. Partially
offsetting the above were higher executive compensation expenses in the current
year quarter due in part to filling the chief financial officer position in May
1997.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998, the Company had $1.0 in cash and cash equivalents and
$14.5 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
meet its short- and long-term cash requirements through its revolving credit
agreement and cash generated from operations.
Cash Flows From Operating Activities
Net cash used for operating activities was $3.9 for the quarter ended March
31, 1998 compared to net cash provided of $8.4 for the prior year quarter. Cash
used for operating assets and liabilities was $3.1 in the current year quarter
compared to cash provided of $7.4 in the prior year quarter. Cash used for
accounts payable increased $5.7 in the current year quarter primarily due to the
timing of payments for the Critics' Choice Video catalog and Entertainment Group
profit participation. Additionally, cash used for accrued employee costs was
$1.0 in the current year quarter compared to cash provided of $2.4 in the prior
year quarter largely due to the Company's change in fiscal year end. The Company
invested $6.5 in Company-produced and licensed entertainment programming during
the current year quarter compared to $7.4 in the prior year quarter, and expects
to invest approximately $24.8 in such programming during the remainder of
calendar year 1998.
13
Cash Flows From Investing Activities
Net cash used for investing activities was $0.7 for the quarter ended March
31, 1998 compared to $0.5 in the prior year quarter.
Cash Flows From Financing Activities
Net cash provided by financing activities was $4.6 for the quarter ended
March 31, 1998 compared to net cash used of $6.9 for the prior year quarter.
This increase was principally due to a $4.5 increase in the level of short-term
borrowings under the Company's revolving line of credit in the current year
quarter to finance ongoing operations, compared to a $7.0 decrease in the level
of short-term borrowings in the prior year quarter.
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 $13.8 at March 31, 1998 based on taxable income for the
current quarter 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:
. 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.
. The Company continues to generate meaningful earnings, particularly from
the Entertainment Group, and the Company's substantial investments in this
group 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, apparently 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 March
31, 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 International Corporation, an Ontario,
Canada corporation ("BrandsElite"), 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, alleges 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 disputes strongly
BrandsElite's allegation that as a result of the
14
Company's breach, BrandsElite has suffered millions of dollars of damages in
future lost profits and diminished value of its stock. BrandsElite also seeks to
recoup out-of-pocket expenses, fees and costs incurred in bringing the action.
The license agreement provides 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. The action is in discovery and
is likely to go to trial during calendar year 1998. 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 assert
future lost profits damages ranging from $3.5 to $12.5.
In response to the Year 2000 issue, 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 issue 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 early
estimate of the total costs associated with the required modifications and
conversions are expected to be approximately $2.0, of which approximately $1.0
is expected to be expensed in calendar year 1998. These costs are being expensed
as incurred.
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 such technology by the cable and
satellite industries that 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, and (6) the
effects of the consolidation taking place nationally in the single-copy magazine
distribution system.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required as the Company's market capitalization was less than $2.5
billion as of January 28, 1997.
15
LEGAL PROCEEDINGS
In February 1996, Congress passed the Telecommunications Act, and President
Clinton signed it into law. 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, whether or not customers request it or need it, to prevent any
possibility of bleeding, or to restrict the period during which the 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 United States Supreme
Court (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 will 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 (at present value at 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. A decision is
expected by summer 1998. There can be no assurance that the Delaware District
Court will grant such an injunction.
On December 18, 1995, BrandsElite 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, alleges 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 disputes strongly BrandsElite's allegation that as a result of the Company's
breach, BrandsElite has suffered millions of dollars of damages in future lost
profits and diminished value of its stock. BrandsElite also seeks to recoup out-
of-pocket expenses, fees and costs incurred in bringing the action. The license
agreement provides 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. The action is in discovery and is likely to go
to trial during calendar year 1998. 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 assert future lost profits
damages ranging from $3.5 million to $12.5 million.
16
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
- ------ -----------
3 Composite bylaws of the Company (as amended)
#10.1 DBS License Agreement dated April 1, 1997 between Playboy
Entertainment Group, Inc. and PrimeStar Partners, L.P. regarding the
satellite distribution of Playboy TV or any other service mark that
retains a Playboy Mark
10.2 Playboy Mansion West Lease Agreement, as amended, between Playboy
Enterprises, Inc. and Hugh M. Hefner
a Amendment to June 1, 1979 lease dated January 12, 1998
10.3 Chicago Office Lease Documents
a Fifth Amendment to April 7, 1988 lease dated March 19, 1998
27 Financial Data Schedule
- ----------
# Certain information omitted pursuant to a request for confidential
treatment filed separately with the Securities and Exchange Commission
(b) Reports on Form 8-K
During the quarter ended March 31, 1998, the Company filed a Current Report
on Form 8-K dated February 4, 1998 under Item 5 of such report. The purpose
of this report was for the Company and Spice to announce an agreement
whereby the Company will acquire all of the outstanding shares of Spice,
subject to the satisfactory completion of various items.
17
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 May 12, 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)
18