1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[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: 1-6739
SPELLING ENTERTAINMENT GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 59-0862100
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
5700 WILSHIRE BOULEVARD
LOS ANGELES, CALIFORNIA 90036
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (213) 965-5700
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 [ ]
On May 11, 1998, the registrant had outstanding 92,413,124 shares of Common
Stock, $.001 par value.
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SPELLING ENTERTAINMENT GROUP INC.
PART I. FINANCIAL INFORMATION
PAGE
----
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets -
March 31, 1998 and December 31, 1997 (Unaudited) 3
Condensed Consolidated Statements of
Operations - Three Months Ended
March 31, 1998 and 1997 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows -
Three Months Ended March 31, 1998 and 1997 (Unaudited) 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 14
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 21
2
3
SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
March 31, December 31,
1998 1997
--------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,446 $ 860
Accounts receivable, net 129,032 104,150
Entertainment product, net 221,413 246,955
Other current assets 4,965 4,372
--------- ---------
TOTAL CURRENT ASSETS 362,856 356,337
Accounts receivable, net 90,149 90,593
Entertainment product, net 138,699 127,901
Property and equipment, net 10,754 11,409
Intangible assets, net 185,949 187,320
Other noncurrent assets 20 20
--------- ---------
$ 788,427 $ 773,580
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable, accrued expenses and other liabilities $ 43,756 $ 34,691
Accrued participation expense 71,894 59,490
Deferred revenue 22,222 15,430
Income and other taxes 3,841 4,103
--------- ---------
TOTAL CURRENT LIABILITIES 141,713 113,714
Accrued participation expense 42,373 48,159
Long-term debt payable to Viacom 262,000 289,000
Deferred income and other taxes 27,405 25,245
Net liabilities related to discontinued operations of VIE 26,745 21,909
Net liabilities related to discontinued operations of Charter 3,595 4,535
--------- ---------
503,831 502,562
--------- ---------
Commitments and contingent liabilities
SHAREHOLDERS' EQUITY
Preferred Stock -- --
Common Stock, $.001 par value,
- 300,000,000 shares authorized
- 92,399,999 and 90,987,329 shares issued and outstanding 92 91
Capital in excess of par value 588,585 578,704
Accumulated deficit (311,741) (313,355)
Accumulated other comprehensive income 7,660 5,578
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 284,596 271,018
--------- ---------
$ 788,427 $ 773,580
========= =========
The accompanying notes are an integral part of these statements.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended March 31,
----------------------------
1998 1997
--------- ---------
Revenue $ 167,425 $ 166,503
Costs and expenses:
Entertainment product costs 123,970 141,152
Selling, general and administrative 13,286 14,987
Provision for closure of film division 20,000 --
--------- ---------
Operating income 10,169 10,364
Interest income 443 240
Interest expense, net (5,444) (4,889)
Other, net (49) (1)
--------- ---------
Income from continuing operations
before income taxes 5,119 5,714
Provision for income taxes 3,505 4,986
--------- ---------
Net income $ 1,614 $ 728
========= =========
Weighted average number of common shares:
Basic 91,740 90,720
Diluted 92,723 90,755
Net income per common share:
Basic $ 0.02 $ 0.01
Diluted $ 0.02 $ 0.01
The accompanying notes are an integral part of these statements.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Three Months Ended March 31,
----------------------------
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,614 $ 728
Adjustments to reconcile net income to cash flows
from continuing operations:
Depreciation and amortization 2,349 2,178
Provision for closure of film division 20,000 --
Amortization of entertainment product costs 103,683 118,982
Additions to entertainment product costs (102,783) (108,292)
Increase in accounts receivable (24,210) (34,777)
Increase (decrease) in accounts payable, accrued expense,
other liabilities and income taxes 2,842 (2,069)
Increase in accrued participation expense 8,369 10,338
Increase (decrease) in deferred revenue 6,793 (906)
Other, net (538) (727)
--------- ---------
Net cash provided (used) by continuing operations 18,119 (14,545)
Net cash provided by discontinued operations 7,331 11,360
--------- ---------
25,450 (3,185)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (323) (597)
Repayments by discontinued operations of VIE 6,892 12,684
Changes in net liabilities related to
discontinued operations of Charter (940) 1,570
--------- ---------
Net cash provided by continuing operations 5,629 13,657
Net cash used by discontinued operations (221) (1,068)
--------- ---------
5,408 12,589
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under credit facilities 16,000 23,000
Repayments of credit facilities (43,000) (24,000)
Issuances of Common Stock 9,838 4
--------- ---------
Net cash used by continuing operations (17,162) (996)
Net cash used by discontinued operations (8,316) (19,009)
--------- ---------
(25,478) (20,005)
--------- ---------
Net increase (decrease) in cash and cash equivalents 5,380 (10,601)
Cash and cash equivalents at beginning of period 10,113 16,175
--------- ---------
Cash and cash equivalents at end of period $ 15,493 $ 5,574
========= =========
Cash and cash equivalents at end of period:
Continuing operations $ 7,446 $ 1,441
Discontinued operations 8,047 4,133
--------- ---------
$ 15,493 $ 5,574
========= =========
The accompanying notes are an integral part of these statements
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
1. INTERIM FINANCIAL STATEMENTS
The accompanying unaudited condensed consolidated financial statements of
Spelling Entertainment Group Inc. and subsidiaries (the "Company") have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). The Company believes that the disclosures contained herein
are adequate to make the information presented not misleading; however, these
unaudited condensed consolidated financial statements should be read in
conjunction with the more detailed financial statements and notes thereto
included in the Company's most recent Annual Report on Form 10-K.
The financial statements reflect, in the opinion of management, all normal
recurring adjustments necessary to present fairly the Company's financial
position and results of operations. In order to maintain consistency and
comparability between periods presented, certain amounts have been reclassified
from the previously reported financial statements in order to conform with the
financial statement presentation in the current period.
Viacom Inc. ("Viacom") currently owns approximately 80% of the Company's common
stock ("Common Stock"). (See Note 5 regarding the Company's agreement with
Viacom regarding tax reporting and administrative matters).
On July 30, 1994, the Company acquired approximately 91% of the ordinary shares
("Ordinary Shares") of Virgin Interactive Entertainment Limited ("VIEL") and
also entered into put- and call-option agreements with respect to the Ordinary
Shares of VIEL not owned by the Company and currently owned by Viacom. Viacom
and the Company have executed amendments to extend the put- and call-option
agreements, which were originally scheduled to expire in July 1995, through June
30, 1998. (See Note 9 regarding the planned disposition of VIEL (together with
its subsidiaries, "VIE")).
In February 1998, the Company announced its intention to exit the feature film
business and close Spelling Films Inc. ("Spelling Films"). The Company recorded
a charge of approximately $20,000,000, including the write-down to estimated net
realizable value of capitalized development projects which will be sold or
abandoned, reserves for commitments to various talent, as well as severance
costs related to Spelling Films' employees. As of March 31, 1998, the remaining
accrual balance for this provision of $6,582,000 is included in accounts
payable, accrued expenses and other liabilities in the accompanying balance
sheet.
2. ENTERTAINMENT PRODUCT, NET
Entertainment product, net, includes development, production or acquisition
costs (including advance payments to producers), capitalized overhead and
interest, home video manufacturing costs, and prints, advertising and other
related distribution costs expected to benefit future periods. These costs are
amortized, and third-party participations and residuals are accrued, generally
on an individual product basis in the ratio that current year gross revenue
bears to estimated future gross revenue. Domestic
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
syndication and basic cable revenue estimates are not included in estimated
future gross revenue of television programming until such sales are probable.
Entertainment product, net, is stated at the lower of cost less amortization or
estimated net realizable value. Estimates of total gross revenue, costs and
participations are reviewed quarterly and revised as necessary. When estimates
of total revenue and costs indicate that an individual product will realize an
ultimate loss, additional amortization is provided to fully recognize such loss
in that period.
Entertainment product, net, is comprised of the following:
March 31, December 31,
1998 1997
--------- -----------
Entertainment product:
Theatrical
Released $ 135,750 $ 147,301
In process and other 2,207 12,607
--------- ---------
137,957 159,908
--------- ---------
Television
Released 191,039 189,624
In process and other 31,116 25,324
--------- ---------
222,155 214,948
--------- ---------
Total 360,112 374,856
Less: non-current portion (138,699) (127,901)
--------- ---------
Current portion $ 221,413 $ 246,955
========= =========
3. DEBT
On September 30, 1996, the Company and Viacom executed a credit agreement (the
"Viacom Credit Agreement") which replaced its previous credit agreement with
Viacom. The Viacom Credit Agreement provides for (i) a term loan of $200,000,000
and (ii) a revolving credit facility of $155,000,000 to fund the Company's
working capital and other requirements. All outstanding borrowings under the
Viacom Credit Agreement mature on December 31, 1999.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
Under the Viacom Credit Agreement, the Company pays an annual fee (currently
0.375%) based on the unused portion of the facility, as well as certain facility
and administration fees. Effective as of October 1, 1996, interest on all
outstanding borrowings is payable, at the Company's option, at LIBOR plus a
spread based on the Company's leverage ratio, as defined (currently 2.5%), or at
Citibank N.A.'s base rate. The average interest rate at March 31, 1998 and
December 31, 1997, on borrowings under the Viacom Credit Agreement, was 8.2% and
8.5%, respectively. Additional terms of the Viacom Credit Agreement require,
among other items, a minimum amount of net worth, as defined. Borrowings under
the Viacom Credit Agreement are secured by all of the assets of the Company and
its domestic subsidiaries and the entire amount outstanding under the Viacom
Credit Agreement may be accelerated if Viacom's borrowings under its separate
credit facilities were to be accelerated. At March 31, 1998, the carrying value
of all of the Company's debt approximated fair value.
See Note 9 regarding debt related to discontinued operations.
4. SHAREHOLDERS' EQUITY
The following is a summary of the changes in the components of shareholders'
equity:
Accumulated
Capital In Other
Common Excess of Accumulated Comprehensive
Stock Par Value Deficit Income Total
--------- --------- ----------- ------------- ---------
Balance at December 31, 1997 $ 91 $ 578,704 $(313,355) $ 5,578 $ 271,018
Exercise of options and warrants 1 9,837 -- -- 9,838
Income tax benefit
related to stock options -- 44 -- -- 44
Net income for the period -- -- 1,614 -- 1,614
Unrealized holding gain, net -- -- -- 3,828 3,828
Cumulative translation adjustment -- -- -- (1,746) (1,746)
--------- --------- --------- --------- ---------
Balance at March 31, 1998 $ 92 $ 588,585 $(311,741) $ 7,660 $ 284,596
========= ========= ========= ========= =========
In February 1998, Viacom exercised warrants to acquire 1,337,148 shares of
Common Stock for a total exercise price of approximately $9,316,000.
Included in net liabilities related to discontinued operations of VIE at March
31, 1998 and December 31, 1997, is a common stock investment at a carrying value
(fair value) of $20,444,000 and $16,611,000, respectively.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
The Company has accounted for this common stock investment as an "available for
sale" security under the applicable provisions of Statement of Financial
Accounting Standards ("SFAS") No. 115, adjusting the carrying value to fair
market value, with a corresponding adjustment, net of tax, to shareholders'
equity.
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," effective
January 1, 1998. Total comprehensive income (loss) for the quarters ended March
31, 1998 and 1997 was $3,696,000 and $(4,122,000), respectively. Total
comprehensive income (loss) is comprised of net income and other comprehensive
income items, including foreign currency translation adjustments and unrealized
holding gains on securities.
5. INCOME TAXES
Income taxes have been provided in each period based on the Company's expected
effective income tax rate.
Viacom has acquired approximately 80% of the outstanding shares of the Company
and, therefore, the Company is required to be included in the consolidated
federal income tax return of Viacom. The Company and Viacom are party to an
agreement that provides for the administration of federal, state and foreign tax
matters (the "Tax Agreement"). Under the Tax Agreement, the Company will remain
in the same tax position as it would have if it were continuing to file its tax
returns separate and apart from Viacom. As a result, the Company does not
anticipate any material impact to its consolidated financial condition or
results of operations.
6. NET INCOME PER COMMON SHARE
Basic income per common share amounts are based on the weighted average number
of common shares outstanding during the respective periods. Diluted income per
common share amounts are based on the weighted average common shares outstanding
during the period and shares assumed issued upon conversion of stock options and
warrants when the effect of such conversions would have been dilutive to income
from continuing operations.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
Prior period amounts have been restated to conform to SFAS No. 128. The table
below presents a reconciliation of weighted average shares used in the
calculation of basic and diluted income per common share:
March 31,
1998 1997
------ ------
Basic shares - weighted average
of common shares outstanding 91,740 90,720
Additional shares assuming conversions
of stock options and warrants 983 35
------ ------
Diluted shares 92,723 90,755
====== ======
7. LEGAL MATTERS
The Company is subject to various lawsuits, claims and other legal matters in
the course of conducting its entertainment business operations. The Company
believes such lawsuits, claims and other legal matters should not have a
material adverse effect on the Company's consolidated results of operations or
financial condition.
The Company also is involved in a number of legal actions including threatened
claims, pending lawsuits and contract disputes in connection with certain
bankruptcy and environmental matters relating to the Company's discontinued
operations of Charter, as well as other matters. Some of the parties involved in
such actions seek significant damages. While the outcome of these suits and
claims cannot be predicted with certainty, based upon (i) its current knowledge
of the facts and circumstances and its understanding of the applicable law; (ii)
allowances for estimated losses on disposal of the discontinued operations; and
(iii) an indemnity agreement, the Company believes that the ultimate resolution
of such suits and claims will not have a material adverse effect on the
Company's consolidated results of operations or financial condition.
8. RELATED PARTY TRANSACTIONS
The Company was charged interest and fees by Viacom of $5,873,000 and $6,522,000
during the three months ended March 31, 1998 and 1997, respectively, in
connection with the Viacom Credit Agreement. Included in accounts payable,
accrued expenses and other liabilities is accrued interest payable to Viacom of
$1,584,000 and $568,000 as of March 31, 1998 and December 31, 1997,
respectively. See Note 3 regarding the Company's credit facilities with Viacom
and Note 9 regarding Viacom's guarantees of the Company's credit agreements with
banks.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
The Company participates in the Viacom insurance programs with respect to
general business and workers' compensation coverage. Effective January 1, 1998,
the Company also began participating in certain Viacom health and welfare
benefit plans for its employees. As of March 31, 1998, the Company had a net
payable to Viacom of approximately $1,306,000 with respect to these and other
expenses.
During the three months ended March 31, 1998 and 1997, the Company sold home
video product to several operating subsidiaries of Viacom International Inc., a
subsidiary of Viacom. Additionally, the Company licensed certain entertainment
product to the following parties in which Viacom has or had an ownership
interest (i) Showtime Networks Inc. ("Showtime"), a subsidiary of Viacom; (ii)
MTV Networks, a division of a subsidiary of Viacom; (iii) certain television
stations owned by Viacom; (iv) USA Network and Sci-Fi Channel, in which Viacom
had equity interests until October 1997; and (v) United Paramount Network,
Nickelodeon U.K. and Comedy Central, in which Viacom has equity interests. For
the three months ended March 31, 1998 and 1997, these transactions are not
material.
Republic Entertainment Inc. ("Republic") has entered into agreements with, and
in certain cases has advanced funds to Viacom, a partnership in which a
subsidiary of Viacom is the managing partner and Showtime to distribute certain
of their productions in the home video market.
The Company has entered into agreements with Paramount Pictures Corporation
("Paramount"), a Viacom subsidiary, with respect to the distribution of two of
the Company's feature film releases, "Night Falls on Manhattan" and "Stephen
King's Thinner," in the domestic theatrical, non-theatrical and pay television
markets. Additionally, the Company has entered into agreements with Paramount
for the production and funding of two additional feature films, "In & Out" and
"Breakdown," to which the Company owns the international distribution rights. In
August 1997, Republic entered into an agreement with Paramount and licensed its
domestic home video rights to seven 1997 rental titles, including "Night Falls
on Manhattan."
The Company has entered into an agreement with Comedy Partners, in which Viacom
has an equity interest, to perform certain licensing and merchandising
activities on its behalf in exchange for a fee.
In November 1997, the Company entered into an agreement with Famous Music
Corporation and Ensign Music Corporation, subsidiaries of Paramount, with
respect to administration of the Company's music rights.
In the ordinary course of business, the Company has and expects to continue to
do business with Viacom and its affiliates.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
9. DISCONTINUED OPERATIONS
On February 20, 1997, the Company announced its intention to dispose of its
interactive game business, VIE, and expects to complete a transaction in 1998.
Accordingly, the operations of VIE are reflected as discontinued.
VIE's net liabilities as of March 31, 1998 and December 31, 1997, are as
follows:
March 31, December 31,
1998 1997
--------- -----------
Current assets $ 69,943 $ 115,043
Current liabilities (169,212) (194,505)
--------- ---------
Net current liabilities (99,269) (79,462)
--------- ---------
Property and equipment, net 12,690 14,081
Intangibles, net 87,719 91,707
Other non-current assets 4,612 5,066
Non-current liabilities (32,497) (53,301)
--------- ---------
Net non-current assets 72,524 57,553
--------- ---------
Net liabilities $ (26,745) $ (21,909)
========= =========
During the year ended December 31, 1996, the Company provided for an estimated
loss on disposal of VIE of approximately $139,501,000, which included a
provision for future operating losses of approximately $56,000,000. In the
fourth quarter of 1997, the Company recorded an additional provision of
$40,000,000, net of income taxes, for future operating losses and cash funding
requirements projected for the remaining holding period through completion of
the disposition. For the three months ended March 31, 1998 and 1997, revenue of
VIE was $33,319,000 and $46,393,000, respectively. The net operating losses of
VIE were $19,306,000 and $15,199,000, respectively, for the same periods. The
net operating losses were provided for in the estimated loss on disposal as of
December 31, 1997 and 1996 discussed above.
On December 23, 1993, a wholly owned subsidiary of VIE established a
multi-currency credit agreement (the "Credit Agreement") with a bank in the U.S.
The Credit Agreement initially provided for maximum borrowings of $15,000,000,
subject to a borrowing base test. Following the Company's acquisition of VIE,
the amount of borrowings allowable under the Credit Agreement was increased to
$75,000,000 and the borrowing base test and other ratio tests were eliminated,
based on the guarantee of all borrowings under the Credit Agreement by Viacom.
During 1995, the borrowings allowable under the Credit
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
Agreement were increased to $100,000,000. In February 1998, the term was
extended to September 30, 1998. Interest is payable monthly at the bank's
reference rate or, at the Company's option, certain alternative rates.
Additionally, the Company must pay a commitment fee of 0.125% on the unused
portion of the available credit. Borrowings under the Credit Agreement as of
March 31, 1998 and December 31, 1997 were $97,000,000 and $97,472,000,
respectively. As of March 31, 1998 and December 31, 1997, the Company had no
letters of credit outstanding under the Credit Agreement.
On September 8, 1993, another wholly owned subsidiary of VIE established a
5,000,000 pounds sterling credit facility (the "UK Facility") with a bank in the
United Kingdom. On April 12, 1994, the UK Facility was increased to 10,000,000
pounds sterling, based in part on the personal guarantee of two of the directors
of the subsidiary. Following the acquisition of VIE, the Company guaranteed the
UK Facility and the guarantees of the two directors were terminated. Advances
under the UK Facility bear interest at the bank's prime rate plus 1.0%.
Effective as of April 3, 1997, the UK Facility was renegotiated on terms more
favorable to the subsidiary. The renegotiated UK Facility will expire on June
30, 1998 and is guaranteed by Viacom and the Company. Advances under the
renegotiated UK Facility bear interest at the bank's prime rate plus 1.0% or
alternatively at selected Eurocurrency rates. Borrowings under the UK Facility
as of March 31, 1998 and December 31, 1997 were $10,137,000 and $11,090,000,
respectively. As of March 31, 1998 and December 31, 1997, the Company had
approximately $157,000 and $938,000, respectively, in letters of credit
outstanding under the UK Facility to guarantee its interactive game purchases.
The Company and Viacom also provide a rent guarantee, which expires in 2005, for
this subsidiary.
Pursuant to the separate credit facilities under which Viacom is a borrower,
certain subsidiaries of Viacom, including the Company, are restricted from
incurring indebtedness (other than indebtedness owing to Viacom) without the
prior consent of Viacom's lenders. Such consent has been given with respect to
the Credit Agreement and the UK Facility.
10. SUBSEQUENT EVENTS
In April 1998, the Company sold TeleUNO, its Latin American entertainment
channel. The Company will reflect a gain from this transaction in the second
quarter.
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SPELLING ENTERTAINMENT GROUP INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
unaudited condensed consolidated financial statements and the related notes
thereto. References to Notes refer to the notes to such statements.
RESULTS OF OPERATIONS
The results of operations for any period are significantly affected by the
quantity and performance of the Company's entertainment product which is
licensed or sold to, and available for exhibition by, licensees or customers in
various media and territories. Consequently, results of operations may vary
significantly between periods, and the results of operations in any one period
may not be indicative of results of operations in future periods.
The success of the Company's television programming business depends, in part,
upon the successful network exhibition of its television series over a
sufficient number of years to allow for off-network exhibition opportunities.
During the initial years of a one-hour television series, network and
international license fees substantially offset the production costs of the
series, and accordingly the Company normally recognizes a loss during this
period. With respect to half-hour network programming, the production costs can
substantially exceed the combination of the network and international license
fees during the initial years and the Company normally recognizes larger losses
during this period. However, if a sufficient number of episodes of a one-hour or
half-hour series are produced, the Company is reasonably assured that it will
also be able to sell the series in the domestic off-network market, and the
Company would then expect to be able to recoup its deficits and realize a profit
with respect to these series.
First-run syndicated television series, which are sold on a cash basis, barter
basis or a combination of both, typically do not generate sufficient revenue to
cover the production and promotion costs of the programs during their initial
years and such financial risk is borne exclusively by the Company. However, with
strong ratings, the revenue which may be realized by the Company through its
cash license fees and barter arrangements can be significant.
The Company's business in general is affected by the public's acceptance of its
product, which is unpredictable and subject to change, and by conditions within
the entertainment industry, including, but not limited to, the quality and
availability of creative talent and the negotiation and renewal of union
contracts relating to writers, directors, actors, musicians and studio
technicians and craftsmen as well as any changes in the law and governmental
regulations. On September 6, 1995, the Federal Communications Commission
released an order repealing its rules which prohibited television networks from
acquiring financial interests and syndication rights in television programming
produced by program suppliers such as the Company. Accordingly, the networks are
able to own the programming which they broadcast and may increasingly become
competitors of the Company in the production and distribution of programming.
The Telecommunications Act of 1996 eliminates the restrictions on the number of
television stations that one entity may own and increases the national audience
reach
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SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
limitation by one entity from 25% to 35%, which serves to further increase the
broadcast networks' and major studios' ability to secure distribution for their
own product.
REVENUE
The following table sets forth the components of the Company's revenue for the
three months ended March 31 (in thousands):
1998 1997
-------- --------
Television $148,803 $139,866
Home video 6,823 18,124
Film distribution 6,715 4,297
Licensing and merchandising 3,527 3,426
Other 1,557 790
-------- --------
$167,425 $166,503
======== ========
Television revenue increased $8,937,000 (6%) in the three-month period ended
March 31, 1998, from the comparable period in 1997. The increase in the 1998
period arose primarily from (i) higher per episode network license fees for the
Company's continuing series; and (ii) higher revenue from exploitation of the
Company's library, including a significant sale of program rights.
Home video revenue decreased $11,301,000 (62%), in the three-month period ended
March 31, 1998, from the same period in 1997. The decrease in the three-month
period is due primarily to a decline in the number of initial releases during
the period, specifically in connection with the Company's decision to exit the
business of distributing video titles in the domestic rental market. The home
video market continues to be very competitive due to home video retailers
purchasing greater volumes of major theatrical film releases from the major
studios and lower volumes of made-for-video product, such as the Company's. It
is expected that this trend will continue, at least in the near term. The
Company has ceased to acquire made-for-video titles other than those for which
it had previously made contractual commitments. Further, in August of 1997, it
licensed its made-for-video titles scheduled for initial release during the
remainder of 1997, as well as "Night Falls on Manhattan," and eliminated the
sales infrastructure and other support functions specifically serving this
market.
Film distribution revenue increased $2,418,000 (56%) in the three-month period
ended March 31, 1998, compared to the same period in 1997. The increase in the
1998 period is due primarily
15
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
to the international theatrical releases of "Breakdown" and "In & Out" in
certain territories. The comparable release in the 1997 period was "Roseanna's
Grave." Film distribution revenue is expected to decrease significantly in the
future as a result of the Company's decision to exit the feature film business
in February 1998, and thus cease the production, acquisition and distribution of
new feature films.
Licensing and merchandising revenue remained consistent in the three-month
period ended March 31, 1998, compared to the same period in 1997. The decline in
the licensing revenue for "Beverly Hills, 90210" and "Melrose Place" was offset
by an overall increase in revenue from third-party clients.
Other revenue increased $767,000 (97%) in the three months ended March 31, 1998,
compared to the same period in 1997. This increase is due primarily to higher
music, airlines and promotional fee revenue in the 1998 period.
Certain operations of the Company generate revenue denominated in foreign
currencies, and as a result, fluctuations in foreign currency exchange rates may
affect operating results. In particular, the Company generates revenue
denominated in French francs, Canadian dollars and Mexican pesos, among others.
ENTERTAINMENT PRODUCT COSTS
Entertainment product costs consist primarily of the amortization of capitalized
product costs and the accrual of third-party participations and residuals. Such
costs decreased $17,182,000 (12%) in the quarter ended March 31, 1998, from the
comparable prior-year period. The decrease resulted primarily from the decrease
in the percentage relationship between such costs and the related revenue to 74%
from 85% for the three months ended March 31, 1998 and 1997, respectively. This
percentage relationship is a function of (i) the mix of entertainment product
generating the revenue in each period and (ii) changes in the projected
profitability of individual entertainment product based on the Company's
estimates of such product's ultimate revenue and costs. The Company recorded
write-downs to net realizable value with respect to its entertainment product of
$8,851,000 and $10,918,000 in the quarters ended March 31, 1998 and 1997,
respectively. The decrease in write-downs in the 1998 period is primarily
attributable to changes in the expected revenue from the domestic off-network
market for certain programs. This was partially offset by the domestic
performance of made-for-video feature films during the period, and the related
revisions to profitability estimates resulting in net realizable value
adjustments. Included were write-downs to net realizable value of $4,503,000 and
$3,123,000 in 1998 and 1997, respectively, related to theatrical and
made-for-video feature films.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative costs decreased $1,701,000 (11%) in the
quarter ended March 31, 1998, from the comparable prior-year period. The
decrease results primarily from the Company's decision in August 1997 to exit
the business of distributing video titles in the domestic rental market.
16
17
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
PROVISION FOR CLOSURE OF FILM DIVISION
Charges of approximately $20,000,000, of which approximately $14,400,000 are
non-cash, were recorded in the quarter ended March 31, 1998 related to the
Company's decision to exit the theatrical feature film business and close
Spelling Films Inc. ("Spelling Films"). These charges include the write-down to
estimated net realizable value of capitalized development projects which will be
sold or abandoned, reserves for commitments to various talent, as well as
severance costs related to Spelling Films' employees. As of March 31, 1998, the
remaining accrual balance for this provision of $6,582,000 is included in
accounts payable, accrued expenses and other liabilities in the balance sheet.
(See Note 1.)
INTEREST EXPENSE
Interest expense, net of amounts capitalized, increased $555,000 (11%) in the
three-month period ended March 31, 1998, due to (i) an increase in the weighted
average interest rate; and (ii) a decrease in capitalized interest associated
with the Company's theatrical production activities. This was partially offset
by lower average indebtedness outstanding under the Company's credit
arrangements.
PROVISION FOR INCOME TAXES
During the three months ended March 31, 1998, the Company's provision for income
taxes decreased $1,481,000 to a provision of $3,505,000 in 1998 as compared to a
provision of $4,986,000 in 1997, largely as a result of a decrease in the
effective tax rate. The effective tax rate decreased to 68% in 1998 from 87% in
1997, largely as a result of changes in the relationships between revenue and
expenses comprising income from continuing operations before income taxes.
Viacom has acquired approximately 80% of the outstanding shares of the Company
and, therefore, the Company is required to be included in the consolidated
federal income tax return of Viacom. The Company and Viacom are party to an
agreement that provides for the administration of federal, state and foreign tax
matters (the "Tax Agreement"). Under the Tax Agreement, the Company will remain
in the same tax position as it would have if it were continuing to file its tax
returns separate and apart from Viacom. As a result, the Company does not
anticipate any material impact to its consolidated financial condition or
results of operations.
17
18
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
DISCONTINUED OPERATIONS
On February 20, 1997, the Company announced its intention to dispose of its
interactive game business, VIE, and expects to complete a transaction in 1998.
Accordingly, VIE is presented as a discontinued operation in the accompanying
financial statements. See "Financial Condition - Discontinued Operations" below.
FINANCIAL CONDITION
CONTINUING OPERATIONS. The Company's continuing operations require significant
capital resources for the production of entertainment product and the
acquisition of distribution or other rights to entertainment product produced by
third parties. The Company's expenditures in this regard totaled $102,783,000
and $108,292,000 in the three months ended March 31, 1998 and 1997,
respectively.
Additionally, future expenditures by the Company are expected to increase from
1997 expenditures in conjunction with its projected production levels. The cost
of producing network television programming is largely funded through the
receipt of the related network license fees.
The deficit financing of its network programming and the cost of other
production and acquisition activities has historically been funded through the
Company's operating cash flow and borrowings under its credit arrangements. The
Company's principal credit agreement is with Viacom. The Viacom Credit Agreement
provides for a term loan facility of $200,000,000 and a revolving credit
facility of $155,000,000 to fund the Company's working capital and other
requirements. (See Note 3.)
The Company continues to explore opportunities for additional sources of
financing. No assurance can be given that the Company will obtain such
additional external financing.
The Company believes that its financial condition remains strong and that it has
the financial resources necessary to meet its anticipated capital requirements.
The Company expects to have sufficient resources available from the cash
provided by operating activities and that available under its credit facility
and other financing sources to meet its ongoing plans for the production,
acquisition and distribution of entertainment product and to take advantage of
internal and external development and growth opportunities. See Note 3 regarding
certain acceleration provisions of the Viacom Facility.
Net cash flow from operating activities of the Company's continuing operations
increased to $18,119,000 for the three months ended March 31, 1998 from negative
$14,545,000 for the comparable prior-year period due in significant part to
increased collections during the period. Net cash flow from investing activities
of the Company's continuing operations decreased to $5,629,000 from $13,657,000
for the three months ended March 31, 1998 and 1997, respectively. In the 1997
period the Company received $12,684,000 in repayment of advances by VIE,
compared to $6,892,000 in the 1998 period. Financing activities principally
reflect borrowings and repayments under the Viacom Credit Agreement in both
periods, and the exercise of warrants by Viacom in the first quarter of 1998.
(See Note 4.)
18
19
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
DISCONTINUED OPERATIONS. A wholly owned subsidiary of VIEL has a revolving
multi-currency credit agreement for $100,000,000 with a bank in the U.S.
Borrowings under the Credit Agreement as of March 31, 1998 and December 31, 1997
were $97,000,000 and $97,472,000, respectively. As of March 31, 1998 and
December 31, 1997, the Company had no letters of credit outstanding under the
Credit Agreement to guarantee its interactive game purchases. (See Note 9.)
Viacom has guaranteed all of the borrowings under the Credit Agreement, which
are due September 30, 1998.
Another wholly owned subsidiary of VIEL has a credit facility with a bank in the
United Kingdom in the net amount of 10,000,000 pounds sterling, which the
Company and Viacom have guaranteed. The UK Facility expires on June 30, 1998.
Borrowings under the UK Facility as of March 31, 1998 and December 31, 1997 were
$10,137,000 and $11,090,000, respectively. As of March 31, 1998 and December 31,
1997, the Company had approximately $157,000 and $938,000, respectively, in
letters of credit outstanding under the UK Facility to guarantee its interactive
game purchases. (See Note 9.)
VIE's net liabilities as of March 31, 1998 and December 31, 1997, are as follows
(in thousands):
March 31, December 31,
1998 1997
--------- ---------
Current assets $ 69,943 $ 115,043
Current liabilities (169,212) (194,505)
--------- ---------
Net current liabilities (99,269) (79,462)
--------- ---------
Property and equipment, net 12,690 14,081
Intangibles, net 87,719 91,707
Other non-current assets 4,612 5,066
Non-current liabilities (32,497) (53,301)
--------- ---------
Net non-current assets 72,524 57,553
--------- ---------
Net liabilities $ (26,745) $ (21,909)
========= =========
During the year ended December 31, 1996, the Company provided for an estimated
loss on disposal of VIE of approximately $139,501,000, which included a
provision for future operating losses of approximately $56,000,000. In the
fourth quarter of 1997, the Company recorded an additional provision of
$40,000,000, net of income taxes, for future operating losses and cash funding
requirements projected for the remaining holding period through completion of
the disposition. For the three months ended March 31, 1998 and 1997, revenue of
VIE was $33,319,000 and $46,393,000, respectively. The net operating losses of
VIE were $19,306,000 and $15,199,000, respectively, for the same periods.
19
20
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
The net operating losses were provided for in the estimated loss on disposal as
of December 31, 1997 and 1996 discussed above.
OTHER FINANCING ITEMS. Viacom owns approximately 80% of the Company's common
stock. Pursuant to the separate credit facilities under which Viacom is a
borrower, certain subsidiaries of Viacom, including the Company, are restricted
from incurring indebtedness (other than indebtedness owing to Viacom) without
the prior consent of Viacom's lenders. Such consent has been given with respect
to the Credit Agreement and the UK Facility.
UNCERTAINTIES
The Company is subject to various lawsuits, claims and other legal matters in
the course of conducting its entertainment business operations. The Company
believes such lawsuits, claims and other legal matters should not have a
material adverse effect on the Company's consolidated results of operations or
financial condition.
The Company also is involved in a number of legal actions including threatened
claims, pending lawsuits and contract disputes in connection with certain
bankruptcy and environmental matters relating to the Company's discontinued
operations of Charter, as well as other matters. Some of the parties involved in
such actions seek significant damages. While the outcome of these suits and
claims cannot be predicted with certainty, based upon (i) its current knowledge
of the facts and circumstances and its understanding of the applicable law; (ii)
allowances for estimated losses on disposal of the discontinued operations; and
(iii) an indemnity agreement, the Company believes that the ultimate resolution
of such claims will not have a material adverse effect on the Company's
consolidated results of operations or financial condition.
20
21
SPELLING ENTERTAINMENT GROUP INC.
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11 Computation of net income per common share.
27 Financial Data Schedule.
(b) Reports on Form 8-K:
None
21
22
SPELLING ENTERTAINMENT GROUP INC.
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SPELLING ENTERTAINMENT GROUP INC.
May 14, 1998 By: /s/ Peter H. Bachmann
------------------------------------
Peter H. Bachmann
President
(Principal Executive Officer)
By: /s/ Ross G. Landsbaum
------------------------------------
Ross G. Landsbaum
Vice President, Finance and Business
Development and Treasurer
(Principal Financial Officer)
22