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, 1999 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: (323) 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 13, 1999, the registrant had outstanding 93,297,901 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, 1999 and December 31, 1998 (Unaudited) 3
Condensed Consolidated Statements of Operations --
Three Months Ended March 31, 1999 and 1998 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows --
Three Months Ended March 31, 1999 and 1998 (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
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 23
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 24
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
March 31, December 31,
1999 1998
--------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,199 $ 7,086
Accounts receivable, net 127,596 127,473
Entertainment product, net 228,588 252,600
Other current assets 3,607 4,256
--------- ---------
TOTAL CURRENT ASSETS 363,990 391,415
Accounts receivable, net 56,531 43,248
Entertainment product, net 145,533 145,556
Property and equipment, net 12,626 10,875
Intangible assets, net 180,463 181,835
Other non-current assets 20 20
--------- ---------
$ 759,163 $ 772,949
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable, accrued expenses and
other liabilities $ 40,532 $ 52,389
Accrued participation expense 80,934 78,252
Deferred revenue 18,888 29,990
Income and other taxes 5,881 5,940
--------- ---------
TOTAL CURRENT LIABILITIES 146,235 166,571
Accrued participation expense 44,649 41,572
Long-term debt payable to Viacom 231,000 239,930
Deferred income and other taxes 32,649 24,546
Net liabilities related to discontinued operations 28,260 29,123
--------- ---------
482,793 501,742
--------- ---------
Commitments and contingent liabilities
SHAREHOLDERS' EQUITY
Preferred Stock -- --
Common Stock, $.001 par value,
- 300,000,000 shares authorized
- 93,165,554 and 92,995,756 shares issued and
outstanding 93 93
Capital in excess of par value 594,197 592,298
Accumulated deficit (317,439) (320,663)
Accumulated other comprehensive income (481) (521)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 276,370 271,207
--------- ---------
$ 759,163 $ 772,949
========= =========
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,
----------------------------
1999 1998
--------- ---------
Revenue $ 184,955 $ 167,425
Gain on sale of TeleUNO 543 --
Costs and expenses:
Entertainment product costs 155,763 123,970
Selling, general and administrative 12,952 13,286
Provision for closure of film division -- 20,000
--------- ---------
Operating income 16,783 10,169
Interest income 232 443
Interest expense, net (4,512) (5,444)
Other, net (28) (49)
--------- ---------
Income from continuing operations
before income taxes 12,475 5,119
Provision for income taxes 9,251 3,505
--------- ---------
Net income $ 3,224 $ 1,614
========= =========
Weighted average number of common shares:
Basic 93,028 91,740
Diluted 93,217 92,723
Net income per common share:
Basic $ 0.03 $ 0.02
Diluted $ 0.03 $ 0.02
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,
----------------------------
1999 1998
---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,224 $ 1,614
Adjustments to reconcile net income to cash flows
from continuing operations:
Depreciation and amortization 2,545 2,349
Provision for closure of film division -- 20,000
Amortization of entertainment product costs 130,891 103,683
Additions to entertainment product costs (110,704) (102,783)
Gain on Sale of TeleUNO (543) --
Increase in accounts receivable (13,406) (24,210)
(Decrease) increase in accounts payable, accrued
expense, other liabilities and income taxes (492) 2,842
Increase in accrued participation expense 6,181 8,369
(Decrease) increase in deferred revenue (11,102) 6,793
Other, net 1,490 (538)
--------- ---------
Net cash provided by continuing operations 8,084 18,119
Net cash provided by discontinued operations -- 7,331
--------- ---------
8,084 25,450
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (2,948) (323)
Repayments by discontinued operations of VIE -- 6,892
Changes in net liabilities related to
discontinued operations (863) (940)
--------- ---------
Net cash (used) provided by continuing operations (3,811) 5,629
Net cash used by discontinued operations -- (221)
--------- ---------
(3,811) 5,408
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under credit facilities 19,000 16,000
Repayments of credit facilities (27,930) (43,000)
Issuances of Common Stock 1,770 9,838
--------- ---------
Net cash used by continuing operations (7,160) (17,162)
Net cash used by discontinued operations -- (8,316)
--------- ---------
(7,160) (25,478)
--------- ---------
Net (decrease) increase in cash and cash
equivalents (2,887) 5,380
Cash and cash equivalents at beginning of
period 7,086 10,113
--------- ---------
Cash and cash equivalents at end of period $ 4,199 $ 15,493
========= =========
Cash and cash equivalents at end of period:
Continuing operations $ 4,199 $ 7,446
Discontinued operations -- 8,047
--------- ---------
$ 4,199 $ 15,493
========= =========
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.
2. BUSINESS COMBINATIONS, ACQUISITIONS AND DISPOSITIONS
As of March 31, 1999, Viacom Inc. ("Viacom") owned approximately 80% of the
Company's common stock ("Common Stock"). On March 19, 1999, Viacom submitted a
proposal to the Company's Board of Directors (the "Board") to acquire all
outstanding shares of the Company not already held by Viacom. The Board formed a
Special Committee of independent directors to review Viacom's proposal. The
Special Committee has retained legal and financial advisors to assist in its
review of the proposal. See Note 11 regarding a definitive merger agreement and
the forthcoming commencement of a tender offer.
In February 1998, the Company announced its intention to exit the theatrical
feature film business and close Spelling Films Inc. ("Spelling Films"), and in
September 1998, the Company entered into a seven-year licensing agreement with
Artisan Home Entertainment, Inc. ("Artisan") covering the domestic and Canadian
home video and digital video disc ("DVD") distribution rights to approximately
3,000 titles in the Company's library resulting in the closure of its domestic
home video distribution business. Accordingly, in 1998 the Company recorded
charges of $20,000,000 and $3,995,000, respectively, to exit the theatrical
feature film business and the domestic home video distribution business. As of
March 31, 1999, the Company had a reserve relating to the shut-down of these
business units of $2,071,000 which is included in accounts payable, accrued
expenses and other liabilities in the accompanying balance sheet.
In April 1998, the Company sold TeleUNO, its Latin American entertainment
channel. The Company recognized a gain of $7,030,000 from this transaction in
the quarter ended June 30, 1998. In the first quarter of 1999, the Company
recognized an additional gain of $543,000 relating to a contractual contingent
payment received in connection with the sale of TeleUNO.
See Note 10 regarding the disposition of Virgin Interactive Entertainment
Limited ("VIEL," together with its subsidiaries, "VIE").
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
3. ENTERTAINMENT PRODUCT, NET
Current and noncurrent 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. 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 or, for new television product, generally as the episodes are
delivered.
Entertainment product, net, is comprised of the following:
March 31, December 31,
1999 1998
--------- -----------
Entertainment product:
Television
Released $ 228,439 $ 231,366
In process and other 34,832 43,560
--------- ---------
263,271 274,926
--------- ---------
Theatrical
Released 109,109 121,595
In process and other 1,741 1,635
--------- ---------
110,850 123,230
--------- ---------
Total 374,121 398,156
Less: non-current portion (145,533) (145,556)
--------- ---------
Current portion $ 228,588 $ 252,600
========= =========
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
4. DEBT
On September 30, 1996, the Company and Viacom executed a credit agreement (the
"Viacom Credit Agreement"), which 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, 2000.
Under the Viacom Credit Agreement, the Company pays an annual fee (currently
0.2375%) based on the unused portion of the facility, as well as certain
facility and administration fees. Effective October 1, 1998, 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, 1999 and
December 31, 1998, on borrowings under the Viacom Credit Agreement, was 7.5% and
5.9%, 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, 1999, the carrying value
of all of the Company's debt approximated fair value.
5. 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, 1998 $ 93 $ 592,298 $(320,663) $ (521) $ 271,207
Exercise of options and warrants -- 1,770 -- -- 1,770
Income tax benefit
related to stock options -- 129 -- -- 129
Net income for the period -- -- 3,224 -- 3,224
Unrealized holding gain, net -- -- -- 11 11
Cumulative translation adjustment -- -- -- 29 29
----- --------- --------- ------- ---------
Balance at March 31, 1999 $ 93 $ 594,197 $(317,439) $ (481) $ 276,370
===== ========= ========= ======= =========
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
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.
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," effective
January 1, 1998. Total comprehensive income for the quarters ended March 31,
1999 and 1998 was $3,264,000 and $3,696,000, respectively. Total comprehensive
income is comprised of net income and other comprehensive income items,
including foreign currency translation adjustments and unrealized holding gains
on securities.
6. INCOME TAXES
Income taxes have been provided in each period based on the Company's expected
effective income tax rate.
As of March 31, 1999, Viacom owned 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
remains in the same tax position as if it continued 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. Furthermore, the majority of the amount reported as income taxes
represents amounts that are ultimately payable to or receivable from Viacom
pursuant to the Tax Agreement. (See Note 11.)
7. 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 only in periods when the effect of such conversions would have been
dilutive to income from continuing operations.
The table below presents a reconciliation of weighted average shares used in the
calculation of basic and diluted income per common share:
March 31,
1999 1998
------ ------
Basic shares -- weighted average
of common shares outstanding 93,028 91,740
Additional shares assuming conversions
of stock options and warrants 189 983
------ ------
Diluted shares 93,217 92,723
====== ======
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
8. 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.
In March 1999, individual shareholders of the Company, including Crandon Capital
Partners, Jim Giannone, Emil Gold, The Great Neck Capital Appreciation
Investment Partnership, L.P., Richard D. Greenfield, Fred T. Isquith, Patty
Lisa, Harold A. Meyerson and Suzanne P. Goodman, Gaile Pisnoy, and Muriel
Winicki, in Delaware; and Howard Gunty Profit Sharing Plan and Deidra Graulich,
in California, filed lawsuits in the Court of Chancery for the State of
Delaware and in the Superior Court of the State of California against the
Company and certain officers and directors of the Company with respect to
Viacom's proposal to acquire all outstanding shares of the Company that it
does not already own (the "Merger").
The lawsuits purport to be class actions on behalf of all persons who hold
securities of the Company (except the defendants and their affiliates). The
lawsuits make allegations as to various violations of fiduciary duty by the
Company, its directors and Viacom including, among other things, that the per
share price to be offered to the Company's public stockholders pursuant to the
Merger is inadequate and that the Company failed to take adequate steps to
determine and disclose the fair value of the Company's publicly held shares.
Plaintiffs seek injunctive relief, recission, damages, costs (including
attorneys' and experts' fees) and other equitable relief. Settlement
negotiations are currently being held. Regardless of the outcome of these
negotiations, the Company believes such lawsuits will not have a material
adverse effect on the Company's results of operations or financial condition.
9. RELATED PARTY TRANSACTIONS
The Company was charged interest and fees by Viacom of $4,469,000 and $5,873,000
during the three months ended March 31, 1999 and 1998, respectively, in
connection with the Viacom Credit Agreement. Included in accounts payable,
accrued expenses and other liabilities is accrued interest payable to Viacom of
$3,603,000 and $882,000 as of March 31, 1999 and December 31, 1998,
respectively. (See Note 4 regarding the Company's credit facilities with Viacom
and Note 10 regarding Viacom's guarantees of the Company's credit agreements
with banks.)
The Company participates in certain Viacom health and welfare benefit plans for
its employees. In addition, the Company participates in Viacom insurance
programs with respect to general business and workers' compensation coverage.
Included in accounts payable, accrued expenses and other liabilities is a net
payable to Viacom of $4,251,000 and $3,495,000 as of March 31, 1999 and December
31, 1998, 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)
During the three months ended March 31, 1999 and 1998, 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) United Paramount Network, Nickelodeon U.K. and Comedy Central, in
which Viacom has equity interests and (ii) Showtime Networks Inc. ("Showtime"),
a subsidiary of Viacom; (iii) MTV Networks, a division of a subsidiary of
Viacom; and (iv) certain television stations owned by Viacom. For the three
months ended March 31, 1999 and 1998, the net impact of these transactions was
not material.
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 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)
10. DISCONTINUED OPERATIONS
On February 20, 1997, the Company announced its intention to dispose of its
interactive game business, VIE. On September 4, 1998, the Company completed the
sale of the stock of Westwood Studios, Inc., a subsidiary of VIE, and certain
development assets of VIE for $122,500,000 in cash. The proceeds of this
transaction were used to pay down bank debt and other costs associated with the
transaction. On November 10, 1998, the Company completed the sale of all
non-U.S. operations of VIE, effectively completing the disposal of its
interactive game business. The Company expects to shut-down the remaining VIE
operations in 1999. Accordingly, the operations of VIE are reflected as
discontinued.
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 and an
impairment loss of $74,000,000 with respect to the carrying value of goodwill
associated with that business. 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. In 1998, the Company
recorded an additional provision of $16,250,000, net of a $8,750,000 currently
realizable income tax benefit, to provide for the remaining costs of shut-down.
For the three months ended March 31, 1998, revenue of VIE was $33,319,000. The
net operating loss of VIE was $19,306,000 for the same period. The net operating
loss was provided for in the estimated loss on disposal as of December 31, 1997
and 1996 discussed above.
Included in net liabilities related to discontinued operations is a reserve
related to discontinued operations of VIE of $28,773,000 and $28,673,000 as of
March 31, 1999 and December 31, 1998, respectively.
A wholly owned subsidiary of VIE had a multi-currency credit agreement with a
bank in the U.S. (the "Credit agreement") which was due to expire on September
30, 1998. On September 8, 1998, total borrowings under the Credit Agreement in
the amount of $97,000,000 were repaid and the Credit agreement was terminated.
Another wholly owned subsidiary of VIE had a 10,000,000 pounds sterling credit
facility (the "UK Facility") with a bank in the United Kingdom which was due to
expire on December 31, 1998 and was guaranteed by Viacom and the Company. On
November 10, 1998, total borrowings under the UK Facility were repaid and the UK
Facility was terminated. The Company and Viacom provide a rent guarantee for
this subsidiary which expires in 2005.
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 had been given with respect to
the Credit Agreement and the UK Facility.
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SPELLING ENTERTAINMENT GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(000's omitted in all tables)
(Continued)
11. SUBSEQUENT EVENT
On May 17, 1999 Viacom and the Company announced that they have entered into a
definitive merger agreement for the purchase by Viacom of the shares of Spelling
Common Stock that it does not already own, approximately 20%, for $9.75 per
share in cash. The Company's Board of Directors approved the merger agreement
after approval by a Special Committee of independent directors, which was
advised by separate legal and financial advisors. The merger agreement provides
for the commencement of a tender offer by Viacom on May 21, 1999. Under the
terms of the merger agreement, each Spelling share that is not purchased in the
offer will be acquired by merger as soon as practical thereafter in a
second-step merger, also for $9.75 per share.
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SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 2.
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; the number of series being produced by the
Company during a given period; and the volume, public acceptance and production
costs associated with the Company's new television product. 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. Due to the aforementioned factors and those discussed below, the
Company's net income is generally negatively impacted in the fourth quarter each
year.
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, domestic network and
international license fees offset a substantial portion of the production costs
of the series, and accordingly the Company normally recognizes a loss during
this period. With respect to half-hour domestic network programming, the
production costs can substantially exceed the combination of the domestic
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 have continued international sales, 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, a series may generate significant revenue which may be realized
by the Company through its future cash license fees and barter arrangements.
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 that they broadcast, and increasingly compete with
the Company in the production and distribution of
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SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
programming. The Telecommunications Act of 1996 eliminated the restrictions on
the number of television stations that one entity may own and increased the
national audience reach limitation by one entity from 25% to 35%, which served
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):
1999 1998
-------- --------
Television $168,452 $148,803
Licensing and merchandising 7,770 3,527
Non-television distribution 7,102 13,538
Other 1,631 1,557
-------- --------
$184,955 $167,425
======== ========
Television revenue increased $19,649,000 (13%) in the three-month period ended
March 31, 1999, from the comparable period in 1998. The increase in the 1999
period resulted primarily from (i) higher per episode network license fees for
the Company's continuing series; (ii) increased hours of programming delivered
to the networks; and (iii) improved performance of the Company's first-run
syndication series, including "Judge Judy." These increases were partially
offset by reduced revenue from the exploitation of the Company's library during
the reporting period.
Licensing and merchandising revenue increased $4,243,000 (120%) in the
three-month period ended March 31, 1999 compared to the same period in 1998. The
increase is due primarily to increased revenues from third-party clients,
particularly relating to merchandising and licensing agreements with Comedy
Partners for the show "South Park." (See Note 9.)
Non-television distribution revenue represents revenue generated from the
distribution of entertainment product in the home video and theatrical markets.
Such revenue decreased $6,436,000 (48%) in the three-month period ended March
31, 1999 from the same period in 1998. This decrease is primarily due to the
closure in February 1998 of Spelling Films and the Company's decision to exit
the business of distributing home video titles in the domestic market.
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SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Other revenue remained consistent in the three months ended March 31, 1999
compared to the same period in 1998.
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 and Canadian dollars, among others. The Company has
no material transactions denominated in Asian currencies.
GAIN ON SALE OF TELEUNO
In April 1998, the Company sold TeleUNO, its Latin American entertainment
channel. The Company recognized a gain of $7,030,000 in the quarter ended June
30, 1998, relating to the sale. In the first quarter of 1999, the Company
recognized an additional gain of $543,000 relating to a contractual contingent
payment received in connection with the sale of TeleUNO.
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 increased $31,793,000 (26%) in the quarter ended March 31, 1999, from the
comparable prior-year period. The increase resulted primarily from an increase
in the percentage relationship between such costs and the related revenue to 84%
from 74% for the three months ended March 31, 1999 and 1998, respectively. This
percentage relationship is a function of (i) the mix of entertainment product
generating the revenue in each period; (ii) changes in the projected
profitability of individual entertainment product based on the Company's
estimates of such product's ultimate revenue and costs; and (iii) the
recognition of deficits associated with new television production.
Included in entertainment product costs above were write-downs to net realizable
value with respect to television product of $7,416,000 and $4,348,000 in the
quarters ended March 31, 1999 and 1998, respectively. The increase in the
current period is primarily attributable to deficits associated with increased
production levels for new television product. Also, write-downs to net
realizable value of $3,023,000 and $4,503,000 were recorded in the quarters
ended March 31, 1999 and 1998, respectively, related to theatrical and
made-for-video feature films.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative costs decreased $334,000 (3%) in the quarter
ended March 31, 1999 from the comparable prior-year period. The decrease is due
primarily to the Company's exit from the home video and theatrical feature film
businesses in 1998, offset by higher costs associated with the Company's year
2000 remediation efforts.
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SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
PROVISION FOR CLOSURE OF FILM AND VIDEO DIVISIONS
In February 1998, the Company announced its intention to exit the theatrical
feature film business and close Spelling Films Inc. ("Spelling Films"), and in
September 1998, the Company entered into a seven-year licensing agreement with
Artisan Home Entertainment, Inc. ("Artisan") covering the domestic and Canadian
home video and DVD distribution rights to approximately 3,000 titles in the
Company's library resulting in the closure of its domestic home video business.
Accordingly, in 1998 the Company recorded charges of $20,000,000 and $3,995,000,
respectively, to exit the theatrical feature film business and the domestic home
video distribution business. As of March 31, 1999, the Company had a reserve
relating to the shut-down of these business units of $2,071,000 which is
included in accounts payable, accrued expenses and other liabilities in the
accompanying balance sheet.
INTEREST EXPENSE
Interest expense decreased $932,000 (17%) in the three-month period ended March
31, 1999 from the comparable prior-year period due to (i) a decrease in the
weighted average interest rate and (ii) lower average indebtedness outstanding
under the Company's credit arrangements.
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SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
PROVISION FOR INCOME TAXES
For the three months ended March 31, 1999, the Company's provision for income
taxes increased $5,746,000 to a provision of $9,251,000 in 1999 as compared to a
provision of $3,505,000 in 1998, largely as a result of an increase in the
effective tax rate. The effective tax rate increased to 74% in 1999 from 68% in
1998, largely as a result of changes in the relationship between revenue and
expenses comprising income from continuing operations before income taxes.
As of March 31, 1999, Viacom owned approximately 80% of the outstanding shares
of the Company. 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. Under the Tax Agreement, the Company remains in the same
tax position as if it continued 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. Furthermore, the
majority of the amount reported as income taxes represents amounts that are
ultimately payable to or receivable from Viacom pursuant to the Tax Agreement.
DISCONTINUED OPERATIONS
The financial position of the discontinued operations of VIE and Charter are
included in the balance sheets under the caption "Net Liabilities Related To
Discontinued Operations" as of March 31, 1999 and December 31, 1998. On February
20, 1997, the Company announced its intention to dispose of its interactive game
business, VIE. On September 4, 1998, the Company completed the sale of the stock
of Westwood Studios, Inc., a subsidiary of VIE, and certain development assets
of VIE for $122,500,000 in cash. The proceeds of this transaction were used to
pay down bank debt and other costs associated with the transaction. On November
10, 1998, the Company completed the sale of all non-U.S. operations of VIE,
effectively completing the disposal of its interactive game business. The
Company expects to shut-down the remaining VIE operations in 1999.
FINANCIAL CONDITION
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 $110,704,000 and $102,783,000 in the three
months ended March 31, 1999 and 1998, respectively.
The cost of producing network television programming is borne by the Company to
the extent costs are not recouped through network license fees and cash receipts
from both cash and barter licensing arrangements on syndicated product.
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 4.)
18
19
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
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 funds 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 4
regarding certain acceleration provisions of the Viacom Facility.)
Net cash flow from operating activities of the Company's continuing operations
decreased to $8,084,000 for the three months ended March 31, 1999 from
$18,119,000 for the comparable prior-year period primarily due to increased
entertainment product costs. Net cash flow from investing activities of the
Company's continuing operations decreased to $(3,811,000) from $5,629,000 for
the three months ended March 31, 1999 and 1998, respectively. The decrease in
the 1999 period is primarily due to the wind-down of business activity of VIE,
as well as increased expenditures in conjunction with the Company's year 2000
remediation efforts. 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. At March 31, 1999,
$124,000,000 was available under the Credit Agreement to fund the Company's
operations and investments. (See Note 4.)
As of March 31, 1999, 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.
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.
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20
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
YEAR 2000
OVERVIEW
The widespread use of computer programs that rely on two-digit dates to perform
computations and decision making functions may cause computer systems to
malfunction prior to or in the year 2000 ("Y2K") and lead to significant
business delays and disruptions in the U.S. and internationally. The Company
started its Y2K initiative in December 1997 by developing a program to identify
and mitigate Y2K risks. External consulting firms and contractors have been
engaged by the Company to assist with Y2K remediation. At present it is
anticipated that the Company will complete its program to have substantially all
critical and non-critical systems compliant prior to the end of the third
quarter of 1999.
The Company is reviewing its Y2K issues based upon three areas: applications,
infrastructure and business partners.
- - The applications cover the software systems resident on mid-range, network
and desktop computers. The Company defines an application as a collection
of programs directly related to a common system. For example, a financial
application can include all the general ledger and accounts receivable
software code used to process information throughout an operating segment.
In addition, the Company's applications have been segregated into critical
and non-critical applications. Critical applications are software systems
which, if not operational, would have a material impact on business
operations.
- - Infrastructure includes the computers, data and voice communications
networks, and other equipment which use embedded chip processors (e.g.,
film projectors, tape duplication equipment, inventory movement systems,
etc.).
- - The business partners include third-party vendors, customers and public
entities whose systems may interface with the Company or whose own
operations are important to the Company's daily operations.
These three areas have been addressed using a five-phase program: inventory,
assessment, remediation, testing and contingency planning.
- - Phase 1 inventories the respective applications, hardware and business
partners.
- - Phase 2 involves assessing the Y2K effects concerning each application,
hardware systems or business partner relationship; and subsequently
determining the risk to operations and assigning priorities.
- - Phase 3 establishes and implements specific plans for the remediation of
applications and hardware systems and for the determination of business
partners' compliance.
- - Phase 4 tests each application and hardware system and reviews business
partners' compliance under the plans established in Phase 3, to ensure that
Y2K issues no longer exist.
- - Phase 5 covers the development of contingency plans in the event internal
or external systems are not compliant.
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21
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
Changes may occur to the Company's operations during the implementation of its
Y2K program or subsequent to the completion of each phase; therefore, management
may periodically revise its plans. The Company continues to review and test
systems for Y2K compliance as changes occur.
STATE OF READINESS
The Company's Y2K progress as of April 30, 1999 is as follows:
APPLICATIONS
The inventory and assessment phases for the Company have been completed. The
critical applications for accounting, rights management and payroll have been
remediated. All critical milestones have been met. The critical applications for
domestic and non-domestic banking operations have been remediated and testing is
currently scheduled to be completed in the second quarter.
INFRASTRUCTURE
The inventory and assessment phases for computer systems have been completed.
The inventory and assessment of the remaining non-computer domestic systems
(e.g., telecommunications equipment) will be completed by the second quarter of
1999. The remediation and testing of all critical equipment is more than 90%
complete and is expected to be completed in the third quarter of 1999.
BUSINESS PARTNERS
During the course of business operations, the Company relies on third-party
business partners to provide goods and services to the Company, and to
distribute and to sell the Company's products. These business partners also
include public utilities, governmental agencies and financial institutions. The
disruption of receiving goods or services, or distributing and selling the
Company's products could adversely affect the financial condition of the
Company. Although the Company has little or no control over the remediation and
testing of these third-party systems, the Company is taking action in an effort
to determine the level of Y2K compliance at each third-party operation. These
actions may include, but are not limited to, requesting written confirmation of
a business or business system's Y2K compliance; directly meeting with a
business' management; and, performing additional independent tests. Subsequent
to the Company's review of third-party Y2K compliance, management is determining
the need for contingency plans.
The Company has completed approximately 90% of the inventory and assessment
phases of business partners and expects to be completed by the end of the second
quarter of 1999. The determination of third-party Y2K compliance will continue
through the end of the year.
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22
SPELLING ENTERTAINMENT GROUP INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
CONTINGENCY PLANS
As the remediation, testing and review of each application, infrastructure item
and business partner occurs, the Company is determining the need for contingency
plans. Where appropriate, plans addressing both operational and technical
requirements and alternatives are being developed. This phase will continue
through the end of 1999.
COSTS
Y2K costs have been expensed as incurred, except those directly related to the
replacement of non-compliant systems which have been capitalized. As of March
31, 1999, the Company had incurred costs of approximately $1,857,000 of which
$959,000 has been capitalized. The estimated additional costs to complete the
Y2K program are currently expected to approximate $1,031,000 of which
approximately $175,000 is expected to be capitalized. Based on these amounts,
the Company does not expect the costs of its Y2K program to have a material
effect on its results of operations, financial position or liquidity.
RISKS
The Company's goal is to achieve timely and substantial Y2K compliance, with
remediation work assigned based upon how critical each system is to the
Company's business. In addition, the Company's international operations may be
adversely affected by failures of businesses in other parts of the world to take
adequate steps to address the Y2K problem. Due to the general uncertainty
inherent in the Y2K problem resulting in part from the uncertainty of compliance
by the Company's principal business partners and third-party providers, the
Company is unable to determine at this time what the consequences of Y2K may be.
The Company will continue to devote the necessary resources to complete its Y2K
program and contingency plans and believes that the completion of its Y2K
program and contingency plans should significantly mitigate operational and
financial risks.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Not applicable.
23
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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
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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 17, 1999 By: /s/ Peter H. Bachmann
-----------------------------------
Peter H. Bachmann
President
(Principal Executive Officer)
By: /s/ Ross G. Landsbaum
-----------------------------------
Ross G. Landsbaum
Senior Vice President --
Chief Financial Offer
(Principal Financial Officer)
25